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Damages for Unpatented Items
Category 3: Single Device with Patented and Unpatented Features
A. General Legal Principles
Similar to the case with convoyed sales, Rite-Hite is generally regarded as a leading case on this principle. Rite-Hite laid out the test for determining whether an entire machine – one that includes both a patented feature and unpatented features – can constitute the damages base: “[T]he entire market value rule permits recovery of damages based on the value of a patentee’s entire apparatus containing several features when the patent-related feature is the basis for customer demand.” Rite-Hite, 56 F.3d at 1549. Over time, and especially as the accused products have become more integrated and harder to apportion, it has become increasingly difficult to determine what exactly it means for something to be “the basis for customer demand.” Accordingly, in a recent district court decision issued by Chief Judge Rader of the Federal Circuit, who was sitting by designation, the district court formulated a three-prong test for the EMVR in a reasonable royalty case:
The entire market value rule in the context of royalties requires adequate proof of three conditions: (1) the infringing components must be the basis for customer demand for the entire machine, including the parts beyond the claimed invention, Fonar Corp. v. General Elec. Co., 107 F.3d 1543, 1552 (Fed. Cir. 1997); State Indus., Inc. v. Mor-Flo Indus., Inc., 883 F.2d 1573, 1580 (Fed. Cir. 1989); (2) the individual infringing and noninfringing components must be sold together so that they constitute a functional unit or are parts of a complete machine or single assembly of parts, Paper Converting Mach. Co., 745 F.2d at 23; and (3) the individual infringing and noninfringing components must be analogous to a single functioning unit, Kalman v. Berlyn Corp., 914 F.2d 1473, 1485, 16 USPQ2d 1093, 1102 (Fed. Cir. 1992). It is not enough that the infringing and noninfringing parts are sold together for mere business advantage. See Rite-Hite, 56 F.3d at 1549-50. Notably, these requirements are additive, not alternative, ways to demonstrate eligibility for application of the entire market value rule. See id.
Cornell Univ. v. Hewlett-Packard Co., 609 F. Supp. 2d 279, 268-87 (N.D.N.Y. 2009) (Cornell II). We refer to this case as Cornell II because the district court had issued an earlier opinion on the EMVR.
It is difficult to tell how, if at all, the district court in Cornell II is distinguishing between categories 1, 2, and 3, as the articulated test appears to include portions of all three. That being said, given how recent Cornell II is, and its authorship by a sitting Federal Circuit judge, it gives useful insight into where the Federal Circuit may be headed.
B. Applying the EMVR to Electronics, Computers, and Software: Where Should the Royalty “Box” Be Drawn?
The EMVR has become a hot-button issue over the past few years due to its potential application in multi-function products such as integrated circuits, personal computers, computer peripherals, and software. These products are generally not easily separable into distinct components, and thus it becomes more difficult to determine an appropriate damages base. In the past few years, some plaintiffs have attempted to apply the EMVR to complex hardware and software products, but defendants have argued that the EMVR is inapplicable. See, e.g., Cornell II, 609 F. Supp. 2d. 279; Cornell Univ. v. Hewlett-Packard Co., 2008 WL 2222189 (N.D.N.Y. 2008) (Cornell I); Lucent Technologies, Inc. v. Gateway, Inc., 509 F. Supp. 2d 912, 937 (S.D. Cal. 2007), aff’d on other grounds, 543 F.3d 710 (Fed. Cir. 2008) (Lucent I). The Cornell case settled before it reached the Federal Circuit and Lucent I was affirmed on other grounds. Thus in neither case did the Federal Circuit give guidance on how to apply the EMVR to complex software or computers.
Moreover, through the end of 2008, the Federal Circuit cases had addressed the EMVR in situations involving less complex technology, and therefore gave only limited guidance to litigants in the fields of computers and electronics:
See, e.g., Fonar Corp. v. General Elec. Co., 107 F.3d 1543, 1549, 1553 (Fed. Cir. 1997) (the multi-angle oblique (MAO) imaging feature claimed in the patent was emphasized as a selling feature in the device found to infringe and thus a reasonable royalty was based on the cost of the entire device).
