<i>Lucent v. Gateway</i>

Background

In 2002, Lucent filed a patent infringement suit against Gateway; Microsoft subsequently intervened. Three of Microsoft's products were accused in the case including Microsoft Outlook, Microsoft Money, and Windows Mobile. The patent at issue, U.S. Patent No. 4,763,356 (the Day patent), was alleged to cover the “calendar date-picker tool” that is incorporated in a few of Outlook's features. In arguing its case, Lucent claimed, among other things, that the “calendar date-picker tool” allowed for the infringement of certain method claims that it was asserting. The jury ultimately found infringement of those method claims and awarded a lump-sum royalty of more than $357 million. While Microsoft Money and Windows Mobile have similar functionality, the district court found that infringement by use of Microsoft Outlook apparently constituted the vast majority of the award.

On appeal, the CAFC found that the substantial evidence of record did not support the jury's damage award. Additionally, although the jury did not clearly distinguish whether or not the award was based on the EMVR, the court ruled that any application of the EMVR is against the clear weight of the evidence. The court also considered the evidence put forth by Lucent in connection with several of the Georgia-Pacific factors including, but not limited to, factor 2 (comparable license agreements), factor 10 (the nature of the patented invention), and factor 13 (the portion of the profit attributed to the invention). In connection with its analysis of each of those factors, the court again found a lack of evidence to support the jury's award.

The Entire Market Value Rule

The EMVR is a U.S. patent law doctrine that allows the owner of a component invention to capture the entire value of a larger infringing product that unlawfully incorporates the invention. Many argue that the EMVR can result in the overcompensation of patent owners relative to the contribution provided by their inventions. Proponents of patent reform have at times cited it as the cause of excessive damage awards and the resultant need to overhaul the current patent system.

As stated above, in the current case, the CAFC ruled that an award based on the EMVR was not supported by substantial evidence. More specifically, the court found two flaws in the application of the EMVR. First, the court found a lack of evidence demonstrating that the Day patent was the basis (or even a substantial basis) for customer demand. That said, the need for such evidence to support an EMVR analysis is not new law. As the court stated, its position was made “quite clear” in Rite-Hite and State Industries that, for the entire market value rule to apply, the patentee must prove that the patent-related feature is the basis for customer demand.

The second flaw cited by the court was in the approach adopted by Lucent's licensing expert. As described by the court, Lucent's expert initially applied a 1% royalty to the entire price of infringing computers incorporating the accused software. Later however, after the district court granted a motion in limine to exclude the expert's EMVR opinion, he changed his opinion to 8% of the software price. In ruling on the expert's approach, the CAFC found that, after being precluded from applying the EMVR, Lucent's expert tried to reach the same damages number by inflating the royalty rate to compensate for the smaller base. The court's finding in this regard clearly illustrates the need for an integrated approach that considers the royalty rate, royalty base, and potentially other considerations in combination with one another.

Georgia-Pacific Factor #2: Comparable License Agreements

The second Georgia-Pacific factor addresses “the rates paid by the licensee for the use of other similar patents.” One recognized method used by damages experts to consider the influence of such licenses in a reasonable royalty analysis is commonly referred to as the Market Approach.

The Market Approach attempts to measure the value of an intangible asset by drawing inferences from actual market transactions. In general, the more similar those market transactions are to the transaction in question, the more useful the information. While closely analogous transactions cannot always be found, they do exist in some situations. In the absence of an analogous transaction, market transactions that share some characteristics with the subject transaction can provide guidance as to the terms and conditions that may be applicable in a particular case.

In the case at hand, the CAFC provided an extensive discussion of eight license agreements relied upon by Lucent's expert. Ultimately, the court found no basis for the expert's reliance on those agreements stating:

When we examine these license agreements, along with the relevant testimony, we are left with two strong conclusions. First, some of the license agreements are radically different from the hypothetical agreement under consideration for the Day patent. Second, with the other agreements, we are simply unable to ascertain from the evidence presented the subject matter of the agreements, and we therefore cannot understand how the jury could have adequately evaluated the probative value of those agreements.

Said differently, the license agreements that Lucent's expert relied upon were not closely analogous to the hypothetical license and there was insufficient evidence and/or analysis to prove their comparability (i.e., probative value) to the license that would have resulted from the hypothetical negotiation. While the court's discussion of the agreements is extensive, in summary it found that the evidence of record relating to the allegedly comparable agreements failed to address several important issues such as the subject matter of the patents, types of products covered, and the structure of the agreements.

While a comprehensive evaluation of the court's discussion of the agreements is beyond the scope of this article, it should suffice to say that the court's focus on evidence supporting the comparability of market agreements to the hypothetical license is seemingly consistent with the previously discussed language regarding the application of the EMVR and the need to ensure the comparability and consistency of the royalty rate and the base to which it is applied.

Georgia-Pacific Factors #10 And #13: Apportionment of Profits

The court considered Georgia-Pacific factors 10 and 13 collectively. Georgia-Pacific factors 10 and 13 can be particularly relevant in matters such as Lucent where the patented functionality provides for only one of numerous features incorporated into an accused product. In such cases, it is often necessary to determine the portion of the total profit earned on the accused product that should be apportioned (credited) to the patented functionality.

