Suppose an expert is determining royalty damages in a patent infringement suit for an industry significantly impacted by the COVID-19 pandemic. The parties agree the hypothetical negotiation date is pre-2020. How should the COVID-related economic impacts factor into the analysis and determination of royalty damages, if at all? While there is no clear one-size-fits-all answer to the question, two relevant considerations are 1) how is the royalty structured?, and 2) how has the expert considered the book of wisdom?

The purpose of damages is to put the plaintiff back in the economic position it would have been in but for the infringement. In a patent infringement case, the plaintiff is entitled to “damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer, together with interest and costs as fixed by the court.” 35 U.S.C. § 284. 

A reasonable royalty may be determined through consideration of a hypothetical license negotiation between a willing licensor and a willing licensee and “attempts to ascertain the royalty upon which the parties would have agreed had they successfully negotiated an agreement just before infringement began.” Lucent Techs., Inc. v Gateway, Inc., 580 F.3d 1324 (Fed. Cir. 2009). This well-established approach to estimating royalty damages is outlined in the Georgia-Pacific matter, which identifies fifteen factors for consideration in determining a reasonable royalty as of the hypothetical negotiation date. Georgia Pacific Corp. v U.S. Plywood Corp. (318 F. Supp. 1116, 166 USPQ 235 (S.D.N.Y. 1970), modified, 446 F.2d 295, 170 USPQ 369 (2d Cir. 1971), cert. denied, 404 U.S. 870 (1971)).

The hypothetical license structure is an important consideration when analyzing the effect of COVID-related economic issues. A hypothetical license with a running royalty structure, either on a per unit basis or as a percentage of revenues or profits, generally accounts for an increase or decline in the performance of the defendant’s business. Therefore, a running royalty damage construct would likely address much of the COVID-related economic impacts to sales. However, an upfront lump-sum royalty structure presents significant opportunities for debate about the royalty rate and base, as well as the discount rate to be applied in light of potential material and widespread COVID-related economic impacts post-negotiation.

The hypothetical negotiation concept – what the parties would have agreed to as a license entered into just before infringement – is generally consistent with valuation theory, where the expert focuses on information known or knowable as of the valuation date. While the hypothetical negotiation construct is well established, there is mixed guidance from the courts on the use and acceptance of post-negotiation information and the weight an expert should place on subsequent events in determining a reasonable royalty (known as the ‘book of wisdom’) and how unanticipated events, like COVID, should be considered in the hypothetical negotiation. 

The Book of Wisdom

The Supreme Court introduced the book of wisdom concept in 1933 in a breach of contract matter, Sinclair Refining Co. v Jenkins Petroleum Process Co., 289 U.S. 689 (1933). As the Supreme Court explained in Sinclair, when the trial occurs years after the breach, “[e]xperience is then available to correct uncertain prophecy. Here is a book of wisdom that courts may not neglect. We find no rule of law that sets a clasp upon its pages, and forbids us to look within.” The Federal Circuit adopted the book of wisdom concept in the hypothetical negotiation context for patent damages in Fromson v Western Litho Plate and Supply Co., 853 F.2d 1568 (Fed. Cir. 1988). Certain Georgia-Pacific factors also direct the practitioner to consider events after the date of the hypothetical negotiation, including the actual sales data and the commercial success of the infringing product or device.

As summarized below, post-Fromson cases vary in allowing post-negotiation information with opinions noting case-by-case circumstances. The varying guidance reflects the courts’ objective to put the plaintiff back in the economic position it would have been in but for the infringement and the nuances surrounding the facts and evidence in each case.

In some instances, such as the following three cases, courts have determined that post-hypothetical negotiation data and information does not supplant the information available at the time. 

Interactive Pictures Corp. v Infinite Pictures, Inc.

In this matter, sales projections were available before the negotiation date, but the defendant argued that the court should ignore the pre-negotiation sales projections. The Federal Circuit rejected the defendant’s request to remand damages because the fact that actual sales were less-than-projected sales does not imply that the projections were “grossly excessive or based only on speculation or guesswork.” The Federal Circuit allowed the jury’s damages award to stand.  Interactive Pictures Corp. v Infinite Pictures, Inc., 274 F.3d 1371, 1384 (Fed. Cir. 2001). 

Riles v Shell Exploration

In Riles v Shell Exploration, 298 F.3d at 1313 (Fed. Cir. 2002), the Federal Circuit remanded the damages back to the district court for reconsideration, stating that the reasonable royalty determination “must relate to the time infringement occurred, and not be an after-the-fact assessment.”   

