Calculating Reasonable Royalty Damages for Indirect Infringement

Many of the most publicized patent infringement suits are based on theories of indirect liability, codified in the Patent Act under 35 U.S.C. ' 271(b) (inducement of infringement) and ' 271(c) (contributory infringement). For example, a scenario that gives rise to inducement claims under ' 271(b) is the defendant's manufacture and sale of a device capable of performing a claimed method, accompanied by instructions on how to use the device in a manner that would infringe the method. See, e.g., Moleculon Research Corp. v. CBS, Inc., 793 F.2d 1261 (Fed. Cir. 1986) (method for solving Rubik's cube); see also i4i Ltd. Partnership v. Microsoft Corp., 598 F.3d 831 (Fed. Cir. 2010), cert. granted, 2010 WL 3392402 (U.S. Nov. 29, 2010), (method of using custom XML editor). Since suing directly infringing end users, like one's customers, may be impractical or inadvisable, plaintiffs often opt to go after manufacturers who “aid and abet” infringing conduct. Given the importance of indirect liability in patent law, it is troubling that the state of the law on calculating damages in judgments of indirect infringement appears to be in disarray. The confusion centers on the relevance of the extent of directly infringing conduct for figuring a “reasonable royalty,” which is the statutory minimum for patent infringement damages, 35 U.S.C. ' 284; the reasonable royalty method is used far more frequently than the alternative “lost profits” approach.

Conflicting Pronouncements

In two recent cases decided only three weeks apart, the Federal Circuit gave conflicting pronouncements on the issue of whether trial courts can limit damages as a matter of law to proven instances of direct infringement. In Lucent Technologies v. Gateway, Inc., 580 F.3d 1301, 1308 (Fed. Cir. 2009), cert. denied, 130 S. Ct. 3324 (2010), the court affirmed the jury's finding of infringement of Lucent's claims on a “method of entering information into fields on a computer screen without using a keyboard.” Customers directly infringed the claims by using Microsoft Outlook's appointment-scheduling feature, and the defendant was found indirectly liable on both inducement and contributory infringement theories. The court vacated the jury award of reasonable royalty damages (a lump sum of $357,693,056.18) as unsupported by evidence, but opined that “we have never laid down any rigid requirement that damages in all circumstances be limited to specific instances of infringement proven with direct evidence.” Id. at 1334. The court stated that such a damage-limiting rule would be inconsistent with the hypothetical negotiation approach to calculating reasonable royalty damages by assuming a scenario that would be “far removed from what parties regularly do during real world licensing negotiations. ' [For example], companies in the high-tech computer industry often strike licensing deals in which the amount paid for a particular technology is not necessarily limited to the number of times a patented feature is used by a consumer. A company licensing a patented method often has strong reasons not to tie the royalty amount strictly to usage.” Id. In the context of this case, if the defendant actually took a licensee for Lucent's patent, it would likely owe a royalty on each sale of a Microsoft Outlook software package ' whether or not the particular customer who bought the software actually used the patented appointment-scheduling feature.

