Feature Comment: The Impact of Uniloc USA, Inc. v. Microsoft Corp. on Patent Damages under 28 U.S.C. §1498(a)

By James G. McEwen[1]

While many of the aspects of infringement claims against the Government have seemingly similar elements to actions against private parties under 35 U.S.C. §271, it is important to understand that 28 U.S.C. §1498(a) is not an exact counterpart to 35 U.S.C. §271.  For instance, 28 U.S.C. §1498(a) does not allow for actions against the Government for inducement and contributory infringement, or infringement through infringement of product by process claims.[2]  At the same time, the Government is directly liable for infringement by its contractors if the Government has authorized and consented to such uses of the patented invention, which outside of claims of inducement, contribution, or vicarious liability, does not exist in private party litigation under 35 U.S.C. §271.  The requirement for such authorization and consent claims is to ensure that the Government is able to secure contractor-provided goods and services by extending its immunity to contractors and thereby ensure that the contractors cannot be enjoined.[3]

This same distinction exists in relation to damages.  Under 35 U.S.C §271(a), a court can award an injunction under 35 U.S.C §283 and “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” under 35 U.S.C §284.  In contrast, the Government may not be enjoined for infringing a patent or authorizing a contractor to do the same. Instead, where the Government utilizes a privately owned patent, the exclusive remedy available to the owner is set forth in 28 U.S.C. § 1498 (a), which limits relief to “recovery of [the patentee’s] reasonable and entire compensation for such use and manufacture.” This limit also prevents the imposition of damages for willfulness under in 28 U.S.C. § 1498 (a) even where such damages would be appropriate under 35 U.S.C §284.[4]

Accepted measures of damages under 28 U.S.C. §1498(a) include (1) a “reasonable royalty” based on the hypothetical willing buyer/willing seller approach,[5] (2) a lost profits analysis,[6] or (3) the savings-to-the-Government approach.[7] The “reasonable royalty” analysis is the preferred approach.[8] Importantly, the “reasonable royalty” analysis generally tracks the analysis performed under 35 U.S.C §284 in regards to what royalty rate would be reasonable under a hypothetical negotiation, and what systems are included in the entire market of the invention.  Thus, given the distinction between damages awarded under 35 U.S.C §283 and those available under 28 U.S.C §1498(a), the Federal Circuit’s decision in Uniloc USA, Inc. v. Microsoft Corp.[9] is of interest to the procurement community as well as to third parties believing that the Federal Government has infringed their patent.

As noted in Gargoyles Inc. v. U.S,[10] “[w]hile perhaps in some cases government contractors can expect less profit when licensing to the government than in the private sector, the success in the private marketplace was a reasonable starting point for the trial court to analyze the hypothetical royalty negotiation.”  Given the reliance on commercial practices for royalty rates, the Unlioc decision at the very least is going to require use of true license comparisons to arrive at damages.  Short cuts, such as the now-discredited 25% rule of thumb, will not be usable as a matter of law.

In theory, starting without this 25% rule should result in lower royalty rates.  For instance, in Uniloc, there was evidence that the actual starting royalty rate used in licensing within the industry was rarely 25%.  At the same time, the starting point in a particular industry is generally not well known or publicized.  Therefore, what is likely to happen is experts will be sought who start at higher rates (and can testify that their normal starting point for negotiations is high), and then to a negotiated rate.  Indeed, it was Dr. Gemini’s whole reliance on a rule of thumb as opposed to testifying that, in fact, the industry standard is to start at 25% and work downward which doomed his testimony.  Therefore, it is just as likely that the battle of the experts will now focus on justifying a high starting royalty rate in order to obtain, from the plaintiff’s point of view, an adequate measure of damages.  And this battle will extend into damages under 28 U.S.C. §1498 in like manner. Continue reading

Federal Circuit Clarifies Damages For Patent Infringement

Federal Circuit Finds 25% Damages Rule Is Too Unreliable to be Used In Calculating Patent Damages

In Uniloc USA, Inc. v. Microsoft Corp., Civ Case No. 2010-105, -1055 (Fed. Cir. January 4, 2011), Uniloc owns U.S. Patent No. 5,490,216 (“’216 patent”), which is drawn to a registration system designed to prevent illegal software copying.  Specifically, the ‘216 patent discloses a program which only allows software to run without restrictions on a system when the system determines that the software is legitimate.  Microsoft includes a Product Activation feature in its Windows XP software and accompanying software which requires the use of a product key which, if valid, allows unrestricted use of the software, and if not valid, only allows use of the software in a demo mode.

