8.01 Relevance and Application

8.02 Analysis 86

8.03 Discovery and Using Your Experts 89

Th e factor that, more than any other, is virtually designed to drive up the reasonable royalty rate is one in which the patentholder and the accused infringer are direct competitors. Among all of the economic criteria, it is hard to imagine one that would be more probative or more easily understood by a court or jury. In the hypothetical negotiation, it would seem obvious that, where the plaintiff and the defendant are head-to-head competitors, the plaintiff would charge a very high price to the defendant to license the very patent that enables it to maintain a competitive advantage.

Th is factor has been covered in some detail in the context of a plaintiff refusing to license its patent to an infringer. However, this Georgia-Pacifi c factor considers the situation in which the plaintiff might actually license to certain companies but might be more reticent when confronted with licensing the patent to a company that could do it competitive injury. Indeed, in this context, a plaintiff might be faced with a decision as to whether to license the patent to a competitor or not, depending on whether the patentholder thought it could make more money licensing than it would lose in sales in the marketplace. In some cases, a small plaintiff might choose to get out of the

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market altogether if it thought it could make more money licensing than it could ever make selling its product.

When examining this factor of competitive parties, and the eff ect its analysis has on the reasonable royalty rate, it is important to determine whether the plaintiff and the defendant are actually competitors and whether their competition is impacted by the patent-in-suit. What is critical is the eff ect that their competition, at least as of the date of the hypothetical negotiation, may have on the deal they may reach in this negotiation poses the challenge in using this factor.

Th e obvious principle that one competitor will normally be unwilling to go out of its way to help its rival was recognized by the court in Novozymes A/S v. Genencor Int’l, Inc. , 474 F. Supp. 2d 592, 608 (D. Del. 2007). Th ere, the court recognized that an infringement of a patent by a direct competitor is a direct threat to its investment of time and money. A competitor’s infringement of a patent is normally a direct attack on the business of the patentholder and enables the infringer to more eff ectively compete. In the hypothetical negotiation, therefore, the patentholder would be loath to give its direct competitor access to its proprietary technology and would only be willing to license that technology at a relatively high rate — one that would enable the patentee to recoup the losses it would incur by permitting the defendant to compete with a license. Indeed, where the patentholder is seeking to maintain a monopoly on its technology, it would be even more unwilling to grant a license to a direct competitor, thus pushing the rate even higher. Th e court, while recognizing that the 20 percent royalty rate requested by the plaintiff “is higher than the rates in other licenses off ered by the parties and the average rates reported for the relevant industries,” the fact that the parties are direct competitors justifi es a higher “reasonable royalty.”

Th is observation was echoed in Telemac Corp. v. US/Intelicom Inc. , 185 F. Supp. 2d 1084, 1101–02 (N.D. Cal. 2001), where the court noted that Telemac, the plaintiff , “would not have willingly licensed a direct competitor such as USI and, if forced to do so, would only have licensed USI at the highest pos- sible royalty rate it could obtain. In eff ect, in order to license a direct competitor, Telemac would have required signifi cantly higher royalty rates to compensate it for the risks of quality, fraud, and general price erosion caused by USI. Th is fact weighs in favor of applying a higher reasonable royalty rate for USI’s infringing activity than that applied to Telemac’s non-competitor licensees.

Obviously, where a plaintiff and defendant are direct competitors in selling a product covered by the patent-in-suit, the plaintiff will usually choose to seek lost-profi ts damages attributable to the sales lost by the plaintiff due to the infringement. Th is remedy will usually result in a higher damages award, if applicable.

In some cases, however, the plaintiff ’s lost-profi ts remedy may not be available for some reason, or the plaintiff may simply choose not to pursue it.

Relevance and Application 85 Th e same economic factors, however, apply in the reasonable royalty context — the plaintiff supposedly loses a sale of its product for each sale made by the defendant of the infringing product. In the hypothetical negotiation, the plaintiff will seek to recover at least the profi ts it would have made on that sale.

In the reasonable royalty context, the analysis of the eff ect of competition on the hypothetical negotiation is relatively straightforward. A patent is the right to exclude others — usually competitors — from using one’s invention. An inventor is normally motivated to do the research necessary to come up with an invention by competition. Indeed, in the corporate world, most

inventions are developed because of competition — the development of

improvements or new products that will enable the company to more eff ectively compete against its rivals.