Factor 10 addresses “the nature of the patented invention, its character in the commercial embodiment owned and produced by the licensor, and the benefits to those who used it.” In evaluating that factor, the court found the infringing feature contained in Microsoft Outlook to be a “tiny” feature of only one part of a much larger software program. The court also found that it was “inconceivable” to conclude that the date-picker feature accounted for a substantial portion of the value of Outlook.

Factor 13 relates to “the portion of the realizable profit that should be credited to the invention as distinguished from any non-patented elements, manufacturing process, business risks or significant features or improvements added by the infringer.” Although the court found little evidence presented by either party regarding this factor, it nonetheless concluded that it was reasonable to credit most of the profit earned on sales of Outlook to non-patented elements. In finding such, the court stated that “the glaring imbalance between infringing and non-infringing features must impact the analysis of how much profit can properly be attributed to the use of the date-picker compared to non-patented elements and other features of Outlook.”

Ultimately, because the date-picker feature was found to be a minor aspect of Outlook, accounting for an “exceedingly small” portion of its profits, the court found little support for the jury's $357 million lump-sum damages award.

Conclusion

Ultimately, any damages claim based on a running royalty is a product of the chosen base and rate. To that point, while Lucent discusses the EMVR, comparable license agreements, and profit apportionment, at a higher level it reinforces the notion that the determination of reasonable royalty damages is a systemic exercise that considers a multitude of factors, all of which must be supported by the evidence and internally consistent. Only then, will a damages award most accurately reflect the economic contribution of the technology.

On Sept. 11, 2009, the U.S. Court of Appeals for the Federal Court (“CAFC”) issued an opinion in the case of Lucent Technologies Inc. et al. v. Gateway Inc. et al. (“Lucent“). In its ruling, the CAFC found that “the damages evidence of record was neither very powerful, nor presented very well by either party” and that the plaintiff's damages calculation “lacked sufficient evidentiary support.” The CAFC therefore vacated the district court's award and remanded the case for a new trial on damages.

In vacating the damages award, the CAFC provided insight into its current views on issues often considered in connection with the determination of damages in patent infringement litigation. While the case does not establish any fundamentally new methodologies, it does discuss a number of intellectual and economic issues related to the determination of reasonable royalty damages.

This article is not intended to provide a comprehensive analysis of the damages-related topics discussed in Lucent. Rather, it will summarize the court's discussion on three issues that are often debated in intellectual property infringement actions. Those issues include the Entire Market Value Rule (“EMVR”), the comparability of market-based license agreements, and the apportionment of profits. While the CAFC discussed each of those issues in connection with the district court's award, it also stressed the need for systemic consideration and internal consistency of the factors impacting a reasonable royalty analysis:

Although our law states certain mandatory conditions for applying the entire market value rule, courts must nevertheless be cognizant of a fundamental relationship between the entire market value rule and the calculation of a running royalty damages award. Simply put, the base used in a running royalty calculation can always be the value of the entire commercial embodiment, as long as the magnitude of the rate is within an acceptable range (as determined by the evidence).

The remainder of this article provides an overview of Lucent and reviews the decision in light of the issues introduced above. Because the breadth of the decision prevents a comprehensive discussion of the court's ruling, we have attempted to provide a focused and summarized discussion of some of the more salient aspects.

Background

In 2002, Lucent filed a patent infringement suit against Gateway; Microsoft subsequently intervened. Three of Microsoft's products were accused in the case including Microsoft Outlook, Microsoft Money, and Windows Mobile. The patent at issue, U.S. Patent No. 4,763,356 (the Day patent), was alleged to cover the “calendar date-picker tool” that is incorporated in a few of Outlook's features. In arguing its case, Lucent claimed, among other things, that the “calendar date-picker tool” allowed for the infringement of certain method claims that it was asserting. The jury ultimately found infringement of those method claims and awarded a lump-sum royalty of more than $357 million. While Microsoft Money and Windows Mobile have similar functionality, the district court found that infringement by use of Microsoft Outlook apparently constituted the vast majority of the award.

On appeal, the CAFC found that the substantial evidence of record did not support the jury's damage award. Additionally, although the jury did not clearly distinguish whether or not the award was based on the EMVR, the court ruled that any application of the EMVR is against the clear weight of the evidence. The court also considered the evidence put forth by Lucent in connection with several of the Georgia-Pacific factors including, but not limited to, factor 2 (comparable license agreements), factor 10 (the nature of the patented invention), and factor 13 (the portion of the profit attributed to the invention). In connection with its analysis of each of those factors, the court again found a lack of evidence to support the jury's award.

The Entire Market Value Rule

The EMVR is a U.S. patent law doctrine that allows the owner of a component invention to capture the entire value of a larger infringing product that unlawfully incorporates the invention. Many argue that the EMVR can result in the overcompensation of patent owners relative to the contribution provided by their inventions. Proponents of patent reform have at times cited it as the cause of excessive damage awards and the resultant need to overhaul the current patent system.

