The Federal Circuit, in Prism Tech. LLC v. Sprint Spectrum L.P., Nos. 2016-1456, 2016-1457 (Fed. Cir. March 6, 2017) (Judge Taranto authoring), issued an opinion addressing comparable license agreements and the cost savings approach for reasonable royalties. We summarize the opinion here. The section on comparable license agreements is lengthy and worth reading in full.
The technology relates to managing access to protected information provided over certain networks, which the parties agreed must be “untrusted” networks. Slip op. at 2. The representative claim quoted in the opinion recites controlling access by an authentication server to protected computer resources provided via an Internet Protocol network, and also recites an identity associated with a client computer device and in which the client computer is seeking access to protected computer resources. At issue were Sprint’s 3G, 4G LTE, and 4G WiMAX networks, and in particular their use of Ethernet backhaul network services purchased from third parties to transport data from Sprint’s base stations to its data centers at the core of the network. Slip op. at 4.
Prism had also sued AT&T on the same patents. The case was consolidated to some extent with the Sprint case, but they were tried separately. The AT&T trial proceeded first, and on the last day of the trial, just before closing arguments, AT&T and Prism settled and the case was dismissed. Sprint moved the court not to admit the AT&T settlement agreement into evidence during its trial, arguing that it was not comparable to the hypothetical license and on grounds of FRE 403. Sprint also moved to exclude the testimony of Prism’s damages expert, James Malackowski. Both motions were denied.
The jury awarded $30M in reasonable royalty damages. Sprint moved for JMOL and new trial, both of which were denied, and Sprint appealed.
Comparable license agreements
Sprint first argued that the district court abused its discretion in allowing the settlement agreement under FRE 403. Slip op. at 10. The court first made some general pronouncements that are worth quoting:
As to settlements generally, the Supreme Court has explained the normal settlement calculus for litigants: “Most defendants are unlikely to settle unless the cost of the predicted judgment, discounted by its probability, plus the transaction costs of further litigation, are greater than the cost of the settlement package.” Evans v. Jeff D., 475 U.S. 717, 734 (1986); Staton v. Boeing Co., 327 F.3d 938, 964 (9th Cir. 2003) (quoting Evans, 475 U.S. at 34). That formulation—enumerating “the cost of the predicted judgment,” “its probability,” and “costs of further litigation”— helps identify why and when a district court, conducting the inquiry required by Rule 403, can find earlier patent-suit settlements admissible in valuing a patented technology.
On one side of the Rule 403 balance is the strong connection a settlement can have to the merits of an issue common to the earlier and later suits. Specifically, a settlement involving the patented technology can be probative of the technology’s value if that value was at issue in the earlier case. The reason is simple: such a settlement can reflect the assessment by interested and adversarial parties of the range of plausible litigation outcomes on that very issue of valuation. And given the necessary premise that discovery and adversarial processes tend to move a legal inquiry toward improved answers, the parties’ agreement seems especially probative if reached after the litigation was far enough along that the issue was already well explored and well tested. See AstraZeneca, 782 F.3d at 1336–37.
On the other side of the balance, for various reasons a settlement may be pushed toward being either too low, as in Hanson, or too high, as in LaserDynamics, relative to the value of the patented technology at issue in a later suit. As to the former, for example, even if the technology is identical in the earlier and later suits, the earlier suit’s settlement figure may be too low to the extent that it was lowered by the patent owner’s discounting of value by a probability of losing on validity or infringement. As the unchallenged jury instructions in this case indicate, the hypothetical-negotiation rubric for the assessment of royalty damages assumes that the asserted patents are valid and infringed. See J.A. 23473–75; Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301, 1325 (Fed. Cir. 2009). Accordingly, whereas a settlement reached after a determination of liability (though subject to appeal) is particularly reliable as evidence of value, AstraZeneca, 782 F.3d at 1337, a settlement tends to undervalue the technology where it reflects a discount for the probability of losing. A patent owner may also accept too little, relative to the patent’s value, when it accepts an amount out of a desire to avoid further expenditure of (presumptively unrecoverable) litigation costs.