Interesting issues arise, however, where the competitive relationship between the parties is not as clear. Such a situation was presented in Union Carbide Chems. & Plastics Tech. Corp. v. Shell Oil Co. , 425 F.3d 1366 (Fed. Cir. 2005). In that case, Union Carbide claimed that Shell had infringed its patents on the use of silver catalysts for the production of ethylene oxide.

Th e wrinkle in the damages analysis here was that the patents were not actually owned by Union Carbide Corporation, which did produce and sell ethylene oxide, but rather by a subsidiary holding company that did not sell any products or, indeed, have any purpose other than owning and enforcing the patents. Th e district court, indeed, characterized Union Carbide as a nonexclusive licensee of the patent at issue and noted that “the present case presented a problem of fi rst impression for this court, namely, the extent to which the impact on a nonexclusive licensee may be a factor considered in a reasonable royalty analysis where the nonexclusive licensee is the parent corporation of the patent holder and the patent holder is solely a technology holding corporation.”

Over Shell’s objections, the court permitted Union Carbide’s damages expert, in performing his reasonable royalty analysis, to take into account the eff ect that granting such a license would have on the business of the patentholder’s corporate parent, not on the business of the patentholder itself. Th e court did, however, bar the expert from characterizing the hypothetical negotiation as between the corporate parent and Shell, and required him to make clear that the holding company would take into account, in that negotiation, the eff ect that such a license would have on the fortunes of its patent. Id .

Th e Federal Circuit agreed, noting that the relationship between the holding company and the parent who was in competition with Shell “goes far beyond a licensor/licensee arrangement. . . . Because of the genuine relationship between these companies, the district court decision properly permitted consideration of these sales. Simply put, the holding company would not enter any negotiation without considering the competitive position of its

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corporate parent, Union Carbide Corporation. Shell is a direct competitor of Union Carbide Corporation in EO production and MEG sales. Th erefore any hypothetical negotiation with the holding company must necessarily include the reality that the economic impact on the Union Carbide Corporation would weigh heavily in all decisions.”

8.02 Analysis

Before one can even begin to determine the eff ect of competition between the plaintiff and the defendant on a reasonable royalty, one must determine whether the plaintiff and the defendant actually compete at all and, if so, how. One must examine the intersection of the arena in which these two companies compete and the economic benefi ts bestowed by the patented invention to determine how much the patent would be “worth” in this competitive context.

Th e fi rst step in this analysis is to defi ne the market in which the plaintiff and the defendant compete. Th e most economically signifi cant form of competition for purposes of analyzing the damages that may be obtained by the plaintiff is, of course, where the parties directly compete against each other in selling products that embody — and depend on — the patented invention. In this case, it is likely that any sale of an infringing product by the defendant will result in the loss of a sale by the plaintiff . Where the parties directly compete with each other in this manner, however, the most lucrative, and obvious, remedy for the plaintiff will be in the form of lost profi ts. Th e details of that analysis are covered elsewhere in this work.

What about the situation where the competition between the parties is not as clear, direct, or obvious or is less clearly related to the patented invention? What if the sales of the defendant’s product do not depend on the employment of the patented invention? What if the patented invention is relatively unimportant to the plaintiff ’s product? What if the parties’ competition with each other is indirect (i.e., at diff erent levels of distribution) or is relatively tangential, where, for example, the defendant competes with the plaintiff in the sale of accessories for the defendant’s primary product? How should the eff ect such competition may have on the reasonable royalty be measured?

Before the eff ect of the parties’ competition on a reasonable royalty can be determined, however, one must fi rst examine the ways in which the parties compete with each other. Th is requires defi ning the market in which the parties compete with their rivals — and each other.

Th e process of market analysis is familiar to any antitrust practitioner. As the Federal Circuit held in Intergraph Corp. v. Intel Corp ., 195 F.3d 1346 (Fed. Cir. 1999), the “relevant market” is “the market in which sellers compete, based

Analysis 87 on products that are in competition with each other.” Th e “outer boundaries of a product market are determined by the reasonable interchangeability of use or the cross-elasticity of demand between the product itself and substitutes for it.” Th e Intergraph court quoted the Th ird Circuit’s opinion in SmithKline Corp. v. Eli Lilly & Co. , 575 F.2d 1056, 1063 (3d Cir. 1978), defi n- ing the relevant market as the market wherein producers “have the ability, actual or potential, to take signifi cant amounts of business away from each other.”

Indeed, the most commonly used form of market defi nition — and the one most likely to be accepted by the courts — is the one used by the Department of Justice and the Federal Trade Commission in merger cases: the Horizontal Merger Guidelines.