Uniloc sued Microsoft in the District of Rhode Island alleging that the Product Activation feature infringed the ‘216 patent.   After a first remand from the Federal Circuit rejecting the District Court’s initial claim construction, the jury found that Microsoft had infringed the ‘216 patent, that the infringement was willful, and awarded damages of $388 million based in part on testimony from a damages expert using a “25% rule” as a basis for determining a reasonable royalty.  Microsoft filed six post trial motions including motions JMOL for invalidity, non-infringement, and no willfulness, as well as a motion for a new trial on the issue of damages for improper use of the 25% rule.  The District Court denied the motion JMOL on the issue of invalidity, granted the motion JMOL of non-infringement as well as no willfulness, and granted the motion JMOL new trial on the issue of damages.

On appeal, the Federal Circuit reversed the District Court grant of the JMOL motion of noninfringement and sustained the denial of the JMOL motion on the issue of invalidity, thus sustaining the jury verdict on the issue of infringement of a valid claim.  The Federal Circuit also upheld the District Court grant of JMOL on the issue of no willfulness, noting that the District Court was correct in finding that Uniloc had not presented any evidence of subjective or objective recklessness, especially as the claims involved complex issues relating to equivalencies.  As such, the Federal Circuit found no need for a new trial on the issue of willfulness such that the issues of infringement and willfulness were resolved.

On the next issue of damages, the Federal Circuit also upheld the District Court’s grant of a new trial on the issue of damages.  In order to arrive at the $388 million dollar award, the jury evaluated the testimony of Uniloc’s expert, Dr. Gemini.  As summarized by the Federal Circuit, Dr. Gemini testified that damages should be $564,946,803, which is based upon a hypothetical negotiation using the factors outlined in Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970).

As a starting point, Dr. Gemini noted that a Court-accepted methodology used a 25% “rule of thumb”, whereby 25% of the value of a product would go to the patent owner.  In this case, Dr. Gemini valued each Product Activation feature as being worth $10 to Microsoft given the importance of preventing piracy, such that the rule of thumb began with a royalty rate of $2.50 per Product Activation.  From this, Dr. Gemini arrived at a reasonable royalty of $564,946,803.

 

As a check to ensure that this royalty rate was within industry standards, Dr. Gemini testified that this resulted in a royalty rate of 2.9% relative to the $19 billion gross revenue for Windows XP and related software.  In comparison, Dr. Gemini indicated the industry rate was above 10%. Based upon this analysis as well as the comparison of the resulting award against the gross revenue, the jury awarded the $388 billion in damages.

The Federal Circuit, in upholding the District Court’s grant of the motion JMOL to reverse the award and allow a new trial on damages, reviewed the history and use of the 25% rule of thumb utilized by Dr. Gemini.  The Federal Circuit noted that 35 U.S.C. § 284 allows a damages in the amount of a reasonable royalty, which is determined according to a hypothetical negotiation between the parties. Wang Labs Inc. v. Toshiba Corp., 993 F.2d 858, 869-70 (Fed. Cir. 1993).  The Federal Circuit noted that legal scholars have reasoned that the 25% rule of thumb approximates the reasonable royalty by leaving the infringer with sufficient remaining profits (75%) to reward the infringer for the risk of developing and marketing the product. Robert Goldscheider, John Jarosz and Carla Mulhern, Use Of The 25 Per Cent Rule in Valuing IP, 37 les Nouvelles 123 (Dec. 2002).  While enjoying widespread acceptance as a starting point, others have criticized the rule as not correlating to the relative importance of the patent to the product, or any unique relationship between the parties.  Gregory K. Leonard and Lauren J. Stiroh, Economic Approaches to Intellectual Property Policy, Litigation, and Management, 949 PLI/Pat 425, 454-55 (Sept.-Nov. 2008); Richard S. Toikka, Patent Licensing Under Competitive and Non-Competitive Conditions, 82 J. Pat. & Trademark Off. Soc’y 279, 292-93 (Apr. 2000); Ted Hagelin, Valuation of Patent Licenses, Tex. Intell. Prop. L.J. 423, 425-26 (Spring 2004).  The Federal Circuit then noted that, while never formally approved, the Federal Circuit has nevertheless “passively tolerated” its use since the issue was never squarely before the court.