In contrast, in the more defendant-friendly case of Cardiac Pacemakers, Inc. v. St. Jude Medical, Inc., 576 F.3d 1348, 1358 (Fed. Cir. 2009), cert. denied, 130 S. Ct. 1088 (2010), the Federal Circuit affirmed a district court's order limiting damages to “sales of [accused devices] that performed the steps of the claimed method” in the summary judgment posture. The trial court reached this result without considering whether the litigants, had they entered into a licensing negotiation, would have based the royalty on actual customer usage or on other factors. Cardiac Pacemakers, Inc. v. St. Jude Medical, Inc., 418 F. Supp. 2d 1021 (S.D. Ind. 2006). The accused products were implantable cardiac devices (“ICDs”) capable of various heart stimulation functions such as defibrillation and cardioversion, which is a brief procedure where an electrical shock is delivered to the heart to convert an abnormal heart rhythm back to a normal rhythm (see www.arrhythmia.org). For various strategic and procedural reasons, the plaintiff asserted only one claim for a method of performing cardioversion. The district court found that the defendant “cannot be held liable for infringement of [the asserted claim] on a device that was not programmed to execute the claimed method of cardioversion,” and even on those devices that were so programmed but have not actually been used to execute the method. Id. at 1040, 1042. By ruling that damages cannot be recovered for those units that were not used to infringe directly, the court turned proof of direct infringement from a threshold requirement for indirect liability, see ACCO Brands v. ABA Locks Manufacturer Co., Ltd., 501 F.3d 1307, 1313 (Fed. Cir. 2007), into a tool for capping recovery as a matter of law. The Federal Circuit affirmed this approach in a relatively brief panel portion of its opinion; another section of the Cardiac Pacemakers opinion, not directly relevant to the issue at hand, was decided en banc.

Lucent and Cardiac Pacemakers are in considerable tension because the former case views actual usage merely as one of the 15 Georgia-Pacific factors for figuring a reasonable royalty, see Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116, 1120 (S.D.N.Y. 1970), modified sub nom. Georgia-Pacific Corp. v. U.S. Plywood-Champion Papers Inc., 446 F.2d 295 (2d Cir. 1971), the factor at issue being “the extent to which the infringer has made use of the invention; and any evidence probative of the value of that use.” Cardiac Pacemakers, however, treats proven instances of direct infringement as decisive on the issue of damages, denying recovery as a matter of law for those units of the accused device that were not utilized to carry out infringing acts. Lucent is consistent with numerous direct infringement cases that caution trial courts not to overvalue the evidence of actual usage in their damages rulings because the hypothetical negotiation construct for arriving at a reasonable royalty asks the trier of fact to imagine a “negotiation between the patentee and the infringer at a time before the infringement began.” Riles v. Shell Exploration and Production Co., 298 F.3d 1302, 1313 (Fed. Cir. 2002) (citing Hanson v. Alpine Valley Ski Area, Inc., 718 F.2d 1075, 1078 (Fed. Cir. 1983)) (emphasis added). If the extent of use of a patented feature turns out to be much more widespread than could have been predicted in a hypothetical negotiation, the patentee gets a windfall, and the opposite result obtains if the feature did worse than expected.

While Lucent gives the trier of fact the flexibility to consider these scenarios and take into account the parties' negotiating positions in figuring reasonable royalty damages, Cardiac Pacemakers creates a special rule for indirect infringement cases that results in the systematic undercompensation of the plaintiff. In the extreme case, if the plaintiff can prove that only one unit of a particular device was used to carry out the patented method, it can collect damages only for that specific unit under the Cardiac Pacemakers rule. Since the rule allows for limitation of damages as a matter of law, the plaintiff can recover only minimal damages in this scenario even if it can show at trial that negotiating parties would not have tied the royalty to actual usage of the patented feature, or that the feature would have been predicted to be popular, but flopped unexpectedly. Strict applications of Cardiac Pacemakers may severely undermine the indirect infringement causes of action by cutting the associated remedies, which is an undesirable result because “the indirect infringer may be more morally culpable than the direct infringers.” Timothy W. Holbrook, The Intent Element of Induced Infringement, 22 Santa Clara Computer & High Tech. L.J. 399, 400 (2006). A finding of indirect infringement requires a culpable state of mind (for example, 35 U.S.C. 271(b) states that liability attaches to “whoever actively induces infringement of a patent,” emphasis added), while direct infringement is a strict liability offense.

