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A Beautiful Mind Nobel Laureate’s Theory is No Good for Calculating Patent Damages

By Stephen B. Schott

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Imagine you own several patents for software related to video calling over wireless networks. And further imagine that a mobile phone manufacturer uses a built-in program that you believe infringes your patents. The question that the Federal Circuit in VirnetX v. Cisco faced was: Is an infringing damages calculation based on the price of the entire phone, or just the smallest salable unit that infringes the patent and is contained in the phone?

VirnetX accused iOS devices that had FaceTime and VPN On Demand of infringing its patents  and at trial, VirnetX’s damages expert offered three theories of damages.

(1) Reasonable rate as applied to the sale price of each device. VirnetX’s theory was that it had a policy of seeking to license its patents for 1-2% of the entire value of products sold.

(2) Bargain theory that the parties would have split between themselves the incremental or additional profits associated with the revenue generated from the technology. This theorem is called the Nash Bargaining Solution named for Nobel Laureate John Nash, portrayed by Russell Crowe in A Beautiful Mind.

The damages calculation under this theory is based on the profits associated with FaceTime from the revenue generated from the front-facing camera. From that revenue, VirnetX’s expert surmised that Apple would be entitled to 55% of the profit generated and VirnetX would be entitled to 45% because of its weaker bargaining position.

(3) Bargain theory based on what “drove sales” of the device. This is also a Nash Solution.  Based on a survey, VirnetX concluded that 18% of all iOS sales would not have occurred without the addition of the allegedly infringing FaceTime program installed. VirnetX again invoked its conclusion that it would be entitled to 45% of Apple’s profits under this theory.

When the district court issued its jury instruction, it instructed the jury to consider not just these theories, but also another possible damages theory based on the smallest saleable unit.

In determining a royalty base, you should not use the value of the entire apparatus or product unless either: (1) the patented feature creates the basis for the customers’ demand for the product, or the patented feature substantially creates the value of the other component parts of the product; or (2) the product in question constitutes the smallest saleable unit containing the patented feature.

This opened up the jury to do its damages math based, potentially, on the revenue generated from the entire iOS device, not just the portions that are the subject of the infringement claim. This, according to the Federal Circuit, was not a harmless error since according to Supreme Court precedent dictates that a patentee “must in every case give evidence tending to separate or apportion the defendant’s profits and the patentee’s damages between the patent feature and the unpainted feature….”

The Federal Circuit’s Take on VirnetX’s Damages Theories

250px-John Forbes Nash, Jr. by Peter Badge

The Federal Circuit considered each of VirnetX’s damages theories and found the reasonable royalty rate based theory acceptable—although based on the wrong base—and the theories based on Nash’s theories wanting.

The Federal Circuit did not criticize Nash’s Solution as wrong, but it did take issue with Nash’s starting place in his Bargaining Solution, namely, that each party in the bargain start with half of the profits, and then there is apportionment up and down from that number based on factors around the bargaining power of the parties. The Federal Circuit criticized this 50-50 starting point as “subject to abuse” and compared it to another “rule of thumb” damages theory that it described as originating from a “flawed premise.”

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