As the issue was now squarely before the court, the Federal Circuit now held “as a matter of Federal Circuit law that the 25 percent rule of thumb is a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation.”  Importantly, the Federal Circuit went so far as to hold that any use of evidence related to the rule is “inadmissible under Daubert and the Federal Rules of Evidence, because it fails to tie a reasonable royalty base to the facts of the case at issue.”  Specifically, the Federal Circuit noted that the Supreme Court in Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 589 (1993) interpreted Federal Rule of Evidence 702 as requiring that expert testimony be based on a firm scientific or technical grounding. Daubert, 509 U.S. at 589-90.”  Where the testimony does not tie a general rule well to the specific facts of a case, the evidence and testimony is inadmissible.

The Federal Circuit further noted that it has, in the past declared that licenses which were radically different from the facts of a given case were similarly inadmissible in attempting to find a reasonable royalty since these can result in damages in excess of the statutory award. ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860, 869 (Fed. Cir. 2010); Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301, 1324 (Fed. Cir. 2009); Wordtech Systems, Inc. v. Integrated Networks Solutions, Inc., 609 F.3d 1308 (Fed. Cir. 2010).  According to the Federal Circuit:

The meaning of these cases is clear: there must be a basis in fact to associate the royalty rates used in prior licenses to the particular hypothetical negotiation at issue in the case. The 25 percent rule of thumb as an abstract and largely theoretical construct fails to satisfy this fundamental requirement.

Since the 25% rule is not even related to a real negotiation as much as the licenses at issue in ResQNet.com, Inc, Lucent Techs., Wordtech Systems, Inc., the Federal Circuit found that the link between this rule of thumb and any hypothetical negotiations was even more attenuated.

The Federal Circuit further noted that, while the 25% rule was only a starting point, it was a starting point that neither reflected the parties and industries involved, nor the importance of the patents to the infringed products.  As noted by the Federal Circuit, “[b]eginning from a fundamentally flawed premise and adjusting it based on legitimate considerations specific to the facts of the case nevertheless results in a fundamentally flawed conclusion.” Moreover, the Federal Circuit noted that Dr. Gemini had only used the 25% rule as a starting point once in his non-litigation negotiations.  As such, the Federal Circuit found that Microsoft should be allowed a new trial on the issue of damages.

In addition, the Federal Circuit took issue with Dr. Gemini’s use of the $19 billion gross sales figure as the entire market in order to “check” whether the royalty rate of 2.9% was reasonable in the industry.  The Federal Circuit noted that the use of the entire market is only appropriate where the patented feature is the “‘basis for customer demand’ or ‘substantially create[s] the value of the component parts.’ Lucent Techs., 580 F.3d at 1336; Rite-Hite Corp. v. Kelley Co., 56 F.3d 1538, 1549-50 (Fed. Cir. 1995).”  As such, the Supreme Court has allowed the entire market to be the basis for a reasonable royalty where there is evidence that the patented feature is what gives value to the entire machine.  Garretson v. Clark, 111 U.S. 120, 121 (1884).  The Federal Circuit next noted that it was undisputed that the Product Activation feature did not create the consumer demand for Windows XP and the accompanying software.  Thus, the $19 billion gross sales figure was irrelevant as a check as to whether the calculated damages were within industry norms for licensing royalty rates.  As such, the Federal Circuit agreed with the District Court that the comparison of the entire market for Windows XP and the accompanying software as a check for whether the award was reasonable in the industry was an inappropriate use of the entire market rule and a new trial was an appropriate remedy.

Significance for Patent Owners and Applicants

Given the reliance on commercial practices for royalty rates, the Uniloc decision at the very least is going to require use of true license comparisons to arrive at damages.  Short cuts, such as the now-discredited 25% rule of thumb, will not be usable as a matter of law.  In theory, starting without this 25% rule should result in lower royalty rates.  For instance, in Uniloc, there was evidence that the actual starting royalty rate used in licensing within the industry was rarely 25%.  However, this does not necessarily mean that all industries experience the same lower royalty rate, and it is further likely that certain technologies as well as pioneering patents could well demand rates in excess of 25%.  All that is certain is that whatever the starting point will be, there must be evidence that it comports with actual commercial standards.

