NEWS

By William C. Rooklidge

Mr. Rooklidge, a partner at Jones Day in Irvine, Calif., practices intellectual property litigation and related counseling, focusing on patent infringement trial and appellate litigation. He thanks Hon. Martha Gooding, Blake Inglish and Mary Woodford for their helpful criticisms and suggestions on drafts of this article. The views expressed in this paper should not be attributed to those reviewers, Jones Day, any of its lawyers or clients, or anyone else.

“A royalty based on 'profit’ … is an open invitation to a continuing dispute.”¹

The Federal Circuit recently characterized the award of infringer's profits to a patentee as an “antiquated damages regime.”² Indeed, almost 70 years ago, Congress eliminated the infringer's profits as a remedy for utility patent infringement, leaving the patentee with damages sufficient to compensate for “use made of the invention by the infringer.” The principal reasons for making this change were the difficulty in apportioning between the profits properly awardable to the patentee for the infringer's use of the invention and the profits attributable to the infringer's contributions,³ and to avoid patentees obtaining windfall recoveries where apportionment could not be performed.⁴

At the same time it eliminated the remedy of infringer's profits, Congress placed a floor on the patentee's damages of “no less than a reasonable royalty.”⁵ Now, almost 70 years later, although the predominant patent damages reasonable royalty analysis is the hypothetical negotiation, damages experts in patent infringement cases are advocating basing reasonable royalty awards on the “residual” or other portion of the accused infringer's profit (anticipated or actual) under the so-called “analytical method.” What is more, courts, including the Federal Circuit, have allowed such testimony without any analysis of the hypothetical negotiation.

This paper reviews the historical development of and the current case law on the use of infringer's profits in reasonable royalty analyses and concludes that the analytical method, as articulated by the Federal Circuit, was developed in error, is an arbitrary rule of thumb that in most circumstances bears no relation to the value of the patentee's loss from the infringing use, and in some circumstances has turned into a mere proxy for the infringer's apportioned profits, which Congress long ago rejected as a utility patent infringement remedy. As a result, “analytical method” damages testimony not only can provide patentees with the very “windfall recoveries” Congress sought to avoid in eliminating the infringer's profit as a utility patent infringement remedy, but also can result in compensating patentees for far more than “the use made of the invention.”⁶

The Relevance of Infringer's Profits to Reasonable Royalty Patent Damages

Identifying the relevance of infringer's profits to the reasonable royalty remedy requires a brief review of the development of patent infringement damages remedies. In the Patent Act of 1790, Congress provided for an award of damages in an action at law, and in the Patent Act of 1836 Congress added the remedy of an award of the infringer's profits in an action in equity.⁷ In practice, however, the latter remedy was difficult to prove,⁸ so in 1870 Congress authorized the court in equity to award both the infringer's profits and compensatory damages,⁹ which the courts construed as authorizing an award of damages only insofar as “the injury sustained by the infringement is plainly greater than the aggregate of what was made by the [infringer.]”¹⁰

Because courts limited patentees to that portion of the infringer's profits which the patentee could prove attributable to the patented feature,¹¹ through a process known as “apportionment,”¹² patentees continued to face difficulty in proving the amount of the infringers' profits, and they often found themselves relegated to an award of nominal damages. To ameliorate the harsh effect on patentees who could not prove either an established royalty rate or lost profits, the courts developed the reasonable royalty analysis, which the Supreme Court first sanctioned by that name in 1915¹³ and which Congress then grafted onto the patent damages statute in 1922.¹⁴

In 1946, Congress both required that the patentee recover at least a reasonable royalty and eliminated from the patent damages statute reference to the award of infringer's profits.¹⁵ Because neither the language nor the legislative history of the subsequent “codification” of the patent statute in 1952 reflected the continued availability of infringer's damages, the circuits and district courts subsequently expressed confusion over whether they could continue to award a patentee damages in the amount of the infringer's profits, with some continuing to do so despite Congress's apparent elimination of that remedy from the statute.¹⁶ The Supreme Court eliminated that confusion in its 1964 opinion in Aro Manufacturing Co. v. Convertible Top Replacement Co. by holding that under the 1952 Act the patentee could not recover the infringer's profits “as such.”¹⁷

In patent nomenclature what the infringer makes is “profits”; what the owner of the patent loses by such infringement is “damages.” Profits and damages have traditionally been all-inclusive as the two basic elements of recovery. Prior to 1946, the statutory precursor of the present §284 allowed recovery of both amounts … . By the 1946 amendment, … the statute was changed to approximately its present form, whereby only “damages” are recoverable. The purpose of the change was precisely to eliminate the recovery of profits as such and allow recovery of damages only… . There can be no doubt that the amendment succeeded in effectuating this purpose; it is clear that under the present statute only damages are recoverable.

…

But the present statutory rule is that only “damages” may be recovered. These have been defined by this Court as “compensation for the pecuniary loss [the patentee] has suffered from the infringement, without regard to the question whether the defendant has gained or lost by his unlawful acts.” They have been said to constitute “the difference between his pecuniary condition after the infringement, and what his condition would have been if the infringement had not occurred.” The question to be asked in determining damages is “how much had the Patent Holder and Licensee suffered by the infringement. And that question [is] primarily: had the infringer not infringed, what would the Patent Holder-Licensee have made?”¹⁸

 

That the patentee no longer can recover the infringer's profits “as such” does not mean that those profits are irrelevant to all reasonable royalty analyses or that the patentee's recovery cannot be a portion of the infringer's profits. Which form of the infringer's profit, if any, may be relevant, and how that profit may be relevant, however, depends on the analysis under which the reasonable royalty is determined.

Today, the reasonable royalty damages analysis most commonly takes the form of a “hypothetical negotiation” or “willing buyer-willing seller” methodology, in which the trier of fact determines what a willing licensee in the place of the infringer reasonably would have paid and what a willing licensor in the place of the patentee reasonably would have accepted for the grant of a license under the patent in suit, if such a license had been negotiated before the infringement began.¹⁹ This approach assumes that both parties reasonably wished to enter into a license and that both parties conducted the negotiation based on the understanding that the patent was valid, enforceable and infringed.²⁰

The first step in this analysis is to determine when the asserted infringement began, because the hypothetical license would have been negotiated before initiation of the infringing activity.²¹ Reasonable royalty damages are not based on a hindsight evaluation of what happened, but on what the parties to the hypothetical license negotiations would have agreed before the infringement began.²²

The second step in a hypothetical negotiation reasonable royalty analysis is to determine what royalty the parties to the hypothetical negotiation would have agreed upon as of the negotiation date. This requires determining not only the form of royalty the parties would have agreed upon--a single, lump sum license payment, for example, or a running royalty based on ongoing sales or usage--but also the amount of the royalty.²³

The hypothetical negotiation reasonable royalty analysis may consider a wide range of evidence, and some of the factors to which that evidence may relate are referred to as the Georgia-Pacific factors, after the district court opinion that set out the analytical framework.²⁴ They include a threshold factor and 13 evidentiary factors (plus a 15th “factor” that effectively restates the analytical framework), which the Georgia-Pacific trial court compiled from a “conspectus of the leading cases” and described as “seemingly more pertinent” to the issue.²⁵ These factors, however, are not exclusive.²⁶ Moreover, “there is no formula by which these factors can be rated precisely in the order of their relative importance or by which their economic significance can be automatically transduced into their pecuniary equivalent.”²⁷

The infringer's profits may be relevant to the Georgia-Pacific reasonable royalty hypothetical negotiation²⁸ in two ways.²⁹ But before addressing how infringer's profits may be relevant, it also is important to keep in mind how they are not relevant.

Georgia-Pacific Factor 8, “[t]he established profitability of the product made under the patent … ,”³⁰ does not refer to the infringer's profit, but instead is directed at the established profitability of the patentee's product, if the patentee does in fact sell a product.³¹ The patentee's product is that which is “made under the patent,” and its profitability is relevant because “the more popular and profitable the product sold by the [patentee] that is covered by the patent, the more the [infringer] would have paid to license that patent to use in its own product.”³²

The infringer's profit also is generally not relevant to Georgia-Pacific Factor 11, “The extent to which the infringer has made use of the invention; and any evidence probative of the value of that use.”³³ Factor 11 traditionally applies to facts such as the number of instances of the infringer's use of the patented invention, the portion of the infringer's sales that implement the patented invention, as well as any direct evidence of the value of that use in ways other than profit directly attributable to the infringing use.³⁴ In rare instances where the patented feature creates the customer demand for the infringing product or service, as in the Georgia-Pacific case itself, Factor 13 allows the infringer's profit to provide evidence of the value of the infringer's use of the patented invention.