Bose Corp. v. JBL, Inc., 274 F.3d 1354, 1361 (Fed. Cir. 2001) (entire loudspeaker cost was the proper royalty base where the patented feature functioned as one unit with the other components to provide the desired audible performance, the patented feature improved the performance of the loudspeaker, and the improved performance was the basis for the customer demand).
Tec Air, Inc. v. Denso Mfg. Michigan Inc., 192 F.3d 1353, 1362 (Fed. Cir. 1999) (damages based on entire assembly of motor, radiator, and condenser where the performance of the whole assembly was important to the customer, the fan was required for the assembly and the patented method of balancing the fan was critical to the function of the assembly and important to customer demand for the assembly).
Compare, e.g., Imonex Services, Inc. v. W.H. Munzprufer Dietmar Trenner GMBH, 408 F.3d 1374, 1380 (Fed. Cir. 2005) (insufficient evidence for the entire market value rule where the patented feature, which differentiated which coins were put into the machine, was not shown to be the basis for the customer demand of the entire laundry machine).
In 2009 and 2010, the Federal Circuit issued two opinions in which the EMVR was applied to features in Microsoft software programs. The first was Lucent Technologies, Inc. v. Gateway, Inc., 580 F.3d 1301 (Fed. Cir. 2009) (“Lucent II”), which involved Microsoft Outlook. The second was Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292 (Fed. Cir. 2011), which involved Microsoft’s Product Activation feature that acts as a gatekeeper to Word XP, Word 2003, and Windows XP software.
In Lucent II, the accused feature in Outlook was a “date-picker” function that allowed the software user to insert a date into a field using a calendar tool. The Federal Circuit held that to the extent the jury had applied the EMVR, its decision constituted legal error for two reasons: (1) the lack of evidence demonstrating that the patented method was “the basis—or even a substantial basis—of the consumer demand for Outlook,” slip op. at 58; and (2) the approach adopted by Lucent’s licensing expert, who changed his position from using the entire computer as the royalty base with a 1% royalty rate to using the price of the software but with an increased rate of 8%–effectively giving the same amount of damages. In the process, the court made a number of noteworthy observations:
- “[T]he only reasonable conclusion supported by the evidence is that the infringing use of the date-picker tool in Outlook is but a very small component of a much larger software program. The vast majority of the features, when used, do not infringe. The date-picker tool’s minor role in the overall program is further confirmed when one considers the relative importance of certain other features, e.g., e-mail.” Slip op. at 58.
- “Consistent with this description of Outlook, Lucent did not carry its evidentiary burden of proving that anyone purchased Outlook because of the patented method. Indeed, Lucent’s damages expert conceded that there was no “evidence that anybody anywhere at any time ever bought Outlook, be it an equipment manufacturer or an individual consumer, … because it had a date picker.” And when we consider the importance of the many features not covered by the [patent-in-suit] compared to the one infringing feature in Outlook, we can only arrive at the unmistakable conclusion that the invention described in claim 19 of the [patent-in-suit] is not the reason consumers purchase Outlook.” Slip op. at 58-59 (citation omitted).
- “Lucent’s expert tried to reach the damages number he would have obtained had he used the price of the entire computer as a royalty base. Being precluded from using the computer as the royalty base, he used the price of the software, but inflated the royalty rate accordingly. This cannot be an acceptable way to conduct an analysis of what the parties would have agreed to in the hypothetical licensing context. The approach of Lucent’s expert ignores what the district court’s evidentiary ruling tried to accomplish. The district court implicitly recognized that any damages computation based on the value of the entire computer using common royalty rates (e.g., 1-5%) would be excessive.” Slip op. at 60.
See also Uniloc, 632 F.3d at 1320 (“This case provides a good example of the danger of admitting consideration of the entire market value of the accused where the patented component does not create the basis for customer demand. … The disclosure that a company has made $19 billion dollars in revenue from an infringing product cannot help but skew the damages horizon for the jury, regardless of the contribution of the patented component to this revenue.”).
