Determinants of Patent Value in U.S. Litigation

Part One of a Two-Part Series

Although patent enforcement efforts have been historically dominated by the technology-elite, few businesses of the future will be exempt from the impact of patent infringement litigation. Indeed, data published by the USPTO and the federal judiciary reveal that the number of patent applications filed annually and the number of patent infringement litigations initiated annually have both more than doubled since 1990. Simply stated, business leaders of the future are increasingly likely to encounter one of two situations:

1) The firm believes others are infringing its patents; or

2) Others accuse the firm of infringing their patents.

Yet, for most business leaders, the potential risks and rewards associated with patent infringement litigation remain a marsh of murky waters teeming with perilous decisions. For instance, a firm could spend millions of dollars obtaining discovery against an infringer only to find that its patents are worth a nominal royalty. Conversely, the same firm could contain its budget on discovery and inadvertently forego evidence probative of patent value.

As discussed in this article, many quantitative and qualitative factors that influence patent value in litigation may be known or knowable to business leaders before litigation commences. The authors suggest that an assessment of such factors may yield important insight into the potential litigation exposure, thereby providing meaningful guidance to business leaders facing or contemplating patent litigation.

Generally speaking, in order to assess potential damages in a patent infringement case one must first assume that the patents at issue are valid and infringed. Second, one must determine whether and to what extent the plaintiff would have realized additional sales had the defendant not infringed its patents. If it can be proven that the plaintiff 'lost' sales as a result of the defendant's infringement, the plaintiff may be able to claim the 'lost profits' associated with those sales as damages. Such lost profit damages are relatively complicated and beyond the scope of this article.

Under 35 U.S.C. '284, a successful claimant in patent infringement litigation is entitled to collect no less than a reasonable royalty. Reasonable royalty damages are awarded when the plaintiff cannot prove that it has lost any sales as a result of the defendant's infringement. Reasonable royalty damages are often determined by envisioning the terms of a 'hypothetical negotiation' between the plaintiff and defendant for a license to the patent(s)-in-suit around the time infringement began. The reasonable royalty that would result from such a negotiation is described in the often-cited Georgia-Pacific case as:

[t]he royalty that a licensor (such as the patentee) and a licensee (such as the infringer) would have agreed upon if both had been reasonably and voluntarily trying to reach an agreement; that is, the amount which a prudent licensee ' who desired, as a business proposition, to obtain a license to manufacture and sell a particular article embodying the patented invention ' would have been willing to pay as a royalty and yet be able to make a reasonable profit and which amount would have been acceptable by a prudent patentee who was willing to grant a license.

Simply stated, a reasonable royalty analysis focuses on the economic and bargaining positions of the plaintiff and defendant at the time of the hypothetical negotiation. Although the outcome of this hypothetical negotiation (and the amount of damages due the plaintiff) would be determined by the court with the assistance of independent damages experts, a prospective litigant can begin evaluating its litigation exposure by considering several questions:

1) Did the alleged infringer have a non-infringing alternative to using the patented technology? If the accused infringer had a commercially acceptable alternative to using the patents-in-suit, then most courts have found that the cost of implementing such an alternative should weigh heavily on the determination of a reasonable royalty. Often, such alternatives are advanced by defendants in the form of redesigned (non-infringing) products that purportedly yield the same advantages as those of the patented product. Other forms of non-infringing alternatives include sourcing the infringing functionality from a licensed vendor or eliminating the accused functionality from the product. In determining the cost of implementing a non-infringing alternative, both out-of-pocket expenditures as well as the business risks associated with potential lost sales or other adverse economic impacts should be considered along with its commercial acceptability.

2) Do any comparable license agreements exist? In addition to considering the cost of alternatives, most courts allow evidence about historical license agreements involving similar considerations. An evaluation of such agreements can potentially provide insight into the 'market rate' for the patents-in-suit in a manner similar to residential real estate appraisals that assess home prices based on comparable transactions.

A comparable license evaluation can be easily conducted if there is a history of licensing the patent(s)-in-suit. However, even in the absence of such transactions, an examination of licenses for similar technologies could potentially yield insight into customary terms that may pertain to a particular technology sector or industry. Some of the terms that may be relevant to the hypothetical negotiation include the range of accepted royalty rates, definitions of accepted royalty bases, and the royalty structure including a lump-sum, running royalty, or some combination thereof.

Although license agreements maintained by the counter-party to the litigation are typically not available in the public domain, a broader market perspective may be obtained by reviewing publicly available license agreements for a particular technology or in a particular industry. One company that maintains and sells such publicly available data is Royalty Source (www.royaltysource.com).

The second installment of this series will discuss the two remaining questions that a prospective litigant can ask to evaluate its litigation exposure.

Kevin Arst and Michael Milani are managing directors in Ocean Tomo, LLC's Expert Services division. Their practices are focused on assisting clients and counsel with the determination of damages in IP infringement litigation. They are based out of the firm's San Francisco and Chicago offices, respectively.

