CAFC: Reliance on Unrelated Licenses Doom Damage Award

By Eric Guttag
February 8, 2010

In September of last year, the Federal Circuit overturned a “mega” jury award of over $357 million in damages in Lucent Technologies, Inc. v. Gateway, Inc. because the “lump-sum” royalty payment was not supported by “substantial evidence.”  See Entire Market Value Rule Lives As $357 Million Verdict Dies .  At the heart of the Lucent case was how to calculate damages based on a reasonable royalty using the Georgia-Pacific factors, especially the “entire market value” rule (aka factor 13).  In the recent case of ResQNet.com, Inc. v. Lansa, Inc., a majority of a Federal Circuit panel (per curiam) overturned a even more modest damage award (just over half a million dollars) based on an allegedly incorrect royalty rate based on the Georgia-Pacific factors, this time factor one (aka “existing licenses”).  Judge Newman, who was a member of the Lucent panel, took a different view of the evidentiary value of these “existing licenses” and dissented in part.

In ResQNet.com, the patented technology involved screen recognition and terminal emulation processes to download a screen of information from a remote mainframe computer onto a local personal computer (PC).  Basically, the patented technology facilitated the ability of the PC to operate like earlier “dumb terminals” in recognizing information sent by a mainframe connected to the PC.  The alleged infringing terminal emulator program called “NewLook” was developed in Australia (by Looksoftware Proprietary Limited) but was sold by Lansa, Inc. (Lansa) in the U.S.

The protracted legal fight between the parties began in 2001 when ResQNet sued Lana for infringing five patents covering this terminal emulation technology:  U.S. Pat. No. 6,295,075 (the ‘075 patent), U.S. Pat. No. 5,831,608 (the ‘603 patent), U.S. Pat. No. 5,812,127 (the ‘127 patent), U.S. Pat. No. 5,792,659 (the ‘659 patent), and U.S. Pat. No. 5,530,961 (the ‘961 patent).  The ‘127 and ‘608 patents were later dropped from the suit during a first appeal to the Federal Circuit in 2003 which modified the district court’s claim construction.  A second appeal of Rule 11 sanctions imposed by the district court against ResQNet was dismissed by the Federal Circuit in 2005 as not ripe for review.  A bench trial by the district court concluded in 2008 with the following rulings:  (1) the ‘075 patent was valid and infringed; (2) the ‘608 patent was not infringed; (3) sanctions under Rule 11 were assessed against ResQNet and its counsel; and (4) damages of $506,305 were awarded for infringement of the ‘075 patent based on a royalty rate of $12.5%.

I won’t address the first three rulings other than to say the entire Federal Circuit panel affirmed the district court’s first two rulings (on validity and infringement) and reversed the third ruling (on the Rule 11 sanctions).  Instead, I’ll focus on the district court’s fourth ruling, the damage award and especially the district court’s acceptance of the 12.5% royalty rate.

At the center of this 12.5% royalty rate determination was the testimony, and particularly the methodology used by ResQNet’s damages expert (Dr. Jesse David) in determining this royalty rate.  The Federal Circuit panel majority asserted that this 12.5% royalty rate determination was based strictly on “royalties received by the patentee from existing licenses” (i.e., Georgia-Pacific’s “existing license” factor).  In calculating this royalty rate, Dr. David used seven ResQNet licenses, five of which related to what were referred to as re-branding (re-bundling) licenses.  These “re-bundling licenses” had royalty rates ranging from 25% to 40%, and thus tended to drive up Dr. David’s royalty rate calculation.

What particularly drew the ire of the Federal Circuit panel majority in using these “re-bundling licenses” in the royalty rate calculation was the relatedness of these licenses to the patented technology at issue in the suit.  Specifically, the Federal Circuit panel majority said that “none of these [re-bundling] licenses even mentioned the patents in suit or showed any other discernible link to the claimed technology.”  In fact, the Federal Circuit panel majority asserted that the “re-bundling licenses are not consistent at all with the other two licenses in the record.”  These “other two licenses” were characterized as “straight” licenses which arose out of litigation involving the patents in the ResQNet suit.

Most significantly, the Federal Circuit panel majority observed that one of these “straight” licenses had an ongoing royalty rate that was substantially less than 12.5%.  Why was this observation significant?  Because the Federal Circuit panel majority earlier criticized Dr. David’s royalty rate calculation using the five re-bundling licenses as “driv[ing] the royalty rate up to unjustified double-digit levels.”  In other words, the Federal Circuit panel majority viewed the inclusion of these allegedly unrelated “re-bundling licenses” in Dr. David’s calculation as strictly for the purpose of boosting the royalty rate.  In fact, the Federal Circuit panel majority said as much:  “[t]this court finds two parts of this analysis particularly troubling:  first, the extremely high rates in the re-bundling licenses compared with the license on the claimed technology, and second, the unconvincing reasons that Dr. David gave for considering these re-bundling licenses at all.”

