While the pendulum has clearly swung in favor of limiting recovery of patent infringement damages, most notably in patent cases where non-practicing entities seek reasonable royalty damages, lost profits damages are not among the casualties.

Photo of Judge Alsup in Chambers
Hon. William Alsup: courtesy Google Images

United States District Court Judge William Alsup (ND Cal) is a notoriously hard grader when it comes to determining whether to allow patent infringement damage studies to go to the jury.  He nonetheless allowed expert studies calculating lost profits on the infringer’s sales to go to the jury in his Order in Plantronics v. Aliph, 3:09-cv-1714 (ND Cal).  His analysis confirms that, notwithstanding current trends favoring aggressive judicial gatekeeping over expert damage studies in patent cases, lost profits are recoverable so long as they are supported by an appropriate market reconstruction theory.

Quick note: this post focuses on patent cases between competing operating companies separate and apart from patent cases brought by non-practicing entities (NPEs) sometimes called “trolls.”  While in NPE cases there are compelling policies favoring aggressive use of the entire market value rule and related apportionment rules to limit reasonable royalty damages, these same policies are nowhere near as strong in competitor patent litigation.

At least three highlights of the lost profit rulings in Plantronics:

  • Reasonable royalty apportionment rules don’t apply to lost profits
  • You can use the patent owner’s market share in the reconstructed market to calculate lost profits
  • You can recover lost profits under a market share theory even if there are acceptable, non-infringing substitutes

So let’s break this down.

Reasonable royalty apportionment rules don’t apply to lost profits.

In Plantronics, Aliph’s counsel attacked lost profits for not properly apportioning damages between invented and non-invented features.  In what must have set a world’s record for the number of times the word “apportionment” was used in a single brief, Aliph’s counsel sought to extend the rules governing reasonable royalty damages to lost profits.  What Aliph’s counsel was trying to do was take advantage of recent Federal Circuit decisions limiting the size of reasonable royalty damages.  True enough, the pendulum has clearly swung in favor of imposing more stringent requirements to recover reasonable royalty damages, but Judge Alsup was having none of the attempt to extend these rules to lost profits:

Aliph leads its attack by imposing on Dr. Lynde, Plantronics’ lost profits expert, a duty to apportion consumer demand for the allegedly infringing features by citing to reasonable royalty decisions. This supposed duty that Aliph wants under the first Panduit factor is not required by Federal Circuit decisions:

The Panduit factors do not require showing demand for a particular embodiment of the patented functionality . . . . Nor does it require any allocation of consumer demand among the various limitations recited in a patent claim.

Versata Software, Inc. v. SAP Am., Inc., 717 F.3d 1255, 1265 (Fed. Cir. 2013), cert. denied, No. 13-716, 2014 WL 210681 (2014) (internal citations omitted). “Instead, the first Panduit factor simply asks whether demand existed for the ‘patented product,’ i.e., a product that is ‘covered by the patent in suit’ or that ‘directly competes with the infringing device.’” DePuy Spine, Inc. v. Medtronic Sofamor Danek, Inc., 567 F.3d 1314, 1330 (Fed. Cir. 2009). There is ample evidence from which a jury could reasonably conclude that there was and is demand for the patented part of the goods in question, the earbud using the claimed design.

You can use the patent owner’s market share in the reconstructed market to calculate lost profits.

To get lost profits as damages, the patent owner must demonstrate that there was a reasonable probability that, but for the infringement, it would have made the infringing sales.  The “but for” inquiry therefore requires reconstruction of the market as it would have developed absent the infringing product to determine what the patentee would have made.  Significantly, the Federal Circuit has not blessed one particular market reconstruction theory as supreme, but instead permitted experts to proffer a variety of theories and evidence in support of their opinions.

Plantronics’ expert used the market share reapportionment theory from State Industries, Inc. v. Mor-Flo Industries, Inc. to reconstruct the market.  Under Mor-Flo, a patent holder can recover lost profits based on lost sales in proportion to its market share within a multiple competitor market adjusted to exclude the infringing sales.

Aliph’s counsel attacked the use of Mor-Flo market share on the grounds the infringing sales allegedly had little to no effect on Aliph’s sales, return rates and market share.  Judge Alsup disagreed, finding that Plantronics’ use of a market share theory to reconstruct the “but for” market was sufficiently sound under not just Mor-Flo, but also more recent Federal Circuit decisions in Crystal Semiconductor Corp. v. TriTech Microelectronics Int’l, Inc., and Versata Software, Inc. v. SAP Am., Inc.See Order at 5-7.

Aliph also argues that Dr. Lynde opined that all of Aliph’s relevant sales would have flowed to Plantronics. Not exactly. What Dr. Lynde did was reconstruct the market to remove Aliph’s infringing sales and reallocate those sales to the remaining competitors. After such reconstruction, he found that Plantronics would hold approximately 17% of the market share for the relevant period. He found that Plantronics had the manufacturing and marketing capacity via its own facilities and third-party suppliers to take on the lost units. He found that Plantronics would have won its share of Aliph’s infringing sales.

