October 30, 2012
LES Insights
Authored by D. Brian Kacedon; John C. Paul; and Xiaoxiao Xue, Ph.D.
In LaserDynamics, Inc. v. Quanta Computer, Inc.,1 the Federal Circuit examined the proper legal framework for evaluating reasonable-royalty damages in the patent-infringement context. In particular, the court reiterated the high standard of proof for the use of the entire-market-value rule for reasonable-royalty calculation, where a small feature of a multi-component product is accused of infringement.
LaserDynamics owns a patent for enabling an optical disc drive ("ODD") to determine whether a disc inserted into the disc drive is a CD or DVD. From 1998 to 2001, LaserDynamics granted 16 non-exclusive licenses to ODD and electronics manufacturers in exchange for one-time, lump-sum payments ranging from $57,000 to $266,000.
Later, in August 2006, LaserDynamics sued Quanta Computer, Inc. ("QCI") and its partially owned subsidiary, Quanta Storage, Inc. ("QSI"), for infringement. QCI assembles laptop computers for various computer companies. It does not manufacture ODDs, but typically buys ODDs from its customers, who in turn purchase the ODDs from ODD manufacturers. QSI, in contrast, is an ODD manufacturer. QCI also sometimes purchases ODDs directly from ODD manufacturers, such as QSI. Neither QCI nor QSI has taken a license to LaserDynamics's disc-discrimination patent.
At trial, LaserDynamics argued that, had the parties engaged in a hypothetical negotiation, they would have agreed to a reasonable royalty of 2% of QCI's total sales of laptop computers. LaserDynamics arrived at this royalty rate by concluding that 6% would be a reasonable royalty rate for an ODD alone and that the ODD is responsible for one-third of the value of a laptop computer containing such an ODD. This resulted in proposed damages of about $52 million, which the jury awarded.
QCI filed a motion, based on LaserDynamics's reliance on the entire-market-value rule, seeking either lower damages or a new trial. The district court, granting the motion, gave LaserDynamics the option of either damages of $6 million or a new trial on damages; LaserDynamics took the new trial.
During the new trial on damages, LaserDynamics this time argued for damages of $10.5 million, based on the 6% royalty rate applied to the average price of a standalone ODD. QCI, on the other hand, argued that the appropriate damages amount should be a lump-sum payment of $1.2 million, based on the fact that none of LaserDynamics's licenses in evidence exceeded lump-sum amounts of $1 million. The jury ultimately awarded $8.5 million in damages.
LaserDynamics appealed, challenging the district court's earlier grant of a new trial on damages, and QCI cross-appealed to second damages award.
On appeal, the Federal Circuit upheld the district court's grant of a new trial on damages because LaserDynamics improperly relied on the entire-marketvalue rule to reach the first verdict. The Federal Circuit reiterated its general rule that reasonable royalties be based on the smallest salable patent practicing unit—in this case, the ODD. As a narrow exception, a patentee may base damages on the entire market value of a multi-component end product only if the patentee can show that the patented feature drives the demand for the end product. In that situation, the patentee may be entitled to damages measured as a percentage of revenues or profits attributable to the entire product. The Federal Circuit explained that the required showing—demand created by the patented component—cannot be avoided by simply using a very small royalty rate because calculating a royalty on the entire end product carries a considerable risk that the patentee will be overcompensated for having exclusive rights to only a small elements of the multi-component product.
In this case, the Federal Circuit noted that LaserDynamics's use of the entire-market-value rule was impermissible since it failed to present evidence showing that the patented disc-discrimination method drove demand for the laptop computers. It was not enough, the Federal Circuit emphasized, to show merely that the patented disc-discrimination method is viewed as valuable, important, or even essential to the use of the laptop computer.
LaserDynamics argued that practical and economic necessities compelled it to base the royalty rate on the entire laptop rather than just the ODD for two reasons. First, QCI does not track the prices, revenue, or profits associated with each ODD. Second, QCI purchases ODDs for a mask price, which does not reflect the drive's actual value. The Federal Circuit rejected these arguments, noting that, in addition to a per-unit running royalty, the parties could use a lump-sum royalty, as shown by LaserDynamics's existing license agreements. Moreover, the court reasoned, LaserDynamics's arguments failed to address the fundamental concern of the entire-market-value rule, since permitting LaserDynamics to use a laptop-computer royalty base would not protect from overcompensation.
The Federal Circuit also addressed the issue of implied license. QSI assembles ODDs for Philips and Sony/NEC/Optiarc, which are both licensed by LaserDynamics to make and sell ODDs within the scope of LaserDynamics's disc-discrimination patent. QCI then purchases ODDs directly from Philips or Sony/NEC/Optiarc to install them into laptops—such sales apparently accounted for the majority of the accused products. According to the Federal Circuit, QCI therefore has an implied license for those ODDs made by QSI and sold to QCI via Philips or Sony/NEC/Optiarc. Specifically, QSI only assembled ODDs to meet its customers' needs and requests. This, according to the Federal Circuit, was a legitimate transaction and valid exercise of the "have made" and "sell" rights under the license agreements.
Noting that the correct determination of the hypothetical negotiation date is essential for properly assessing damages, the Federal Circuit also found that the district court erred by setting the hypothetical negotiation date to the date LaserDynamics filed the lawsuit. The district court had used this date because notice of the patent is an element of liability for induced infringement, so LaserDynamics could not recover damages until QCI had the required notice. Instead, the Federal Circuit held that in the context of active inducement of infringement, the hypothetical negotiation is deemed to take place on the date of the first direct infringement traceable to the inducer's conduct. This remains true even when damages could not accrue from that point because, for example, the infringer lacked notice of the patent until some time later. The difference in the LaserDynamics case was important because it changed which of LaserDynamics's licenses should be considered for a reasonable royalty. Because the damages had used an improper date for the hypothetical negotiation, the court remanded for another new trial on damages for the sales that were not protected by an implied license.
The Federal Circuit reiterated that reasonable-royalty calculations should be based on the smallest salable patent-practicing unit and that the entire-market-value rule is only appropriate when the patentee can show that the patented feature drives demand for the entire product. The patentee may make this showing by conducting market studies or consumer surveys to show that the patented feature motivated consumers to buy the broader product.
1 The LaserDynamics decision may be found here.
Copyright © Finnegan, Henderson, Farabow, Garrett & Dunner, LLP. This article is for informational purposes, is not intended to constitute legal advice, and may be considered advertising under applicable state laws. This article is only the opinion of the authors and is not attributable to Finnegan, Henderson, Farabow, Garrett & Dunner, LLP, or the firm's clients.
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