Sound Evidence Required for Lost Profits Claim

Tyco Healthcare Group LP v. Ethicon Endo-Surgery, Inc., 2013 U.S. Dist. LEXIS 43992 (March 28, 2013)

In this patent infringement suit in federal court (D. Conn.), the plaintiffs claimed lost profits, in addition to reasonable royalty damages, but their expert stumbled when he tried to show causation to lost sales by calculating the market share allocation the plaintiffs would have had “but for” the defendant’s infringing products. His reasonable royalty analysis gained better traction in the court.

Both parties manufactured “advanced energy” surgical products for laparoscopic and minimally invasive procedures. The plaintiffs claimed the defendant violated three of its patents for ultrasonic surgical devices—instruments that use ultrasonic energy to cut and coagulate vessels in surgery. In a bench trial, the court found infringement as to all three patents.

Entire value of devices. In terms of damages, the parties stipulated that the plaintiff only had a right to a reasonable royalty for the defendant’s initial six-year infringement, from 2004 to January 2010. At the same time, the plaintiffs requested lost profits and royalty damages for violations from 2010 to the present. Both sides presented expert testimony.

The plaintiffs’ expert calculated damages based on the entire market value of the patented products. The defendant objected, but the court agreed with the expert’s approach. The patented features of the accused devices were physically connected to and part of the instruments, and, besides, the defendant’s damages expert used the entire market value of the infringing products in his own calculations.

Lost Profits. The plaintiffs had to prove a right to lost profits by passing the four-part Panduit test, showing: (1) there was demand for the patented product; (2) causation to lost sales, through evidence that there was no non-infringing substitute for the protected products or that the plaintiffs had an established market share; (3) a manufacturing and marketing capability to exploit the demand; and (4) the amount of profit they would have made absent the infringement. Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F.2d 1132 (6th Cir. 1978).

They satisfied the first part and sought to meet the second requirement by way of a model their expert developed to reconstruct the market and show the plaintiffs’ share absent the infringing products. The relevant market was one of advanced-energy-based cutting and coagulating devices in which the plaintiffs competed with two different types of products, those using ultrasonic energy and others using radiofrequency (RF), the expert said. The litigants dominated the market and competed directly with each other. The defendant’s marketing and R&D materials showed that it considered the plaintiffs’ RF energy products competition, and witnesses for both sides stated that surgeons used both types of instruments for the same type of surgeries. This proved that these devices functioned interchangeably, the expert stated.

In the “actual market” in 2010, when the infringing products were available, the plaintiffs had a 24% market share, he determined. In the “but for” market of 2010, the plaintiffs would have had a 54.2% market share. For 2011, the plaintiffs’ actual market share was 27.5%, but, under the expert’s reconstruction, it would have been 60.2%. This increase was due to the steady rise in the use of RF technology, he said, relying on a 2010 report from the Millennium Research Group (MRG) on vessel-sealing instruments. The analysis projected that by 2014 the two energy sources would have something akin to a 50-50 market share. In a world without the infringing products, the plaintiffs would achieve a higher share, he concluded.

The defendant’s expert painted a different picture, claiming primarily that the “immune” products would fill in the “hole” the market experienced once the infringing devices were unavailable. In 1999, those products had an 86.9% market share. But, by his account, in the actual 2010 world, it was at most 0.2%. As expected, the plaintiff’s expert completely disagreed with the defendant’s expert’s line of thinking.

The court rejected the model the defendant’s expert proposed but found the market reconstruction of the plaintiffs’ expert also problematic. For one, the MRG document included information that found the two product types had “separate strength,” a point that “undercut” the expert’s argument. There was insufficient evidence from which to infer that “RF technology would have taken over the advanced energy market to the extent [the plaintiffs’ expert] claimed,” the court concluded. Because the plaintiffs failed to prove causation, they could not claim lost profits.

Cooperators versus competitors. Next, the court considered the experts’ rival reasonable royalty testimony based on the Georgia-Pacific factors.

Reasonable royalty. Both experts agreed on the starting date of a hypothetical negotiation but disagreed over the significance of a series of licensing agreements between the plaintiffs and outside parties and the defendant and third parties.

