Measuring patent damages — and excluding reexam evidence

The Federal Circuit again tightened the criteria for setting damages awards in patent infringement cases. But, in a bit of good news for infringement plaintiffs, it lent further support to the general inclination of district courts to exclude evidence of non-final results of patent reexaminations by the U.S. Patent and Trademark Office.

In VirnetX, Inc. v. Cisco Systems, Inc., No. 13-1489 (Fed. Cir. Sept. 16, 2014), a two-judge panel^* ruled that a mistake in a jury instruction and a gap in the patent holder's damages evidence required the court to set aside a $368 million jury award against Apple.

The patents

VirnetX, the patent holder, sued Cisco, Apple, and others in the Eastern District of Texas for infringing two patents that relate to "secure communication links" using Internet "domain names". VirnetX's claim against Apple focused on the FaceTime feature in iPhones, iPods, and iPads.

FaceTime allows users of an Apple device to make a secure link with another user and to send and receive audio and video via packets.

The trial and verdict; Apple's appeal

In a five-day trial, the district court in Tyler excluded Apple's evidence that the USPTO had reexamined the patents and initially rejected them. The court also overruled Apple's critiques of VirnetX's damages evidence.

The jury found that FaceTime infringed VirnetX's patents and awarded the company $368,160,000 as a reasonable royalty.

Apple claimed on appeal to the Federal Circuit that the district court had made a great many errors. Two warrant notice.

No error in excluding reexam

Apple urged that the district court should have let it tell the jury about the reexams. It contended that the USPTO's initial rejection of the patents in the reexams supported Apple's claim that it reasonably believed the patents invalid and therefore did not infringe them willfully.

The panel disagreed. It noted that "this court's precedent has often warned of the limited value of actions by the PTO when used for such purposes." Id. at 23 (citing cases). It then held that the district court did not abuse its discretion "in finding that the probative value was substantially outweighed by the risk of unfair prejudice to the patentee, confusion with invalidity (on the merits), or misleading the jury, thereby justifying exclusion under Federal Rule of Evidence 403." Id. at 23-24 (citing cases).

Damages for "smallest salable unit"; Nash bargaining

Apple also attacked the underpinnings of the $368 million damages verdict. It urged that the jury based its award on the "entire market value" of Apple devices rather than the contribution of only the infringing feature. The Federal Circuit agreed.

The district court erred in two ways, the panel held. The court's instruction that the jury "should not use the value of the entire apparatus or product" did not go far enough, the panel concluded, because the instruction permitted the jury to use the "entire market value" of the infringing devices if it found "the product in question constitutes the smallest saleable unit containing the patented feature." Id. at 28 (quoting instruction).

As the panel explained:

[T[he instruction mistakenly suggests that when the smallest salable unit is used as the royalty base, there is necessarily no further constraint on the selection of the base. That is wrong. For one thing, the fundamental concern about skewing the damages horizon — of using a base that misleadingly suggests an inappropriate range — does not disappear simply because the smallest salable unit is used.

Moreover, the smallest salable unit approach was intended to produce a royalty base much more closely tied to the claimed invention than the entire market value of the accused products. . . . Where the smallest salable unit is, in fact, a multi-component product containing several non-infringing features with no relation to the patented feature (as VirnetX claims it was here), the patentee must do more to estimate what portion of the value of the product is attributable to the patented technology.

Id. at 29.

The other error related to testimony by VirnetX's expert on "Nash bargaining", which John Forbes Nash, Jr. — he of A Beautiful Mind — originated. The expert used the "Nash Bargaining Solution" to opine that, in a hypothetical bargain, Apple and VirnetX would have agreed to split Apple's profits from the infringing feature on a 55-45 basis after using 50-50 as a benchmark.

The panel compared the approach to one it outlawed in Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292 (Fed. Cir. 2011) — "the 25 percent rule of thumb", which posited that parties to a hypothetical reasonable royalty negotiation would start by assuming that 25 percent of the infringer's profits from the infringing product provided an appropriate starting point. See Blawgletter, Jan. 6, 2011, Rule Behind Huge Patent Damages Dies at Hands of Federal Circuit, Second Rule Lives to Fight Another Day.

Like the old rule of thumb, the panel observed, the 50-50 premise "would . . . run the significant risk of inappropriately skewing the jury's verdict." Id. at 39. The fact that the damages expert did not establish that the "premises" of the Nash model "fit" the facts of the case, the court held, "was an essential failing in invoking the Solution." Id. at 38-39.

The court remanded the case for further proceedings.

Upshot

The rulings in VirnetX (a) bolster the inclination of most district courts to exclude evidence of non-final action by the USPTO in reexam proceedings and (b) clarify the sort of evidence that infringement clamants should submit in support of damages awards.

The court did not disapprove using an entire device as the "smallest saleable unit" but did require further analysis when the SSU has both infringing and important non-infringing features. The court also demanded more rigor from invocations of Nash bargaining but did not categorically preclude them.

____________________

^*One of the panel members, Randall R. Rader, retired on June 30, 2014. The panel heard oral argument on March 3, 2014.