Distinguishing Lost Profits from Reasonable Royalties

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INTRODUCTION

Patent damages are designed to compensate patentees for their losses, not punish accused infringers or require them to disgorge their profits. (1) The governing statute provides for "damages adequate to compensate for the infringement, but in no event less than a reasonable royalty." (2) Courts interpreting this provision have divided patent damages into two groups--lost profits, available to patent owners who would have made sales in the absence of infringement, and reasonable royalties, a fallback remedy for everyone else. (3) Traditionally, patentees want to prove lost profits because only that measure captures the monopoly value of excluding competitors from the market. As the statutory language suggests, reasonable royalties exist as a floor or backstop for those who cannot prove that they have lost profits as a result of infringement. (4) The rationale is that an infringed patent is valuable and could be licensed for a fee even by patent owners who don't employ the patent in the marketplace.

In practice, however, the lines between lost profits and reasonable royalties are blurring. In significant part, this is because courts have insisted on strict standards of proof for entitlement to lost profits. Specifically, patentees must prove demand for the patented product, the absence of noninfringing substitutes, the ability to meet additional demand in the absence of infringement, and the proportion of those sales that represent profits. (5) This in turn means that many patent owners who have in fact probably lost sales to infringement cannot prove lost profits damages and must fall back on the reasonable royalty measure. (6) The result is that courts have distorted the reasonable royalty measure in various ways, adding "kickers" to increase damages, artificially raising the reasonable royalty rate, or importing inapposite concepts like the "entire market value rule" in an effort to compensate patent owners whose real remedy probably should have been in the lost profits category. (7) Unfortunately, Congress is now considering locking one of those distortions--the entire market value rule--into reasonable royalty law. (8)

In Part I, I explain the strict requirements for proving lost profits and give examples of patentees who have failed to meet these requirements. In Part II, I explain how relegating these patentees to reasonable royalties has led to problematic changes in reasonable royalty law. Finally, I suggest in Part III that courts should draw a sharp division between the injury suffered by patentees who compete with infringers and those who do not. Patentees who compete should be entitled to the best estimate of lost profits, even if not all elements of proof are available. Those entitled to a reasonable royalty should get just that--a reasonable award that reflects what a buyer would have been willing to pay to license a valid patent. By distinguishing the two types of harm and the corresponding remedies, courts can end the overcompensation of patent owners in reasonable royalty cases.

I. LOSING ENTITLEMENT TO LOST PROFITS

The traditional conception of patent protection is to give patent owners a means of excluding competitors from selling the patented product, thereby increasing their profits and therefore the incentive of putative patent owners to invent. This traditional conception requires exclusivity; the value of a patent is accordingly commensurate with the value of the market or market niche it controls. It explains why the normal remedy for infringement of a patent is an injunction against continued infringement. (9)

Lost profits fit logically within this traditional conception. Giving patentees the profits they would have made absent the infringement effectively puts them in the same position as if they had had an injunction in place all along. (10) To the extent that it doesn't--when a patentee lost market traction early in a growing market and never built market share, for example--the law of lost profits has expanded over time to try to compensate the patent owner for those uses. …