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As patent reform debate in the 111th Congress focused on limiting juries' excessive damages awards, the U.S. Court of Appeals for the Federal Circuit addressed the need for rethinking patent infringement damages in four cases--culminating with the court's Jan. 4 ruling in Uniloc v. Microsoft--that each appeared to chip away at the motivation behind the reform provision.
With the Uniloc decision fresh in their minds, experts on the issue told BNA that the concern over district courts' misapplication of the “entire market value” rule--a key element of the congressional debate--was greatly minimized. Some further questioned the need for Congress to codify the “gatekeeper” role of the district court judge.
If the new Congress takes the advice of these experts and further limits or eliminates compensatory damages from patent reform measures expected to be introduced, it will be the third Congress to step back while a key reform issue was resolved instead by either the Federal Circuit or the U.S. Supreme Court.
Legislation aimed at reforming U.S. patent law emerged in the wake of reports by the Federal Trade Commission in 2003 (66 PTCJ 727, 10/31/03) and the National Academy of Sciences in 2004 (67 PTCJ 586, 4/23/04).
The first bill was drafted in 2005 with provisions addressing the multitude of problems cited in the reports (70 PTCJ 142, 6/10/05), but a major focus of congressional debate was on a provision that limited the ability of a patent holder to obtain an injunction in a patent infringement action (70 PTCJ 201, 6/17/05). The 110th Congress ended in December 2006 without agreement on the bill.
In May of that year, the U.S. Supreme Court addressed injunctive relief in eBay Inc v. MercExchange LLC, 547 U.S. 388, 78 USPQ2d 1577 (2006) (72 PTCJ 50, 5/19/06).
The decision apparently pleased the bill's proponents. Bicameral and bipartisan bills were again introduced in 2007 (73 PTCJ 727, 4/20/07) without the provision on injunctive relief. A provision on willful infringement was then a hotly debated point, until the Federal Circuit's curtailment of willfulness findings in In re Seagate Technology LLC, 497 F.3d 1360, 83 USPQ2d 1865 (Fed. Cir. 2007) (en banc) (74 PTCJ 491, 8/24/07)
Though the bills introduced in the 111th Congress--S. 515 and H.R. 1260--retained provisions on willfulness (77 PTCJ 438, 3/6/09), the sponsors contended that those provisions merely codified Seagate's “objective recklessness” standard.
As the 2009 bills were debated, it became clear that the provision on compensatory damages had risen to the top of the controversial issue pile (78 PTCJ 28, 5/8/09). The damages provisions in the original bills attempted to limit application of the “entire market value,” or EMV, rule for assessing patent infringement damages, and otherwise calculate a reasonable royalty based on “the economic value of the infringing product or process properly attributable to the claimed invention's specific contribution over the prior art.”
A Senate Judiciary Committee compromise sharply curtailed the damages provisions and instead focused on the district court judges' “gatekeeper” role. Those revisions--part of a “Manager's Amendment” to S. 515--would have provided opportunities for trial judges to limit the evidence that can be introduced and the damages calculation factors to be presented in jury instructions. But the House clearly disagreed with the purported compromise (78 PTCJ 28, 5/8/09), and once again no action was taken on the legislation in either house through 2011.
Early in the debate in 2009, Sen. Arlen Specter (D-Pa.) urged the bill's primary sponsor, Senate Judiciary Committee Chairman Patrick J. Leahy (D-Vt.), to postpone consideration of the bill until the Federal Circuit heard arguments in Lucent Technologies Inc. v. Gateway Inc. (77 PTCJ 488, 3/13/09). The Lucentcase was considered a poster child for runaway jury awards--$385 million in damages based on Microsoft Corp.'s infringing sale of software programs, including the multifunctional Microsoft Outlook, for infringing a patent on picking a date from a calendar.