 

Federal Circuit Rejects Ensnarement Defense and Finds that the Ensnarement Defense is an Issue of Law

In DePuy Spine, Inc. v. Medtronic, Inc., Civ. Case Nos. 90 USPQ2d 1865 (Fed. Cir. 2009), DePuy owns U.S. Pat. No. 5,207, 678 (the ‘678 patent).  The ‘678 patent is directed to a medical device that is a pedicle screw used in spinal surgeries.  DePuy sued Medtronic, accusing Medtronic of infringing the ‘678 patent with Medtronic’s Vertex pedicle screws.  The U.S. District Court for the District of Massachusetts denied Medtronic’s ensnarement defense, found that Medtronic engaged in litigation misconduct, with both decisions being appealed before the Federal Circuit Court.  Additionally, DePuy cross-appeals from the District Court’s granting of Medtronic’s motion for judgment as a matter of law (JMOL) of no willful infringement and from the denial of DePuy’s motion for a new trial for reasonable royalty damages. 

In a prior appeal, the Federal Circuit Court upheld the District Court’s granting of summary judgment as per Medtronic not literally infringing the ‘678 patent with Medtronic’s Vertex pedicle screws.  However, the Federal Circuit Court reversed the District Court’s granting of summary judgment of noninfringement under the doctrine of equivalents.  In the prior appeal, the Federal Circuit Court remanded the case because it found a question of fact existed on whether the Vertex screw’s conical shape was insubstantially different from the ‘678 patent’s screw having a limitation in claim 1 of the patent reciting a “spherically-shaped portion.  In the remanded case, Medtronic asserted an “ensnarement” defense against the doctrine of equivalents issue, wherein the Medtronic asserted that the scope of equivalency of the ‘678 patent would “ensnare” the prior art.  Continue reading

Federal Circuit Finds Reduction of Compensatory Damages Requires New Trial By Jury and that Actual Notice of Infringement Can Occur With a Qualified Charge of Infringement

In Minks v. Polaris Industries, Inc., 546 F.3d 1364 (Fed. Cir. 2008), Floyd M. Minks (“Minks”) designs electronic components for all-terrain vehicles.  Minks holds U.S. Patent No. 4,664,080 (“the ‘080 patent”), which is drawn to an electric governor system for internal combustion engines which uses a circuit to limit the reverse speed of an all-terrain vehicle (“ATV”). When the ATV is shifted into reverse gear, the reverse speed limiter circuit senses the direct current (DC) voltage.  Once activated, the circuit also senses the alternator’s alternating current (AC) output to thereby sense engine speed. If the alternator’s AC voltage output exceeds a predetermined limit, the circuit emits a control signal to interrupt the ignition of the engine.

Polaris Industries (“Polaris”) is a manufacturer of ATV’s and a purchaser of Mink’s electrical components since about 1970. In 1996, Polaris engaged Minks in discussions regarding the ‘080 patent and its ability to purchase reverse speed limiters from different manufacturers. Minks responded by informing Polaris that reverse speed limiters based on engine speed and a DC input were covered by the ‘080 patent. Polaris then began implementing a new speedometer in its ATVs that had an integrated reverse speed limiter that sensed engine speed, and when Minks confirmed that the new Polaris ATV infringed the ’080 patent, he sent Polaris a letter to this effect on November 23, 2004.

When Minks did not get a positive response to the November 23, 2004 letter, Minks then filed suit against Polaris on December 22, 2005, alleging that Polaris infringed apparatus claim 2 of the ‘080 patent. After a trial, the jury found that Polaris infringed the ’080 patent.  Moreover, the jury found that since Polaris received actual notice of infringement for purposes of 35 U.S.C. §287(a) on November 23, 2004 such that all damage calculations are relative to November 23, 2004.  The jury also found that Polaris willfully infringed claim 2 of the ‘080 patent, and that Minks was entitled to $1,294,620.91 in royalty damages.

