Use of the Book of Wisdom in Reasonable Royalties

By Mark Pedigo
November 19, 2018

A reasonable royalty in patent infringement litigation is often determined through the construction of a hypothetical negotiation between the patentee and the infringer at the time of first infringement. In these cases, a key question that courts, parties to patent infringement litigation, and damages experts have wrestled with is just how relevant, admissible and useful is information that post-dates the date of first infringement (book of wisdom) in the determination of a reasonable royalty? From a review of Federal Circuit and notable District Court cases, there appears to be conflicting guidance as to whether a royalty should be based on:

  1. Only information known as of the date of first infringement (i.e., date of the hypothetical negotiation);
  2. Information known as of the date of the hypothetical negotiation plus the book of wisdom; or
  3. Information known as of the date of the hypothetical negotiation and only a limited amount of book of wisdom information.

What are the implications of notable book of wisdom cases on the determination of reasonable royalties?

The role of the book of wisdom was first addressed in Sinclair Refining v. Jenkins Petroleum and in more recent years in Federal Circuit and District Court cases. In Sinclair, Justice Cardozo writing for the Supreme Court concluded that, if years have gone by since the time of first infringement, “[e]xperience is then available to correct uncertain prophecy. Here is a book of wisdom that courts may not neglect…[t]o correct uncertain prophecies in such circumstances is not to charge the offender with elements of value nonexistent at the time of his offense. It is to bring out and expose of light the elements of value that were there from the beginning…” [Sinclair Refining Co., 289 U.S. @ 698]. Note that the Supreme Court stated that the objective was not to charge the offender/infringer with value that was not present at the time of infringement, but rather to address value that existed in the beginning. In other words, the book of wisdom was intended to reflect what the parties might have realized at the time of first infringement.

In the well-known Georgia-Pacific v. U.S. Plywood case, the District Court took “into account the modifying effect of the facts developed subsequent to 1955 and has assessed them together with all other probative evidence so far as they bear upon the reasonableness of the assumptions and expectations of the parties in their hypothetical negotiations in 1955…” In this case all of the substantive quantitative and qualitative facts were derived from the time period preceding the hypothetical negotiation in 1955 and subsequent information was only used as a reasonableness check of the expectations as of the date of the hypothetical negotiation. An important distinguishing factor of this case is the fact that the patent was near its expiration and there had been many years of commercial success prior to the hypothetical negotiation.

A decade later, in Trans-World Mfg v. Al Nyman & Sons, the Federal Circuit ruled that Nyman’s profits were relevant to the determination of a reasonable royalty and noted that “[e]vidence of the infringer’s actual profits generally is admissible as probative of his anticipated profits…”  The Court, however, declined to opine as to the weight that should be given to actual profits.

In TWM Manufacturing v. Dura Corp, the special master noted that the “analytical approach takes the anticipated net profit realized by the infringer…and subtracts the usual or acceptable net profit of the infringer…” , emphasis added]. The master based the royalty, in part, on projected profit margins. In affirming the decision, the Federal Circuit stated that “[a]lthough evidence of actual profits is generally admissible…the district court here correctly focused on the date when infringement began…” 

In Fromson v. Western Litho Plate, the Federal Circuit noted that “[t]he methodology [of calculating a reasonable royalty] encompasses fantasy and flexibility; fantasy because it requires a court to imagine what warring parties would have agreed to as willing negotiators; flexibility because it speaks of negotiations as of the time infringement began, yet permits and often requires a court to look to events and facts that occurred thereafter and that could not have been known to or predicted by the hypothesized negotiators…” [Fromson v. Western Litho Plate, overruled in part on other grounds by Knorr-Bremse Systems v. Dana Corp.] In Procter & Gamble v. Paragon Trade Brands, the District Court cited Fromson and reached a royalty opinion based, in part, on sales and profit information subsequent to the date of the hypothetical negotiation and a license agreement entered into six years after the hypothetical negotiation.

