November 14, 2011
LES Insights
By John C. Paul; D. Brian Kacedon; Andrew J. Ra Jr.
Authored by D. Brian Kacedon, John C. Paul, and Andrew J. Ra Jr.
Under the laws of the United States, patent owners are entitled to recover damages from the infringing party in the form of lost profits or a reasonable royalty. In order to calculate a reasonable royalty, courts postulate a hypothetical negotiation between a willing licensor and licensee at the time the infringement commenced. While engaging in this hypothetical negotiation, courts also consider a number of different factors to determine the appropriate reasonable royalty.
The U.S. District Court for the Southern District of California recently addressed this issue in Divix Golf Inc. v. Mohr, No. 05CV1488 (S.D. Cal. Aug. 19, 2011).1 Although the evidence indicated that the typical royalty rate was ten percent or less, the court concluded that it was reasonable to infer that a higher royalty rate would be assessed due to the contentious past relationship between the plaintiff and the defendant. As a result, the court concluded that a 20 percent royalty rate was appropriate.
Plaintiff, Divix Golf, Inc. ("Divix") held a patent that covered a switchblade divot repair tool that it also manufactured and sold. Defendant Jeffrey Mohr ("Mohr") was formerly the President of Divix from January 2003 until his termination in June 2004. As President of Divix, Mohr learned Divix's manufacturing techniques, processes, know-how, and had access to all of Divix's books and records. In addition, Mohr also determined and controlled the pricing of Divix products and created Divix's price structure. Prior to his termination, Mohr had a falling out with one of Divix's founders and sent a letter in February 2004 threatening to leave Divix and make sure it "collapsed" and that he would challenge Divix's patent with a "competitive, low cost, offshore product."
Shortly after sending the letter, Mohr ordered molds for Divix's switchblade divot repair tool from third party Bandwagon in late February or March 2004. After Mohr left Divix, Mohr formed co-defendant, Remedy Golf, Inc. ("Remedy"). Remedy then obtained the molds from Bandwagon and began the process of manufacturing the switchblade divot repair tool in China for sale in the United States. Subsequently, Divix filed suit against Mohr and Remedy for infringing its patent.
After a trifurcated bench trial, the court determined that Divix Golf did not commit inequitable conduct and that its patent was not invalid based on anticipation or obviousness. Because the defendant stipulated that it infringed the patent if it was found valid, the court then moved to the damages phase of the trial. The court first determined that Divix was not entitled to lost profits. Divix conceded that it could not meet the four Panduit factors and instead attempted to show that sales would have been made but for the infringement. Divix's expert argued that 46 percent of the revenue obtained by Remedy would have gone to Divix. The expert, however, presented no evidence that Divix would have received Remedy's remaining 54 percent in light of the existence of other similar, non-infringing products. Because Divix had not shown a reasonable probability that it would have made the majority of Remedy's sales given the existence of other non-infringing switchblade divot repair tools, the court found that Divix was not entitled to lost profits.
As for the reasonable royalty, Divix's expert argued that a 20 percent royalty was appropriate because of the following factors: 1) high gross profit of 70 percent; 2) few competitors; 3) low retail price, therefore making it an impulse buy; 4) effective and low-cost promotional product that can be labeled with any brand name for advertising purposes; 5) unique design and function; and 6) accepted and known in the marketplace. Defendants argued that the appropriate royalty was 5 percent because that equaled the plaintiff's net profit.
After examining the evidence, the court only considered the first four factors raised by Divix's expert and rejected Defendants' argument. Rather, it agreed with Divix that the gross profit was more important in determining the reasonable royalty rather than the net profit. In addition, the court considered the undisputed testimony of Divix's expert that most royalty rates are 10 percent or less. Further, it also considered that manufacturing companies with a gross profit between 40 and 50 percent would warrant a royalty between six and eight percent and that because plaintiff's gross profit was 70 percent, it therefore warranted a higher royalty. Most importantly, the court considered Mohr's contentious past relationship with Divix in determining the reasonable royalty rate.
The court found that due to Mohr's previous employment, he had a unique knowledge of plaintiff's pricing and manufacturing structure which enabled Defendants to undercut Divix's prices. In addition, the court found few acceptable non-infringing substitutes in the marketplace and that the patented device was an extremely valuable component of Divix's business. Under these circumstances, the court concluded that it was highly unlikely that plaintiff would have issued a license to Remedy to sell infringing products as Remedy was a direct competitor with knowledge of plaintiff's pricing structure and ability to sell the product for a lower royalty amount. Further, the court found that the fact that the owner of Remedy had been previously fired from Divix under contentious circumstances and threatened to ruin Divix's business made a future business relationship highly unlikely. In light of the circumstances, the court concluded that if the parties did come to a licensing agreement, it was reasonable to conclude that a high royalty rate would be assessed and concluded that a 20 percent royalty rate was appropriate.
The Divix decision highlights the fact that courts will consider other, non-quantitative factors when determining the appropriate royalty rate. Due to the falling out between the parties, the court determined that a future business relationship was unlikely and that a higher royalty beyond what was typical in manufacturing was appropriate. Litigants should be aware that prior relationships with the opposing party may have a bearing on the determination of the royalty rate and should seek to highlight, or mitigate, that past relationship when arguing the appropriate royalty rate in court.
Endnotes
1 The Divix decision: http://patentlaw.jmbm.com/Divix.pdf
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.
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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