Introduction
35 U.S.C. § 284 provides that, where infringement is found, "the court shall award . . . damages adequate to compensate for the infringement but in no event less than a reasonable royalty for the use made of the invention by the infringer." What is a reasonable royalty?
Typically, a reasonable royalty is estimated using the "hypothetical negotiation approach," which "attempts to ascertain the royalty upon which the parties would have agreed had they successfully negotiated an agree- ment just before the infringement began."2 While a reasonable royalty may be a lump sum, most commonly it is calculated as the product of two values: a royalty base and a royalty rate. The royalty base reflects the revenue netted by sale of an infringing product, while the roy- alty rate indicates the percentage of each product sale that would, in the hypothetical negotiation, be paid to the patentee.
At first glance, determining a reasonable royalty seems simple. Imagine a new drug. The "reasonable royalty," the Federal Circuit has explained, "is the amount that a person," desiring to sell the drug, "would be willing to pay as a royalty and yet be able to . . . sell the [drug], in the market, at a reasonable profit."3 But what happens when the patented technology covers only a portion of the product being sold? Imagine, for instance, a patent that covers an improvement to an existing product, or a patent that covers a component implemented into a larger product. There, the Federal Circuit cautions, "the patent holder should only be compensated for the approximate incremental benefit derived from his invention."4 This is where apportionment comes in.5
Apportionment
Apportionment has its roots in Garretson v Clark, a 19th century Supreme Court case that directed "[t]he patentee, . . . must in every case give evidence tending to separate or apportion the defendant's profits and the patentee's damages between the patented feature and the unpatented features."6 That is, the patentee must show what portion of the defendant's profits is attributable to the patentee's invention. This prevents the patentee from being overcompensated for his or her contribution. As the Federal Circuit put it, the patentee must "carefully tie proof of damages to the claimed invention's footprint in the market place."7 But, as the court has recognized, this "can be an exceedingly difficult and error-prone task."8
Thus, a patentee seeking to prove damages must first consider whether apportionment is needed to avoid over-compensation. If so, then the patentee must identify the most appropriate way for apportionment to be calculated. Both considerations are discussed below.
When Is Apportionment Needed?
Typically, the Federal Circuit has stated, "[w]here small elements of multi-component products are accused of infringement, calculating a royalty on the entire product carries a considerable risk that the patentee will be improperly compensated for non-infringing components of that product."9 Thus, in these situations, "it is generallyrequired that royalties be based not on the entire product."10
Of note, apportionment may be required even when the claim does cover the entire multi-component product, if some aspects of the claim are not inventive. In AstraZeneca AB v. Apotex Corporation, for example, the Federal Circuit explained that ''[w]hen a patent covers the infringing product as a whole, and the claims recite both conventional elements and unconventional elements, the court must determine how to account for the relative value of the patentee's invention in comparison to the value of the conventional elements recited in the claim, standing alone.''11
Importantly, not every multi-component product requires apportionment. As Garretson itself acknowledged, there are cases where "the profits and damages are to be calculated on the whole machine, for the reason that the entire value of the whole machine, as a marketable article, is properly and legally attributable to the patented feature."12 That is, "when the patent-related feature" of a larger product "is the basis for customer demand," no apportionment is needed.13 This is called the entire market value rule (EMVR).
For the EMVR to apply, the patented feature must "drive[] the demand for an entire multi-component product."14 "It is not enough to merely show that [the patented feature] is viewed as valuable, important, or even essential" to the larger product, or even that, without the patented feature, the product "would be commercially unviable."15 It must be shown that "this feature alone motivates consumers to purchase" the product.16 "In the absence of such a showing, principles of apportionment apply."17
Typically, the EMVR is only appropriate where the patented and unpatented aspects of a product are physically part of the same product, but it may also apply where unpatented components are sold together with a patented component, and "derive[] their market value from the patented [component]," for instance if they "ha[ve] no useful purpose independent of the patented [component]."18 The EMVR does not extend, however, to unpatented components that are sold with a patented component "only as a matter of convenience or business advantage."19
The Federal Circuit has largely treated the EMVR as "a narrow exception to [the] general rule" that apportionment is required where the patented technology is only a portion of the product sold.20 Most often, where a multi-component product is at issue, apportionment must be used.
How Should Apportionment Be Calculated?
Where apportionment is required, the Federal Circuit has considered several techniques for its calculation.
