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In two recent decisions, the U.S. Court of Appeals for the Federal Circuit elaborated on the standards to be used when considering whether to award lost profit damages to a patent owner who has successfully shown validity and infringement. Both decisions were released by the Federal Circuit on Dec. 4, 2003. ( Ferguson Beauregard/Logic Controls, Div. of Dover Res., Inc. v. Mega Sys., LLC, 350 F.3d 1327 (Fed. Cir. 2003); and Utah Med. Prods., Inc. v. Graphic Controls Corp., 350 F.3d 1376 (Fed. Cir. 2003)). These cases should provide direction to patent owners, defendants, and their counsel when attempting to assert or defend against lost profits claims. The decisions do not set new legal standards for lost profits damages awards. Instead, they clarify and restate the court’s interpretation of the basic tenet of a successful lost profits claim: The patent owner must show with reasonable certainty that, but for the infringement, he or she would have made the portion of the infringer’s historical sales on which the claim is based. Without a clear showing of the number of sales the patent owner would have made had the infringer not been in the market, any lost profits claim is at risk. There are two threshold questions that must be answered to provide a basis for a claim of lost profits on the infringer’s sales: 1) How many of the infringer’s historical sales would not have been made had the infringing feature(s) not been available; and 2) How many of those sales would have been made by the patent owner had the infringer not been in the market. Ferguson deals with the first question. Utah Medical deals with the second. Taken together, the two decisions make clear that a patent owner must pay attention to market reality when making a claim for profits on lost sales and that an accused infringer may be able to deflect a claim that does not take those realities into account. ‘FERGUSON BEAUREGARD v. MEGA SYS., LLC’ In the lower court case, Ferguson Beauregard (“Ferguson”) filed suit in the Eastern District of Texas in July 1999 against Mega Systems, LLC (“Mega Systems”) for patent infringement. Ferguson alleged that Mega Systems infringed two patents owned by Ferguson’s parent company, Delaware Capital Formation Inc.: U.S. Patent Nos. 4,352,376 (the “’376 patent”), and 5,146,991 (the “’991 patent”). The two patents cover technology related to well-controllers, products that use control systems and methods for the recovery of petroleum products from oil and gas wells. Ferguson’s AutoCycle well-controller product embodies both of the patents and competes with Mega Systems’ APC 1000 well-controller product. The record showed that Ferguson historically earned profits of $837 per unit on sales of the AutoCycle. Ferguson also sells a similar (presumably less profitable) product known as LiquiLift that employs only the technology of the ’376 patent and not that of the ’991. Mega Systems sold three versions of its APC 1000 well-controller over the relevant period. The district court found that the APC 1000 infringed the ’376 patent. Since the ’376 patent expired before the end of the damage period, only those products sold prior to the date of expiration were subject to damages. The court awarded Ferguson lost profits of $408,456 for APC 1000 sales that infringed the ’376 patent. The court also found that the 10 APC 1000 Version 2 units sold after expiration of the ’376 patent infringed the ’991 patent and awarded Ferguson $8370 in lost profits on those sales. Both of the damage calculations were based on applying Ferguson’s historical profit margin on the AutoCycle to the number of infringing units sold by Mega Systems. The district court also ruled that Version 3 of the APC 1000 (which was only sold after expiration of the ’376 patent) did not infringe the ’991 patent and therefore awarded no damages on sales of those units. Ferguson appealed, asking among other things that the Federal Circuit reconsider whether Version 3 of the APC 1000 infringed the ’991 patent and seeking a determination that Mega Systems’ infringement was willful. Mega Systems appealed the lost profits award claiming that the district court erred in basing the amount of the lost profits award on Ferguson’s profits on the AutoCycle. Instead, Mega Systems argued that the district court should have determined the amount of Ferguson’s lost profits using its historical margin on the LiquiLift product which embodied only the ’376 patent, as did most of the historical sales of the APC 1000 on which the lost profits award was based. The Federal Circuit, in an opinion authored by Judge Richard Linn, agreed with Ferguson on both willfulness and infringement of the ’991 patent. It remanded the case, instructing the district court on interpretation of certain claims and directing it to reconsider whether Version 3 of the APC 1000 infringed the ’991 patent. In addition, it overturned the district court’s ruling that Mega Systems’ infringement was not willful. The Federal Circuit also agreed in part with Mega Systems on damages, finding that the district court erred in its ruling on lost profits and remanded for redetermination of damages. However, the court did not agree with Mega Systems as to the reason for the error or as to how it should be corrected, nor did it direct the district court to base lost profit damages on Ferguson’s LiquiLift product. In reaching these decisions, the Federal Circuit recognized that the district court’s award and the evidence in the record did not distinguish between the effects of the two patents on the APC 1000′s historical sales. The court recognized that most of the APC 1000 products infringed only one and not both of the patents. Apparently the Federal Circuit saw nothing in the record to show the relative importance of the two patented technologies to the historical customers of the APC 1000. Without such a determination, it was not clear how many of the historical customers of the APC 1000 would