The jury did not find that the discussions prior to November 23, 2004 were sufficient to find notice had been given prior to this date.  Specifically, the District Court instructed the jury on actual notice that “[t]he date notice was given is the date on which Minks communicated to Polaris a specific charge that one of its products may infringe claim two of the ’080 patent.” The jury found that Minks’s November 23, 2004 letter to Polaris satisfied 35 U.S.C. §287(a)’s notice requirement.

Additionally, Polaris filed a JMOL motion for noninfringement, contenting that claim 2 included a means plus function element for which there was no corresponding part in Polaris’s speed limiter.  However, the District Court denied the motion because Figure 2 in the ‘080 patent is the only structure linked or associated with the functions required by claim 2.  Thus, the District Court concluded that “the means-plus-function limitations of claim 2 are limited to the structures set forth in Figure 2 (and their equivalents).” Based on this, the District Court denied Polaris’s JMOL motion of noninfringement, ruling that “to one skilled in the art of circuit design/electrical engineering, [the amplitude and the frequency of the AC voltage] are equivalent for purposes of determining speed.” Therefore, the jury “could reasonably conclude that the methods employed in the ‘080 Patent and in the accused devices were equivalent or interchangeable.”

The District Court judge did, however, grant Polaris’s Motion for a Reduction in Damages and came to a final award of $117,316.50. The District Court judge further reduced the damages award as a matter of law under Federal Rule of Civil Procedure 50 without offering Minks a new trial on damages.

As for enhanced damages and attorney fees under 35 U.S.C. § 285, the District Court determined that a “reasonable fee” would be $234,633.00 after all deductions. However, the District Court only awarded half this amount as it found Minks to have wasted a great deal of trial time with his “economic nonsense” damages theory.

The court denied Minks’s motion for reconsideration, so Minks filed a notice of appeal on July 25, 2007, challenging (1) the District Court’s reduction of the damages award, (2) the amount of attorney fees awarded, and (3) the jury instruction on actual notice.

Reduction of Compensatory Damages Without New Trial

The first issue on appeal before the Federal Circuit was whether the Seventh Amendment required the District Court to offer Minks the option of a new trial in lieu of accepting the reduced damages award. The Reexamination Clause of the Seventh Amendment states that “no fact tried by a jury, shall be otherwise re-examined in any Court of the United States, than according to the rules of the common law.” The Supreme Court’s interpretation history of the Seventh Amendment has required that the exercise of a District Court’s discretion to set aside an excessive jury award be accompanied by an offer of a new trial. See e.g., Kennon v. Gilmer, 131 U.S. 22, 29 (1889), Hetzel v. Prince William County, 523 U.S. 208, 211 (1998). However, the Eleventh Circuit held in Johansen that when a jury’s award is premised on “legal error,” a court may reduce the award and enter an absolute judgment in an amount sufficient to correct the legal error without offering the plaintiff the option of a new trial in two situations—“where a portion of a verdict is for an identifiable amount that is not permitted by law” or when the award “enter[s] that ‘zone of arbitrariness that violates the Due Process Clause of the Fourteenth Amendment.’” N.Y., L.E. & W.R. Co. v. Estill, 147 U.S. 591 2007-1490, -1491 (1893), Johansen v. Combustion Eng’g, Inc., 170 F.3d 1320, 1330-31 (11th Cir. 1999).

The District Court examined the evidence in the record with respect to the components of a reasonable royalty—number of infringing sales, royalty base, and royalty rate—and found that the evidence could not support the jury’s damages award. However, in determining a reasonable jury award, the Federal Circuit found that the District Court necessarily engaged in an independent review of the evidence and substituted its conclusion for that of the jury on the factual issue of compensatory damages. The District Court’s decision amounted to an exercise of discretion subject to Hetzel’s requirement that Minks be offered a new trial.  Thus, the Federal Circuit vacated the District Court’s order reducing the jury’s compensatory damages award and remanded for a new trial on damages.

Reduction of Enhanced Damages

In the second issue on appeal, the Federal Circuit discussed the District Court’s award of enhanced damages and attorney fees to Minks under 35 U.S.C. § 285. The Federal Circuit detected no abuse of discretion in the District Court’s reduced award of attorney fees seeing as even on appeal, Minks did not articulate a coherent damages theory. The Federal Circuit, therefore, affirmed the award of attorney fees but noted that the trial judge could exercise discretion to modify the award if it warranted further consideration on remand.