The Cornell II and Lucent I cases are also instructive on EMVR as applied to complex software and hardware. In both cases, smaller components within larger computer systems were deemed not to be “the basis for customer demand” as a matter of law. Cornell II, 609 F. Supp. 2d at 279; Lucent I, 509 F. Supp. 2d at 937. Both judges seemed to view it as unlikely—and unproven on the facts presented—that a large computer system would be purchased primarily due to small components that were essentially unknown to the buying public. Id. This of course does not preclude the EMVR from ever being applicable to large computer systems, but it is a harbinger to future litigants that they must come forward with more persuasive evidence than the patentees in these existing cases. It seems that future litigants should try to find better and/or different evidence than what the patentees in the Cornell II and Lucent I cases were able to muster.
C. The Relationship Between the EMVR and Exhaustion: Who Should Be the Patentee’s Hypothetical Negotiation Partner?
The Supreme Court’s ruling in Quanta Computer, Inc. v. LG Electronics, Inc., 128 S.Ct. 2109 (2008), may have an effect on which party or parties a plaintiff and/or defendant “call to” the hypothetical negotiation table. In Quanta, the Supreme Court clarified the patent exhaustion doctrine, specifically its application to industries where licensed products are combined and resold by downstream customers. Quanta Computer, Inc. v. LG Electronics, Inc., 128 S.Ct. 2109, 2122 (2008). In short, the Supreme Court held that once a royalty is obtained from one party in the supply chain, no royalty can be collected from the downstream customers:
The authorized sale of an article that substantially embodies a patent exhausts the patent holder’s rights and prevents the patent holder from invoking patent law to control postsale use of the article. Here, LGE licensed Intel to practice any of its patents and to sell products practicing those patents. Intel’s microprocessors and chipsets substantially embodied the LGE Patents because they had no reasonable noninfringing use and included all the inventive aspects of the patented methods. Nothing in the License Agreement limited Intel’s ability to sell its products practicing the LGE Patents. Intel’s authorized sale to Quanta thus took its products outside the scope of the patent monopoly, and as a result, LGE can no longer assert its patent rights against Quanta.
Id. at 2122. In light of the Supreme Court’s ruling a patentee may want to have the furthest “downstream” customer as the other party to the hypothetical negotiation, irrespective of whether that downstream customer is the defendant, to obtain the largest royalty base. Id. at 2118. The reason is because the most downstream customer will have paid the most for the infringing assembly (or will sell the assembly for the greatest amount) and will thus have the largest royalty base. In short, the patentee will generally have an incentive to go after the party selling the most expensive article.
For example, if the infringing product is a chip that is assembled onto a circuit board with other components and then the circuit board is integrated into a personal computer and sold to consumers, the largest royalty base would result from the company that sold the personal computer, not the original company that made the infringing chip. Thus, seeking to maximize damages, the patentee would argue that the infringing article is the computer, making the hypothetical negotiator the computer seller. This may be the case even if the computer seller is not even a party to the lawsuit. For example, if a chip manufacturer files a declaratory judgment action against a patentee who is trying to license the chip manufacturer’s downstream customer, the patentee will likely want to assert that its hypothetical negotiation would never have been with the $10 chip manufacturer but instead the $1,000 computer maker, regardless of who the party in the lawsuit happens to be. Similarly, even if the patentee had not been negotiating with the downstream customer, once litigation ensues it may serve the patentee’s best interest to go after the greatest revenue – the downstream customer.
This is effectively what the patentee attempted in the Lucent I case. Lucent’s patents were allegedly infringed by functionality in Microsoft’s products, but Lucent argued that the royalty should have been based on computers sold by Dell and Gateway (and others), that Microsoft as an indemnitor should stand in the shoes of Dell and Gateway, and that computers should be the royalty base, even though Microsoft did not manufacture or sell computers. Lucent I, 509 F. Supp. 2d at 937. As noted above, Lucent lost on this point because it was unable to prove that the accused functionality provided in Microsoft’s products was the “the basis” for customer demand with regard to personal computers. Lucent I, 509 F. Supp. 2d at 937.
