Springboard Profits/Damages in Canadian Intellectual Property Litigation

A few weeks ago, I co-presented at the Intellectual Property Institute of Canada’s annual conference in Vancouver on the topic of financial remedies in patent litigation. My portion of the talk focused on springboard profits as part of the accounting of profits remedy. In this post, I’ll share some of my thoughts from the presentation, as well as some other ideas that were suggested to me by my co-panelists and audience members.

The Concept

The concept behind springboard profits is that, by virtue of having infringed a patent, the infringer has achieved a financial advantage that continues beyond the expiry of the patent. This can occur for several reasons:

• A valid patent prohibits not only the sale, but also the manufacture and offering for sale of an invention covered by the patent. This means that had the infringer not infringed during the life of the patent, it would have taken some time to develop its product, to build up inventory, to market the product and build distribution channels. In short, it would have taken months, if not years, to build up their sales to a steady plateau. By infringing, the infringer is able to “hit the ground running” following the expiry of the patent.
• If the patented product is a durable good, then the benefits to the infringer in selling that good may include not only the initial sale, but also the sale of replacement parts, maintenance services, or other associated revenue streams. While the initial sale of the good may have taken place during the life of the patent, there will be additional benefits accruing to the infringer well beyond the life of the patent.
• In some instances, there may be an even longer-lasting benefit to the infringer. The existence of multiple firms already selling the patented product by the time of the patent’s expiry may dissuade additional firms from joining the market following the patent’s expiry, firms who may otherwise have entered the market if there had been only a single incumbent with whom to compete. In situations like this, the infringer’s benefit will continue into the indefinite future.

Are such post expiry springboard profits recoverable in an accounting of profits? In Dow Chemical Company v. Nova Chemicals Corporation, 2017 FC 350 (CanLII), Justice Fothergill found that they were. He was persuaded by Dow’s argument that if the incremental profits earned by the infringer following the expiry of the patent are not also disgorged, then the infringer will be left in a better financial position than if it had not infringed, a result that is antithetical to the very concept of the accounting of profits remedy.

Nova’s Argument

While they were ultimately rejected, the arguments raised by Nova also deserve some comment. Nova advanced several arguments. Conceptually, the most interesting arguments was the following:

• An infringer who disgorges its profits from infringement is implicitly acting as the agent of the patentee, and such payments implicitly serve to effectively condone the infringing activities themselves.
• The difficulty with this argument is that the profits remedy is not necessarily equal to the amount that, in the real world, the plaintiff would have agreed to in exchange for use of its patented technology. In many cases (such as the Dow case) the plaintiff would clearly never have agreed to license the technology under those terms, as its Minimum Willingness to Accept would be based on the damages it would suffer by reason of losing its monopoly over the invention in question.

The same argument would hold if the remedy awarded was lost profits (i.e. damages). The damages award compensates the patentee for its losses during the patent period only; any losses beyond that period would also need to be considered insofar as they are causally connected to the infringement.

Could Nova’s argument work in a damages context?

Is there a situation in which Nova’s argument would have carried more weight? Perhaps.

Suppose a plaintiff elects a damages remedy, which it measures based on a reasonable royalty since it is unable to prove it suffered any loss of sales as a result of the infringement.  In that scenario, the plaintiff’s MWTA is less than the defendant’s MWTP; that is, the benefit to the defendant from licensing is greater than the value to the plaintiff of its monopoly. This arises most commonly where the plaintiff is a smaller firm, while the defendant is much larger and able to scale to market.

In that case, a hypothetical royalty rate (and a fortiori an empirically based royalty rate, measured based on comparable transactions) should incorporate the fact that the defendant will thereby gain a springboard advantage. If so, then there should be no award of springboard damages.

This conclusion is implicit in the words of Justice Fothergill at paragraph 123 of the Dow decision:

[123]      Dow is entitled to awards under both ss 55(1) and 55(2) of the Patent Act. Even if the royalty rates calculated by Dr. Heeb and Dr. Leonard can be said to include the period following the expiration of the ’705 Patent, the royalty compensates Dow only for Nova’s infringement during the period December 9, 2004 to August 21, 2006. The accounting of profits extends over a much longer period.

