A New Framework for Determining Reasonable Royalty Damages in Patent Litigation

Following a jury trial in 2012, a US federal district court entered judgment in the amount of $1 billion in favor of Monsanto in a patent infringement dispute against DuPont. The strange thing about this case is that DuPont had not sold any infringing product at all; yes, you are reading correctly – $1 billion in royalties on zero sales. The $1 billion damages award reflected the jury’s best estimate of the lump-sum royalties that would have been agreed to in a hypothetical negotiation taking place just before the infringement began, in which the parties would only have had information available to the parties at that time (“ex ante information”) That DuPont ultimately did not actually sell any infringing product was ignored as being information that would not have been available to the parties at the time of the negotiation (“ex post information”).

Professor Tom Cotter and I have just posted a draft paper on SSRN, "A New Framework for Determining Reasonable Royalty Damages in Patent Litigation," arguing that this result is wrong. More generally, we argue that the hypothetical negotiation used for assessing a reasonable royalty should be assumed to take place at the time of first infringement (or, more precisely, first reliance), but the parties should be assumed to have available to them all the information that was available at trial. We call this the “contingent ex ante” approach; the hypothetical negotiation takes place ex ante, but it is contingent on all information available ex post. We apply our analysis to a variety of contexts, including standard essential patents; unexpected exogenous events (the market value of the invention changes because of unforeseen factors); separate and distinct infringements (when should damages be assessed on the basis of two distinct hypothetical negotiations, rather than one); regulatory uncertainty (when the patented invention received regulatory approach after the time of the first infringement); non-infringing alternatives (when a patent covering an NIA is held to be invalid after the time of the first infringement, but prior to trial), as well as in the context of lump-sum versus running royalties (which raises considerations of risk-shifting, strategic considerations in licensing and the time value of money).

While our discussion focuses entirely on US law, in my view the principles we discuss are equally applicable to Canadian law. Indeed, I suggest the argument is even stronger in Canadian law, for two reasons.

First, our basic argument is that using all available information, including ex post information, better serves the purpose of the Patent Act, which is to provide an incentive to develop inventions for the benefit of the public. Using ex post information allows more accurate determination of the true value of the invention, and so better aligns the patent incentive with the purpose of the Act. While patent damages are often analogized to a species of tort, they are ultimately statutory, and under the modern Canadian approach to statutory interpretation, the statutory provisions should be interpreted in a manner that it consistent with the purpose of the Act. (This makes our argument stronger than in the US, which has not yet fully embraced a purposive approach to statutory interpretation.)

Secondly, our argument is fully consistent with the Canadian approach to tort damages. In Athey v Leonati [1996] 3 SCR 458, the SCC said “past events must be proven, and once proven they are treated as certainties” [28]. This refers to all event prior to trial: “In this case, the disc herniation occurred prior to trial. It was a past event, which cannot be addressed in terms of probabilities” [30]. Most obviously, special damages are assessed on the basis of reasonable expenses that were actually incurred prior to trial, not what expenses the parties might have anticipated would be incurred. The fact that the plaintiff had not in fact suffered any harm as a result of a tort, perhaps because of a miraculously quick recovery, or that she had suffered unusually severe harm (the thin-skull rule), would certainly be considered in a Canadian tort case; we argue that in a case like Monsanto v DuPont, the fact that the infringer had not in fact made any sales should also be taken into account, for essentially the same reasons.

Here is the abstract:

Conventional analysis often assumes that there are only two theoretical options for calculating a reasonable royalty in patent disputes: a "pure ex ante" approach, under which a court reconstructs the hypothetical bargain the parties would have struck prior to infringement, based on the information available to them at that time; and a "pure ex post" approach, under which the court considers the bargain the parties might have reached as of some later date such as the date of judgment. The first approach avoids patent holdup - basing the royalty partly on the infringer's ex post switching costs - but cannot easily explain other longstanding features of how royalties are calculated, and can lead to awards that reflect the parties' erroneous ex ante expectations. By contrast, the pure ex post approach uses more accurate information about the invention's actual value, but it also enables the patentee to capture some of the patent's ex post holdup value. In this Article, we show that a "contingent ex ante" framework, under which the court reconstructs the bargain the parties would have reached ex ante, based on all relevant information that is available ex post, is superior to both of the conventional approaches. More specifically, our framework enables courts to base the royalty on the most accurate information available of patent value while avoiding the holdup risk arising from the pure ex post approach. We analyze how courts can apply our approach in various settings, including cases involving SEPs, sequential infringement, regulatory uncertainty, and unexpected exogenous events.

The paper is available at SSRN. It is a draft, so comments are welcome.

“The reasonable person thinks in terms of economics, not principle"

Apotex Inc v Canada 2014 FC 1087 Hughes J
            Trazodone

This decision emerged from a test case in which Apotex and Health Canada battled over the question of whether a generic could apply for an NOC on the basis of a foreign reference product. The case settled on terms favourable to Apotex, but HPB did not live up to the settlement agreement. In this decision Hughes J held Canada liable for breaching that agreement (though because of quirks in the pleadings, the formal ground of liability was in tort rather than contract). In an interesting part of the decision, Hughes J held that Apotex was subject to a duty to mitigate, which would essentially have required it to abandon its test case and leave the question of legal principle unanswered. Hughes J held that the duty to mitigate was nonetheless applicable, because “the reasonable person thinks in terms of economics, not principle” [159].