"[W]here multi-component products are involved," the Federal Circuit has directed, "the governing rule is that the ultimate combination of royalty base and royalty rate must reflect the value attributable to the infringing features of the product, and no more."21. This per-product reasonable royalty is given by the product of the royalty base and the royalty rate. Mathematically, of course, the reasonable royalty could be apportioned by apportioning either the royalty baseor the royalty rate, and the royalty calculated would be the same.22 But some courts have not viewed these alter- natives equally on account of "an important evidentiary principle" necessary to "help our jury system reliably implement" apportionment.23 That principle is this: "[W]here a multi-component product is at issue and the patented feature is not the item which imbues the combination of the other features with value, care must be taken to avoid misleading the jury by placing undue emphasis on the value of the entire product."24
The jury may be misled because sharing the revenue garnered by the entire product "cannot help but skew the damages horizon for the jury, regardless of the contribution of the patented component to this revenue."25 Once a jury has heard "such overall revenues, which have no demonstrated correlation to the value of the patented feature alone, . . . a patentee's proffered damages amount appear[s] modest by comparison," leading the jury to "artificially inflate [their] damages calculation."26
Thus, apportionment through the royalty base is often used rather than apportionment through the royalty rate. But this approach is not absolute: In Exmark Mfg. Co. v. Briggs & Stratton Power Products, the Federal Circuit approved of a damages analysis that apportioned the royalty rate, instead of the royalty base.27 Exmark's patent covered only a component of a lawn mower, but Exmark's damages analysis used the entire mower as the royalty base. The court saw no issue, stating "[w]e hold that such apportionment can be done in this case through a thorough and reliable analysis to apportion the royalty rate."28 In particular, the court recommended "a proper analysis of the Georgia-Pacific factors," which "takes account of the importance of the inventive contribution in determining the royalty rate that would have emerged from the hypothetical negotiation."29 Using the entire mower as the royalty base, the court added, "is consistent with the realities of a hypothetical negotiation and accurately reflects the real-world bargaining that occurs, particularly in licensing."30
Thus, the court has at times allowed that "[t]here is nothing inherently wrong with using the market value of the entire product, especially when there is no established market value for the infringing component or feature," so long as the royalty rate is apportioned to "account[] for the portion of the base represented by the infring- ing component or feature."31 Often though, "courts must insist on a more realistic starting point for the royalty calculations," namely, an apportioned royalty base.32
Estimating the Royalty Base
How is the royalty base to be apportioned then? According to the Federal Circuit, "where multi-component products are accused of infringement, the royalty base should not be larger than the smallest salable unit embodying the patented invention."33 In LaserDynamics, Inc. v. Quanta Computer, Inc., for example, the Federal Circuit insisted that the royalty base be tied to an "opticaldisk drive" as claimed, rather than the laptops sold containing them.
As the Federal Circuit has pointed out, though, it would be wrong to assume "that when the smallest salable unit is used as the royalty base, there is necessarily no further constraint on the selection of the base."34 There are situations where even the smallest salable unit lacks a "close relation to the claimed invention," such that "the small- est salable patent-practicing unit is simply a step toward meeting the requirement of apportionment."35 Where the smallest salable unit is itself a multi-component product containing patented and unpatented features alike, further apportionment is required, lest "the entire mar- ket value exception . . . swallow the rule of apportionment."36 Thus, "the patentee must estimate what portion of that smallest salable unit is attributable to the patented technology."37
Estimating the Royalty Rate
As discussed above, the aim of the "hypothetical negotiation approach" is "to ascertain the royalty upon which the parties would have agreed had they successfully negotiated an agreement just before the infringement began."38 Put differently, "reasonable royalty damages are not calculated in a vacuum without consideration of the infringement being redressed."39 Estimation of the royalty rate must consider circumstances impacting the negotiation, from "the time infringement occurred" to whether components of the accused product are covered by other patents of the patentee.40
