Reasonable Royalty Patent Damages: A Proper Reading of The Book Of Wisdom

In patent infringement cases where the patentee seeks reasonable royalty damages, the patentee most often tries to carry its burden of proof by showing the amount the patentee and the accused infringer reasonably would have agreed upon had they negotiated a royalty at the time before the infringement began. ¹Uniloc USA Inc. v. Microsoft Corp., 632 F.3d 1292, 1312, 2011 BL 1830, 98 U.S.P.Q.2d 1203 (Fed. Cir. 2011) (81 PTCJ 275, 1/7/11) (“A reasonable royalty is the predominant measure of damages in patent infringement cases.”); Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301, 1324, 2009 BL 193956, 92 U.S.P.Q.2d 1555 (Fed. Cir. 2009) (78 PTCJ 583, 9/18/09) (hypothetical negotiation takes place “just before infringement began”); Integra Lifesciences I, Ltd. v. Merck KgaA, 331 F.3d 860, 869, 66 U.S.P.Q.2d 1865 (Fed. Cir. 2003) 66 PTCJ 200, 6/13/03 (hypothetical negotiation occurs “at a time before the infringing activity began”). Although the case law has not addressed the distinction, the Federal Trade Commission has taken the position that the negotiation should be deemed to have taken place “at the time the decision to use the infringing technology was made” in order to prevent damage awards based on the costs from switching designs after making investments based on that decision. Federal Trade Commission, The Evolving IP Marketplace: Aligning Patent Notice and Remedies with Competition 189-91 (2011). Identifying the date of the hypothetical negotiation on “the eve of infringement” is a critical first step in such a damages analysis because the very purpose of the hypothetical negotiation framework is “to discern the value of the patented technology to the parties in the marketplace when infringement began.” ²LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51, 76, 2012 BL 222195, 104 U.S.P.Q.2d 1573) (Fed. Cir. 2012) (84 PTCJ 809, 9/14/12 (“[T]he basic question posed in a hypothetical negotiation is: if, on the eve of infringement, a willing licensor and licensee had entered into an agreement instead of allowing infringement of the patent to take place, what would that agreement be?”).

Thus, the Federal Circuit has emphasized that the reasonable royalty determination must relate to the time infringement first occurred; ³Applied Med. Res. Corp. v. U.S. Surgical Corp., 435 F.3d 1356, 1363-64, 77 U.S.P.Q.2d 1666 (Fed. Cir. 2006) 71 PTCJ 313, 1/27/06 (“[T]he hypothetical negotiation relates to the date of first infringement.”); Riles v. Shell Exploration & Prod. Co., 298 F.3d 1302, 1313, 63 U.S.P.Q.2d 1819 (Fed. Cir. 2002) 64 PTCJ 350, 8/9/02 (“A reasonable royalty determination for purposes of making a damages evaluation must relate to the time infringement occurred … .” (citing Hanson v. Alpine Valley Ski Area, Inc., 718 F.2d 1075, 1079, 219 U.S.P.Q. 679 (Fed. Cir. 1983))). it must “not be an after-the-fact assessment”; ⁴LaserDynamics, 694 F.3d at 75 (quoting Riles, 298 F.3d at 1313). and correctly determining the hypothetical negotiation date “is essential for properly assessing damages.” ⁵Id. (citing Integra, 331 F.3d at 870)); see also Hanson, 718 F.2d at 1079 (“The key element in setting a reasonable royalty … is the necessity for return to the date when the infringement began.” (internal citation and quotation marks omitted)). Indeed, the court has observed that, because the timing of the hypothetical negotiation can make a significant difference in the economic risks and rewards the negotiating parties would have factored into their bargaining, even a one-year difference in the hypothetical negotiation date could alter the amount of the royalty the parties would have negotiated. ⁶Integra, 331 F.3d at 870. Failure to properly identify the hypothetical negotiation date can be a path to reversal and remand. In Integra, for example, the court remanded the case for further consideration of damages, noting (among other reasons) that “the record is not clear on the hypothetical negotiation date.” Id. Likewise, after concluding that the trial court had used the wrong hypothetical negotiation date, the LaserDynamics court remanded for a new trial on damages “[b]ecause our decision alters the time period when the analysis under Georgia-Pacific is to take place … .” 694 F.3d at 76.

The courts recognize, however, that in certain cases there will be little or no evidence of the patent’s value at the time of the hypothetical negotiation or of how parties to the negotiation would have determined that value. This arises in part because patents are intrinsically unique and consequently there may be no evidence of their value until the claimed inventions are used; thus, valuations at the time of a hypothetical negotiation contain an element of speculation and uncertainty. In such cases, facts that post-date the hypothetical negotiation—“ex post data” or “subsequent events”—may be relevant to ascertaining the negotiated value of the patented technology, namely by shedding light on the information the parties to the hypothetical negotiation would have considered in determining the value, such as sales projections, estimates of future use, and the like. As the Federal Circuit explained in Lucent Techs., Inc. v. Gateway, Inc., “[c]onsideration of evidence of usage after infringement started can, under appropriate circumstances, be helpful to the jury and the court in assessing whether a royalty is reasonable. Usage (or similar) data may provide information that the parties would frequently have estimated during the [hypothetical] negotiation.” ⁷580 F.3d at 1333-34.