Dramatic Extension of Standard Havens

The district court's error in Cardiac Pacemakers stems partly from its reliance on Standard Havens Products, Inc. v. Gencor Products, Inc., 953 F.2d 1360 (Fed. Cir. 1992), in which a “damage limitation” was eminently reasonable because the plaintiff sought to recover damages for two completely different types of accused devices ' one that was capable of performing the claimed method, and another that was not. The Cardiac Pacemakers court took this rather unremarkable result and extended it dramatically to prevent the plaintiff from collecting damages on some units of the same device that were capable of performing the claimed method but were never actually used in such manner, and the Federal Circuit affirmed without considering whether Standard Havens was correctly applied. Incidentally, Standard Havens dealt with the lost profits rather than reasonable royalty measure of damages, but this distinction does not affect the foregoing analysis.

Cardiac Pacemakers, to be sure, was not the first decision to entertain the idea of limiting damages as a matter of law to proven acts of direct infringement. For example, the court in Dynacore Holdings Corp. v. U.S. Philips Corp., 363 F.3d 1263, 1274 (Fed. Cir. 2004) suggested, in language followed by some later decisions but contradicted within the Dynacore opinion itself, that “[p]laintiffs who identify individual acts of direct infringement must restrict their theories of vicarious liability ' and tie their claims for damages or injunctive relief ' to the identified act” (emphasis in original). The defendant relied on this language to advance its damage limitation argument in Lucent, but, as discussed above, the Lucent court rejected this approach.

Conclusion

The Federal Circuit should sit en banc to resolve the Lucent-Cardiac Pacemakers panel split to forestall future confusion in district courts. It should repudiate Cardiac Pacemakers as inconsistent with the hypothetical negotiation method for calculating a reasonable royalty, and affirm the approach of Lucent.

A full paper on the problem discussed in this article will be presented at the Samsung-Stanford Conference on Patent Remedies at Stanford Law School on Feb. 18, 2011.

Dmitry Karshtedt, Ph.D., is a J.D. candidate, Stanford Law School, and a Scientific Adviser at Wilson Sonsini Goodrich & Rosati. The views expressed herein are solely the author's own. The author performed initial research on indirect infringement damages while a summer associate at Davis Polk & Wardwell LLP.

Many of the most publicized patent infringement suits are based on theories of indirect liability, codified in the Patent Act under 35 U.S.C. ' 271(b) (inducement of infringement) and ' 271(c) (contributory infringement). For example, a scenario that gives rise to inducement claims under ' 271(b) is the defendant's manufacture and sale of a device capable of performing a claimed method, accompanied by instructions on how to use the device in a manner that would infringe the method. See, e.g., Moleculon Research Corp. v. CBS, Inc. , 793 F.2d 1261 (Fed. Cir. 1986) (method for solving Rubik's cube); see also i4i Ltd. Partnership v. Microsoft Corp. , 598 F.3d 831 (Fed. Cir. 2010), cert. granted, 2010 WL 3392402 (U.S. Nov. 29, 2010), (method of using custom XML editor). Since suing directly infringing end users, like one's customers, may be impractical or inadvisable, plaintiffs often opt to go after manufacturers who “aid and abet” infringing conduct. Given the importance of indirect liability in patent law, it is troubling that the state of the law on calculating damages in judgments of indirect infringement appears to be in disarray. The confusion centers on the relevance of the extent of directly infringing conduct for figuring a “reasonable royalty,” which is the statutory minimum for patent infringement damages, 35 U.S.C. ' 284; the reasonable royalty method is used far more frequently than the alternative “lost profits” approach.