On appeal, Microsoft argued that the jury inappropriately applied the EMV rule to calculate the damages based on the total value of each infringing Microsoft program. In September 2009, the Federal Circuit affirmed patent validity and infringement judgments that Microsoft had also challenged, but ruled that the jury's damages calculation lacked sufficient evidentiary support. 580 F.3d 1301, 92 USPQ2d 1555 (Fed. Cir. 2009) (78 PTCJ 583, 9/18/09).
Writing for the court, Chief Judge Paul R. Michel remanded the case for a new trial on damages, saying, “In the present case, the jury had almost no testimony with which to recalculate in a meaningful way the value of any of the running royalty agreements to arrive at the lump-sum damages award.” But the court sent at least two messages to Congress as well. First, as to the gatekeeper role of the district court judge--keeping evidence out of the trial that has tended to lead to large jury awards--Michel was clear in noting that the problem in the Lucent case did not arise from any failing by the district court judge on that count. Rather, he faulted Microsoft for allowing excessive royalty rate evidence to be presented without objecting.
Second, he addressed criticisms of the court's prior EMV jurisprudence. “There is nothing inherently wrong with using the market value of the entire product, especially when there is no established market value for the infringing component or feature,” he said, “so long as the multiplier accounts for the proportion of the base represented by the infringing component or feature.”
Two cases after Lucent focused on limiting at trial the introduction of purportedly “comparable” licenses that patent owners had with licensees, suggesting that the royalty bases and rates--or lump-sum royalties--in those licenses should form the basis for the award after an infringement finding. The patent owners had included as evidence high-value licenses that inevitably included more than just a license to the patent or patents at issue in the infringement case.
In February 2010, in ResQNet.com Inc. v. Lansa Inc,, 594 F.3d 860, 93 USPQ2d 1553 (Fed. Cir. 2010) (79 PTCJ 422, 2/12/10), the court criticized the trial expert's reliance on licenses that included services unrelated to the claimed invention, such as training, maintenance, marketing, and software upgrades. Then on June 15, in Wordtech Systems Inc. v. Integrated Networks Solutions Inc., 609 F.3d 1308, 95 USPQ2d 1619 (Fed. Cir. 2010) , the appeals court ordered a new trial on damages because the lump-sum licenses introduced did not describe “how the parties calculated each lump sum, the licensees' intended products, or how many products each licensee expected to produce.” Further, the court said that for running-royalty licenses, “some basis for comparison [to the infringing product] must exist in the evidence presented to the jury.”
Most recently, on Jan. 4, the court vacated another $388 million jury award against Microsoft, in Uniloc USA v. Microsoft Corp., No. 2010-1035 (Fed. Cir. Jan. 4, 2011) (81 PTCJ 275, 1/7/11).
The Uniloc court held that the 25 percent “rule of thumb,” that many lower courts have used to determine what percentage of an infringer's profits should go to the patent holder, is “a fundamentally flawed tool.” Since that rule was the basis of the damages calculations heard in the Uniloc case, the court said that the district court erred by not excluding the testimony.
The court further held that testimony as to the entire market value of the Microsoft products that used the alleged infringing component was improper as well. It reaffirmed that for the EMV rule to apply, the patentee must prove that the patented feature is the basis for customer demand, and that testimony using that value as a “check” on the reasonableness of the 25 percent calculation skewed the jury's calculation.
Consequently, with this collection of decisions as a backdrop, BNA asked former Chief Judge Michel and other experts to address whether the Federal Circuit has reined in the problem in damages sufficiently so as to negate the need for reform.
“We're seeing changes in Lucent, ResQnet, and Uniloc, the same as happened in other areas of patent reform in the last six years,” Mark A. Lemley, a noted patent law professor at Stanford University, Stanford, Calif., told BNA. “While Congress stalled, the courts stepped in.”
“Damages law is unavoidably complex due to the myriad factual situations presented in the vast variety of cases,” Michel said as an initial comment. “Consequently, it does not lend itself to the simplistic, one-size-fits-all approach that legislation necessarily embodies. That is precisely why damages law in nearly every other area has wisely been left to the courts. Their case-by-case method of adjudication tailors the remedy to fit the wrong.”
