Lost Profits Damages for Multicomponent Products: Clarifying the Debate.

• Author: Reinecke, Jason

Table of Contents Introduction I. The Law and Controversy Surrounding Lost Profits in Multi-component Patent Infringement Cases A. Introduction to Modern Patent Damages Law 1. Lost profits damages 2. Reasonable royalties B. The Mentor Graphics Decision C. Was Mentor Graphics Correctly Decided? II. Compensatory Damages in Patent Law: A Comprehensive Economic Framework A. Two or More Market Competitors, Each with Essential Patents B. Three or More Interested Parties: Handling Additional Market Competitors C. Three or More Interested Parties: Considering Nonpracticing Entities. D. Summary of the Analysis: Two Novel Rules III. Clarifying the Debate A. The Value of One Feature of a Multicomponent Product 1. Difference of presumptions 2. Treatment of patented technology 3. Treatment of unpatented technology B. Additional Damages After Paying Lost Profits C. Additional Patents Are Worthless Conclusion Introduction

The application of patent law to multicomponent products has never been as important as it is now. Although single-component products were more common up until the 1990s, (1) multicomponent products have become the norm over the last two decades. (2) To provide just one example, it has been estimated that there are over 250,000 active patents that impact smartphones. (3)

In Mentor Graphics Corp. v. EVE-USA, Inc., the Federal Circuit determined that the "but for" compensatory damages test applies to calculate lost profits damages in patent infringement cases involving multicomponent products. (4) In Mentor Graphics, Mentor proved that Synopsys infringed one of Mentor's essential patents--that is, Synopsys infringed one of Mentor's patents covering a technology that the buyer in the market demanded and which could not be satisfied by any noninfringing alternatives. (5) The court determined that damages should equal the profits the patent owner would have earned "but for" the infringement. (6) Because Mentor's patented technology was absolutely essential to the buyer in the market, Mentor was entitled to damages equal to the sales it would have made had it excluded Synopsys from the market and sold the technology directly to the buyer (that is, monopoly profits). (7) The court rejected Synopsys's argument that because only two of the products' thousands of features were infringing, the damages award should be apportioned between the infringing and noninfringing features; in the court's view, the "but for" damages test "ensures that damages are commensurate with the value of the patented features." (8)

Scholars have hotly debated whether patentees in such cases should receive all damages incurred due to the infringement or a smaller, apportioned award. (9) At first blush, there appear to be particularly forceful arguments on both sides of this debate. On one side, scholars correctly argue that patent law provides patentees with the right to prevent infringement, and that only a "but for" compensatory damages structure adequately compensates patentees when their essential patents are infringed. (10) On the other side, scholars argue that any single feature of a product with thousands of components can only account for a portion of the product's total value, even if it is essential to the buyer in the market. (11) And scholars on both sides agree that the two rules would generally produce drastically different damages awards. (12) I discuss these arguments in greater detail in Part I of this Note, (13) after offering an introduction to the law of patent damages (14) and a deeper dive into the Mentor Graphics decision. (15)

In Part II, I offer a comprehensive economic framework for how this "but for" compensatory damages scheme should be implemented in scenarios that differ from the one before the court in Mentor Graphics but which will inevitably arise in the future. I describe many scenarios in which, even under the rule set forth in Mentor Graphics, parties should not be able to obtain large lost profits awards.

The Mentor Graphics court only explained how a "but for," "make-whole" damages structure would be implemented under the "narrow" facts of the case. (16) In particular, the court only resolved how lost profits should be calculated where there are two interested parties (parties with relevant product sales or patent rights), and where one of those interested parties has a patent on an absolutely essential feature of the product at issue (a feature for which there are no noninfringing alternatives). (17) But in reality, the essential (and nonessential) patents required to produce multicomponent products are often widely dispersed among many different entities, both practicing (entities that compete in the relevant market) and nonpracticing (entities that own a relevant patent but do not compete in the relevant market). In other words, the set of "remarkably simple" (18) facts in Mentor Graphics is the exception, not the rule.