Actual Notice under 35 U.S.C. §287

In the third issue on appeal, the Federal Circuit addressed the jury instruction on the issue of notice. Under 35 U.S.C. § 287(a), where a patentee has failed to mark its patented product, “no damages shall be recovered by the patentee in any action for infringement, except on proof that the infringer was notified of the infringement and continued to infringe thereafter, in which event damages may be recovered only for infringement occurring after such notice.” Minks Engineering did not mark its products, so damages recoverable by Minks were limited by the date that Polaris received notice satisfying the requirements of 35 U.S.C. § 287(a).

Minks argued that the District Court’s jury instruction on actual notice was inadequate because a patentee can provide sufficiently specific notice to an accused infringer before the patentee discovers the actual infringement by the accused. Thus, a patent owner can give notice both by a positive charge of infringement as well as by a qualified charge of infringement.  The Federal Circuit agreed with Minks that the given instruction did not fairly and correctly state the issues and the law, and that the jury should have been more clearly instructed that it was permitted to find notice prior to the date Minks discovered Polaris’s infringement. Minks made a qualified charge of infringement when he informed Polaris that reverse speed limiters that sensed engine speed and a DC input infringe the ‘080 patent, and as a long time customer of Minks, Polaris knew of the ‘080 patent.  Moreover, as early as 1997, Minks specifically communicated his belief that reverse speed limiters sensing engine speed and a DC input infringed the ‘080 patent. Therefore, the Federal Circuit found that the District Court’s instruction to the jury should have more clearly articulated that in this context, knowledge of a specific infringing device was not a legal prerequisite to a finding of actual notice.   Thus, the Federal Circuit also required a new trial on this issue.

Infringement of Means Plus Function Element

Additionally, Polaris cross-appealed from the District Court’s denial of its JMOL motion on noninfringement. On appeal, the Federal Circuit noted that claim 2 is a means plus function claim whose bounds are construed by identifying the claim’s function then identifying the corresponding structure in the written description necessary to perform that function. Texas Digital Sys., Inc. v. Telegenix, Inc., 308 F.3d 1193, 1208 (Fed. Cir. 2002). It is undisputed that the circuitry of the accused devices differs and has different components than that taught by Figure 2 of the ‘080 patent. However, based on expert testimony and the teachings of the ‘080 patent, the Federal Circuit found that the functions of the accused device and the claim were identical, that the two devices had equivalent structures (noting that difference in physical structure alone is not determinative of § 112 ¶ 6 equivalents), and that the structures performed in substantially the same way. The Federal Circuit, therefore, agreed with the District Court that the jury’s verdict of infringement was supported by substantial evidence that the accused devices met claim 2 of the ‘080 patent and affirmed that the District Court’s denial of Polaris’s JMOL motion.

Willfulness

Lastly, the Federal Circuit addressed Polaris’s second cross appeal that the jury instruction on willful infringement constituted plain error based on the Federal Circuit’s decision in In re Seagate Technology, LLC, 174 F.3d 1360 (Fed. Cir. 2007) (en banc). The Federal Circuit did not decide this issue because Polaris made no argument and cited no evidence to establish two of the elements for plain error as outlined by In re Seagate. Furthermore, because in the order granting Minks’s request for enhanced damages the trial court concluded that “it is fairly clear” that Polaris deliberately copied Minks’s patented reverse speed limiter “and the case was not close,” the Federal Circuit said it appeared that error in the jury instruction was not prejudicial because the jury probably would have arrived at the same result nevertheless. The Federal Circuit found that Polaris did not demonstrate plain error in the jury instruction on willfulness and affirmed the jury’s finding of willful infringement.

Parent Corporation Cannot Recover Lost Profits of Subsidiary When Subsidiary is Non-Exclusive Licensee of Parent’s Patent

In Mars, Inc v. Coin Acceptors, Inc., Nos. 07-1409, -1436 (Fed. Cir. June 2, 2008), Mars, Inc., a U.S. based candy company producing popular treats such as M&Ms and Milky Way bars, developed and obtained patents on a technique for identifying coins deposited in a vending machine.  Mars does not produce any vending machines itself but created a wholly-owned subsidiary, Mars Electronics International (MEI), to produce the machines.  Mars licensed MEI to use its patents in the design of its vending machines.

