The District of Arizona, in GoDaddy.com LLC v. RPost Communications Limited, Case No. CV-14-00126-PHX-JAT (Judge James A. Teilborg) (May 10, 2016), excluded the entire report of Defendant’s damages expert, Gregory Smith, but allowed a do-over.
Plaintiff GoDaddy moved to exclude Smith’s testimony under FRE 702, asserting two grounds: (1) Smith inappropriately accounted for non-infringing features in his royalty rate analysis rather than apportioning the royalty base, and (2) because Smith used the entire revenue of the accused product as the royalty base, he necessarily applied the entire market value rule (“EMVR”) but failed to demonstrate that the patented features form the basis of consumer demand. Defendant RPost denied that Smith applied the EMVR, arguing that the accused products were the smallest saleable unit (“SSU”), and the Federal Circuit has never defined a particular formula for apportioning damages for SSUs. Smith used the operating margin of the accused products and apportioned the royalty rate instead of the royalty base.
The court’s exclusion of Smith’s report was not based on his use of the entire product revenue as the base, but on his failure to adjust the rate to allow for proper apportionment. The court based its analysis on the following dicta from Ericsson, Inc. v. D-Link Sys., Inc., 773 F.3d 1201, 1226-27 (Fed. Cir. 2014), regarding the interplay between the royalty base and royalty rate in apportionment:
Logically, an economist could do this 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. The essential requirement is that the ultimate reasonable royalty award must be based on the incremental value that the patented invention adds to the end product.
It seems that this dicta, however, was only intended to illustrate how a proper royalty can be constructed. Ericsson appeared to acknowledge that flexing the base and rate had been previously rejected in LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51, 67, 68 (Fed. Cir. 2012), and Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292, 1320 (Fed. Cir. 2011)). Ericsson stated:
…where 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. 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.
773 F.3d at 1227 (citing LaserDynamics, 694 F.3d at 67, 68; Uniloc, 632 F.3d at 1320). Ericsson concludes this dicta with the following language addressing whether high royalty base can be offset by a low royalty rate:
Thus, where the entire value of a machine as a marketable article is "properly and legally attributable to the patented feature," the damages owed to the patentee may be calculated by reference to that value. Where it is not, however, courts must insist on a more realistic starting point for the royalty calculations by juries—often, the smallest salable unit and, at times, even less.
Ericsson, 773 F.3d at 1227 (citing VirnetX, Inc. v. Cisco Systems, Inc., 767 F.3d 1308, 1327-28 (Fed. Cir. 2014)). Thus Ericsson appears to be consistent with LaserDynamics and Uniloc in terms of the conclusion that entire product value may mislead a jury. However, Ericsson seems to leave the door open to flexing the rate and base by stating: “courts must insist on a more realistic starting point for the royalty calculations by juries—often, the smallest salable unit and, at times, even less.” 773 F.3d at 1227 (emphasis added).
The district court in GoDadday appeared to adopt these suggestions by Ericsson. The court denied the motion to exclude the plaintiff’s expert strictly on the ground that the base was not apportioned. It is not a stretch to think that other courts will similarly interpret Ericsson.
Ultimately, however, the district court achieved the same result as Ericsson, LaserDynamics and Uniloc—i.e., exclusion—albeit through a different reasoning process. The district court found that Smith was obligated, but failed, to determine the patented technology’s value relative to all other components in the accused products through his rate calculations. Smith’s opinions concerned two groups of patents: the Feldbau patent and the Tomkow patents. The court found that Smith’s conclusions as to both were plagued by the same problems.
For the Feldbau patent, Smith concluded that GoDaddy would have agreed to a 2.5% running royalty of the accused products’ net revenues based on the following reasoning: the accused product was the SSU; 10% of GoDaddy’s profits for the products were attributable to the Feldbau patent; and RPost had previously rejected a licensing offer from Authentix that included a royalty rate of 5% increasing to 8% of “total revenues” derived from the Feldbau patent’s technology, and thus the 2.5% rate—half of 5%—was proper.
The court found that Smith did not have even the permissible level of “shaky” evidence to support his opinions that the accused products were in fact the SSU (in fact, Smith even acknowledged that there were several features that drove consumer demand); that 10% of GoDaddy’s profits for the products were attributable to the Feldbau patent; or that the offer with the 5% rate was sufficiently similar to be relevant. Interestingly, the court did not take an issue, as some other courts have, with the licensing offer to operate being used as comparable for setting a reasonable royalty rate. Instead, the court found that the offer was not comparable because it concerned a royalty based on revenues generated only by the patented technology. In contrast, the Feldbau patent’s technology was not the accused products’ only feature. The court found the above errors to be “foundational.” Slip op. at 12.
For the Tomkow patents, Smith concluded that GoDaddy would have entered into a license with a 15% royalty of the accused products’ net revenues. He again treated the accused products as the SSU. Unlike for the Feldbau patent, Smith did not attempt to apportion the accused products’ operating margin but simply used 15% of the accused products’ net revenue. The 15% rate was based on the parties’ market penetration rates, prices, and Smith’s conclusion that e-mail marketing programs are comprised of four main elements and the Tomkow patents constituted the “core” of one element.
Here, again, the court found Smith failed to provide any evidence showing that the accused products are the SSU. In fact, GoDaddy presented a survey showing that other features of the accused products drove consumer demand. But the court found the most problematic Smith’s failure to explain how his 15% royalty rate adequately ensured that he could properly calculate damages based on the entire product revenue. He did not even mention in his report that he apportioned for any non-infringing features and thus, the court found, “it appears that Mr. Smith plucked 15% out of thin air.” Slip op. at 16.
Having excluded the entire report, “in consideration of RPost’s due process rights and because RPost would be left without any real evidence of damages at trial,” the court allowed it one more opportunity to offer a new report. GoDaddy was allowed to depose Smith again and update its own damages report.