In the recent Federal Court decision of Jay-Lor International Inc. and Jay-Lor Fabricating Inc. v. Penta Farm Systems Ltd. and Penta One Limited (2007 FC 358) the Federal Court, for the first time, calculated damages pursuant to subsection 55(2) of the Patent Act (the Act).

The Court had found the two Penta entities (referred to collectively herein as Penta Farm) liable for infringing the patent currently owned by Jay-Lor International. A patent owner whose patent has been infringed may elect, as a remedy, either an accounting of profits or an award in damages. In this case, Jay-Lor International elected an award of damages.

In calculating damages, there are two periods that must be considered. First, pursuant to subsection 55(1) of the Act, the defendant is liable to the patent owner for all damages sustained after the grant of the patent, by reason of the patent being infringed. Secondly, pursuant to subsection 55(2) of the Act, the defendant is liable to the patent owner to pay "reasonable compensation" for any damages sustained by the patent owner prior to the grant of the patent and after the patent is laid open for public inspection (i.e. published).

What constitutes "reasonable compensation" under s. 55(2) has only been discussed once before, in Baker Petrolite Corp. v. Canwell Enviro-Industries Ltd., (2002), 13 C.P.R. (4th) 193. In that decision, the Federal Court described reasonable compensation as being in the nature of a reasonable royalty, the onus being on the party claiming to prove what a reasonable royalty would be. In this decision, the Federal Court was, for the first time, called upon to calculate reasonable compensation pursuant to s. 55(2).

The Court rejected Jay-Lor International’s assertion that "reasonable compensation" should be determined in the same way that damages are determined for the period after a patent is issued. In the Court’s view, such an approach is not warranted in view of the different language used in ss. 55(1) and 55(2). Subsection 55(1) provides that "a person who infringes a patent is liable…for all damages sustained by the patentee," while s. 55(2) provides that a person is liable to pay "reasonable compensation…for all damages sustained by the patentee" during the laid-open period. Parliament could have provided for the same assessment of damages for each period, but it did not.

Therefore, the Court held that "reasonable compensation" must be something other than damages as contemplated by s. 55(1). The Court acknowledged that there may be other means to provide reasonable compensation beyond a royalty. However, the parties presented no other alternatives; therefore, the Court decided to equate "reasonable compensation" with a "reasonable royalty."

The Court noted that a reasonable royalty rate has been previously described as "that which the infringer would have had to pay if, instead of infringing the Patent, [the infringer] had come to be licensed under the Patent… The test is what rate would result from negotiations between a willing licensor and a willing licensee." (AlliedSignal Inc. v. Du Pont Canada Inc. (1998), 78 C.P.R. (3d) 129).

Jay-Lor International presented the Court with an expert on the question of determining a reasonable royalty in the context of damages for a patent infringement action. This expert put forward three different methodologies for calculating a reasonable royalty rate: the AlliedSignal approach, the analytical approach, and the anticipated profits approach. Each approach applies the notion of hypothetical negotiations between a willing licensor and a willing licensee.

The Court concluded that the anticipated profits approach was the methodology that would lead to the best "judicial estimation" of a reasonable royalty. Using this methodology, Penta Farm would negotiate a reasonable royalty by estimating its anticipated profits arising from the sale of the patented invention and then paying a portion of those profits to the Plaintiffs.

The first step was to assess, as a percentage, what Penta Farm would have anticipated as a profit once it began selling the patented invention. The key to the anticipated profits approach is an estimate of the anticipated economic benefit in the hands of the licensee. The Court found that Penta Farm would have anticipated a net profit of 20% from sales of product featuring the patented technology.

The second step was to determine what portion of the profits would be paid to the patent holder. In this case, the expert witnesses agreed that an appropriate royalty would be in the range of 25% to 33.3%. The Court then considered whether the thirteen factors set out in the AlliedSignal decision would tend to increase or decrease the royalty within that range; the Court arrived at a royalty of 30%.

The final step was to multiply the anticipated profit (20%) by the royalty rate (30%), to arrive at the reasonable royalty rate; in this case, a rate of 6% of Penta Farm’s sales. The Court went on to add 1% based on Penta Farm’s anticipated penetration into the market through the use of the Plaintiffs’ successful patented technology, and the upside potential of being both a manufacturer and a dealer. Therefore, the Court concluded that a reasonable royalty rate would be 7%.

Jay-Lor International also argued that it should be entitled to "estimated additional costs" during the laid-open period for being forced to provide competitive allowances and discounts to customers in order to avoid losing even further sales to Penta Farm. The Court declined to award these additional damages, because to do so would double-count the effect of competition between Jay-Lor International and Penta Farm, which had already been factored in to the calculation of the reasonable royalty.