“Legislation is a very blunt instrument with which to attack the damages problem, far too blunt to avoid collateral damage,” according to William C. Rooklidge of the Howrey law firm, Irvine, Calif. Rooklidge and Martha K. Gooding wrote a paper, “When Hypothetical Turns to Fantasy: The Patent Reasonable Royalty Hypothetical Negotiation, (80 PTCJ 700, 9/24/10), for this journal that was cited by the Uniloc court favorably. “The Federal Circuit went a long way toward barring the tactics that Martha and I identified in our article,” Rooklidge said in BNA's Uniloc follow up with the damages expert. “The court's job isn't done, but they've made huge strides.”
Michel was even more adamant. “Congress should simply let the courts do their work and not intervene in an area where it cannot help,” he concluded.
Even Lemley, a pro-reform witness at the Senate Judiciary Committee hearing on S. 515 (77 PTCJ 484, 3/13/09), questioned whether the EMV-related language was still necessary in the next legislative attempt. “The gatekeeper provision, coupled with the bifurcation of damages in trials, may well be sufficient, assuming the courts step up,” he told BNA.
“The Federal Circuit has done some encouraging things,” he said. Though he conceded that the appeals court's decisions got rid of a number of the largest problems, he said that the patent community still needs more affirmative guidance. For one, Lemley argued, the court has yet to deal with examples of instances where the patented component is actually found to be the reason for consumer demand. We do not yet have guidance on how to determine the appropriate royalty rate when a court finds that the EMV rule would thus be applied, he said.
However, one comment by Michel at least partially explained why such guidance will take time: “The EMV rule is not the real problem, for it is seldom invoked since one component of an electronic device rarely is the reason consumers buy the device.”
But just failing to pass the threshold test may not prove to be enough to keep out of the courtroom evidence of the total revenues from a product containing a component found to be infringing.
One such showing occurred in Uniloc, in fact, as Uniloc's expert used total revenues of the Microsoft products as a basis for a “reality check” against his 25 percent rule-of-thumb calculation. The Uniloc court rejected that as an alternative way to enter total revenues into evidence, Rooklidge said.
But if the component is at least one reason consumers buy the product, as litigator Douglas R. Nemec of Skadden, Arps, Slate, Meagher & Flom, New York, put it, “It's still a percentage question one way or another.”
In his comments to BNA, Michel clarified his Lucent position along those lines. “In many cases, courts simply cannot value the component by itself because it is not sold alone,” he said. “Therefore, courts are compelled to rely on amounts that represent an aggregation of many components, occasionally the device itself. I see nothing wrong with this approach so long as the multiplier is appropriately discounted to reflect the value that the component adds to the device, which ordinarily is quite modest.”
Indeed, in Lucent, the court would have allowed total revenues as a base. “Microsoft surely would have little reason to complain about the supposed application of the entire market value rule had the jury applied a royalty rate of 0.1% (instead of 8%) to the market price of the infringing programs,” the court said.
But Nemec agreed with the Uniloc court's conclusion that just giving the trial lawyer the ability to “throw out a big number” for total revenues--even with a miniscule royalty rate--has the potential to “skew the damages horizon for the jury,” as the court described.
Similarly, Rooklidge had been troubled by the Lucent court's specific statement, after recognizing there was “nothing inherently wrong” with the EMV rule: “The base used in a running royalty calculation can always be the value of the entire commercial embodiment, as long as the magnitude of the rate is within an acceptable range (as determined by the evidence).”
“Many patentees have relied [on that dictum] to use total sales revenue as a royalty base even though the entire market value rule is inapplicable,” Rooklidge said. He told BNA that Uniloc “contextualized this Lucent dictum out of existence.”