The first way in which the infringer's profit may be relevant to the hypothetical negotiation is through Georgia-Pacific Factor 12, “the portion of profit that may be customarily allowed in the particular business for the use of the invention or similar inventions.”³⁵ In view of the Federal Circuit's focus on tethering the damages to the facts and circumstances of the present case as opposed to industry data,³⁶ analysis of the infringer's profit under this factor should become relevant only where one or both of the parties to the hypothetical negotiation has entered into a patent license agreement in which a patent has been licensed in exchange for a royalty calculated as a portion of the infringer's profit.³⁷ And while such circumstances are relatively rare because of the practical difficulties caused by licensing based on a percentage of the licensee's profits,³⁸ they do occur, most commonly in the pharmaceutical and medical devices fields.³⁹

The second way in which the infringer's profits may be relevant to the hypothetical negotiation is through Georgia-Pacific Factor 13, “[t]he portion of the realizable profit that should be credited to the invention as distinguished from non-patented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer.”⁴⁰ This factor, the infringer's apportioned profit, should sound familiar: it is the very measure of damages that Congress eliminated in 1946. Then why did the Georgia-Pacific opinion--issued six years after the Aro Court held that the infringer's apportioned profit was not an available utility patent infringement remedy--include it in the list of factors considered in the hypothetical negotiation? The answer lies in Factor 15.

Factor 15 is not a factor at all, but a restatement of the analytical construct in which the factors are applied: it references the hypothetical negotiation taking place between “a licensor (such as the patentee) and a licensee (such as the infringer)” and characterizes the reasonable royalty as an amount that “a prudent licensee--who desired, as a business proposition, to obtain a license to manufacture and sell a particular article embodying the patented invention--would have been willing to pay as a royalty and yet be able to make a reasonable profit … .”⁴¹ The Georgia-Pacific opinion identifies as one of the circumstances the parties to the hypothetical negotiation would consider the “anticipated amount of net profits that the prospective licensee reasonably thinks he will make,”⁴² and explains that the suppositious licensee sitting at the hypothetical negotiating table in the place of accused infringer would expect to make a reasonable profit from its anticipated use of the patented invention.⁴³ In other words, “a [hypothetically negotiated] reasonable royalty would leave [the suppositious licensee sitting in place of the] infringer with a reasonable profit.”⁴⁴

An infringer's actual profit margin may in limited circumstances be relevant to the determination of a royalty rate in a hypothetical negotiation.⁴⁵ In other words, the infringer's actual apportioned profits are not always relevant, but can be relevant under the “Book of Wisdom.”⁴⁶ As evidence of the apportioned profits the party sitting at the negotiation table would have expected to make from using the invention, evidence of the infringer's actual post-hypothetical negotiation apportioned profits can be relevant if the circumstances under which those profits were made were comparable to what the negotiation party would have foreseen.⁴⁷ That an infringer actually made unexpectedly low profits, or even lost money, from its infringing use may have little or no relevance, and a reasonable royalty may exceed the infringer's actual profit.⁴⁸ Therefore, the infringer's actual profits are properly considered as part of a hypothetical negotiation reasonable royalty analysis only when there were no pre-negotiation profit projections and the evidence reflects the state of mind of the parties to the hypothetical negotiation at the time of the negotiation and does not in itself “create value.”⁴⁹

One final caveat, to be relevant under Georgia-Pacific Factor 13, the infringer's profit must be apportioned to separate the profit attributable to the patented feature from that of all the other features and other bases for profit.⁵⁰ In other words, to be used in the reasonable royalty analysis, the infringer's profit must be apportioned.

The Analytical Method

In a case dealing with the hypothetical negotiation reasonable royalty, the Federal Circuit suggested in Lucent Technologies, Inc. v. Gateway, Inc. that there is a way to determine reasonable royalty patent infringement damages that is separate from the hypothetical negotiation approach.⁵¹ This approach, which the Court called the “analytical method,” “focuses on the infringer's projections of profit for the infringing product.”⁵²

The case cited as the wellspring of the “analytical method” is the Federal Circuit's 28-year old opinion in TWM Mfg. Co. v. Dura Corp.,⁵³ which affirmed a reasonable royalty damages award by a lower court that, in turn, had relied on Georgia-Pacific and Tektronix, Inc. v. United States.⁵⁴ As we shall see, the Federal Circuit's analysis in TWM, as well as the Court of Claims' analysis in Tektronix on which the TWM Court relied, are fundamentally flawed. The opinions that have applied the “analytical method” as a stand-alone alternative to the hypothetical negotiation damages calculation have misused the infringer's anticipated profits attributable to the patented feature in three ways, by: (1) ignoring that the infringer's anticipated profits properly serve only to cap the hypothetical negotiation reasonable royalty; (2) failing to apply anything approaching rigorous apportionment, the requirement of which led to Congress' rejection of the profits remedy in the first place; and (3) when using actual, instead of anticipated, profits under the Book of Wisdom, awarding those infringer's apportioned profits or a proxy even though that remedy long ago was rejected by Congress. These failings, however, become most apparent after reviewing the district court and appellate court opinions in Georgia-Pacific, as well as their progeny.

The Trial Court and the Second Circuit's Georgia-Pacific

The Georgia-Pacific district court reviewed the facts in the context of the framework established by its list of factors, and then “attempted to exercise a discriminating judgment reflecting its ultimate appraisal of all pertinent factors in the context of the credible evidence.”⁵⁵ According to the Court, particularly relevant facts included: the lack of an established royalty;⁵⁶ the patentee's policy to maintain a monopoly; the infringer's status as a competitor; the lack of competitive products (except the infringer's later product);⁵⁷ the popularity and profitability of the patentee's product, both by itself and from collateral sales;⁵⁸ the infringer's perception of the infringing product as highly profitable, both by itself and due to “substantial additional profits” from collateral sales;⁵⁹ and the patented invention contributing “substantially the entire value to the structure represented by the infringing article.”⁶⁰ Faced with no evidence of royalties in comparable circumstances,⁶¹ the district court relied on the testimony of the patentee's expert witnesses to find that the patentee's established profit was $48 per thousand square feet of product, that the infringer expected to profit from the infringing product “at least approximately the same rate” and to make more profit on the collateral sales, and that the reasonable royalty was $50 per thousand square feet of product. That royalty, the district court found, would have enabled the infringer “to realize a substantial profit,” even apart from its profit on collateral sales.⁶² The Georgia-Pacific district court hastened to point out, however, that its finding was “derived from a close factual analysis of the total record,” and to the extent the court relied on precedential guidance, the precedent was “subjected to the qualifications and modifications required by a realistic comparison of the particular facts and individual circumstances in the prior decisions and those in the case at bar.”⁶³

Perhaps more important than the analysis the district court did adopt was the analysis it did not adopt. The infringer had argued that it would have been willing to split evenly with the patentee what it estimated as its roughly $50 per thousand square feet expected profit from the sale of the product only (ignoring the profit on the collateral sales) and that negotiations would have led to agreement at the midpoint between the suppositious licensee's $25 initial position and the $50 that the patentee's experts testified the patentee would have found acceptable, for a final royalty rate of $37.50 per thousand square feet.⁶⁴ The district court rejected this testimony as being “at odds with the preponderant weight of the credible evidence.”⁶⁵ In other words, the trial court rejected the profit-split analysis and instead relied on an analysis heavily dependent on all the facts and circumstances as informed by the factors drawn from the case law.

On appeal, the Second Circuit parted ways with the district court on the effect of the unquantified profit on the collateral sales, and held that the trial court had erred by failing to apply the suppositious licensee's expected profit as a limitation because “the royalty imposed … gobbles up all of [the suppositious licensee's] expected profit.”⁶⁶ According to the appellate court, the trial court's “failure to quantify leaves us no recourse but to ignore profits on collateral sales or to assume that such profits were taken into account in arriving at the $50 figure for [the suppositious licensee's] reasonably expected profits”--and it chose the latter.⁶⁷ Because the error left the suppositious licensee with no profit, the appellate court subtracted the infringer's 9% actual “average net profit on sales of all products over the period of infringement” from the infringer's actual “average realization” to achieve a $35.65 royalty, and it reduced the trial court's award accordingly.⁶⁸ The Second Circuit properly considered evidence of the suppositious licensee's expected profit to fashion a cap on the reasonable royalty, that is, to fix the royalty “so as to leave the infringer, or suppositious licensee, a reasonable profit.”⁶⁹

The Court of Claims' Tektronix

In Tektronix, the seven-judge Court of Claims, sitting en banc, reviewed a trial judge's award of reasonable compensation for the Government's infringement of eight patents related to oscilloscopes.⁷⁰ The infringer argued in favor of a sliding-scale, established royalty based on the sales price of the scopes, relying on licensing practices of other companies in the “commercial electronics field.”⁷¹ The patentee sought lost profits for some of the infringing sales, and for the remainder contended that “compensation must be determined by adopting a reasonable royalty based on a willing-buyer/willing-seller concept as enunciated in Georgia-Pacific Corp. v. U.S. Plywood-Champion Papers, Inc.”⁷² The trial judge had concluded that “the best method of computing compensation in this case is to adopt the approach of establishing a reasonable royalty,” as “exemplified by the Georgia-Pacific case, … involv[ing] a willing-buyer/willing-seller concept, in which a suppositious meeting between the patent owner and the prospective manufacturer of the infringing item is held to negotiate a license agreement” for the accused products.⁷³ The appellate court explained:

The negotiation formula which the trial judge borrowed from Georgia-Pacific is, as already mentioned, to start with the infringer's selling price, deduct its costs in order to find its gross profit, then allocate to the infringer its normal profit, and end up with the residual share of the gross profit which can be assigned to the patentee as its royalty.⁷⁴

 

In other words, the Tektronix trial court skipped the Georgia-Pacific trial court's multi-factor reasonable royalty analysis and proceeded straight to the Georgia-Pacific appellate court's application of the limit on that reasonable royalty as the “beginning of [its] suppositious negotiation,” and used that limit to set the residual profit as the reasonable royalty. Like others that would follow,⁷⁵ the Tektronix trial court failed to recognize that the Georgia-Pacific appellate court's analysis did not supplant that of the trial court, but instead modified the trial court's analysis by applying a cap.

