Intellectual property disputes: Understanding how to calculate damages
INSIGHT ARTICLE |
Intellectual property (IP) assets can often make up a large portion of the purchase consideration for a modern corporation. In fact, a recent study indicates that IP and intangible assets represent upward of 80 percent of the corporate value in the United States.1 Accordingly, the number of patents granted and trademarks registered each year continues to increase and the commercialization and licensing of IP remains a core strategy for many companies.2 As IP continues to dominate the corporate balance sheet, disputes involving IP assets arise frequently from allegations that one party infringed another party’s IP rights. In an IP dispute, the accusing party will seek certain remedies from the infringing party in the form of damages, injunctions, lost profits or other means of making the accusing party whole again. Thus, it is increasingly important to understand the various types of IP disputes as well as the typical methodologies, calculations and considerations relevant to owners of IP in a dispute situation.
This article discusses the various remedies available in different types of IP disputes as well as examines some, but not all, of the key considerations independent financial experts may use when calculating damages figures.
IP damages methodology
There are various general methodologies, applications and common measurements typically applied in IP disputes to calculate damages figures. Commonly utilized approaches in valuing IP assets include the income, cost and relief from royalty method (a hybrid approach). The most applicable approach or approaches when valuing IP assets or calculating damages figures should be determined based on considerations of key facts, circumstances and input from counsel in a particular dispute. Below is a brief overview of common approaches in the context of damages:
- Income approach: Considers expected future income streams related to the IP asset to calculate the present value of future economic benefits. Significant inputs can include future income streams, duration of the stream and the risks associated with the income stream (discount rate).
- Market approach: Utilizes actual transaction data derived from comparable sales or licensing agreements to compare the relative value of the IP asset in question.
- Cost approach: Calculates the cost of developing a similar IP asset. Two common cost methodologies are valuing the asset using a historical cost basis or calculating a value for the asset based on the costs required to reproduce or replace the asset.
- Relief from royalty method: Incorporates aspects of the income approach and the market approach. Among other considerations, the asset is valued based on the hypothetical negotiation that would have taken place between a willing licensor and licensee, and the selected royalty rate is based on a selection of comparable market transactions.
Key types of IP disputes
With many different types of IP in use by companies, a variety of disputes or litigation may occur. Each type of dispute brings unique factors that must be considered. The key types of IP disputes and the various aspects of damages calculations that may be considered by an independent financial expert are illustrated below.
As seen in the general rise in the volume of patent litigation over the past decade, it is important to understand the types of patents that give rise to IP disputes. The two most frequently filed types of patents are utility and design patents. A utility patent is granted to anyone who invents a new and useful process, machine, article of manufacture or composition of matter, or any new and useful improvement, while a design patent covers the invention of a new, original and ornamental design for an article of manufacture. According to the U.S. Patent and Trademark Office, patent rights allow the owner to prevent others from making, using, selling or importing the patented invention in the United States.
Damages in a patent infringement case often involve lost profits (i.e., profits on sales lost “but for” the infringement) or a reasonably royalty (royalty income a plaintiff would have earned through a license agreement of the IP to the defendant), among other measures. The plaintiff’s goal is to receive an award for damages to compensate for the alleged infringement. Given the various remedies and methodologies for calculating damages related to patent infringement, different forms of analysis may be required in order to accurately calculate a damages figure. These analyses may include:
- Determining the defendant’s hypothetical lost profits “but for” the alleged infringement by analyzing sales and costs
- Working with counsel in determining the applicable damages time period in which the infringing action affected the defendant
- Conducting a review of comparable royalty rates in the market, including a review of existing license agreements as well as contemplating quantitative and qualitative factors commonly referenced as the Georgia-Pacific factors3
- Reviewing damages methodologies such as a reasonable royalty or the infringer’s profits to avoid double counting damages
- Reviewing detailed sales and profit information for the purposes of apportioning profits to the protected feature
- Determining the market share of the defendant and reviewing the current economic outlook to help guide the expert opinion
- Reviewing capacity and production to support a determination of feasibility regarding lost profits
A trademark refers to the use of a word, phrase, symbol, product shape, logo, slogan, color, packaging, or device by a manufacturer or merchant to identify the source of the goods or services. Trademarks act to identify and distinguish the goods and services of one company from another, as well as indicate the source of those goods and services. A trademark infringement case typically involves a question of whether the alleged infringement results in the likelihood of confusion regarding origin, sponsorship, or approval of the goods or services in question. The Lanham Act allows the plaintiff to seek either recovery of the defendant’s profits, damages sustained by the plaintiff, or the costs of the action.4 An expert conducting damages analysis in a trademark dispute may use some of the following methods:
- Analyzing claims of price erosion by looking at projected sales and calculating damages by comparing actual sales to projected sales during the infringement period, in addition to conducting a price elasticity study
- Measuring the gain obtained by a defendant for the purposes of an unjust enrichment award, by analyzing increased assets of the defendant, market value of intangibles used by the defendant, or gains realized by the defendant using market indicators or actual sales or transfers of assets
- Determining the costs of a corrective advertising campaign in order to repair the effect of the defendant’s misleading advertising as well as any misimpressions that were formed in the marketplace
The Copyright Act protects various artistic, dramatic, literary and musical works in a tangible form from illegal display, reproduction, performance or other means of distribution. Copyrights can also cover unpublished works.
