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The assessment of damages as compensation for patent infringement and trade secret misappropriation is a complex process. Damages can often take the form of a reasonable royalty—which 35 U.S.C. § 284 sets as the floor for compensation for the tort of patent infringement. Many courts and damages experts often look to what are referred to as the Georgia-Pacific factors when determining the reasonable royalty. Among the many factors considered, the nature and scope of the license with regard to exclusivity can have a sizable impact on the reasonable royalty award. This article examines how the timing of the hypothetical negotiation may raise the premium for exclusivity under certain circumstances.
General Framework for Determining a Reasonable Royalty Rate
Section 284 provides that, where patent infringement is found, "the court shall award . . . damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer."1 In the case of damages relating to a misappropriated trade secret, both the Uniform Trade Secrets Act and the Defend Trade Secrets Act also allow for reasonable royalty damages.2
When determining a reasonable royalty award for patent infringement, a damages expert may consider the expected outcome of a hypothetical license negotiation between the infringer and the patent owner as if the two parties willingly negotiated a license for the infringer's right to practice the patent.3 For trade secret misappropriation, an expert may also consider a hypothetical negotiation between the misappropriator and the trade secret owner. The hypothetical negotiation occurs just prior to the date of the first patent infringement or at the time of the trade secret misappropriation.
Because the hypothetical negotiation occurs just prior to the date of the first infringement or misappropriation, it is not uncommon for a court or damages expert to consider information evidencing the knowledge, circumstances, and facts that existed many years prior to the subject litigation.4 For a variety of reasons, the date of the hypothetical negotiation can contribute to a higher or lower royalty rate. For instance, courts have held that the value of the license could be "drastically different" depending on whether the subject technology was in a nascent or developed state during the relevant time period.5
As a general matter, the hypothetical negotiation is assumed to yield a hypothetical license that can theoretically reflect a real-world licensing negotiation occurring prior to first infringement or misappropriation. Jury instructions have explained the process of determining a reasonable royalty as follows:
In considering this hypothetical negotiation, you should focus on what the expectations of the patent holder and the infringer would have been if they had entered into an agreement at that time, and if they had acted reasonably in their negotiations. You should also assume that both parties to that hypothetical negotiation believed the patent to be valid and infringed and that both parties are willing to enter into a license.
Having that in mind, you may consider any relevant fact in determining the reasonable royalty for the use of a patented invention, including the opinion testimony of experts. The reasonable royalty you determine must be a royalty that would have resulted from the hypothetical negotiation, and not simply a royalty either party would have preferred.6
There is no single set of facts or circumstances that economists must consider when determining what royalty rate the parties would have agreed upon at the time of the hypothetical negotiation. However, while not required, many courts and damages experts look to what are referred to as the Georgia-Pacific factors when calculating a reasonable royalty rate.7 Georgia-Pacific offers a list of 15 factors to consider when determining a reasonable royalty.8
Use of Comparable Agreements
Based on Georgia-Pacific factor two, which considers "[t]he rates paid by the licensee for the use of other patents comparable to the patent in suit," economists often proffer comparable licenses when assessing a reasonable royalty.9 An established royalty for the patents at issue is "usually the best measure of a 'reasonable' royalty for a given use of an invention because it removes the need to guess at the terms to which parties would hypothetically agree."10 The ability to rely on established royalty rates can hinge upon whether the "patentee has consistently licensed others to engage in conduct comparable to the defendant's."11 However, economists may also proffer licenses for purportedly comparable patents, particularly when the patents at issue have yet to be licensed. "Assessing the comparability of licenses requires a consideration of whether the license at issue involves comparable technology, is economically comparable, and arises under comparable circumstances as the hypothetical negotiation."12
Damages experts may draw on their own economic expertise to compare business and financial considerations of various licenses and may consult technical experts on questions relating to the specific technologies. Generally, the "licenses relied on by the patentee in proving damages [must be] sufficiently comparable to the hypothetical license at issue in suit."13 When differences exist in the technologies and economic circumstances of the contracting parties, the comparability analysis should account for these differences.14 The "'degree of comparability' of the license agreements [is] '[a] factual issue[] best addressed by cross examination'" of the damages expert.15
Exclusivity Provision in Hypothetical Licenses
Damages experts frequently look to Georgia-Pacific factor three, which considers "[t]he nature and scope of the license, as exclusive or non-exclusive; or as restricted or non-restricted in terms of territory or with respect to whom the manufactured product may be sold," to evaluate what, if any, exclusivity provisions would be included in a hypothetical license when calculating a hypothetical royalty rate.16 For example, the hypothetical license may grant rights to the licensee that are limited to certain territories, certain products, and in the case of prescription pharmaceuticals, certain indications or disease areas. An exclusivity provision may similarly limit the licensor's right to grant licenses to other parties in certain territories, indications, or disease areas. Further, an exclusivity provision may grant an infringer the right to be the only party permitted to practice the licensed patent.
