By: Joseph Aquino, CPA Director
Calculating damages in patent infringement cases still poses a challenge in today’s world. In addition, expert testimony on the matter typically comes under heavy Daubert scrutiny. In the case of Brandeis University, et al, v. Keebler Co., et al, Judge Posner of the Seventh Circuit Court of Appeals (sitting by designation in a federal district court) pretty much excluded most of an expert’s proposed damages testimony — despite finding her to be “highly qualified” and quite competent to estimate reasonable royalties.
Infringing a patent
This case involved patents for a certain type of margarine that doesn’t contain any trans-fats. The plaintiffs alleged that the Keebler Company’s reduced-fat biscuit, cookie, cookie dough and crescent roll products infringed the patents. What was at issue here? The reasonable royalty that Keebler would have paid the licensor if it had just negotiated a license before it started using the infringing product rather than risk being sued.
Judge Posner stated that Keebler wouldn’t have paid a royalty that’s higher than the cost of switching to a noninfringing substitute for the plaintiffs’ margarine . . . or otherwise reworking its manufacturing process to help avoid making the infringing margarine. Posner rejected the plaintiffs’ expert’s conclusion on the basis that no noninfringing alternatives to the patented margarine could be found. (See the sidebar “Why you shouldn’t go it alone.”) But he also explained that just the lack of a perfect substitute by itself wouldn’t allow the estimation of a reasonable royalty. That royalty would depend on the costs of higher production expenses and loss of business to competitors to create the best imperfect substitute. The expert offered no evidence on either cost.
Instead, the expert based the calculation of a maximum reasonable royalty on the business’s maximum profits that she deemed to be at risk if Keebler didn’t get a license. So, she relied on three “comparable” licenses in order to project the maximum amount of profits that Keebler put at risk by simply failing to obtain a license.
Understanding the licensing issue
The court actually rejected the expert’s reliance on two of the licenses out of hand. One license resulted from the settlement of a patent infringement suit. Judge Posner found that licensee to be “wholly dissimilar to Keebler.”
As to the second license, it was also granted in settlement of litigation. The stated payment for the license was just a one-time payment, but it seemed to have been returned to the licensee as consulting fees over the next several months. Moreover, the settlement allowed for changing a strategic partnership between the licensee and a subsidiary of the licensor. And, in return for those benefits, the licensor agreed to dismiss the lawsuit and grant a license.
Judge Posner postulated that the expert had made no attempt to value any individual component of the settlement agreement that produced the second license. Therefore, she really couldn’t “responsibly” value the patent license itself.
Only the third license came even close to providing a reasonable comparable. Like the Keebler company, the licensee was a large food conglomerate that creates baked goods alleged to infringe, thus allowing an inference that Keebler would have paid just as much as the licensee. Changes occurring since that license was negotiated in 2005 would thus drive the licensor to insist on a higher royalty.
Using reasonable methodology
In the end, Judge Posner found that the plaintiffs’ expert had truly failed to use a reasonable methodology when calculating the damages by reference to two of the licenses. He also noted that the expert had failed to calculate the profits at risk or even assess the cost of noninfringing alternatives. But, he did allow her to testify on the third license, which remained a “possible basis” for estimating a reasonable royalty, and on the general principles of patent damages.
Sidebar: Why you shouldn’t go it alone
The plaintiffs’ expert in Brandeis University, et al, v. Keebler Co., et al (see the main article) got into a lot of trouble because she simply didn’t make proper use of input from other types of experts. The damages expert testified that there was simply no cheap and satisfactory substitute to the patented margarine. The expert also testified that, in order to avoid both trans-fats and use of an infringing margarine, Keebler would have had to consider all the possible effects of substituting a noninfringing margarine (which would likely cause sogginess) on consumer demand.
But the expert was an economist, and not an expert on consumer demand for cookies, and she didn’t consult with a sales or marketing expert. She did, indeed, consult with a biochemist specializing in food, but he wasn’t a food scientist. Judge Posner also faulted the expert for not consulting with an industrial baker on the cookie’s sogginess issue. He ruled that the damages expert couldn’t rely on the biochemist’s conclusion that no noninfringing alternatives were available that would cost Keebler less than a “hefty royalty to the plaintiffs.”
In conclusion, it is critical in cases such as these to make sure that input from qualified experts are chosen to verify the information utilized in each particular case. Valuation analysts and CPA’s can provide solid litigation support in these cases by researching and providing adequate comparables as well as analyzing financial results that ultimately lead to an accurate determination of value or calculation of damages.