Use of ex Post Information in Assessing a Reasonable Royalty

Seedlings Life Science Ventures, LLC v Pfizer Canada ULC 2020 FC 1 Grammond J
             2,486,935 / Auto-Injection of Medication

The facts in Seedlings are summarized here along with a discussion of claim construction. Novelty and utility are discussed in yesterday’s post. Despite his holding that all the asserted claims were either invalid or not infringed, Grammond J went on to consider remedies, which had been fully argued. This post discusses a timing issue that arises in assessing a reasonable royalty. In particular, I will argue that the timing of the hypothetical negotiation construct used in assessing a reasonable royalty must reflect its purpose, which is to ensure proper compensation. This implies that there is no strict rule that the hypothetical negotiation takes place at the time of first infringement, nor is there a rule that ex post information cannot be used.

Grammond J noted that the usual approach in assessing a reasonable royalty is to consider the bargain the parties would have arrived at in a hypothetical negotiation [218]. At the outset, he stated that:

[220] The hypothetical negotiation takes place at the time of first infringement. . . . Therefore, the exercise must be informed by the then existing situation. Changes that took place later are not relevant, as the parties would not have been aware of them at the time of the hypothetical negotiation. Subsequent events may only be relevant insofar as it can be said that they would have been expected or anticipated by the parties at the time of negotiation”

(See [226] to the same effect.) The view that subsequent events are irrelevant can be referred to as a “pure ex ante” approach to determining the hypothetical negotiation. This view is not established in Canadian law, as I understand it. While it is usually said that the hypothetical negotiation takes place at the time of first infringement, this does not necessarily imply that ex post information cannot be taken into account.

Issues related to the timing of the hypothetical negotiation are discussed in Ch 1 Reasonable Royalties (at 48ff) of Biddle, Contreras, Love & Siebrasse (eds), Patent Remedies and Complex Products: Towards a Global Consensus (2019) [Complex Products]. As a starting point, we recommend that the courts should recognize “the hypothetical bargain’s status as a legal fiction employed as an aid to arriving at reasonable compensation, rather than as a foundational principle in its own right to be applied strictly and literally.” Put another way, principles of damages assessment should reflect a purposive interpretation of the Act. As the FCA explained in Lovastatin Damages 2015 FCA 171

[42] The Act as a whole is intended to advance research and development, and to encourage broader economic activity. The Act coaxes inventive solutions to practical problems into the public domain through the promise of a limited monopoly for a limited period of time. At the heart of this bargain with the inventor, and at the heart of the Act, is the concept of balance between the benefit conferred on the public through the disclosure of a new and useful invention, and the benefit conferred on the inventor through the grant of a monopoly.

The purpose of the damages assessment is to reflect the same balance:

[42] Thus, in the event of infringement, under-compensation of an inventor discourages research and development, and the disclosure of useful inventions. Equally, over-compensation of an inventor chills potential competition to the extent that a potential infringer is uncertain about the scope and validity of a patent. The balance at the heart of the Act requires perfect compensation.

The hypothetical negotiation is not an end in itself, but only a construct intended to aid in assessing “perfect compensation.”

So far as timing goes, this has two implications. First, it is usually said that the hypothetical negotiation takes place at the time of first infringement. But in some cases it may be necessary to use an even earlier date to achieve perfect compensation. In the context of standard essential patents, for example, the implementers of a standard are locked in once this standard is adopted, and they will normally have invested substantial sunk costs before any infringement actually occurs. A strict use of the date of first infringement in such a case would give rise to “hold up” by allowing the patentee to extract some of those sunk costs, and it is preferable to instead use the date at which the standard is adopted, which is the date at which the implementers still have the practical ability to choose another option: see Complex Products Ch 1 at 50-51.

A second issue relates to the use of ex post information. The basic argument in favour of using ex post information is that it provides a more accurate assessment of the true value of the invention. As Justice Cardozo explained in Sinclair Refining 289 US 689, 698–99 (1933):

To correct uncertain prophecies in [assessing damages] is not to charge the offender with elements of value non-existent at the time of his offense. It is to bring out and expose to light the elements of value that were there from the beginning.

. . . . An imaginary bid by an imaginary buyer, acting upon the information available at the moment of the breach, is not the limit of recovery where the subject of the bargain is an undeveloped patent. Information at such a time might be so scanty and imperfect that the offer would be nominal. The promisee of the patent has less than fair compensation if the criterion of value is the price that he would have received if he had disposed of it at once, irrespective of the value that would have been uncovered if he had kept it as his own.

Using only information available at the date of first infringement might result in undercompensation, as Justice Cardozo suggests, but it might also result in overcompensation. For example, in Monsanto v DuPont 2012 WL 2979080 (ED Mo 2012) an award of $1 billion was entered against DuPont based on a hypothetical infringement taking place just prior to infringement; this is even though DuPont never sold any infringing seed, and therefore enjoyed no sales revenue, much less profit, as a result of the infringement. The jury was of the view that the parties would have anticipated more than $1 billion in sales, but the jury was wrong in the view; and what is more, at the time of trial it was an established past fact that the jury was wrong. The result was an award that grossly exceeded the true value of the invention.

Using the best information available at the date of trial ensures that the patentee receives compensation that best reflects the true value of the invention: see Complex Products Ch 1 at 52-57; Siebrasse & Cotter,(2016) 68 Florida Law Review 929. Indeed, in some respects, ex post information is routinely taken into account in Canadian (and US) law. Once a reasonable royalty is determined, damages are normally assessed by multiplying the reasonable royalty by the number of units of infringing product which were actually sold, not the number of units that the parties would have anticipated at the time of first infringement. That was what Grammond J did in this case itself, where he held that if the patent had been infringed, Seedlings would have been entitled to compensation equal to 2.05% of the net sales revenue of the [infringing] EpiPen: [248]. It might be said that this is because the parties would have negotiated a royalty based on actual sales, but expected profits. But that implicitly assumes that the goal of the damages calculation is to replicate a hypothetical negotiation. The simpler reason for using actual sales information is that it provides a much more accurate assessment of the actual value of the invention than the sales that would have been anticipated at the time of first infringement.

In summary, there are important issues of principle to be considered in determining the timing of the hypothetical negotiation. On the facts in this case, “nothing of substance” turns on the exact choice of date [221], and I suggest that this point remains open in Canadian law.

Grammond J’s analysis was otherwise a standard application of the hypothetical negotiation framework, which was primarily concerned with establishing the Pfizer’s maximum willingness to pay [MWP] and Seedlings’ minimum willingness to accept [MWA] on the facts. There was a somewhat subtle point regarding Seedlings’ MWA at [243]-[245], which was a bit difficult to follow because of redactions. The basic point appears to have been that because Seedlings never had any intention of manufacturing, distributing or selling an auto-injector [253], its only option was to licence, and it’s minimum willingness to accept would therefore be de minimis, because some money is better than no money. This makes sense, keeping in mind that this only sets the minimum willingness to assess, and not the reasonable royalty itself.

Once the MWA and MWP were established, the next question is how the parties would divide the gains from trade, and there was no dispute between the parties on this point: [247]-[248].