The Impact Of Patent Licensing On Patent Litigation

One of the great advantages of IP, as compared to tangible assets, is that the IP owner can deploy his IP assets to generate revenue without incurring significant capital costs. The most common method of generating such revenue is through licensing.

The patent is the IP asset upon which this paper focuses. Patent attorneys and other technology transfer professionals are normally eager to assist their clients in generating revenue through patent licensing. Patent licensing professionals are well acquainted with the flexibility available to define the scope of a license in terms of several variables, including geographic territory and field of use. This flexibility allows the patent licensor to fine tune his licensing program to his particular business and/or economic objectives.

These business and economic objectives are frequently defined or measured in terms of cash flow generation and/or market penetration. These two considerations are often the major considerations to the licensing professional and the IP owner. This paper focuses on other, longer term ramifications of patent licensing. These ramifications include:

1. the ability to obtain a preliminary injunction against an infringer of the patent;
2. the lost profits and royalties that are recoverable as damages in litigation; and
3. the ability to rebut an invalidity attack based upon obviousness, made either in a Patent Office proceeding or in patent litigation.

District courts may grant injunctions in patent cases "in accordance with the principles of equity to prevent the violation of any right secured by patent, on such terms as the court deems reasonable." High Tech Med. Instrumentation, Inc. v. New Image Indus., Inc. 49 F.3d 1551, 1554 (Fed. Cir. 1995). A preliminary injunction prohibiting patent infringement involves substantive issues unique to patent law and, therefore, is governed by the law of the Federal Circuit. Reebok Int’l Ltd., v. J. Baker, Inc., 32 F.2d 1552, 1555 (Fed. Cir. 1994).

In order to obtain a preliminary injunction, a movant must show:

1. a reasonable likelihood of success on the merits;
2. irreparable harm will be suffered if preliminary relief is not granted;
3. the balance of hardships tip in favor of the movant; and
4. a tolerable effect on this public interest.

Sofamor Danek Group, Inc. v. DePuy-Montech, Inc., 74 F.3d 1216, 1219 (Fed. Cir. 1996). The movant’s burden is no more stringent in patent cases than it is in other preliminary injunction proceedings. H.H. Robertson Co. v. United Steel Deck, Inc., 820 F.2d 384, 388 (Fed. Cir. 1987).

The second element which the patentee must establish in order to obtain a preliminary injunction is that he will suffer irreparable harm if the preliminary injunction is not granted. Where there is a strong showing of likelihood of success on the merits, and that strong showing is coupled with continuing infringement, a presumption is raised of irreparable harm to the patentee. Reebok Int’l Ltd., 32 F.3d at 1556.

Factors to be considered in the irreparable harm inquiry include (a) whether the patentee’s reputation will be injured by the public mistaking inferior, infringing goods of the alleged infringer for the patentee’s product; (b) whether the patentee or its licensees will be injured by competition from the alleged infringer; and © whether the patentee runs the risk of loss of sales or goodwill in the market. High Tech Med. Instrumentation, Inc., 49 F.3d at 1556-58; Reebok Int’l Ltd., 32 F.3d at 1558, Roper Corp. v. Litton Sys., Inc., 757 F.2d 1266, 1273 (Fed. Cir. 1985).

The Federal Circuit has recognized market realities that help and hinder the patentee seeking to prove irreparable harm. The Federal Circuit has held that infringement may have market effects, such as decreases in market share and revenue, that are not fully compensable in money. Atlas Powder Co. v. Ireco Chem., 773 F.2d 1230, 1233 (Fed. Cir. 1985); Hybritech Inc. v. Abbott Labs, 849 F.2d 1446, 1447 (Fed. Cir. 1988). The Federal Circuit has also recognized that "a concept that every patentee is always irreparably harmed by an alleged infringer’s pretrial sales would . . . disserve the patent system." (emphasis in original); Illinois Toolworks Inc. v. Grip-Pak Inc., 15 U.S.P.Q. 2d 1307, 1310 (Fed. Cir. 1990).