And the Tektronix trial court made another error: It made no finding that the patented features, like the grooves in the infringing plywood in Georgia-Pacific, gave the infringing oscilloscopes their “entire value.” Without that finding, the “residual share” of the profit could and likely did contain profit attributable not to the patented features, but to “non-patented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer.”⁷⁶ That was error because “the contribution of any particular patent or feature should be considered in the context of the often vast patent landscape that is relevant to the product as well as the contribution of the other product features.”⁷⁷

The Tektronix appellate court accepted the trial court's general approach, but modified the calculation in two respects. First, it concluded that the trial court's calculation understated the infringer's manufacturing costs and therefore inflated what it called the infringer's “residual share.”⁷⁸ Second, after correcting the residual share to 7.65% of the unit price, the Court concluded that, on the facts before it, a reasonable patentee would have insisted upon (and a reasonable licensee would have been willing to pay) a royalty somewhat higher than the 7.65% residual profit.⁷⁹ Accordingly, the Tektronix appellate court found 10% to be the proper royalty rate, noting that that rate represented its best judgment of “what the parties would have agreed upon, if both were reasonably trying to reach an agreement.”⁸⁰ In short, the Tektronix appellate court doubled down on the trial court's errors, not only by using the residual profit as a basis for the reasonable royalty calculation itself, but by imposing a reasonable royalty rate even higher than the residual profit, so that the infringer was left with less than a reasonable profit.

The Federal Circuit’s TWM v. Dura

In TWM v. Dura, the Federal Circuit affirmed a patent infringement damages award that had been crafted by a magistrate sitting as a special master and then adopted in its entirety by the district court.⁸¹ The award included amounts for lost profits, a reasonable royalty (for sales where lost profits could not be proven), price erosion and enhanced damages.⁸² Then-Chief Judge Markey noted that, “[f]or the years TWM could not establish its lost profits, [the parties] agreed that the district court should determine a reasonable royalty based on a 'hypothetical royalty resulting from arm's length negotiations between a willing licensor and a willing licensee.’”⁸³ The magistrate ostensibly relied on the “willing licensor/willing licensee” method, citing Tektronix and Georgia-Pacific,⁸⁴ but especially relied on the Tektronix trial court's analysis in arriving at the 30% reasonable royalty award:

The [magistrate], citing Georgia-Pacific and Tektronix, used the so-called “analytical approach,” in which she subtracted the infringer's usual or acceptable net profit from its anticipated net profit realized from sales of infringing devices.

Relying principally on a memorandum written by “[the infringer's] top management” before the initial infringement, the special master found that [the infringer] projected a gross profit averaging 52.7% from its infringing sales. From that figure, she subtracted overhead expenses to get an anticipated net profit in the range of 37% to 42%. Subtracting the industry standard net profit of 6.56 % to 12.5% from that anticipated net profit range, she arrived at a 30% reasonable royalty.⁸⁵

 

TWM v. Dura presented unusual facts in that, like the grooved plywood of Georgia-Pacific, the patented feature in TWM v. Dura created the customer demand for the entire device.⁸⁶ Moreover, instead of challenging the trial court's use of the industry standard profit, the infringer challenged use of an internal memorandum identifying the infringer's profit expectation for the infringing product. Despite these unusual facts, to the extent deducting the “standard profit” from the profit expectations served as a rough proxy for the profit attributable to the patented feature, the resulting value should not have been awarded as damages: It should have been used only as a cap. Because the accused infringer did not raise this argument, and because of the unusual facts, however, TWM v. Dura is less than helpful precedent for proper application of the analytical method.⁸⁷

The Federal Circuit's Lucent v. Gateway

The opinion most often cited today in connection with the analytical method is the 2009 Federal Circuit opinion in Lucent v. Gateway.⁸⁸ As part of a general, introductory discussion of damages--including citations to the damages statute, the compensatory purpose of the statute, the burden of proof, and the availability of lost profits or royalty damages--the court noted that “litigants routinely adopt several approaches for calculating a reasonable royalty”: the “analytical method” and the “hypothetical negotiation” approach.⁸⁹ The Court went on to explain:

The first [approach], the analytical method, focuses on the infringer's projections of profit for the infringing product. SeeTWM Mfg. Co. v. Dura Corp., 789 F.2d 895, 899 (Fed. Cir. 1986) (describing the analytical method as “subtract[ing] the infringer's usual or acceptable net profit from its anticipated net profit realized from sales of infringing devices”); see also John Skenyon et al., Patent Damages Law & Practice §3:4, at 3-9 to 3-10 (describing the analytical method as “calculating damages based on the infringer's own internal profit projections for the infringing item at the time the infringement began, and then apportioning the projected profits between the patent owner and the infringer”).⁹⁰

 

Because Lucent v. Gateway did not involve application of the analytical method, the Court's description of the approach is dictum, and the analytical method was not the subject of further discussion or analysis in the opinion.⁹¹ The Court's reference to the analytical method is, nevertheless, noteworthy. The two definitions of the analytical method cited by the Court are not the same: one is simply a mathematical exercise to determine the infringer's anticipated incremental profits on the accused product over its usual profit, and the other requires some kind of apportionment of the infringer's anticipated profits for the accused products. Evaluating both formulations in light of current Federal Circuit damages law reveals flaws in both.

The “Residual-Profits” Version of the “Analytical Approach”

Lucent v. Gateway’s first analytical approach formulation is a simple mathematical exercise: the reasonable royalty for infringement equals (1) the net profit the infringer expected to realize from the sales of the infringing product minus (2) the infringer's usual or acceptable net profits.⁹² This “residual-profits” formulation, which is the same as the limit applied by the Georgia-Pacific appellate court, is “based on the premise that any rate of return in excess of a normal rate of return can be attributed to the patent.”⁹³ In other words, the residual profits serve as a proxy for the apportioned share of the anticipated profits attributable to the infringer's use of the patented feature. Indeed, because this approach is the roughest of proxies, it suffers from the same three overriding flaws that caused the Federal Circuit in Uniloc v. Microsoft to sound the death knell for the 25% rule of thumb.⁹⁴

First, mechanically awarding all the “residual” profit (above the infringer's “usual” or “acceptable” profit) to the patentee as a reasonable royalty “fails to account for the unique relationship between the patent and the accused product.”⁹⁵ It assumes that every penny of residual anticipated profit would be attributable solely to the patented invention. It therefore makes no attempt to account for the importance of the infringed technology in generating those profits and does not reflect “the invention's contribution to the infringing product or service.”⁹⁶ It is easy to imagine an accused product that incorporates a number of valuable features or technologies that were not included in the infringer's prior product lines, only one of which is the patented feature. Likewise, the accused product may well benefit from the contribution of manufacturing processes and business risk unique to that product and distinct from the patented invention. In such instances, assuming that all increases in anticipated profit margin for the product are properly attributed to the infringed feature is precisely the kind of unsupported speculation the courts should and do reject.⁹⁷ Moreover, automatically awarding the entire residual anticipated profit to the patentee as a “reasonable royalty” would do far more than make the patentee whole, which is inconsistent with the goal of compensatory patent damages and the statutory mandate that the patentee be compensated only “for the use made of the invention by the infringer … .”⁹⁸

Second, a mechanical calculation (and automatic award) of residual anticipated profits also “fails to account for the unique relationship between the parties.”⁹⁹ Simply awarding 100% of the residual anticipated profits to the patentee ignores the parties' relative bargaining strength, competitive positions, market conditions, contributions to the accused product or process, and levels of risk in implementing the technology, and all the other facts peculiar to the parties.

