Assessing And Calculating Economic Damages In IP Disputes

Monday, November 19, 2012 - 11:04

The Editor interviews Richard J. Gering, PhD, Principal, EisnerAmper LLP.

Editor: Please tell us about your background and experience.

Gering: I have a PhD in economics from the University of Maryland and did my undergraduate studies in South Africa. I also have a CLP designation which stands for Certified Licensing Professional. This designation relates to valuing and evaluating intellectual property.

While at Maryland, I worked for a small economic consulting firm called Meridian Research. After that, I went to Coopers & Lybrand which became PwC. I moved to ParenteBeard in 2002 and joined EisnerAmper in August. At all of those firms I have been doing similar work.

Editor: What types of economic damages are available in intellectual property infringement disputes?

Gering: I will focus on patent damages because this is the most developed area of case law in the IP world. Assuming there is infringement, the patent holder is entitled to no less than a reasonable royalty, and the holder may also be entitled to lost profits. Lost profits are available if you can show that, absent the infringement, you would have made additional sales. The profits on those additional sales are the lost profits.

Economic damages may be available as part of lost profits in other ways. For example, the infringement may cause price erosion – a decrease in the product price – which means that not only did you lose sales but also that your existing sales are made at a lower price because of the infringer’s entry into the market.

Editor: Take us through the process of determining damages.

Gering: Going back to the concept of a reasonable royalty, the idea is that there are two parties: the patent holder who would be the licensor, and the assumed infringer who would be the licensee. The process involves taking them back in time to the start of the licensee’s infringement and assuming that the licensee asks the patent holder for a license.

The ensuing “hypothetical negotiation” leads to the determination of a royalty. Royalty structures can be expressed, for example, as a straight percentage of sales or as a fixed amount per unit sold, or as a lump-sum amount.

The seminal case Georgia-Pacific Corp. v. United States Plywood Corp. resulted in the enumeration of 15 factors for the calculation of reasonable royalty damages. Economists assess a hypothetical negotiation in the context of those 15 factors while also applying the unique facts and circumstances of the parties and of the technology or product at issue.

Of course, this hypothetical negotiation is based on certain assumptions, namely that there was infringement, that the patent is valid and that the parties would have reached a licensing agreement.

It’s up to the damages expert to examine the situation from both sides to determine what the licensor would demand and what the licensee would actually pay. There’s a lot of flexibility in determining the “reasonableness” of a royalty, and there’s a tremendous amount of new case law that, at present, is not always perfectly consistent and can go in different directions.

Editor: How has the process of calculating IP damages evolved since the advent of technology?

Gering: Damages are more difficult to calculate in today’s IP disputes. Certainly the fast pace of innovation is an important factor, one that also may cause businesses to select other forms of IP protection, such as copyright or trade secret, instead of patenting an invention.

To put things in perspective, some people estimate that 80 to 90 percent of a company’s value may be tied to its IP. And technology-related products complicate matters further, for instance, smartphones may contain technology covered by 500 patents – only one of which may be at issue in a given dispute.

So how do you evaluate the importance of individual patents in this context? No one buys a piece of a smartphone, though certain features may be optional, such as a specific application. Tying it back specifically to the IP in dispute can therefore be complicated.

Further, there’s a tremendous amount of flux in the recent case law. Juries find these cases difficult because, for instance, the entire concept of “telephone” has changed dramatically in recent years. Today a smartphone is a computer, a device for listening to music, browsing the Internet and video conferencing. Personal computers often come with an entire software package, only one piece of which may be in dispute. Cars have many components, so a dispute involving one aspect such as the anti-lock brakes requires a determination of how important this individual component is to a consumer’s decision to buy one car versus another.

Assessing how these issues translate in economic terms requires piecing together a story by looking at the facts and circumstances, understanding the technology, making valid assumptions and trying to understand how the businesses actually behave and compete in the real world. The difficulty of this process contributes to the variability and uncertainty in litigation that I mentioned earlier.

In dealing with a technology patent, the dispute could be over whether the patent actually does cover the technology. As the economist, you need to get an understanding of the technology in order to make assumptions. If the trier of fact doesn’t believe the economist’s starting assumptions on the patent, the outcome can be as stark as invalidating a patent and having no damages awarded.

