Trevor Cook, Wilmer Cutler Pickering Hale and Dorr LLP
This is an extract from the third edition of GAR’s The Guide to Damages in International Arbitration. The whole publication is available here.
European approaches to assessing damages
Although national jurisdictions in Europe have widely differing approaches to, and traditions of, assessing monetary compensation for intellectual property infringement, a basis for harmonisation now exists and is starting to emerge within the EU by virtue of Article 13 of Directive 2004/48/EC on the enforcement of intellectual property rights,and the interpretations now starting to be placed on this, by national courts in Europe and the Court of Justice of the EU. Article 13 provides:
(1) Member States shall ensure that the competent judicial authorities, on application of the injured party, order the infringer who knowingly, or with reasonable grounds to know, engaged in an infringing activity, to pay the right holder damages appropriate to the actual prejudice suffered by him/her as a result of the infringement.When the judicial authorities set the damages:(a) they shall take into account all appropriate aspects, such as the negative economic consequences, including lost profits, which the injured party has suffered, any unfair profits made by the infringer and, in appropriate cases, elements other than economic factors, such as the moral prejudice caused to the right holder by the infringement; or(b) as an alternative to (a), they may, in appropriate cases, set the damages as a lump sum on the basis of elements such as at least the amount of royalties or fees which would have been due if the infringer had requested authorisation to use the intellectual property right in question.(2) Where the infringer did not knowingly, or with reasonable grounds know, engage in infringing activity, Member States may lay down that the judicial authorities may order the recovery of profits or the payment of damages, which may be pre-established.
This provision, representing as it does a legislative compromise, and couched as much of it is in permissive, rather than prescriptive, terminology cannot be said to be entirely clear as to the relationship between these various bases of assessment. In particular, as discussed below, presenting ‘unfair profits made by the infringer’ as a type of damage suffered by the rights holder is a potential source of confusion as to whether such ‘unfair profits’ should be calculated wholly without reference to the actual damage so suffered. Unfortunately, the corresponding Recital 26 does little to assist except to make it clear, as it does in its final sentence, that the Article provides no mandate for damages (in the general sense), however assessed, to be punitive:
With a view to compensating for the prejudice suffered as a result of an infringement committed by an infringer who engaged in an activity in the knowledge, or with reasonable grounds for knowing, that it would give rise to such an infringement, the amount of damages awarded to the right holder should take account of all appropriate aspects, such as loss of earnings incurred by the right holder, or unfair profits made by the infringer and, where appropriate, any moral prejudice caused to the right holder.As an alternative, for example where it would be difficult to determine the amount of the actual prejudice suffered, the amount of the damages might be derived from elements such as the royalties or fees which would have been due if the infringer had requested authorisation to use the intellectual property right in question.The aim is not to introduce an obligation to provide for punitive damages but to allow for compensation based on an objective criterion while taking account of the expenses incurred by the right holder, such as the costs of identification and research.
Thus Article 13(1) establishes the following four bases for assessing damages where the infringer knew, or ought to have known, that it was infringing:
(i) at least the amount of royalties or fees which would have been due if the infringer had requested authorisation to use the intellectual property right in question . . .(ii) the negative economic consequences, including lost profits, which the injured party has suffered . . .(iii) any unfair profits made by the infringer . . .(iv) in appropriate cases, elements other than economic factors, such as the moral prejudice caused to the right holder by the infringement.
If Member States choose also to render innocent infringers liable for damages, Article 13(2) permits them to provide for the ‘recovery of profits’, which can only mean the same as ‘any unfair profits made by the infringer’ or, as an alternative, ‘the payment of damages, which may be pre-established’. The first three of the four bases of assessment under Article 13(1)are met in most legal systems in one context or another, and are discussed further below.
‘At least the amount of royalties or fees which would have been due if the infringer had requested authorisation to use the intellectual property right in question’
If the rights holder does not itself exploit an intellectual property right at all, or does not exploit it other than by licensing, there is no logical basis on which it can claim a loss of manufacturing or other profits from exploitation of such intellectual property and so, unless it can claim an account of the infringer’s profits or pre-established damages, it is limited to recovering royalties. Even a rights holder that does use intellectual property to protect its own sales but that is infringed may not be able to show that, but for the infringement, it would have captured all of the infringer’s sales, leaving it to recover royalties on those that it could not have captured. Although unpaid royalties can be seen as a form of lost profit under Article 13(1)(a) for an entity that licenses out its patents, royalties are expressly treated as an alternative, appropriate for innocent infringers, under Article 13(1)(b).