It is well established that even a "presumption of irreparable harm to a patentee is, like all presumptions, rebuttable." Polymer Technologies Inc. v. Bridwell, 103 F.3d 970, 974 (Fed. Cir. 1996). The Federal Circuit has attempted to balance the various presumptions and absences of presumptions that result from the grant of a patent with respect to irreparable harm by holding:

1. "the nature of the patent grant weighs against holding that monetary damages will always suffice to make the patentee whole;" and
2. "there is no presumption that money damages will be inadequate in connection with a motion for an injunction."

(emphasis in original); High Tech, 49 F.3d at 1557.

The availability of monetary damages coupled with admissions made by the patentee that monetary damages are adequate to compensate him for the use of his patent likely will result in a finding that the patentee has failed to establish irreparable harm at the preliminary injunction stage. In High Tech, the Federal Circuit noted that "the availability of damages is particularly significant where, as here, the patentee can point to no specific interest that needs protection through interim equitable relief." Id.

In High Tech, the Federal Circuit held that "licensing is incompatible with the emphasis on the right to exclude that is the basis for the presumption [of irreparable harm] in a proper case." Id. at 1557. The Federal Circuit interpreted the patentee’s offer of licenses as a willingness "to forgo its patent rights for compensation." Id. The Federal Circuit found that the evidence in High Tech suggested that any injuries suffered by the patentee "would be compensable in damages asserted as part of the final judgment in the case." Id. The Federal Circuit concluded that the District Court had committed legal error in its analysis of irreparable harm and reversed the District Court’s grant of a preliminary injunction. Id. at 1558.

In several other cases, the Federal Circuit has found that patent licensing is inconsistent with a claim of irreparable harm. T.J. Smith and Nephew Limited v. Consol. Med. Equip. Inc., 802 F.2d 646, 648 (Fed. Cir. 1987); Illinois Toolworks Inc., 15 U.S.P.Q. 2d at 1310. In Smith and Nephew, the patentee had not only licensed its patent, but had also waited 15 months before seeking a preliminary injunction. The Federal Circuit held that even if there were a presumption of irreparable harm, "it would have been rebutted here by Nephew’s delay in seeking an injunction and by its grant of licenses, acts incompatible with the emphasis on the right to exclude that is the basis for the presumption in a proper case." Id. at 648.

In Illinois Toolworks, the District Court held:

(emphasis added); Illinois Toolworks Inc. v. Grip-Pak Inc., 725 F.Supp 951, 958 (N.D. Ill. 1989). The Federal Circuit affirmed the District Court’s denial of a preliminary injunction in Illinois Toolworks. 15 U.S.P.Q. 2d at 1311.

The patentee who agrees to a royalty in an arms length transaction makes an admission that there is a sum certain which he will accept in exchange for the right not to be excluded from practicing the patented invention. That admission is inconsistent with the argument that pretrial infringement will result in irreparable harm. Thus, a prospective licensing transaction which may appear to favor the patentee from a cash flow or market penetration perspective may have a lurking "downside" that is not readily appreciated by all licensing professionals.

Patentees are well served by patent licensing professionals who advise the patentees of the potential adverse effects of patent licensing on the availability of preliminary injunctive relief, as explained above. The prudent patent licensing professional will wish to avoid having his client become educated about this issue at the preliminary injunction hearing.

3. The Impact Of Patent Licensing Onthe Award Of Damages In Patent Litigation

The scope of damages available to patentees has increased significantly in the last five years as a result of the Federal Circuit’s en banc decision in Rite-Hite Corp. v. Kelley Co. Inc., 56 F.3d 1538 (Fed. Cir. 1995), approving the application of the "entire market value," to determine the award of damages in patent infringement litigation. The scope of damages available to the patentee now encompasses various combinations of one or more of the following remedies:

1. lost profits¹ suffered by the patentee from lost sales of the patented item as well as the sales of collateral items ("tag along sales"); and
2. a reasonable royalty applicable to the infringing units made, used, or sold as well as collateral items.