Part One of a Two-Part Series

Although patent enforcement efforts have been historically dominated by the technology-elite, few businesses of the future will be exempt from the impact of patent infringement litigation. Indeed, data published by the USPTO and the federal judiciary reveal that the number of patent applications filed annually and the number of patent infringement litigations initiated annually have both more than doubled since 1990. Simply stated, business leaders of the future are increasingly likely to encounter one of two situations:

1) The firm believes others are infringing its patents; or

2) Others accuse the firm of infringing their patents.

Yet, for most business leaders, the potential risks and rewards associated with patent infringement litigation remain a marsh of murky waters teeming with perilous decisions. For instance, a firm could spend millions of dollars obtaining discovery against an infringer only to find that its patents are worth a nominal royalty. Conversely, the same firm could contain its budget on discovery and inadvertently forego evidence probative of patent value.

As discussed in this article, many quantitative and qualitative factors that influence patent value in litigation may be known or knowable to business leaders before litigation commences. The authors suggest that an assessment of such factors may yield important insight into the potential litigation exposure, thereby providing meaningful guidance to business leaders facing or contemplating patent litigation.

Generally speaking, in order to assess potential damages in a patent infringement case one must first assume that the patents at issue are valid and infringed. Second, one must determine whether and to what extent the plaintiff would have realized additional sales had the defendant not infringed its patents. If it can be proven that the plaintiff 'lost' sales as a result of the defendant's infringement, the plaintiff may be able to claim the 'lost profits' associated with those sales as damages. Such lost profit damages are relatively complicated and beyond the scope of this article.

Under 35 U.S.C. '284, a successful claimant in patent infringement litigation is entitled to collect no less than a reasonable royalty. Reasonable royalty damages are awarded when the plaintiff cannot prove that it has lost any sales as a result of the defendant's infringement. Reasonable royalty damages are often determined by envisioning the terms of a 'hypothetical negotiation' between the plaintiff and defendant for a license to the patent(s)-in-suit around the time infringement began. The reasonable royalty that would result from such a negotiation is described in the often-cited Georgia-Pacific case as:

[t]he royalty that a licensor (such as the patentee) and a licensee (such as the infringer) would have agreed upon if both had been reasonably and voluntarily trying to reach an agreement; that is, the amount which a prudent licensee ' who desired, as a business proposition, to obtain a license to manufacture and sell a particular article embodying the patented invention ' would have been willing to pay as a royalty and yet be able to make a reasonable profit and which amount would have been acceptable by a prudent patentee who was willing to grant a license.

Simply stated, a reasonable royalty analysis focuses on the economic and bargaining positions of the plaintiff and defendant at the time of the hypothetical negotiation. Although the outcome of this hypothetical negotiation (and the amount of damages due the plaintiff) would be determined by the court with the assistance of independent damages experts, a prospective litigant can begin evaluating its litigation exposure by considering several questions:

1) Did the alleged infringer have a non-infringing alternative to using the patented technology? If the accused infringer had a commercially acceptable alternative to using the patents-in-suit, then most courts have found that the cost of implementing such an alternative should weigh heavily on the determination of a reasonable royalty. Often, such alternatives are advanced by defendants in the form of redesigned (non-infringing) products that purportedly yield the same advantages as those of the patented product. Other forms of non-infringing alternatives include sourcing the infringing functionality from a licensed vendor or eliminating the accused functionality from the product. In determining the cost of implementing a non-infringing alternative, both out-of-pocket expenditures as well as the business risks associated with potential lost sales or other adverse economic impacts should be considered along with its commercial acceptability.

2) Do any comparable license agreements exist? In addition to considering the cost of alternatives, most courts allow evidence about historical license agreements involving similar considerations. An evaluation of such agreements can potentially provide insight into the 'market rate' for the patents-in-suit in a manner similar to residential real estate appraisals that assess home prices based on comparable transactions.

A comparable license evaluation can be easily conducted if there is a history of licensing the patent(s)-in-suit. However, even in the absence of such transactions, an examination of licenses for similar technologies could potentially yield insight into customary terms that may pertain to a particular technology sector or industry. Some of the terms that may be relevant to the hypothetical negotiation include the range of accepted royalty rates, definitions of accepted royalty bases, and the royalty structure including a lump-sum, running royalty, or some combination thereof.

Although license agreements maintained by the counter-party to the litigation are typically not available in the public domain, a broader market perspective may be obtained by reviewing publicly available license agreements for a particular technology or in a particular industry. One company that maintains and sells such publicly available data is Royalty Source (www.royaltysource.com).

The second installment of this series will discuss the two remaining questions that a prospective litigant can ask to evaluate its litigation exposure.

Kevin Arst and Michael Milani are managing directors in Ocean Tomo, LLC's Expert Services division. Their practices are focused on assisting clients and counsel with the determination of damages in IP infringement litigation. They are based out of the firm's San Francisco and Chicago offices, respectively.