not have selected the product under different “but-for” assumptions about the availability of the patented features. If the customers would have purchased the APC 1000 without one or the other of the patents, under a “but-for” analysis, those sales would not be “lost” and lost profit damages might not be available on those sales. The Ferguson opinion directed the lower court (and Ferguson) to segregate the demand for the APC 1000 product that was attributable to the ’376 patent from that of the ’991 patent. Without such evidence, the appeals court reasoned, there was no way to determine how many of Mega Systems’ historical sales would have been lost but-for Mega Systems’ infringement. Citing King Instrument Corp. v. Perego, 65 F.3d 941, 952, (Fed. Cir. 1995), the Federal Circuit noted that it was necessary for a patent owner seeking to recover lost profits to show “that it would have received the additional profits ‘but-for’ the infringement.” The opinion went on to find that: “The district court based its lost profits award on evidence of sales of a device embodying features in addition to those present in the infringed ’376 patent, namely those features attributable to the ’991 patent. The district court therefore failed to distinguish the allocation of profits that would have been made ‘but for’ the infringement of the ’376 patent with the profits that could fairly be allocated to customer demand related to the features embodying the ’991 patent.” The opinion cited Rite-Hite Corp. v. Kelley Co., 56 F. 3d 1538,1549 (Fed. Cir. 1995) for the proposition that recovery of damages on a patent owner’s entire product, incorporating patented and nonpatented features, was permissible. But, the court noted that such a claim requires a showing that “the patent-related feature is the basis for the customer’s demand.” Ferguson at 32. The Federal Circuit’s opinion also pointed to an inconsistency in the district court award. The lower court’s award of lost profit damages on APC 1000 units sold prior to expiration of the ’376 patent implied a finding that features related to the ’376 patent were the basis for consumer demand for the product. Then, the lower court’s award of damages on the Version 2 APC 1000 implied a finding that features related to the ’991 patent were the basis for consumer demand, because these sales all occurred after expiration of the ’376 patent. Based on this apparent inconsistency in the district court’s determinations, the Federal Circuit reversed the lower court decision and remanded it, observing that the record was not clear on whether each of the patents independently could have been the basis for consumer demand. The Federal Circuit took no position on the proper amount of Ferguson’s lost profits damages. In a new damages trial, Ferguson would have been free to present evidence that Mega Systems would have lost the same number of sales whether the historical APC 1000 units infringed only one or both of the patents. If successful in such a showing, Ferguson might have been able to receive an award equal to the original award after a new trial. In fact, the damages could be significantly higher after a new trial if the district court, following the Federal Circuit’s claim interpretation, were to find that the APC 1000 Version 3 infringed the ’991 patent, then the number of infringing sales would be greater than the amount covered in the original award. Damages might also increase if the district court were to rule in favor of Ferguson on willfulness and issue an award of enhanced damages. Alternatively, if Mega Systems were to show at a new trial that some of its historical APC 1000 customers would have purchased the product even if it did not incorporate the technology of one of the patents, the number of sales subject to a lost profits claim would be smaller than in the original award. Note, however, that Ferguson might still be able to collect a reasonable royalty on those infringing sales if the lost profits claim were rejected. ‘UTAH MED. PRODS., INC. v. GRAPHIC CONTROLS CORP.’ Utah Medical deals with another aspect of a lost profits claim, the question of how many of the infringer’s historical sales would have gone to the patent owner (as opposed to other competitors) if the infringer had not been in the market. In January 2002, a jury in the District of Utah found in favor of plaintiff Utah Medical Products Inc. (“Utah Medical”) in a patent infringement suit against Graphic Controls Corp. (“Graphic Controls”). The jury’s verdict was that Graphic Controls had infringed Utah Medical’s U.S. Patent No. 4,785,822 (the “’822 patent”). The district court awarded Utah Medical $20 million in lost profits. The ’822 patent claims a medical device for measuring the pressure within a body cavity. In its most common application, the device is used for measuring the pressure inside the uterus of a woman during childbirth. Graphic Controls appealed the award, arguing that the jury’s damages verdict was unsupported by the evidence: That instead, the record was clear that the relevant market to be considered included numerous competitors in addition to the accused product and the patent owner’s product. The appeal noted that both parties openly acknowledged this fact. In making its decision, the Federal Circuit recognized evidence in the record that the relevant industry for lost profits analysis included both Utah Medical and Graphic Controls, which sold transducer-tipped intrauterine pressure catheters (“IUPCs”), as well as several companies selling fluid-filled IUPCs. The record also included testimony offered by experts for Utah Medical that the two types of IUPCs did not compete directly. Utah Medical presented a damage theory premised on a two-competitor market limited to transducer-tipped IUPCs. The jury apparently agreed, and the court awarded lost profits damages based on Utah Medical’s theory and the assumption that had Graphic Controls’ infringing product not been available, virtually all of Graphic Control’s historical