Th ose guidelines describe an economically reliable way of determining whether the plaintiff and defendant compete and the structure of the market in which they compete. Essentially, what is bring measured is cross-elasticity of demand — the response in the demand for one good to a change in the price of another good.

Under the Horizontal Merger Guidelines, a product market is defi ned by the primary product (here, the product covered by the patent) and the substitutes recognized by the consumer. When the producer of the relevant product raises its price a “small but signifi cant and nontransitory” amount, to which products do its customers go? As the guidelines state, “[A]ssuming that buyers likely would respond to an increase in price for a tentatively identifi ed product group only by shift ing to other products, what would happen? If the alternatives were, in the aggregate, suffi ciently attractive at their exist- ing terms of sale, an attempt to raise prices would result in a reduction of sales large enough that the price increase would not prove profi table, and the tentatively identifi ed product group would prove to be too narrow.”

Under this analysis, the party “will begin with each product (narrowly defi ned) produced or sold by each merging fi rm and ask what would happen if a hypothetical monopolist of that product imposed at least a ‘small but signifi cant and nontransitory’ increase in price, but the terms of sale of all other products remained constant. If, in response to the price increase, the reduction in sales of the product would be large enough that a hypothetical monopolist would not fi nd it profi table to impose such an increase in price, then the [party] will add to the product group the product that is the next- best substitute for the merging fi rm’s product.”

Th e market analysis, however, is merely preparatory. What this factor seeks to measure is the real eff ect that competition has on the reasonable royalty. Th e eff ect of this factor can be measured in stages — all of which will be biased by the relative positions of the parties.

Th e fi rst stage is where the parties are the only two parties in the relevant market, where they sell the same products, both of which are indisputably covered by the patent. While this situation would, obviously, justify a high

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reasonable royalty, it is much more likely in that situation that the plaintiff would choose to pursue — and would be likely to recover — its lost profi ts resulting from the infringement. Such a remedy would, in most circum- stances, justify a higher damages recovery than a reasonable royalty.

Th e next stage is where the relevant market may contain more than the two parties to the lawsuit, but where the plaintiff and the defendant still sell the same product, both covered by the patent. Although this situation would also justify a high royalty, here it is also likely that the plaintiff will do better if it chooses to seek to recover its lost profi ts.

Next comes the situation where the plaintiff and defendant do not sell the same product but do compete with each other in that their products are considered suffi cient substitutes for each other to be considered in the same relevant market. Th e defendant’s product, however, still uses the patented invention (or there would, obviously, be no infringement). Here, where the defendant is using its infringement of the plaintiff ’s patent to enable it to compete, the utility of the patent to the defendant is less clear, as is the interest of the plaintiff in using the patent to exclude the defendant from the market. Th e reasonable royalty in this circumstance will depend on a mea- surement of the competitive harm the defendant is causing to the plaintiff by infringing and the competitive advantage the plaintiff gains by exclusion. As discussed in the section on hypothetical negotiation, each of these measures can be represented by the pot of money associated with the advantage each gains through use of the patent. Where the degree of competition is less than head to head, competition between the parties is still an important factor in the reasonable royalty analysis; its eff ect is just more challenging to measure and analyze.

Th e “territorial” competition discussed in this Georgia-Pacifi c factor is of this latter type — where the parties are not clearly direct competitors. In this circumstance, the parties’ competition is not quite head to head, but is tem- pered by other factors. Th e plaintiff would not have as great an interest in completely excluding the defendant from the marketplace as it would if it were competing with the defendant in all regional markets. Indeed, the plaintiff might be glad to receive some revenue from a geographic market it did not cover from selling its own products.

Another stage is where the parties are indirect competitors — that is, the parties are at diff erent levels of distribution, such as where the plaintiff makes a component that is included in its customers’ products and the defendant competes with those customers by selling a product that contains an infringing component. In this stage, the plaintiff would still have an incentive to charge a relatively high royalty in order to preserve the revenue it receives from selling its own product to its customers, but this royalty would be tem- pered by the amount it would be able to obtain from licensing the patent to the defendant — as long as it could obtain the same amount from both, the plaintiff should not care by which method it receives payment. Th us, the marginal

Discovery and Using Your Experts 89 profi t the plaintiff obtains from selling its product to its customers will prob- ably be the upper limit of the reasonable royalty rate.

In document Winning the Patent Damages Case (Page 98-104)