Often referred to as the “book of wisdom”—a shorthand one court colorfully characterized as a “corny moniker” ⁸BASF Corp. v. Aristo, Inc., No. 2:07-cv-222, 2012 BL 162179, at *2 (N.D. Ind. June 29, 2012).—this principle is the subject of considerable misunderstanding, misinterpretation, and abuse. ⁹The purpose of the book of wisdom has been misconstrued. See, e.g., Dorsey Baker, Patent Damages—Quantifying the Award, 69 J. Pat. & Trademark Off. Soc’y 121, 148 (1987) (the book of wisdom “permits a test of the analytical tools used by business managers” and “provides further standards by which the adequacy of the compensation can be evaluated”). The book of wisdom also has produced some occasional, unintended comic relief. In Bowling v. Hasbro, Inc., No. CA 05-229 S, 2008 BL 54435 (D.R.I. Mar. 17, 2008), for example, the patentee’s proffered damages expert was questioned by the court during the Daubert hearing about his knowledge of the “book of wisdom.” The expert advised the court that it was “a book that references application of the Georgia-Pacific factors, and it’s a reference or literature that talks about these topics.” Id. at *6 n.2. The expert even helpfully offered to provide the court a copy of the book. Id. The court excluded the expert’s opinion and, in a fine example of judicial restraint, noted that the expert’s comments about the book of wisdom “raise questions” and “undermine[] his credibility before this Court.” Id. Some critics suggest that the book of wisdom cases articulate no guiding principle that defines what ex post data may—or may not—be considered. ¹⁰See BASF, 2102 BL 162179, at *2 (suggesting that the information the parties are “imagined to have at the hypothetical royalty negotiation exists on a spectrum” between “blank slate” and “perfect hindsight” and that the Federal Circuit has used a “case-by-case, fact-driven analysis” to determine when an expert’s reliance on post-negotiation fact is—or is not—appropriate); Michael J. Wagner, Book of Wisdom—Is It Fact or Fiction?, Dunn on Damages 7 (Summer 2011) (“Fact or Fiction?”) (stating that Lucent limits the use of subsequent information to “appropriate circumstances” “without giving any guidance as to what is appropriate circumstances”); D. Christopher Holly, The Book of Wisdom: How to Bring a Metaphorical Flourish Into the Realm of Economic Reality by Adopting a Market Reconstruction Requirement in the Calculation of a Reasonable Royalty, 92 J. Pat. & Trademark Off. Soc’y 156, 181 (2010) (“[L]ack of guidance has led to confusion and litigation regarding the availability of the book of wisdom.”); Peter Strand, Cracking Open the Book of Wisdom: Where the Past Can Become the Present, 1 IpQ 1, 3 (No. 5, 2009) (“Living with the ‘book of wisdom’ after Fromson hasn’t been a model of clarity, and there are few guidelines for its use.”). Others suggest that the guiding principle is “all in”—that is, every fact known at the time of trial is deemed to have been known to the parties at the time of the hypothetical negotiation. ¹¹See Enzo Biochem, Inc. v. Applera Corp., No. 3:04-cv-929, 2013 BL 204770, at *19 (D. Conn. Aug. 1, 2013) (emphasis added) (quoting damages expert’s trial testimony that one of the “main ideas behind this hypothetical negotiation … is the sense that it’s cards on the table. All the information is revealed. And, in fact, the courts have called this the idea of a book of wisdom.”); Mobil Oil Corp. v. Amco Chems. Corp., 915 F. Supp. 1333, 1352 (D. Del. 1994) (“The Court must also assume, for purposes of the hypothetical negotiations, that all parties would have known all relevant information.”); St. Clair Intellectual Prop. Consultants, Inc. v. Canon, Inc., No. 1:03-cv-00241-LPS, slip op. at *7 (D. Del. Sept. 28, 2004) (same); Fact or Fiction?, supra note 10, at 7 (book of wisdom is “consistent” with an “outcome” approach to damages, in which “[a]ll information up until the time of trial is used to make the most accurate calculation of damages possible”). This approach has been justified by one commentator as focusing on the financial loss to the patentee caused by the infringement, measured by the patentee’s “condition before and after the infringement”—that is, “the difference between his pecuniary condition after the infringement, and what his condition would have been if the infringement had not occurred.” John J. Barnhardt, III, Revisiting a Royalty as a Measure of Damages for Patent Infringement, 86 J. Pat. & Trademark Off. Soc’y 991, 995 (2004) (quoting Yale Lock Mfg. Co. v. Sargent, 117 U.S. 536, 522 (1886)). See also Fact or Fiction?, supra note 10, at 6-7. One court has described the book of wisdom as permitting consideration of “every advantageous change in profits, sales and other conditions” that has occurred prior to trial. ¹²See Affinity Labs. of Tex., LLC v. BMW N. Am., LLC, 783 F. Supp. 2d 891, 898 n.6 (E.D. Tex. 2011) (“If there have been any changes in the market between the date of the hypothetical negotiation and the date of trial a damages expert may include in his or her pre-suit calculations every advantageous change in profits, sales, and other conditions under the ‘book of wisdom’ rubric.” (emphasis added) (citing Lucent, 580 F.3d at 1333-34, and Sinclair Refining Co. v. Jenkins Petroleum Process Co., 289 U.S. 689, 698 (1933))).