Any number of approaches exist to estimate a royalty rate. Perhaps the best known is the Georgia-Pacific41 factors, which invite consideration of circumstances that would impact the reasonable royalty in a hypothetical negotiation. Of note, the Federal Circuit has cautioned that "[w]hen performing a Georgia-Pacific analysis, dam- ages experts must not only analyze the applicable factors, but also carefully tie those factors to the proposed royalty rate."42 The court recognizes that "mathematical precision is not required," but it does demand "some explanation of both why and generally to what extent the particular factor[s] impact[] the royalty calculation."43
Other approaches for estimating a royalty have been met with mixed results. Feature counting, for example, has in some instances been approved and others not.44 But "rule[s] of thumb" like the 25% Rule and the Nash Bargaining Solution have been decidedly rejected.45
Finally, the Federal Circuit has observed that comparablelicenses—which are also considered in the Georgia- Pacific analysis—"may be the most effective method of estimating the asserted patent's value."46 This is because "[w]here the licenses employed are sufficiently comparable, this method is typically reliable because the parties are constrained by the market's actual valuation of the patent."47
No matter how the royalty rate is calculated, an expert must "sufficiently tie [his or her] testimony on damages to the facts of the case."48 This is true "[r]egardless of how low the royalty rate" is.49
Conclusion
Courts are "cognizant of the difficulty that patentees may face in assigning value to a feature that may not ever have been individually sold" and are, accordingly, accepting of "some degree of approximation and uncertainty."50 And, in any case, "there may be more than one reliable method for estimating a reasonable royalty."51 But patentees should remember that the Federal Circuit has directed courts to be "proactive to ensure that the [damages] testimony presented—using whatever methodology—is sufficiently reliable to support a damages award."52
Footnotes
2. VirnetX, v. Cisco Sys., 767 F.3d 1308, 1326 (Fed. Cir. 2014) (quotingLucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301, 1324 (Fed. Cir. 2009)).
3. Applied Research Corp. v. U.S. Surgical Corp., 435 F.3d 1356, 1361 (Fed. Cir. 2006).
4. Ericsson, v. D-Link Systems, Inc., 773 F.3d 1201, 1233 (Fed. Cir. 2014).
5. While this article focuses on the role of apportionment in a reasonable royalty analysis, the Federal Circuit has recognized that apportionment is necessary when damages are calculated using a lost profits analysis as Mentor Graphics Corp. v. EVE-USA, Inc., 851 F.3d 1275, 1287 (Fed. Cir. 2016).
6. Garretson Clark, 111 U.S. 120, 121 (1884).
7. Virnetx, 767 3d at 1327.
8. LaserDynamics, v. Quanta Computer, Inc., 694 F.3d 51, 66 (Fed. Cir. 2012).
9. Id. at 67-68.
10. Id. at 67.
11. AstraZeneca AB v. Apotex Corp., 782 F.3d 1324, 1338 (Fed. Cir. 2015). But see Exmark Co. v. Briggs & Stratton Power Prods., 879 F.3d 1332, 1348 (Fed. Cir. 2018) ("Using the accused lawn mower sales as the royalty base is particularly appropriate in this case because the asserted claim is, in fact, directed to the lawn mower as a whole There is no unpatented or non-infringing feature of the product.").
12. Garretson, 111 S. at 121.
13. Rite-Hite v. Kelley Co., Inc., 56 F.3d 1538, 1549 (Fed. Cir. 1995).
14. LaserDynamics, 694 3d at 67.
15. Id. at 68.
16. Id. at 69. See also Lucent, 580 F.3d at 1336 (asking whether "the feature patented constitutes the basis for customer demand.").
17. VirnetX, 767 3d at 1326.
18. Rite-Hite, 56 F.3d at 1549-50 (discussing Paper Converting Machine Co. v. Magna-Graphics Corp., 745 F.2d 11, 23 (Fed. Cir. 1984)).
19. Id. at 1550.
20. LaserDynamics, 694 3d at 67. See also VirnetX, 767 F.3d at 1326 ("[W]hen claims are drawn to an individual component of a multi-component product, it is the exception, not the rule, that damages may be based upon the value of the multicomponent product.").
21. Ericsson, 773 3d at 1226.
22. Id. ("Logically, an economist could do this [apportion the reasonable roy- alty] in various ways—by careful selection of the royalty base to reflect the value added by the patented feature, where that differentiation is possible; by adjustment of the royalty rate so as to discount the value of a product's non- patented features; or by a combination thereof.").
23. Id.
24.Id.
25. Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292, 1320 (Fed. Cir. 2011) (noting "the $19 billion cat was never put back into the bag").
