Federal Circuit Puts Bite on Entire Market Value Rule

Practical Law Legal Update 5-521-1924 (Approx. 7 pages)

Federal Circuit Puts Bite on Entire Market Value Rule

by PLC Intellectual Property & Technology

Key Litigated Issues

Among the issues decided by the Federal Circuit, the key litigated issues before the court in LaserDynamics, Inc. v. Quanta Computer, Inc. were whether:

QCI was entitled to obtain damages based on the entire market value rule.
QCI has an implied license to assemble and sell laptops using ODDs purchased from Philips and Sony/NEC/Optiarc.
August 2006 is the hypothetical negotiation date.
The BenQ settlement agreement should have been admitted into evidence.

Background

LaserDynamics, Inc. owns US Patent No. 5,587,981 (the '981 Patent), which is directed to an optical disc discrimination method that enables an optical disc drive (ODD) to automatically identify the type of optical disc, such as a compact disc or a digital video disc, that is inserted into the ODD.

Between 1998 and 2001, LaserDynamics entered into 16 license agreements for the '981 Patent. These were exclusive licenses granted in exchange for one time lump sum payments ranging from $57,000 to $266,000. LaserDynamics granted several more license agreements to other ODD and electronics manufacturers through more aggressive licensing efforts.

On February 15, 2006, LaserDynamics entered into a $6 million license agreement with BenQ Corporation to settle a two-year long litigation. At the time of the settlement, BenQ had been repeatedly sanctioned by the district court for discovery misconduct and misrepresentation. For example, the court in that case:

Allotted BenQ one-third less time for voir dire, opening statement and closing argument.
Awarded attorneys' fees to LaserDynamics for bringing the sanctions motion.
Struck one of BenQ's pleaded defenses.
Sanctioned BenQ $500,000 as an additional punitive and deterrent measure.

Quanta Storage, Inc. (QSI), a partially-owned subsidiary of Quanta Computer, Inc. (QCI), manufactures ODDs. QCI assembles laptop computers for its various customers. It does not manufacture ODDs, but does install ODDs into computers as instructed by its customers. QCI's typical practice is to buy ODDs from its customers, who purchased the ODDs from the ODD manufacturers. QCI eventually sells the fully assembled laptop computers, including the ODDs, to its customers. This is known as a buy/sell arrangement.

QSI first sold its ODDs for integration into laptop computers in the US in 2001. In 2002, LaserDynamics offered QSI a license for the '981 Patent. However, QSI disputed whether its ODDs were covered by the '981 Patent's claims and rejected LaserDynamics' offer. In 2003, QCI sold its first computer in the US using a QSI ODD.

QSI also assembles ODDs for Philips and Sony/NEC/Optiarc, which are licensed by LaserDynamics to make and sell ODDs within the scope of the '981 Patent. Under these license agreements, Philips and Sony/NEC/Optiarc enjoy "have made" rights that permit them to retain companies to assemble ODDs for them.

In August 2006, LaserDynamics concurrently filed suit against QCI and QSI for patent infringement and offered QCI a license for the '981 Patent. In its lawsuit, LaserDynamics argued that QSI's and QCI's sales of ODDs and laptop computers, respectively, actively induced infringement of the patented method by the end users of the ODDs and laptop computers. QCI and QSI moved for summary judgment relating to their defenses of patent exhaustion and implied license. The US District Court for the Eastern District of Texas ruled that:

The exhaustion doctrine does not apply to sales made overseas by LaserDynamics' licensees.
QCI has an implied license for drives manufactured by certain entities licensed by LaserDynamics and sold by those licensees to QCI for incorporation into QCI computers and QSI is not liable for manufacturing drives for Philips or Sony/NEC/Optiarc.
The Quanta defendants do not have an implied license for drives manufactured by QSI and later sold to QCI, even though those drives are sold through Philips or Sony/NEC/Optiarc.

After these rulings, LaserDynamics dropped its claims against QSI and pursued its active inducement of infringement claims against only QCI.

First Trial

The first trial addressed both infringement and damages.

