2015 ASIP Jeju Conference

• Presented by:

Alex Timberman: Juris Doctor in business law, PhD candidate in economics of Hannam University, licensed attorney in the United States

Seol Sung-Soo: Professor of Economics at Hannam University, President of Asian Society for Innovation and Policy, Honorary Chairman of the Korea Valuation Association, Director of the Hi-Tech Business Research Institute

Evolution of Patent Infringement Damages Awards in the U.S. IT

Industry

Introduction

In the information and technology field (IT),awards in recent years have eclipsed the billion dollar mark at the initial adjudication stage: Lucent Technologies v. Microsoft Corp; Carnegie Mellon University v. Marvell Technology Group; Apple Inc. v. Samsung Electronics Co.

Others awards from major cases were in the hundreds of millions: Mirror Worlds LLC v. Apple Inc.; Eolas Technologies, Inc. v. Microsoft Corp.; Uniloc USA Inc. V Microsoft Corp.; Smartflash LLC v. Apple Inc.

Introduction Under the U.S. system there is a constitutional right to a trial by jury. Because juries are known to frequently award much higher damages than judges, most firms in the IT industry favor a jury trial. From 1995 to 2004 reasonable royalties composed 74% of damages awards and from 2005 to 2015 they composed 81% of damages awards (PwC, 2015).

Problem

Patents and patent litigation are key areas studied by innovation scholars. However, despite damages awards taking center stage in the media, the topic receives little scholarly attention.

Agenda To better understand infringement damages awards, we examine cases in the IT industry.

100% 87% 75%

50% 43% 25%

Theoretical framework

Literature review Methodology

Case studies Discussion Conclusion

Theoretical framework

Freeman (1987) found Japan’s innovation arises from its system of critical elements and key actors. Cooke, et al. (1997) expanded the ‘systems of innovation’ notion to regional innovation systems. Malerba (2002) focused the object of study to sectoral systems of innovation. Porter (1998) introduced the cluster theory, which is related, but more tethered to related fields in a similar locale. The spirit of these theories is that innovation springs from an ecology of actors and institutions, as opposed to being an isolated phenomena of the firm.

1987 1998 2002

Patents and Innovation

Other studies further tie patents to R&D and innovation. Paulson et al. (2007) argued the patent is a meaningful signal of radical innovation governance. Schultz and Urban (2012) argued for a defensive patent strategy to protect Open Innovation.

Patents and Innovation

• Sweet and Maggio (2015) used a world sample to examine the impact of stronger intellectual property laws on innovative advances.• Nandkumar and Srikanth (2015) reviewed

the strength of an intellectual property regime (IPR) in a host country and its impact on the offshoring of R&D to that country.

Career

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Link to Valuation Rulings

Generally, income, market, and cost approaches are typically used to value intangible assets such as patents. Related approaches in the legal literature include the asset valuation approach, which excludes the hypothetical negotiation process (Smith and Parr, 2000)

and the conjoint analysis approach, which uses consumer surveys to determine value (Yang, 2014); and even a revenue-based (Parr and Smith, 2005); or an option-based approach (Seol and Yoo, 2002).

the structured approach, which would limit the inquiry of juries (Lemley and Durie, 2010); the Nash bargaining solution, which focuses on a hypothetical bargaining between two parties

Link to Accounting and Valuation Rulings

IACVA? KVA? USPAP? IVSC – Synergistic Value / 2014

FASB – SFAS No. 157 / Fair Value / 2006

IASB – IFRS 13 / Hierarchy of Inputs / 2011

*Similar to Legal Rulings

FASB

Interestingly, the Financial Accounting Standards Board (FASB) issued SFAS No. 157 in 2006 to determine fair value: “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” This ruling is similar to the reasonable royalty analysis of seeking infringement awards based on an orderly hypothetical negotiation to include the critical starting date of infringement.

IASB

International Accounting Standards Board (IASB) issued Financial Reporting Standards (IFRS) 13 in 2011, which went into effect in 2013. IFRS 13 defines fair value through a hierarchy of level 1, level 2, and level 3 inputs; level 1 means highest priority for unadjusted market prices of same assets, level 2 means priority to quoted prices for similar assets, and level 3 means lowest priority for unobservable inputs that are based on little, if any, market activity. This ruling is similar to courts’ preference of real world comparables and real market data over hypothetical valuations. The IASB was founded in 2001 as the successor of the International Accounting Standards Committee (IASC) and develops the IFRS, which since 2001 has been the new name for the International Accounting Standards.

