RECONSTRUCTING TRADEMARK INFRINGEMENT DAMAGES FROM THE PERSPECTIVE OF OPTION THEORY.

• Author: Wang, Min-Chiuan

Table of Contents I. Introduction II. Basic Theories--Liability Rules, Options, and Focal Points A. Nonconsensual use and liability rules B. Liability rules from the perspective of option theory C. Higher-order liability rules and internal auction D. Focal points in game theory III. The Continuum of Monetary Relief and Equity A. The continuum of monetary relief B. Equity applied to all kinds of monetary remedies C. Auction by focal points IV. Three Types of Monetary Relief along the Continuum A. Actual damages B. Reasonable royalty i. Reasonable royalty and liability rules ii. From reasonable royalty to actual damages iii. From reasonable royalty to accounting of profits iv. Reasonable royalty and call options C. Accounting of profits V. Conclusion I. Introduction

Intellectual property law typically provides several methods of calculating damages. Various monetary remedies are available to a successful plaintiff in a trademark, patent, or copyright infringement case. (1) These types of "damages" ostensibly resemble different measurements of the harm that the plaintiff has suffered from an infringement. (2) However, a closer assessment of the literature reveals that some methods of "calculating damages" have considerably exceeded the function of measuring the right owner's actual damages. (3) Several types of monetary remedies divide the surplus created by the defendant's use of the plaintiff's intangible asset. (4) Regarding the types of monetary remedies for a trademark infringement, Section 35 of the Lanham Act provides that a plaintiff may claim actual damages and an accounting of the defendant's profits. (5) In practice, a prevailing plaintiff can recover what are actual damages (including lost profits, injury to goodwill, and costs for corrective advertising), the defendant's profits, and/or a reasonable royalty. (6)

These remedies are "subject to the principles of equity," according to Section 35 of the Lanham Act. (7) The court has broad discretion to decide whether and to what extent to grant damages, according to equity and the facts of the case. (8) A finding of trademark infringement or dilution does not necessarily mean that a prevailing plaintiff is entitled to monetary recovery. (9) In other words, monetary recovery is not "automatic in every case where [a] plaintiff has proved infringement," (10) All types of monetary remedies authorized by Section 35(a) of the Lanham Act are subject to the control of a court's equity power. (11) By exercising this power, courts have ensured that monetary remedies are suitable to the facts and fairness of each case. (12)

This article argues that the result of the prevalent application of equity principles and the methods of calculating damages in trademark infringement cases exhibit the character of hybrid regimes. All methods of calculation are ranked on a continuum. (13) On one end are actual damages, the nature of which is primarily liability rules, but property rules are not ruled out. On the other end is accounting of profits, which is close to property rules. In the middle of the continuum is reasonable royalty, which itself is a hybrid regime that is slightly closer to liability rules. The occurrence of hybrid regimes can be traced to judicial exercise of equity power resulting in the appearance of hybrid regimes in case law.

Calculation of damages is a method of pricing the unconsented use of the plaintiffs property by the defendant. (14) Valuation of property use can be undertaken by consenting parties or by the government in cases in which the parties fail to reach an agreement; damages are determined by the courts. (15) Damages consist of property allocations by the courts when parties' transaction costs are high. (16) Under ideal conditions, the governmental allocation of property rights on behalf of the parties should approximate an equilibrium (the pareto optimality to which the parties would have agreed).

In trademark infringement cases, monetary relief normally comprises three major types--actual damages, reasonable royalty, and accounting of profits. Ideally, any of these methods approximate an equilibrium; however, from the perspective of game theory, when a game has more than one equilibrium, the problem then becomes which optimality the court should choose and how to determine that choice. (17)

A simple answer is that the plaintiff should choose. This idea is based on the concept of sequential game: (18) the parties unfold their respective claims and defenses based on the plaintiff's initial choice. (19) This article investigates the preconditions of the plaintiffs choice. Case law has developed prerequisites to the plaintiffs choice--the plaintiff is not allowed to choose any type of monetary relief he or she wants. if the prerequisite for a type of monetary relief is not satisfied, the plaintiff is not allowed to choose that type of relief.