Dow Chemical v Nova - Differential Profits and "Indirect NIA"s

Last year’s award of over $644M in Dow Chemical Company v. Nova Chemicals Corporation, 2017 FC 350 [1] is one of the largest awards for intellectual property infringement in Canadian history. The decision of Justice Fothergill contains many novel points of interest, but perhaps none so significant as his treatment of the issue of non-infringing alternatives and the deduction of fixed and capital costs in determining Nova’s profits to be disgorged to Dow.

The case involved Dow’s patent (the “705 patent”) for the production of a certain type of metallocene linear low density polyethylene (mLLDPE), a type of plastic. The patent was used by Dow to produce its ELITE mLLDPE, and the same technology was used by Nova in its SURPASS product. A previous trial had found that Nova had infringed on the 705 patent from 2002 until it expired on April 19, 2014, and as its financial remedy Dow elected (and was granted) an accounting of Nova’s profits from the sale of SURPASS.

Differential Profits

Over the past decade, Canadian courts have generally adopted what has come to be known as the “differential profits” approach. This approach, as described by the Supreme Court in Monsanto Canada Inc. v. Schmeiser, [2004] 1 SCR 902, 2004 SCC 34, says that in accounting for the defendant’s profits from infringement, one makes “a comparison … between the defendant’s profit attributable to the invention and his profit had he used the best non-infringing option”.

The notion behind this treatment is that the defendant should only be required to disgorge the incremental benefit it received as a result of the infringement of the patent. If, instead of infringing, the defendant would have devoted its efforts to some other enterprise, then the true benefit of the infringement is only the difference between the profit actually earned and the profit that would have earned from the alternative.

In much of the case law since Schmeiser, the application of the concept of “differential profits” has generally been limited to cases where it has been possible to identify a non-infringing alternative product (or technology) that would have been sold to the same customers that purchased the infringing units.

The effect of this focus on non-infringing alternative products has been that, when the infringing product embodies proprietary technologies that are key drivers of sales, such that it is not plausible the same customers would have purchased an alternative, non-infringing product from the defendant, the differential profits approach has generally been ignored, until Nova.

“Indirect NIA”

In Nova, it was acknowledged that there was no real non-infringing product that could have been sold to the purchasers of SURPASS; while Nova produces many other types of LDPE, none of these contained the unique features of ELITE or SURPASS that made those products so appealing to their customers.

However, Nova argued that but for its infringing activities, it would have deployed the production capacity used to manufacture SURPASS to make other types of plastic, which would have been sold to different customers. Nova referred to this as an “indirect non-infringing alternative” (para. 146).

The court accepted this argument, and allowed Nova to deduct a proportionate share of its fixed costs and capital expenditures related to the plant that had been used to manufacture the infringing product. The court noted that:

The “best non-infringing option” has generally been interpreted to mean a “true substitute” or “real alternative”. But appellate courts have frequently sought to reduce over-generous awards, including those that neglected to take into account alternative profits. The Federal Court of Appeal recently emphasized that “at bottom is the need to ensure that a patentee only receives that portion of the infringer’s profit that is causally attributable to the invention” (para 164, citations omitted).

Did the Court Apply a True “But for” Analysis?

Nova had argued that but for the infringement, it would have manufactured other products; if so, then it might have been appropriate for the court to analyze what the profits from those other products would have been. The court could have looked to the average profit per pound of other product during the relevant period and deducted this amount against the actual profits.

Why did the court instead simply allow for a pro-rata deduction of fixed and capital costs? First, it is not clear from the written decision whether Nova in fact attempted to claim as an offset, the profits it would have made from these alternate products. In addition, there is precedent for the court’s approach from other Commonwealth jurisdictions.

As a “shorthand” approach, the court’s approach has much to recommend it; rather than undertake a full analysis of the profits earned on other products, one can likely assume that in most cases, at the very least, those profits would have covered the fixed operating costs of the plant. But by deducting only a pro-rata portion of fixed and capital costs, rather than projecting the profit Nova would have made from alternate use of its fixed capacity, the court may have overstated Nova’s true benefit from its infringing activity.

What this means

This ruling would seem to augur the adoption of a broader, more holistic approach to the accounting of profits. The profits to be disgorged should be equal to a) the actual profits achieved as a result of the infringement in the real world, less b) the level of profit that would have been achieved in the “but for” world in which the defendant does not infringe.

