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Issue #26-1 | July 4, 2013

Judge Posner rejects another expert’s testimony in late May Daubert hearing

Seventh Circuit Judge Richard Posner, this time sitting by designation in the Northern District of Illinois, again rejected an expert’s opinion in a Daubert hearing, Promega Corp. v. Applied Biosystems, LLC, et al.

The expert for patent holder Life Technologies claimed a reasonable royalty rate would be 10%, offering as evidence 20 IP licenses entered into by either Life Technologies or Promega and having royalty rates ranging from 3% to 15%.

In making his argument for a reasonable royalty for sales of infringing products outside the field of use, the expert narrowed the range to 7.5% to 15% based on six licenses that he claimed were the ones most relevant to the patent in suit and then further narrowed it to 8% to 12% without explanation before finally settling on 10%, the midpoint of that range. (A cross-license agreement between Promega and a Life Technologies subsidiary specified 2% as the royalty rate in the field of use, “genetic identity.”)

Posner’s brief description of the six licenses relied upon by the expert witness foretells the outcome of the Daubert hearing:

[The expert’s] report does not identify the six licenses he relied on or explain why they were the most relevant, and he could not identify them at the Daubert hearing.

Posner reasoned:

  1. Some of the agreements used by the expert license a predecessor to the patent in suit but license it for applications that may not relate to the patent claims at issue in this case; and
  2. Each of the license agreements covers multiple patents, not just the patent in suit and its predecessor, and the expert has not attempted to attribute a percentage of the royalty rates in those licenses to the patent in suit; Wordtech Systems, Inc. v. Integrated Networks Solutions, Inc. and Lucent Technologies, Inc., v. ateway, Inc. each held that licenses held up as comparable to the hypothetical license at issue must take into account economic and technological differences. “Generalized impressions are no substitute for a method of computing, and evidence justifying, a reasonable royalty rate.”

Posner went one step further, suggesting the expert offered no help in estimating or quantifying market changes from 2006 (the year of the 2% cross-license between the parties for field-of-use sales). Nor did he offer an estimate of the profits that Promega would have lost had it not obtained a lawful license and ceased selling the products in question outside the field of use.

Promega’s Daubert motion to exclude the expert’s testimony was granted.

Royalty rate negotiators should not throw out the 25% rule

Though the courts have ruled out use of the 25% rule as a basis for determining reasonable royalty, should negotiators of royalty rates shun the formula as well?

Jonathan E. Kemmerer and Jack Lu of KPMG say no, it can be quite useful as a starting point in the royalty rate negotiations of a licensing deal, though 25% of the EBITDA may be more statistically significant.

Furthermore, in a 2012 white paper, the authors defend licensing negotiations as an efficient market, suggesting that the pursuit of comparable licenses is a worthwhile exercise:
Regression analyses indicate that there is a linear relationship between reported royalty rates and various profitability measures, which suggests that the licensing market is efficient and that cost structure and profitability across industries have been factored into royalty rate negotiation.

Good news for licensing programs: Licensing improves overall company value

Though not specifically looking at IP, in 1997 Su Chan, John Kensinger, Arthur Keown, and John Martin sought to determine whether strategic alliances create value. See their research here.

The group measured the size of firm, the industry sector, high-tech versus low-tech alliances, company objectives (related industry alliances), and firm performance to determine whether these were factors that affected value. The authors’ conclusions:

  • Horizontal alliances create more value than nonhorizontal alliances;
  • Technical alliances create more value than marketing and promotion alliances; and
  • Companies that enter into alliances “exhibit superior operating performance relative to their industry peers.”

What is the value of concert merchandising?

As reported in The Licensing Letter, in his first year as an opening act for George Strait in 1998, country singer Kenny Chesney racked up merchandise sales averaging 15 cents per concertgoer. In his third year on the tour, with a hit country single behind him, sales jumped to $1 a head. 

Chesney the headliner now averages $8 to $12 per capita, according to The Wall Street Journal. “Fans in Dallas bought 8,200 T-shirts, 1,200 hats, and sundry gear for a total of $379,885. About 20% of that revenue went to the house. The rest went directly into Mr. Chesney’s coffers.”

Whereas many artists farm out merchandising rights to third parties, Chesney “thanks God every day” that he never gave up those rights.

The Rolling Stones pulled in an average $40 per head for the first three concerts on their 50th-anniversary current tour. At the recent Licensing Expo in Las Vegas, it was reported that the popular boy band One Direction was grossing in excess of $300,000 for each concert night.

Does apportionment rule extend to trade secrets cases?

