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Lost Profits?

… what every lawyer should know

The Patent Guys, Richard Malagiere wrote Patent Infringement Damages – Lost Profits for the Bergen County Bar Association Intellectual Property Committee

Per 35 U.S.C. §284, upon finding of infringement, a patentee (owner of the patent) is entitled to damages adequate to compensate for the infringement in no event less than a reasonable royalty for the use made of the invention by the infringer. So, a reasonable royalty is the minimum measure of damage to which a patentee is entitled when infringement has been found.

In this edition we will focus our comments on the “lost profit” type of damages in patent infringement cases. In the damage portion of a patent infringement case (which can be decided by either the jury or the court) the patentee must prove that “but for” the infringer’s acts, the patentee would have made greater sales (sales diversion), charged higher prices (price erosion) or incurred lower expense. Section 284 also provides that the court may increase the damages up to three times the amount found by the jury or assessed by the court. This damage enhancement is typically reserved for willful infringement cases. Expert testimony as to damages is permitted under section 284 (in either case lost profits or reasonable royalty) but not required for a prime facie damage showing. The standard on appeal for a review of a lost profit determination is de novo.

The reasonable probability standard is applied to lost profits damages in patent infringement cases. Specifically, the patentee must show a reasonable probability that “but for” the infringement of the defendant infringer, the patentee would have made the sales that were made by the defendant infringer. So, lost profits are, of course, reserved for patentees who are actually competing in the marketplace as contrasted with individuals or entities that hold patents without actively manufacturing products or licensing the right to do so. Remember, a patent is a right to exclude others from making, using or offering for sale the patented item. See 25. U.S.C. §271. So, there is not requirement that a patentee actually practice its invention (i.e., make it, use it or offer it for sale) in order to stop another from doing so.

The elements of lost profit damages generally take three forms – diverted sales, price erosion and loss of future profits due to price erosion due to infringement. In order to prove diverted sales, the patentee bears the initial burden of showing a reasonable probability that “but for” the infringement, the patentee would have made the sales that the infringer made. Once this burden is met by the patentee, the burden shift to the infringer to show that “but for” causation analysis is unreasonable under the specific circumstances of the case under consideration.

The inquiry is the diverted sales setting requires that the fact finder to make a determination into what would have happened in the market place if the infringer had not entered into the marketplace – basically evaluating a theoretical revision of historical events. As such, direct proof of causation of the damages that flow from the infringement are rarely if ever found or used. So, under the reasonable probability test, a fact finder may infer causation by looking at the demand of the patented item in the market place, the capacity of the patentee to have met this demand and the absence of alternative non-infringing substitutes for the patented item.

The implied proof of causation attempts to create a model of the market as it would have existed had the infringer not entered it with its infringing item. Basically, the patentee must provide proofs tending to establish the following elements by direct proofs: (i) there was demand for the patented product in the market; (ii) there was an absence of acceptable noninfringing substitutes for the patented product; (iii) the patentee had the manufacturing and marketing capabilities to exploit the market demand consumed by the infringer and (iv) the amount of profit the patentee would have made.

Often, item (ii) – the absence of adequate noninfringing alternatives – presents some difficulty. The idea behind this element is that a fair and accurate reconstruction of the “but for” market must take into account alternative actions the defendant infringer foreseeably would have taken had it not infringed. The consideration of noninfringing alternatives appropriately reflects rationale competitive behavior and economic theory on the market value of a patent. Remember, the idea behind any damage calculus is to compensate the plaintiff for the harm caused by the defandant, not to provide a windfall.

So, we assume that if the infringer had not offered the infringing item, it would have instead offered a noninfringing alternative, if available, to compete with the patentee’s product rather than leave the market altogether. Only by comparing the patented invention to its next best available alternative – regardless of whether the alternatives were actually produced and sold during the infringement – can the court discern the market value of the patent owners’s exclusive right, and therefore its expected profit or reward, had the infringer’s activities not prevented it from taking full economic advantage of this right. In short, when considering this damage proof element, the infringer has to be assumed to have not infringed and instead competed and the approximate sales associated with that noninfringing competition needs to be subtracted form the patentee’s damages.

The logic behind the above calculus is best demonstrated when one considers a market served by only a few suppliers – such as gas turbine engines for jet airlines. Basically, there are only three suppliers of note, GE, Pratt & Whitney and Rolls Royce. If GE is found to have infringed on Pratt & Whitney’s patented item, then it would seem unreasonable when calculating Pratt’s damages to ignore the possibility of GE entering the market with a non-infringing alternative had it not infringed.

Chisum on Patents, Donald S. Chisum Lexis (2015)