These interpretations of the book of wisdom are premised on a misreading of the appellate cases that established and have applied the book of wisdom principle. Moreover, to the extent they suggest the book of wisdom permits consideration of any and all ex post data, they are inconsistent with case law and effectively would eliminate the hypothetical negotiation construct that has been a core part of patent jurisprudence for at least 75 years. ¹³See, e.g., Deere & Co. v. Int’l Harvester Co., 710 F.2d 1551, 1559, 218 U.S.P.Q. 481 (Fed. Cir. 1983) (citing Georgia-Pacific to hold that the district court’s use of a “hypothetical willing seller” and “theorized licensing negotiations” constituted “an eminently reasonable approach to the willing seller-willing buyer analysis”); Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F.2d 1152, 1159, 197 U.S.P.Q. 726 (6th Cir. 1978) (“Determination of a ‘reasonable royalty’ after infringement, like many devices in the law, rests on a legal fiction. Created in an effort to ‘compensate’ when profits are not provable, the ‘reasonable royalty’ device conjures a ‘willing’ licensor and licensee, who like Ghosts of Christmas Past, are dimly seen as ‘negotiating’ a ‘license.’ There is, of course, no actual willingness on either side, and no license to do anything, the infringer being normally enjoined … from further manufacture, use, or sale of the patented product.”); Horvath v. McCord Radiator & Mfg. Co., 100 F.2d 326, 336 (6th Cir. 1938) (“In fixing damages on a royalty basis against an infringer, the sum allowed should be reasonable and that which would be accepted by a prudent licensee who wished to obtain a license but was not so compelled and a prudent patentee, who wished to grant a license but was not so compelled. In other words, the sum allowed should be that amount which a person desiring to use a patented machine and sell its product at a reasonable profit would be willing to pay.”). If the value of the use of the patented technology were determined as of the trial date based on all the facts and events known at that time, the hypothetical negotiation date would cease to have any significance—a result that would be decidedly at odds with decades of Federal Circuit law. ¹⁴See George P. Roach, Correcting Uncertain Prophecies: An Analysis of Business Consequential Damages, 22 Rev. of Lit. 1, (2003) (Rather than identifying the patent license’s market value at the date of the hypothetical negotiation, “the use of ex post data … could be abused in such a way as to calculate what market value should be rather than what it should have been.”).

In fact, the appellate courts have articulated guiding principles for when ex post data properly can be used to inform a reasonable royalty damages analysis. And neither the Supreme Court, which first articulated the book of wisdom concept 70 years ago, nor the Federal Circuit, which subsequently has addressed the concept, has ever suggested that it is a wide-open book that allows consideration of every post-hypothetical negotiation fact and development.

Quite the contrary. The cases demonstrate that admission of ex post data under the book of wisdom is not boundless. Many cases expressly reject certain ex post data, a fact that alone proves the fallacy of the “all in” view of the scope of the book of wisdom. In general, the cases establish that the only purpose of the book of wisdom is to permit consideration of ex post data that constitute inferential evidence of a particular value determined in the past. In patent infringement suits, the amount of a reasonable royalty is most often determined by a hypothetical negotiation. Thus, the book of wisdom is available in the patent infringement context to shed light on the state of mind of the parties to the hypothetical negotiation, namely what the parties would have considered as they assessed the value of a license under the patent during their hypothetical negotiation. ¹⁵See Lucent, 580 F.3d at 1333-34. Ex post data are admissible only to fill evidentiary “gaps” about the parties’ valuation of the patent at the time of the hypothetical negotiation; they may not be used to contradict pre-hypothetical negotiation evidence that illuminates how the parties would have valued the patent rights. As in the tax valuation context, the key distinction is “between later-occurring events which affect … value as of the valuation date, and later-occurring events which may be taken into account as evidence of … value as of the valuation date,” with only the latter being admissible. ¹⁶Estate of Jung v. Comm’r, 101 T.C. 412, 431 (1993); see also Ithaca Trust Co. v. United States, 279 U.S. 151, 155 (1929) (Holmes, J.) (“The first impression is that it is absurd to resort to statistical probabilities when you know the fact. But this is due to inaccurate thinking. The estate so far as may be is settled as of the date of the testator’s death. The tax is on the act of the testator not on the receipt of property by the legatees. Therefore the value of the thing to be taxed must be estimated as of the time when the act is done. But the value of property at a given time depends upon the relative intensity of the social desire for it at that time, expressed in the money that it would bring in the market. Like all values, as the word is used by the law, it depends largely on more or less certain prophecies of the future; and the value is no less real at that time if later the prophecy turns out false than when it comes out true.” (internal citations omitted) (emphasis added)). For these reasons, the book of wisdom, which the Federal Circuit has cautioned may be consulted only “in certain circumstances,” ¹⁷Lucent, 580 F.3d at 1333. is but a slim volume.

I. The Contents of the Book of Wisdom

Few precedential cases explicitly discuss the “book of wisdom.” Taken together with other cases that consider use of ex post information, they identify four categories of information that, under proper circumstances, might properly be considered in a patent infringement case: (1) ex post information about the infringer’s actual usage of the patented invention; (2) ex post agreements, including sales and license agreements; (3) ex post information about the profits derived by the infringer from the use of the patented invention; and (4) ex post information about noninfringing alternatives to the patented invention.

Even those four categories, however, are subject to an important qualifier: where there is ex ante evidence of what the parties to the hypothetical negotiation would have considered as of the date of the hypothetical negotiation, that contemporaneous information is the best evidence of how the parties to the hypothetical negotiation would have valued the use of the patent rights at the time. Such evidence may look to potential usage of the patented technology (e.g., in the form of pre-negotiation sales projections), the value of a license under the patent (e.g., in the form of pre-negotiation licenses to the same or similar technology), the infringer’s anticipated profits from use of the patented invention (e.g., in the form of pre-negotiation profit projections), and the infringer’s noninfringing alternatives to the patented invention (e.g., in the form of pre-negotiation rejection of alternatives as infeasible or unacceptable to customers). Regardless of the category, however, ex post data cannot properly be used to supersede contemporaneous evidence of the parties’ state of mind.