Case analysis: Versata Software, Inc. v. Internet Brands, Inc., 2012 U.S. Dist. LEXIS 145020 (October 9, 2012)

Background: Both the plaintiff and the defendant sold software to large automobile manufacturers that permitted customers to comparison shop for cars on line. After the plaintiff lost its contract with Chrysler to the defendant, it sued for patent infringement related to the software technology. In response, the defendant countersued for theft of trade secrets and breach of contract, claiming it owned the critical comparison-enabling components of the software and calculating damages based on the plaintiff’s continuing contracts with Toyota.

Expert testimony: In assessing damages for a jury trial, the defendant’s expert reviewed various documents related to the plaintiff’s work for Toyota, including contracts and financial and business records related to income from the contracts and licenses for the software. He also looked at industry research that both parties had conducted, including market and consumer studies, and drew on his prior experience working with automobile manufacturers and service providers, including Toyota. (He noted one document “highlighted” the plaintiff’s need for the comparison component of the software.) An additional technical expert for the defendant testified how the plaintiff used the component in preparing its software products for Toyota.

Based on this review, the damages expert testified that the comparison functionality was the basis for Toyota’s purchase of the plaintiff’s software and that the defendant was entitled to all of the profits from related contracts, which amounted to $2 million. If the jury was not prepared to accept the proposition, he still believed that “not less than 50%” of those profits were attributable to the plaintiff’s theft. Notably, the plaintiff cross-examined the expert but did not present its own expert to calculate damages for the alleged trade secret theft.

Trial court verdict: After the defendant vigorously contested the patent infringement claims on the basis of invalidity and anticipation, the jury returned entirely in the defendant’s favor of $2 million, and the plaintiff appealed.

Appeal: As a preliminary matter, the plaintiff argued that the defendant’s expert incorrectly applied all of its revenues from the Toyota contracts, in violation of the entire market value rule (EMVR). Borrowing the rule from federal patent law, which permits recovery of damages based on the entire value of the accused product if the patented feature drives consumer demand, the plaintiff claimed the expert’s evidence “was not up to the task.” That is, he never showed that the basis for Toyota’s interest in the plaintiff’s software was the trade secret component, and he failed to prove that all of the profits from the Toyota contract were attributable to the same. At a minimum, the plaintiff maintained that the expert should have apportioned the amount of profits that were due directly from the stolen technology.

Importantly, the plaintiff did not cite any legal authority or case precedent for its argument to apply the EMVR to trade secret cases. “In any event,” the court said, “all that is at issue here is whether the evidence supports the jury’s finding that [the defendant’s] trade secret[s] were of sufficient importance to [the plaintiff’s] work on the Toyota project” such that its award of all of the profits is appropriate.

To determine this narrower issue, the court acknowledged generally the financial documents and market/industry surveys that the defendant’s expert relied on, noting in particular that the plaintiff was free to explore any of their shortcomings on cross-examination. Similarly, the plaintiff had “ample” opportunity to point out any flaws in the expert’s calculations as well as any alleged inconsistencies in his offering a lesser amount. Finally, the plaintiff could have had an expert offer an alternative measure of misappropriation damages but chose not to. “At the end of the day, the jury apparently chose to believe” the testimony of the defendant’s expert, “which it was entitled to do,” the court said, and affirmed the $2 million award.

Subscribers can read the text of the decision in BVLaw.

FTC expected to peer into the inner workings of NPEs

FTC chairwoman Edith Ramirez is planning to ask the full commission to approve an inquiry into the effect on competition of the existence and actions of nonpracticing entities (NPEs), increasingly known as patent assertion entities (PAEs) but often broadly, derogatorily referred to as “patent trolls.” (IP Value Wire will continue to attach the NPE moniker to each such story so that researchers can find all related articles on the subject.) The move appears to be a coordinated response to several executive orders issued by the White House directing agencies to take steps to “protect innovators from frivolous litigation.”

The FTC investigation would require the target NPEs to answer questions about their operations, including what role any lawsuits play in their business.

As reported on Patent Progress, Ramirez is expected to recommend what is known as a 6(b) study to gather information for use by Congress, the courts, or executive agencies in dealing with the issue of frivolous lawsuits. Through a 6(b) study, the FTC can analyze the competitive impact of many of the practices of PAEs. For instance, much of the concern focuses on their lack of transparency. The FTC can remedy that. A 6(b) study can focus on the following issues, among others:

  • Who owns the NPE and what does the NPE own?
  • What are the types and scope of demand letters used by NPEs?
  • What are the success/failure metrics on NPE-instigated litigation?
  • How do NPEs acquire patents and from whom?
  • What is the purpose of an NPE acquiring a patent?
  • How does the NPE determine which patents to acquire?
  • How does the inventor benefit from NPE activities, and how would any changes to the system affect the inventor?

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