The difference in context is evident in the difference in the fact situations in the two cases. In Lucent, the patented element of the much larger product is a feature for which consumer demand could be relevant, however small. But in Uniloc, the invention is in preventing users from making copies of Microsoft software on more than one machine. Thus, it was Microsoft--not consumers--who valued the patented element, and it was directed to a cost factor for software maker. If revenues even could be considered a relevant base, the value of the invention to Microsoft would not be based on its total revenues from the software, but rather only on revenues it received that it would have lost had users made the illegal copies.
Rooklidge said that Uniloc and Lucent teach that “the percentage royalty approach works if--and only if--the patentee can quantify in a reliable way the value of an invention expressed as a percentage royalty on a base of revenues, but the total dollar amount of compensation must be compensation for the use of the claimed invention.”
Indeed, he noted examples of fact patterns in which the claimed invention affords the infringer a reduction in the cost of the product, regardless of the revenue the product generates. In those fact patterns, he said, “No percentages would be involved, or should be involved, because the cost savings are not tied to the price, revenue, or profit” of the product containing the infringing component.
“Patentees' damages experts can be creative, and the courts need to address the more creative approaches to avoiding the requirement for rigor in damages analysis,” Rooklidge said. But the question remains whether the Federal Circuit's decisions have given--or at least, with more refinement, will eventually give--district courts sufficient guidance to identify such rigor and keep faulty analysis away from the jury.
As noted above, Lemley still argued in favor of keeping the gatekeeper language in the patent reform bill. “[Federal Circuit judges] are not accepting damages decisions no matter how crazy the underlying theory,” he conceded. “They are not accepting implausible theories.” But that does not necessarily mean that district courts are now prepared to do the same, he said.
For example, while Nemec argued that courts can keep prejudicial evidence away from the jury with properly filed motions in limine, Lemley countered that not all courts treat such motions with the same level of importance. The gatekeeper language in the S. 515 Manager's Amendment “creates an affirmative obligation on the district court judge,” he said. In fact, Nemec conceded that point. “Perhaps not all courts are vigilant in enforcing [Federal Rules of Civil Procedure and Evidence] when it comes to damages,” he said, “and in that sense the proposed legislation could prove beneficial by shining a light on the importance of the gatekeeping role in the patent damages context.”
But Rooklidge and Michel were opposed to any legislation on the issue of patent infringement damages whatsoever. “Even the seemingly innocuous gatekeeper provisions of S. 515 will do more harm than good,” Michel said. “The provisions contain new, ambiguous terms that parties will fight over for years. So the provisions would increase uncertainty, cost, and delays.”
“Congress cannot even begin to legislate with the precision needed, let alone obtain a consensus among the affected stakeholders,” Rooklidge added. And as a practical matter, he said, “By the time any bill gets through to President Obama's desk, the Federal Circuit will have moved the law further in the positive direction. The affected stakeholders should move on to more constructive topics.”
But Lemley and Nemec pressed the issue of giving more guidance to courts, whether legislatively or through additional court decisions. Each pointed specifically to the problem of presenting to the jury all 15 factors for determining a reasonable royalty as defined in Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116, 166 USPQ 235 (S.D.N.Y. 1970). Precedents to date “don't do a lot to help draw lines on relevance” of individual factors, Nemec said. The problem is that experienced litigators can “argue that virtually anything is at least 'relevant' to patent damages” under one of the factors, he said.
“Yes, we want the district courts to limit the number of factors that the jury should consider,” Lemley said. “And it needs to be determined on a case-by-case basis, but it would help to know more about what factors tend to apply to what situations.”
Lemley pointed to a paper he co-authored with Daralyn J. Durie of Durie Tangri, San Francisco. The authors suggested, “Most of the factors in the Georgia-Pacific test, in fact, boil down to three fundamental questions: (1) what is the marginal contribution of the patented invention over the prior art?; (2) how many other inputs were necessary to achieve that contribution, and what is their relative value?; and (3) is there some concrete evidence suggesting that the market has chosen a number different than the calculus that results from (1) and (2)? ”
“By structuring the inquiry in this way, courts (or Congress) will not only simplify the question for the jury, but also enable district courts and the Federal Circuit to easily review the factual basis for a jury award,” Lemley and Durie contended.
