A Texas court recently rejected a defendant’s proposed reasonable royalty for failing to account for the infringed patent's true value. The defendant tried to base the royalty on the price of a product component physically implementing the patent's inventive aspect. But the court found this royalty base insufficient, emphasizing that the true value lay in the patented idea and the solution it brought to a prevailing problem in the industry. The defendant's proposal was particularly problematic, the court noted, given the pervasive infringement of the plaintiff's patent in the industry, which artificially deflated the price of the product's components. The court then ruled that the defendant's end products served as the most appropriate royalty base, as they more suitably captured the patent's value and reflected the patent owner's licensing practices.
Patent owners seeking to monetize patents covering technologies essential to practice technical standards ratified by standards organizations, such as the Institute of Electrical and Electronics Engineers ("IEEE"), may have contractual obligations to the standards organizations and its members that they will license the patents, known as standard-essential patents, on reasonable and nondiscriminatory ("RAND") terms. In determining a proper royalty rate, some courts have made specific adjustments to the traditional Georgia-Pacific analysis to take into account RAND commitments. In a recent case involving patent-infringement damages, Commonwealth Scientific & Industrial Research Organisation v. Cisco Systems, Inc.,1 the United States District Court for the Eastern District of Texas determined that a patent owner had committed to license under RAND terms for only a single technical standard out of many standards at issue. This commitment did not require modification of the traditional royalty analysis, the court found, because the accused infringing products practicing that particular standard constituted an insignificant fraction of the total products at issue.
Proceeding to ascertain an appropriate "reasonable royalty" in the case, the court found that the defendant's proposed royalty—based on the price of a product component physically implementing the patent's inventive aspect—failed to account for the patent's true value. Compounding this problem, the court noted, was the pervasive infringement of the plaintiff's patent in the industry, which artificially deflated the price of the components. The court then held that the defendant's end products served as the most appropriate royalty base, as they more suitably captured the patent's value and reflected the patent owner's licensing practices.
Commonwealth Scientific and Industrial Research Organisation (CSIRO) sued Cisco Systems, Inc. accusing Cisco of infringing its patent disclosing a wireless LAN that solved certain challenges to indoor wireless networking. The patent covered various 802.11 standards ratified by the IEEE, including the 802.11a and 802.11g standards. The accused products practiced a variety of these 802.11 standards, but the accused 802.11a products made up only a small fraction of the total products at issue. In addition, while each of the accused products contained a variety of components necessary to practice the patent-in-suit, it was largely undisputed that the wireless-chip component executed the patent's inventive aspect.
Cisco did not contest liability. Thus, the parties stipulated to try the case only on damages. They further agreed on the scope of Cisco's accused products and that damages should be based on a reasonable royalty. The parties differed, however, in calculating a reasonable royalty, so they proceeded to a bench trial leading to the present decision.
As a preliminary matter, the court rejected Cisco's affirmative defenses of legal and equitable estoppel, which asserted that CSIRO was obligated to license its patent under RAND terms for each of the 802.11 standards. Although CSIRO submitted letters of assurance to the IEEE contractually obligating it to license its patent under RAND terms for practicing the 802.11a standard, CSIRO did not do the same for the other 802.11 standards. Nor did any participants in the wireless industry accept CSIRO's voluntary offer to license its patent under RAND terms. According to the court, because the accused 802.11a products made up only a small fraction of the total products at issue, CSIRO's RAND commitment for that particular standard would insignificantly impact the royalty analysis. Thus, the court analyzed the record under a traditional Georgia-Pacific royalty analysis.
Turning to the parties' proposed royalty calculations, the court found both unreliable. Cisco argued that chip prices were the appropriate royalty base because the chip was the component most closely tied with the invention. Rejecting this theory, the court emphasized that Cisco's proposal failed to account for the true value of the patent-in-suit, which solved the "multi-path problem" for indoor wireless data communication. The chip itself, the court reasoned, is not the patented invention. Thus, according to the court, the price of the physical chip did not capture the patent's benefit, which lay in the idea. The court further analogized:
Basing a royalty solely on chip price is like valuing a copyrighted book based only on the costs of the binding, paper, and ink needed to actually produce the physical product. While such calculation captures the cost of the physical product, it provides no indication of its actual value.
Compounding this problem, the court noted, was the rampant infringement of CSIRO's patent in the wireless industry. Specifically, the court found it "illogical to attempt to value the contributions of the asserted patent based on wireless chip prices that were artificially deflated because of pervasive infringement." Ultimately, the court determined, Cisco's end products served as the most appropriate royalty base, as they more suitably captured the patent's value and reflected CSIRO's later licensing practices under its "Voluntary Licensing Program."
Although CSIRO's royalty proposal used Cisco's end products as the royalty base, the court found it suffered from a number of flaws, such as inadequate sample size and broad disparities in CSIRO's calculations of initial profit premiums for accused versus nonaccused products. Moreover, the court found, CSIRO's expert considered several Georgia-Pacific factors only qualitatively, without hard data. This approach further rendered CSIRO's proposal unreliable.
In the end, the court ordered a flat-rate royalty on each of Cisco's end products and based the royalty rate largely on CSIRO's "Voluntary Licensing Program."
Strategy and Conclusion
This case shows that in a reasonable-royalty damages analysis, courts are mindful of the true benefit that a patented technology brings to an industry and that a defendant receives from practicing such technology. Thus, although a particular product component may be most closely tied to the inventive features, the price of such a physical component may not provide an adequate indication of the patent's value. Moreover, parties should be aware that pervasive infringement of a patented technology may result in a false indicator of its true value due to artificially deflated prices.
1 The opinion can be found at http://www.finnegan.com/files/upload/LES_Insights_Column/2014/CommonwealthScientific_v_CiscoSys.pdf.