Reasonable Royalties in Patent Litigation

Introduction

Until recently, there had been few reported Canadian patent infringement decisions dealing with reasonable royalties. This has changed in the past several years. This article looks at some of the key developments in this area of patent infringement financial remedies.

In patent litigation, the concept of a “reasonable royalty” is employed in two ways. First, a plaintiff is entitled to a reasonable royalty for infringement during the period between when the patent is “laid open” to inspection and when it is issued. Second, during the period following the issuance of the patent, a plaintiff who elects an award of damages and who is not able to demonstrate a direct loss of sales as a result of the infringement may claim a reasonable royalty on each infringing act.

Previous Approaches

In AlliedSignal Inc. v. Du Pont Canada Inc., 1998 CanLII 7464 (FC), the court ruled that a reasonable royalty would generally pay the patentee 25% to 33% of the incremental profit earned by the defendant from the use of the technology. The court noted various factors that would tend to move the rate within that range of percentages. For example, if the patentee was a competitor of the infringer, selling its products to a similar group of customers, this would tend to increase the royalty rate.

In Jay-Lor International Inc. v. Penta Farm Systems Ltd., 2007 FC 358, the court considered both the Allied Signal approach as well as two other approaches: the “analytical approach” and the “anticipated profits approach”.

The infringer’s use of the invention will often lead to a) higher selling prices for its goods, and/or b) lower manufacturing costs, depending on the nature of the invention.  Under the analytical approach as described in Jaylor, one measures the royalty rate based on the increase in the infringer’s gross margin percentage as a result of the infringement. For example, if the gross margin on non-infringing product sales is 30%, and the gross margin on infringing product sales is 50%, then the royalty on infringing sales should be somewhere between 0% and 20% of infringing sales.

Under the anticipated profits approach, one estimates the increase in the overall profit of the infringer as a result of the infringement, some portion of which is then allocated as a royalty to the patentee. The advantage of this approach is that it considers not only changes in gross margin percentage, but other changes in the business that result from the infringement, including (potentially) higher sales volumes and higher administrative costs. This was the approach adopted by the court in Jaylor; it determined that for every sale of infringing products, 20% of the selling price made its way to the bottom line. It then decided to award 35% of these profits to the patentee based on its analysis of the Allied Signal factors.

More recent cases

Some recent cases have continued with the sort of approach used in Allied Signal and Jaylor. In Frac Shack Inc. and Frac Shack International Inc. v AFD Petroleum Ltd. 2017 FC 104, for example, the court accepted the evidence that a royalty rate, across all technologies, would typically fall between 25% and 33% of the defendant’s profits. It adopted a mid-point of 29%.

However, most recent Canadian cases have tended to move away from these sorts of “rules of thumb”, mirroring a similar development in the United States (e.g. Uniloc USA Inc et al v Microsoft Corporation, 632 F (3d) 1292 (2011)). Instead, they have adopted a bargaining framework that considers two main elements of a hypothetical negotiation:

• The patentee’s minimum willingness to accept (MWA); and,



• The infringer’s maximum willingness to pay (MWP).

The reasonable royalty will fall somewhere in between the MWA and the MWP. For example, if the patentee’s MWA is 5% and the infringer’s MWP is 10%, the reasonably royalty will be somewhere between 5% and 10%.

The idea behind these concepts is that an economic actor will gauge what it is willing to pay or accept for a piece of technology based on the economic benefit or harm that this will cause to that actor.

Thus, in deciding to license its technology to an infringer, a patentee will consider:

• Whether this will result in a loss of market share due to granting a competitor access to a key technology.
• Whether this will result in a loss of sales dollars to the patentee, as a result of its loss of its previous monopoly position in the marketplace.

For the infringer, the analysis is the same, but from the opposite perspective, namely: will use of the invention allow the infringer to sell more units, and/or sell its existing products for a higher price?

In some instances, the patentee’s MWA may be quite low; this will be the case where the patentee does not produce or sell any products embodying its invention, such that any volumes sold by the infringer will not displace amounts that would otherwise have been sold by the patentee.

In other instances, the MWA will higher than the MWP, and there will be no effective bargaining range. Consider a case where the patentee and the infringer are the only two competitors in a given market. If the patentee keeps a monopoly on its invention, it will be able to sell to 100% of the potential market at monopolistic prices. If it licenses its invention to its competitor, every sale its competitor makes will represent a lost sale to the patentee; moreover, the presence of competitor in the marketplace will lead to a decrease in prices and an increase in certain expenses such as advertising. In this type of a scenario, no rational patentee would choose to license its technology.

The first mention of the MWP/MWA approach in Canadian jurisprudence appears to be Merck & Co., Inc. v. Apotex Inc., 2013 FC 751. Notwithstanding that Justice Snider ruled that she was not required to rule on a reasonable royalty rate, she accepted the basic MWP/MWA framework as conceptually sound. She also accepted that in a case where there is no effective bargaining range, the royalty should be set at the plaintiff’s MWA. In such a case the reasonable royalty will be very similar to an award for lost profits.

The approach was used again in Airbus Helicopters S.A.S. v. Bell Helicopter Texteron Canada Limitée, 2017 FC 170.  In that case, much of the analysis centred on the MWP, rather than the MWA; the facts of the case were somewhat unique, in that the infringing products were never actually sold by the defendant, and the financial impact of the infringement on the patentee was very difficult to measure. Most recently, the MWP/MWA approach was adopted by both experts in Dow Chemical Company v. Nova Chemicals Corporation, 2017 FC 350; once again, in that case the court found that there was no effective bargaining range and awarded a royalty based on Dow’s MWA.

Conclusion

Over the past several years, Canadian courts have adopted a more rigorous approach to quantifying reasonable royalties that considers the economic impact of the use of the technology in question on both the patentee and infringer. Similar to claims for lost profits or an accounting of the defendant’s profits, litigants in reasonable royalty cases will now need to address this fundamental point: what is the technology really worth to their business?


(This article was originally published by The Lawyer’s Daily (www.thelawyersdaily.ca), part of LexisNexis Canada Inc.)