As a matter of economics, the nature of an exclusivity clause can have a significant impact on a reasonable royalty. Typically, broader exclusivity rights—e.g., the right to be the only licensee—in a license may warrant a higher reasonable royalty, all else equal. The exclusive right to operate in a broader territory is more valuable than the right to operate in a smaller territory so long as there is an expected market opportunity in the expanded territory. Similarly, the exclusive right to sell drug products that treat multiple diseases is more valuable than the right to sell a drug product that treats only one of those diseases so long as there is an expected market opportunity for treating the additional diseases.
Overlooked Premium for Exclusivity
Damages experts have often overlooked a critical factor in assessing the reasonable royalty in an exclusive hypothetical license when proffering comparable licenses. As discussed earlier, the hypothetical negotiation occurs on the date of the first infringement or at the time of the trade secret misappropriation.17 In general, the hypothetical negotiation is based on the information available to the parties at this time, including the parties' knowledge that the licensee will imminently practice the licensed patent or trade secret. By contrast, a comparable license is typically negotiated well before the licensee sells a product that practices the patent or trade secret under the license.18 In the case of pharmaceuticals, the negotiation can take place years before the licensee's drug completes clinical trials and receives market approval from the Food and Drug Administration, if ever.
In comparison to a hypothetical license negotiation, a comparable license carries a greater degree of uncertainty: uncertainty about when the licensee will practice the licensed patent or trade secret, let alone uncertainty about whether the licensee's product will ever reach the market. For example, a drug manufacturer may license patents covering a micelle (a type of drug delivery system) during the drug development stage but not expect to complete clinical trials for several years. In that time, the drug product could fail to reach the market for any number of reasons, such as failing to meet the primary endpoint or generating severe adverse effects. Moreover, the drug developer could also choose to develop the drug product with an alternate micelle than the one licensed.
At the time of negotiation, greater uncertainty regarding the licensee's ability to commercialize the product at issue also gives rise to greater uncertainty (i.e., risk) in the licensor's compensation. From an economic perspective, both the licensor and licensee expect to benefit from entering into the license; otherwise, the parties would not enter into the license. When a license is not exclusive, a licensor is able to reduce the risk of lost royalties by granting multiple licenses. However, that is not the case for an exclusive license. The greater the risk that the licensee will not practice the patent or trade secret, the greater the licensor's risk for lost royalties in an exclusive license.
Economically, the licensor is entitled to a greater reward when taking on greater risk. This is often referred to as the risk-return tradeoff. The incentive to accept greater risk is the opportunity for a greater reward; otherwise, there is no motive to take on such a level of risk. All else equal, the licensor of a purportedly comparable exclusive license takes on greater risk than the licensor of an exclusive hypothetical license. Consequently, the premium for exclusivity should be larger in a comparable exclusive license than the premium in an exclusive hypothetical license negotiation.
Economic Implications of Exclusivity in Hypothetical License Negotiations
When assessing a reasonable royalty award for patent infringement or trade secret misappropriation, damages experts may consider the expected outcome of a hypothetical license negotiation between the infringer and the patent owner or the misappropriator and the trade secret owner. Based on the Georgia-Pacific factors, economists often proffer comparable licenses, accounting for differences in the technologies and economic circumstances of the parties, and examine potential exclusivity provisions, which can significantly impact the royalty calculations.