In Odetics, the Federal Circuit affirmed the exclusion of licenses that were negotiated years after the date of first infringement noting that, in the view of the District Court, the licenses were irrelevant because the financial landscape had changed remarkably in the four to five years following first infringement. Both the District Court and the Federal Circuit noted that while the use of post-infringement information in a reasonable royalty analysis is permissible and sometimes relevant, it is not required. [Odetics v. Storage Technology Corp.(Fed. Cir. 1999)]

In Interactive Pictures, the Federal Circuit affirmed a jury’s reasonable royalty award on a projected business plan from two months before first infringement, despite evidence later showing that the actual sales did not meet those projections noting that “the negotiation must be hypothesized as of the time infringement began…” The Court also noted that the “fact that Infinite did not subsequently meet those projections is irrelevant to Infinite’s state of mind at the time of the hypothetical negotiation…, Infinite’s failure to meet its projections may simply illustrate the “element of approximation and uncertainty” inherent in future projections…,” and if it had required sales projections to bear a close relation to actual sales revenue, it “would essentially eviscerate the rule that recognizes sales expectations at the time when infringement begins as a basis for a royalty base as opposed to an after-the-fact counting of actual sales…” [Interactive Pictures v. Infinite Pictures (Fed. Cir. 2001)]

In Honeywell, the District Court allowed sales projections from four to five years after the infringement began despite the existence of projections from one to two years prior to first infringement. Because of the events of September 11, 2001, and a resulting significant increase in the importance of the patented technology, the sales projections from several years later were much higher than could have been predicted at the time the infringement began. The District Court discussed the history and policy of the “book of wisdom” approach, including Sinclair, noting that the book of wisdom prevents the hypothetical negotiation method from determining a reasonable royalty at a point in time before the patent has proven its worth and also promotes flexibility “by not erecting an unnecessarily rigid barrier to relevant post-negotiation information… and discourages infringement by placing the risk of success on the infringer…” [emphasis added]. [Honeywell Intern., Inc. v. Hamilton Sundstrand Corp. (D. Del. 2005)] It is important to note that the Court emphasized placing the risk on the infringer. While not always the case, it is evident in several of the cases that when there is a conflict between pre-infringement and post-infringement information, courts tend to give the benefit of the doubt to the patentee. For other example cases, please contact the author.

The Federal Circuit in Lucent provided a general principle regarding the book of wisdom by stating that “our case law affirms the availability of post-infringement evidence as probative in certain circumstances… and that post-infringement evidence ought to be given its proper weight, as determined by the circumstances of each case…” [Lucent v. Gateway (Fed. Cir. 2009)] The book of wisdom has also been used due to a lack of reliable evidence of anticipated profits as of the date of first infringement. [Energy Transportation Group v. Sonic Innovations (D.Del. June 7, 2011)]

In Astrazeneca, the District Court used a significant amount of book of wisdom information, including sales, profits, market share, strategic plans, settlement agreements, rebates offered and licenses and even had a section in the opinion entitled The Book of Wisdom: Post-entry Information. [Astrazeneca v. Apotex, (SDNY 2013), Royalty Rate Aff’d, (Fed. Cir. 2015)]

In Aqua Shield, the Federal Circuit vacated the District Court’s royalty determination because it treated the infringer’s actual profits as a royalty cap. The Federal Circuit also noted that post-infringement profits “may be relevant, but only in an indirect and limited way—as some evidence bearing on a directly relevant inquiry into anticipated profits…” and that “the core economic question is what the infringer…would have anticipated the profit-making potential of the patented technology to be, compared to using non-infringing alternatives…” The Court also cautioned against replacing the forward-looking hypothetical inquiry into what the parties would have anticipated with a backward-looking inquiry into what turned out to have happened. [Aqua Shield v. Inter Pool Cover Team (Fed. Cir. 2014)