Integra Lifesciences v Merck

In Integra Lifesciences v Merck, 331 F.3d at 870 (Fed. Cir. 2003), the Federal Circuit remanded after determining that the hypothetical negotiation date was not clear, among other issues. The court explained that “an earlier date [would] change the risks and expectations of the parties” and therefore, it was critical in determining what the parties would have considered at the hypothetical negotiation. Integra at 871. 

In contrast, there are other cases where courts have found that post-negotiation evidence was relevant to the hypothetical negotiation, including the following two cases. 

Honeywell Intern v Hamilton Sundstrand Corp.

In Honeywell Intern v Hamilton Sundstrand Corp. 378 F. Supp. 2d 459 (D. Del 2005), the district court reflected back to Fromson in its reasoning to allow the plaintiff to use post-9/11 evidence regarding the increased demand for regional jets to be considered in the hypothetical negotiation despite the March 2000 first infringement date. The court in Honeywell reasoned that allowing the post-negotiation information (1) “promotes flexibility in damage calculations,” (2) “discourages infringement by placing the risk of success on the infringer,” (3) prevents a “premature valuation of the patent,” and (4) “permits a damage award more in keeping with the plain language of § 284 by adequately compensating the plaintiff for the ‘use made of the invention’ by the defendant.” Honeywell at 430. 

Lucent v Gateway

Similarly, in Lucent v Gateway, in the Federal Circuit’s evaluation of Georgia-Pacific factor 11, the court explained, “[c]onsideration of evidence of usage after infringement started can, under appropriate circumstances, be helpful to the jury and the court in assessing whether a royalty is reasonable.” Lucent at 1334. The court stated that usage data from sales projections based on past sales, consumer surveys, focus group testing, and other sources “may provide information that the parties would frequently have estimated during the negotiation.” Lucent at 1334.

The objective to put the plaintiff back in the economic position it would have been in but for the infringement and to adequately compensate the plaintiff for the infringement will be relevant in the court’s assessment of the reasonableness of the weight placed on post-negotiation evidence.  These assessments will be made on a case-by-case basis. Therefore, it is important for the damages expert to consider how the specific evidence in the case can bolster his or her damages opinion and how such evidence aligns with or differs from previous court opinions.

Potential Impacts of COVID-related Economic Issues on Patent Damages

The hypothetical negotiation date is critical to the determination of a reasonable royalty as it establishes ownership of the patent as of the date of first infringement, the identity of the infringing party, and the date for which pre- and post-negotiation information becomes delineated. Therefore, the impact of COVID-related economics on the negotiating parties’ financial performance as of the hypothetical negotiation date can also be critical to determining a reasonable royalty. 

While parties may, at times, dispute the hypothetical negotiation date (see, for example, the Federal Circuit opinion referenced above in Integra), given the potential COVID-related impact on the royalty calculation, it is likely that disputes between parties regarding the first act of infringement (i.e. the hypothetical negotiation date) will increase.   

The impact of COVID on the parties’ business operations may also have implications to the determination of the reasonable royalty rate. Ideally, the reasonable royalty rate is representative of the portion of profit attributed to the invention. Pre-negotiation expectations are generally the basis for profitability determinations. If the defendant’s profit margin changes substantially post-negotiation, one party may seek to assert (or block) the use of the book of wisdom to obtain the most beneficial damages claim. The parties are likely to dispute whether such impacts were or were not foreseeable or COVID-related. 

The royalty base depends on the economic structure of the hypothetical license. When a party seeks an upfront, lump-sum royalty, the royalty base is typically based on pre-negotiation projections. However, these projections could be materially impacted by COVID-related economic impacts on the defendant’s business. In addition, a lump sum royalty requires a discount rate to adjust projected royalties to present value. As a result, there are likely to be disputes between the parties regarding whether or not the discount rate adequately considered the potential risk of a pandemic occurring during the royalty period. One party may argue that discount rates derived from averaging long periods of observed returns will adequately account for the possibility of the risk of a pandemic; however, such arguments may be challenged in these “unprecedented” times.

For damage calculations exchanged between the parties before the COVID-related economic impacts began, counsel and the expert should consider how, if at all, COVID-related economic changes impact their royalty damages claim. It may well be relevant to reopen discovery of financial records, including information related to the parties’ sales and profits. Damage reports may also need to be updated to account for changed conditions. As a practical matter, jurors have also suffered through the COVID pandemic, and would likely consider the impact of COVID-related economic changes to an industry or business as relevant, even if such events happen post-negotiation.

The impact of COVID-related economic issues will likely be important to the determination of damages for years to come. Parties will be best positioned if they carefully consider how their damages claim has accounted for COVID-related economic impacts, including the extent to which the book of wisdom is relied upon and the strength of their position relative to the over-arching objective of restoring the plaintiff to the same financial position it would have been in but for the infringement.