At the same time, various factors may work in the opposite direction, tending to make a settlement of an earlier suit too high as evidence on the valuation question presented in a later suit. An earlier settlement may cover technology either not the same as or comparable to the patented technology at issue in the later suit, or may cover the patented technology plus other technologies. The earlier suit may have included a risk of enhanced damages, a factor in the settling parties’ assessment of risk that would push settlement value above the value of the technology. And, of course, the litigation costs still to come at the time of settlement may loom large in parties’ decisions to settle. See Rude v. Westcott, 130 U.S. 152, 164 (1889) (“Many considerations other than the value of the improvements patented may induce the payment in such cases. The avoidance of the risk and expense of litigation will always be a potential motive for a settlement.”); LaserDynamics, 694 F.3d at 78 (discussing “desire to avoid further litigation under the circumstances,” including “the numerous harsh sanctions imposed” on the settling defendant in the earlier suit).
Slip op. at 11-13.
The court provided further guidance for litigants and courts in handling litigation settlements. The court noted that “as a logical matter, the mere filing of a complaint … does not automatically turn the prejudice side of the Rule 403 balance into one that substantially outweighs the probativeness side.” Slip op. at 14. Instead, counseled the court, it is the particulars of the settled case and the settlement agreement that should be considered in the 403 balance. Id.
Addressing the facts in the particular case, the court cited several factors that supported its decision to uphold the district court’s allowance of the AT&T agreement into evidence:
- Sprint had sought admissions of other Prism licenses that issued from litigations.
- The AT&T agreement covered the patents at issue against Sprint.
- Although the AT&T agreement also included other patents, Prism supplied evidence to address “what bearing the amounts in [the AT&T agreement] had on the value of the particular patents at issue here.” Slip op. at 15.
- Prism supplied evidence about the comparability of AT&T’s and Sprint’s use of the patents at issue.
- Prism also accounted for lesser uses made by licensees in “lower-amount Prism settlements that Sprint emphasized.” Id.
- Sprint did not show any reason—“for example, material technological or market changes between the agreed-on date for the hypothetical negotiation, in early 2012, and the signing of the [AT&T agreement], in late 2014—that required the district court to find non-comparability and thus decisively undermined the Agreement’s probative value.” Id.
- The AT&T agreement was entered into after “the entire trial was finished,” except for closings and jury deliberations. Id.
- This timing also meant that the large share of litigation costs “had already been sunk, reducing (though of course not eliminating) the role of litigation-cost avoidance in the settlement decision.” Id. at 15-16.
- Sprint had not suggested that enhanced damages were at issue by the time of settlement, and the jury instructions and verdict forms suggested they were not.
- Validity and infringement were still open, but “Sprint cannot rely on that fact: possible non-liability is a factor that tends to make settlements too low, not too high.” Id. at 16.
Sprint also made two additional arguments—both of which urged “a categorical legal rule barring admission of a patentee’s licenses entered into in a settlement of infringement litigation ….” Id. The court held that Sprint had not preserved these arguments, and in any case that they were “inconsistent with Sprint’s position before and during trial in this case.” Id. In so doing, however, the court offered some further guidance on litigation settlements.
First, the court addressed Sprint’s citation of Rude v. Westcott, 130 U.S. 152 (1889)—the seminal case on “established royalty” as a measure of damages—for the proposition that “Rude categorically bars admission of litigation settlements on the issue of a reasonable (but not ‘established’) royalty.” Slip op. at 18. The court noted that any skepticsm in Rude about “reasonable royalty” as a reliable measure of damages in the absence of an established royalty must be considered against the fact that both patent damages law and evidence law have “changed significantly since Rude.” Id. at 17. The court noted that since Rude patent damages had changed judicially and legislatively to accept reasonable royalty damages, and that federal evidence law is now embodied in the FRE and not earlier Supreme Court decisions. Id. at 18. The court concluded that “for at least those reasons, Sprint faces challenges in suggesting” that Rude bars admission of settlement agreements. But the court did not need to address the issue further since it decided that Sprint’s argument was not presented in a timely fashion.
