Are Case Predictions Part of the Hypothetical Negotiation?

Some time ago, in a nondescript conference room chosen for its convenience, two parties negotiated a license. On one side of the long oak table sat the patentee; on the other, the infringer. “Okay,” said the patentee, “I know everything about the product you want to sell, and you know everything about my patent. We agree that your product infringes and that my patent is valid, so we've agreed on an amount you will pay me to use my patent. But before we go any further, I have one question: Do we agree that if we went to court, I would most certainly win?”

The conference room does not exist, however, and the preceding discussion never took place. In reality, the accused infringer instead sold the product in question without obtaining a license from the patentee, who accordingly brought a claim for patent infringement. The jury declared the patent valid and infringed, and the court is now pondering the amount of damages to award. But it does not have “hard numbers” to work with; the patentee did not present evidence of lost profits or established royalty rates from other license agreements. Forced to develop an alternative method of determining damages, the court thus imagines the meeting described above: the “hypothetical negotiation.”

First articulated in Georgia Pacific v. U.S. Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970), the hypothetical negotiation considers a variety of factors, but boils down to a construct in which the parties, when infringement first began, 1) were privy to all relevant information, 2) assumed that the patents were valid and infringed, and 3) were willing to negotiate ' and thereby hypothetically agreed upon a royalty rate. The court then uses this rate as a basis to determine the proper amount of pre-verdict damages. Procter & Gamble Co. v. Paragon Trade Brands, Inc., 989 F. Supp. 547, 606 (D. Del. 1997).

This method generally worked well until the Supreme Court decided eBay, Inc. v. MercExchange, L.L.C., 547 U.S. 388 (2006), which ended courts' rote practice of granting injunctions requested by patentees as long as their patents had been found valid and infringed. Now, because a finding of infringement no longer automatically results in an injunction, courts have been struggling to determine the proper calculus for calculating post-verdict damages ' or “ongoing royalty rates” ' when the court declines to issue an injunction.

Which brings us back to the question posed by the patentee: Did the parties to the hypothetical negotiation assume not only that the patent was valid and infringed, but also that a court would make those findings? If so, then an actual verdict merely affirms that belief and should have no effect on the royalty rate going forward. If not ' and the parties did not assume during the hypothetical negotiation that a court would find the patents infringed ' then the ongoing royalty rate arguably could be increased to account for the certainty of an actual infringement verdict. Courts recently have begun to turn their attention to this issue.

Paice, Amado, and Uncertainty

In 2007, after the Eastern District of Texas awarded a post-judgment royalty rate that was identical to the pre-judgment royalty rate found by the jury without an explanation, the Federal Circuit remanded the case for the district court to explain its calculations. Paice LLC v. Toyota Motor Corp., 504 F.3d 1293, 1315 (Fed. Cir. 2007). The Federal Circuit's guidance to the district court for calculating post-judgment royalties was relatively neutral, noting that the court may consider “any additional economic factors arising out of the imposition of an ongoing royalty.” Id. Judge Randall Ray Rader, however, was more suggestive in his concurring opinion: “pre-suit and post-judgment acts of infringement are distinct, and may warrant different royalty rates given the change in the parties' legal relationship and other factors.” Id. at 1317.

Shortly thereafter, the Federal Circuit decided Amado v. Microsoft Corp., 517 F.3d 1353 (Fed. Cir. 2008). In Paice, the district court had awarded an ongoing royalty because an injunction was not warranted. Amado, in contrast, presented a scenario where the court had awarded an injunction following a finding of infringement, but stayed it pending appeal. During the appeal, the court awarded Amado a royalty rate (from an escrow account) that exceeded the pre-judgment royalty rate determined by the jury. Microsoft argued that the pre- and post-judgment royalty rates should be identical, but the court disagreed, finding a “fundamental difference ' between a reasonable royalty for pre-verdict infringement and damages for post-verdict infringement.” Id. at 1361. The court explained: “Prior to judgment, liability for infringement, as well as the validity of the patent, is uncertain, and damages are determined in the context of that uncertainty. Once a judgment of validity and infringement has been entered, however, the calculus is markedly different because different economic factors are involved.” Id. at 1362.