Third, awarding 100% of the residual anticipated profits to the patentee “is essentially arbitrary,” just as arbitrary as allocating 25% of the profits from the infringing product to the patentee under a “rule of thumb.”¹⁰⁰ Moreover, the purpose of using the infringer's anticipated, instead of actual, profits in the reasonable royalty analysis is to comport with the hypothetical negotiation construct, which values the license as of a date before infringement began and necessarily considers the risk each party is taking in entering into the hypothetical license agreement. Stripped of that construct, using the infringer's anticipated profit, with its inherent risk allocation, makes no sense.

In short, Lucent v. Gateway’s “residual-profits” version of the analytical method should be rejected, like the 25% rule, because it “fails to tie a reasonable royalty base to the facts of the case at issue”¹⁰¹ and thus fails to “carefully tie the proof of damages to the claimed invention's footprint in the market place.”¹⁰² It is difficult to see how this approach could--or why it should--survive scrutiny.

The “Apportioned-Profits” Version of the Analytical Approach

The other version of the analytical approach suggested in the Lucent v. Gateway dictum “calculate[s] damages based on the infringer's own internal profit projections for the infringing item at the time the infringement began, and then apportion[s] the projected profits between the patent owner and the infringer.”¹⁰³ Although this “apportioned-profits” version of the analytical approach is subject to most of the same criticisms as the “residual-profits” version, to the extent that it suggests a rigorous apportionment to ensure that the royalty awarded reflects the actual contribution made by the patented invention to the accused products' commercial success, it at least acknowledges an important principle of patent damages law.¹⁰⁴ The difficulty lies in the apples and oranges nature of performing apportionment on anticipated profits, apportionment having developed before 1946 as applied to the infringer's actual profits and often requiring reliance on evidence that post-dates the hypothetical negotiation even though the profits being apportioned are those anticipated at the time of the hypothetical negotiation and the apportionment evidence is not properly considered under the Book of Wisdom. Accordingly, as applied in practice, the apportionment that is performed under this version of the analytical method, as in reasonable royalty analyses generally, rarely identifies in any meaningful way the portion of the anticipated profits attributable to the “patented feature.”¹⁰⁵ Similarly, although the pre-1946 “infringer's profit” remedy required that the infringer's actual profits be apportioned to reflect the value of the infringer's use of the patented invention,¹⁰⁶ it is in part because of the difficulties in performing that apportionment that Congress adopted the reasonable royalty remedy.¹⁰⁷ Particularly in view of the Supreme Court's determination that Congress intended “to eliminate the recovery of profits,”¹⁰⁸ it is hard to justify reintroducing a similarly afflicted analysis, albeit directed to anticipated rather than actual profits, through a judicially-created “analytical method.”

The “apportioned-profits” version of the analytical method veers into direct conflict with Congressional action when using the infringer's actual profits under the Book of Wisdom as a proxy for the infringer's anticipated profits.¹⁰⁹ At that point, this version of the analytical method becomes the identical remedy that Congress rejected in 1946, the infringer's apportioned profits. Under no circumstances should the courts resurrect this remedy that Congress has rejected.

Conclusion

The infringer's profits have a role to play in reasonable royalty determinations. As part of the hypothetical negotiation analysis, the infringer's anticipated profits should act to cap the reasonable royalty, so as to leave the suppositious licensee with a reasonable profit. Also as part of the hypothetical negotiation, those infringer's anticipated profits may be relevant to show the benefit to the infringer by its use of the patented invention, but only if carefully apportioned to identify the profits attributable to the patented invention, and not other features. And as part of the hypothetical negotiation, the infringer's actual profits may evidence the infringer's anticipated profits, but only under circumstances identified under the Book of Wisdom. Moreover, the Federal Circuit has left open the door to other ways to calculate reasonable royalties, and some that have been proposed would consider the infringer's apportioned actual profits.¹¹⁰

But the use of the infringer's anticipated profits in the so-called “analytical method” mentioned in the Lucent v. Gateway dictum finds no sound basis in the opinions from which that method purportedly springs. The analytical method found its way into patent damages jurisprudence through a misapplication of the notion that a hypothetical negotiation reasonable royalty should be limited to that which would leave the suppositious licensee with a reasonable profit based on its profit expectations. Instead of applying that profit limitation as a cap, the Tektronix court, the TWM court, and courts that have followed in their wake, have applied it either to define the royalty itself or, worse, as the baseline for a royalty negotiation in which the patentee receives a royalty that would have left the suppositious licensee with little or no profit expectation. The analytical method has in practice allowed patentees to seek reasonable royalty damages based on anticipated profits unencumbered by the burdens of apportionment or rigorous analysis of the other Georgia-Pacific factors.

Both versions of the Federal Circuit's analytical method--the “residual-profits” and “apportioned-profits” versions--inappropriately use the infringer's anticipated profits, not to cap the patentee's recovery, but as a crude proxy to allow disgorgement of a portion of the infringer's profits, a remedy that Congress rejected in 1946. Where, under the Book of Wisdom, the patentee uses the infringer's actual, instead of anticipated, profits, the apportioned-profits version of the analytical method is exactly the remedy that Congress rejected. Accordingly, either the Federal Circuit en banc or the Supreme Court should strike down both versions of the Federal Circuit's analytical method.

 

¹ Albert S. Davis Jr., Royalty--Rate and Basis, in THE ENCYCLOPEDIA OF PATENT PRACTICE AND INVENTION MANAGEMENT 703, 705 (R. Calvert ed., 1964).

² Univ. of Pittsburgh v. Varian Med. Sys., Inc., 561 F. App'x 934 (Fed. Cir. 2014).

³ See H.R. Rep. No. 1587, 79th Cong., 2d Sess. 2 (1946), reprinted inU.S.C.C.S. 79th Cong., 2d Sess. 1386-87 (1946); see alsoKori Corp. v. Wilco Marsh Buggies & Draglines, Inc., 761 F.2d 649, 654-55, 225 U.S.P.Q. 985 (Fed. Cir. 1985).

⁴ See Recovery in Patent Infringement Suits, H.R. 5231, 79th Cong., 2d Sess. 3, 14-15 (1946) (statement of Hon. Robert K. Henry of Wisconsin decrying that patentees obtain “in very many cases enormously more than that to which he is really entitled”).

⁵ 35 U.S.C. §284.

⁶ Id. A recent study concluded that “[d]amages awards for [non-practicing entities] averaged more than triple those for practicing entities over the last four years” at least in part because non-practicing entities “are ineligible for lost profit damages,” which “can be more difficult to establish.” PriceWaterhouseCoopers, 2014 Patent Litigation Study 2-3, 9 (2014). Professor Lemley argues that the situation in which “the reasonable royalty approach systematically overcompensates patent owners in component industries … has gotten so bad that some patentees who can prove lost profits elect instead to seek a 'reasonable’ royalty that is far in excess of both what the parties would have negotiated and of the actual losses the patentee suffered.” Mark A. Lemley, Distinguishing Lost Profits From Reasonable Royalties, 51 Wm. & Mary L. Rev. 655, 6687 (2009).

⁷ See generally Nike, Inc. v. Wal-Mart Stores, Inc., 138 F.3d 1437, 1440, 46 U.S.P.Q.2d 1001 (Fed. Cir. 1998).

⁸ See Birdsall v. Coolidge, 93 U.S. 64, 69 (1876); Coupe v. Royer, 155 U.S. 565, 582 (1895).

⁹ Act of 1870, 16 Stat. 201.

¹⁰ Birdsall, 93 U.S. at 69.

¹¹ See Garretson v. Clark, 111 U.S. 120, 121 (1884).

¹² Apportionment is said to be “a rational separation of the net profits so that neither party may have what rightfully belongs to the other….” Dowagiac Mfg. Co. v. Minnesota Moline Plow Co., 235 U.S. 641, 647 (1915).

¹³ Dowagiac, 235 U.S. at 648 (holding that, where no established royalty could be proven, the patentee may “show the value [of what was taken] by proving what would have been a reasonable royalty, considering the nature of the invention, its utility and advantages, and the extent of the use involved.”). By the time the Dowagiac Court sanctioned the reasonable royalty approach, the circuit courts had been applying that approach for decades. Id. at 649-50. Perhaps the most comprehensive analysis of the pre-Dowagiac opinions may be found in U.S. Frumentum Co. v. Lauhoff, 216 F. 610, 615-26 (6th Cir. 1914), which traces the development of the reasonable royalty to Suffolk v. Hayden, 70 U.S. 315, 319-20 (1865) (“There being no established patent or license fee in the case, in order to get at a fair measure of damages, or even an approximation to it, general evidence must necessarily be resorted to. And what evidence could be more appropriate and pertinent than that of the utility of the invention over the old modes or devices that had been used for working out similar results? With a knowledge of these benefits to the persons who have used the invention, and the extent of the use by the infringer, a jury will be in possession of material and controlling facts that may enable them, in the exercise of sound judgment, to ascertain the damages, or, in other words, the loss to the patentee or owner, by the piracy, instead of purchase of the use of the invention.”).

