Damages Aren’t Always Patently Obvious.

EXECUTIVE SUMMARY

IN PATENT DISPUTES, CPA LITIGATION CONSULTANTS help patent holders demonstrate that “but for” an infringement they could have sold more of their product. Quantifying damages in patent infringement cases can be the focus of a forensic and litigation services practice. THE PANDUIT CASE PROVIDED FOUR QUESTIONS CPA litigation consultants had to address: Is there demand for the patented product? Are there acceptable noninfringing alternatives to the infringing product? Does the patent holder have the manufacturing and marketing capacity to make and sell more of the product? Can the damages consultant quantify the lost profits to a reasonable degree of certainty? THE BREAD AND BUTTER FOR CPA litigation consultants is the ability to quantify the actual lost sales and the lost profits related to those sales. In damages consulting CPAs must begin the analyses by assessing the revenues lost because of the infringement. THE LAW HAS CHANGED SINCE THE PANDUIT CASE. It now is possible to receive an award of lost profits based on a patentee’s market share—despite the presence of acceptable noninfringing alternatives in the marketplace—for related products not actually covered by the patent in question. LITIGATION CONSULTANTS SHOULD CONSIDER other damages that may have resulted from the alleged infringement, such as collateral sales or erosion of prices.

GLENN NEWMAN, CPA, CFE, is a principal at Parente Randolph, LLC, Philadelphia, where he heads the forensic accounting and litigation services group. He is a member of the firm’s executive committee and serves on the AICPA Forensic and Litigation Services Committee. His e-mail address is gnewman@parentenet.com . RICHARD J. GERING, PhD, principal at Parente Randolph, provides consulting assistance including economic and statistical analyses related to commercial disputes. He teaches litigation strategy at Villanova University School of Law. His e-mail address is rgering@parentenet.com .

he jury finds the plaintiff’s patent to be valid and infringed and awards damages in the amount of….”

In recent years juries increasingly have delivered some variation of this message. A spike in lawsuits alleging infringements of intellectual property (IP) rights, usually in the area of patents, has created a niche for CPA litigation consultants who provide in-depth detailed financial analyses to calculate economic damages and give testimony as expert witnesses. Often the disputes are “bet-the-company” matters that can force an infringer to stop manufacturing or selling its top products. A finding of infringement also may open up an exclusive market for a patent holder’s products without fear of violating antitrust laws. Those are very high stakes.

Specifically, federal law (USC title 35, section 284) provides for the recovery of damages resulting from a patent infringement. It says, in part, that “upon finding for the claimant, the Court shall award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty.” Over time an extensive case law road map has developed to clarify the code and its relationship to changing technology and business practices. In most patent disputes the lead attorney hires a CPA and/or other experts to analyze, quantify and report on the potential damages suffered by the patent holder. This article will address relevant issues for CPA litigation consultants when evaluating lost profits from patent infringements (for more information see “ 20 Steps for Pricing a Patent ”).

Guidelines From Georgia-Pacific
The court used these 15 factors—paraphrased here—to determine the type of monetary payments that would compensate for a patent infringement in Georgia-Pacific Corp. v. United States Plywood Corp., 318 FSupp 1116, 6 USPQ 235 (SD NY 1970): The royalties received by Georgia-Pacific for licensing the patent, proving or tending to prove an established royalty. The rates paid by the licensee for the use of other similar patents. The nature and scope of the license, such as whether it is exclusive or nonexclusive, restricted or nonrestricted in terms of territory or customers. Georgia-Pacific’s policy of maintaining its patent monopoly by licensing the use of the invention only under special conditions designed to preserve the monopoly. The commercial relationship between Georgia-Pacific and licensees, such as whether they are competitors in the same territory in the same line of business or whether they are inventor and promoter. The effect of selling the patented specialty in promoting sales of other Georgia-Pacific products; the existing value of the invention to Georgia-Pacific as a generator of sales of nonpatented items; and the extent of such derivative or “convoyed” sales. The duration of the patent and the term of the license.	The established profitability of the patented product, its commercial success and its current popularity. The utility and advantages of the patent property over any old modes or devices that had been used. The nature of the patented invention, its character in the commercial embodiment owned and produced by the licensor, and the benefits to those who used it. The extent to which the infringer used the invention and any evidence probative of the value of that use. The portion of the profit or selling price that is customary in the particular business or in comparable businesses. The portion of the realizable profit that should be credited to the invention as distinguished from any nonpatented elements, manufacturing process, business risks or significant features or improvements added by the infringer. The opinion testimony of qualified experts. The amount that Georgia-Pacific and a licensee would have agreed upon at the time the infringement began if they had reasonably and voluntarily tried to reach an agreement.
Source: Georgia-Pacific Corp. v. United States Plywood Corp., 318 FSupp 1116, 6 USPQ 235 (SD NY 1970).