Rite-Hite, 56 F.3d at 1554; Minco, Inc. v. Combustion Eng’g Inc., 40 U.S.P.Q. 2d 1001, 1008 (Fed. Cir. 1996) ("the Patent Act permits damages awards to encompass both lost profits and a reasonable royalty on that portion of an infringer’s sales not included in the lost profit calculation").

The lost profits remedy is usually the more lucrative remedy for the patentee to pursue. There may, however, be scenarios where a reasonable royalty is more lucrative than a lost profits remedy. Such a scenario may exist where the patentee’s profit margin is low due to his high overhead or other operating inefficiencies and the reasonable royalty is high due to large up front royalty payments or large minimum annual royalty payments which are present in existing licenses.

One of the factors which must be proven in order to establish entitlement to lost profits for patent infringement is the absence of acceptable noninfringing alternatives². BIC Leisure Products Inc. v. Windsurfing Int’l Inc., 1 F.3d 1214, 1219 (Fed. Cir. 1993). In the "old days" this element was difficult to prove in a market with more than two suppliers. In recent years, the Federal Circuit has demonstrated flexibility by accepting various methods by which patentees may prove the absence of acceptable noninfringing alternatives. These methods include the patentee’s submission of "proof of its market share for proof of the absence of acceptable substitutes." Id.

"In a market with only two suppliers, the patentee and the infringer," proof of the absence of the acceptable nonfringing substitutes "is readily met." Pall Corp. v. Micron Separations Inc., 36 U.S.P.Q. 2d 1225, 1233 (Fed. Cir. 1995). When the patentee grants nonexclusive licenses, the patentee creates acceptable noninfringing substitutes³. In Pall, the patentee and his licensees had 25% and 75% of the market share for the patented product, respectively. The Federal Circuit remanded the case with instructions to the district court to award the patentee lost profits damages for 25% of the defendant’s infringing sales and a reasonable royalty for 75% of the infringer’s sales.

Thus, the patentee who grants nonexclusive licenses may find that the later availability of lost profits damages is reduced in direct proportion to the nonexclusive licensees’ market share. A patentee who is informed of this consequence prior to licensing may elect to license only in fields of use or territories where his major competitors are unlikely to compete. This practice will mitigate the adverse impact of the licensees’ market share on the availability of a lost profits recovery.

Section 284 of the Patent Act states, in part:

35 U.S.C. § 284. Thus, the reasonable royalty is regarded as the "floor" below which the award of damages for patent infringement shall not submerge.

The Federal Circuit has recognized that "the reasonable royalty may be based upon an established royalty, if there is one, or if not upon a hypothetical royalty resulting from arms length negotiations between a willing licensor and a willing licensee. Hanson v. Alpine Valley Ski Area Inc., 718 F.2d 1075, 1078 (Fed. Cir. 1983).

As a general rule, the greater the number of license agreements there are involving the patent-in-suit, the greater the probability that those agreements will be sufficient to evidence "an established royalty." The Federal Circuit has provided the following guidance on this issue:

One should not infer, however, that the existence of only one or two license agreements will not be admissible as relevant evidence in determining what a reasonable royalty would be.

The customary ranges of royalty rates available for patented inventions may vary widely from industry to industry, based on many factors, including but not limited to the capital-intensive nature of the technology, the projected life of the technology, and the projected size of the market for the technology. Thus, the terms "high" and "low," as applied to royalty rates, are used in this paper relative to the industry in which the patented technology is to be sold.

Patentees who license their patents at "high" royalties will build a base of evidence from which to support the assertion that the established royalty for the patented invention is equivalently "high." The converse is true for patentees who license their patents at "low" royalties. Patentees will often elect to license at a "low" royalty at the incipient stage of a technology, in order to gain market share and acceptance.

One way to mitigate the adverse effect of a "low" royalty license is to state in the recital section of the license that it is entered into between the licensor and the licensee in order to avoid patent litigation⁴. The Federal Circuit has held that licenses entered into where litigation "was threatened or probable . . . should not be considered evidence of an established royalty since license fees negotiated in the face of a threat of high litigation costs may be strongly influenced by a desire to avoid full litigation." Id. at 1078-1079.