A. Ex Post Usage and Sales Data

The most common use of ex post evidence is the infringer’s usage or sales. Calculation of the reasonable royalty as a running royalty based on usage (such as a “per-unit royalty” or a royalty based on a percentage of sales) is not, however, an application of the book of wisdom. In such cases, the hypothetical negotiation arrives at the royalty amount per unit or royalty rate as a percentage of sales or other value, and the calculation of damages therefore necessarily requires that the royalty amount or rate be applied to ex post data, namely the ensuing sales numbers or amounts. In such cases, the use of ex post data has nothing to do with the book of wisdom. The book of wisdom applies only where ex post facts or circumstances are used to shed light on the state of mind of the parties to the hypothetical negotiation regarding, for example, the extent of usage or sales in negotiation of a lump-sum royalty. Whereas a running royalty is premised on ex post events that subsequently affect the patent’s value, the book of wisdom involves situations in which ex post events are considered as evidence of value on a prior date—i.e., at the time of the hypothetical negotiation. ¹⁸See Estate of Jung, 101 T.C. at 431; Lucent, 580 F.3d at 1325, 1334-35. With this in mind, let us turn to cases that have addressed the book of wisdom in connection with ex post usage or sales data.

1. The Supreme Court’s Sinclair v. Jenkins

Understanding the scope of the book of wisdom necessarily begins with Justice Cardozo’s 1933 opinion in Sinclair Refining Co. v. Jenkins Petroleum Process Co., in which the Supreme Court introduced the book of wisdom concept to patent valuation jurisprudence. ¹⁹289 U.S. 689 (1933). The damages at issue in that action were not for patent infringement, but for breach of contract for failure to assign a patent upon its issuance as required by the parties’ written agreement. The claimed damages, therefore, were for the value of the patent at the time it issued. ²⁰Id. at 690-91. More specifically, the court’s opinion addressed whether the plaintiff was entitled to discovery to assist it in determining and proving the value of the patent and whether such discovery could include the extent of the “commercial use that had been made of the patented device.” ²¹Id. at 692. After holding that the plaintiff was entitled to damages discovery, the court concluded that “[t]he use that has been made of the patented device is a legitimate aid to the appraisal of the value of the patent at the time of the breach.” ²²Id. at 697.

The Sinclair court began by underscoring that, because a patent is “a unique thing,” its value could not be measured by then-current sale prices in the marketplace. Absent such a “market test,” however, “[t]he law will make the best appraisal that it can, summoning to its service whatever aids it can command.” ²³Id. In such circumstances, “there must be reference to the values inherent in the thing itself, whether for use or for exchange.” ²⁴Id. at 699 (emphasis added). The court explained:

At times the only evidence available may be that supplied by testimony of experts as to the state of the art, the character of the improvement, and the probable increase of efficiency or saving of expense. This will generally be the case if the trial follows quickly after the issue of the patent. But a different situation is presented if years have gone by before the evidence is offered. Experience is then available to correct uncertain prophecy. Here is a book of wisdom that courts may not neglect. We find no rule of law that sets a clasp upon its pages, and forbids us to look within. ²⁵Id. at 698 (citations omitted).

The court made clear, however, that it was not abandoning the “date of breach” valuation date: “[t]o correct uncertain prophecies in such circumstances is not to charge the offender with elements of value non-existent at the time of his offense. It is to bring out and expose to light the elements of value that were there from the beginning.” ²⁶Id. (emphasis added).

In sum, the Supreme Court made clear that the book of wisdom it articulated (1) is employed to fill an evidentiary gap, namely where the value to be ascertained is uncertain at the time of valuation—in that case due to a lack of actual market-based valuation data on the valuation date; (2) extends only to ex post data revealing “the values inherent in the [patent or invention] itself,” the quintessential example of which is usage data; and (3) is firmly anchored in—and fully consistent with—the core principle that the value of the patent must be determined at the time of breach, which in patent infringement cases is the eve of infringement. ²⁷In the Second Circuit’s Guggenheim v. Helvering decision, Judge Learned Hand interpreted Sinclair as follows:

In Sinclair Refining Co. v. Jenkins Petroleum Process, … the court was passing upon the damages suffered by a promisee from the breach of a contract to assign a patent, and held that it was proper to look to what the seller had earned by exploiting it after the breach. There the test was that amount which would put the buyer in as good position as though the seller had performed, and the best way to learn that would have been to wait and see what the patent actually brought in. Estimates of its value are mere makeshifts permissible only because the suit cannot wait so long. There are indeed situations when present value is itself an issue, and that may be true even in contracts; for if the goods are fungibles the law imposes upon the buyer the duty to stop his loss by a covering contract. Estate taxes are another instance of this, because they are assessed upon value at the decedent’s death (often with extremely harsh results) and present value is present opinion. Only so far as present opinion is composed in part of a forecast of the future can the future be supposed to have anything to do with it; and it really has none even then, because a forecast of the future is an entirely different thing from the actual future which will confirm or falsify it.

117 F.2d 469, 473 (2d Cir. 1941).

2. The Federal Circuit’s Lucent v. Gateway.

The Federal Circuit addressed usage data and the book of wisdom in 2009 in one of its leading patent infringement damages cases, Lucent Techs., Inc. v. Gateway, Inc.
²⁸580 F.3d 1301, 2009 BL 193956, 92 U.S.P.Q.2d 1555 (Fed. Cir. 2009) (78 PTCJ 583, 9/18/09). Microsoft Outlook’s date-picker tool was alleged to infringe a patented method for entering information into fields on a computer screen without using a keyboard. The Federal Circuit reviewed the jury’s nearly $358 million lump-sum royalty award within the Georgia-Pacific framework ²⁹See Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116, 166 U.S.P.Q. 235 (S.D.N.Y. 1970), modified sub nom., 446 F.2d 295 (2d Cir. 1971). and concluded that it was not supported by substantial evidence. ³⁰Lucent, 580 F.3d at 1324.