26. LaserDynamics, 694 F.3d at 68. See also VirnetX, 767 F.3d at 1333 ("[A] patentee may not balance out an unreasonably high royalty base simply by asserting a low enough royalty rate. Although the result of that equationwould be mathematically sound if properly applied by the jury, there is concern that the high royalty base would cause the jury to deviate upward from the proper "); Ericsson, 773 F.3d at 1226-27 ("It is not that an appropriately apportioned royalty award could never be fashioned by starting with the entire market value of a multi-component product—by, for instance, dramatically reducing the royalty rate to be applied in those cases—it is that reliance on the entire market value might mislead the jury, who may be less equipped to understand the extent to which the royalty rate would need to do the work in such instances.").
27. Exmark, 879 3d at 1348.
28. Id.
29. Id. at 1348–49 (quoting AstraZeneca AB v. Apotex Corp., 782 F.3d 1324, 1338 (Fed. Cir. 2015)).
30. Id. at 1349.
31. Lucent, 580 3d at 1325.
32. Ericsson, 773 3d at 1226.
33. Power Integrations Fairchild Semiconductor, 904 F.3d 965, 977 (Fed. Cir. 2018). But see CSIRO v. Cisco Systems, Inc., 809 F.3d 1295, 1303 (Fed. Cir. 2015) ("The rule Cisco advances—which would require all damages models to begin with the smallest salable patent-practicing unit—is untenable.").
34. VirnetX, 767 3d at 1327.
35. Id.
36. Id. at 1327–28.
37. Power Integrations, 904 3d at 977.
38. VirnetX, 767 3d at 1326 (quoting Lucent, 580 F.3d at 1324.
39. Applied Res. v. U.S. Surgical, 435 F.3d 1356, 1361 (Fed. Cir. 2006).
40. Id. (requiring separate damages analyses for separate instances of infringe- ment); Exmark, 879 F.3d at 1350 ("We are skeptical that other patented com- ponents of [the product] bear no relation to the overall value of the [product], which would influence the relative value of the patented [component] and thus the royalty rate.").
41. Georgia-Pacific v. U.S. Plywood Corp., 318 F. Supp. 1116, 1120 (S.D.N.Y. 1970).
42. Exmark, 879 3d at 1350.
43. Whitserve, LLC Comput. Packages, In., 694 F.3d 10, 31 (Fed. Cir. 2012).
44. See, e.g., Finjan, Inc. v. Blue Coat Sys., 879 F.3d 1299, 1311 (Fed. Cir. 2018) (approving of apportionment based on counted "functional block" features). But see Eidos Display, LLC Chi Mei Innolux Corp., No. 6:11-CV-00201- JRG, 2017 U.S. Dist. LEXIS 52641, at *19–20 (E.D .Tex. Mar. 29, 2017) (rejecting apportionment based on counted "manufacturing steps").
45. Uniloc, 632 F.3d at 1312-18 (rejecting the assumption that, in a hypotheti- cal negotiation, the parties' starting point would be a royalty rate of 25%); VirnetX, 767 3d at 1331–33 (rejecting the assumption, posited by economist John Nash, that, in a hypothetical negotiation, the parties' would reach a royalty rate of 50%).
46. CSIRO, 809 3d at 1303–04.
47. Id. at 1303. For discussions of what makes a license "comparable," see, e.g., Ericsson, 773 F.3d at 1228; ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860, 870–71 (Fed. Cir. 2010); Lucent, 580 F.3d at 1327–28; LaserDynamics, 694F.3d at 77–78.
48. Exmark, 879 F.3d at 1349 (quoting Uniloc, 632 F.3d at 1315 (alteration in original)).
49. Id. at 1350.
50. VirnetX, 767 3d at 1328. See also Summit 6, LLC v. Samsung Elecs. Co., 802 F.3d 1283, 1296 (Fed. Cir. 2015) ("[E]stimating a reasonable royalty is not an exact science.").
51. Apple v. Motorola, Inc., 757 F.3d 1286, 1315 (Fed. Cir. 2014), overruled on other grounds by Williamson v. Citrix Online, LLC, 792 F.3d 1339 (Fed. Cir. 2015).
52. Commonwealth & Indus. Res. Org. v. Cisco Sys., 809 F.3d 1295, 1301 (Fed. Cir. 2015). See also VirnetX, 767 F.3d at 1328 (directing courts to exercise "gatekeeping authority to ensure that only theories comporting with settled principles of apportionment were allowed to reach the jury").
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