¹⁴ Act of February 18, 1922, Ch. 58, 42 Stat. 392. Although the courts previously had referred to “reasonable royalty,” the 1922 Act used the formulation “reasonable sum as profits or general damages.” Not until the 1946 Act did Congress adopt the phrase “not less than a reasonable royalty.” Act of August 1, 1946, Ch. 726, §1, 60 Stat. 778.

¹⁵ Act of August 1, 1946, Ch. 726, §1, 60 Stat. 778. The legislative history of the 1946 Act, the Federal Circuit has asserted, explains that the new statute “would not preclude the recovery of profits as an element of general damages.” Kori v. Wilco, 761 F.2d at 654 (quoting H.R. Rep. No. 1587, 79th Cong., 2d Sess. (1946); S. Rep. No. 1503, 79th Cong., 2d Sess. (1946)).

¹⁶ See, e.g., William Bros Boiler & Mfg. Co. v. Gibson Stewart Co., 312 F.2d 385, 386, 136 U.S.P.Q. 239 (6th Cir. 1963) (concurring in the special master's ruling that infringer “has shown no good reason, and has furnished the Master with no satisfactory accounting figures why the [infringer's] gross profits should not be taken into consideration as a measure of damages, in the absence of any other suitable measure.”); Graham v. Jeoffroy Mfg., 253 F.2d 72, 74, 116 U.S.P.Q. 542 (5th Cir. 1958) (“The parties agree that compensatory damages, as provided in the statute, may comprehend the profits of the infringer.”); Zysset v. Popeil Bros., Inc., 134 U.S.P.Q. 222, 230 (N.D. Ill. 1962) (“It is well established that a patent owner in a patent infringement action is entitled to recover the profits which the infringer has made by reason of his infringement.”); but seeRic-Wil Co. v. E.B. Kaiser Co., 179 F.2d 401, 407-08, 84 U.S.P.Q. 121 (7th Cir. 1950) (reversing award of accounting for profits because 1946 Act eliminated reference to infringer's profits, so “profits realized by an infringer are not recoverable as such.”).

¹⁷ Aro Mfg. Co. v. Convertible Top Replacement Co., 377 U.S. 476, 507, 141 U.S.P.Q. 681 (1964).

¹⁸ Id. at 479-80 (citations omitted).

¹⁹ Lucent Techs., Inc. v. Gateway Inc., 580 F.3d 1301, 1325, 2009 BL 193956, 92 U.S.P.Q.2d 1555 (Fed. Cir. 2009) (“The hypothetical negotiation tries, as best as possible, to create the ex ante licensing negotiation scenario and to describe the resulting agreement.”); see alsoHorvath v. McCord Radiator & Mfg. Co., 100 F.2d 326, 335 (6th Cir. 1938) (“In fixing damages on a royalty basis against an infringer, the sum allowed should be reasonable and that which would be accepted by a prudent licensee who wished to obtain a license but was not so compelled and a prudent patentee, who wished to grant a license but was not so compelled.”).

²⁰ Rite Hite Corp. v. Kelley Co., 56 F.3d 1538, 1554, 35 U.S.P.Q.2d 1065 (Fed. Cir. 1995) (en banc); Lucent v. Gateway, 580 F.3d at 1325.

²¹ Integra Lifesciences I, Ltd. v. Merck KgaA, 331 F.3d 860, 870, 66 U.S.P.Q.2d 1865 (Fed. Cir. 2003) (hypothetical negotiation occurs “at a time before the infringing activity began.”); Lucent v. Gateway, 580 F.3d at 1324 (hypothetical negotiation takes place “just before infringement began.”). Although the case law has not addressed the distinction, the Federal Trade Commission has taken the position that the negotiation should be deemed to have taken place “at the time the decision to use the infringing technology was made” in order to prevent damage awards based on the costs from switching designs after making investments based on that decision. Federal Trade Commission, The Evolving IP Marketplace: Aligning Patent Notice And Remedies With Competition 189-91 (2011).

²² LaserDynamics v. Quanta Computer, Inc., 694 F.3d 51, 75, 2012 BL 222195, 104 U.S.P.Q.2d 1573 ( Fed. Cir. 2012) (reasonable royalty determination must relate to the time infringement occurred and “not be an after-the-fact assessment”); Powell v. Home Depot U.S.A., Inc., 663 F.3d 1221, 1238, 100 U.S.P.Q.2d 1742 (Fed. Cir. 2011) (same); see also Fromson v. Western Litho Plate & Supply Co., 853 F.2d 1568, 1575, 7 U.S.P.Q.2d 1606 (Fed. Cir. 1988) (hypothetical negotiation analysis “requires a court to imagine what warring parties would have agreed to as willing negotiators,” and in some cases allows the “court to look at events and facts that occurred thereafter and that could not have been known to or predicted by the hypothesized negotiators” in order to “bring out and expose to light the elements of value that were there from the beginning,” but “not to charge the offender with elements of value non-existent at the time of his offense.”).

²³ See Lucent v. Gateway, 580 F.3d at 1325-27.

²⁴ See Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116, 1120-21, 166 U.S.P.Q. 235 (S.D.N.Y. 1970), rev'd in part, 446 F.2d 295, 170 U.S.P.Q. 369 (2d Cir. 1971); Whitserve, LLC v. Computer Packages, Inc., 694 F.3d 10, 26-27, 104 U.S.P.Q.2d 1024 (Fed. Cir. 2012) (Georgia-Pacific factors are “meant to provide a reasoned economic framework” for a hypothetical negotiation); Energy Transp. Group, Inc. v. William Demant Holding A/S, 697 F.3d 1342, 1357, 105 U.S.P.Q.2d 1061 (Fed. Cir. 2012) (“this court does not endorse Georgia-Pacific as setting forth a test for royalty calculations, but only as a list of admissible factors informing a reliable economic analysis.”); Uniloc USA Inc. v. Microsoft Corp., 632 F.3d 1292, 1317, 2011 BL 1830, 98 U.S.P.Q.2d 1203 (Fed. Cir. 2011) (“[T]his court has sanctioned the use of the Georgia-Pacific factors to frame the reasonable royalty inquiry. Those factors properly tie the reasonable royalty calculation to the facts of the hypothetical negotiation at issue.”); ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860, 869, 2010 BL 24667, 93 U.S.P.Q.2d 1553 (Fed. Cir. 2010) (Georgia-Pacific factors are a “comprehensive (but unprioritized and often overlapping) list of relevant factors for a reasonable royalty calculation”).

²⁵ Georgia-Pacific, 318 F. Supp. at 1120.

²⁶ Other factors not enumerated in Georgia-Pacific may be relevant to the royalty determination. For example, the cumulative effect of “stacking royalties”--the number of patent licenses required to produce the accused product--may color the character of a hypothetical negotiation. Integra v. Merck, 331 F.3d at 871-72. In addition, where the patent in suit was transferred (along with products, other patents and know-how, or other assets) as part of a business acquisition, the overall acquisition price may be relevant in assessing the value of a license to the patent. Id.

²⁷ Georgia-Pacific, 318 F. Supp. at 1121.

²⁸ The infringer's profits also may be relevant to the lost profits analysis “for comparison purposes with the patentee's proof of his lost profits.” Kori v. Wilco, 761 F.2d at 655.

²⁹ Georgia-Pacific, 318 F. Supp. at 1120, 1127-29.

³⁰ Id. at 1120.

³¹ The Georgia-Pacific district court opinion devoted considerable analysis to this issue. Id. at 1127-29 (“What must be considered now as one of the elements, inter alia, relevant to the determination of the reasonable royalty, is the rate of profits that [the patentee] was making on [its patented product] at the time [the infringer] began its infringement …, profits that [the patentee] made and was making on and before [the hypothetical negotiation date] and that it reasonably anticipated it would continue to make ….”). Nonetheless, in Finjan, Inc. v. Secure Computing Corp., 626 F.3d 1197, 1171, 97 U.S.P.Q.2d 1161 (Fed. Cir. 2010), the Federal Circuit analyzed the infringer's profit in terms of factor 8:

Defendants disagree most with Parr's analysis of Georgia-Pacific factor 8: “The established profitability of the product made under the patent; its commercial success; and its current popularity.” 318 F. Supp. at 1120. Under this factor, a wide profit margin for accused products supports a higher reasonable royalty. E.g.,Lucent, 580 F.3d at 1335.

 

The Lucent passage on which the Finjan Court relies says only “Factor 8, the profitability of the product made, supports a higher versus a lower reasonable royalty, given the unrebutted evidence that the products at issue are sold with an approximately 70-80% profit margin.” 580 F.3d at 1335. That the patentee's expert in one or more Federal Circuit cases has analyzed the infringer's profits under Georgia-Pacific factor 8 does not make the one relevant to the other.

³² Richard F. Cauley, WINNING THE PATENT DAMAGES CASE 97 (2009).

³³ Georgia-Pacific, 318 F. Supp. at 1120.