As stated above, in the current case, the CAFC ruled that an award based on the EMVR was not supported by substantial evidence. More specifically, the court found two flaws in the application of the EMVR. First, the court found a lack of evidence demonstrating that the Day patent was the basis (or even a substantial basis) for customer demand. That said, the need for such evidence to support an EMVR analysis is not new law. As the court stated, its position was made “quite clear” in Rite-Hite and State Industries that, for the entire market value rule to apply, the patentee must prove that the patent-related feature is the basis for customer demand.

The second flaw cited by the court was in the approach adopted by Lucent's licensing expert. As described by the court, Lucent's expert initially applied a 1% royalty to the entire price of infringing computers incorporating the accused software. Later however, after the district court granted a motion in limine to exclude the expert's EMVR opinion, he changed his opinion to 8% of the software price. In ruling on the expert's approach, the CAFC found that, after being precluded from applying the EMVR, Lucent's expert tried to reach the same damages number by inflating the royalty rate to compensate for the smaller base. The court's finding in this regard clearly illustrates the need for an integrated approach that considers the royalty rate, royalty base, and potentially other considerations in combination with one another.

Georgia-Pacific Factor #2: Comparable License Agreements

The second Georgia-Pacific factor addresses “the rates paid by the licensee for the use of other similar patents.” One recognized method used by damages experts to consider the influence of such licenses in a reasonable royalty analysis is commonly referred to as the Market Approach.

The Market Approach attempts to measure the value of an intangible asset by drawing inferences from actual market transactions. In general, the more similar those market transactions are to the transaction in question, the more useful the information. While closely analogous transactions cannot always be found, they do exist in some situations. In the absence of an analogous transaction, market transactions that share some characteristics with the subject transaction can provide guidance as to the terms and conditions that may be applicable in a particular case.

In the case at hand, the CAFC provided an extensive discussion of eight license agreements relied upon by Lucent's expert. Ultimately, the court found no basis for the expert's reliance on those agreements stating:

When we examine these license agreements, along with the relevant testimony, we are left with two strong conclusions. First, some of the license agreements are radically different from the hypothetical agreement under consideration for the Day patent. Second, with the other agreements, we are simply unable to ascertain from the evidence presented the subject matter of the agreements, and we therefore cannot understand how the jury could have adequately evaluated the probative value of those agreements.

Said differently, the license agreements that Lucent's expert relied upon were not closely analogous to the hypothetical license and there was insufficient evidence and/or analysis to prove their comparability (i.e., probative value) to the license that would have resulted from the hypothetical negotiation. While the court's discussion of the agreements is extensive, in summary it found that the evidence of record relating to the allegedly comparable agreements failed to address several important issues such as the subject matter of the patents, types of products covered, and the structure of the agreements.

While a comprehensive evaluation of the court's discussion of the agreements is beyond the scope of this article, it should suffice to say that the court's focus on evidence supporting the comparability of market agreements to the hypothetical license is seemingly consistent with the previously discussed language regarding the application of the EMVR and the need to ensure the comparability and consistency of the royalty rate and the base to which it is applied.

Georgia-Pacific Factors #10 And #13: Apportionment of Profits

The court considered Georgia-Pacific factors 10 and 13 collectively. Georgia-Pacific factors 10 and 13 can be particularly relevant in matters such as Lucent where the patented functionality provides for only one of numerous features incorporated into an accused product. In such cases, it is often necessary to determine the portion of the total profit earned on the accused product that should be apportioned (credited) to the patented functionality.

Factor 10 addresses “the nature of the patented invention, its character in the commercial embodiment owned and produced by the licensor, and the benefits to those who used it.” In evaluating that factor, the court found the infringing feature contained in Microsoft Outlook to be a “tiny” feature of only one part of a much larger software program. The court also found that it was “inconceivable” to conclude that the date-picker feature accounted for a substantial portion of the value of Outlook.

Factor 13 relates to “the portion of the realizable profit that should be credited to the invention as distinguished from any non-patented elements, manufacturing process, business risks or significant features or improvements added by the infringer.” Although the court found little evidence presented by either party regarding this factor, it nonetheless concluded that it was reasonable to credit most of the profit earned on sales of Outlook to non-patented elements. In finding such, the court stated that “the glaring imbalance between infringing and non-infringing features must impact the analysis of how much profit can properly be attributed to the use of the date-picker compared to non-patented elements and other features of Outlook.”

Ultimately, because the date-picker feature was found to be a minor aspect of Outlook, accounting for an “exceedingly small” portion of its profits, the court found little support for the jury's $357 million lump-sum damages award.

Conclusion

Ultimately, any damages claim based on a running royalty is a product of the chosen base and rate. To that point, while Lucent discusses the EMVR, comparable license agreements, and profit apportionment, at a higher level it reinforces the notion that the determination of reasonable royalty damages is a systemic exercise that considers a multitude of factors, all of which must be supported by the evidence and internally consistent. Only then, will a damages award most accurately reflect the economic contribution of the technology.