A Futile Effort? Efforts to Clarify the Entire Market Value Rule

Company A owns a patent that tells the difference between CDs and DVDs. Company B infringes on A’s patent by incorporating A’s technology into the laptops B manufactures, which incorporates thousands of other patents. Generally in calculating damages, total royalties awarded equal the royalty base multiplied by the royalty rate. Should the proper royalty base be the value of all the infringing laptops sold or the value of all infringing disc-drives sold? Suppose there was some evidence customers were buying the infringing laptops because of A’s patent?   This hypothetical, based on LaserDynamics Inc. v. Quanta Computer, Inc., illustrates an area of patent reform subject to debate regarding the proper scope of the Entire Market Value Rule (EMVR). Company B may pay hundreds of millions more in damages in this multi-component patent case depending on whether EMVR applies yet the present case law describing when EMVR applies is murky. Despite efforts by the Federal Circuit to clarify EMVR’s application, uncertainties remain. This post reviews some of the present uncertainties and surveys commentary regarding EMVR.

EMVR in a Nutshell

The Patent Act requires that courts “award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer, together with interests and costs.” 35 U.S.C. § 284 (2006). The statute further provides that courts “may receive expert testimony as an aid to the determination of damages or of what royalty would be reasonable under the circumstances.”

Generally, reasonable royalties must be based not on the entire product, but instead on the “smallest salable patent-practicing unit.” For example, in Cornell Univ. v. Hewlett-Packard Co., the court found that a computer processor was the “smallest salable patent-practicing unit” where a patent pertained to “multiple and out-of-order computer processor instructions in a single machine clock cycle” and where the marketed product was a server that contained the infringing processors.

However, Rite-Hite Corp. v. Kelley Co., Inc. established that a royalty award may be based on the entire unit if (1) the infringing component forms the basis for consumer demand for the entire apparatus, (2) the infringing and non-infringing components are parts of a complete machine, or single assembly of parts, and (3) the infringing and non-infringing components are analogous to a single functioning unit. This rule is known as the Entire Market Value Rule.

In 2012, the Federal Circuit limited the application of EMVR to “narrow” circumstances in LaserDynamics. There, LaserDynamics claimed infringement to a patent describing “a method of optical disc discrimination” that allows an optical disc drive to determine the type of disc inserted, for example, a CD or a DVD. Quanta used LaserDynamics’ patent in manufacturing their laptops. Finding that LaserDynamics failed to show the patent “drove demand for the laptop computers,” the court denied application of EMVR and set a high evidentiary hurdle for Plaintiffs.

Uncertainties Remain

Even in light of LaserDynamics and an abundance of case law attempting to explain the applicability of EMVR, predicting EMVR’s applicability remains difficult for practitioners.

The standard of forming the “basis for consumer demand” is unsettled. Does the patent have to be “the basis” for demand? Or is it enough to be just a “substantial basis”? This confusion stems in part from Marconi Wireless Tel. Co. of Am. v. United States, 99 Ct. Cl. 1 (1942), which provided that a patent that “substantially created the value of the components parts” permitted application of EMVR. There, a patent for tuning in radios “substantially created” the value of radio receivers and transmitters. Commentators note that the possible relaxation of the higher “the basis” standard was due to the difficulty in determining “the basis” in a complex device like the radio.

Conversely, in Lucent Techs., Inc. v. Gateway, Inc., a method patent pertaining to the entering of information into Microsoft Outlook was found not to invoke EMVR where evidence failed to show “the basis—or even a substantial basis” of consumer demand. In Uniloc USA, Inc. v. Microsoft Corp., the Federal Circuit, citing Lucent and Rite-Hite, noted that EMVR was appropriate where the patent forms the “basis for customer demand” or “substantially create[s] the value of the component parts.” Applying this standard, the court found that EMVR does not apply where Uniloc failed to present evidence that their patent for deterring software copying in Microsoft office products formed the basis or the substantial basis of consumer demand. Following LaserDynamics, Brocade Commc’ns. Sys. Inc. v. A10 Networks, Inc. found that patents for global server load balancing and recording round trip information for host server switches did not serve as the primary basis of consumer demand for products incorporating those patents. Although the expert testified that the patented features were important and that A10 could not have sold the products without them, the judge found that “Brocade presented no evidence, such as consumer surveys or even customer testimony, that the patented features were the primary reason consumers bought the AX product.”

Most recently, a Pennsylvania district court applied LaserDynamics to hold that total values could be used to support reasonable-royalty calculations where evidence showed that the patents-in-suit were considered “must have” technology.

Prior versions of the Senate and House patent reform bills, S. 515 and H.R. 1908, would have EMVR apply only upon a showing that the invention’s “specific contribution over the prior art is the predominant basis for market demand.” While that provision was ultimately removed, criticism of the EMVR persists.

Implications

Even if courts or the legislature settle the standard for forming the “basis for consumer demand,” predicting what is enough to satisfy this standard remains difficult. For instance, consumer surveys have been frequently used to asses consumer demand, most successfully in i4i Limited Partnership v. Microsoft Corp.  But their reliability is highly uncertain due to problems with sample size, bias in creating survey questions, and underreporting. This has led some commentators to conclude that in addition to not knowing what showing of consumer demand is sufficient, it is unclear when the survey data itself will be admissible.

Evidentiary rules may sometimes conflict with application of the EMVR, as a patentee who has a strong case for application of EMVR may have its consumer demand evidence excluded on evidentiary grounds. However, the possibility of the lower “substantial basis” standard may be a driver towards settlement even where EMVR may not be ultimately applied.

Creative experts may find ways to subtly incorporate EMVR information into their analysis of a reasonable royalty. For example, if EMVR applies, experts could recommend a low royalty percentage to correspond with the large royalty base. Should EMVR not apply, experts could merely adjust their royalty percentage higher to correspond with the lower royalty base. This was tacitly permitted in Lucent where the court noted that there was “nothing inherently wrong” which such a tactic.

What originally began as a protection for patentees has substantially eroded in favor of infringers, leading some to advocate for abolishing the EMVR. However the uncertainties are resolved, patentees arguing in favor of flexible EMVR standards and lower evidentiary hurdles will contend that the high hurdles favor infringement, and deter invention, development, manufacture, and marketing of inventions. Patentees may point to commentary indicating that abolishing the EMVR would provide infringers with “nothing to lose, and everything to gain.” Accused infringers will vigorously argue that any relaxation of EMVR will force newcomers to a field into settling lawsuits where the validity of the patent is doubtful, and lead to excessive damages, pointing to studies of overcompensation of patentees and urging reform of the EMVR.

Cite as: Jonathan Ma, A Futile Effort? Efforts to Clarify the Entire Market Value Rule, Berkeley Tech. L.J. Bolt (February 23, 2014), http://btlj.org/?p=3207.
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