Mars maintained consolidated financial statements reflecting the incomes of all its subsidiaries.  However, Mars licensed MEI to use its patents on a royalty basis per gross sales.  Thus Mars would receive revenue regardless of whether MEI turned a profit or not.  As will be described below, the Federal Circuit found this fact particularly compelling in finding that there was not a significantly direct flow of profits from MEI to Mars.

A competing vending machine manufacturer, Coin Acceptors, Inc. (“Coinco”), began producing vending machines which infringed Mars’ patents.  Mars sued Coinco for this infringement in 1990.  The District Court, after consolidating, found that Coinco infringed both of Mars’ patents and entered final judgment on liability in 2005.  Coinco appealed and the Federal Circuit affirmed the liability holding.  The District Court then began to calculate damages.

Calculation of damages was shaped by several factors.  First, one of the two patents expired in 1992.  Second, Coinco introduced an non-infringing alternative in 1994, so the parties agreed that lost profits did not apply after 1994.  Third, in 1996 Mars transferred its entire interest in the patents to MEI.  Fourth, the second patent expired in 2003.

Mars sought lost profits for sales prior to 1994, or at a minimum a reasonable royalty on such sales.  Mars further sought a reasonable royalty on sales after 1994 until 2003.  Coinco acknowledged that Mars was entitled to a reasonable royalty prior to 1994, but disputed Mars’ other claims.

The District Court ruled that Mars could not recover on a lost profits theory as Mars itself did not lose any sales and there was no evidence that MEI’s profits flowed inexorably to Mars.  Mars sought to add MEI as a co-plaintiff, but the court denied this motion because MEI lacked standing to seek damages, at least prior to the 1996 transfer.  On a motion for reconsideration, the District Court found that Mars lacked standing to pursue the claims from 1996 onward, after it transferred its interests to MEI.  The District Court allowed MEI to immediately transfer the interests back to Mars in order to re-establish standing under Schreiber Foods, Inc. v. Beatrice Cheese, Inc., 402 F.3d 1198 (Fed. Cir. 2005).  Mars accomplished this through a document asserting that MEI transferred the rights to litigation of the patents back to Mars.

After a four day bench trial, the District Court found that a 7% royalty was reasonable and found $14,376,062 in damages.

Four issues were addressed by the Federal Circuit on appeal: (1) whether Mars was entitled to lost profits; (2) whether MEI lacked standing prior to 1996; (3) whether Mars had standing to seek damages after 1996; and (4) whether the 7% royalty was reasonable.

Lost Profits

The Federal Circuit began its consideration by recognizing that patent infringement is a tort, and that the purpose of damages is to restore the victim to the position he would be in had the tort not occurred.  Brooktree Corp. v. Advanced Micro Devices, Inc., 977 F.2d 1555, 1579 (Fed. Cir. 1992); see also Aro Mfg. Co. v. Convertible Top Replacement Co., 377 U.S. 476, 507 (1964) (“had the Infringer not infringed, what would the [Patentee] have made?”).  There was no dispute that Coinco’s actions harmed Mars; the dispute was over whether Mars could recover under lost profits.

After a lengthy discussion of compensation theories, the Court addressed whether or not Mars could claim MEI’s lost profits.  Mars argued that, due to MEI being a wholly owned subsidiary and the consolidated financial statements, the profits of MEI flowed inexorably to Mars.  The Federal Circuit did not agree.  Uncontradicted testimony in the record showed that Mars and MEI had a traditional royalty-bearing license agreement.  Such royalty payments were the only payments on record which Mars received from MEI.  The court saw no evidence that the profits of MEI flowed inexorably to Mars.  Mars at 11.  As such, the Court determined that the harm suffered by Mars was lost royalty payments, for which the appropriate recompense is a reasonable royalty by the infringer.  The court affirmed the District Court’s holding on this point.

The Court declined the opportunity to address whether or not a parent company can recover lost profits of a subsidiary when the profits do flow inexorably from the subsidiary to the parent as that is not the case here.  Id. at 12.

1.       MEI’s Standing Prior to 1996

In order to seek lost profits, Mars attempted to add MEI as a co-plaintiff.  The District Court denied this motion, as MEI lacked standing.  The Federal Circuit affirmed.