Though Rooklidge did not comment specifically on Lemley's approach, he undoubtedly prefers that courts--not Congress--eliminate any confusion resulting from the multi-factor test.
“The district court judges get it,” Rooklidge said, “and they are moving to impose the Federal Circuit's recent emphasis on rigor.”
He pointed to the Jan. 6 decision in the U.S. District Court for the Eastern District of Texas--a consistent target of pro-reform advocates because of its perception as a pro-patentee, excessive-award court--throwing out a jury award and calling for a new trial on damages, in Versata Software Inc. v. SAP America Inc., No. 2:07-cv-00153-CE (E.D. Tex Jan. 6, 2011). Judge Charles Everingham wrote that, in light of the four Federal Circuit rulings noted above, “the court is persuaded that it erred when it admitted [the plaintiff”s expert's] testimony and his damages model.”
In fact, Lemley noted that he may well have the opportunity to advance his approach to district courts' analyses in another manner without necessarily requiring legislation. Lemley serves on the committee responsible for the model jury instructions for the U.S. District Court for the Northern District of California. Along with upcoming Supreme Court decisions on unrelated aspects of patent law, he said, the Federal Circuit's recent damages jurisprudence may give the committee a reason to reconvene.
One additional provision in the S. 515 Manager's Amendment last year could have an impact that the Federal Circuit, at least, cannot resolve--bifurcating the liability and damages issues at trial, dealing with the latter only after liability is found. The provision called this bifurcation “sequencing,” and required that a “court shall grant such a request absent good cause to reject the request.”
Explaining his support for the provision, Lemley cited a further structural issue with case presentation when liability and damages arguments are decided together. “A lot of problems arise from the fact that the parties don't spend much time on damages,” he said. “The defendants in particular don't want to undercut their story that they don't have to pay anything.” As for the plaintiffs and their disincentive to be rigorous in the damages analysis in some cases, he said, “They probably don't want to know the answer.”
But Rooklidge said the decision should be left up to the courts. “Trial judges need flexibility to manage the cases on their dockets, and sequencing trials should be left to their informed discretion.”
Whatever the arguments for or against proceeding with patent reform on damages, and what the provisions should encompass, BNA asked the experts if they were willing to predict what will happen in the 112th Congress.
Michel said that the pressure on Congress is coming from just a dozen companies, most based in Silicon Valley in California, and that those companies “will renew their massive lobbying anyway. I do not expect them to stop unless they achieve their goal of reducing damages for infringement of patents for parts of complex electronic devices.”
Lemley, whose university sits in the heart of Silicon Valley, assumed the high technology firms were “more or less happy with what's been going on in the courts” as to damages. He believed that their negative reaction to the S. 515 Manager's Amendment was a result of multiple instances of their patent reform expectations being “whittled away” in the congressional negotiations. “They felt like they were losing the political battle even though the [full bill] was generally positive to them.” But, he suggested, “The Manager's Amendment is better than nothing.”
Again, Rooklidge would prefer that Congress leave the damages issue alone completely. He hoped that, after the recent decisions, the firms “would have to realize that the perfect is the enemy of the good, and the law has been clarified very much for the good.”
By Tony Dutra
Lemley's paper is published at 14 Lewis & Clark L. Rev. 627 (2010) and is also available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1567019
The damages provisions of H.R. 1260 (containing the EMV language) and the S. 515 Manager's Amendment (containing the gatekeeper and bifurcation language) are at, respectively, http://pub.bna.com/ptcj/HR1260onDamages.pdf and http://pub.bna.com/ptcj/S515MAonDamages.pdf
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