The Law and Economics of Patent Infringement Damages
| Publication year | 1997 |
| Pages | 11 |
| Citation | Vol. 10 No. 2 Pg. 11 |
Mark A Glick, J.
Traditionally, economists have played a surprisingly limited role in the damage phase of patent infringement cases. Until recently, patent infringement damages have been the exclusive domain of accountants and patent lawyers. This is unfortunate because economic theory can be a powerful tool for both calculating your client's damages or challenging the logic of your opponent's damage calculation.[1] The purpose of this article is to familiarize Utah Bar members with how economists approach the murky law of patent damages.
THE PATENT STATUTE
The starting point for any analysis of patent damages is 35 U.S.C. § 284 (the "Patent Statute"), which provides that: Upon finding for the claimant the court shall award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty, for use made of the invention by the infringer. (Emphasis added.)
Prior to 1946, the precursor to section 284 went beyond "compensation", allowing for both recovery of compensation and the infringer's profits. The 1946 Amendment, Act of August 1, 1946, Ch. 726, § 1, eliminated the language regarding the infringer's profits and added the reference to compensation.[2]
This revision is important. Before 1946, patent owners were awarded damages that included both the lost profits to the patent owner and the infringer's profits.[3] Essentially, a successful plaintiff was placed in a better position than had the infringement not occurred because profits on some sales were counted twice—once as lost profits to the patent owner and again as the actual profits the infringer received. The Supreme Court interpreted the 1946 revision as correcting this situation. Aw Manufacturing Co. v. Convertible Top Replacement Co., 377 U.S. 476 (1964), held that the intent of the revised statute was to limit a plaintiff's damages to "compensation for the pecuniary loss [the patent owner] has suffered from the infringement, without regard to the question whether the defendant has gained or lost by his unlawful acts." Id. at 507. According to the Court, the statutory reference to compensatory damages means that damages are limited to "the difference between [the patent owner's] pecuniary condition after the infringement, and what his condition would have been if the infringement had not occurred." Id. In other words, "[h]ad the infringer not infringed, what would [the] Patent Holder . . . have made?" Id.
LOST PROFITS
The Patent Statute is also abundantly clear as to how compensation is to be calculated. Compensatory damages have consistently been interpreted by the United States Court of Appeals for the Federal Circuit (the "Federal Circuit")[4] to mean "lost profits," with a reasonable royalty acting as the floor for damages when lost profits cannot be proven. Accordingly, plaintiffs will typically seek lost profits when possible, and attempt to calculate a reasonable royalty only when insufficient information is available to prove lost profits, or when the requirements of such proof cannot be satisfied.
Proof of lost profits requires that the patent owner demonstrate that, absent infringement, he would have made the sales that the infringer actually made. The standards for such proof have changed measurably in the last fifteen years. Before the establishment of the Federal Circuit, the burden of proof to establish lost profits was substantial. Any possibility that someone other than the patent owner could have made any sales of the infringer completely negated a recovery of lost profits. See Tektronix, Inc. v. United States, 552 F2d 343, 349 (Ct. CI. 1977) ("if lost profits are ever to be awarded ... it should be only after the strictest proof that the patentee would actually have earned and retained those sums in its sales"). In contrast, the Federal Circuit has adopted a lower standard of "reasonable probability." Under that standard, the patent owner must show only that it is more probable than not that he would have made the infringer's sales.
While the Federal Circuit has made it clear that there is no single method by which the patent owner must carry its burden of proving lost profits, by far the most common approach is the four-part test outlined in Panduit Corp. v. Stahlin Brothers Fibre Works, Inc., 575 F.2d 1152 (6th Cir. 1978). The Panduit test requires that the plaintiff establish (1) the existence of demand for the patented product, (2) the absence of acceptable noninfringing substitutes, (3) the patent owner's ability to meet demand, and (4) some proof of the amount of profit lost per lost sale. Id. at 1156. Satisfying these four factors results in the establishment of the fact that, absent infringement, the patent owner would have made the infringer's sales.
The first prong of the Panduit test is rarely difficult for the plaintiff to meet. In fact, it is nonsensical. After all, if there were no demand for the patented product, there would be no infringement either. Likewise, the fourth factor may require little more than the production of the plaintiff's income statement. It is not surprising, then, that the key inquiries involved in proving lost profits are the absence of acceptable noninfringing substitutes and the patent owner's ability to produce, market and sell to the infringer's customers. Both of these questions are well-suited for economic analysis, and the Federal Circuit has increasingly incorporated economic analysis when addressing these issues.
Initially, the Federal Circuit required proof that noninfringing substitutes did not possess all of the attributes of the patented product. See e.g., TWM Manufacturing Co., Inc. v. Dura Corp., 789 F.2d 895, 901 (Fed Cir. 1986) ("a product lacking the advantages of the patented [product] can hardly be termed a substitute acceptable to the consumer who wants those advantages"). Such a test cannot withstand even cursory scrutiny, however, because substitutes that possess literally all of the attributes of the patented product would be infringing, not "noninfringing." Accordingly, the effect of this early Federal Circuit doctrine was to assure that patent owners virtually automatically met the critical second prong of the Panduit test.
The logical defect in this first approach led the Federal Circuit to focus on the attitudes of consumers toward the patented product and any substitutes, rather than on their physical attributes. While this change of focus marked an improvement, the Federal Circuit also held that acceptable noninfringing substitutes are legally absent when some set of customers can be shown to prefer the patented product. See Standard Havens Products, Inc. v. Gencor Industries, Inc., 953 F.2d 1360, 1373 (Fed. Cir. 1991) ("if purchasers are motivated to purchase because of particular features available only from the patented product, products without such features - even if otherwise competing in the market place -would not be acceptable noninfringing substitutes"). The difficulty with this approach is that, if consumer tastes are not uniform, some subset of consumers will always prefer the patented product. As a consequence, this second approach also negated any serious analysis and assured that the patent owner could satisfy the second Panduit prong.
Federal Circuit case law has now advanced significantly. In State Industries, Inc. v. Mor-Flo Industries, Inc., 883 F2d 1573 (Fed. Cir. 1989), the Federal Circuit held that lost prof' its are available to the patent owner only for the share of the infringing sales that would have gone to the patent owner absent the infringement. The Federal Circuit has thus finally dispensed with the rigid all or nothing approach of Panduit. Under this new procedure, a court can award lost profits to the patent owner on the portion of the infringer's sales that are equal to the patent owner's market share. This approach, though a substantial improvement, is still not without its problems, however. The Mor-Flo approach is economically correct only for cases in which the products at issue are "homogenous", that is, where the products lack significant brand name recognition or significant physical or quality differences. However, in cases where products are heterogenous, the Mor-Flo market share approach may still lead to erroneous conclusions.
Consider the following example of infringement in the carbonated soda industry where products are heterogenous. Suppose it were found that Pepsi had been infringing on the patented formula used by Coca-Cola (in reality the formula is a trade secret). Assume further that the relevant market is defined as branded soda in the United States and includes the sales of 7-Up, Dr. Pepper, several root beer brands and a few other products sold nationally[5] . Moreover, for purposes of illustration, assume that in this market, Coca-Cola's market share is 30% and Pepsi's is 20%. Using the Federal Circuit's current analysis, Coca-Cola would be entitled to lost profits on 30% of Pepsi's sales...
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