In Versata, the Federal Circuit affirmed the jury’s award of lost profits. 717 F.3d at 1267.  The expert identified a pool of potential customers for the accused software and counted defendant’s infringing sales during the relevant period. Then, the expert used plaintiff’s historical customer win-rate to calculate the customers plaintiff would have won but for defendant’s infringement. The expert went on to discount the customer pool because plaintiff would not likely resume making sales at the same pace as historical rates and the expert isolated the value of each lost sale. He differentiated between sales with the licensed technology and general sales. The pool of lost sales was then multiplied by the amount lost per sale to result in lost profits. Id. at 1265–67.

In much the same fashion, Dr. Lynde started by calculating the sales Plantronics would have made but for Aliph’s infringing sales and then calculated the incremental profit that Plantronics would have made on those lost sales.

You can recover lost profits under a market share theory even if there are acceptable, non-infringing substitutes.

In Plantronics, there were acceptable, non-infringing substitutes in the relevant market (premium Bluetooth headsets), but this did not warrant exclusion of the expert’s lost profit study.  Why? Because, as Judge Alsup found compelling, Plantronics’ expert had determined that there were no acceptable, non-infringing substitutes for the infringing products in at least that portion of the relevant market in which Plantronics’ products practicing the patent competed directly with the infringing Aliph products.  Plantronics’ expert limited the number of diverted sales that Plantronics would recapture to the market share of these specific Plantronics’ products.

Contrary to Aliph, Dr. Lynde did not state that no acceptable non-infringing substitutes existed. What Dr. Lynde did say was that for at least a portion of Aliph’s sales, there was no acceptable non-infringing substitute. He based this opinion on the lack of design-around options, Plantronics’ and Aliph’s sales trends, and that Aliph switched to the accused earbuds to address “fit problems,” product returns, and complaints.  To estimate the appropriate portion, he focused on three of Plantronics’ products which allegedly practice the asserted patent.’

Judge Alsup’s analysis demonstrates that a successful Mor-Flo market share calculation requires more than simply identifying the relevant market, but instead further removing from the market products with disparate pricing and features.

A final note on the relationship between Mor-Flo market share theory and proof of non-infringing substitutes:  Typically, proof that there are no non-infringing substitutes is a precondition to showing the patent infringement caused the patent holder to sustain lost profit damages.  Plantronics, in its brief to the court, provided ample authority for finding Mor-Flo market share methodology substitutes for proof there are non-infringing substitutes for the infringing products – in other words, under the Mor-Flo market share, lost profits may be recovered even if there are acceptable, non-infringing substitutes in the market:

Under this approach, a patent holder can recover lost profits based on lost sales in proportion to its (adjusted) market share even where there are non-infringing substitutes in the relevant market. Mor-Flo, 883 F.2d at 1577-78 (“So we think that in these circumstances the presence or absence of acceptable noninfringing alternatives does not matter.”)

In Grain Processing, the Federal Circuit cited Mor-Flo as an example of a viable approach to market reconstruction. Grain Processing Corp. v. Am. Maize–Prods., 185 F.3d 1341, 1350 (Fed. Cir. 1999) ([T]rial courts, with this court’s approval, consistently permit patentees to present market reconstruction theories showing all of the ways in which they would have been better off in the “but for world,” and accordingly to recover lost profits in a wide variety of forms. See, e.g., . . . State Indus., 883 F.2d at 1580 (upholding award of lost profits in proportion to patentee’s market share of the relevant market including acceptable noninfringing substitutes). See also Crystal Semiconductor, 246 F.3d at 1355 (Fed. Cir. 2001) (Federal Circuit affirmed award of lost profits based upon market share of relevant segment of the market); Abbott Diabetes Care Inc. v. Roche Diagnostics Corp., 2007 WL 4166030 at *2 (N.D. Cal. Nov. 19, 2007) (“Where there are non-infringing alternatives, a patentee may still be able to recover lost profits based on market share of the reconstructed market, without the defendant’s infringing products.); 2011 N.D. Cal. Model Patent Jury Instructions, Instr. 5.3 (“[Patent holder] is entitled to lost profits if it proves … there were no non-infringing substitutes, or, if there were, the number of the sales made by [alleged infringer] that [patent holder] would have made despite the availability of other non-infringing substitutes.”) and 5.3 (“One way [patent holder] may prove the number of sales it would have made if the infringement had not happened is to prove its share of the relevant market excluding infringing products. You may award [patent holder] a share of profits equal to that market share.”)

As it turned out, Judge Alsup, in ruling on the admissibility of Plantronics’ lost profit damage study, did not reach this issue because Plantronics’ expert presented sufficient evidence that were no acceptable, non-infringing substitutes in the specific market segment used to calculate Plantronics’ “but for” market share.  But if Judge Alsup had reached this issue, he had ample authority to support a finding that under a Mor-Flo market share methodology proof there were no non-infringing substitutes is not required.