When the Paice district court eventually reconsidered its ongoing royalty rate determination on remand, it embraced Amado despite the factual differences between the two cases: “[t]he Federal Circuit has made it clear that damages for past infringement are separate and distinct from damages for future infringement and may require different royalty rates given the change in the parties' legal relationship.” Paice LLC v. Toyota Motor Corp., 2009 WL 1035218 (E.D. Tex. Apr. 17, 2009). Using this logic, the district court found that Toyota was subject to a higher ongoing royalty rate because it was now an “adjudged infringer” subject to a finding of infringement. Moreover, by the time the Paice district court issued this decision, two other courts had reached the same result. Boston Sci. Corp. v. Johnson & Johnson, 2009 WL 975424, at *5 (N.D. Cal. Apr. 9, 2009); Joyal Prods, Inc. v. Johnson Elec. N. Am., Inc., 2009 WL 512156, at *14 (D.N.J. Feb. 27, 2009).

So it would seem settled after Amado and Paice that parties in “hypothetical negotiations” are uncertain of how a court might rule, so post-judgment royalties should be adjusted upward once an infringement verdict becomes a certainty. But it isn't. The Federal Circuit in Paice only remanded for an explanation of how post-infringement royalties were awarded; it was Judge Rader's concurrence, not the panel decision, that suggested that the verdict itself should have a role in the calculus. Further, Amado concerned the amount of escrow to advance during an appeal after an injunction had been awarded, and may not apply to cases where injunctions do not issue. Other judges, therefore, have freely arrived at the opposite result that an infringement verdict should not be considered in ongoing royalty calculations: “It is logically inconsistent to argue that a calculation based upon assumptions of infringement and validity would change when those assumptions are replaced by jury findings of the same facts.” Ariba, Inc. v. Emptoris, Inc., 567 F. Supp. 2d 914, 918 (E.D. Tex. 2008). See also Cummins-Allison Corp. v. SBM Co., 584 F. Supp. 2d 916, 918 (E.D. Tex. 2008) (“[A] jury finding of infringement and no invalidity ' merely confirms the original assumption of those facts”).

The Federal Circuit's intervention is required to definitively decide whether hypothetical negotiations include the assumption that a court would rule for the patentee. The Ariba court specifically asked for such clarification: “It has been suggested that ' at the hypothetical negotiation, the parties would have considered the relative strength of their legal positions and teams. ' This kind of expansion of the Georgia-Pacific factors will have to be authorized by a higher court.” Ariba, 567 F. Supp. 2d at 917, n.2.

Consequences of Each Approach

Assuming the hypothetical negotiation already accounted for an infringement verdict keeps the calculus simple, because the verdict itself will then have no practical effect on the ongoing royalty rate. At the same time, the court would not be precluded from assessing other conditions that may have changed since the hypothetical negotiation (such as how technology may have made more non-infringing alternatives or design-arounds possible, or conversely, made the patented invention more valuable than before). Similarly, there would be no need for the court to determine the level of uncertainty present during the hypothetical negotiation, and how that may have affected the pre-judgment royalty rate. Indeed, the more certain the parties were during negotiations that a court would find infringement, the higher the royalty rate should have been in the first place. Thus, a higher initial royalty rate should negate the need to adjust it upward a second time for a verdict already accounted for.

On the other hand, the Federal Circuit may prefer to work with the fact of an actual verdict over the assumption of a verdict from a hypothetical negotiation. If so, then an actual infringement verdict will result in an increased ongoing royalty rate. But besides requiring new royalty calculations to adjust for the effect of the verdict, this approach may require other additional calculations: If the certainty of an actual verdict results in an increased ongoing royalty rate, then courts should also consider the effect of parties' uncertainty at the time of the hypothetical negotiation. As the negotiating parties become more uncertain about an infringement verdict, the lower the agreed-upon royalty rate should be, resulting in decreased pre-judgment royalties. As a result, calculation of pre-judgment reasonable royalties, although possibly more accurate, could become more difficult and require expert testimony concerning the parties' litigation expectations at the time of the hypothetical negotiation.

Conclusion

Which approach is correct is uncertain, and depending on the patent terms and time frames involved, it does not necessarily follow that plaintiffs will want one interpretation and defendants another. Accused infringers may welcome the chance to reduce the pre-verdict royalty rate through the introduction of uncertainty evidence ' though that would be tempered by the risk of larger ongoing royalty rates once a verdict is reached. Similarly, patentees' preference may rest on whether their patents have many years remaining, or whether they hope to claim mostly pre-judgment damages. Either way, courts probably will continue to come down on both sides of this issue until the Federal Circuit wades back in.

Michael D. Billok is a litigation associate with Gibson, Dunn & Crutcher LLP.