Where there is no established royalty, the trier of fact may engage in the fiction of hypothetical licensing negotiations between a willing licensor and a willing licensee. Id. at 1078; Rite-Hite Corp., 56 F.3d at 1554. The Federal Circuit in Rite-Hite held:

Id. The Federal Circuit has held that any determination reached by the trier of fact regarding a reasonable royalty "must be supported by relevant evidence in the record." Unisplay, S.A. v. Am. Elec. Sign Co. Inc., 69 F.3d 512, 517 (Fed. Cir. 1995).

The most widely recognized family of factors to be evaluated in determining a reasonable royalty resulting from hypothetical licensing negotiations are known as the "Georgia Pacific" factors. Georgia-Pacific Corp. v. United States Plywood Corp., 318 F.Supp. 1116, 1120, 166 U.S.P.Q. 235, 238 (S.D. N.Y. 1970) modified and affirmed 446 F.2d 295, (2nd Cir.) cert. denied 404 U.S. 870 (1971). The first two Georgia-Pacific factors are relevant to preexisting licenses. These first two factors are:

1. the royalty received by the patentee for the licensing of the patent-in-suit, proving or tending to prove an established royalty; and
2. the rates paid by the licensee for the use of other patents comparable to the patent-in-suit.

Georgia-Pacific, 166 U.S.P.Q. at 238. The relative magnitude of the royalty rates in preexisting license will have the same favorable or adverse impact upon the Georgia-Pacific analysis as such magnitude has upon the determination of an established royalty, as discussed above. Thus, even a single prelitigation license may impact the determination of a reasonable royalty.

Where the magnitude of the royalty in the prelitigation license is relatively "low," the license should state that it has been entered into between the parties in order to avoid patent litigation. This prophylactic measure should increase the probability that this low royalty license will not be considered in determining a reasonable royalty. Deere & Co. v. Int’l Harvester Co, 710 F.2d 1551, 1558 (Fed. Cir. 1983) (where a "license was negotiated against a backdrop of continuing litigation" the District Court could "discount the probable value" of the license "with regard to a reasonable royalty").

A claimed invention may be challenged as obvious in a Patent Office proceeding (prosecution or reexamination) or during patent litigation, in order to argue that the patent claim is invalid. Once a prima facie case for obviousness is made, the burden shifts to the patent applicant, patentee, or assignee (collectively, "patentee") to rebut it, if he can, with objective evidence of nonobviousness. In re Rouffet, 149 F.3d 1350, 1355, 47 U.S.P.Q.2d 1453 (Fed. Cir. 1998); In re Fielder, 471 F.2d 640, 176 U.S.P.Q. 300, 302 (C.C.P.A. 1973). These so-called "secondary considerations" or indicia of nonobviousness may relate to any of the Graham v. John Deere Co. factors, such as:

• copying by others;
• fulfilling a long-felt but unsolved need;
• failure of others;
• commercial success;
• unexpected results or properties;
• skepticism of skilled artisans before the invention; and
• licenses showing industry respect for or acquiescence in the invention.

In re Rouffet, 149 F.3d at 1355; Graham v. John Deer Co., 381 U.S. 1, 148 U.S.P.Q. 459 (1966).

Accordingly, a license under the patent may be offered as persuasive evidence in rebutting a prima facie case for obviousness. In re Sernaker, 702 F.2d 989, 996, 217 U.S.P.Q. 1 (Fed. Cir. 1983). At least one district court has held that even the mere attempt to obtain a license under the patent is admissible evidence that is relevant to obviousness. Amsted Industries Inc. v. National Castings Inc., 16 U.S.P.Q.2d 1737, 1751 n.11 (N.D. Ill. 1990) ("[E]vidence reflecting the merits and profitability of the patented invention as seen through the eyes of a potential competitor in the industry [is] probative.").

However, evidence from licenses is merely persuasive, not infallible. For example, it is possible that those who seek licenses and refrain from infringement may do so not "out of respect for the strength of the patent" but "out of a desire to avoid the costs of litigation." Pentec, Inc. v. Graphic Controls Corp., 776 F.2d 309, 316, 227 U.S.P.Q. 766 (Fed. Cir. 1985). Thus, a license may be viewed as having been entered into merely to avoid litigation, rather than as evidence of industry respect.