By contrast, if the defendant/infringer is the downstream customer (e.g., the computer seller), it may be advantageous for the defendant to take the opposite position. That is, it may be worthwhile for downstream customers to argue that the hypothetical negotiation should be between the upstream supplier (e.g., the chip maker) and the patentee, regardless of whether that supplier is a party in the suit, since the patentee would likely be unable to obtain another royalty downstream from the computer seller. See Quanta, 128 S.Ct. at 2118. The upstream supplier’s royalty base would be smaller than the computer seller’s, and thus may result in reduced damages.
D. Relationship Between the EMVR and Contributory Infringement: Be Careful What You Wish For.
An issue related to the one above involves a balancing act between damages and contributory infringement. For situations in which there is no direct infringement by the alleged infringer (such as when the claims at issue are method claims that are practiced only by downstream customers), both the patentee and the defendant have to balance their respective positions on damages and contributory infringement. For damages purposes, a patentee may want to get the largest royalty base by asserting the EMVR applies (for example, to the computer seller in the example above), but this may have negative ramifications with respect to contributory infringement, since the accused device may have substantial noninfringing uses. Cf. Cornell II, 609 F. Supp. 2d. at 287-88 (“Without any real world transactions, or even any discernible market for CPU bricks, less intrepid counsel would have wisely abandoned a royalty base claim encompassing a product with significant noninfringing components. The logical and readily available alternative was the smallest salable infringing unit with close relation to the claimed invention–namely the processor itself.”).
A defendant, meanwhile, may want to limit the royalty base by pointing to the smallest component that allegedly performs the patented technique, but this may foreclose the defendant from arguing that the component has substantial noninfringing uses. Cf. id. at 285 (“Accordingly, Hewlett-Packard now requests that this court … reduce the royalty base to account only for the value of the processors incorporating the patented technology.”).
To use the above example of the $10 chip manufacturer and the $1000 computer maker, a patentee needs to carefully weigh all its options. Unless there has been testing or other direct infringement by the defendant itself, the likely direct infringers are end-users who are not parties to the suit itself. This leaves the patentee with only inducement and contributory infringement theories against the defendant. But the $1,000 computer has a litany of noninfringing uses beyond whatever method is being claimed, meaning that contributory infringement may be difficult if not impossible to prove. If that is the case, only inducement is left, which may be difficult to prove depending on the specific facts and jury instructions in the given case. Accordingly, a patentee may be better served in the longrun by lowering the royalty base to the component or components that have no noninfringing uses, leaving contributory infringement in pla.
By the same token, a defendant who strongly believes it does not directly infringe or induce infringement may actually be better served to “agree” to the larger damages base, only then to turn around and argue that there can be no contributory infringement, since the $1,000 computer has hundreds of substantial noninfringing uses. The damages base may be enormous, but of course that is of no moment if the patentee cannot prove infringement.
Cornell Univ. v. Hewlett-Packard Co., 2008 WL 2222189 (N.D.N.Y. 2008) (“Cornell I“).
Cornell Univ. v. Hewlett-Packard Co., 609 F. Supp. 2d 279, 268-87 (N.D.N.Y. 2009) (“Cornell II“).
Quanta Computer, Inc. v. LG Electronics, Inc., 128 S.Ct. 2109, 2118 (2008).
Lucent Technologies, Inc. v. Gateway, Inc., 509 F. Supp. 2d 912, 937 (S.D. Cal. 2007) (“Lucent I”).
Lucent Technologies, Inc. v. Gateway, Inc., 580 F.3d 1301 (Fed. Cir. 2009)(“Lucent II”).
Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292 (Fed. Cir. 2011).
- Category 1: Convoyed (or Collateral) Sales
- Category 2: Derivative Sales (repair parts or spare parts)
- Category 3: Single Device with Unpatented and Patented Features