Much has been written and many courts have opined on how to determine an appropriate royalty rate in any given case. In Europe, the primary approach of the English and German courts has been to use the rates set out in comparable licences, to the extent that these exist and can meaningfully be compared, as a starting point for such determination. Of these the German courts have adopted the more generous approach, often applying an uplift of up to 100 per cent on a case-by-case basis to the royalty rate found in comparable licences to reflect the fact that most real-life negotiations of royalty rates, unlike those notional negotiations envisaged by the courts after a finding of liability, concern rights that have not yet been held to be either valid or infringed by the activity in question. Such an ‘infringer surcharge’ should, however, be distinguished from a specific ‘infringer supplement’ applied on a flat-rate basis in every case, which would probably constitute a penalty. English courts also recognise as an alternative where there is no satisfactory comparable licence, the ‘profits available’ approach, involving an assessment of the profits that would be available to the licensee, absent a licence, and apportioning them between the licensor and the licensee.
‘The negative economic consequences, including lost profits, which the injured party has suffered’
A convenient, and it is suggested uncontroversial, set of principles for assessing the lost profits suffered by a rights holder that exploits an intellectual property right that has been found to have been infringed were set out in Ultraframe (UK) Ltd v. Eurocell Building Products Ltd,a decision of the English Patents Court:
(i) Damages are compensatory. The general rule is that the measure of damages is to be, as far as possible, that sum of money that will put the claimant in the same position as he would have been in if he had not sustained the wrong.(ii) The claimant can recover loss which was (i) foreseeable, (ii) caused by the wrong, and (iii) not excluded from recovery by public or social policy. It is not enough that the loss would not have occurred but for the tort. The tort must be, as a matter of common sense, a cause of the loss.(iii) The burden of proof rests on the claimant. Damages are to be assessed liberally. But the object is to compensate the claimant and not to punish the defendant.(iv) It is irrelevant that the defendant could have competed lawfully.(v) Where a claimant has exploited his patent by manufacture and sale he can claim (a) lost profit on sales by the defendant that he would have made otherwise; (b) lost profit on his own sales to the extent that he was forced by the infringement to reduce his own price; and (c) a reasonable royalty on sales by the defendant which he would not have made.(vi) As to lost sales, the court should form a general view as to what proportion of the defendant’s sales the claimant would have made.(vii) The assessment of damages for lost profits should take into account the fact that the lost sales are of ‘extra production’ and that only certain specific extra costs (marginal costs) have been incurred in making the additional sales. Nevertheless, in practice costs go up and so it may be appropriate to temper the approach somewhat in making the assessment.(viii) The reasonable royalty is to be assessed as the royalty that a willing licensor and a willing licensee would have agreed. Where there are truly comparable licences in the relevant field these are the most useful guidance for the court as to the reasonable royalty. Another approach is the profits available approach. This involves an assessment of the profits that would be available to the licensee, absent a licence, and apportioning them between the licensor and the licensee.(ix) Where damages are difficult to assess with precision, the court should make the best estimate it can, having regard to all the circumstances of the case and dealing with the matter broadly, with common sense and fairness.
The application of the first two of these principles has allowed a patentee to recover damages that exceed its turnover in the articles that actually infringe, by taking account of foreseeable consequences, such as loss of sales of spare parts and of servicing contracts, even after patent expiry. The sixth principle is especially applicable in the not uncommon situation of a market in which there are other competitors, when an assessment of the patentee’s sales prospects absent the infringement has to be made.