IVSC

The International Valuation Standards Council (IVSC) has a different definition for fair value but in 2014 signed a protocol with IFRS to establish a “shared interest in the consistent measurement of fair value.” IVSC distinguishes fair value from market value on the basis that fair value may include special value, that is, the special value from the particular synergies between two parties that may make the fair value higher than the market value (IVSC, 2014). It appears the hypothetical negotiation construct takes into consideration “special value” without explicitly saying so. Hence, the spirit of apportionment in legal cases is correlative with the spirit of valuation by FASB, IFRS, and IVSC.

Georgia-Pacific Factors

• The federal statute, 35 U.S. Code § 284, provides “Upon 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.”

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Factor 1 Actual established royalty

Factor 2 Royalty from comparable patents

Factor 3 Nature and scope of the license

Factor 4 Licensor’s policy to maintain monopoly

Factor 5 Commercial relationship between parties

Factor 6 Profits from infringement or value to infringer

Factor 7 Duration of the patent and the term of the license

Factor 8 Established profit of the product containing the infringing matter

Factor 9 Excess benefits of infringed product over previous model

Factor 10 The actual benefit of the patent to infringer

Factor 11 Any indication of importance of the infringement to the infringer

Factor 12 Comparable licenses in the industry

Factor 13 Profits based on patent that is apportioned from other elements

Factor 14 Expert opinion

Factor 15 Hypothetical negotiation by two parties

GP Factors Simplified

Simply, the fifteen factors can be simplified into 1-8 as dealing with royalties, 8-11 as dealing with benefits of infringement, and 12-15 as the great factors.

Seol (2015)

Criticisms of GP

• In summary, the majority of the criticisms of the GP factors boil down to excessiveness, unpredictability, the level of difficulty for judge and jury in terms of comprehensibility, how unrealistic the hypothetical negotiation is to a real negotiation, the difficulty in apportioning the value of the infringement to the patent, and the perils of royalty stacking and trolls.

Changes toward Apportionment

• Prior to Uniloc v. Microsoft Corp. (2009), however, courts used the now defunct 25% rule of thumb as the starting point in determining the royalty base. Under the rule, 25% of expected profits from an infringing product were to be paid to the plaintiff.

25% Rule of Thumb

In Uniloc v. Microsoft, the 25% rule and its ensuing $388 million dollars were overturned, based on the ruling that the determined royalty base lacked any connection to the real

facts of the case. The elimination of the 25% rule by Uniloc was a significant step towards stricter apportionment by federal courts.

EMVR

The rule is often argued in hi-tech cases because it naturally allows for the

adjustment of damages from a larger royalty base. Under the rule, as cited in Uniloc v.

Microsoft Corp. (2009), a plaintiff may use the entire market value of the product as the

royalty base if the patented feature or technology creates the “basis for customer

demand.”

In Uniloc, both parties agreed that Microsoft sold 110 million units containing the infringing part, which was a date picker function on Microsoft Outlook. The jury

in the case decided the royalty base should be $19 billion dollars based off the revenue of Microsoft

Outlook, resulting in a $358 million dollar damages award.

EMVR Lucent Techs., Inc. v. Gateway, Inc., 580 F. 3d 1301 (Fed. Cir.

2009).

EMVR

The Federal Circuit remanded and ordered a new trial on damages

holding the “only reasonable conclusion”

was that the date picker function was not

the basis for sales of Outlook software, and

concluded the jury award was untenable.

Question is, was the infringing part the

“basis for consumer demand?”

EMVR

• The Entire Market Value Rule (EMVR) • Allows recovery of damages based on sales/profits of the entire product –

not just the patented part or features of the product • Patentee Must Prove . . . • –  Infringing features are basis for customer demand for product • –  Infringing and non-infringing components sold together as “functional

unit” or “single assembly” • Otherwise . . . • –  “Analytical Approach” required • –  Royalty base is the incremental value of the infringing features over the

next best non-infringing alternative • –  Must separate out (“apportion”) from sales of total device defendant’s

profits and patentee’s damages

Economic Exception to EMVR?

Lucent Techs., Inc. v. Gateway, Inc., 580 F. 3d 1301 (Fed. Cir. 2009).

