Patentee overcompensation and the entire market value rule.

• Author: Love, Brian J.

INTRODUCTION I. PATENT DAMAGES FOR COMPONENT INVENTIONS A. General Standards for Patent Infringement Damages B. The Apportionment Requirement C. The Evolution of the Entire Market Value Rule II. THE CASE FOR MODIFYING THE ENTIRE MARKET VALUE RULE A. An Economic Model of Patentee Compensation 1. A benchmark royalty level 2. Deriving a benchmark royalty level for an entire complex device 3. Two conditions for benchmark level compensation 4. Measuring patentee overcompensation B. Consequences of Patentee Overcompensation 1. Decreased incentive for investment in beneficial activities 2. Royalty stacking 3. Increased incentive for patent trolling 4. Overvaluation as a patent infringement deterrent C. Predictability and Ease of Administration III. THE ENTIRE MARKET VALUE RULE AND COMPLEX ELECTRONIC DEVICES: A CASE STUDY OF PERSONAL COMPUTER SYSTEMS A. Complex Electronic Devices Under Current Entire Market Value Rule Case Law 1. The functional unit test under Rite-Hite and Juicy Whip 2. Consumer demand and anticipation of sales B. Complex Electronic Devices Under a Modified Entire Market Value Rule IV. POLICY RECOMMENDATIONS A. Evidence of Alternative Technologies B. Evidence of Consumer Demand CONCLUSION INTRODUCTION

Imagine a computer chip composed of millions of transistors and hundreds or even thousands of individually patented inventions. Could just one of those patented components ever account for the entire economic value of the chip? Could just one such invention ever account for the entire value of a total personal computer system--monitor, keyboard, mouse, printer, software, and all--sold along with the chip? While these questions may seem far-fetched, they may soon be answered in the affirmative under a U.S. patent law doctrine known as the "entire market value rule."

The entire market value rule allows for recovery of patent infringement damages based on the value of an entire product or device containing an infringing component, rather than on the value of the infringing component alone, provided that the entire value of the device as a whole is legally attributable to the patented invention. (1) The doctrine can mean the difference between orders of magnitude in potential patent infringement liability, and yet, surprisingly, the rule has been largely ignored by scholars of the U.S. patent system. This Note asks whether the entire market value rule remains a viable doctrine in a world of increasing technological complexity in which new products are generally not covered by a single patent, but instead incorporate many patentable components. While the U.S. patent system was designed primarily on the premise that new inventions would be covered by a single patent, recent advances in technology have ushered in an era of unprecedented complexity and detail in technological innovation. Gone are the days when inventions were primarily simple mechanical devices. (2) Now, the patent system must adapt to accommodate areas of rapid advancement--such as the computing and biotechnology industries--where products sold to consumers consist of numerous components, each of which may itself be a patented invention.

This Note demonstrates that application of the entire market value rule routinely overcompensates patentees and thereby exacerbates many problems inherent in the current system for awarding patent infringement damages. It concludes that the doctrine's current form should be abandoned so that when calculating infringement damages the infringing device's value must always be apportioned between value added by the patent at issue and value attributable to the infringer's own contributions or to the public domain. In addition, it suggests a number of less drastic patent reform measures that, if adopted, can easily correct much of the doctrine's current overapplication. Part I introduces the current state of entire market value rule case law, emphasizing the expansion of the doctrine over time. It explains that, from its modest origins, the doctrine has been expanded far beyond the rationales behind its creation. Part II presents the case for modifying the entire market value rule by identifying how the doctrine frequently overcompensates patentees compared to their contributions to society. It first introduces and develops an economic model that demonstrates the doctrine's overcompensating effect. It then addresses the negative consequences that result when patents are overvalued. These consequences include a chilling effect on innovation and increased incentives for "patent trolling." (3) The Part concludes by explaining how scaling back the entire market value rule would make the doctrine more predictable and easily administrable. Part III explores how the entire market value rule will likely be applied in future patent litigation involving complex electronic devices. Using a hypothetical infringing personal computer system as a case study, it explains that while complex devices will likely be aggressively targeted under current entire market value rule case law, scaling back the doctrine would largely eliminate its overapplication in this beneficial area. Drawing on the economic model introduced in Part II, Part IV suggests patent reform measures that can help counteract the overapplication of the entire market value rule and the problems caused by the overvaluation of patented inventions.