Ultimately, the plaintiffs’ expert concluded the royalty rate would fall between 12% and 15%, whereas the defendant’s expert put it between 1.5% and 5%, recommending a 2.6% rate.

The agreements included a 1996 contract in which another company granted the plaintiffs a license for one of the patents in suit at a 5% royalty rate. The plaintiffs’ expert found it not probative because the parties were “cooperators,” instead of direct competitors—thus, in a relationship unlike that of the litigating parties. Under the agreement, both sides would develop technology to build an ultrasonic device.

He also rejected a second agreement involving the plaintiffs and showing a 5% rate because it centered on technologies that were not sufficiently related to the technology at issue. The fact that the plaintiffs had not granted any other licenses for the patents in suit would drive up the rate.

The defendant’s expert used the first agreement to set a 5% upper limit for his royalty range, but the court agreed with the plaintiffs’ expert. There were substantial dissimilarities, such that the 5% rate did not “necessarily indicate an upper ceiling of the reasonable royalty rate.”

An agreement the defendant made with a third party in 1995 covered components with which to assemble a licensed instrument—an ultrasonic handpiece design. It limited the defendant’s right to operate in a “licensed field” and required it to pay a lump sum of $200,000, plus a royalty of 1.5% of net sales. Based on this rate, the defendant’s expert set the lower limit of his range at 1.5%.

The plaintiffs’ expert pointed out that the contract “significantly predated” the date of the hypothetical negotiation and was irrelevant to the success of the ultrasonic technology that factored into a 2000 negotiation. The court agreed this rate was not probative.

A 1998 agreement between the defendant and another company built on the parties’ earlier 1992 contract. The parties cross-licensed their patents at a zero percent royalty rate; they specified there would be negotiations for any patents either side wanted to add and that the rate would not exceed 3%. If one side wanted to add a second patent to the same product, they could negotiate a rate up to 5%.

The defendant’s expert found those rates to be “ceilings.” The plaintiffs’ expert focused on the contract’s last clause, stating that, in the event of termination of the agreement, “the royalty rate for any patent licensed by such terminating party … shall be doubled for the remaining term of the license.” This provision, he contended, was critical because it showed what would happen if the relationship between licensing parties changed from cooperative to competitive.

Under another agreement, the defendant granted a third party a license to a patent that covered ultrasonic surgical technology for a $66-per-unit royalty payment. This contract was “highly relevant,” the plaintiffs’ expert stated, because it revealed the value the defendant placed on this very type of technology. Considering the sales price for the defendant’s best-selling ultrasonic surgical instrument—between $376 and $624—the per-unit royalty payment would equal 11% to 18% of the per-unit revenue of that product, he calculated.

The defendant’s expert dismissed it as not comparable because it was a collaborative agreement. The court disagreed, noting that the defendant’s expert, himself, had described the patent at the heart of the contract as “one of the foundational patents … of ultrasonic.” The agreement was relevant in that it showed the defendants required a relatively high royalty rate “for a technology that shares some common features with the ultrasonic patents in suit.”

Considering several other factors, the court concluded that the appropriate royalty rate was 8%. It was sufficiently higher than the 5% rate the 1996 agreement specified for cooperating parties. And, on one hand, it accounted for the fact that the defendant had its own ultrasonic technology in the form of the “foundational” patent and its immune products; on the other, it considered that the defendants’ accused products were far more successful than its immune products.

While the court denied the lost profits claim, the court applied its 8% rate to $1.75 billion of infringing sales, awarding the plaintiffs royalty damages of nearly $141 million.

The calculation of lost profits are prophesies of the future – and like all prophesies they are subjective. At Rosenfarb LLC we produce well supported, well-reasoned and well communicated damage calculations that withstand the rigors of litigation. We are a firm of forensic accounting and valuation experts. We understand business, have keen insights and always connect the dots. We understand the litigation process. We frame the issues simply and in alignment with the litigation strategy. We use logic to support our opinions, while creating compelling stories. We are sincere, professional and credible. We are accounting experts with legal acumen.