Besides the allegedly “inflated” royalty rate, what obviously bothered the Federal Circuit panel majority about Dr. David’s calculation was the failure to tie this 12.5% royalty rate “to the claimed invention’s footprint in the market place,” citing one of the Federal Circuit’s seminal “damages” cases prior to Lucent, Grain Processing Corp. v. American Maize-Products Company.  In fact, the Federal Circuit panel majority noted that Lucent had rejected a patentee’s reliance on existing licenses as being “radically different from the hypothetical agreement under consideration.”  Likewise, the Federal Circuit panel majority in ResQNet found that the “majority of the licenses on which ResQNet relied in this case are problematic for the same reasons that doomed the damage award in Lucent.”  Accordingly, the Federal Circuit panel majority concluded that “the district court’s award relied on speculative and unreliable evidence divorced from proof of economic harm linked to the claimed invention and is inconsistent with sound damages jurisprudence.”

What makes the Federal Circuit panel majority’s opinion unusual (and problematic) was the instruction to the district court on remand to “not rely on unrelated licenses to increase the reasonable royalty rate above rates more clearly linked to the economic demand for the claimed technology.”  That instruction drew a strong protest from partially dissenting Judge Newman:  “[m]y colleagues, in setting strict barriers as to what evidence can be considered, leave the damages analysis without access to relevant information.”  Instead, Judge Newman viewed the damage assessment in ResQNet as “not analogous to that criticized in Lucent, where the damages award was based on the entire market value of a system in which the infringing component was but a small part” because, in ResQNet, “the patented technology was a large part of the ‘bundled’ licenses, and these licenses were fairly considered for their content and value.”

Judge Newman’s dissent also asserts that the Federal Circuit panel majority’s opinion disregards relevant royalty rate evidence based on other Georgia-Pacific factors, especially factor two (royalties paid by the licensee to others) and factor four (licensor’s policies and practices regarding the grant of licenses to its technology).  In fact, there appears to be a huge disconnect between the Federal Circuit panel majority’s and Judge Newman’s view of the “totality” of Dr. David’s testimony.  For example, regarding Dr. David’s testimony, Judge Newman was particularly blunt in asserting that the Federal Circuit majority panel’s opinion “misdescribe[s] this testimony by stating that Dr. David considered only ‘a few’ of those factors  .   .   .   for he discussed all fifteen factors.”

Unlike the Lucent case where the damage award was rightly challenged as not being supported by “substantial evidence” based on the Georgia-Pacific factors, the ResQNet case unfortunately creates tremendous uncertainty over how those factors are to be evaluated, and especially which of those factors should (or should not) be given priority in a given case.  The Federal Circuit panel majority is perhaps correct that the district court gave undue weight to damage expert’s reliance upon the five “re-bundled licenses” to inflate the royalty rate determined.  But Judge Newman is also rightly perturbed at upsetting a damage award based strictly on one Georgia-Pacific factor allegedly being given undue weight while apparently ignoring royalty rate evidence based on several other Georgia-Pacific factors.

Also unlike Lucent, ResQNet didn’t involve a “mega” damage award.  But what can safely be said about the ResQNet case is that it highlights the danger of relying upon one specific Georgia-Pacific factor to support the royalty rate calculation, particularly if that one factor appears to unduly “inflate” what that royalty rate should be relative to other factors.  Also, the importance of tying that royalty rate back to the value of the claimed invention (which the Lucent case had already alluded to) is even more imperative after ResQNet.  Otherwise, even a modest damage award (e.g., ~$500,000) granted at trial may be doomed on appeal.

© 2010 Eric W. Guttag.

The Author

Eric Guttag

Eric Guttag  
Mr. Guttag has over 38 years of corporate and private intellectual property law experience on patent, trademark, copyright, trade secret and unfair competition matters, computer and Internet law, including patent application drafting, prosecution, and patentability studies; infringement and validity studies; international patent prosecution; patent and know-how licensing; consulting, confidentiality, clinical study and research agreements; trademark searches and opinions; trademark registration and prosecution; trademark freedom-to-use studies and trademark litigation and dispute resolution.

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