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Hypothetical Negotiation in Inducement of Infringement Takes Place on Date of First Direct Infringement Traceable to Defendant’s First Instance of Inducement Conduct

August 30, 2012

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Last Month at the Federal Circuit - September 2012

Judges: Dyk, Clevenger, Reyna (author)

[Appealed from: E.D. Tex., Judge Ward]

In LaserDynamics, Inc. v. Quanta Computer, Inc., Nos. 11-1440, -1470 (Fed. Cir. Aug. 30, 2012), the Federal Circuit reviewed seven issues from two district court trials involving U.S. Patent No. 5,587,981 (“the ’981 patent”), which LaserDynamics, Inc. (“LaserDynamics”) asserted against Quanta Computer, Inc. (“QCI”). In sum, the Court remanded for a new trial on damages that QCI owed pertaining to the infringing optical disc drives (“ODDs”) it did not purchase from LaserDynamics’s licensees, and for which QCI did not have an implied license to the ’981 patent.

Claim 3 of the ’981 patent recites a method that enables an ODD to identify the type of optical disc—e.g., a CD versus a DVD—that is inserted into the ODD. LaserDynamics alleged that QCI actively induced infringement of claim 3 under 35 U.S.C. § 271(b) by assembling laptop computers that include infringing ODDs. QCI’s typical practice is to buy ODDs from laptop manufacturers, which in turn purchase them from ODD manufacturers. Because QCI eventually sells the fully assembled laptop computers—including the ODDs—to its customers, this process is called a “buy/sell” arrangement.

QCI’s partially owned subsidiary, Quanta Storage, Inc. (“QSI”), is a manufacturer of ODDs. QCI does not manufacture ODDs, but will sometimes purchase ODDs directly from ODD manufacturers, such as QSI. QSI also assembles ODDs for companies that are licensed by LaserDynamics to “make” and “sell” ODDs within the scope of the ’981 patent. Under the license agreements, these companies also enjoy “have made” rights, which permit them to retain companies like QSI to assemble ODDs for them.

When QCI purchases ODDs directly from ODD manufacturers—i.e., not under a “buy/sell” arrangement—QCI has no knowledge of which entity assembled the ODDs. QCI pays the manufacturer directly for the ODDs, which are not sold under the QSI brand name, even if assembled by QSI.

The district court granted LaserDynamics’s motion for SJ that (1) the patent exhaustion doctrine did not apply to the ODDs that QCI bought overseas from LaserDynamics’s licensees; and (2) QCI did not have an implied license to use ODDs manufactured by its subsidiary, even though QCI bought those ODDs from LaserDynamics’s licensees who were authorized to outsource manufacturing to QCI’s subsidiary. At the first trial, the jury returned a verdict finding QCI liable for active inducement of infringement, and awarded $52 million in damages to LaserDynamics. The district court denied QCI’s JMOL motion of noninfringement, but set aside the damages verdict as excessive and ordered a new trial on damages after LaserDynamics declined the option of a remittitur to $6.2 million. At the second trial, the jury returned a damages verdict of $8.5 million. The district court denied QCI’s post-trial motion for a new trial on damages. LaserDynamics appealed and QCI filed two cross-appeals.

At the outset, the Federal Circuit considered LaserDynamics’s appeal of the grant of the second trial on damages and/or remittitur after the conclusion of the first trial. Only after the end of the first trial did QCI argue that LaserDynamics improperly invoked the entire market value rule, which the district court then accepted to order the second trial. Thus, LaserDynamics argued, QCI had waived the argument. The Federal Circuit, however, held that the district court had the discretion to order the second trial, relying on a two-part analysis. First, the Court found that LaserDynamics improperly invoked the entire market value rule—it used the revenue from sales of laptop computers as the royalty base, without having established that the infringing ODDs drove the demand for the laptop computers. The Court clarified that the presence of the infringing ODDs must be shown to motivate consumers to buy the laptops in the first place. The Court found that LaserDynamics proved only that consumers would hesitate to buy a computer that did not include the infringing ODDs, but not that the presence of the ODDs motivated consumers to buy the laptops. Second, applying Fifth Circuit law that gives the district court discretion to consider new theories raised for the first time in a post-trial brief, the Court concluded that the district court had discretion to consider QCI’s meritorious post-trial argument.