In assessing the sufficiency of the evidence, the court discussed a number of the Georgia-Pacific factors, including Factor 11, which is “[t]he extent to which the infringer has made use of the invention; and any evidence probative of the value of that use.” ³¹Id. at 1333 (quoting Georgia-Pacific, 318 F. Supp. at 1120). The court explained that, “as with Factors 10 and 13, the eleventh factor informs the court and jury about how the parties would have valued the patented feature during the hypothetical negotiation.” ³²Id. Factor 10 is “[t]he nature of the patented invention; the character of the commercial embodiment of it as owned and produced by the licensor; and the benefits to those who have used the invention.” Georgia-Pacific, 318 F. Supp. at 1120. Factor 13 is “[t]he portion of the realizable profit that should be credited to the invention as distinguished from non-patented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer.” Id. Both factors “aim to elucidate how the parties would have valued the patented feature during the hypothetical negotiation.” Lucent, 580 F.3d at 1332.

The court rejected Microsoft’s argument that evidence about how often the date-picker tool actually had been used by consumers was irrelevant because it post-dated the hypothetical negotiation, explaining:

[N]either precedent nor economic logic requires us to ignore information about how often a patented invention has been used by infringers. Nor could they since frequency of expected use and predicted value are related. ³³Id. at 1333 (emphasis added).

Citing Sinclair, the Lucent court held that evidence of usage can “under appropriate circumstances” be helpful in assessing the reasonableness of a royalty, because “[u]sage (or similar) data may provide information that the parties would frequently have estimated during the negotiation.” ³⁴Id. at 1333-34 (citing Sinclair, 289 U.S. at 697 (“The use that has been made of the patented device is a legitimate aid to the appraisal of the value of the patent at the time of the breach.”)). It elaborated:

Such data might, depending on the case, come from sales projections based on past sales, consumer surveys, focus group testing, and other sources. Even though parties to a license negotiation will usually not have precise data about future usage, they often have rough estimates as to the expected frequency of use. This quantitative information, assuming it meets admissibility requirements, ought to be given its proper weight, as determined by the circumstances of each case. ³⁵Id. at 1334.

The court emphasized that the jury’s lump-sum damages award “ought to be correlated, in some respect, to the extent the infringing method is used by consumers,” and “[t]his is so,” the court explained, “because this is what the parties to the hypothetical negotiation would have considered” when negotiating a lump-sum royalty. ³⁶Id. Finally, the court observed “that the evidence of record is conspicuously devoid of any data about how often consumers use the patented date-picker invention,” and the patentee therefore failed to meet its “burden to prove that the extent to which the infringing method has been used support[ed] the lump-sum damages award.” ³⁷Id. at 1335. In particular, the evidence showed only “that at least one person performed the patented method one time in the United States sometime during the relevant period.” Id. at 1334.

In short, Lucent does not support an expansive “anything goes” reading of the book of wisdom. To the contrary, the court left no doubt that Sinclair’s book of wisdom is limited and that, under a Georgia-Pacific Factor 11 lump-sum royalty analysis, the book permits consideration of certain post-hypothetical negotiation evidence only “under appropriate circumstances.” In Lucent, the “appropriate circumstance” was to show what future usage of the patented method the parties to the hypothetical negotiation might have estimated in their efforts to determine the value of the lump-sum royalty payment at the time of the hypothetical negotiation. The crux in Lucent, as in other book of wisdom cases, was the hypothetical negotiation construct as a vehicle for ascertaining the value of a reasonable royalty on the date of the negotiation. To the extent ex post data were used, it was only as inferential evidence of the expectations of the parties to the hypothetical negotiation.

3. The Federal Circuit’s Interactive Pictures v. Infinite Pictures

Nearly a decade before Lucent, the Federal Circuit decided another case that, without explicitly invoking “book of wisdom” terminology, rejected the infringer’s effort to rely on ex post sales data and, in the process, underscored the limits on the use of such data in a reasonable royalty calculation. In Interactive Pictures Corp. v. Infinite Pictures, Inc., ³⁸274 F.3d 1371, 1384-85, 61 U.S.P.Q.2d 1152 (Fed. Cir. 2001) 63 PTCJ 178, 1/4/02. the Federal Circuit affirmed a reasonable royalty damages award that was based on sales projections formulated by the infringer just two months before the hypothetical negotiation date. The patentee sought—and the jury awarded—a lump-sum reasonable royalty calculated as a percentage of the infringer’s projected sales figures. The infringer argued that calculating a royalty based on its sales expectations was too speculative and pointed to the fact that its actual sales ultimately failed to meet the projections. The patentee countered that the projections made by the infringer just two months prior to the hypothetical negotiation date were “the best information” that would have been available to the infringer at the time of the negotiation and therefore would have been the basis for the negotiated royalty amount. ³⁹Id. at 1384. The Federal Circuit agreed with the patentee.

The Interactive Pictures court began by reaffirming that “the negotiation must be hypothesized as of the time infringement began.” ⁴⁰Id. It pointed out that it previously had upheld damages awards “premised on a lump sum royalty payment based on an infringer’s expected sales.” ⁴¹Id. It noted that the infringer’s sales projections were not “outdated” and that they “would have been available to [the infringer] at the time of the hypothetical negotiation.” ⁴²Id. at 1385. Finally, the court concluded that the infringer’s subsequent failure to “meet those projections is irrelevant to [its] state of mind at the time of the hypothetical negotiation.” ⁴³Id. In short, the court rejected the infringer’s attempt to use “book of wisdom” information—specifically, its actual ex post sales data—to supersede the contemporaneous sales projections it actually would have had available at the time of the hypothetical negotiation. The court reaffirmed that the key to the hypothetically negotiated royalty was the parties’ “state of mind” as of the date of the hypothetical negotiation. ⁴⁴Id.