Conflicting Pronouncements

In two recent cases decided only three weeks apart, the Federal Circuit gave conflicting pronouncements on the issue of whether trial courts can limit damages as a matter of law to proven instances of direct infringement. In Lucent Technologies v. Gateway, Inc. , 580 F.3d 1301, 1308 (Fed. Cir. 2009), cert. denied , 130 S. Ct. 3324 (2010), the court affirmed the jury's finding of infringement of Lucent's claims on a “method of entering information into fields on a computer screen without using a keyboard.” Customers directly infringed the claims by using Microsoft Outlook's appointment-scheduling feature, and the defendant was found indirectly liable on both inducement and contributory infringement theories. The court vacated the jury award of reasonable royalty damages (a lump sum of $357,693,056.18) as unsupported by evidence, but opined that “we have never laid down any rigid requirement that damages in all circumstances be limited to specific instances of infringement proven with direct evidence.” Id. at 1334. The court stated that such a damage-limiting rule would be inconsistent with the hypothetical negotiation approach to calculating reasonable royalty damages by assuming a scenario that would be “far removed from what parties regularly do during real world licensing negotiations. ' [For example], companies in the high-tech computer industry often strike licensing deals in which the amount paid for a particular technology is not necessarily limited to the number of times a patented feature is used by a consumer. A company licensing a patented method often has strong reasons not to tie the royalty amount strictly to usage.” Id. In the context of this case, if the defendant actually took a licensee for Lucent's patent, it would likely owe a royalty on each sale of a Microsoft Outlook software package ' whether or not the particular customer who bought the software actually used the patented appointment-scheduling feature.

In contrast, in the more defendant-friendly case of Cardiac Pacemakers, Inc. v. St. Jude Medical, Inc. , 576 F.3d 1348, 1358 (Fed. Cir. 2009), cert. denied , 130 S. Ct. 1088 (2010), the Federal Circuit affirmed a district court's order limiting damages to “sales of [accused devices] that performed the steps of the claimed method” in the summary judgment posture. The trial court reached this result without considering whether the litigants, had they entered into a licensing negotiation, would have based the royalty on actual customer usage or on other factors. Cardiac Pacemakers, Inc. v. St. Jude Medical, Inc. , 418 F. Supp. 2d 1021 (S.D. Ind. 2006). The accused products were implantable cardiac devices (“ICDs”) capable of various heart stimulation functions such as defibrillation and cardioversion, which is a brief procedure where an electrical shock is delivered to the heart to convert an abnormal heart rhythm back to a normal rhythm (see www.arrhythmia.org). For various strategic and procedural reasons, the plaintiff asserted only one claim for a method of performing cardioversion. The district court found that the defendant “cannot be held liable for infringement of [the asserted claim] on a device that was not programmed to execute the claimed method of cardioversion,” and even on those devices that were so programmed but have not actually been used to execute the method. Id. at 1040, 1042. By ruling that damages cannot be recovered for those units that were not used to infringe directly, the court turned proof of direct infringement from a threshold requirement for indirect liability, see ACCO Brands v. ABA Locks Manufacturer Co., Ltd. , 501 F.3d 1307, 1313 (Fed. Cir. 2007), into a tool for capping recovery as a matter of law. The Federal Circuit affirmed this approach in a relatively brief panel portion of its opinion; another section of the Cardiac Pacemakers opinion, not directly relevant to the issue at hand, was decided en banc.

Lucent and Cardiac Pacemakers are in considerable tension because the former case views actual usage merely as one of the 15 Georgia-Pacific factors for figuring a reasonable royalty, see Georgia-Pacific Corp. v. U.S. Plywood Corp. , 318 F. Supp. 1116, 1120 (S.D.N.Y. 1970), modified sub nom. Georgia-Pacific Corp. v. U.S. Plywood-Champion Papers Inc. , 446 F.2d 295 (2d Cir. 1971), the factor at issue being “the extent to which the infringer has made use of the invention; and any evidence probative of the value of that use.” Cardiac Pacemakers , however, treats proven instances of direct infringement as decisive on the issue of damages, denying recovery as a matter of law for those units of the accused device that were not utilized to carry out infringing acts. Lucent is consistent with numerous direct infringement cases that caution trial courts not to overvalue the evidence of actual usage in their damages rulings because the hypothetical negotiation construct for arriving at a reasonable royalty asks the trier of fact to imagine a “negotiation between the patentee and the infringer at a time before the infringement began .” Riles v. Shell Exploration and Production Co. , 298 F.3d 1302, 1313 (Fed. Cir. 2002) ( citing Hanson v. Alpine Valley Ski Area, Inc. , 718 F.2d 1075, 1078 (Fed. Cir. 1983)) (emphasis added). If the extent of use of a patented feature turns out to be much more widespread than could have been predicted in a hypothetical negotiation, the patentee gets a windfall, and the opposite result obtains if the feature did worse than expected.

