The misuse of reasonable royalty damages as a patent infringement deterrent.

• Author: Love, Brian J.

1. INTRODUCTION II. DETERRING INFRINGEMENT WITH REASONABLE ROYALTY AWARDS A. Brief Introduction to Patent Infringement Damages B. Patent Damages as Pecuniary Compensation C. Inflation of the Reasonable Royalty Measure of Damages D. Heads-I-Win, Tails-You-Lose: Reasonable Royalties as an Infringement Deterrent III. THE RATIONAL INFRINGEMENT MYTH A. The Willfulness Doctrine and Others Exist to Deter Blatant Infringers B. Reasonable Royalties Already Incorporate a Premium C. Patent Holdup IV. INNOCENT INFRINGERS CANNOT BE DETERRED A. Ignorance Is No Defense--But Should Be B. Most Infringement Is Innocent Infringement 1. No One Reads Patents--And for Good Reason 2. Independent Invention Is the Rule, Not the Exception V. HEADS-I-LOSE, TAILS-YOU-WIN: PATENT CHALLENGES AS PUBLIC GOODS VI. PATENT REFORM MEASURES A. Carve Out Ordinary Infringers B. Single Out Blatant Copyists VII. CONCLUSION I. INTRODUCTION

   Psychologists, economists, and biologists agree that humans feel an instinctive need to punish bad actors--to seek revenge against liars, cheats, and free riders--regardless of the deterrent effect such retribution has on future scoundrels. (1) Although we hope the judges who apply society's laws are capable of rising above such primal desires, are we so sure that judges are different? If u.s. patent law is any indication, the answer is a resounding no. As this Article demonstrates, the proclivity of jurists and jurors toward just-desserts retribution has had a significant impact on the evolution of how u.s. patent law treats those found liable for patent infringement.

   This Article documents the striking fact that courts have time and again awarded reasonable royalty damages for patent infringement that rise well above any objectively "reasonable" level for the apparent purpose of punishing defendants for their infringing conduct. (2) Numerous cases demonstrate that the Federal Circuit is more than willing to award inflated reasonable royalties--at times enhanced by an order of magnitude or more (3)--to ensure that patentees receive what the court deems an appropriate level of recovery, punish infringers, and deter those who might choose to infringe in the future. Although this practice may be commendable in intent (4) and supported by simple intuitive appeal, (5) when considered in context of the patent system as a whole, distorting the reasonable royalty measure of damages is a needless (indeed, almost certainly counterproductive) and ineffective means of ensuring an optimal level of reward for inventors and deterrence for infringers.

   This Article explores the inflation of reasonable royalty awards and concludes that this practice simply makes no sense in a patent system that already consistently overvalues patent rights compared to their value to society, especially when courts mete out this punishment to innocent and willful infringers alike. Part II explores cases in which the Federal Circuit and other courts following its lead have awarded increased reasonable royalty awards for punitive impact and explains the Federal Circuit's professed rationale for doing so. Part III demonstrates that this practice makes little sense, given the number of other powerful deterrents already present in the patent system. Part IV explains that, to the extent they exist at all, any deterrence-related benefits resulting from excess damages do not materialize when courts impose those damages against innocent infringers--a group that likely makes up the lion's share of patent infringers. Part V argues that, even without the additional burden of inflated damages awards, there is good reason to believe that the patent system already over deters infringement because accused infringers participating in a competitive market face strong incentives not to challenge patents asserted against them. Finally, Part VI outlines proposed patent reforms for efficiently deterring willful copyists, while sparing ordinary, innocent infringers from that threat.

2. DETERRING INFRINGEMENT WITH REASONABLE ROYALTY AWARDS

   Although traditional black-letter patent law states that damages for patent infringement are intended only to compensate patent owners, the Federal Circuit has shaped the law of reasonable royalty damages to incorporate an additional deterrent function. This Part introduces cases in which courts have awarded enhanced reasonable royalty awards to deter infringers and explains why courts believe this is necessary.