Some time ago, in a nondescript conference room chosen for its convenience, two parties negotiated a license. On one side of the long oak table sat the patentee; on the other, the infringer. “Okay,” said the patentee, “I know everything about the product you want to sell, and you know everything about my patent. We agree that your product infringes and that my patent is valid, so we've agreed on an amount you will pay me to use my patent. But before we go any further, I have one question: Do we agree that if we went to court, I would most certainly win?”

The conference room does not exist, however, and the preceding discussion never took place. In reality, the accused infringer instead sold the product in question without obtaining a license from the patentee, who accordingly brought a claim for patent infringement. The jury declared the patent valid and infringed, and the court is now pondering the amount of damages to award. But it does not have “hard numbers” to work with; the patentee did not present evidence of lost profits or established royalty rates from other license agreements. Forced to develop an alternative method of determining damages, the court thus imagines the meeting described above: the “hypothetical negotiation.”

First articulated in Georgia Pacific v. U.S. Plywood Corp. , 318 F. Supp. 1116 (S.D.N.Y. 1970), the hypothetical negotiation considers a variety of factors, but boils down to a construct in which the parties, when infringement first began, 1) were privy to all relevant information, 2) assumed that the patents were valid and infringed, and 3) were willing to negotiate ' and thereby hypothetically agreed upon a royalty rate. The court then uses this rate as a basis to determine the proper amount of pre-verdict damages. Procter & Gamble Co. v. Paragon Trade Brands, Inc. , 989 F. Supp. 547, 606 (D. Del. 1997).

This method generally worked well until the Supreme Court decided eBay, Inc. v. MercExchange, L.L.C. , 547 U.S. 388 (2006), which ended courts' rote practice of granting injunctions requested by patentees as long as their patents had been found valid and infringed. Now, because a finding of infringement no longer automatically results in an injunction, courts have been struggling to determine the proper calculus for calculating post-verdict damages ' or “ongoing royalty rates” ' when the court declines to issue an injunction.

Which brings us back to the question posed by the patentee: Did the parties to the hypothetical negotiation assume not only that the patent was valid and infringed, but also that a court would make those findings? If so, then an actual verdict merely affirms that belief and should have no effect on the royalty rate going forward. If not ' and the parties did not assume during the hypothetical negotiation that a court would find the patents infringed ' then the ongoing royalty rate arguably could be increased to account for the certainty of an actual infringement verdict. Courts recently have begun to turn their attention to this issue.

Paice, Amado, and Uncertainty

In 2007, after the Eastern District of Texas awarded a post-judgment royalty rate that was identical to the pre-judgment royalty rate found by the jury without an explanation, the Federal Circuit remanded the case for the district court to explain its calculations. Paice LLC v. Toyota Motor Corp. , 504 F.3d 1293, 1315 (Fed. Cir. 2007). The Federal Circuit's guidance to the district court for calculating post-judgment royalties was relatively neutral, noting that the court may consider “any additional economic factors arising out of the imposition of an ongoing royalty.” Id. Judge Randall Ray Rader, however, was more suggestive in his concurring opinion: “pre-suit and post-judgment acts of infringement are distinct, and may warrant different royalty rates given the change in the parties' legal relationship and other factors.” Id. at 1317.

Shortly thereafter, the Federal Circuit decided Amado v. Microsoft Corp. , 517 F.3d 1353 (Fed. Cir. 2008). In Paice, the district court had awarded an ongoing royalty because an injunction was not warranted. Amado, in contrast, presented a scenario where the court had awarded an injunction following a finding of infringement, but stayed it pending appeal. During the appeal, the court awarded Amado a royalty rate (from an escrow account) that exceeded the pre-judgment royalty rate determined by the jury. Microsoft argued that the pre- and post-judgment royalty rates should be identical, but the court disagreed, finding a “fundamental difference ' between a reasonable royalty for pre-verdict infringement and damages for post-verdict infringement.” Id. at 1361. The court explained: “Prior to judgment, liability for infringement, as well as the validity of the patent, is uncertain, and damages are determined in the context of that uncertainty. Once a judgment of validity and infringement has been entered, however, the calculus is markedly different because different economic factors are involved.” Id. at 1362.