CASE LAW GUIDELINES
Patent holders may be entitled to lost profits if they can demonstrate that “but for” an infringement they would have sold more of a product than they did during the affected time frame. The 1978 Panduit case provided a four-factor approach that has been widely accepted as identifying the key issues necessary for a recovery of lost-profits damages (see “ Case Citations ”). CPA litigation consultants assessing lost profits should discuss with counsel both Panduit and subsequent case law.

Case Citations Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F2d 1152 (6th Cir. 1978). Rite-Hite Corp. v. Kelley Company, Inc., 56 F3d 1538 (Fed. Cir. 1995). King Instruments v. Perego, 65 F3d 941 (Fed. Cir. 1995). Georgia-Pacific Corp. v. United States Plywood Corp., 318 FSupp 1116, 6 USPQ 235 (SD NY 1970). State Industries, Inc. v. Mor-Flo Industries, Inc. 883 F2d 1573 (Fed. Cir. 1989). Lam, Inc. v. Johns-Manville Corp. 718 F2d 1056, 1065 (Fed. Cir. 1983). Grain Processing Corp. v. American Maize-Products, Co., 185 F3d 1341 (Fed. Cir. 1999). BIC Leisure Prods., Inc. v. Windsurfing Int’l, Inc., 687 FSupp 134, 138 (SD NY 1998), rev’d in part, 1 F3d 1214 (Fed. Cir. 1993).

The four ( Panduit ) questions CPA litigation consultants address are: Is there demand for the patented product? Are there acceptable noninfringing alternatives to the infringing product? Does the patent holder have the manufacturing and marketing capacity to make and sell more of the product? Can the damages consultant quantify the lost profits to a reasonable degree of certainty? To perform patent infringement lost-profits analyses, practitioners need to research the following:

Is there demand for the patented product? Practitioners will analyze sales data, contemporaneous business records and plans related to the product’s launch, marketing and promotion to help the team (lead attorney, CPA and/or other experts) demonstrate a demand for the patented product. Depending on the specific facts and circumstances, demand may apply to a feature within the product or to the product itself. If it is merely a feature, then the damages specialist for that case (who may be the CPA, a marketing analyst or another type of expert) needs to consider whether there is a link between the patented feature and customer demand and, if so, demonstrate that it is an important factor in the purchase of the product.

Are there acceptable noninfringing alternatives to the infringing product? At one time a damages consultant’s infringement analysis by and large consisted of verifying whether there were noninfringing product alternatives in the marketplace. If there were noninfringing substitutes, the law held that the patent holder wasn’t entitled to damages in the form of lost profits. However, this point has evolved as the marketplace has become more complex, and under some circumstances the law allows for lost profits when there are alternatives or substitutes.

Does the patent holder have the manufacturing and marketing capacity to make and sell more of the product? Assuming there’s demand for the patented product and there are no acceptable noninfringing alternatives, CPA damages consultants need to demonstrate the patent holder can both manufacture and market the product. (That’s the basis for asserting profits have been lost.) Typically, the damages specialist should consider current production levels, past manufacturing expansions and any plans for future growth to demonstrate manufacturing capacity. In some industries, such as pharmaceuticals, understanding the sector’s regulatory framework is an important factor. For example, a business with the plant capacity to make a product that it doesn’t have regulatory approval to sell does not meet the “but for” test necessary to obtain lost-profits damages.

After addressing manufacturing capacity, damages specialists also must look at whether the patent holder could have sold the additional product it would have manufactured. This typically is done by assessing the channels of distribution, geographic markets, common customers, and the size and nature of the patent holder’s and the infringer’s sales forces. Analysis of working capital and interviews with key personnel also will help show whether the patent holder had the financial and management capacity to generate the additional sales.

Can the lost profits be quantified to a reasonable degree of certainty? This is the bread and butter for the CPA litigation consultant: the ability to quantify the actual lost sales and the related lost profits. To quantify lost profits, damages specialists must subtract from the projected lost sales all the incremental costs necessary to manufacture, market and sell the additional products that could have been produced “but for” the infringement. Typically, this means performing an analysis to arrive at the incremental margin—the difference between the top-line and bottom-line figures (see “ Innovator v. Copycat ”).

10 Largest Patent-Damages Awards Polaroid Corp v. Eastman Kodak $873.2 million IGEN International, Inc. v. Roche Diagnostics, GmbH $505 million City of Hope National Medical Center v. Genentech, Inc. $500.1 million Haworth, Inc. v. Steelcase, Inc. $211.5 million Hughes Tool Company v. Smith International, Inc. $204.8 million Procter & Gamble Co. v. Paragon Trade Brands, Inc. $178.4 million Exxon Corp. v. Mobil Oil Corp. $171 million Advanced Cardiovascular Systems, Inc. v. Medtronic AVE $166.7 million Viskase Corp. v. American National Can Co. $164.9 million Hughes Aircraft Corp. v. United States $154 million Source: Intellectual Property Today, March 2003.

WHAT'S THE LAW NOW?
The first two factors in the Panduit case have evolved over the years, and it now is possible to obtain lost profits

Based on a patentee’s market share, despite the presence of acceptable noninfringing alternatives in the marketplace.