Only a patent owner or an exclusive licensee can have constitutional standing to bring an infringement suit; a non-exclusive licensee does not.  Sicom Sys., Ltd. V. Agilent Techs., Inc., 427 F.3d 971, 976 (Fed. Cir. 2005).  MEI did not possess standing to sue prior to 1996 because it was neither owned the patents in question nor was it the exclusive licensee.  Mars had licensed another of its subsidiaries, MEI-UK, to practice the patent in the U.S., making MEI a non-exclusive licensee.

Thus the court determined that the District Court had correctly denied Mars’ motion to add MEI as a co-plaintiff for damages occurring prior to the 1996 transfer.

2.       Mars’ Standing After 1996

When Mars transferred its interests in the patents to MEI in 1996, it lost standing to seek infringement.  Under Schreiber, Mars could correct this jurisdictional defect by reacquiring the title to the patent.  See Schreiber, 402 F.3d at 1204 (“Here Schreiber reacquired its stake in the litigation by reacquiring the ‘860 patent (and causes of action thereunder) before the entry of judgment.  The jurisdictional defect that had existed was cured before the entry of judgment and thus the judgment was not void” (emphasis added)).  Therefore, the Federal Circuit turned to analyzing whether the 1996 agreement transferred title to MEI and if the agreement in 2006 transferred it back.

The 1996 transaction by its terms transferred Mars’ “entire interest” in the patents to MEI.  The Federal Circuit recognized that it is well known that a transfer of one’s entire interest equates to a full assignment of the patent and a transfer of title.  Mars at 17.  As a result, the court found that Mars lacked standing as of 1996, confirming the District Court’s finding.

Turning to the 2006 retransfer from MEI to Mars, the court relied upon the plain and common meaning of the words in the contract.  Under New York corporate law, which governed that contract, words are given their plain meaning and a dictionary is often used to determine such meaning.  After defining the terms used in the document, the court determines that the document assigns the right to sue for past infringement to Mars, but not title. Id at 19.  The court saw no provision in the contract which purports to transfer full title back to Mars.

Mars argued that, as the patent had expired, the only remaining right associated with the patent was the right to sue for past damages.  As such, they argued, transfer of that right should amount to a transfer of title.  The court rejected this argument, stating that the title to an expired patent contains more than the right to sue. Id at 20.  Seeing nothing in the contract which would transfer full title to Mars, the Federal Circuit held that Mars failed to satisfy Schreiber and lacked standing from 1996 through 2003.

Reasonable Royalty

Coinco argued that the District Court erred in setting the royalty rate.  One of its arguments was that the royalty which the court settled upon was higher than the cost of developing non-infringing alternatives.  Specifically, Coinco claimed that no rational entity would infringe if the cost exceeded the cost of developing an alternative.  The court rejected this argument as a matter of law. Id at 22; see also Montsanto Co. v. Ralph, 382 F.3d 1374, 1383 (Fed. Cir. 2004).  In a related argument, Coinco argued that a reasonable royalty can never result in the infringer operating at a loss.  This argument was also dismissed as a matter of law. Id at 24; see Montsanto.

Conclusion

The Federal Circuit affirmed the District Court’s holding that Mars could not recover MEI’s lost profits, as the profits did not flow inexorably to Mars and the financial relationship between Mars and MEI was a traditional royalty-based license relationship.  The District Court’s denial of Mars’ motion to add MEI as a co-plaintiff was also affirmed because MEI lacked standing, as they were neither the owner of the patent nor the exclusive licensee.  The Federal Circuit reversed the decision of the District Court and held that Mars lacked standing from 1996 to 2003 and was not entitled to recover damages from that time period. The Court affirmed the royalty set by the District Court and remanded the case for a recalculation of damages.

Significance to Patent Owners

Mars continues the Federal Circuit’s view that lost profits damages should rarely be granted, and further shows the limitations of attempting to obtain lost profits damages where a subsidiary is the entity actually losing the sales, but the parent is enforcing the patent.  As such, while it is often convenient to hold intellectual property at a parent corporation level, such convenience can come at the price of limiting damages which could possibly be obtained if the damaged subsidiary actually owns the intellectual property and is allowed to assert damages for infringement.