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Courts often award damages in patent infringement suits based on the economic results that the patent holder would have achieved in a market reconstructed to reflect an absence of the infringing product. The U.S. Court of Appeals for the Federal Circuit’s decision in Grain Processing Corp. v. American Maize-Products Co., 185 F.3d 1341 (Fed. Cir. 1999), makes clear that an accurate reconstruction of this hypothetical “but for” market takes into account options that were available to the accused infringer — including the ability to meet demand with a noninfringing product. The case provides several important guideposts for counsel and experts attempting to estimate the type and amount of patent infringement damages when alternatives to the infringing product were available to the infringer. The Grain Processingcase involved patent 3,849,194, which claims maltodextrins — food additives made from starch — with particular attributes. Grain Processing Corp. (GPC), which acquired the ’194 patent from Corn Products Corporation in 1979, sued American Maize-Products (AMP) in 1981, asserting that AMP’s Lo-Dex-10 product infringed the ’194 patent. During the damages phase of the litigation, GPC claimed damages of approximately $35 million — an amount that included lost profits, revenue lost as a result of price erosion, damages due to AMP’s accelerated entry into the market after the patent expired, and a reasonable royalty of 28 percent on all of AMP’s infringing sales that were not covered by a lost profits award. The U.S. District Court for the Northern District of Indiana held, and the Federal Circuit ultimately affirmed, that some of Lo-Dex-10 produced by AMP did infringe the ’194 patent. The district court further held and the Federal Circuit further agreed that GPC nevertheless was not entitled to lost profits. The court so held because “Process IV” — a process that AMP employed to make Lo-Dex-10 after the district court chose a test for determining infringement that would indicate that AMP’s former processes infringed the ’194 patent — was available to AMP as a means of producing Lo-Dex-10 throughout the damages period, and the noninfringing Lo-Dex-10 made using Process IV offered consumers the same benefits as the accused product. In a “but for” world in which AMP did not sell infringing Lo-Dex-10 made using processes other than Process IV, AMP would have sold noninfringing Lo-Dex-10 made using Process IV. From the point of view of the consumers, there was no difference between the Lo-Dex-10 made using Processes I-III and the Lo-Dex-10 made using Process IV, and, therefore, no consumers would have behaved differently in the “but for” world. As a result, there were no profits lost by GPC due to the infringement since it would not have gained any additional consumers in the “but for” world absent the infringement. The Federal Circuit held that the availability of Process IV not only “scotch[ed]” a lost profits award, but also “ effectively capped the reasonable royalty award.” Accordingly, the Federal Circuit awarded GPC damages based on a 3 percent reasonable royalty rate — a sum that amounted to approximately $2.5 million. The 3 percent reasonable royalty rate was based on the cost differences between Process IV (the process that resulted in a noninfringing product) and the other processes that AMP used to make Lo-Dex-10, adjusted to reflect possible cost fluctuations and the elimination of the risk of producing an infringing product. From the point of view of AMP during a hypothetical negotiation with GPC, the cost associated with switching to a process yielding a noninfringing version of Lo-Dex-10 set a ceiling on the amount that AMP would offer to pay. If GPC were unwilling to accept an amount approximately equal to the cost of producing a noninfringing version of Lo-Dex-10, then AMP simply would switch to the other process and incur the higher costs without needing to license the ’194 patent. IMPLICATIONS FOR DAMAGES AWARDS In patent infringement cases, the patent holder may be entitled to the profits from sales that it could have made “but for” the allegedly infringing product. The Grain Processingcase provides several guidelines for calculating these hypothetical profits. � If the alleged infringer can prove that, in lieu of the allegedly infringing product, an acceptable noninfringing alternative was available for the accused infringer to have sold during the damages period, the patent holder will find it difficult to prove lost sales in the “but for” world, and therefore, will find it difficult to provide support for a claim of lost profits. � If the patent-holder cannot prove that it could have sold more of the subject product in the “but for” world, the patent holder is entitled to a reasonable royalty. The amount of that reasonable royalty likely will be constrained by the cost of the available alternative since — at a hypothetical negotiation before the sale of the allegedly infringing product — the potential infringer would pay no more than its cost of switching to the available alternative. In the Grain Processingcase, the district court increased the 2.8 percent cost of offering the alternative to a 3.0 percent reasonable royalty rate to account for possible cost fluctuations and the elimination of risk involved with producing an infringing product. Additionally, as the Federal Circuit noted in Grain Processing, comparing the patented invention to the next-best alternative permits the court to discern the market value of the patent holder’s exclusive right. � The reasonable royalty rate “rule of thumb” — one-quarter to one-third of the infringer’s profit margin — is not always applicable. The district court noted that GPC’s expert concluded that AMP made (or anticipated making) 43 percent of net sales, 893 F. Supp. 1386, 1389 (N.D. Ind. 1995) (although the court’s discussion does not indicate whether this is a gross, operating or incremental profit margin). One-quarter to one-third of 43 percent would have been 11 percent to 14 percent rather than the 5 percent that GPC offered for its portfolio of malto-dextrin patents or the 3 percent that the court ultimately found was appropriate for the ’194 patent. Use of the “rule of thumb” would have resulted in a royalty rate that was three to four times too high for the patent in Grain Processing. � Whether the noninfringing alternative is “available” during the damages period is based on the specific facts in each case. In the Grain Processingcase, the noninfringing alternative product — Lo-Dex-10 made using Process IV — was produced