This article originally appeared in The Lawyer's Daily (a LexisNexis Publication) on September 14, 2017

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[1] In that decision, Justice Fothergill set out the framework for the calculation of damages. In 2017 FC 637, he addressed certain outstanding issues and issued the award.

Foreign Exchange Issues in Damage Quantification: Part II - Applying the Concepts

In the previous post, we presented a basic framework for analyzing the impact of foreign exchange fluctuations on quantifying financial remedies. We argued that the treatment of foreign exchange should be consistent with the principal underlying the financial remedy being awarded; we referred to this as a "matching principle".

In this post, we extend that basic logic to consider other scenarios.

 

1.     What if we are not sure how to match?

Consider Mr. Canuck, an executive working for a Canadian subsidiary of a US-based public company is wrongfully terminated. As a result, the stock options to which he would have been entitled as of July 2009 did not vest. He sues for wrongful dismissal, and is successful. His damages are assessed as the difference between the exercise price ($1 USD per share) of the options and the market value of the stock on July 2009 ($10 USD per share). The trial occurs in 2011, and an award for damages is granted shortly thereafter.

Arguably, the appropriate exchange rate will depend on particular findings of fact:

 ·         Assume that the court determines damages based on the profit that could have been earned by exercising the options on the date they vested, and immediately selling the shares thus acquired and converting the proceeds into Canadian dollars (to buy a new sportscar). Under this set of assumptions, the relevant exchange rate is the rate in effect on the vesting date, since that is the date Mr. Canuck would have converted his $USD-denominated assets into $CDN. Converting his award based on the current exchange rate will not provide Mr. Canuck with sufficient funds to buy his sportscar![1]

 

·         Conversely, supposing that Mr. Canuck held a large $USD-denominated stock portfolio at the time he would have exercised his options. In that case, it may be more appropriate to assume that he would have simply rolled his company stock into another US investment, which he would have continued to hold. If so, then his damages award should be based on the exchange rate in effect at the award date; Mr. Canuck can take his award, convert it into USD and purchase the same portfolio of stock that he would have purchased following the exercise of his options.

2.     Future Losses

Let us now turn to the example of a personal injury claimant, Ms. Nascar. She is a US resident, and is injured in a motor vehicle accident in Canada, and will never be able to work again. What sort of foreign exchange rate should be applied to her prospective losses?

But for her injuries, Ms. Nascar would have continued to work in the US, earning USD. Her lump sum damages award will be calculated in USD; she will then need to be given a CDN amount such that she will be able to use it to purchase a USD stream of income (e.g. a portfolio of US government bonds) sufficient to replace her lost income. This will be accomplished by looking to the current exchange rate on the award date.

(Some may argue that if the exchange rate on the award date is unusually high or low, it may be fairer to apply some sort of long term forecast exchange rate. I would argue that generally speaking, actual exchange rates are the best reflection of anticipated future rates; to the extent that they are not, the defendant can always enter into a hedging arrangement.

Suppose the liability insurer of the defendant feels that the exchange rate of $1 USD = $1.25 CDN is abnormally high, and that a “fairer” exchange rate to use would be $1 USD = $1.10 CDN. The insurance company could simply borrow USD now, exchange the USD for CDN at the “favourable” exchange rate, and then pay back the USD when the exchange rate “normalizes” to $1 USD = $1.10 CD.)

3.     Damages and Profits

Consider the case of Maple Leaf Technologies Inc. (“MLT”), a Canadian firm who infringes a patent by manufacturing goods in Canada and selling them in the United States. Most of the MLT's operations are in Canada.

 

Under Canadian law, the patent owner – a US based firm, Stripes and Stars Inc. (“SSI”) - may sue for either damages on its lost sales, or an accounting of the defendant’s profits from the infringing sales. I would argue that the appropriate exchange rate to use may depend on the type of financial remedy that is being pursued. 

In an award for damages, the goal is to return the plaintiff to the position it would have been in had the wrongdoing not occurred. The analysis centres on the plaintiff. In the case of the SSI, whose patent was infringed, arguably the treatment of the damages award should depend on what it would have done with its USD sales. Since SSI’s operations are all US-based, the damages award needs to be such that SSI can take the award (based on the exchange rate in effect on the award date) and convert it into USD.[2]

The analysis in an accounting of profits case is different. The focus is on the profit taken by the infringer, which in this case is a Canadian company, MLT. MLT is in the practice of converting the proceeds of its USD sales into CDN, since virtually all of its operations are carried out in the Canada. In order to eliminate the benefit received by MLT from its wrongful sales, it would be more appropriate to quantify the profits to be disgorged based on the actual historic rate at which Maple Leaf Technologies had converted its USD sales into CDN, and not on the rate in effect on the award date.