³⁴ As the Georgia-Pacific trial court explained, “If [the infringer] had been negotiating with [the patentee] for a license, [it] would have taken into consideration all advantages that might accrue to it in determining a royalty which it would be willing to pay,” including that a “license to sell the patented striated fir plywood would have enabled [the infringer] to expand its business, increase its sales of non-infringing materials and thereby increase its profits.”

³⁵ In Uniloc, 632 F.3d at 1317-18, the court explained that Georgia-Pacific “factor 12--looking at the portion of profit that may be customarily allowed in the particular business for the use of the invention or similar inventions--[remains a] valid and important factor [] in the determination of a reasonable royalty rate.” Consideration of this factor often includes third party licenses that do not fit under factors 1 (“royalties received by the patentee for the licensing of the patent in suit, proving or tending to prove an established royalty”) and 2 (“rates paid by the licensee for the use of other patents comparable to the patent in suit”).

³⁶ See Uniloc, 632 F.3d at 1318; Multimedia Patent Trust v. Apple, Inc., No. 10-cv-2618, 2012 BL 306087, slip op. at 10 (S.D. Cal. Nov. 20, 2012) (excluding testimony on “generic industry data” as “not tethered to the relevant facts and circumstances of the present case); Oracle Am., Inc. v. Google, Inc., 798 F. Supp. 2d 1111, 1119-21, 2011 BL 191701 (N.D. Cal. 2011) (rejecting fifty/fifty split because “there is no anchor for this fifty-percent assumption in the record of actual transactions”).

³⁷ See VirnetX, Inc. v. Cisco Systems, Inc., No. 2013-1489, 2014 BL 256078, slip op. at 38-41 (Fed. Cir. Sept. 16, 2014) (rejecting a 45%/55% split because of patentee's expert's failure to establish a fit between the particular situation and the premises underlying the Nash Bargaining Solution); Uniloc, 632 F.3d at 1318 (rejecting award based on 25% rule where patentee's expert did not testify that either of the parties “had a practice of beginning negotiations with a 25%/75% split, or that the contribution of the [patented feature] to the [accused products] justified such a split”); Digital Reg of Texas, LLC v. Adobe Sys., Inc., No. 12-cv-1971, ECF No. 632, slip op. at 6 (N.D. Cal. Aug. 19, 2014) (excluding patentee's damages expert's testimony based on “a 50% split of the saved profits” because he conceded in deposition “he had not seen an evidence of either [of the parties] commencing negotiations with a fifty-fifty profit split”); Suffolk Techs. LLC v. AOL Inc., No. 1:12-cv-625, ECF No. 518, slip op. at 4 (E.D. Va. Apr. 12, 2013) (rejecting patentee's damages expert's testimony based on “50/50 split” where expert “does not explain why these parties would have accepted a 50/50 split”).

³⁸ The practical difficulties associated with such an arrangement are cataloged in Davis, supra note 1, at 705-06.

³⁹ See, e.g., Astrazeneca AB v. Apotex Corp., 985 F. Supp. 2d 452, 2013 BL 333777 (S.D.N.Y. 2013) (awarding 50% of profits as a reasonable royalty for sales of the pharmaceutical omeprazole based on evidence of license agreements requiring 7-40% (presumably) of net revenue and 35-50% of profits, offers requiring 50% and 70% of profits, and a settlement agreement equating to 54% of profits).

⁴⁰ 318 F. Supp. at 1120.

⁴¹ Id. (emphasis added).

⁴² Id. at 1121. The Georgia-Pacific court emphasized the distinction between anticipated and actual profits: “GP is in error when it argues that, because this Court rejected the master's use of GP's infringing profits as the legal measure of damages, evidence of GP's reasonably anticipated profits as of 1955 is irrelevant to the present inquiry.” Id. at 1123. The Georgia-Pacific court went on to analyze the profits the patentee “would reasonably have expected to earn.” Id. at 1130.

⁴³ See id.at 1122; Lindemann Maschinenfabrik GmbH v. American Hoist & Derrick Co., 895 F.2d 1403, 1408, 13 U.S.P.Q.2d 1871 (Fed. Cir. 1990) (affirming award of damages and rejecting testimony of patentee's damages expert that reasonable royalty would have exceeded infringer's anticipated net profit, stating that his “opinion that [infringer] 'would agree to pay a royalty in excess of what it expected to make in profit’ was, in light of all the evidence in this case, absurd”). See also Daralyn J. Durie & Mark A. Lemley, A Structured Approach to Calculating Reasonable Royalties, 14 Lewis & Clark L. Rev. 627, 640 n.57 (2010) (arguing that reasonable royalty should be limited by the infringer's expected profits) (“Structured Appoach”). That the infringer may have not expected to make a profit, that is, planned to make and sell a product or perform a service to garner market share, to boost sales of convoyed goods, or for another purpose, does not mean that its expectation is irrelevant, only that the profit limitation may have little or no effect. In Powell v. Home Depot, 663 F.3d at 1238-39, where the Federal Circuit properly rejected the infringer's argument that the reasonable royalty could not, under the facts of the case, exceed the patentee's expected profits, the panel went on, gratuitously, to reject the infringer's profit expectation as a limit on the reasonable royalty, relying solely on the 1983 opinion in Stickle v. Heublien, Inc., 716 F.2d 1550, 1563, 219 U.S.P.Q. 377 (Fed. Cir. 1983), which it characterized as “rejecting the accused infringer's argument that the reasonable royalty is capped by the sales prices of the patented product.” 663 F.3d at 1239. But the post-hypothetical negotiation sales price of the product alone says nothing about the profit expectation of the party to the negotiation. Based on this inapposite authority, in a case in which the issue does not appear to have been presented, the Powell panel purported to eliminate from the reasonable royalty analysis the proper role of the infringer's expected profit as a limitation on the reasonable royalty. Because that ruling conflicts with several other Federal Circuit pronouncements on the issue, including Lindemann, 895 F.2d at 1408, and Hanson v. Alpine Valley Ski Area, Inc., 718 F.2d 1075, 1081, 219 U.S.P.Q. 679 (Fed. Cir. 1983), however, the extent to which the infringer's profit expectation serves to limit the reasonable royalty remains for future Federal Circuit panels, the Court en banc, or the Supreme Court to decide. SeeNewell Co. v. Kinney Mfg. Co., 864 F.2d 757, 765, 9 U.S.P.Q.2d 1417 (Fed. Cir. 1988) (under Federal Circuit precedent, prior decisions are binding unless and until overturned by the court en banc, and where the court's precedential decisions conflict, the earlier decision controls).

⁴⁴ Hanson, 718 F.2d at 1081; see alsoApplied Med. Res. Corp. v. United States Surgical Corp., 435 F.3d 1356, 1361, 77 U.S.P.Q.2d 1666 (Fed. Cir. 2006); Trans-World Mfg. Corp. v. Al Nyman & Sons, Inc., 750 F.2d 1552, 1568, 224 U.S.P.Q. 259 (Fed. Cir. 1984). Georgia-Pacific aptly uses the phrase “suppositious licensee” instead of “infringer” for the party sitting at the hypothetical negotiating table because that party is not actually the infringer, but someone imbued with the infringer's knowledge at the time. Likewise, sitting in place of the patentee would be the “suppositious licensor,” who might have the knowledge of an entirely different party: the party that owned the patent at the time of the hypothetical negotiation. See, e.g., Oracle v. Google, 798 F. Supp. 2d at 1116-17 (patentee at the time, rather than plaintiff that later acquired the patent, was proper party to hypothetical negotiation), Nichols Institute v. Scantibodies Clinical Laboratory, No. 3:02-cv-0046-B, 2006 BL 129651, slip op. at 7-10 (S.D. Cal. May 2, 2006) (same); see also generally Samuel T. Lam, Musical Chairs In Reasonable Royalty Hypothetical Negotiations: Who Occupies The Seat At The Table Across From The Accused Infringer, 88 BNA Pat. Trademark & Copyright J. 426 (June 6, 2014).

⁴⁵ See Interactive Pictures Corp. v. Infinite Pictures, Inc., 274 F.3d 1371, 1385, 61 U.S.P.Q.2d 1152 (Fed. Cir. 2001); Trans-World v. Al Nyman & Sons, 750 F.2d at 1568.

⁴⁶ See generally Martha K. Gooding, Reasonable Royalty Patent Damages: A Proper Reading of the Book of Wisdom, BNA Pat., Trademark & Copyright J. (Apr. 18, 2014) (“Proper Reading”). Some cases have taken the position that the infringer's actual profits are considered as part of the hypothetical negotiation. See, e.g., Faulkner v. Gibbs, 199 F.2d 635, 640, 95 U.S.P.Q. 400 (9th Cir. 1952) (affirming award of $15,000 in damages after considering much evidence, including “largely conjectural” evidence that the infringer's profits were $36,000 per year for five and one-half years of operation). The authority on which the Ninth Circuit relied in Faulkner v. Gibbs, however, predated the 1946 Act and involved an award of infringer's profits for a portion of the period of infringement and a reasonable royalty of 10% of net sales during the remainder; the issue was whether the patentee could establish the basis for an award of the infringer's profits for the remainder by relying on the profits of a competitor. SeeAutographic Register Co. v. Sturgis Register Co., 110 F.2d 883, 886, 45 U.S.P.Q. 58 (6th Cir. 1940).