Interactive Pictures thus confirms that the role of book of wisdom information is limited to filling an evidentiary gap concerning the parties’ considerations at the time of the hypothetical negotiation. Where there is contemporaneous evidence of those considerations—in Interactive Pictures, actual sales projections for the infringing products that existed at the time of the hypothetical negotiation—the book of wisdom and ex post evidence of actual usage or sales should play no role in the royalty calculation.

B. Ex Post Infringer’s Profits

Closely related to the infringer’s ex post usage and sales data is ex post information about the profits the infringer has made from the sales or use of the patented technology. The Federal Circuit addressed this type of ex post data in Fromson v. Western Litho Plate & Supply Co.,
⁴⁵853 F.2d 1568, 7 U.S.P.Q.2d 1606 (Fed. Cir. 1988). in which the court suggested in dicta that a trier of fact may consider ex post information about the infringer’s actual profits from use of the patented technology in evaluating a reasonable royalty.

The Fromson court began by characterizing the hypothetical negotiation methodology:

The methodology encompasses fantasy and flexibility; fantasy because it requires a court to imagine what warring parties would have agreed to as willing negotiators; flexibility because it speaks of negotiations as of the time infringement began, yet permits and often requires a court to look to events and fact that occurred thereafter and that could not have been known to or predicted by the hypothesized negotiators. ⁴⁶Id. at 1575.

The court then quoted at some length from the Sinclair court’s “book of wisdom” discussion and also cited Trans-World Mfg. Corp v. Al Nyman & Sons, Inc. as a case that “found error in excluding evidence of infringer’s actual profits, but gave no opinion on weight to be given that evidence.” ⁴⁷Id. at 1575-76 (citing Trans-World Mfg. Corp. v. Al Nyman & Sons, Inc., 750 F.2d 1552, 1556-58, 224 U.S.P.Q. 259 (Fed. Cir. 1984)). In Trans-World, the Federal Circuit noted that “the infringer’s anticipated profit from use of the patented invention” is one of the factors to be considered in determining a reasonable royalty and that evidence of the infringer’s actual profits is often “probative of his anticipated profit.” 750 F.2d at 1568 (emphasis added). There is no indication in the Court’s opinion that there was any evidence of the accused infringer’s actual profit expectations as of the date of the hypothetical negotiation. The Court thus concluded that the extent of profits from use of the patented product “could be relevant in determining the amount of a reasonable royalty” and that the trial court should not have excluded such evidence, though it emphasized that “we express no opinion concerning the weight, if any, to be given such evidence or any conditions that might properly be imposed upon its admission.” Id. The court also noted that, in their arguments to the court, “the parties emphasize[d] either the May 1965 date of first infringement or selected later events depending on which they s[aw] as best serving their interests.” ⁴⁸Fromson, 853 F.2d at 1577.It did not, however, specify what those “later events” were, other than to note that the parties pointed to contradictory testimony about both anticipated and actual profits earned by the accused infringer from its use of the patented invention. ⁴⁹Id. The court concluded that the trial court erred in its apportionment methodology and remanded the case for recalculation of a reasonable royalty, noting that if the trial court “elects to consider the infringer’s profits, … it would appear sufficient to fix a reasonable royalty as a percentage of the dollar amount of profit made by the infringer from its use of the invention, whatever that dollar amount may have from time to time been”—so long as it was clear whether the royalty rate would apply to gross or net profits. ⁵⁰Id. at 1578 (emphasis added).

In sum, the court in Fromson did little more than (1) quote Sinclair’s “book of wisdom” observations; (2) cite Trans-World, which in turn made clear that the infringer’s anticipated profit from use of the invention is a factor to be considered in a reasonable royalty calculation and that the infringer’s actual (that is, ex post) profits can be probative of its anticipated profits as of the hypothetical negotiation date; and (3) suggest that, where the ex ante evidence of anticipated profits was in conflict, the trier of fact may consider the infringer’s profits from actual use of the invention after the date of the hypothetical negotiation to inform the calculation of the royalty. It certainly did not hold that all ex post facts could be (or must be) factored into the royalty calculus, or even that ex post profit data are always relevant.

Fromson has been clarified by a handful of Federal Circuit cases analyzing the role of actual profits of the infringer. An infringer’s actual “profit margin can be relevant to the determination of a royalty rate in a hypothetical negotiation.” ⁵¹Interactive Pictures, 274 F.3d at 1385 (citation omitted). In Uniloc, 632 F.3d at 1317-18, the court explained that Georgia-Pacific “factor 12—looking at the portion of profit that may be customarily allowed in the particular business for the use of the invention or similar inventions—[remains a] valid and important factor[] in the determination of a reasonable royalty rate.” In affirming a liability determination and remanding for an accounting of damages, the Federal Circuit explained the relevance of the infringer’s profits to the reasonable royalty analysis:

A reasonable royalty is the amount that “a person, desiring to manufacture [, use, or] sell a patented article, as a business proposition, would be willing to pay as a royalty and yet able to make [, use, or] sell the patented article, in market, at a reasonable profit.” Among the factors to be considered in determining that amount is the infringer’s anticipated profit from use of the patented invention, including “[t]he effect of [using] the patented specialty in promoting sales of other products of the licensee.” Evidence of the infringer’s actual profits generally is admissible as probative of his anticipated profits. ⁵²Trans-World, 750 F.2d at 1568. This observation was not dicta because the trial court already had excluded evidence of the infringer’s post-negotiation profits and would have to reverse course on remand. Id.

