Joe Aquino, CPA, CVA
Director | Freed Maxick
A district court strikes testimony in a patent case
Recently, a district court judge noted that the overall percentage of successful Daubert challenges to damages in patent cases is “exceedingly small.” Yet, he went on to say that, “every once in a great while, a Daubert challenge to a patent damages expert is justified.” This judge found that to be the case in Dynetix Design Solutions, Inc. v. Synopsys, Inc., where the patent expert’s reasonable royalty testimony was neither tied to the facts nor reliable.
The ins and outs of the expert’s testimony
As you know, calculating a reasonable royalty is a two-step process. In the first step, an expert determines the revenue pool that’s implicated by the infringement (that is, the royalty base). Next, the expert determines the percentage of that pool adequate to compensate the plaintiff for that infringement (that is, the royalty rate).
In the Dynetix case, the plaintiff’s expert started by determining the royalty base. The patented feature was just one of numerous features in the defendant’s product. Nonetheless, the expert determined that the royalty base would be the entire sales of the product simply because the defendant hadn’t separately sold any smaller unit with the patented component. And he also didn’t further apportion the royalty base to account for nonpatented features.
As to the royalty rate, the expert divided the gross margin of the infringing product equally between the two parties. And then he applied the Georgia-Pacific factors for determining reasonable royalties in order to alter the rate. When focusing on the third and fourth factors (the nature and scope of the hypothetical license in terms of exclusivity and the licensor’s policy for maintaining its patent monopoly by limiting licensing), he then reduced the royalty rate to 19%.
After he made a couple more adjustments, the expert arrived at a royalty rate of 14.25%. He then applied that rate to the royalty base for the relevant time period, thus concluding that the reasonable royalty would be around $156 million. Because only one of the two components originally accused of infringement remained in the case, he then apportioned 75% of the royalty to the remaining component, which resulted in a royalty of some $117 million.
The court weighs in
The district court ultimately rejected the royalty base, finding that the expert had failed to apportion profits between the numerous noninfringing features in the defendant’s product and the patented feature. So, even though he was correct that the smallest salable infringing unit was the defendant’s entire product, he should not have ended his analysis there. Moreover, he needed to determine the infringing component’s value relative to the entire product’s other components. This failure to apportion justified the exclusion of his opinion.
But the court also rejected the royalty rate. It found that the expert’s analysis only compounded the problems with his opinion. Although half of the gross margin for the infringing profits may indeed have been “one reasonable starting point,” the law required the expert to customize the royalty rate to the specific facts of the case — including the particular industry, technology or party. And, as the court explained, “an arbitrary starting point is impermissible under Uniloc.”
The Federal Circuit in Uniloc rejected a “25% rule of thumb” profit margin for starting the royalty rate calculation. And the 50% starting place, the district court said, was even more arbitrary because the expert based it solely on his own judgment and experience, without even considering analogous licenses offered in the industry or the nature of the patented component as an optional and small feature in the product.
The court’s striking of the expert testimony wasn’t the end of the matter. The court then granted the plaintiff five days to submit a new expert report on the damages.
The bottom line
Many have questioned the “gatekeeper” role of courts in evaluating and admitting the reliability of expert testimony. But many courts still exclude testimony based on Daubert objections. It’s critical that attorneys keep on top of developments in this area and work with qualified experts who’re unlikely to face Daubert challenges.
Sidebar: Limits to the gatekeeper role
The Supreme Court’s decision in Daubert assigned district courts a type of “gatekeeper” role in admitting expert testimony and evaluating its reliability. A recent case, Manpower, Inc. v. Insurance Co. of the State of Pennsylvania, demonstrates that this role has limits.
The “Manpower” case involved a dispute over reimbursement for business interruption losses under an insurance policy. The insured’s forensic accounting expert expressed an opinion on the total loss, and the insurance company moved to exclude the testimony, saying it wasn’t the product of reliable methodology.
The district court found that the expert had, indeed, followed the insurance policy’s prescribed methodology for calculating losses. But the reliability of the expert’s calculations turned on whether he’d used reliable methods when he selected numbers for the projected total expenses and revenues. The court held that the method for projecting revenues was unreliable due to his estimated growth rate, so it excluded his testimony. The insured party then appealed.
The court of appeals acknowledged that district court judges have a lot of leeway when determining whether particular expert testimony is reliable. It pointed out, however, that a district court “usurps the role of the jury … if it unduly scrutinizes the quality of the expert’s data and conclusions rather than the reliability of the methodology.”
The appellate court determined that the district court’s concerns weren’t due to the reliability of the expert’s methodology, but the resulting conclusions. The district court then took issue with his selection of particular data. But the selection of data inputs to apply in a model is a question that’s separate from the reliability of the methodology reflected in the model itself.
The appellate court warned that it wasn’t saying that an expert can rely on data with no quantitative or qualitative connection to the methodology. Experts should use the type of data on which specialists in the field would reasonably rely.