for less than one year of the more than 10-year period for which GPC claimed damages. Nevertheless, the court found that the Lo-Dex-10 made using Process IV was available during the entire period of infringement. This holding was based on a combination of factors, including the following: the accused infringer’s switch from an accused product to a noninfringing product; findings regarding the technology in question; the price and market structure of the patentee’s and accused infringer’s products; and the fact that AMP was able to develop and produce the noninfringing product within two weeks — an amount of time that the district court characterized as “practically instantaneous.” Id. at 1391. � What constitutes an available acceptable noninfringing alternative also is based on the perceptions of consumers. If some of the elements of the patent are irrelevant to consumers, the number of available acceptable alternatives may expand. In the Grain Processingcase, the Federal Circuit noted that “[c]onsumers demand low-dextrose maltodextrins of which the patented product is just one exemplar.” Grain Processing Corp., 185 F.3d at 1354. Therefore, the court held, in the “but for” world, AMP would have been free to sell an alternative low-dextrose maltodextrin of a different type that met the consumer demand (and call it “Lo-Dex-10″). � The consumer’s perceptions about an alternative’s acceptability can be measured, in part, by the number of consumer complaints registered when the products were switched in the market, changes in consumer demand and the determinations about whether the changes require/permit a price change. In Grain Processing, the acceptability of the noninfringing alternative was supported by AMP’s sales records, which did not significantly change when AMP introduced Lo-Dex-10 made using Process IV at the same price as previous versions of Lo-Dex-10, and the testimony of witnesses. Grain Processing Corp., 185 F.3d at 1355. IMPACT ON PRICE EROSION AND ‘HYBRID’ DAMAGES CLAIMS In Grain Processing, the Federal Circuit, without separate discussion, denied both price erosion and hybrid damages claims. Price erosion claims typically argue that the patent holder lowered its price to match the accused infringer’s price and that, absent the infringement, the patent holder would have charged a higher price. If, however, the accused infringer could have offered an available noninfringing alternative at the same price as the allegedly infringing product and gained the same market acceptance, there would be no difference between the pricing strategy that the patent holder employed in the actual world and the one that it employed in the “but for” world. As a result, the patent holder would have reduced its price regardless of the extent to which the patent was infringed. If the accused infringer would have priced the available “but for” alternative product at a higher level than the actual allegedly infringing product, the patent holder might not have had to reduce its prices as much to meet the competition. In that case, the patent holder may be able to claim some price erosion damages based on the difference between its actual price reduction and the reduction it would have taken in the “but for” world to meet the price of the accused infringer’s “but for” alternative product. A claim for hybrid damages typically argues that the patent holder is entitled to lost profits on certain sales that it would have made absent the infringement, plus a reasonable royalty on the remainder. If, however, the “but for” world is indistinguishable from the actual world from the consumers’ point of view, there would be no impact on the consumers’ behavior in the “but for” world. In such a situation, consumers would not have stopped purchasing the accused infringer’s product to purchase the patent holder’s product. Accordingly, there would be no increase in the sales of the patent holder’s product to translate into lost profits damages in a hybrid model. OPEN ISSUES There are several questions regarding the estimation of damages that the Grain Processingcase leaves unanswered. First, under the Federal Circuit’s direction that “a fair and accurate reconstruction of the ‘but for’ market must take into account, where relevant, alternative actions that the infringer foreseeably would have undertaken had he not infringed,” Grain Processing Corp., 185 F.3d at 1350-1351, the accused infringer, in lieu of abandoning the market or negotiating a reasonable royalty rate to make the patented product that it viewed as excessive, might have undertaken an action that provides an acceptable alternative to most consumers, or some of the consumers but not all of them. Would the patent holder be entitled to its lost profits on the portion of the accused infringer’s sales that were made to those consumers who would not perceive the next-best product as an acceptable alternative? Would the accused infringer’s cost of switching to that next-best product constrain the reasonable royalty for the remaining portion of the accused infringer’s sales? What if the noninfringing alternative becomes available during the period of infringement such that the accused infringer could have switched at some point during the period of infringement? Finally, will the courts accept survey results prepared for purposes of the litigation as support for the parties’ positions regarding consumers’ acceptance of noninfringing alternatives? The courts have considered surveys regarding the state of mind of consumers when evaluating trademark and false advertising cases. Courts may be willing to consider surveys in patent cases. The Grain Processingcases are an important articulation of the principle that “[a] fair and accurate reconstruction of the ‘but for’ market must take into account, where relevant, alternative actions the infringer foreseeably would have undertaken had he not infringed.” Grain Processing Corp., 185 F.3d at 1350. The availability and acceptability of the results of those alternative actions must be evaluated on a case-by-case basis; however, the increased sensitivity to this issue may result in the district courts’ increased scrutiny of patent holders’ claims prior to awarding lost profits. Karl Hampe is a director in the New York office of BDO Seidman, a consulting firm. He has estimated damages in patent infringement matters for counsel retained by both plaintiffs and defendants, and has presented on the topic of patent damages and other matters before professional groups such as the American Institute of Certified Public Accountants.

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