The Federal Circuit next affirmed-in-part and reversed-in-part QCI’s cross-appeals.

First, the Court reversed the district court’s SJ of QCI’s lack of implied license. Under the agreement with LaserDynamics’s licensees, QCI’s subsidiary manufactured ODDs only for the benefit of LaserDynamics’s licensees—i.e., QCI could not order its subsidiary to manufacture ODDs to fill QCI’s own needs, and QCI could not immediately buy back from LaserDynamics’s licensees ODDs that its subsidiary had produced. The Court found that the manufacture and sale of the ODDs were valid exercises of the “have made” and “sell” rights, respectively, under LaserDynamics’s patent license agreements with its licensees and did not expand or circumvent those agreements. Accordingly, the Court held that QCI had an implied license to the ’981 patent with respect to the ODDs made by QCI’s subsidiary and sold to QCI via LaserDynamics’s licensees. Further, because QCI’s patent exhaustion defense applied only to those ODDs to which the implied license defense was also applicable, the Federal Circuit dismissed the patent exhaustion question as moot.

On the second issue on cross-appeal, the Court affirmed the district court’s denial of JMOL on noninfringement against QCI following the first trial. The Court found that “[t]he record amply support[ed] that the depth of the data layer precisely correlates to the pit configuration arrangement, such that the measurement of the depth (via a counter value) is a measurement of the pit arrangement.” Slip op. at 36. This, the Court found, satisfied the requirements of claim 3; thus, the Court held that the jury was entitled to enter the infringement verdict.

With regard to the third issue on cross-appeal, the Court reversed the district court’s denial of QCI’s motion for a new trial on damages following the second trial. The Court held that, although the jury instructions in the second trial that QCI challenged did not alone warrant a new trial on damages, the district court erred in three important ways. First, the Court reasoned, the district court selected an incorrect date for the hypothetical negotiation for a reasonable royalty analysis. In general, the date when infringement began is used as the date of the hypothetical negotiation. Because there can be no inducement of infringement under 35 U.S.C. § 271(b) unless there is also direct infringement, the Court held that the “hypothetical negotiation is deemed to take place on the date of the first direct infringement traceable to [the defendant’s] first instance of inducement conduct.” Id. at 40-41. Here, that date was 2003, not August 2006, as the district court ruled.

Second, the Court held that the district court admitted a settlement agreement whose probative value was substantially outweighed by its prejudicial impact. The Court found that the settlement agreement was entered into under unique circumstances, namely, the unduly coercive environment of patent litigation that ill represents the environment in which the hypothetical negotiation would have taken place. The Court observed that “[t]he notion that license fees that are tainted by the coercive environment of patent litigation are unsuitable to prove a reasonable royalty is a logical extension of Georgia-Pacific, the premise of which assumes a voluntary agreement will be reached between a willing licensor and a willing licensee, with validity and infringement of the patent not being disputed.” Id. at 43. Thus, the Court concluded, “[t]he propriety of using prior settlement agreements to prove the amount of a reasonable royalty is questionable.” Id. Accordingly, the Court held that the district court erred in entering the settlement agreement into evidence.

Finally, the Court found that the district court admitted expert testimony that was unreliable under Fed. R. Evid. 702. The Court noted that although “[a]ctual licenses to the patented technology are highly probative as to what constitutes a reasonable royalty,” “[w]hen relying on licenses to prove a reasonable royalty, alleging a loose or vague comparability between different technologies or licenses does not suffice.” Id. at 47. Here, however, LaserDynamics’s expert determined a royalty rate of 6% of each ODD sold within a QCI laptop computer using two DVD-related patent licensing programs and a 1997 licensing executives survey, none of which involved either the ’981 patent or another disc discrimination method. “The 1997 licensing survey was even further removed from the patented technology, since it was not even limited to any particular industry, but ‘was across whatever technologies were being licensed by the people who responded.’” Id. at 49 (citation omitted). Further, the evidence of licenses to the ’981 patent were all for lump-sum amounts, whereas the expert testified to a running royalty rate on the basis of that evidence. Thus, the Court concluded that “the 6% royalty rate was untethered from the patented technology at issue and the many licenses thereto and, as such, was arbitrary and speculative.” Id. at 51. The Court therefore remanded for a new trial on damages.

Summary authored by Karthik Kumar, Ph.D., student associate at Finnegan.