Court Excludes Damages Testimony that Unpatented Collateral Products Should Be Included in Royalty Base

Authored by Aaron V. Gleaton, D. Brian Kacedon, and John C. Paul

District-court judges are often said to fulfill a necessary "gatekeeper" function by excluding unreliable testimony of expert witnesses. A recent decision from the Northern District of Illinois shows the need for damages experts in patent litigations to use reliable methodologies backed by credible data to survive scrutiny and avoid having the court exclude such evidence from being considered in determining the appropriate amount of damages to award. In particular, care is needed in establishing a reliable methodology in attempts to increase a potential damages award in a patent infringement case by including profits of unpatented collateral parts.

Background

Sloan Valve Company sued industry rival Zurn Industries for infringement of a patent relating to a flush valve for plumbing fixtures such as toilets. Depending on the direction of actuation of the handle, users can select one of two flush volumes to converse water. During expert discovery, Sloan offered Richard Bero as its expert on compensatory damages based on Zurn's sales of the accused products. Bero opined on a reasonable-royalty rate based on the entire market value of the valve assembly, profits from lost sales of collateral products, and price erosion. Zurn sought to exclude Bero's testimony on several grounds, including that he failed to limit his analysis to the value attributable to the patented invention and that he misapplied the factor relevant to the analysis, as set forth in Georgia-Pacific Corp. v. United States Plywood Corp., 318 F. Supp. 1111 (S.D.N.Y. 1970).¹

The Sloan Valve Decision

Applying Daubert v. Merrell Dow Pharmaceuticals, 509 U.S. 579 (1993),² and Fed. R. Evid. 702, the Court agreed with Zurn, concluding that Bero's methodology was flawed for several reasons. First, the Court rejected Bero's inclusion of profits allegedly earned on unpatented features of the accused valve assemblies. Despite generally agreeing with Bero's use of the entire-market rule, the Court faulted Bero's inclusion of features not found in the patented valve assembly. Specifically, the Court rejected Bero's inclusion of unpatented features such as packages, handles, and other related accessories not part of the valve assembly. Citing Federal Circuit precedent, the Court explained that, because the unpatented features constituted individual products that did not serve as a single functional unit, the entire-market rule did not apply to those features. With that, the Court excluded Bero's damages opinion because of his failure to apportion the royalty rate to only the value attributable to the patented invention.

Second, the Court rejected Bero's inclusion of profits from lost sales of collateral products as part of the royalty base. Relying on the testimony of Sloan executives, Bero assumed that Sloan's valves drove the sales of other related products, such as replacement kits. After determining that the value of the collateral products equaled the value of the patented product, Bero then added the value of the collateral products to the royalty base. The Court disagreed with this approach, holding that the proper application of the relevant Georgia-Pacific factor requires a qualitative evaluation of whether lost sales of collateral products support a higher or lower royalty rate, not a quantitative addition of the sales of the collateral products to the royalty base. Interestingly, the Court cited Bero's own scholarly literature to support its holding.

Third, the Court heavily criticized Bero's "price effect," which made up more than half of the $71 per-unit rate proposed. Bero described this "price effect" as "based on Sloan's initial and subsequent pricing being lower than its intended pricing." Stated differently, Bero based roughly half of his proposed royalty rate on Sloan's executives' representations that Sloan would have sold its products at higher prices at the same volumes but for Zurn's entry to the market. The Court flatly rejected that opinion, finding no "foundation to conclude that Sloan would have made every sale that Zurn did at its intended higher price." Further, the Court characterized Bero's label "price effect" as a "cover to what appears to be lost profits." These same reasons served as the basis for the Court's rejection of Bero's similarly proffered testimony on price erosion.

Finally, the Court generally discounted Bero's overall methodology, stating that Bero did not use the "classic way to determine" a running royalty, which is to multiply the revenue generated by the infringement by a percentage royalty rate. Rather, Bero multiplied the number of infringing units sold by a dollar figure. The Court held that such a calculation bore "no resemblance to a reasonable-royalty analysis," improperly using the contrived "dollar figure" rate to incorporate lost profits, collateral goods, and the "price effect." Finding Bero's analysis unreliable, the Court granted Zurn's motion to exclude his testimony.

Strategy and Conclusion

This decision shows how courts try to ensure that damages expert opinions are based on reliable methodologies before allowing those opinions to be presented and considered at trial and illustrates a number of factors they consider, including legal precedent, apportioning the royalty based on the value attributable to the patented invention, using qualitative evaluations, creating a reliable foundation for conclusions, and using established methods for computing royalties.

Endnotes

¹ The Georgia-Pacific opinion can be found at http://www.finnegan.com/files/upload/LES_Insights_Column/2014/SloanValve_v_Zurn.pdf.

² The Daubert opinion can be found at http://supreme.justia.com/cases/federal/us/509/579/case.html.

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