First published in LES Insights

Abstract

A California court recently excluded from trial certain testimony of a patent owner's damages expert because his reasonable-royalty calculations relied on a different court's damages award in an earlier case and the value of a prior litigation-settlement agreement. The patent owner argued that its expert properly looked to those events in calculating reasonable royalties, because each of them involved the defendant as the accused infringer and technologies similar to the patents-in-suit. The court, however, held that the expert's reliance was improper because each of those events took place under circumstances distinct from the "hypothetical negotiation" at issue for determining reasonable-royalty damages. According to the court, the expert's failure to account for those differing circumstances rendered his reasonable-royalty calculations unreliable.

In patent-infringement litigation, plaintiffs and defendants commonly retain experts to testify about the amount of damages sufficient to compensate for infringement. Damages may take the form of a reasonable royalty, which is determined by what the parties would have agreed to had they successfully negotiated an agreement just before infringement began. Parties therefore rely on damages experts to evaluate this "hypothetical negotiation" in calculating a proposed reasonable royalty.

To be admissible, these experts' opinions must be based on reliable principles and methods—a concept often fiercely contested. For example, although the Court of Appeals for the Federal Circuit has ruled that settlement agreements can be used in certain circumstances to support a reasonable-royalty calculation, there is much debate at the district-court level over what those circumstances are. Recently, in Sentius Int'l, LLC v. Microsoft Corp.,1 the U.S. District Court for the Northern District of California excluded an expert's reasonable-royalty testimony that relied on a prior settlement license agreement and a damages award in a previous case.

Background

Sentius International, LLC sued Microsoft Corporation for infringement of reissue patents RE 40,731 and RE 43,633. Sentius alleged that certain features of applications within Microsoft's Office products, including the spell-and grammar-checking functionality and a smart-tags feature, infringed the asserted patents.

Sentius hired damages expert Robert Mills to offer his opinion on the proper amount of damages to compensate Sentius for the alleged infringement. First, Mills proposed a royalty to compensate Sentius for Microsoft's accused spell-and grammar-checking functionality. To reach this royalty, Mills relied on a damages award in an earlier infringement action between Microsoft and Alcatel-Lucent. According to Mills, it was proper to look to the Lucent case for guidance on an appropriate royalty because Sentius's technical expert concluded that the technology at issue in Lucent was similar to the asserted reissue patents.

In Lucent, the jury awarded Lucent damages of $70 million, but upon motion by Microsoft, the district court evaluated whether the jury's award was supported by the evidence, and eventually decided, as a matter of law, that damages could not exceed $26.3 million. In a settlement agreement, Microsoft ultimately agreed to pay Lucent an undisclosed amount higher than the district court's cap. In his deposition, Mills testified that he derived his reasonable-royalty rate from the district court's damages award. According to Mills, this was a conservative approach because basing the royalty on the higher amount in the settlement agreement would have led to a considerably higher royalty.

Regarding a reasonable royalty for the accused smart-tags feature, Mills relied on a litigation-settlement agreement between Arendi S.A.R.L. and Microsoft. Arendi had filed actions in the U.S. and Europe accusing Microsoft's smart-tags feature of infringing Arendi's U.S. and European patents. The parties entered into a settlement agreement in which Microsoft agreed to pay Arendi a certain amount. Mills used that amount to calculate his proposed royalty rate for Microsoft's use of the accused smart-tags feature.

Challenging Mills's methodology, Microsoft moved to exclude from trial Mills's reasonable-royalty calculations to the extent they relied on the Lucent damages award and the Arendi settlement.

The Sentius Decision

The court agreed with Microsoft that Mills's reliance on the Lucent damages award and the Arendi settlement was improper.

Turning first to the Lucent damages award, the court deemed immaterial the notion that Mills's reliance on the district court's damages analysis was a more conservative approach. According to the court, "[a] damages theory that stems from an erroneous methodology is not admissible even if it results in a low ultimate damages figure." The court then offered several reasons to explain why Mills could not use the Lucent damages award as a basis for the "hypothetical negotiation" that would have taken place between Sentius and Microsoft: 1) the district court in Lucent "did not independently assess" a reasonable royalty in the context of the requisite "hypothetical negotiation," but instead "analyzed the more limited question" of whether sufficient evidence supported the jury's $70 million award; 2) Lucentinvolved a different court, a different patentee, and a different patent; and 3) the Lucent award occurred in a timeframe different from that of the hypothetical negotiation at issue in this case.

Turning to Mills's reliance on the Arendi settlement agreement, the court generally noted that parties must be careful when attempting to establish Reasonable-royalty damages based on settlement agreements because those agreements are often made under circumstances much different from a "hypothetical negotiation." According to the court, unless experts adequately account for any differing circumstances, their opinions may be excluded as unreliable.

Here, the court found that Mills failed to adequately account for the differences between the "economic circumstances" of the parties in the Arendi settlement and those of Sentius and Microsoft in the hypothetical negotiation at issue. Specifically, the Arendi settlement involved both U.S. and European infringement claims and also included patents not asserted by Arendi, whereas in the hypothetical negotiation between Sentius and Microsoft, Sentius would have granted Microsoft rights only to the two asserted reissue patents. According to the court, "[w]ithout an accounting of the effect of the European infringement claims and the value of patents that Arendi did not assert, Mills could not meet his duty to 'account for differences in the . . . economic circumstances of the contracting parties.'" Finding Mills's methodologies unreliable, the court excluded his reasonable-royalty analysis because he relied on the Lucent dispute and the Arendisettlement.

Strategy and Conclusion

This decision teaches that while external settlement agreements are "fair game in assessing patent damages," experts should take care to use an approach that is both candid and methodologically sound. For example, the circumstances surrounding a settlement agreement should be evaluated and any technological or economic differences should be accounted for in the damages calculation.