LaserDynamics presented its reasonable royalty damages case through its expert, Emmett Murtha, who opined that the parties would have agreed to a royalty rate of two percent of QCI's total laptop computer sales and would have engaged in a hypothetical negotiation in August 2006, when QCI first became aware of the '981 Patent, to arrive at the reasonable royalty. Murtha reached the two percent royalty rate after concluding that six percent would be a reasonable royalty rate to pay for an ODD alone. Between August 2006 and the end of the first trial in June 2009, QCI sold approximately $2.53 billion of accused laptops into the US, which would have resulted in a $52.1 million royalty.

In contrast, QCI argued that, based on the 16 LaserDynamics license agreements in evidence, a lump sum of $500,000 would be a reasonable royalty.

At the end of the trial, the jury found QCI liable for active inducement of infringement and awarded LaserDynamics $52 million in damages. QCI filed a motion for a remittitur or new trial and argued that the verdict was grossly excessive and against the great weight of the evidence. It also argued that Murtha's testimony should have been excluded due to his unreliable methodology in applying the entire market value rule. The district court granted QCI's motion and found that LaserDynamics improperly invoked the entire market value rule. Specifically, the district court noted that LaserDynamics presented no evidence that its patented method drove the demand for QCI's computers. As a result, the district court concluded that the $52 million damages award was unsupportable and excessive.

LaserDynamics declined to accept the proposed remittitur to $6.2 million and elected to have a new damages trial.

Second Trial

Before the second trial, QCI:

Objected to Murtha's anticipated testimony concerning the existing '981 Patent licenses.
Challenged Murtha's six percent royalty rate based on ODD average price for being improperly based on non-comparable licensing evidence.
Challenged Murtha's two percent royalty rate based on the entire market value rule.
Filed a motion in limine to exclude the BenQ settlement agreement.

The district court:

Permitted LaserDynamics to introduce evidence regarding a six percent royalty damages model based on ODD average price, subject to certain restrictions regarding proof of comparability to the hypothetically negotiated license.
Sustained QCI's objections concerning the application of the entire market value rule.
Denied the motion in limine.

During the second trial, LaserDynamics argued that damages should be $10.5 million based on a six percent royalty on the average price of a standalone ODD. QCI's expert testified that the appropriate damages amount was a lump sum payment of $1.2 million based in large part on the fact that none of LaserDynamics' license agreements in evidence (excluding the BenQ settlement) exceeded lump sum amounts of $1 million.

The jury awarded LaserDynamics a lump sum amount of $8.5 million in damages. QCI moved for a judgment as a matter of law (JMOL) on the grounds that:

The district court improperly set the hypothetical negotiation date as August 2006.
The evidence did not support the $8.5 million damages award.
LaserDynamics failed to offer proof to support its $10.5 million damages theory.

The district court denied QCI's motion.

Outcome

Among its rulings in its August 30, 2012 opinion, the Federal Circuit held that:

QCI is not entitled to obtain damages based on the entire market value rule.
QCI has an implied license to assemble and sell laptops using ODDs purchased from Philips and Sony/NEC/Optiarc.
August 2006 is the hypothetical negotiation date.
The BenQ settlement agreement should not have been admitted into evidence.

The Federal Circuit Limits the Application of the Entire Market Value Rule

The Federal Circuit held that the district court properly granted a new trial on damages because LaserDynamics' entire market value rule damages theory was legally unsupportable. Specifically, the Federal Circuit noted that:

When the patent at issue covers a multi-component product, the general rule is that the reasonable royalty measure of damages is based on the smallest salable patent-practicing unit.
The entire market value rule is a narrow exception where a patentee may be awarded damages as a percentage of revenues or profits from the entire product, if the patentee can show that the patented feature drives the demand for the entire multi-component product.
The entire market value rule is a narrow exception to avoid artificially inflating the jury's damages calculation through the use of an arbitrary base for the calculation.

In this case, the Federal Circuit held that LaserDynamics did not present sufficient evidence showing that the patented disc discrimination method was the feature that motivated consumers to purchase the laptop computer. Specifically, Murtha never conducted any market studies or consumer surveys on whether the patented technology drives the demand for a laptop to justify the entire market value rule. It was not sufficient to show that the method is valuable, important or even essential to the use of the laptop computer, or that a laptop computer without this technology would be commercially unviable.