While Lucent gives the trier of fact the flexibility to consider these scenarios and take into account the parties' negotiating positions in figuring reasonable royalty damages, Cardiac Pacemakers creates a special rule for indirect infringement cases that results in the systematic undercompensation of the plaintiff. In the extreme case, if the plaintiff can prove that only one unit of a particular device was used to carry out the patented method, it can collect damages only for that specific unit under the Cardiac Pacemakers rule. Since the rule allows for limitation of damages as a matter of law, the plaintiff can recover only minimal damages in this scenario even if it can show at trial that negotiating parties would not have tied the royalty to actual usage of the patented feature, or that the feature would have been predicted to be popular, but flopped unexpectedly. Strict applications of Cardiac Pacemakers may severely undermine the indirect infringement causes of action by cutting the associated remedies, which is an undesirable result because “the indirect infringer may be more morally culpable than the direct infringers.” Timothy W. Holbrook, The Intent Element of Induced Infringement, 22 Santa Clara Computer & High Tech. L.J. 399, 400 (2006). A finding of indirect infringement requires a culpable state of mind (for example, 35 U.S.C. 271(b) states that liability attaches to “whoever actively induces infringement of a patent,” emphasis added), while direct infringement is a strict liability offense.

Dramatic Extension of Standard Havens

The district court's error in Cardiac Pacemakers stems partly from its reliance on Standard Havens Products, Inc. v. Gencor Products, Inc. , 953 F.2d 1360 (Fed. Cir. 1992), in which a “damage limitation” was eminently reasonable because the plaintiff sought to recover damages for two completely different types of accused devices ' one that was capable of performing the claimed method, and another that was not. The Cardiac Pacemakers court took this rather unremarkable result and extended it dramatically to prevent the plaintiff from collecting damages on some units of the same device that were capable of performing the claimed method but were never actually used in such manner, and the Federal Circuit affirmed without considering whether Standard Havens was correctly applied. Incidentally, Standard Havens dealt with the lost profits rather than reasonable royalty measure of damages, but this distinction does not affect the foregoing analysis.

Cardiac Pacemakers, to be sure, was not the first decision to entertain the idea of limiting damages as a matter of law to proven acts of direct infringement. For example, the court in Dynacore Holdings Corp. v. U.S. Philips Corp. , 363 F.3d 1263, 1274 (Fed. Cir. 2004) suggested, in language followed by some later decisions but contradicted within the Dynacore opinion itself, that “[p]laintiffs who identify individual acts of direct infringement must restrict their theories of vicarious liability ' and tie their claims for damages or injunctive relief ' to the identified act” (emphasis in original). The defendant relied on this language to advance its damage limitation argument in Lucent, but, as discussed above, the Lucent court rejected this approach.

Conclusion

The Federal Circuit should sit en banc to resolve the Lucent-Cardiac Pacemakers panel split to forestall future confusion in district courts. It should repudiate Cardiac Pacemakers as inconsistent with the hypothetical negotiation method for calculating a reasonable royalty, and affirm the approach of Lucent.

A full paper on the problem discussed in this article will be presented at the Samsung-Stanford Conference on Patent Remedies at Stanford Law School on Feb. 18, 2011.

Dmitry Karshtedt, Ph.D., is a J.D. candidate, Stanford Law School, and a Scientific Adviser at Wilson Sonsini Goodrich & Rosati. The views expressed herein are solely the author's own. The author performed initial research on indirect infringement damages while a summer associate at Davis Polk & Wardwell LLP.