Vacating $357 Million Award, Federal Circuit Addresses Key Patent Damages Issue

On September 11, the U.S. Court of Appeals for the Federal Circuit vacated Lucent's $357 million patent infringement award against Microsoft. Lucent Technologies, Inc. v. Gateway, Inc., Nos. 2008-1485, 1487, 1495 (Fed. Cir. Sept. 11, 2009).  

In an opinion by Chief Judge Michel (joined by Judges Newman and Lourie), the court reaffirmed that application of the "entire market value rule," which allows patent infringement damages to be assessed based on the value of the product into which a patented item is placed, requires a showing that the patented feature is the basis for customer demand. The court, however, reiterated that determination of the "precise methodologies" to be used in determining infringement damages is committed to the district court's sound discretion and the "base used in a running royalty calculation can always be the value of the entire commercial embodiment, as long as the magnitude of the rate is within an acceptable range (as determined by the evidence)." In its detailed substantial evidence analysis, which emphasizes that "speculation, without more," and "superficial testimony" are not sufficient, the court provides extensive guidance to litigants regarding necessary damages proofs.

Lucent sued Gateway alleging infringement of "the Day patent," which the Federal Circuit described as "generally directed to a method for entering information into fields on a computer screen without using a keyboard." Microsoft intervened and a jury trial was held in the U.S. District Court for the Southern District of California. At trial, Lucent alleged that four Microsoft products indirectly infringed the Day patent. Lucent sought reasonable royalty damages of $561.9 million "based on an 8% royalty [on sales of] the accused software products" and Microsoft countered that "a lump-sum payment of $6.5 million" adequately compensated Lucent. The jury returned a verdict awarding Lucent a lump sum royalty payment of $357,693,056.18. Microsoft appealed, arguing that the verdict was based on an improper application of the entire market value rule and was not supported by "substantial evidence."

After reaffirming that "the precise methodology used in 'assessing and computing damages is committed to the sound discretion of the district court,'" and noting that "sophisticated parties routinely enter into license agreements based on the value of the patented invention as a percentage of the commercial products' sales price," the Federal Circuit rejected the suggestion "that the entire market value rule should have little role in reasonable royalty law." There are, however, "certain mandatory conditions for applying the entire market value rule." The court found a complete lack of evidence that the patented feature, "a very small component of a much larger software program," was the basis for consumer demand for Microsoft's infringing products or any evidence to support Lucent's request for an 8% royalty on the price of the entire software product. Thus, "[a]ssuming that the jury did apply the entire market value rule, such application would be legal error."

The court, however, went on to explain that because "the realities of patent licensing" should not be ignored and parties routinely value patented inventions as a percentage of the price of the larger product in which they are placed, the "base used in a running royalty calculation can always be the value of the entire commercial embodiment, as long as the magnitude of the rate is within an acceptable range (as determined by the evidence)," and "even when the patented invention is a small component of a much larger commercial product, awarding a reasonable royalty based on either sale price or number of units sold can be economically justified." Thus, "[t]here is nothing inherently wrong with using the market value of the entire product, especially when there is no established market value for the infringing component or feature, so long as the multiplier accounts for the proportion of the base represented by the infringing component or feature."

Beyond the methodology issue, the Federal Circuit found that substantial evidence did not support the jury's award. Though the court recognized that "any reasonable royalty analysis 'necessarily involves an element of approximation and uncertainty'" and licensing of intellectual property "is, at best, an inexact science," the Federal Circuit nonetheless found numerous "evidentiary lacunae" in the trial record. Among the deficiencies were the "conspicuous" absence of evidence showing how the patented method was used by consumers, and mere "superficial testimony" regarding the extent to which the technology or structure of actual licensing agreements relied upon by Lucent's expert are comparable to that of the case. Moreover, the court concluded that what substantial evidence existed did not support the jury's award because it showed that the infringing feature was "but a tiny feature in one part of a much larger software program." Thus, a remand was required by "the substantial infirmities in the evidence."

The Federal Circuit's analysis addresses several issues that have been debated in connection with proposed patent reform legislation. The court's analysis, which argues for flexibility regarding patent damage methodologies based on "real world" conduct but emphasizes the need for concrete evidentiary support for the assumptions underlying any methodology, also provides support for consensus regarding proposed damages language in the patent reform legislation. Beyond its potential impact on proposed patent reform legislation, the decision provides guidance to parties regarding the proper analysis for estimating potential infringement damages and to litigants regarding necessary damage proofs.

If you have any questions regarding any of the issues discussed in this LawFlash, please contact either of the following Morgan Lewis attorneys:

Washington, D.C.
Anthony C. Roth

Houston
Rick L. Rambo

Palo Alto
Michael J. Lyons

Philadelphia
Thomas B. Kenworthy