For related products not actually covered by the patent in question.

But lost profits are not appropriate if a noninfringing alternative would have been available to market with minimal effort.

How does “market share”relate? Based on the 1989 Mor-Flo case, a patent holder is entitled to lost profits, even though acceptable noninfringing alternatives are available in the market at the time of infringement. Under Mor-Flo guidelines patent holders may claim lost profits based on market share. That is, if three companies’ products each have a one-third share of the market and a patent’s validity and infringement are established, the infringement posits that both the patent holder and the company with the noninfringing alternative would have generated 50% of the infringing sales. The patent holder’s damages would be lost profits on half of the infringing units and a reasonable royalty on the remaining half.

What is an “acceptable” alternative? A refinement through case law addresses which noninfringing alternatives are acceptable. In Bic Windsurfing, the court said an alternative is not acceptable if the product is in a completely different price range or category. For example, if a product is intended for an introductory user rather than an advanced user, a lost-profits claim still may be appropriate. Thus, a product has to be not only noninfringing from a technical perspective, but also acceptable from an economic and consumer perspective.

Do the patentee’s products have to be covered by the patent? Is a patent holder entitled to lost profits if the infringing product competes with a product made by the patent holder but not covered by the patent? The 1995 Rite-Hite and King Instruments cases dealt with this issue. If it is “reasonably foreseeable” that but for the infringement the patent holder would have sold more of its product, it is entitled to lost profits on those lost sales regardless of whether the patent holder’s product is covered by the patent at issue.

What is an “available” alternative? Does a product have to be on the market to be considered available? In the 1999 Grain Processing case, the alleged infringer could have designed around the patent in a couple of weeks using readily available technology that was more expensive than the patented process. The court held that because the design-around option was “available” at the time of infringement, the patent holder had no basis for claiming it would have made more sales “but for” the infringement and was not entitled to lost profits. The court explained that a “but for” analysis is hypothetical. Damages consultants must effectively reconstruct what could reasonably be expected to have happened in the marketplace, including alternative actions the infringer could have taken had it not infringed. That is, what steps would a reasonable businessperson have employed had the favored method not been available?

PRACTICAL TIPS TO REMEMBER

Ask counsel to identify any recent case law that has bearing on the damages you’re being engaged to compute. Remember, as the damages specialist, you haven’t been retained to assess the validity of a patent or its alleged infringement—for your working purposes, those key liability points are assumed. Don’t forget that incremental profits do not necessarily equal gross profits. Identify all the collateral products that may be tied to the patented product at issue (razors with razor blades, for example). When evaluating potential alternatives, look to the market. Assess whether the patent holder will have the ability to raise prices when the infringer is removed from the scene. Understand what options the defendant could have employed other than infringing, such as a design-around.

OTHER DAMAGES-RELATED ISSUES
CPA litigation consultants should consider other available damages that may have resulted from the alleged infringement, including lost profits on collateral sales and erosion of prices, for example. Damages for both collateral sales—sales of accessories to go with the product—and price erosion may exceed damages for lost profits. However, damages consultants must understand the relevant case law and perform thorough analyses to prevent opposing counsel from calling their numbers “speculative.”

Understanding the reasonable royalty approach will enable damages consultants to present balanced alternative-damages computations. Because federal law provides that patent damages can be no less than a “reasonable royalty,” this calculation generally is viewed as the damages “floor” (minimum) in a patent infringement dispute.

COMMITMENT IS ESSENTIAL
Quantifying damages in patent infringement cases can be a key part of a forensic and litigation services practice. The cases are complex and challenging, and the damages awards can be quite large. However, one should not dabble in this field; it is neither a sideline business nor for the faint of heart given the stakes involved. It requires an investment in time to understand the issues, the relevant cases and in many instances a particular industry or technology.

Innovator’s incremental profit margin was 80% and its net profit margin was 20%. A third competitor offered a noninfringing competing drug that had sales identical to those of Innovator from 1997 to 1999, for which it paid Innovator a royalty of 10%. So without Copycat in the market, Innovator would have had a market share of 50%.

Damages
Lost profits. Based on the fact that Innovator launched its product in 1997 and that its market share “but for” the sales of Copycat would have been 50% of 1997 sales of $20 million ($10 million for Innovator and $10 million for the third competitor), the damages would have been calculated as follows:

Price erosion. “But for” the infringement, Innovator would have sold its pills at $1.20 each instead of $1—a price reduction of 20%. Copycat’s 1997–1999 sales of $80 million multiplied by Innovator’s 50% market share plus Innovator’s actual sales of $30 million equals total affected sales of $70 million, multiplied by the price reduction of 20% equals $14 million. There may be an argument the price still would have been $1 a pill without Copycat because of the third entrant into the market. If so, there would have been no price erosion.

Reasonable royalty. $5 million: $50 million in Copycat sales that are not included in the lost-profits calculation (1996 sales and 50% of sales from 1997 to 1999) multiplied by the royalty rate of 10%.

Total damages. $51 million (32 + 14 + 5).