§ Applies EMVR to Microsoft’s Outlook software program (not just to the computer that has the program) and rejects using Outlook as royalty

base.

§ “And when we consider the importance of the many features not covered by the Day patent

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 Day patent is not the reason consumers purchase Outlook. Thus, Lucent did not satisfy its burden of proving the applicability of the entire

market value rule.” Id. at 1338.

Smallest Salable Unit Rule

The Federal Circuit’s 3rd step towards tighter apportionment is the “smallest salable unit” rule. The federal judge in Cornell v. Hewlett-Packard held the royalty base should be derived from the “smallest salable unit.”

Smallest Salable Unit Rule

In the case the judge overruled the jury award of $184 million, which was based on a royalty rate of 0.8% as applied to a CPU brick royalty base of $23 billion. The court under a motion for judgment as a matter of law (JMOL) reduced the award to $53 Cornell University v. Hewlett-Packard Co., 609 F. Supp. 2d 279 (N.D.N.Y. 2009).

Smallest Salable Unit Rule

• LaserDynamics Inc. v. Quanta Computer USA, Inc., 694 F.3d 51 (Fed. Cir. 2012).

• Embraces Cornell decision and smallest saleable patent-practicing unit as appropriate royalty base in multi-component product:

• “[I]t is generally required that royalties be based not on the entire product, but instead on the ‘smallest salable patent-practicing unit.’ . . .The entire market value rule is a narrow exception to this general rule.” (Id. at 67.)

Relationship between EMVR and Smallest Salable Unit Rule

• “[I]f the smallest saleable unit is the product itself, then the entire market value rule should not be considered, since the rule is an exception that allows a jury to consider the entire revenues of a multicomponent product when the patented feature is only a small aspect of the product.”

• VirnetX Inc. v. Apple Inc., 925 F. Supp. 2d 816, 841 (E.D. Tex. 2013).

Case Studies Case Court Implications Initial Award Final Award

i4i Ltd. Partnership v. Microsoft Corp., (2009)

Federal Circuit Following legal procedure is critical

$200m Affirmed

Lucent Technologies, Inc. v. Gateway, Inc., (2009)

Federal Circuit Licenses must be truly comparable

$358m Reverse and remanded

Lucent Technologies, Inc. v. Microsoft Corp. (2011) (Remand from Lucent Technologies, Inc. v. Gateway, Inc,. (2009)

S. District Court of California Apportionment must be strict

$358m $26.3m

Uniloc USA, Inc. v. Microsoft Corp., (2009) and (2011)

District Court of Rhode Island; Federal Circuit

The 25% rule is abolished for being unrealistic

$388m Settled for undisclosed terms

ResQnet.com v. Lansa, Inc., (2010)

Federal Circuit Comparable licenses must have exact link to patent

$506,000 Vacated

Oracle USA, Inc. v. SAP AG, (2011)

N. District Court of California Award must be based on “real-world” data to overcome a new trial

$1.3b $272m but ongoing

Case Studies Google v. Oracle, (2011) N. District Court of California GP factors are preferred to

complex models Ongoing Ongoing

Mirror Worlds, LLC v. Apple, Inc., (2011)

E. District of Texas Apportionment must be strict $208m Vacated

Apple Inc. v. Motorola Mobility, (2012)

7th Circuit Court of Appeals Experts without solid methods may not witness

Ongoing Ongoing

In re MSTG, Inc. v. AT&T Mobility, Inc. (2012)

Federal Circuit Settlement negotiations could be included in trial

Likely settled Likely settled

Carnegie Mellon University v. Marvell Technology Group, (2012)

W. District of Pennsylvania Formal accounting knowledge is unneeded if knowledgeable in GP factor analysis

$1.17b $278m and ongoing

Apple Inc. v. Samsung Electronics, (2012)

N. District of California Judges can reduce awards if juries use impermissible legal theories

$1b $930m and ongoing

AVM Technologies v. Intel, (2013)

District Court of Delaware Difficult to establish a large royalty base under the “smallest salable unit” rule

Unsupported Ongoing

VirnetX Inc. V. Cisco Systems, Inc., (2014)

Federal Circuit NBS is unrealistic like the 25% rule

$368m Vacated and remand in part

Smartflash LLC v. Apple, Inc., (2015)

E. District of Texas Even with proper jury instructions, judge can order a new trial if jury improperly considers the EMVR

$533m Vacated and new trial on damages

Findings

Abolishment of 25% rule begs

plaintiffs to apportion

The EMVR often prevents plaintiffs from using a large

royalty base

The Smallest Salable Unit rule begs plaintiffs to find the smallest

royalty base

In other words, it is becoming more

difficult for plaintiffs to win and win large unsupported

awards!

