Judges Diverge on Use of Patent License Negotiations to Determine a Reasonable Royalty

Authored by D. Brian Kacedon, John C. Paul, and Larry M. Sandell

Patent owners who prevail in litigation are often awarded a "reasonable royalty" on products sold by infringers. Courts consider many factors—known collectively as the Georgia Pacific factors—in determining the appropriate "reasonable royalty.” One factor courts frequently consider is the royalties received by the patentee from licenses of the patent. But when such licenses are entered into in settlement of litigation, courts have historically applied a "settlement negotiations privilege" to prevent such agreements from being subject to discovery and admission in court. See, e.g., Goodyear Tire & Rubber Co. v. Chiles Power Supply, Inc., 332 F.3d 976 (6th Cir. 2003).¹ The purpose of the "settlement negotiations privilege" is to foster settlement of disputes by permitting parties to settle without concern over later use of that agreement against them in a later action.

A recent decision by the Court of Appeals for the Federal Circuit, however, revealed a tension between the desire to encourage settlement by protecting such agreements from discovery and the potentially high degree of relevance of such agreements to the reasonable royalty analysis. Subsequently, several decisions from the United States District Court for the Eastern District Texas have attempted to determine under what circumstances such agreements and related negotiations should be discoverable and admissible. As discussed below, these decisions have not been uniform in their approach to this issue. But they have underscored the importance of recognizing that settlement agreements and the negotiations relating to those agreements may be both discoverable and admissible by third parties in later litigation.

Federal Circuit ResQNet Decision Finds a License Arising out of Litigation Reliable

The Federal Circuit's ResQNet decision² found that the licenses used as evidence in the trial court to calculate the royalty award were irrelevant to the patented invention and observed that the most reliable license on record arose out of litigation. After noting that the hypothetical reasonable royalty calculation occurs before litigation and that litigation itself can skew the results of a hypothetical negotiation, the Federal Circuit ordered the trial court to reconsider the reasonable royalty calculation.

Texas Trial Court Judges Differ Over Whether Settlement Negotiations are Privileged

1. No Privilege Found - Discovery of settlement documents allowed

In March, in the Tyco case,³ Judge Ward required production of settlement documents related to settlement, finding they were not protected by the settlement negotiations privilege. His decision noted that prior to the ResQNet decision, the Eastern District of Texas had a bright-line rule that settlement negotiations were privileged and did not need to be produced during discovery, while the resulting license agreement was not privileged and needed to be produced. However, he found that the ResQNet decision suggested that the underlying negotiations were relevant to the calculation of a reasonable royalty using the hypothetical negotiation damages model, and that the settlement negotiation privilege of Goodyear did not apply in light of the Federal Circuit's ruling in ResQNet."

2. No Privilege Found - Patent license agreements admissible as evidence

Days later, in the Datatreasury case,⁴ Judge Folsom followed Judge Ward's interpretation of the ResQNet decision and denied an attempt to preclude litigation-induced patent license agreements from being introduced into evidence, noting that concerns about the reliability of litigation-related licenses are better directed to weight, not admissibility. In doing so he agreed that since the litigation-related licenses could be introduced into evidence, he would permit discovery on the negotiations surrounding those licenses.

3. Privilege Found - Settlement negotiations admissible as evidence

In April, in the Fenner case,⁵ Magistrate Judge Love disagreed with the interpretation of the ResQNet decision reached by Judges Folsom and Ward, and found that testimony and exhibits related to settlement licenses entered into as a result of prior litigations with third parties were inadmissible as evidence. The party wanting to submit that testimony and exhibits cited the ResQNet decision for the proposition "that license agreements arising out of litigation may be the 'most reliable' evidence of a reasonable royalty." Judge Love, without acknowledging the decisions in Tyco or Datatreasury rebutted the defendants' assertion, stating that "the recent ResQNet decision has not altered the admissibility of agreements entered into under the threat of litigation," and emphasized that the "most reliable license" language was merely used to contrast with the expert's reliance on patent licenses unrelated to the patent-in-suit. In preventing the settlement licenses from being considered as evidence of a reasonable royalty, Judge Love found that the potential for prejudice and jury confusion substantially outweighed whatever probative value the agreements might have.