Moreover, the patentee bears the burden of showing that a nexus exists between the claimed features of the invention and the objective evidence offered to show nonobviousness. WMS Gaming Inc. v. International Game Technology, 1999 U.S. App. LEXIS 16696, *57-58, 51 U.S.P.Q.2d 1385 (Fed. Cir.); see also Pentec, supra. Unless there is a nexus between the secondary indicia of nonobviousness (such as a license or commercial success), the motivation to enter the license or cause of the commercial success may have been due in large part to other economic and commercial factors unrelated to the technical quality of the patented subject matter. Pentec, 776 F.2d at 316.

For example, it could be argued that an IBM® patent is licensed primarily because of the commercial strength of the IBM® mark. As another example, the licensed product may be commercially successful due to a good marketing campaign or due primarily to unclaimed features of a product also embodying the claimed features. Thus, the nexus between the license and the claimed features of the invention must be established in order to use a license as evidence of nonobviousness.

Thus, the patentee’s attorney should carefully negotiate and draft the license to maximize the patentee’s chance of using it to rebut a prima facie case of obviousness. This may be done in the in the recital section of the license agreement. These clauses should refer to the invention which contains the elements or limitations claimed in the broadest patent claims of the patent under license, and should positively recite that this fulfills a long-felt need, and that the agreement is entered into because this invention fulfills various specified needs of the licensee.

The use of such language should help to establish the nexus between the license and the claims, so that the license shows industry respect rather than a desire to avoid litigation. It should be noted, however, that there is a tension between this strategy and that discussed in Section III.B, above, in which it is suggested that, where the magnitude of the royalty in the prelitigation license is relatively low, the license should state that it has been entered into between the parties in order to avoid patent litigation. As discussed above, this is done to mitigate the adverse effect that a low royalty license might have on establishing what a reasonable royalty is for calculation of damages.

Thus, the patentee needs to carefully consider whether to characterize the license as entered into to avoid litigation, or as entered into so that the patentee can obtain the advantages of the claimed invention. Where a high royalty base is established, the latter strategy will often be more attractive. Conversely, where a low royalty base is established, the former strategy may be desirable in order to maximize a reasonable royalty determination, but at the cost of sacrificing the license as evidence of nonobviousness.

Moreover, by utilizing such a recital clause, the license may also be used as evidence of the long-felt need secondary consideration of nonobviousness.

In many respects, patent licenses are like one’s grades in undergraduate school. They never go away and you may be asked to produce them long after the fact. It is hoped that this paper has given the reader a greater appreciation for the long term consequences of patent licensing entered into before the prospect of litigation or reexamination appears on the horizon, and of the tradeoffs and tensions that sometimes accompany various licensing strategies. The patent licensing professional who advises his clients of these ramifications should be spared the unpleasantness of hearing a former client say "I would never have entered into that license if only you had advised me of its long term effects." Consideration of the longer term ramifications of patent licensing discussed herein should enable patent licensing professionals to maximize the value of their clients’ IP assets.

1. The Award Of Lost Profits is based upon patentee's gross or "incremental Profit." State Indus. Inc. v. Mor-Flo Indus,. 883 F.2d 1573, 1579-80 (Fed. Cir. 1989)
2. This is known as the second "Pandit factor."
3. Exclusive licensees have standing to join the patentee in suit and seek a recovery of their lot profits in for infringing sales within the scope of their exclusive license. Rite-Hite Corp. v. Kelley Co. Inc., 774 F. Supp. 1519 (Ed. Wis. 1991); affirmed in part, vacated in part, and remanded, 56 F. 3d 1538 (Fed. Cir. 1995)
4. In many licensing scenarios where the patentee is willing to enforce his patent rights, this proposed clause merely states the obvious, since a licensed product does not infringe, and a license has little incentive to pay a royalty for an activity not covered by the patent claims.