Discussion

Our examination of cases in the IT industry reveal the removal of the 25%rule; the implementation of the EMVR; and the smallest salable unit rule. These steps have more carefully tied infringement awards to a realistic hypothetical negotiation.

Rebutting Literature

As to unpredictability (Mazzeo et al., 2013) examined 340 federal cases between 1995 and 2008, and contracted a model that explains 75% of patent damages. Empirically, few researchers have examined the problem, yet legal and scholarly critiques accept unpredictability as a given. Empirical studies aside, cases in the IT industry are often front-cover news. Moreover, revenue on product lines and patents is public information. With the bright lights on, it is presumptuous to say that potential infringement damages awards are in the dark.

Rebutting Literature

As to excessiveness, numerous cases demonstrate the reluctance of judges to support jury verdicts. Indeed, numerous IT cases, as demonstrated, show a reigning in of awards when there is a violation of the 25% rule, EMVR, and the smallest salable unit. These recent laws help apportion the infringing matter and its value to the non-infringing matter, often times resulting in lower awards. But, more importantly, while infringement awards in recent years have crossed the $1b mark, so have record revenues of IT firms like Samsung and Apple, weakening the argument relating to excessiveness, at least in the IT industry.

Rebutting Literature

• The argument relating to jury ineptitude constitutes a weak argument, considering there are only 15 GP factors to consider. Firstly, as the literature points out, the analysis often turns on factors 12 and 15, or “real-world” comparable licenses and the ensuing hypothetical negotiations. Secondly, juries have been used for over a century in all sorts of complex tort trials, where they have been tasked with quantifying unquantifiable economic losses. But the 15 GP factors, critics claim, is too complex for a jury to handle. No data has been presented in an attempt to prove that patent infringement or the 15 factors are more difficult to understand than other types of law or legal theories. The circuit has opined that alternative factors, such as the NBS, are even more challenging for a jury to understand.

• VimetX, Inc. v. Cisco Systems, Inc., 767 F.3d 1308 (Fed. Cir. 2014). Under the principle of stare decisis, meaning “to stand by things decided” lower federal district courts have to follow the ruling of a higher court, such as the Federal Circuit.

Rebutting Literature

As to the benefit of the hypothetical negotiation, each factor conceptualizes a part of the licensing negotiation scenario for jurors to understand. As was said in Google v. Oracle, courts reckon the GP factors as simpler to understand for jurors than other complex methodologies. Hence, the GP analysis bridges the gap between the inexperienced juror and a technology licensing agreement. Obviously, jurors are usually inexperienced in any law, and a mechanism by which understanding of the law can be brought to the juror is vital for the jury, especially considering the need for the jury to be informed while observing the adversarial fight between lawyers and experts.

Implications for Innovation

Damages proportionate to the sales of a product containing the infringing matter and commensurate with the value of the infringing matter to the product, may not be available in other countries

Implications for Innovation

We believe since damages are available and the threat of

litigation is credible, the U.S. patent system is set up to

encourage innovation. In other words, if there is no risk of paying

proportionate or sufficient damages, then the incentive to

not license but rather steal is high, and without sufficient damages,

the incentives to innovate are weakened.

Implications for Innovation

Strong IPR connected to

Innovation in High Human Capital

Industries (Sweet and Maggio, 2015).

This paper: Sufficient Damages is a proxy for Strong IPR, which aids the U.S. IT industry, a

High Human Capital Industry

Correlative relationship

between U.S. IT firms market cap and infringement damages awards

Conclusion

This article has surveyed the laws and theories behind patent infringement damages awards and the GP framework. Through our examination of recent IT cases, we have rebutted the critical literature, and linked our findings to innovation frameworks.

Conclusion

In conclusion, we find U.S. courts often times award significant infringement damages awards, yet at the same time, forfeit awards when evidence is lacking. Therefore, unless a better solution emerges, it would be a wise decision to leave the system well enough alone.