Second, the court found Sprint to be “in essentially the same position with respect to the second source it cites for its categorical-bar contention: Federal Rule of Evidence 408.” Slip op. at 20. The court first observed that Sprint’s contention “would require decision of an issue … hardly settled in Sprint’s favor in the case law ….” Id. (see the opinion for more detail). However, Sprint had not argued Rule 408 in attempting to exclude the AT&T agreement, but only after trial, and the court concluded that was “an issue not timely raised in the district court.” Id. at 22.
Cost Savings Approach to Reasonable Royalty
Sprint’s last argument was that the district court had erred in admitting “Prism’s principal damages evidence, which was based on estimating costs that Sprint avoided by infringing.” Slip op. at 23. The court wrote:
At trial, Prism presented evidence that a reasonable royalty would reflect Sprint’s willingness, in a hypothetical negotiation, to pay an amount calculated by reference to the costs that Sprint, in order to provide its customers the kind of service it wanted to offer them, would have incurred if it had chosen not to infringe—in this case, the costs of building a private backhaul network instead of leasing backhaul services from third-party providers. Prism’s expert Mr. Malackowski estimated that Sprint’s cost savings, i.e., the difference between Sprint’s building costs and leasing costs, would be at least equal to Sprint’s leasing costs. Sprint argues that Prism’s approach was insufficiently tied to the “footprint” of the invention because Prism did not “invent” backhaul networks. Sprint also argues that Prism did not prove that Sprint’s leasing costs were an appropriate basis for estimating cost savings. We reject these challenges.
Sprint’s argument that Prism’s damages model was not sufficiently tied to the “footprint” of the invention misapprehends the relevant legal principles. The hypothetical-negotiation approach to calculating reasonable royalty damages “attempts to ascertain the royalty upon which the parties would have agreed had they successfully negotiated an agreement just before infringement began.” Lucent Techs., 580 F.3d at 1324. Although a patentee “must carefully tie proof of damages to the claimed invention’s footprint in the market place,” Uniloc, 632 F.3d at 1317 (quoting ResQNet.com, 594 F.3d at 869), that requirement for valuing the patented technology can be met if the patentee adequately shows that the defendant’s infringement allowed it to avoid taking a different, more costly course of action. A price for a hypothetical license may appropriately be based on consideration of the “costs and availability of non-infringing alternatives” and the potential infringer’s “cost savings.” Aqua Shield, 774 F.3d at 771–72; see also Hanson, 718 F.2d at 1080–81 (“Reliance upon estimated cost savings from use of the infringing product is a well-settled method of determining a reasonable royalty.”); Powell v. Home Depot, U.S.A., Inc., 663 F.3d 1221, 1240–41 (Fed. Cir. 2011); Slimfold Mfg. Co. v. Kinkead Indus., Inc., 932 F.2d 1453, 1458–59 (Fed. Cir. 1991).
Slip op. at 23-24.
The court then turned to the evidence offered by Prism and found that it “complied with those principles.” Slip op. at 24. The court noted that Prism’s experts testified that in the absence of a license Sprint would have attempted to design around by building its own backhaul network. Id. In the process, the court distinguished Riles v. Shell Exploration & Production Co., 298 F.3d 1302 (Fed. Cir. 2002). Id. at 24-25.
The court also found unavailing Sprint’s arguments that leasing costs are an unreliable basis for estimating costs savings. The court cited testimony from Mr. Malackowski that leasing costs were an appropriate basis for estimating cost savings. It also observed that Mr. Malackowski had “reasonably relied” on a technical expert’s estimate of Sprint’s cost savings, and that the technical expert had “relied on his decades of experience building and leasing backhaul infrastructure.” Slip op. at 26. Finally, the court cited Mr. Malackowski’s reliance on industry studies and Sprint testimony. From this, the court concluded that “the jury could reasonably rest its reasonable-royalty determination on the evidence presented.” Id.