When the Paice district court eventually reconsidered its ongoing royalty rate determination on remand, it embraced Amado despite the factual differences between the two cases: “[t]he Federal Circuit has made it clear that damages for past infringement are separate and distinct from damages for future infringement and may require different royalty rates given the change in the parties' legal relationship.” Paice LLC v. Toyota Motor Corp., 2009 WL 1035218 (E.D. Tex. Apr. 17, 2009). Using this logic, the district court found that Toyota was subject to a higher ongoing royalty rate because it was now an “adjudged infringer” subject to a finding of infringement. Moreover, by the time the Paice district court issued this decision, two other courts had reached the same result. Boston Sci. Corp. v. Johnson & Johnson, 2009 WL 975424, at *5 (N.D. Cal. Apr. 9, 2009); Joyal Prods, Inc. v. Johnson Elec. N. Am., Inc., 2009 WL 512156, at *14 (D.N.J. Feb. 27, 2009).

So it would seem settled after Amado and Paice that parties in “hypothetical negotiations” are uncertain of how a court might rule, so post-judgment royalties should be adjusted upward once an infringement verdict becomes a certainty. But it isn't. The Federal Circuit in Paice only remanded for an explanation of how post-infringement royalties were awarded; it was Judge Rader's concurrence, not the panel decision, that suggested that the verdict itself should have a role in the calculus. Further, Amado concerned the amount of escrow to advance during an appeal after an injunction had been awarded, and may not apply to cases where injunctions do not issue. Other judges, therefore, have freely arrived at the opposite result that an infringement verdict should not be considered in ongoing royalty calculations: “It is logically inconsistent to argue that a calculation based upon assumptions of infringement and validity would change when those assumptions are replaced by jury findings of the same facts.” Ariba, Inc. v. Emptoris, Inc. , 567 F. Supp. 2d 914, 918 (E.D. Tex. 2008). See also Cummins-Allison Corp. v. SBM Co. , 584 F. Supp. 2d 916, 918 (E.D. Tex. 2008) (“[A] jury finding of infringement and no invalidity ' merely confirms the original assumption of those facts”).

The Federal Circuit's intervention is required to definitively decide whether hypothetical negotiations include the assumption that a court would rule for the patentee. The Ariba court specifically asked for such clarification: “It has been suggested that ' at the hypothetical negotiation, the parties would have considered the relative strength of their legal positions and teams. ' This kind of expansion of the Georgia-Pacific factors will have to be authorized by a higher court.” Ariba, 567 F. Supp. 2d at 917, n.2.

Consequences of Each Approach

Assuming the hypothetical negotiation already accounted for an infringement verdict keeps the calculus simple, because the verdict itself will then have no practical effect on the ongoing royalty rate. At the same time, the court would not be precluded from assessing other conditions that may have changed since the hypothetical negotiation (such as how technology may have made more non-infringing alternatives or design-arounds possible, or conversely, made the patented invention more valuable than before). Similarly, there would be no need for the court to determine the level of uncertainty present during the hypothetical negotiation, and how that may have affected the pre-judgment royalty rate. Indeed, the more certain the parties were during negotiations that a court would find infringement, the higher the royalty rate should have been in the first place. Thus, a higher initial royalty rate should negate the need to adjust it upward a second time for a verdict already accounted for.

On the other hand, the Federal Circuit may prefer to work with the fact of an actual verdict over the assumption of a verdict from a hypothetical negotiation. If so, then an actual infringement verdict will result in an increased ongoing royalty rate. But besides requiring new royalty calculations to adjust for the effect of the verdict, this approach may require other additional calculations: If the certainty of an actual verdict results in an increased ongoing royalty rate, then courts should also consider the effect of parties' uncertainty at the time of the hypothetical negotiation. As the negotiating parties become more uncertain about an infringement verdict, the lower the agreed-upon royalty rate should be, resulting in decreased pre-judgment royalties. As a result, calculation of pre-judgment reasonable royalties, although possibly more accurate, could become more difficult and require expert testimony concerning the parties' litigation expectations at the time of the hypothetical negotiation.

Conclusion

Which approach is correct is uncertain, and depending on the patent terms and time frames involved, it does not necessarily follow that plaintiffs will want one interpretation and defendants another. Accused infringers may welcome the chance to reduce the pre-verdict royalty rate through the introduction of uncertainty evidence ' though that would be tempered by the risk of larger ongoing royalty rates once a verdict is reached. Similarly, patentees' preference may rest on whether their patents have many years remaining, or whether they hope to claim mostly pre-judgment damages. Either way, courts probably will continue to come down on both sides of this issue until the Federal Circuit wades back in.

Michael D. Billok is a litigation associate with Gibson, Dunn & Crutcher LLP.