⁴⁷ See Finjan, 626 F.3d at 1210 (The patentee's expert's “use of the actual profit margins that both [the patentee and infringer] experience on products after [the hypothetical negotiation] date was simply as a reflection of the profits the parties might have anticipated in calculating a royalty in the hypothetical negotiation.”).

⁴⁸ See Douglas Dynamics, LLC v. Buyers Prods. Co., 717 F.3d 1336, 1346 (Fed. Cir. 2013) (vacating reasonable royalty award that trial court limited to infringer's actual profit margins); Golight, Inc. v. Wal-Mart Stores, Inc., 355 F.3d 1327, 1338-39, 69 U.S.P.Q.2d 1481 (Fed. Cir. 2004) (affirming royalty award where infringer's evidence of projected profits was “sparse”);see alsoRadio Steel & Mfg. Co. v. MTD Prods., Inc., 788 F.2d 1554, 1557, 229 U.S.P.Q. 431 (Fed. Cir. 1986) (affirming royalty that exceeded the profits where infringer's treasurer testified infringing products “might have been utilized as loss-leaders at various times during the period of infringement”); Hanson, 718 F.2d at 1081 (“Whether, as events unfurled thereafter, [infringer] would have made an actual profit, while paying the royalty determined as of [the hypothetical negotiation date] is irrelevant.” (internal citation and quotation marks omitted)). Likewise, there is no rule that a reasonable royalty should be capped by a patentee's expected profit margin. Powell v. Home Depot, 663 F.3d at 1238.

⁴⁹ See generally Proper Reading, supra note 46.

⁵⁰ Accord VirnetX, slip op. at 40 (noting that the Nash Bargaining Solution offers a “noticeable improvement over the 25% rule” by focusing “only on the incremental profits earned by the infringer from the use of the asserted patents,” which “more appropriately (and narrowly) defines the universe of profits to be split … .”).

⁵¹ 580 F.3d 1301, 1324 (Fed. Cir. 2009). The Court did not mention a third approach to determining patent damages, the established royalty. See generally William C. Rooklidge, Martha K. Gooding, Philip S. Johnson & Mallun Yen, Compensatory Damages Issue in Patent Infringement Cases: A Pocket Guide for Federal District Court Judgesat 5-7 (Federal Judicial Center 2011) (“Although sometimes characterized as a reasonable royalty, the established royalty is, strictly speaking, a form of actual damages, and is 'reasonable’ in the sense that it typically provides the 'best measure’ of a royalty for the use made of the invention.” (citing Monsanto Co. v. McFarling, 488 F.3d 973, 978, 82 U.S.P.Q.2d 1942 (Fed. Cir. 2007)).

⁵² Lucent v. Gateway,580 F.3d at 1324. Martha K. Gooding, Analyzing the Analytical Method of Calculating Reasonable Royalty Patent Damages, 84 BNA Pat., Trademark & Copyright J. 78 (May 11, 2012), reviews the cases on which the Lucent Court relied, and explains that the supposed “analytical method” (or “analytical approach”) should not be viewed as a damages methodology independent of the Georgia-Pacific hypothetical negotiation approach. The cases on which the Lucent opinion relies certainly purported to apply Georgia-Pacific's willing-buyer/willing-seller hypothetical negotiation approach. See infranotes 72 and 83 and accompanying text. Contemporary opinions, however, view the approaches as entirely distinct. See, e.g., Linear Group Servs., LLC v. Attica Automation, Inc., No. 13-cv-10108, 2014 BL 247506, slip op. at 15 (E.D. Mich. Aug. 25, 2014) (“the analytical method focuses on the infringer's projections of profit or the infringing product, regardless of what the parties might have hypothetically agreed to had they successfully negotiated before the infringement began,” citing TWM, 789 F.2d at 899).

⁵³ 789 F.2d 895, 899, 229 U.S.P.Q. 525 (Fed. Cir. 1986).

⁵⁴ 552 F.2d 343, 193 U.S.P.Q. 385 (Ct. Cl. 1977).

⁵⁵ 318 F. Supp. at 1121.

⁵⁶ Id.

⁵⁷ Id. at 1123-25.

⁵⁸ Id. at 1125-30.

⁵⁹ Id. at 1131-32.

⁶⁰ Id. at 1132-37.

⁶¹ Id. at 1137-40.

⁶² Id. at 1143.

⁶³ Id.

⁶⁴ Id. at 1141-42.

⁶⁵ Id. at 1141.

⁶⁶ Georgia-Pacific Corp. v. U.S. Plywood-Champion Papers, Inc., 446 F.2d 295, 299, 170 U.S.P.Q. 369 (2d Cir. 1971).

⁶⁷ Id. at 299 n.2.

⁶⁸ Id. at 299-300, 302. The Second Circuit explained its arrogation of the trial court's role in failing to remand after identifying the trial court's failure to allow the infringer a reasonable profit by referring to the “extraordinary length of time this litigation has already lingered and the willingness of the party ultimately paying the damages to have us dispose of the case.” Id. at 299.

⁶⁹ Id. at 299.

⁷⁰ The patentee's compensation was based on the statute applicable to determining damages in an infringement action brought against the United States. See 28 U.S.C. §1498 (where the United States uses or manufactures a patented invention without license, the patentee's remedy is “reasonable and entire compensation for such use and manufacture”).

⁷¹ 552 F.2d at 346.

⁷² Id. at 346 (citation omitted).

⁷³ Id. at 348-49.

⁷⁴ Id.

⁷⁵ See Laura B. Pincus, The Computation of Damages in Patent Infringement Actions, 5 Harv. J. of L. & Tech. 95, 126 (1991) (“In Georgia-Pacific, the circuit court entirely neglected to utilize the fifteen-factor analysis recommended by the district court,” but instead “looked only to the profitability of the product and awarded that profit to the patent holder.”).

⁷⁶ Georgia-Pacific, 318 F. Supp. at 1120.

⁷⁷ James E. Malackowski, Justin Lewis & Robert Mazur, New Emphasis on the Analytical Approach of Apportionment In Determination of a Reasonable Royalty, http://www.visiond.com/aipla/midwinter2013/materials/Malackowski_Paper.pdf, at 6 (2013).

⁷⁸ 552 F.2d at 350.

⁷⁹ Id. at 350-51. Distinguishing Tektronix, one court decided that “no upward adjustment is warranted, even though [the patentee] achieved a 19% profit, i.e., more than four times higher than the residual profit on [the infringing] sales” because “unlike the patentee in Tektronix, [the patentee here] did not offer any evidence that it took the risks and bore the expense of developing the [infringing products] and creating a market for them … .” Honeywell Int'l Inc. v. United States, 107 Fed. Cl. 659, 693, 2012 BL 317245 (Fed. Cl. 2012).

⁸⁰ Id. at 352 (citation omitted). Per the Court, the patentee would not have been entitled to its own 25% profit margin as a reasonable royalty because “[a] portion of that 25% profit represented compensation, not for the patented idea itself, but for the efficiencies and risks of manufacture as well as the investment of other capital,” a portion “separate and apart from any compensation due it for use of its patents.” Id. at 350-51.

⁸¹ 789 F.2d at 898. The trial court made a minor modification to the magistrate's report to add a case citation, but otherwise adopted the magistrate's report in its entirety, concluding that it contained no errors of law and the findings of fact were not clearly erroneous. SeeTWM Mfg. Co. v. Dura Corp., 231 U.S.P.Q. 525, 526 (E.D. Mich. 1985).

⁸² TWM v. Dura, 789 F.2d at 898.

⁸³ Id. (citing Hanson, 718 F.2d at 1078; Tektronix, 552 F.2d at 348-49; Georgia-Pacific, 318 F. Supp. at 1120-22).

⁸⁴ TWM v. Dura, 789 F.2d at 899.

⁸⁵ Id.The magistrate had explained:

For the reasons stated below this Magistrate agrees that the analytical approach cited in Georgia-Pacific, supra, and Tektronix, supra, is appropriate to the case at bar. The Magistrate further agrees that during the critical period, given the record in this case, a willing buyer and willing seller would have entered into a royalty of at least 30% of the invoice price of the infringing device. This analytical approach takes the anticipated net profit realized by the infringer from sales of the infringing device and subtracts the usual or acceptable net profit of the infringer. Then the result is analyzed to be sure it constitutes adequate compensation. This approach is imminently [sic] fair to [the infringer] since it awards … the infringer a normally acceptable profit on the lift suspension, while giving the remainder as a royalty to the patentee.