In On Track Innovations, the court did not allow post-infringement evidence because it was irrelevant and also noted that “[t]he law on this issue is far from clear…” and “the apparent tension between these cases has generated significant confusion in the district courts…,” referring to numerous Federal Circuit cases. After commenting on numerous district court cases, the Court stated that “most district courts conclude that they have the discretion, but not the obligation, to consider post-negotiation evidence in calculating a reasonable royalty…” The court noted that the circumstances inform the relevance of post-infringement information. “[P]ost-infringement information is at its most relevant when the infringer experienced a windfall as a result of their misconduct. Comparatively, it is less relevant when it is being presented by the infringer to emphasize the lack of damages caused by their own infringement…” [On Track Innovations v. T-Mobile (SDNY 2015)]

Just this year, in Amgen, the jury was instructed that it could consider post-hypothetical negotiation information but was not required to do so. The District Court referenced Fromson and Sinclair, but also Aqua Shield and noted that the Defendant, in wanting a remittur on the damages award based on a post-hypothetical negotiation event that was not anticipated as of the hypothetical negotiation date, was asking the Court to do what the Federal Circuit has expressly held was error, to “replace the hypothetical inquiry into what the parties would have anticipated, looking forward when negotiating, with a backward-looking inquiry into what turned out to have happened…” [Amgen Inc., et al. v. Hospira, Inc. (D. Del. August 27, 2018)]

Courts consistently focus on the availability of non-infringing substitutes as of the date of the hypothetical negotiation. In most of the cases reviewed, the determination of available substitutes was limited to those available at the date of first infringement. If an alternative introduced after the hypothetical negotiation was considered, its impact was discounted to reflect uncertainty as of the date of the negotiation. For example cases, please contact the author.

From a review of the above cases, it is clear that the book of wisdom can be relevant and useful, but it is not always allowed by courts. Use and acceptance of the book of wisdom is case and court specific. Also, the use or omission of the book of wisdom may significantly impact a royalty conclusion. Potential practice considerations could include obtaining guidance from other cases in the court in question, seeking guidance from the court in advance of expert disclosure, and/or developing a royalty opinion under two alternative assumptions (i.e., with and without the book of wisdom).

 

Image Source: DepositPhotos

The Author

Mark Pedigo

Mark Pedigo is a Director at RGL Forensics. He focuses specifically on the quantification and analysis of economic damages and valuation of assets in matters related to patent, trade secret, trademark and copyright infringement; breach of contract and other commercial disputes; construction disputes; and alter ego and other forensic accounting. Pedigo has performed intellectual property royalty audits and has provided intellectual property royalty rate consulting for clients who are negotiating licensing agreements. Prior to forensic accounting, Pedigo worked in internal audit for an international oil and gas company.

For more information, or to contact Mr. Pedigo, please visit his company profile page.

Warning & Disclaimer: The pages, articles and comments on IPWatchdog.com do not constitute legal advice, nor do they create any attorney-client relationship. The articles published express the personal opinion and views of the author and should not be attributed to the author’s employer, clients or the sponsors of IPWatchdog.com. Read more.

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There are currently 1 Comment comments. Join the discussion.

  1. Uzi Aloush November 20, 2018 10:40 am

    Back in 1933, Justice Cardozo in Sinclair cursed the patent licensing industry by imposing an imaginary idea that Reasonable Royalties should be an amount calculated as a % of product sale price. A percentage value that should be hypothetically negotiated at the time of first infringement. Where did that come from?? Such a strange practice does not exist anywhere else!
    Licenses to inventions are no different from other items on a product’s bill of materials. NO OTHER INDUSTRY negotiates a price of an ingredient as a percentage of the end-product sale price. Imposing such an impossible practice has sent thousands of parties from the negotiations table straight to the courthouse, to “construct a hypothetical negotiation between the patentee and the infringer at the time of first infringement.”
    Time to change the unreasonable practice of calculating Reasonable Royalties as % of product price. No one does that in any other industry.

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