A hypothetical negotiator sitting at the table in the place of the infringer would expect to make a profit from its anticipated use of the patented invention. ⁵³See Lindemann Maschinenfabrik GmbH v.
Am. Hoist & Derrick Co., 895 F.2d 1403, 1408, 13 U.S.P.Q.2d 1871 (Fed. Cir. 1990) (affirming award of damages and rejecting testimony of patentee’s damages expert that reasonable royalty would have exceeded infringer’s anticipated net profit, stating that his “opinion that [infringer] ‘would agree to pay a royalty in excess of what it expected to make in profit’ was, in light of all the evidence in this case, absurd”); accord Hughes Tool Co. v. Dresser Indus., Inc., 816 F.2d 1549, 1558, 2 U.S.P.Q.2d 1396 (Fed. Cir. 1987) (rejecting royalty calculated to leave infringer a profit over expected profits where expected profit figure was clearly erroneous). In other words, “a reasonable royalty would leave an infringer with a reasonable profit.” ⁵⁴Hanson, 718 F.2d at 1081 (internal citation and quotation marks omitted). “The issue of the infringer’s profit is to be determined not on the basis of hindsight evaluation of what actually happened, but on the basis of what the parties to the hypothetical license negotiations would have considered at the time of the negotiations.” ⁵⁵Id.

As evidence of the profits the party sitting at the negotiation table would have expected to make from using the invention, ex post evidence of the infringer’s actual profits is relevant if the circumstances under which those profits were made were comparable to what the negotiation party would have foreseen. That an infringer actually made unexpectedly low profits, or even lost money, from its infringing use may have little or no relevance, and a reasonable royalty may exceed the infringer’s actual profit. ⁵⁶Golight, Inc. v. Wal-Mart Stores, Inc., 355 F.3d 1327, 1338-39, 69 U.S.P.Q.2d 1481 (Fed. Cir. 2004) 67 PTCJ 263, 1/30/04 (affirming royalty award where infringer’s evidence of projected profits was “sparse”); see
Radio Steel & Mfg. Co. v. MTD Prods., Inc., 788 F.2d 1554, 1557, 229 U.S.P.Q. 431 (Fed. Cir. 1986) (affirming royalty that exceeded the profits where infringer’s treasurer testified infringing products “might have been utilized as loss-leaders at various times during the period of infringement”); Hanson, 718 F.2d at 1081 (“Whether, as events unfurled thereafter, [infringer] would have made an actual profit, while paying the royalty determined as of [the hypothetical negotiation date] is irrelevant.” (internal citation and quotation marks omitted)). Likewise, there is no rule that a reasonable royalty should be capped by a patentee’s expected profit margin. Powell v. Home Depot U.S.A., Inc., 663 F.3d 1221, 1238, 2011 BL 291111, 100 U.S.P.Q.2d 1742 (Fed. Cir. 2011) 83 PTCJ 85, 11/18/11.

Therefore, to the extent Fromson and other cases have permitted consideration of the infringer’s actual profits for a reasonable royalty analysis, it is only when there were no contemporaneous or conflicting profit projections and the ex post evidence reflects the state of mind of the parties to the hypothetical negotiation at the time of the negotiation.

C. Ex Post Agreements

Parties on both sides of patent infringement actions often seek to rely on a third type of ex post data—ex post patent sales or license agreements—as part of a reasonable royalty damages analysis. These are agreements that sell or license the patent in suit (or other patents that are asserted to cover comparable technology) and were entered into with or between third parties after the date of the hypothetical negotiation.

Although not typically analyzed under the “book of wisdom” rubric, ⁵⁷But see Lucent, 580 F.3d at 1334 (acknowledging certain license agreements as admissible evidence under the book of wisdom). the admissibility of ex post agreements is based on the same overarching principle that the courts have articulated to assess the admissibility of ex post usage and sales data: that is, their admissibility depends on whether the nature of the agreements and the circumstances under which they were entered into are sufficiently comparable to those of the hypothetical license that they fairly can be said to be probative of how the parties to the hypothetical negotiation would have valued the patented technology at the time of the negotiation. In other words, like ex post usage, sales, or profit data, sales and license agreements entered into after the hypothetical negotiation date can be admissible, but are not necessarily so. Their admissibility turns on satisfying the Federal Circuit’s rigorous comparability requirement.

The Federal Circuit repeatedly has made clear that other agreements may be relevant to the hypothetical negotiation only if they are “sufficiently comparable to the hypothetical license at issue.” ⁵⁸LaserDynamics, 694 F.3d at 79-80 (quoting Lucent, 580 F.3d at 1325) (“Actual licenses to the patent-in-suit are probative not only of the proper amount of a reasonable royalty, but also of the proper form of the royalty structure.”); Lucent, 580 F.3d at 1325-26 (quoting Russell L. Parr, Royalty Rates for Licensing Intellectual Property 64 (2007) (“For similar license agreements to be used as a proxy for derivation of a fair market royalty, the form of license compensation should be on a like-kind basis.”)). “Subsumed within this factor” is the question of the structure of the license—that is, “whether the licensor and license would have agreed on a lump-sum payment or instead to a running royalty based on ongoing sales or usage.” Lucent, 580 F.3d at 1326. If the other agreement is comparable to the one being hypothetically negotiated, it provides inferential evidence of how the parties to the hypothetical negotiation would have valued the patent in suit at the time of the negotiation. This is particularly true, of course, where one of the parties to the litigation was a party to the other agreement.

