Reasonable royalty calculations demand sound expert analysis

Federal courts are cracking down on what they see as sloppy practices in calculating reasonable royalty damages in patent infringement cases. In ResQNet.Com, Inc. v. Lansa, Inc., the U.S. Court of Appeals for the Federal Circuit threw out an award of more than $500,000 and remanded the case for redetermination of damages.

According to the Federal Circuit, the award “relied on speculative and unreliable evidence divorced from proof of economic harm linked to the claimed invention.”

Patent infringement

ResQNet involved the plaintiff’s patented terminal emulation technology, a system that links PCs with mainframe computers. The defendant marketed a terminal emulator program, called NewLook, which was found to infringe on one of the plaintiff’s patents.

The U.S. District Court for the Southern District of New York awarded damages of $506,305 for past infringement based on a hypothetical royalty of 12.5%, plus prejudgment interest. In arriving at this royalty rate, the plaintiff’s damages expert relied on seven licenses, five of which included various nonpatented services (and may or may not have involved the patent at issue) and two of which arose from the settlement of litigation over the infringed patent.

Georgia-Pacific factors

When a patent is infringed, U.S. patent law allows the holder to recover its lost profits, which in no event are to be less than a “reasonable royalty.” Typically, a reasonable royalty is calculated based on the amount that would have been agreed to in a hypothetical negotiation occurring immediately before the infringement began.

In determining this amount, courts generally consider the 15 factors established in the landmark case of Georgia-Pacific Corp. v. U.S. Plywood Corp. Pertinent factors in this case included:

• The nature of the patented invention,
• The extent of the infringer’s use of the invention,
• Actual royalties received by the patent holder for licensing the patent,
• Rates paid by licensees for comparable patents,
• The established profitability of products that use the patented technology,
• The patent’s duration, and
• The lease term

In ResQNet, one of the many ways the plaintiff’s evidence fell short was that the plaintiff’s expert relied exclusively on only one of the Georgia-Pacific factors: royalties received for actual licenses of the patent at issue. He dismissed the other factors, with scant explanation, as having “no real impact here.”

Speculative evidence

The specific licenses the expert relied on also proved to be a problem for the plaintiff. Five of the seven licenses furnished both software and services, such as training, maintenance, marketing and upgrades. These licenses involved high royalty rates in the 25% to 40% range. And they didn’t refer to the patent at issue or show “any other discernible link” to the technology involved in the case.

“The inescapable conclusion,” the Federal Circuit said, “is that [the plaintiff’s expert] used unrelated licenses on marketing and other services — licenses that had a rate nearly eight times greater than the straight license on the claimed technology in some cases — to push the royalty up into double figures.”

The other two licenses were “straight licenses” — that is, they were limited to the technology in question. But they were also unreliable measures of a reasonable royalty. Both licenses arose out of the settlement of patent litigation. One was a lump-sum stock payment that couldn’t be converted into a running royalty rate. The other applied an ongoing rate that averaged substantially less than 12.5%.

Noting that the hypothetical negotiation of a reasonable royalty occurs before infringement, the Federal Circuit explained that license terms arising in a litigation context are not reasonable indicators of an “established royalty” because they may be strongly influenced by a desire to settle the matter and avoid further litigation.

The Federal Circuit also found that the district court’s award was unduly influenced by the defendant’s decision not to offer expert testimony to rebut the plaintiff’s damages calculations. The plaintiff had the burden of proof, the Federal Circuit explained, and the defendant had no obligation to rebut until the plaintiff “met its burden with reliable and sufficient evidence,” which the plaintiff failed to do in this case.

Important guidance

ResQNet provides valuable guidance for lawyers involved in patent litigation, and shows the importance of considering all of the Georgia-Pacific factors in calculating a reasonable royalty, particularly when actual licenses of the technology in question are unreliable.

Moreover, it’s a good idea for defendants to provide expert rebuttal testimony, regardless of weaknesses in the plaintiff’s case. Even though such testimony is technically unnecessary if the plaintiff fails to meet its burden of proof, relying on an appeals court to prove the defendant’s point can be a costly exercise.