Editor: Do you consider macro economic factors in your analyses?

Gering: Yes. For example, it’s an economic reality that the price of consumer electronics, such as laptops, usually decreases over time, or if the price stays constant, the quality and capabilities of the laptop increase. Therefore, consumers may get more for their money with later product versions, and damages calculations should incorporate this concept.

Conversely, the situation may involve a product that is essential to one party’s ability to compete within an industry – which presents the risk of understating value if the economist doesn’t consider macro factors relating to that industry.

Editor: How are damages calculations affected when the patented innovation is held by a non-practicing entity?

Gering: Typically, a non-practicing entity (NPE) only has the option to ask for royalty damages because the NPE never made anything from the patented technology. An NPE could be a university or research institute versus a person who buys patents for the express purpose – as a business model – of enforcing them: so-called “patent trolls.”

There is economic, legal and political discussion as to whether patent troll litigation is bad from the public policy perspective because of a concern that it actually diminishes, rather than enhances, innovation. Our Constitution reflects the concept that innovation is good for the country and that effective protections will encourage innovation because innovators can recoup their costs.

But in reality, the law applies equally to all NPEs. One interesting direction this debate is taking applies to our earlier discussion of how a patent may address only one tiny aspect of a larger product. There is a cottage industry of case law and economic writings involving something called the Entire Market Value Rule (EMVR), which deals with how to analyze the royalty negotiations when the patented technology is a very small component of the disputed product.

Editor: Please talk about assessing value when a particular innovation has a limited life cycle.

Gering: An important valuation factor for such innovation is its launch date and economically useful life, which has a positive correlation with its value. That can be a complicated assessment, let’s say, in the pharmaceutical world where, regardless of huge sales numbers that can be generated in just a few days, it’s extremely valuable to be the first to the market.

The same applies in the technology world, with great value placed on being perceived as the leading innovator, even though you may be constantly updating products. Put simply, many consumers want to buy the “coolest” products from leading-edge companies. So for these industries, a few days can have a big impact on value.

Editor: Please talk about your work as an expert witness in IP infringement damages cases.

Gering: There are three primary aspects to this work. First, you need the right credentials and expertise, certainly training as an economist or CPA but also knowledge of the relevant legal construct because there are certain things you may or may not do depending on how the courts have ruled.

Next is applying that expertise to the facts of the case to determine a reasonable and appropriate answer. The major hurdle to overcome – and what makes the work unique – is that you have to be able to defend your conclusion in depositions and on through various legal motions and, finally, at trial. You want to ensure that the courts accept your answer as reasonable and non-speculative and, therefore, that you will be allowed to testify before a jury.

The last piece involves presenting this often complicated, sophisticated and detailed analysis to a jury that may not have experience with the core concepts involved. You have to tell an engaging and credible story that summarizes all the key facts and nuances so that the jury can understand the story in context.

Then you have to be able to defend that story under cross examination. Juries are very interested in the direct examination because that’s the story, but they’re also interested in how you respond to a very smart person on the other side who might try to paint your direct testimony as biased toward your client.

And this is precisely why the conclusions I provide as an expert witness have to be reasonable and not simply geared toward obtaining the highest settlement. Common sense works with a jury. All people gain economic experience in their daily lives. They may not be economists in the academic sense, but they make buying and selling decisions every day, so my work really has to tie back to this common wisdom.

Editor: Please talk about evaluating intellectual property in non-dispute contexts.

Gering: Disputes often arise because the parties couldn’t reach an acceptable licensing agreement. Once a dispute arises, we’re reduced to looking at monetary damages and testifying for one of the parties.

So, it stands to reason that there is more flexibility in the non-dispute world, where businesses can craft customized arrangements, such as joint ventures or cross-licensing agreements. Trust is a key component of these arrangements, and a critical benefit is that each business remains master of its own fate.

I’ve handled situations where, prior to litigation, people seek my assessment of how things might play out in court. Obviously, this kind of analysis is somewhat down and dirty because you only know one side of the story, but it can lead to productive settlement negotiations and save a lot of time and money in avoiding litigation.

Please email the interviewee at richard.gering@eisneramper.com with questions about this interview.