Runaway Patent Damages Awards: Is Statutory Reform on the Way?

The Los Angeles Daily Journal
by Chris Marchese
August, 11, 2010
Posted with the permission of the Daily Journal Corp. (2010)

Patent infringement damages have become a prominent legal, economic, and social controversy. This controversy has grown from the soaring damages awards handed down by juries over the past decade. The potential to “hit the patent lottery” has spawned scores of lawsuits by non-practicing entities, which function solely to acquire patents and file lawsuits seeking huge damages awards that often have little relation to the actual value of the patented invention.

This growing problem of runaway damages awards stems in large part from the wide-open nature of patent damages law, especially reasonable royalty damages. The damages provision in the current Patent Act gives little guidance, stating only that courts must award damages adequate to compensate for infringement, “but in no event less than a reasonable royalty.” The statute says nothing, however, of how reasonable royalty damages should be calculated, laying responsibility for creating legal structure at the foot of the courts.

Congressional action is needed to bring some order to the damages universe. Although Congress has made an effort over the past few years to reform patent damages law, the damages statute remains unchanged. Decisive legislative action, codifying clear guidelines for courts and juries to calculate awards commensurate with the value of asserted patents, would be a big step in the right direction.

The most common methodology for computing reasonable royalty damages was formulated by a District Court in 1970 in a famous case now known simply as Georgia Pacific. The Georgia Pacific methodology envisions a hypothetical negotiation between a willing licensor and a willing licensee occurring at the time infringement began, using a laundry list of 15 factors to guide the negotiation. The methodology has given plaintiffs and defendants enormous leeway in crafting damages theories, and can lead to verdicts that far exceed the value of the patented invention. The subject of much recent legislative activity is the creation of clearer statutory guidelines that would be user-friendly, uniform, and specific for courts and juries, a change long overdue.

Congress has worked for nearly four years to pass legislation that would reform damages law, but the proposed legislation has failed to pass – in large part due to conflicting interests in different areas of science and technology. Three groups with diverging interests have emerged in the debate: the information technology industry; the biotechnology and pharmaceutical industry; and non-practicing entities and research institutions that license patents but do not sell products.

Dozens or hundreds of various patents, some of which relate to very small parts, often cover information technology products. Information technology companies want the law to limit damages to the value of the specific part covered by the patent and its relative contribution over prior technology.

Biotechnology and pharmaceutical companies often have a single product covered by a single patent, obtained after significant investment into the product’s development. They do not want legislation designed to limit damages. Non-practicing entities often derive income from licensing and litigating patents, and also oppose inserting limitations into the damages statute.

Congress’ first serious effort to reform patent damages law was in 2007. Bills were introduced in the House and Senate that codified two principles of damages law intended to rein-in damages awards: the entire market value rule and apportionment. The entire market rule applies when a patent covers a single feature of a multi-featured product, and precludes reasonable royalty damages based on the entire product price unless the patent’s specific contribution over the prior art drove demand for the product. The apportionment rule requires that the royalty rate would apply “only to the portion of the economic value of the infringing products or process properly attributable to the claimed invention’s specific contribution over the prior art.” The apportionment rule would thus result in higher damages for pioneering inventions and lower damages for slight improvements over the prior art.

The 2007 bills never made it out of Congress mostly because the polarized interest groups were at odds. Information technology companies urged inclusion of the entire market value and apportionment provisions to stem the tide of grossly excessive damages. Non-practicing entities, biotechnology and pharmaceutical companies took essentially the opposite view. In 2009 the Senate drafted compromise legislation, introducing a flexible gatekeeper function for courts, while the House retained the entire market value rule and apportionment. As a gatekeeper, a court would exclude unsound damages theories and irrelevant evidence, and provide clear jury instructions on damages. This would be achieved as follows: Prior to trial, the parties would propose the methodologies and factors for jury instructions on damages; the court would limit the parties and the jury to considering only the relevant methodologies and factors and admit only relevant evidence; the court would determine whether sufficient evidence supports any damages proposed by a party or found by a jury. Although trial courts have always had the discretion to act as a gatekeeper, the new legislation would create a statutory duty to do so, and in the specifically enumerated ways.

Congress’ damages reform effort has sparked the interest of judges on the Court of Appeals for the Federal Circuit, some of whom believe that courts can regulate damages without Congressional interference. The most vocal has been Chief Judge Randall R. Rader. He has authored opinions at the appellate and district court levels aimed at putting limits on reasonable royalties, applying the entire market value rule on several occasions to gut inflated damages numbers submitted by overly aggressive plaintiffs. He has also spoken publicly urging litigants to use sound economic principles in computing damages.

Two of Judge Rader’s district court opinions illustrate that, in the absence of statutory guidance, the court can still exercise its gatekeeping function to prevent parties from ignoring the entire market value rule. In Cornell University v. Hewlett-Packard Co., 609 F.Supp.2d 279 (N.D. N.Y. 2009), the plaintiff’s patent covered a feature that enhanced performance of computer microprocessors, but the plaintiff sought reasonable royalty damages based on the sales price of defendant’s servers, of which the patented feature was but a small part. Judge Rader ruled in limine that plaintiff had run afoul of the entire market value rule and directed the plaintiff to use a more granular part of the servers as the royalty base. (The royalty base is multiplied by the royalty rate to arrive at the damages figure.) After the plaintiff trimmed its royalty base to a server component, called CPU bricks, the jury found infringement and awarded damages of $180 million. Judge Rader, however, ruled post-trial that plaintiff’s patented feature still did not drive demand for CPU bricks, imposed an even smaller server component as the base, and reduced the damages award to $53 million.

Similarly, in IP Innovation LLC v. Red Hat Inc., 2010 WL 986620 (E.D. Tex. 2010), Judge Rader sitting by designation ruled that plaintiff’s damages theory violated the entire market value rule. The plaintiff’s patent covered a single feature within a computer operating system with many features, but plaintiff sought to use the operating system as the royalty base. Judge Rader rejected plaintiff’s royalty base under the entire market value rule because plaintiff had failed to show “some plausible economic connection between the invented feature and the accused operating systems…”

As evidenced by the repeated runaway awards, the existing case law does not have the kind of force, or clarity, that legislation would deliver. Statutory codification of entire market value rule and apportionment would put an end to searching for guidance in the case law – which can be murky and difficult to harmonize into a simple jury instruction – and install the courts’ gatekeeping function as a cogent, statutory mandate to ensure uniform results across the district courts, especially those with limited patent experience.

Given the high stakes and the need for clarity, Congress should step in and pass damages legislation with teeth, providing maximum guidance and ensuring just and fair results. This will require both installing the court’s role as a gatekeeper and including the entire market value rule and apportionment. The plaintiff should be required by statute to prove its patented invention drives demand for the royalty base and the value of the invention relative to the prior art. The defendant should then respond to that proof. This approach will, on the one hand, prevent overreaching jury awards in cases where the invention is a small feature in a large product and, on the other, fairly compensate inventors with pioneering inventions.

Chris Marchese is a principal in the San Diego office of Fish & Richardson. His practice focuses on patent litigation and intellectual property counseling. He is co-author of a treatise on patent damages published by Thomson West.