As already observed, the obscure drafting of Article 13 of the enforcement Directive invites the question of what, if any, relationship exists between the lost profits that the injured party has suffered and the ‘unfair profits’ made by the infringer. Thus, although ‘negative economic consequences, including lost profits which the injured party has suffered’ are clearly a type of ‘damages appropriate to the actual prejudice suffered by [the right holder] as a result of the infringement’, it is less easy to see how, as a matter of logic, ‘unfair profits made by the infringer’ can properly be so characterised. Article 13(1)(a) appears to treat both lost profits and ‘unfair profits’ in the same way, while saying nothing about the relationship between them. Are they alternatives, or should they both be taken into account, and if so which one predominates? To conflate the two concepts, as does Article 13(1)(a), and to characterise a remedy for unjust enrichment as another type of damage suffered by the right holder, rather than as a separate and alternative basis for securing recompense from the infringer, is a recipe for confusion, as has indeed proved to be the case in practice. Thus, in its 2010 review of the national implementation of the enforcement Directive, the Commission commented in the Report that accompanied the Staff Working Paper that:
The main aim of awarding damages is to place the right holders in the same situation as they would have been in, in the absence of the infringement. Nowadays, however, infringers’ profits (unjust enrichment) often appear to be substantially higher than the actual damage incurred by the right holder. In such cases, it could be considered whether the courts should have the power to grant damages commensurate with the infringer’s unjust enrichment, even if they exceed the actual damage incurred by the right holder. Equally, there could be a case for making greater use of the possibility to award damages for other economic consequences and moral damages.
The Commission in its Staff Working Document recognised that the recovery of profits unlawfully made by an infringer was a new concept in many EU Member States and that in this respect Article 13 was being implemented in a variety of different ways, some of which effectively capped such an assessment at the level of damage suffered by the rightholder, which would render any assessment of the profits made by the infringer pointless. However, even without involving the Court of Justice, national courts of different EU Member States have moved towards accepting that these two bases for assessment should be regarded as alternatives, with neither having any bearing on the other.
This approach has been adopted by the English and German courts (which have long been able to provide for recovery on this basis) in assessing the profits to be recovered from those who infringe trademarks by selling repackaged goods parallel imported from elsewhere in the EU without complying with the requirements for so doing as established by the Court of Justice. The English Court of Appeal, reversing the judge at first instance but consistent with a decision of the German Federal Supreme Court in a similar case, held that the damage caused to the trademark proprietor by the infringement had no bearing on a recovery based on determining the infringer’s profits. In France, a decision of the Paris Court of Appeal in 1963 having excluded the possibility of claiming the profits of a patent infringer, the law was then changed expressly to permit it as a result of the enforcement Directive. However, there initially was controversy as to quite how the profits made by the infringer should be determined, and whether or not the loss actually suffered by the infringer was of any relevance in making such assessment. Subsequent cases have, however, shown the French courts, when assessing the level of financial recovery on the basis of the profits of the infringer, doing so without any reference to the actual loss suffered by the patentee.
As recovering the infringer’s profits becomes a more popular approach, the courts are starting to clarify some of the issues that it raises, such as how to apportion profits in patent cases where the infringing process is part of a larger one or the infringing goods do not correspond to the inventive concept underlying the patent that has been held to be infringed, and the extent to which the infringer’s overheads may be deducted.
Constraints on enforcement of certain types of award as penalties
As discussed above, one important advantage of arbitrating international intellectual property disputes is that the parties can specify in their arbitration agreement a particular approach to the calculation of damages. Whatever approach the arbitral tribunal takes to the assessment of damages it should be mindful of the issue of enforceability under Article V(2)(b) of the New York Convention, under which enforcement of an arbitral award can be refused if the recognition or enforcement of the award would be contrary to the public policy of the country in which enforcement is sought. There is thus a concern that the enforcement of an award that can be characterised as a penalty, for example, because it is for pre-established, or ‘statutory’, damages, out of all proportion to the scale of the infringement, or it has been enhanced on grounds of ‘wilful’ infringement, may not be enforced in a country that does not allow for penal awards of damages, even if the award is in accordance with the applicable law as chosen by the parties. While such a concern is real and should be addressed, one should perhaps not overstate it, as in practice, certain jurisdictions that have a ‘rule’ against penalties have not necessarily, at least in relation to contractual penalties, been prepared to characterise it as a rule that is so fundamental as to constitute ‘public policy’ for the purposes of Article V(2)(b) of the New York Convention.
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