In the late 1980s, the attitude of what was then the Health Protection Branch (HPB) of Health Canada towards the use of a foreign drug product as the reference product in a generic’s application for an NOC was uncertain. It was the usual practice to use a product approved in Canada as a reference product, but occasionally an NOC would be granted on the basis of a foreign reference product. Apotex wanted a test case to establish whether it was entitled to use a foreign reference product [105]. It picked trazodone, and in January 1988 Apotex filed a New Drug Submission comparing its Apo-Trazad product to the innovator’s US product. On the particular facts, the use of a foreign reference product was scientifically sound, but HPB was concerned that allowing the use of a foreign reference product might set a precedent for circumstances in which the comparison was not appropriate [39]. Consequently, HPB “insisted on a Canadian standard, unless the United States reference product could be ‘conclusively proven to be identical’ to the Canadian product” [44]. The requirement of identicality made it effectively impossible to use a foreign reference product [44]. In other words, both Apotex and HPB were treating this as a test case. In light of this impasse, in 1990 Apotex sought judicial review of the Minister’s position. That litigation was settled on terms favourable to Apotex by a Settlement Agreement in November of 1990 in which HPB agreed to assess the application on the basis of “equivalency” rather than identicality [51].

No New Cases for the Week of 10 November

No new patent / NOC / data protection cases were released for the week of 10 November 2014.

It Is Not Necessarily an Abuse of Process for an Innovator to Switch Positions Across NOC Proceedings

Apotex Inc v Pfizer Canada Inc and G.D. Searle & Co / celecoxib (NOC) 2014 FCA 250 Noël CJ: Trudel, Boivin JJA aff’g ) 2014 FC 38 and NOC) 2014 FC 314 Harrington J
            2,177,576 / celecoxib / CELEBREX

The decisions under appeal, Mylan / celecoxib (NOC) 2014 FC 38 and Apotex / celecoxib (NOC) 2014 FC 314 (blogged here and here, respectively), turned primarily on the construction of the promised utility of the ‘576 patent. In both cases Harrington J interpreted the promise of the patent modestly and granted an order of prohibition to Pfizer. In a decision which is primarily an application of Plavix FCA 2013 FCA 186 (blogged here), the FCA has now affirmed both of Harrington J’s decisions. (While Harrington J’s decisions were separate, the reasoning was common, and the appeals were heard together [3].) While the FCA decision elaborates on some points relating to the promise of the patent, it is perhaps more noteworthy in its treatment of abuse of process, particularly the holding that it is not necessarily an abuse of process for an innovator to switch positions across NOC proceedings.

Ex Turpi Causa Not Relevant to Patent Litigation

Les Laboratoires Servier & Anor v Apotex Inc & Ors [2014] UKSC 55 aff’g [2012] EWCA Civ 593 (IPKat) rev’g [2011] EWHC 730 (Pat) (here and IPKat)
            perindopril; Ex turpi causa

Patent protection is national, but trade and innovation incentives are international. This case begins to address that tension. The UKSC held that ex turpi causa is not applicable in the patent context, and so will not affect litigation where goods sold in one country were infringing in another country. Instead of using the blunt hammer of ex turpi causa, the tension should be resolved with the finer sword of damages. The result is to make Canadian damages law more relevant to foreign disputes; the damages portion of the bifurcated Canadian Perindopril, 2008 FC 825 aff’d 2009 FCA 222 litigation, in particular, has taken on added significance.

In 2006 Servier commenced an action in the UK against Apotex for infringement of its European patent for a crystalline form of perindopril. Servier obtained an interlocutory injunction, subject to the usual undertaking in damages. Servier's action was ultimately dismissed, as the patent was declared invalid, and Apotex sought damages on the undertaking for the loss of UK sales. However, the perindopril which Apotex would have sold in the UK would have been manufactured by Apotex in Canada, and Servier also held a Canadian patent for the compound perindopril itself. In proceedings paralleling the UK litigation, Servier sued Apotex in Canada for infringement of the Canadian compound patent. An interlocutory injunction was denied, but Servier was ultimately successful. Thus it became clear that manufacture in Canada of the product which Apotex would have sold in the UK but for the interlocutory injunction, would have infringed the Canadian patent. In the UK proceedings on the undertaking, Apotex conceded that the award on the undertaking should be reduced by an amount equal to the liability that Apotex would (hypothetically) have faced under Canadian law for manufacturing the perindopril which it would (hypothetically) have sold in the UK had the interlocutory injunction not been in place [EWCA 22]. Servier, on the other hand, argued that Apotex should be entirely precluded from collecting on the undertaking because the Canadian infringement constituted sufficient "turpitude" to engage the doctrine of ex turpi causa. (This summarizes a somewhat complex procedural history, described in more detail at [2]-[8]; and see also my IPKat post on the EWCA decision.)