The plaintiff in a copyright case may seek various remedies such as actual damages, any additional profits of the infringer, or even statutory damages in certain types of copyright matters. The plaintiff may also file for injunctive relief, or impoundment and destruction of the infringing matter in question.5 Similar to patent and trademark matters, a damages expert can be hired to perform a damages calculation, and may conduct some of these types of analyses:
- Using the market value test, estimate the fair market value that a willing buyer would have paid a willing seller for the use of the copyrighted work, considering reputational harm to the copyrighter, profits and sales from the infringement, and market circumstances conducive to negotiation
- Conduct comparable licensing analysis to determine what the plaintiff would have received if the plaintiff had licensed the copyrighted work
- Calculate the magnitude of sales the copyright holder would have made absent the infringement in a lost profits case, considering differences in price, packaging, advertising, efficiency, cost, production techniques, and potential goodwill of the infringer’s and copyrighter’s sales
Trade secret misappropriation
Trade secrets consist of a formula, pattern, physical device, idea, process or compilation of information that provides the owner of the information with a competitive advantage in the marketplace, and is treated in a way that can reasonably be expected to prevent the public or competitors from learning about it.
A plaintiff in this type of case may seek remedies for misappropriation of trade secrets or theft in the form of the actual damages caused by the misappropriation. In fact, since the passing of the Defend Trade Secrets Act (DTSA) in 2016, there has been a substantial increase in DTSA cases filed which provides for damages related to actual losses, unjust enrichment and a reasonable royalty, amongst other measures. A financial expert in a trade secret-related matter may conduct some of the following damages analyses:
- Calculating lost profits by contemplating plaintiff’s historical financial performance before the event to the plaintiff’s performance after the event through the applicable damages period
- Quantifying unjust enrichment incremental to the owner’s actual losses by estimating the infringer’s revenues and costs associated with the infringement and the portion of the profits attributed to the infringement, in addition to calculating possible prejudgment interest on the damages award
- Using a market share approach for demonstrating the causal relationship between misappropriation and lost profits
- Conducting an analysis of defendant’s time savings, cost efficiencies, and increased profits from trade secret knowledge
Expert client services
Financial experts with experience in various types of IP disputes and expertise in accounting, finance or damages calculations are often hired as part of the dispute resolution process. Experts may provide affirmative or rebuttal (critique) reports detailing their methodology in calculating damages or opinion which can be utilized by a jury or judge for monetary awards or in settlement negotiations. Accordingly, hiring a financial expert can be one of the most important factors in the dispute resolution process.
A competent expert can be the difference between winning or losing millions of dollars over the duration of an IP dispute. For a more detailed list of considerations when hiring a financial expert, read our recent article Successful Use of Financial Experts in Litigation Matters.
With the growing significance of IP assets and costs related to responding to IP disputes, understanding the potential ways IP damages can be quantified is an important step in protecting the value of IP.
1. Intangible Asset Market Value Study, Ocean Tomo, Copyright 2015. For 2015, the implied intangible asset value of the S&P 500 grew to an average of 84%, a growth of four percentage points over ten years.
2. World Intellectual Property Indicators 2017, World Intellectual Property Organization, p. 37, 106.
3. Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970), modified, 446 F.2d 295 (2d Cir. 1970), cert. denied, 404 U.S. 870 (1971). This case provided 15 factors, known as the “Georgia-Pacific” factors, which are typically considered by experts when calculating a reasonable royalty rate.
5. Remedies for Infringement: Damages and Profits, 17 US Code, Section 504