1. PATENT DAMAGES FOR COMPONENT INVENTIONS

   The determination of damages for patent infringement is "not an exact science." (4) Section 284 of the United States Patent Act authorizes a patentee who successfully proves that its patent has been infringed to recover profits lost due to the infringer's unlawful conduct, "but in no event less than a reasonable royalty" for use of the patented invention. (5) An award for infringement under section 284 is intended to provide a patentee with "damages adequate to compensate" for the injury it sustained as a result of the infringement. (6)

   1. General Standards for Patent Infringement Damages

      A patentee's compensation may be comprised of an award for lost profits, a reasonable royalty, or a combination thereof. (7) Lost profits, however, can be hard to show. To obtain lost profits under Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., a patentee must show: (i) consumer demand for the patented product, (ii) sufficient marketing and manufacturing capacity to exploit that demand, (iii) an absence of noninfringing substitutes, and (iv) the dollar amount of profit that it would have made from additional sales absent infringement. (8)

      Patentees who cannot meet the Panduit test or who do not sell products covered by their patents may not recover lost profits. Such patent owners are only entitled to the reasonable royalty for which the infringer could have licensed the patent at issue. Mathematically, a reasonable royalty award requires a court to determine first the proper royalty base--the value of the infringing products or activities for which a royalty is owed--and then multiply that value by a royalty rate to calculate the total amount of damages. In setting a reasonable royalty rate for the license of an infringed patent, courts attempt to reconstruct the hypothetical bargain that the parties would have negotiated at the time when the infringing conduct began. (9) To accomplish this task, courts look to a nonexclusive list of fifteen factors first set out in Georgia-Pacific Corp. v. United States Plywood Corp. (10) In particular, courts rely heavily on evidence pertaining to the rates at which the patent owner previously licensed the patented invention. (11) This fictitious negotiation is notably distorted from reality in a number of respects. For example, in reconstructing this ex ante bargain, courts presume that the patent is valid and covers the in(ringer's product (12)--facts that were likely not at all clear prior to the resolution of the infringement suit. Moreover, the very existence of the infringement suit proves that the parties were in fact not able to strike a bargain prior to infringement or at any time afterwards. While counterfactual, these considerations may be necessary to avoid undercompensation. (13)

   2. The Apportionment Requirement

      Once the finder of fact has decided to award monetary damages, it must determine what compensation base to use in calculating the patentee's lost profits or the reasonable royalty owed by the infringer. When a patent covers an entire infringing product, the royalty base is simply the total value of the sales or uses of the infringing product. (14) However, when the patent at issue covers only a component of or improvement to the infringing item, the value of the sales or uses of that item must be apportioned between the patented invention and the remaining unpatented (15) components. (16) This requirement ensures that a patentee is normally awarded damages in proportion to the value that its patent contributed to the infringing article, and not based on any value attributable to the infringer's own inventions or the prior art.

      Courts have long recognized that damages awards should differ depending on whether the patent at issue covers the entire infringing product or instead covers only a component of or improvement to the infringing product. In Seymour v. McCormick, for example, the U.S. Supreme Court reversed an award for infringement of an improvement patent based on the value of an entire machine including the improvement, stating that "it is a very grave error to instruct a jury that as to the measure of damages the same rule is to govern, whether the patent covers an entire machine or an improvement on a machine." (17) The Court recognized that if patent damages were not calculated after apportioning value between the patented invention and the prior art, "the unfortunate mechanic [who sells a complex device] may be compelled to pay treble his whole profits to each of a dozen or more several inventors of some small...