Part II.A discusses how damages should be calculated in cases involving multiple market actors, each of which owns essential patents. Such a situation presents a potential paradox under Mentor Graphics-. Each party with an essential patent will argue it would have made all the sales but for the others' infringement. Part II.A offers the most appropriate resolution of this potential paradox. It argues that lost profits damages are inappropriate in such a scenario and provides an alternative, more appropriate measure of damages.

Part II.B addresses how damages should be calculated in cases involving many market actors, some with and some without essential patents, addressing cases more complex than the two-party scenario presented in Mentor Graphics. Part II.C addresses how additional nonpracticing entities and market actors with nonessential patents should factor into damages calculations.

Part II.D then coalesces this analysis into two novel rules. First, defendants should be entitled to an essential patent defense to lost profits. Under the essential patent defense, a defendant would be exempt from paying lost profits damages if the plaintiffs relevant product sales infringe one or more of the defendant's essential patents. Second, defendants should be entitled to a lost profits defense. Under this defense, once a defendant compensates a plaintiff for a sale that the plaintiff would have made but for the infringement, the defendant is no longer on the hook for additional damages payments related to that sale.

By addressing each of the scenarios about which the Mentor Graphics court was silent, this Note provides the first comprehensive economic framework for navigating potential lost profits claims in our multicomponent world. By exploring the implications of this framework, Part III provides needed clarity to the scholarly debate over Mentor Graphics. First, Part III shows that a properly constructed compensatory damages rule and the proposed apportionment rule would operate far more similarly than scholars currently believe. Second, it shows that if this Note's proposed framework is adopted, each of the concerns expressed by scholars over the Mentor Graphics rule is either alleviated, overstated, or in need of some revision. But that does not mean a compensatory damages rule is free of concerns. Accordingly, Part III concludes by explaining exactly what might remain problematic about compensatory damages in patent law.

1. The Law and Controversy Surrounding Lost Profits in Multicomponent Patent Infringement Cases

   This Part provides an introduction to modern patent damages law and then describes the Mentor Graphics decision's importance within that doctrine. (19) It then discusses the conditions under which the Mentor Graphics decision was correct. (20)

   1. Introduction to Modern Patent Damages Law

      Patent law permits innovators to obtain patents on sufficiently innovative knowledge goods they create. Patents provide patentees with a statutory "right to exclude others from making, using, offering for sale, or selling" their inventions. (21) The purpose of providing this right to exclude others is to grant patent owners the ability, under some circumstances, to obtain supracompetitive (monopoly) profits, an incentive that motivates the creation of knowledge goods. (22) This incentive is important because of a market defect: Knowledge goods are often public goods; once developed, they can be copied and used by others cheaply and quickly. (23) Absent intervention (such as through granting patents), innovators may not be sufficiently incentivized to create knowledge goods in the first place. (24)

      Depending on the circumstances, a patentee's "right to exclude" is protected through injunctions, (25) damages, (26) or both. Because a patentee's ability to obtain an injunction has been somewhat limited in recent years, (27) patent damages law is more important than ever. The remainder of this Subpart provides an introduction to the law of patent damages.

      Patent damages are designed to compensate patentees for losses incurred when their right to exclude is infringed, thus preserving the monetary incentive to innovate. (28) The patent damages statute provides for "damages adequate to compensate for the infringement, but in no event less than a reasonable royalty." (29) Courts have divided patent damages into two types: (1) lost profits, for patentees who can show that but for the infringement they would have made more profit; and (2) reasonable royalties, a concept that sets the damages floor for patent owners who either cannot prove lost profits or (for any number of reasons) choose to collect reasonable royalties instead. (30)

      Generally speaking, lost profits damages provide an award to patentees that corresponds to the profits they would have made "but for" the infringement, thus providing a compensatory remedy to patent owners whose right to exclude has been violated. (31) By contrast, the idea behind reasonable royalties is that "an infringed patent is valuable and could be...