   1. Brief Introduction to Patent Infringement Damages

      Section 284 of the United States Patent Act states that a patentee may recover profits lost due to infringement, "but in no event less than a reasonable royalty" for an infringer's use of the patented invention. (6) According to the statute, courts should aim to award "damages adequate to compensate" the patentee for losses it sustained as a result of infringement. (7)

      This compensation may take the form of lost profits, a reasonable royalty, or a combination thereof. (8) For many patentees, however, proving lost profits is not a realistic goal. (9) To obtain lost profits, a patentee must show (i) consumer demand for a product it sells that is covered by the patent-at-issue, (10) (ii) sufficient marketing and manufacturing capacity to exploit that demand, (iii) an absence of noninfringing substitutes that might satisfy that demand instead, and (iv) the dollar amount of profit that it would have made from additional sales of its product had the infringer's product never entered the market. (11)

      Patentees who cannot establish all prongs of the above test--frequently because they do not sell a product, let alone one covered by their patent may not recover lost profits. These patent owners may recover as damages only the reasonable royalty for which they could have licensed their patent to the infringer. In setting this reasonable royalty rate, courts attempt to reconstruct the hypothetical bargain that the parties would have negotiated had they willingly tried to do so at the time infringement began. (12) To recreate this "willing licensor-willing licensee" royalty, courts generally rely on fifteen factors set forth in Georgia-Pacific Corp. v. United States Plywood Corp. (13) The exercise of reconstructing the parties' hypothetical ex ante bargain is, unfortunately, by no means one of careful economic analysis--nor is it undertaken on a level playing field. Instead, it relies upon counterfactual assumptions designed to favor the patentee and ensure adequate compensation. Namely, though ostensibly setting royalty rates at the level parties would have negotiated prior to suit, courts presume that the patent-at-issue is valid and infringed (14)--both facts that were no doubt fiercely contested during litigation and far from clear when infringement began.

   2. Patent Damages as Pecuniary Compensation

      Given that the Patent Act expressly calls for patent damages that are "adequate to compensate for the infringement," (15) it should come as no surprise that patent law traditionally provides that the core purpose of reasonable royalty damages is to compensate the patentee by awarding as damages a royalty fee approximating the true market value of a license to practice the patented invention.

      More than 120 years ago, the U.S. Supreme Court defined patent damages as "the difference between [the patentee's] pecuniary condition after the infringement, and what his condition would have been if infringement had not occurred." (16) Only a few years later, the Court explicitly stressed the compensatory nature of patent damages and rejected the notion that damages awarded under the Patent Act should function to punish infringers: "[patent damages] have been defined by this Court as 'compensation for the pecuniary loss he (the patentee) has suffered from the infringement, without regard to the question whether the defendant has gained or lost by his unlawful acts."' (17)

      When infringement does not divert sales from the patentee (for example, because the patentee does not sell a product), the patentee's pecuniary loss is limited to the royalty fee that it could have reasonably charged the infringer for a license to use the patent-at-issue. Reconstruction of that royalty amount as determined by the market value of the patented invention, then, is the traditional sine qua non of calculating reasonable royalty damages. (18)

   3. Inflation of the Reasonable Royalty Measure of Damages

      Courts nevertheless appear to be routinely dissatisfied with the royalty rates that simple economic evidence shows the parties would have agreed to in a negotiation prior to infringement. In such situations, courts have often awarded grossly inflated royalty rates, implicitly rejecting Supreme Court and previously well-established Federal Circuit precedent setting forth a strictly compensatory reasonable royalty formulation.

      This practice is perhaps best embodied by a recent line of cases between Monsanto and farmers who purchased Monsanto's patented seeds. In Monsanto Co. v. McFarling, the Federal Circuit affirmed a jury award of reasonable royalty damages more than six times the licensing fee the patentee, Monsanto, consistently charged for use of the patented invention. (19) In that case, Monsanto brought suit against a Mississippi farmer who purchased (and later saved and replanted) genetically modified seeds that grow into herbicide resistant crops. (20) Monsanto sold its patented seeds through distributors and required purchasers to sign a "Technology Agreement," which licensed two patents Monsanto owned covering the genetic modification. (21) This agreement limited use of the purchased seeds to a single growing season. (22) It also required buyers to pay Monsanto a $6.50 per bag "Technology Fee" to license the patents and to pay the seed distributor another fee of between $19 and $22 per bag. (23) When the jury returned a damages verdict in Monsanto's favor of $40 per bag--more than six times the license fee...