4. Privilege Found - Discovery of settlement negotiations documents not allowed

In June, in the Red Hat case,⁶ Judge Love relied on his earlier decision in Fenner to prevent discovery of settlement negotiations documents pertaining to patent license agreements that were previously produced, while citing the decisions in Tyco and Datatreasury for the proposition that the ResQNet decision brought the "'bright-line rule' into considerable question."

5. No Privilege Found - Settlement licenses admissible as evidence

In August, in the ReedhyCalog case,⁷ Judge Davis considered whether to "prohibit any evidence regarding 'any previous litigation, settlement discussions, license, or agreements, or lack thereof between [plaintiffs] and anyone else regarding the Patents-in-Suit.'" After citing to the decisions in Datatreasury and Fenner, and emphasizing that the admissibility of licenses was not before the ResQNet court, Judge Davis determined that "the admissibility of litigation licenses-like all evidence-must be assessed on a case-by-case basis, balancing the potential for unfair prejudice and jury confusion against the potential to be a 'reliable license.'"

While Judge Davis considered five of the fourteen relevant licenses to be "litigation licenses," he refused to preclude their admission because the litigation licenses were "consistent with the other nine non-litigation licenses having similar running royalty structures. He prohibited the plaintiff from identifying the licenses as having resulted from litigation to "eliminate" "the danger of prejudice from the implication of validity and infringement by a third party willing to pay money to settle a lawsuit." Thus, although ReedhyCalog did not directly implicate the settlement negotiations privilege, this ruling represents yet another interpretation of the ResQNet decision in the Eastern District of Texas.

6. No Privilege Found - Discovery of settlement negotiation documents allowed

In late November, in the Clear with Computers case,⁸ Judge Davis reiterated his view that whether settlement negotiation documents should be produced is an issue that must be assessed on a case-by-case basis. In this case, he ordered the parties to produce settlement negotiations documents because he concluded that whether the license agreements should be considered as evidence of a reasonable royalty would depend on whether the licenses accurately reflected the value of the inventions and because settlement communications were "likely to be key in determining whether the settlement agreements accurately reflect the [value of the inventions] or were strongly influenced by a desire to avoid or end full litigation." Judge Davis, however, suggested that his ruling did not change the law because allowing discovery of settlement negotiation documents would remain the exception, not the rule, and in most cases discovery of the negotiations will not be warranted.

Strategy and Conclusion

Litigants should by wary that communications during patent licensing negotiations may not be protected by the settlement negotiation privilege could be obtained in discovery by an opponent and used as evidence of a reasonable royalty at trial.

Endnotes

¹ Goodyear Tire & Rubber Co. v. Chiles Power Supply, Inc., 332 F.3d 976 (6th Cir. 2003).

² ResQNet.com v. Kaplan & Gilman, LLP, 594 F.3d 860 (Fed. Cir. 2010).

³ Tyco Healthcare Group LP v. E-Z-EM, Inc., No. 2:07-CV-262 (TJW) (Mar. 2, 2010).

⁴ Datatreasury Corp. v. Wells Fargo & Co., No. 2:06-CV-72 DF (Mar. 4, 2010).

⁵ Fenner Investments, Ltd. v. Hewlett-Packard Co., No. 6:08-CV-273 (Apr. 28, 2010).

⁶ Software Tree, LLC v. Red Hat, Inc., No. 6:09-CV-097 (June 24, 2010).

⁷ ReedhyCalog UK, Ltd. v. Diamond Innovations Inc., No. 6:08-CV-325 (Aug. 2, 2010).

⁸ Clear with Computers, LLC v. Bergdorf Goodman, Inc., No 6:09-CV-481 (Nov. 29, 2010).

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