This article treats the process of judicial award of damages as an internal auction. (20) The concept of internal auction was developed by Professor Ian Ayers and other scholars. Ayres argued that multiple exercises of options by both parties can achieve a result that is closer to equilibrium than what traditional liability rules can produce. (21)

However, high administrative costs are incurred if multiple options are really exercised in a court proceeding. As Posner observed, negotiating a point in a wide bargaining range involves very high transaction costs. (22) Nonetheless, courts have developed a method of reducing the judicial costs--by using prerequisites of monetary relief as "focal points," including actual confusion, established royalties, and the defendant's intent. This article argues that the process of choosing a type of monetary relief is an internal auction that uses focal points.

This article applies option theory to connect property rules and liability rules in order to demonstrate that the various types of monetary remedies in trademark infringement cases are hybrid regimes located on a continuum, the two ends of which are pure property rules and pure liability rules. Focal points that appear in particular cases, such as actual confusion, prior or existing royalties, and defendant's bad faith, have a determinative effect on the allocation of monetary remedies.

Part Two of this article briefly restates the theories on which this article is primarily based, including entitlement theory, option theory, and focal points in game theory. Option theory suggests that property rules and liability rules are not a set of contradictory concepts; instead, they comprise two ends of a continuity. Part Three, which is based on the continuity of property rules and liability rules, constructs the continuum of monetary remedies in trademark infringement cases. This article argues that various types of monetary relief are hybrid regimes between property rules and liability rules that are centered on reasonable royalty. This part further attributes the formation of hybrid regimes to courts' power based on the "principles of equity" provision of Section 35 of the Lanham Act. (23) Part Four employs the theory to explain three major types of monetary relief in trademark infringement cases and their respective focal points.

2. Basic Theories--Liability Rules, Options, and Focal Points

   Inherent in the awarding of monetary relief is the idea that because the use of the asset has been non-consensually taken by the defendant, the court, in addition to measuring the plaintiff's injury, is entitled to distribute the surplus created by the defendant's infringement. (24) The literature on liability rules extensively discusses the nonconsensual use of legal entitlements. (25) Hence, this part starts with a discussion of liability rules, including Ayres' and other scholars' interpretation of liability rules from the viewpoint of option theory.

   1. Nonconsensual use and liability rules

      Calabresi and Melamed proposed well-known dichotomous methods of protecting legal entitlements--either by property rules or by liability rules. (26) The term "entitlement" refers to the judicial decision on who should prevail when the parties have conflicting interests. (27) Calabresi and Melamed suggested that the court must determine two legal decisions. The first is a "first-order" decision regarding who, among the conflicting interest holders, should have the entitlement. (28) The second is the "second-order" decision regarding the method of protecting the entitlement. (29)

      Property rules require the consent of the property owner before another party can engage in the use of the holder's property. As Professors Kaplow and Shavell stated, a property rule "guarantees property right assignments against infringement through the threatened use of its police powers." (30) A legal entitlement protected by property rules may not be taken by another party without the consent of the entitlement holder and his or her agreement on the price for taking the entitlement. (31)

      Liability rules allow another party to interfere with the holder's entitlement first and then pay damages for the use taken. (32) Liability rules remove the threshold of ex ante consent by the entitlement holder, instead protecting the entitlement with ex post compensation. (33) Calabresi and Melamed argued that to protect the entitlement with liability rules is to apply "an external, objective standard of value.... to facilitate the transfer of the entitlement." (34)

      Liability rules treat the fact that the defendant used the plaintiff's property as a given. The court's calculation of damages is based on a collective valuation of the resource taken. (35) Valuation can be ex ante or ex post; it can be undertaken either through the market with the parties' consent or by collective valuation (the latter method includes valuation by judicial decisions in the form of awards for damage). (36) These valuation methods are alternatives to each other. (37)

      Professor Robert...