customers would have purchased from Utah Medical instead. The Federal Circuit affirmed the award and accepted Utah Medical’s expert testimony that the two types of IUPCs did not directly compete in price or performance. The court also noted that the evidence clearly established that Utah Medical and Graphic Controls were the only companies that sold transducer-tipped IUPCs rather than fluid-filled IUPCs. The court noted evidence that the transducer-tipped IUPCs were significantly more expensive, but also significantly more capable than the fluid-filled products. In its opinion, which sided with the jury, the Federal Circuit took the view that the evidence was sufficient to support an award, based on its conclusion that Graphic Controls’ historical customers would not have sought fluid-filled IUPCs as substitutes for the transducer-tipped IUPCs had the Graphic Controls product not been available. It accepted that the customers would have gone to the only transducer-tipped alternative that was available: the Utah Medical products. LESSONS FROM ‘FERGUSON’ AND ‘UTAH MEDICAL’ The Federal Circuit’s decisions in the Ferguson and Utah Medical cases illustrate the necessity when considering lost profits claims, first of determining, and providing evidence regarding, the number of the infringers’ historical sales that would not have been made if the infringing features (related to the patents in question) had not been available in the accused products. The second step of this analysis is to determine how many of those lost sales would have gone to the patent owner. The message is the same to both patent owners and accused infringers — to succeed in your lost profits claim or defense you must produce evidence based on an analysis of customer demand and the competitive situation in the historical markets. For patent owners asserting a lost profits claim on more than one patent, Ferguson indicates that it would be prudent to distinguish the effects of each patent claimed on the marketability of the accused product. If a patent owner’s claim fails to differentiate between the “but-for” sales for each asserted patent, it might be vulnerable (as was Ferguson) if the court finds one of the patents to be invalid or not infringed or if one or more of the patents does not cover the entire damages period. Thus, following Ferguson, a patent owner who is asserting more than one patent would be well served to answer the important market questions for each of the patents asserted. For example, if Ferguson had presented evidence that Mega Systems’ historical customers would not have purchased APC 1000 well-controllers if the product did not possess the features covered by either of the patents separately, then the Federal Circuit’s objection as to the scope of the original award might have been avoided. In cases involving claims of infringement for multiple patents, it is often useful to provide a range of what might be called “causation scenarios” — where damages are computed based on the assumption that each patent, individually, is infringed and then recomputed assuming various combinations of infringement and non-infringement. This approach would seem to avoid the problem raised by the Federal Circuit in Ferguson. On the other hand, accused infringers defending multiple-patent infringement claims should be conscious of the causation issue and evaluate the effects of each patent separately on the accused products and on their historical customer base. Utah Medical highlights the need for parties considering a lost-profits claim to complete an effective analysis of the competitive situation in the market of the patent owner and the accused infringer. To be effective, such analysis must go beyond broad categories of products or industry definitions that may mask or distort the actual competitive conditions. In Utah Medical, the accused infringer defined the IUPC industry as the relevant market for analysis, and the industry was presented as including a range of competitive products. In this case, the effective analysis was that presented by the patent owner, which showed that the entire IUPC industry was not the proper level of analysis. By providing evidence on actual competitive patterns involving the accused products within the industry, the patent owner was able to convince the jury that the relevant market for analysis included only the patented product and the accused product. This allowed the jury to ignore the nonpatented products that the defendant would have included, which ultimately should result in a finding for the patent owner. Despite the message of Utah Medical, it should be noted that the proper definition of the market is not something that always enhances the patent owner’s damages claim. For example, these authors were involved in a case in which the patent owner presented a market definition similar to that presented by Graphic Controls. The patent owner was attempting to claim lost profits damages using a broad definition of the relevant market for a medical device. The accused infringer was successful in defining the relevant market more narrowly, showing that the accused device competed closely only with other low-end products in the market. The evidence presented by the defendant showed that the historical customers for the accused device would not have been likely to switch to the patent owner’s high-end product if the accused device had not been available. The jury agreed and declined to award lost profits. William O. Kerr is an economist and co-director of the Intellectual Property Practice of Navigant Consulting Inc. Ronald Washington is an economic consultant, specializing in intellectual property matters. Both are based in the Washington, D.C., office of Navigant Consulting Inc. If you are interested in submitting an article to law.com, please click here for our submission guidelines. To subscribe to the monthly newsletter “Patent Strategy & Management,” click here.

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