Patent damages have become wildly excessive. Or not.

The issue has roiled the courts and produced bruising battles in Congress. It has pitted the pharmaceutical and biotech industries against the IT and software industries.

In September, the Federal Circuit boldly stepped into the fray–and staked out a middle position. The court, in the closely watched case of Lucent Technologies Inc. v. Gateway Inc., declined to dramatically alter the way damages are calculated (and thus slash many awards). The court also rejected business as usual. It effectively raised the standards for proving patent damages and, according to some experts, quietly buried a doctrine that needlessly complicated damage determinations.

Lucent v. Gateway is one of the most important patent damages cases to come out of the Federal Circuit in years,” says Michael Albert, a shareholder at Wolf, Greenfield & Sacks.

The case illustrates the problem of patent damages gone awry, according to critics. At issue was basically one small feature in Microsoft Outlook: Clicking on the date in a graphical calendar entered the corresponding day, month and year into the software (in an appointment form, for instance).

This date-pick feature infringed a patent owned by Lucent Technologies, a jury determined. Then the jury awarded Lucent $358 million in damages–equivalent to approximately 8 percent of Microsoft’s revenues from the infringing sales of Outlook.

Microsoft appealed, and the Federal Circuit threw out the award because it was not supported by “substantial evidence.” The court noted, “Outlook is an enormously complex software program comprising hundreds, if not thousands or even more, features. We find it inconceivable to conclude, based on the present record, that the use of one small feature, the date-picker, constitutes a substantial portion of the value of Outlook.”

Reform Debate

The jury’s damage award in Lucent was not unprecedented. Software and IT companies have been hit repeatedly with huge damage awards when courts found that small aspects of their products had infringed.

That’s why these industries have been lobbying Congress hard to rewrite the law for patent damages. They have advocated apportionment: When part of a product infringes, damages are not determined by the value of the entire product, but are limited to the economic value of the infringing piece of the product. If this rule were applied in Lucent, for instance, damages would be based on the “economic value” of the date-picker in Outlook–and would probably be far less than $358 million.

“Since 2005, Congress has been debating every year about whether to reform the way patent damages are calculated,” says John Desmarais, a Kirkland & Ellis partner who represented Lucent in the Federal Circuit. “This never gets anywhere because there are people on both sides.”

Indeed, powerful groups have opposed changing damages law. The pharmaceutical and biotech industries in particular have fought fiercely on Capitol Hill to retain the status quo.

The resulting deadlock over damages has been one of the main obstacles to larger patent reform. Again and again, the debate over damages has derailed Congressional efforts to overhaul the nation’s patent system.

Then the Federal Circuit issued its opinion in Lucent. This ruling, according to some experts, was a demonstration that the courts can handle the damages issue and Congress need not act in this area. “The Lucent decision is the Federal Circuit’s way of showing Congress that damage reform is unnecessary,” says Kevin McCabe, a director at Sterne, Kessler, Goldstein & Fox.

Wake Up Call

In this case, both Lucent and Microsoft agreed on one thing. The amount of damages in patent cases should equal a reasonable royalty, which they would have hypothetically agreed to immediately prior to the infringement.

Determining the royalty of such a hypothetical licensing agreement requires “some approximation and uncertainty,” the Federal Circuit noted. However, the court found that Lucent failed to present “substantial evidence” to support the jury’s determination of a lump-sum royalty of $358 million.

Lucent argued the award was in line with eight comparable licensing agreements, but the Federal Circuit found no evidence that these agreements were comparable to the Lucent situation. “Lucent had the burden to prove that the licenses were sufficiently comparable to support the lump-sum damages award,” the court wrote. And Lucent had failed to carry this burden, according to the court.

The ruling will make it harder for patentees to prove damages by using comparable licenses, according to many experts. “Lucent opens the door wider … to exclude ‘actual’ licenses as irrelevant when they involve significantly different technologies,” Albert says. “Even in cases where there is a viable connection between actual licenses and the disputed technology, Lucent seems to indicate that … plaintiffs will henceforth need to explain to the jury exactly why the actual licenses are relevant.”

More generally, the decision pushes district courts to review evidence of damages with a more critical eye. “The decision is an important signal to district courts that they have a responsibility to … ensure that damages verdicts are appropriate and based on substantial evidence,” says Jonathan Tropp, a partner at Day Pitney.

Confusing Conclusion

Lucent also addressed the contentious issue of damage apportionment, but there is some confusion over what the court held.

Under well-established case law, a patentee’s damages can be based on the entire market value of an infringing product only if customers buy the product because of its infringing features.

This “entire market value rule” is “quite clear,” said the Lucent court. But then the court went on: “Although our law states certain mandatory conditions for applying the entire market value rule … the base used in a running royalty calculation can always be the value of the entire commercial embodiment, as long as the magnitude of the rate is within an acceptable range. … [E]ven when the patented invention is a small component of a much larger commercial product, awarding a reasonable royalty based on either sale price or number of units sold can be economically justified.”

Experts disagree about what this means. Some say the ruling allows damages to be calculated based on an infringing product’s entire market value, provided the calculation realistically reflects the patent’s importance in the infringing product. Others assert that entire market value can be used only when a plaintiff’s patented feature drives consumer demand for the infringing product, and that any damage calculations must reflect the relative importance of the infringing product.

This disagreement may boost litigation over patent damages, at least in the short term.

“Whenever a patentee’s calculation of damages exceeds what the defendant thinks is realistic, the defendant will argue that the entire market value rule applies,” McCabe says. “It will be up to the court to decide if this is so, or if the patentee is just using entire market value to simplify calculations.”