Evidence-based Patent Damages

• Publication year: 2021

Evidence-Based Patent Damages

Taorui Guan

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EVIDENCE-BASED PATENT DAMAGES

Taorui Guan^*

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Table of Contents

I. Introduction..................................................................................................3

II. The Judicial Doctrines of the Hypothetical Negotiation for Calculating Reasonable Royalty Damages...........................9

A. DATE OF THE HYPOTHETICAL NEGOTIATION AND ROYALTY ADJUSTMENT.......................................................................................................................11
B. THE ENTIRE MARKET VALUE RULE AND THE SMALLEST SALABLE PATENT-PRACTICING UNIT RULE..........................................................................14
C. ROYALTY STACKING.......................................................................................................18

III. Royalties in Patent Licensing Contracts......................................20

A. AN OVERVIEW OF ROYALTIES IN PATENT LICENSING CONTRACTS ....................................................................................................................................................... 20
B. ROYALTY BASE...................................................................................................................26
C. ROYALTY ADJUSTMENT................................................................................................33
D. APPORTIONMENT METHODS....................................................................................38
E. ANTI-ROYALTY-STACKING CLAUSES....................................................................43

IV. Implications....................................................................................................46

A. ADJUSTMENTS TO REASONABLE ROYALTY.....................................................47
B. APPORTIONMENT BY FORMULA.............................................................................51
C. ARRANGEMENTS TO DEAL WITH ROYALTY STACKING..........................56

V. Conclusion.......................................................................................................58

VI. Appendix- The Dataset..............................................................................59

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I. Introduction

The past three decades have witnessed the spread of a movement toward "evidence-based" practices in which scholars and practitioners across a wide variety of disciplines have begun to use the best available evidence to test and improve pre-existing practices that lack the support of rigorous data.¹ This movement began in the field of medicine² then gradually extended to other fields, including psychology,³ education,⁴ business,⁵ and public policy.⁶

This movement has also reached the field of law.⁷ Legal scholars and practitioners have embraced the idea of taking an evidence-based approach to

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law by making improvements to law according to empirical findings.⁸ Since the 1990s, the quantity of empirical scholarship, which builds the evidence base for the reform of existing law, has increased continuously.⁹ Based on existing evidence, some scholars proposed legal reform. For example, in civil procedural law, Jeanne Charn has advocated for improved access to legal services for indigent defendants in civil cases based on the findings of a multi-year program of random controlled trials.¹⁰ In constitutional law, Christine Jolls applied an "evidence-based assessment" to the effect of legally required communications, and then recommended an adjustment to the courts' analysis of the First Amendment with regard to these communications.¹¹ Sonja B. Starr examined both evidence that came from the real world, and evidence that she generated through a "randomized experiment using fictional cases."¹² Based on the findings, she proposed an adjustment to criminal sentencing.¹³ The idea of using evidence to inform legal practice has also spread among legal institutions. As Cecelia Klingele noted, there has been a "surge in the popularity" of "evidence-based practices" in recent years among "courts, community supervision agencies, and correctional institutions" for reducing future crimes.¹⁴ These practices are based on evidence from criminological research about what constitutes effective crime prevention.¹⁵

Although the efforts to generate evidence and use it to improve the law have produced many fruits, the attempt to make all law based on solid evidence is still far from complete.¹⁶ As Jeffrey Rachlinski put it, "it is well short of creating an evidence-based legal system."¹⁷ At least two problems impede the movement in

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this direction. The first is the law itself—"law has conflicting goals."¹⁸ Legal reform is necessary in order to integrate existing evidence into law. However, if the goal of a given law is unclear, evidence will not be sufficient to change it. Because when a law's goal is contestable, the direction in which to reform it—and by extension, on which evidence to base the reform—is unclear as well.¹⁹ But there are areas where the goal of a law is clear, while the factual basis of the law is unclear. In these areas, as the doctrinal areas that this Article will examine, an assessment of the evidence can clarify the factual basis, which will pave the path for the law's reform.

The high cost of collecting evidence is also an impediment to building an evidence-based legal system. For the legal community, developing the research capacity for generating evidence can be a "challenge."²⁰ In certain areas of law, such as intellectual property, a "heavy investment" might be necessary.²¹ This impediment is particularly relevant to the development of evidence-based judicial doctrines. Under the current legal system, litigation results, or case law, become the precedent for future determinations. While the factual basis for a law comes from legislators, who can actively collect and analyze empirical evidence, judicial doctrines stem from judges who tend to base their decisions on the evidence that litigants present. Litigants, however, are unlikely to invest heavily in the production of empirical evidence when they can rely on anecdotal evidence to support their case.²² They have no incentive to collect empirical evidence to inform future judicial doctrines.

Intellectual property is one of the fields where the law still lacks a solid evidence base. As John M. Golden, Robert P. Merges and Pamela Samuelson pointed out, in the foreword of a Texas Law Review symposium called Steps Toward Evidence-Based IP, "[e]ven after decades of growth, IP studies have far to go before we can even hope for consensus about the proper bounds of evidence-based intellectual property."²³ In their view, evidence that reveals the operation of the intellectual property system and that supports potential reforms remains "frustratingly sparse."²⁴ They also called for legal scholarship that would

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generate the empirical evidence that would serve as the base for future legal reform.²⁵

This Article brings the field one step closer to evidenced-based intellectual property law. It investigates one area—the law of patent damages. It tackles the unmet need to examine the factual basis behind the judicial doctrines for calculating patent damages. Under 35 U.S.C § 284, courts frequently use "reasonable royalty" patent damages to compensate patentees for patent infringements.²⁶ A reasonable royalty is calculated by mimicking the ways that patent licensing parties calculate royalties.²⁷ Courts imagine the infringed patentee as a willing licensor and the infringer as a willing licensee. They then envision, "the terms of a licensing agreement reached as the result of a supposed meeting between the patentee and the infringer at the time infringement began."²⁸ Though such a meeting never happened, courts aim to determine the amount of royalties that the infringer would have paid the patentee had there been a negotiated agreement. This number becomes the award of patent damages that the infringer must pay the patentee. This approach is called "hypothetical negotiation."²⁹

The hypothetical negotiation is designed to mimic the way that patent licensing parties calculate royalties. Despite this design, scholars devote little attention to testing the doctrines of the hypothetical negotiation against how parties calculate royalties in actual patent licensing contracts. Legal scholars have conducted several conceptual or analytic assessments to calculate patent damages but have not provided an empirical assessment in this regard.³⁰ Economists have

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conducted some empirical studies of royalty calculation in patent licensing. Still, none of these empirical studies examined the contractual terms against doctrines of patent damages.³¹ Without a study to compare actual licensing practices and the legal doctrines, we cannot know whether the hypothetical negotiation doctrine reflects actual patent licensing practices, as alleged.³²

To fill this gap, this Article has carefully analyzed 400 patent licensing agreements that are the "material contracts" of publicly traded companies (meaning that their business substantially depends on them). These contracts reveal how patent licensing parties calculate royalties for the use of patents. This Article tests the doctrines of the hypothetical negotiation against them to see whether the doctrines reflect actual patent licensing practices. While this set of contracts might not represent the overall population of patent licensing contracts, many being contracts between small private companies and possibly

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not significant enough to be regarded as material contracts, it is the best evidence available to the public. These contracts reveal how parties calculate royalties for high-value patents that are important to their businesses.

After a systematic examination of these patent licensing contracts and the doctrines of the hypothetical negotiation, this Article finds divergences between them in at...