LaserDynamics also argued that practical and economic necessity compelled it to base its royalty on the entire multi-component product because QCI:

Does not track the prices, revenues or profits associated with individual components.
Purchases ODDs for a mask price, which is essentially an accounting fiction that offers little evidence of the drive's actual value.

However, the Federal Circuit noted that the parties could use a lump sum royalty as the measure of damages since a lump sum is not calculated as a percentage of any component or product and LaserDynamics could obtain ODD information from third parties. Therefore, the Federal Circuit concluded that there is no reason to establish a necessity-based exception to the entire market value rule for LaserDynamics in this case.

QCI's Implied License

QCI argued that it has an implied license to assemble laptop computers for its customers that include the ODDs assembled by QSI for Philips or Sony/NEC/Optiarc under their "have made" license rights granted by LaserDynamics. The Federal Circuit agreed, citing Cyrix Corp. v. Intel Corp., and noted that:

The ODDs provided to QCI via Philips and Sony/NEC/Optiarc were assembled by QSI for Philips and Sony/NEC/Optiarc.
Even though the ODDs made by QSI were shipped directly from QSI to QCI, the substance of the transactions make clear that QSI's manufacture of the ODDs was limited to Philips' and Sony's/NEC's/Optiarc's needs and requests.

The Federal Circuit concluded that QSI's and QCI's transactions were legitimate and separate business transactions that did not expand or circumvent LaserDynamics' licenses.

The Hypothetical Negotiation Date

In both trials, the district court ruled that the hypothetical negotiation date for purposes of the reasonable royalty calculation was August 2006, when LaserDynamics filed the lawsuit. The district court reasoned that since LaserDynamics claimed active inducement of infringement, QCI had to have knowledge of the patent. Since QCI was not notified of the patent until August 2006, the district court concluded that QCI first became liable at that time.

However, the Federal Circuit noted that, in general, the date of the hypothetical negotiation for purposes of the reasonable royalty calculation is when the infringement started. In the case of inducement of infringement, a hypothetical negotiation is deemed to occur on the date of the first direct infringement traceable to the first instance of the inducement conduct. In this case, this was in 2003.

The Federal Circuit also noted that its decision in this case is consistent with the hypothetical negotiation framework for determining reasonable royalty damages. Under the Georgia-Pacific test for determining reasonable royalty damages, the basic analytical framework requires:

Determining what agreement a willing licensor and a willing licensee would reach in a hypothetical negotiation on the eve of infringement.
A presumption of knowledge of the patent and infringement at the time the accused inducement conduct began.

The Inadmissible BenQ Settlement Agreement

The Federal Circuit determined that the district court abused its discretion in denying QCI's motion in limine and allowing the BenQ settlement into evidence noting that:

The coercive environment of patent litigation is unsuitable to prove a reasonable royalty because Georgia-Pacific presumes that a voluntary agreement will be reached and validity and infringement are not disputed.
The BenQ settlement was the least reliable license for purposes of establishing a reasonable royalty because it was:
- executed right before a trial where BenQ was subject to harsh sanctions; and
- entered into in 2006, three years after the hypothetical negotiation date.

The Federal Circuit concluded that the $6 million lump sum of the BenQ settlement reflects the desire to avoid further litigation rather than the value of the claimed invention and has minimal reliability and probative value on the damages issue.

Remaining Issues

The Federal Circuit also held that:

The district court properly denied QCI's motion for JMOL of non-infringement because the record supported a jury finding of infringement.
The district court's jury instruction does not warrant a new liability trial because QCI was given a second trial on the damages issue, which cured any prejudice that the district court's instruction might have caused.
The district court erred in admitting Murtha's opinions concerning the six percent royalty rate, which was arbitrary and speculative.

Practical Implications

This case is noteworthy for the Federal Circuit's discussion that the entire market value rule:

Is a narrow exception to the general rule that royalties be based not on the entire product, but on the smallest salable patent-practicing unit.
Requires proof that the patented technology is what motivates consumers to buy the entire product.

Counsel representing owners of patents covering technology that may be incorporated in multi-component products should support their entire market value rule damages theory with market studies or consumer surveys to establish that the patented technology drives the demand for the entire product in which the technology is incorporated.

Federal Circuit Puts Bite on Entire Market Value Rule | Practical Law