 

TWM v. Dura, 231 U.S.P.Q. at 527-29 (citations omitted).

⁸⁶ 789 F.2d at 901.

⁸⁷ Malackowski, Lewis & Mazur, supra note 77, at 2-3 (citations omitted), explains:

Early case law such as Georgia-Pacific and TWM involved asserted patented technologies which were deemed to contribute virtually the entire incremental difference in profits between the accused and non-accused products. In such instances, a further apportionment was not needed… .

With today's feature rich products this single feature Analytical Approach is rarely the case. Recent case law has recognized that it is often the case in today's complex litigation where there are a multitude of non-accused incremental features which contribute to the generation of profits for an accused product. Under these circumstances a further apportionment of the incremental profits is necessary.

 

⁸⁸ Lucent v. Gateway, 580 F.3d at 1324.

⁸⁹ Id.

⁹⁰ Id.

⁹¹ This Lucent v. Gateway dictum has found its way, without analysis, into dicta in later opinions. See, e.g., Wordtech Sys. Inc. v. Integrated Networks Solutions Inc., 609 F.3d 1308, 1319, 2010 BL 135032, 95 U.S.P.Q.2d 1619 (Fed. Cir. 2010) (“A reasonable royalty can be calculated from an established royalty, the infringer's profit projections for infringing sales, or a hypothetical negotiation between the patentee and infringer based on the [Georgia-Pacific] factors … .”); Oracle America, Inc. v. Google, Inc., No. 3:10-cv-3561, ECF No. 352, slip op. at 1 (N.D. Cal. Aug. 23, 2011) (analytical method for determining a reasonable royalty calculates damages based on infringer's internal profit projections for the infringing item at the time infringement began and then apportions projected profits between patentee and infringer).

⁹² Lucent v. Gateway, 580 F.3d at 1324. The deficiencies of this approach catalogued here do not begin to account for the deficiencies as applied in patent infringement testimony, where concepts like “industry standard net profit” and the infringer's “normal profit” are employed. Suffice it to say that profit numbers based on sales by other industry participants or of the infringer's other products can involve technology and market conditions completely unlike that of the accused product or process. Further, the profit margins often times are calculated on inconsistent bases. See, e.g.,Johns-Manville Corp. v. Guardian Indus. Corp., 718 F. Supp. 1310, 1313-14 (E.D. Mich. 1989) (rejecting analytical method analysis that, among other faults, “improperly mixes cost accounting with financial accounting by using plant-level numbers to derive certain figures and annual report numbers to obtain allegedly comparative figures”).

⁹³ Fresenius Med. Care Holdings, Inc. v. Baxter Int'l, Inc., No. 3-cv-1431, 2006 BL 61077, slip op. at 10 (N.D. Cal. May 18, 2006) (denying motion to exclude expert damages report based on different methods of calculating reasonable royalty, including the “analytical method,” and explaining “[t]his method takes the profits of the infringer, subtracts the infringer's normal profit, and awards some portion of the remainder to the patent owner”).

⁹⁴ See Uniloc, 632 F.3d at 1313.

⁹⁵ Id. Or, in the words of the VirnetX court, it “made too crude a generalization about a vastly more complicated world.” VirnetX, slip op. at 38.

⁹⁶ Id.

⁹⁷ See ResQNet v. Lansa, 594 F.3d at 869 (“a reasonable royalty analysis requires a court to hypothesize, not to speculate” (citing Fromson, 853 F.2d at 1574)); Grain Processing Corp. v. American Maize-Products Co., 185 F.3d 1341, 1350, 51 U.S.P.Q.2d 1556 (Fed. Cir. 1999) (“To prevent the hypothetical from lapsing into pure speculation, this court requires sound economic proof of the nature of the market and likely outcomes with infringement factored out of the economic picture.”).

⁹⁸ 35 U.S.C. §284. SeeResQNet v. Lansa, 594 F.3d at 869 (“Any evidence unrelated to the claimed invention does not support compensation for infringement but punishes beyond the reach of the statute.”); Pall Corp. v. Micron Separations, Inc., 66 F.3d 1211, 1223, 36 U.S.P.Q.2d 1225 (Fed. Cir. 1995) (“[T]he purpose of compensatory damages is not to punish the infringer, but to make the patentee whole.”).

⁹⁹ Uniloc, 632 F.3d at 1313.

¹⁰⁰ Id. at 1315 (rejecting 25% rule of thumb).

¹⁰¹ Uniloc, 632 F.3d at 1315; id. at 1316 (“If the patentee fails to tie the [damages] theory to the facts of the case, the testimony must be excluded.”). Or, as the VirnetX court put it, the patentee failed to establish a real world fit between the particular situation and the premises underlying the Nash Bargaining Solution. VirnetX, slip op. at 38.

¹⁰² ResQNet v. Lansa, 594 F.3d at 869.

¹⁰³ Lucent v. Gateway, 580 F.3d at 1324 (citation omitted); seeFresenius v. Baxter, No. 3-cv-1431, ECF No. 446, slip op. at 10 (analytical method subtracts the infringer's normal profit from the infringer's profits on the accused product “and awards some portion of the remainder to the patent owner.” (quoting “Calculating Intellectual Property Damages” (AICPA)). See alsoOracle v. Google, No. 3:10-cv-3561, ECF No. 352, slip op. at 1 (analytical method for determining a reasonable royalty calculates damages based on infringer's internal profit projections for the infringing item at the time infringement began and then apportions projected profits between patentee and infringer).

¹⁰⁴ See, e.g., VirnetX, slip op. at 40 (noting with approval Nash Bargaining Solution being based on “incremental profits earned by the infringer from the sues of the patented features”); Uniloc, 632 F.3d at 1318 (“the patentee must in every case give evidence tending to separate or apportion the defendant's profits and the patentee's damages between the patented feature and the unpatented features, and such evidence must be reliable and tangible, and not conjectural or speculative” (quoting Garretson v. Clark, 111 U.S. at 121). Uniloc's reliance on Garretson recently was called into question by another Federal Circuit panel in a non-precedential opinion in Univ. of Pittsburgh v. Varian, 561 F. App'x at 934.

¹⁰⁵ See, e.g., LaserDynamics, 694 F.3d at 69 (rejecting hypothetical negotiation apportionment that “appears to have been plucked out of thin air based on vague qualitative notions of the relative importance of the … technology”); Ultratec, Inc. v. Sorenson Comm'ns, Inc., No. 13-cv-346, ECF No. 583, slip op. at 9 (W.D. Wis. Oct. 9, 2014) (rejecting hypothetical negotiation apportionment that is mentioned only “in a single footnote” and is not explained); Atlas IP, LLC v. Medtronic, Inc., No. 13-cv-23309, ECF No. 237, slip op. at 7-10 (S.D. Fla. Oct. 6, 2014) (rejecting “conclusory” hypothetical negotiation apportionment analysis that “does not withstand scrutiny”); Comcast IP Holdings I LLC v. Sprint Comm'ns Co., No. 12-cv-205, 2014 BL 270018, ECF No. 324, slip op. at 2 (D. Del. Sept. 29, 2014) (rejecting reliance on allegedly “apportioned revenues and/or profits” as improper for ignoring relevant factors that contribute to the value of the products and failing to even perform a “numerical calculation”); Digital Reg of Texas v. Adobe, ECF No. 632, slip op. at 9 (rejecting inadequately explained apportionment of royalty base from 50% of profits assumed under Nash Bargaining Solution to 30% of profits).

¹⁰⁶ See Dowagiac, 235 U.S. at 646 (“Insofar as the profits from the infringing sales were attributable to the patented improvements, they belonged to the [patentee], and in so far as they were due to other parts or features they belonged to the defendants.”); Westinghouse Elec. & Mfg. Co. v. Wagner Elec. & Mfg. Co., 225 U.S. 604, 614-15 (1912) (“if plaintiff's patent only created a part of the profits, he is only entitled to recover that part of the net gains” and must “give evidence tending to separate or apportion the defendant's profits and the patentee's damages between the patented feature and the unpatented features”); Garretson v. Clark, 111 U.S. at 121 (“When a patent is for an improvement, and not for an entirely new machine or contrivance, the patentee must show in what particulars his improvement has added to the usefulness of the machine or contrivance. He must separate its results distinctly from those of the other parts, so that the benefits derived from it may be distinctly seen and appreciated.”).

¹⁰⁷ See supra notes 11-14 and accompanying text.

¹⁰⁸ Aro, 377 U.S. at 505.

¹⁰⁹ See supranotes 45-49; Proper Reading, supra note 46, at text accompanying notes 45-55.

¹¹⁰ See, e.g., “Structured Approach,” supra note 43, at 639-41 (advocating considering the “share of the profits attributable to the patented invention” but noting the effect of “other successful, pending, and potential patent claims on a technology in deciding how to allocate royalties for that technology”).