Yesterday, in Virnetx, Inc. v. Cisco Systems, No. 2013-1489, the Federal Circuit ruled that an expert’s damages testimony was not admissible. The court’s ruling provides guidance on underlying circumstances required to establish a royalty base and a royalty rate as well as questions the viability of using the Nash Bargaining Solution’s 50/50 split of profits between the patent owner and infringer as a starting point to establish a reasonable royalty.
The patents concern technology for providing security over networks, such as the Internet. Patent owner VirnetX accused Apple of infringing two patents based on the “FaceTime” feature provided on Apple’s iPhone, iPod, iPad and Mac computers. VirnetX accused Apple of infringing two other patents based on its “VPN On Demand” feature in the iPhone, iPad and iPod Touch. A jury returned a verdict that all asserted claims were valid and infringed, and awarded about $368 million reasonable royalty damages.
During the trial, the patent owner’s damages expert presented three reasonable royalty theories.
- First Theory. His first theory applied a 1% royalty to the lowest sale price of each accused device to arrive at $708 million royalty. The 1% amount was based on the patent owner’s “policy of seeking to license its patents for at least 1-2% of the entire value of products sold” as well as allegedly comparable licenses.
- Second Theory. His second theory was applied to FaceTime products using the Nash Bargaining Solution to start at a 50/50 split of profits between the patent owner and accused infringer and then using factors to modify that approach to give the patent owner 45% of the profit. This led to a $588 million royalty.
- Third Theory. His third theory also applied the Nash Bargaining Solution against FaceTime products, but claimed that FaceTime “drove sales” of Apple’s iOS products based on a customer survey asserting that 18% of those sales would not have occurred without the addition of FaceTime to the device. Using the same Nash 50/50 split of profits starting point, the expert attributed 45% of the profits to the patent owner yielding $5.13 per unit royalty that totaled $606 million royalty.
The Federal Circuit started by explaining that, “[n]o matter what the form of the royalty, a patentee must take care to seek only those damages attributable to the infringing features.” The court instructed that apportionment generally applied for claims drawn to an individual component of a multi-component product:
Thus, when claims are drawn to an individual component of a multi-component product, it is the exception, not the rule, that damages may be based upon the value of the multi-component product. Indeed, we recently reaffirmed that “[a] patentee may assess damages based on the entire market value of the accused product only where the patented feature creates the basis for customer demand or substantially creates the value of the component parts.” In the absence of such a showing, principles of apportionment apply.
These strict requirements limiting the entire market value exception ensure that a reasonably royalty “does not overreach and encompass components not covered by the patent.” Thus, “[i]t is not enough to merely show that the [patented feature] is viewed as valuable, important, or even essential to the use of the [overall product].” Instead, this court has consistently held that “a reasonable royalty analysis requires a court to … carefully tie proof of damages to the claimed invention’s footprint in the market place.” Additionally, we have also cautioned against reliance on the entire market value of the accused products because it “cannot help but skew the damages horizon from the jury, regardless of the contribution of the patented component to this revenue.”
Jury Instructions on Entire Unit as Royalty Base. In this case, the Federal Circuit took issue with the jury instruction that, “[i]n determining a royalty base, you should not use the value of the entire apparatus or product unless either: … (2) the product in question constitutes the smallest saleable unit containing the patented feature.” This instruction was wrong because it “mistakenly suggests that when the smallest salable unit is used as the royalty base, there is necessarily no further constraint on the selection of the base.” The smallest salable patent-practicing unit is a “step toward meeting the requirement of apportionment”, but more apportioning is required if such a unit is a multi-component product:
Where the smallest salable unit is, in fact, a multi-component product containing several non-infringing features with no relation to the patented feature (as [patent owner] VirnetX claims it was here), the patentee must do more to estimate what portion of the value of that product is attributable to the patented technology.
Expert’s First Approach. The Federal Circuit agreed that the patent owner’s expert’s testimony should have been excluded because it “relied on the entire market value of Apple’s products without demonstrating that the patented features drove the demand for those products.” In this case, the expert “did not even attempt to substract any other unpatented elements from the base, which therefore included various features indisputably not claimed by VirnetX, e.g., touchscreen, camera, processor, speaker, and microphone, to name but a few.” Where the patented feature does not drive demand for the product, apportionment is required regardless whether the patented feature is “viewed as valuable, important, or even essential,” the Federal Circuit stating:
[A] patentee must be reasonable (though may be approximate) when seeking to identify a patent-practicing unit, tangible or intangible, with a close relation to the patented feature. In the end, [patent owner] VirnetX should have identified a patent-practicing feature with a sufficiently close relation to the claimed functionality. The law requires patentees to apportion the royalty down to a reasonable estimate of the value of its claimed technology, or else establish that its patented technology drove demand for the entire product. VirnetX did neither.
The expert’s testimony should have been excluded here, because he “did not even try to link demand for the accused device to the patented feature, and failed to apportion value between the patented features and the vast number of non-patented features contained in the accused products.”
The Federal Circuit, however, did not find error in admitting the 1% royalty rate portion of the expert’s testimony based on comparable licenses. In this case, four of the alleged comparable licenses related to the actual patents-in-suit, the others were drawn to related technology and “all of the other differences that Apple complains of were presented to the jury”:
[T]hough there were undoubtedly differences between the licenses at issue and the circumstances of the hypothetical negotiation, “[t]he jury was entitled to hear the expert testimony and decide for itself what to accept or reject.”
Expert’s Nash Bargaining Solution Theories. The Federal Circuit agreed that the expert’s using the Nash Bargaining Solution 50/50 split as a starting point was akin to the rejected “25 percent rule of thumb” and could not be relied upon “without sufficiently establishing that the premises of the theorem actually apply to the facts of the case at hand”:
The Nash theorem arrives at a result that follows from a certain set of premises. It itself asserts nothing about what situations in the real world fit those premises. Anyone seeking to invoke the theorem as applicable to a particular situation must establish that fit, because the 50/50 profit-split result is proven by the theorem only on those premises. [Patent owner's expert] did not do so.
The key problem here was starting with the 50/50 split with no basis to do so in this case and then trying to adjust it based on the circumstances of the case, which high starting point could skew a jury’s verdict:
[E]ven if an expert could identify all of the factors that would cause negotiating parties to deviate from the 50/50 baseline in a particular case, the use of this methodology would nevertheless run the significant risk of inappropriately skewing the jury’s verdict. This same concern underlies our rule that a patentee may not balance out an unreasonably high royalty base simply by asserting a low enough royalty rate. … [H]ere, the use of a 50/50 starting point–itself unjustified by evidence about the particular facts–provides a baseline from which juries might hesitate to stray, even if the evidence supported a radically different split.
In sum, the expert’s failure to first establish the required premises of the Nash Bargaining Solution are met in this case to justify starting with a 50/50 split rendered that testimony inadmissible even though the expert attempted to adjust that 50/50 split it started with based on the circumstances of the case.