Comparable exclusive licenses negotiated before a product is commercialized carry more uncertainty, increasing the licensor's risk of lost royalties if the licensee does not practice the patent or trade secret. As such, licensors are entitled to greater rewards for taking on greater risks, suggesting that the premium for exclusivity should be larger in comparable exclusive licenses than in exclusive hypothetical license negotiations.
Footnotes
1. 35 U.S.C. § 284.
2. Unif. Trade Secrets Act (Unif. L. Comm'n 1986); Defend Trade Secrets Act of 2016, 18 U.S.C. § 1836.
3. Ga.-Pac. Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116, 1121 (S.D.N.Y. 1970), award modified on appeal, 446 F.2d 295 (2d Cir. 1971).
4. Riles v. Shell Expl. & Prod. Co., 298 F.3d 1302, 1311 (Fed. Cir. 2002) ("This formulation requires the patentee to reconstruct the market, by definition a hypothetical enterprise, to project economic results that did not occur. 'To prevent the hypothetical from lapsing into pure speculation, this court requires sound economic proof of the nature of the market and likely outcomes with infringement factored out of the economic picture.'" (quoting Grain Processing Corp. v. Am. Maize-Prods. Co., 185 F.3d 1341, 1350 (Fed. Cir. 1999)).
5. Integra Lifesciences I, Ltd. v. Merck KGaA, 331 F.3d 860, 870 (Fed. Cir. 2003), rev'd on other grounds, 545 U.S. 193 (2005).
6. Intell. Ventures I LLC v. Symantec Corp., No. 10-1067, 2015 WL 307572, at *2 (D. Del. Jan. 23, 2015).
7. J.P. Long, Apportionment in the Semiconductor Age, IP Litigator, Mar. 2021, at 1, 5–6, https://www.finnegan.com/a/web/7Zpw8fRtQUB7ADW5mnNZTr/published-ip-litigator-apportionment-in-the-semiconductor-age-jpl-march-april-2021.pdf.
8. Id.; Ga.-Pac. Corp., 318 F. Supp. at 1120.
9. Ga.-Pac. Corp., 318 F. Supp. at 1120.
10. Monsanto Co. v. McFarling, 488 F.3d 973, 978–79 (Fed. Cir. 2007), cert. denied, 552 U.S. 1096 (2008).
11. Id. at 979.
12. Bio-Rad Lab'ys, Inc. v. 10X Genomics Inc., 967 F.3d 1353, 1372–73 (Fed. Cir. 2020).
13. Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301, 1325 (Fed. Cir. 2009).
14. Finjan, Inc. v. Secure Computing Corp., 626 F.3d 1197, 1211 (Fed. Cir. 2010).
15. Virnetx, Inc. v. Cisco Sys., Inc., 767 F.3d 1308, 1330–31 (Fed. Cir. 2014) (quoting ActiveVideo Networks, Inc. v. Verizon Commc'ns, Inc., 694 F.3d 1312, 1333 (Fed. Cir. 2012)).
16. Ga.-Pac. Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116, 1120 (S.D.N.Y. 1970).
17. John C. Paul, D. Brian Kacedon, Anthony D. Del Monaco & Eric A. Liu, The Testimony of a Damages Expert May Be Excluded for Basing the Royalty to Be Awarded on a Hypothetical Negotiation That Occurs at a Time Other Than When Infringement Began, Finnegan (Mar. 29, 2022), https://www.finnegan.com/en/insights/articles/the-testimony-of-a-damages-expert-may-be-excluded-for-basing-the-royalty-to-be-awarded-on-a-hypothetical-negotiation-that-occurs-at-a-time-other-than-when-infringement-began.html.
18. For purposes of this article, the discussion focuses on comparable licenses that are negotiated well before the licensee sells a product that practices the patent or trade secret under the license.
Originally published by Landslide.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