If this analysis is correct, then fluctuations in foreign exchange rates may be a relevant factor for SSI in deciding which remedy to pursue. Assuming that SSI's lost profits and MLT's incremental profits from the infringing sales are very similar (i.e. that any sales MLT made would have been made by SSI, and the two companies have similar cost structures), and the value of the Canadian dollar has depreciated relative to USD by 20%, then SSI will be better off electing damages.

4.     Hedging

Finally, consider a Canadian firm, Stick and Puck Ltd. ("SPL"), which was unable to make sales to the US as a result of its contractor’s negligence. SPL does a steady volume of business in the US, and in order to reduce its exposure to fluctuations in foreign exchange rates, it typically enters into forward contracts to sell USD and purchase CDN. How does one treat the hedging arrangements that Stick and Puck had entered into? Do they matter?

There are many types of such arrangements, but two common ones which we will consider here are:

·    Forward contracts: These contacts obligate the Canadian firm to exchange a certain amount of USD at a certain date at a certain price.

·    Option contracts: These contracts give the Canadian firm the right (but not the obligation) to exchange a certain amount of USD at a certain date at a certain price.

Let us suppose that SPL lost $1M (USD) in sales as a result of the incident. At the time, the spot exchange rate was $1USD = $1.2CDN, but SPL had entered into a forward contract a number of months prior to that, according to which it agreed to trade $1M USD to its counterparty in exchange for $1.15M CDN.

At first glance, one might think that the relevant exchange rate to apply would be the forward contract rate of $1USD = $1.15CDN, on the grounds that, but for the incident, SPL would have taken its $1M (USD) and exchanged it for $1.15M CDN.

This is not correct, however. A forward contract has an intrinsic value of its own, regardless of whether it is being used to hedge against exchange rate risk or for purely speculative purposes. A contract that requires me to sell $1M (USD) for $1.15M (CDN) when the spot exchange rate is in fact 1 (USD):1.2 (CDN) has a value of negative $0.05M to me, and that needs to be considered. In reality, one should really think of there as being two separate transactions that would have occurred:

 1.     Receive sales proceeds of $1M (USD), convert to $1.2M (CDN) at spot rate.

2.     Take $1.2M (CDN), convert it to $1M (USD), and give the $1M (USD) to the counterparty in exchange for $1.15M (CDN).

Had SPL been able to complete both transactions, its net result would have been to have $1.15M (CDN) in its pocket. However, because it was not able to make the sale for $1M (USD) (Transaction #1), it is left with a loss of $0.05M as a result of the forward contract (Transaction #2). Combining the sales proceeds of $1.15M (CDN) that SPL would have had with the negative $0.05M that they now are stuck with, the aggregate loss is $1.2M.

In short, even if a company enters into forward contracts, the relevant exchange rate will be the spot rate at the time the lost sales would have occurred, not the forward contract rate.

What if SPL had the right, but not the obligation, to sell $1M (USD) in exchange for $1.15M (CDN)? In our example, such an option would have a negative intrinsic value (since the spot rate is $1USD=$1.2CDN); SPL would not have exercised the option, but would have simply exchanged its $1M (USD) received from the sale of its goods based on the spot rate. Again, it is the spot rate that is relevant, not the contracted rate.

Conclusion

Foreign exchange rates can add complexity to financial loss calculations. My central argument in this post has been that the choice of exchange rate should never be a mechanical exercise; rather, it should be a function of how best to achieve the underlying goal of the financial remedy in question. Carrying this line of thinking through to its logical conclusion can yield interesting results.

 

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[1] This was essentially the approach adopted by the trial judge in Bailey v. Cintas Corporation, 2008 CanLII 12704 (ON SC),

[2] This was the approach adopted by the trial judge in Alliedsignal Inc. v. du Pont Canada Inc., 1998 CanLII 7464 (FC),; upheld on appeal (Alliedsignal Inc. v. Dupont Canada Inc., 1999 CanLII 7409 (FCA),)