Federal Circuit Reverses Damages Award Based On Hypothetical Freedom-to-Operate Royalty Negotiation
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  • Federal Circuit Reverses Damages Award Based On Hypothetical Freedom-to-Operate Royalty Negotiation

    On November 19, 2018, the Court of Appeals for the Federal Circuit (CAFC) issued an opinion reversing in part a patent-infringement judgment of the United States District Court for the Northern District of California.  Enplas Display Device Corp. v. Seoul Semiconductor Co., —F.3d—, (Fed. Cir. November 19, 2018).  The CAFC ruled that the jury’s damages award was based on sales of non-infringing products, and reversed the District Court’s denial of judgment as a matter of law as to the damages award.

    Thirty-five U.S.C. § 284 provides that “[u]pon finding for the claimant the court shall award the claimant 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, together with interest and costs as fixed by the court.”  (emphasis added).  To determine the amount of a reasonable royalty, courts typically apply the several factors listed in Georgia-Pacific Corp. v. United States Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970).  Of those factors, often the most significant is “[t]he amount that a licensor (such as the patentee) and a licensee (such as the infringer) would have agreed upon (at the time the infringement began) if both had been reasonably and voluntarily trying to reach an agreement,” often referred to as the “hypothetical negotiation” standard.

    At trial, the only expert testimony on damages came from the patent owner’s expert witness.  The expert testified that under all the circumstances of this particular case, the result of a hypothetical negotiation between the patent owner and the accused infringer would not have been, for example, a running royalty on sales of the accused infringing product, nor a lump-sum royalty for past and future sales of the accused infringing product, but rather a lump-sum royalty paid by the accused infringer in exchange for a “freedom to operate” license, which would have permitted the accused infringer to sell any “potentially infringing” products it wished to without fear of an infringement suit.  The expert calculated that a lump-sum royalty for sales of the products accused in the case would have been $500,000, but that this figure should be increased to between $2M and $4M based on the volume of the accused infringer’s sales of other products.  The expert testified that she had no choice but to use the entire volume of sales of other products, because she had no information about what percentage of the other products would have been considered to be “potentially infringing” by the hypothetical negotiators—thus, the range of $2M–$4M:  if the potentially infringing products “were all the products, it would be the upper end of that range, the $4M.  If it were only half the products, it would be the lower end of the range.”  The jury awarded $4M in damages.

    The accuser infringer made a pre-trial Daubert motion challenging the expert’s testimony, which the court denied.  The accused infringer also made a JMOL motion, arguing that the $4M verdict was not supported by sufficient evidence, which the court also denied.  The accused infringer did not appeal the Daubert ruling, but did appeal the denial of JMOL.

    On appeal the Federal Circuit found that the expert’s “freedom to operate” hypothetical-negotiation theory was flawed, at least as applied in this case, because it had the effect of charging a royalty for non-accused products.  The Court stated, “a reasonable royalty cannot include activities that do not constitute patent infringement,” and reversed the denial of JMOL.  The Court further stated, “[r]egardless of the characterization by SSC’s expert, damages calculated by applying a royalty to sales of non-accused lenses cannot support a jury’s verdict on damages.”  However, it is not clear what the result would have been if the damages expert had an evidentiary basis for classifying some percentage of the non-accused products as “potentially infringing.”

    Judge Newman filed a dissenting opinion.  Her view was that the challenge on appeal was really to the basis for the expert’s testimony—e.g., the freedom-to-operate construct—not to the sufficiency of the evidence, and that by not appealing the Daubert ruling the accused infringer had waived that argument.  She would have found that the expert testimony was not excluded and supported the jury’s verdict, and therefore affirmed.