The remedy of lost profits has always seemed to me to be, conceptually, the simplest of the various damages remedies. You calculate how many infringing sales the infringer made; estimate how many of these infringing sales the patentee would have made, but for the infringement (a number which could range from “zero” to “all”); and you calculate the profit the patentee would have earned on those lost sales. To be sure, there are both underlying policy issues and difficult practical issues surrounding this simple concept. From a policy perspective, a recovery of lost profits (coupled with a reasonable royalty on infringing sales the patentee would not have made, but for the infringement) is intended to render the patentee no worse off as a result of the infringement, and therefore to preserve the patent incentive. I generally think this is a sound policy, though reasonable minds may differ–for example, see Ted Sichelman’s interesting paper in a forthcoming issue of the Texas Law Review (to which I will be contributing a response in the review’s online supplement), or Norman Siebrasse’s thoughtful argument that deterrence sometimes should play a greater, or at least somewhat different, role than my work advocates (a point to which I hope to respond in a forthcoming post). And there certainly are a number of practical difficulties, as there are with any damages remedy; there are inevitably tradeoffs between accuracy and administrative efficiency. One of these difficulties involves the accurate calculation of the number of sales the patentee would have made, but for the infringement. This requires one to determine, among other things, what the infringer would have done if it had not infringed. Resolving this issue, in turn, requires an inquiry into the next-best noninfringing alternative. Suppose, for example, that the infringer made 100 sales with the use of patented invention A; and that it could have substituted nonpatented invention B for patented invention A, but in doing so would have lost 10 sales to the patentee. In other words, 90 consumers were indifferent between A and B, but the 10 who preferred A to B would have purchased from the patentee, but for the infringement. The patentee should recover its lost sales on the 10 and a reasonable royalty on the other 90.
This is hardly cutting-edge economic reasoning, and it’s been part of U.S. law for a long time. One can also find application of this reasoning in French case law and, more recently, in cases from Canada. As I discuss in my book, however, the U.K. still follows an outdated nineteenth century precedent holding that courts may not take noninfringing alternatives into account in calculating lost profits (or in awarding defendant’s profits). And Japanese courts have denied the patentee the opportunity to recover both lost profits on sales it lost to the infringer and a reasonable royalty on infringing sales it would not have made. Under these precedents, the patentee must choose one remedy over the other, even though this necessarily renders the patentee worse off than it would have been, but for the infringement.
Two recent U.S. opinions (from the Federal Circuit), both authored by Chief Judge Rader, on the topic of lost profits also raise some questions, at least in my mind. The first, Presidio Components, Inc. v. American Tech. Ceramics Corp., 702 F.3d 1351 (Fed. Cir. 2012), was a case in which the patentee apparently thought it was selling a product that embodied its patent, but (as it turned out) it wasn’t: it was selling a product that was not covered by the patent in suit. The defendant’s infringing product competed with the patentee’s unpatented product, and the defendant’s infringing sales caused the patentee to lose sales on its unpatented product. The court affirmed an award of lost profits on those lost sales. The principle that the patentee can recover lost profits on sales of unpatented goods that compete with infringing goods was established in Rite-Hite Corp. v. Kelley Co., 56 F.3d 1538 (Fed. Cir. 1995) (en banc). As I discuss in my book, I think the principle is probably correct, if the goal is to restore the patentee to the position it would have occupied, but for the infringement. In Rite-Hite, however, there was (according to the majority) evidence that the “unpatented” Rite-Hite products actually were covered by other patents not in suit, and thus were not noninfringing alternatives available to Kelly. In Presidio, there is nothing in the Federal Circuit opinion that indicates whether Presidio’s unpatented products were covered by some other patents or other IP rights. If not, then it seems to me that those products themselves may have incorporated noninfringing alternative technology that the defendant could have used, and thus that a lost profits recovery may not have been appropriate. Perhaps there was good reason not to consider the unpatented products as an adequate substitute technology, but I think the court should have said something about this issue.
The other, more recent opinion, is Versata Software, Inc. v. SAP America, Inc., Nos. 2012-1029, -1049 (Fed. Cir. May 1, 2013). The court wound up affirming a lost profits award of $260 million (and a reasonable royalty award of $85 million). For all I know, these numbers may be the right ones, but there are two aspects of the opinion that I find perplexing. First, the court says (slip op. pp. 14-15) that it won’t consider defendant SAP’s arguments relating to the expert’s methodology because those arguments should be resolved under Daubert (U.S. case law relating to the conditions for the the admissibility of expert testimony), and SAP didn’t appeal the Daubert ruling. But SAP did appeal from the final judgment, which should have preserved SAP’s objection to the expert’s testimony. So does the court mean to say that SAP didn’t object to the expert’s methodology at trial and therefore is precluded from raising this argument on appeal, or is there some fine point of civil procedure that I am missing here? Second, the court affirms a reasonable royalty award, even though “the district court precluded Versata’s expert from presenting a reasonable royalty analysis, and the only evidence for a royalty award came from SAP’s expert.” But Versata, the plaintiff, had the burden of proof, so why is there any reasonable royalty award at all if it failed to carry its burden? At least, I think Judge Posner would wonder about that, as evidenced by his opinion last June in Apple v. Motorola . . .