Thus, whether other agreements are admissible depends on the specifics of the agreements: they must be for sufficiently comparable technology, and they must have been entered into under economic or other circumstances that are sufficiently comparable that the license agreement fairly can be said to yield relevant inferences about how the parties would have valued the patented technology at issue. ⁵⁹See, e.g., Uniloc, 632 F.3d at 1317 (“[T]here must be a basis in fact to associate the royalty rates used in prior licenses to the particular hypothetical negotiation at issue in the case.”); Lucent, 580 F.3d at 1325, 1330 (licenses relied on by patentee to prove damages must be “sufficiently comparable to the hypothetical license at issue”; for example, using a running royalty agreement as a basis to calculate a lump-sum royalty requires “some basis for comparison”); ResQNet.com Inc. v. Lansa Inc., 594 F.3d 860, 870-72, 2010 BL 24667, 93 U.S.P.Q.2d 1553 (Fed. Cir. 2010) (79 PTCJ 422, 2/12/10) (evidence of royalty rates from licenses without a relationship to the claimed invention cannot form the basis of a reasonable royalty calculation; damages witness must “consider licenses that are commensurate with what the defendant has appropriated”); Odetics, Inc. v. Storage Tech. Corp., 185 F.3d 1259, 1277, 51 U.S.P.Q.2d 1225 (Fed. Cir. 1999) 58 PTCJ 318, 7/15/99 (holding there was “no prejudicial error in the [district] court’s determination that the age of the license agreements, in the context of the changing technology and ‘financial landscape’ at issue, made those agreements irrelevant for the hypothetical negotiation analysis,” where the license agreements were negotiated four and five years after the date of first infringement). The Federal Circuit has cautioned that courts must “exercise vigilance when considering past licenses to technologies other than the patent in suit.” ResQNet.com, 594 F.3d at 869 (citing Lucent, 580 F.3d at 1329).

Where the technology, facts, and circumstances of the other agreements are not identical to those at issue in the hypothetical negotiation—and they rarely are—the party seeking to rely on the other agreements must “account for” any economic and technological differences between the other agreements and the hypothetical license. ⁶⁰Finjan, Inc. v. Secure Computing Corp., 626 F.3d 1197, 1211-11, 2010 BL 261450, 97 U.S.P.Q.2d 1161 (Fed. Cir. 2010) 81 PTCJ 55, 11/12/10 (“[U]se of past patent licenses … must account for differences in the technologies and economic circumstances of the contracting parties.” (citation omitted)). This is where the timing of the other agreements comes in. Provided the technology is comparable, agreements entered into shortly before or after the date of the hypothetical negotiation are more likely to have been executed under economic or other circumstances comparable to the hypothetical negotiation, and thus are more likely to support inferences about how one or more of the parties to the hypothetical negotiation would have viewed the value of the hypothetical license. ⁶¹See ActiveVideo Networks, Inc. v. Verizon Commc’ns, Inc., 694 F.3d 1312, 1332-33, 2012 BL 217080, 104 U.S.P.Q.2d 1241 (Fed. Cir. 2012) 84 PTCJ 741, 8/31/12 (no abuse of discretion to allow expert to rely on license agreement that postdated the hypothetical negotiation by two years but to refuse to allow expert to rely on license agreement that postdated the hypothetical negotiation by four years).

Conversely, third party agreements entered into at a time far removed from the hypothetical negotiation—whether before or after that date—are more likely to have been negotiated under circumstances that were too different from those surrounding the hypothetical negotiation to make them a useful basis to infer how the parties would have valued the patent when infringement began. ⁶²Odetics, 185 F.3d at 1276-77 (affirming rejection of license agreements entered into four and five years after the date of the hypothetical negotiation). In either event, the admissibility of such agreements—and any reasonable royalty damages analysis based on them—turns on the trial court’s evaluation of whether the agreements are sufficiently comparable to the hypothetical license at issue to infer how the parties to the hypothetical negotiation would have valued the license.

D. Noninfringing Alternatives or “Design-Arounds”

The fact that the party sitting in the place of the infringer at the hypothetical negotiation table could have continued marketing a noninfringing alternative to the infringing device or using a noninfringing alternative to the infringing method “is a factor relevant to the determination of a proper royalty during hypothetical negotiations.” ⁶³Zygo Corp. v. Wyko Corp., 79 F.3d 1563, 1571-72, 38 U.S.P.Q.2d 1281 (Fed. Cir. 1996) (remanding damages award for district court to “reconsider its award of a 25% royalty rate in light of [infringer’s] ability to market the noninfringing [product] in lieu of marketing the infringing [product]”). As the Federal Circuit has explained, the infringer “would have been in a stronger position to negotiate for a lower royalty rate knowing it had a competitive noninfringing device ‘in the wings.’” ⁶⁴Id. Even where the infringer did not have a noninfringing alternative in hand but had the resources to come up with one at the time of the negotiation, the fact-finder may consider that fact in setting a royalty rate. ⁶⁵See Mars, Inc. v. Coin Acceptors, Inc., 527 F.3d 1359, 1373, 2008 BL 113767, 87 U.S.P.Q.2d 1076 (Fed. Cir. 2008) 76 PTCJ 219, 6/13/08. The cost of that alternative, however, is not necessarily a cap on reasonable royalty damages. Id. (“[A]n infringer may be liable for damages, including reasonable royalty damages that exceed the amount that the infringer could have paid to avoid infringement.”). That is because a damages award should be “adequate to compensate for the infringement, but in no event less than a reasonable royalty,” 35 U.S.C. §284, and such awards are not limited by an amount “so high that no rational self-interested wealth-maximizing infringer acting ex ante would have agreed to it.” Monsanto Co. v. Ralph, 382 F.3d 1374, 1382-83, 72 U.S.P.Q.2d 1515 (Fed. Cir. 2004) 68 PTCJ 578, 9/24/04.

It is not enough, however, that an infringer implemented a noninfringing alternative at some point after the hypothetical negotiation date; the alternative must have been available to the infringer and acceptable to customers at the time of the hypothetical negotiation. ⁶⁶See, e.g., Spectralytics, Inc. v. Cordis Corp., 649 F.3d 1336, 1346, 2011 BL 154571, 99 U.S.P.Q.2d 1012 (Fed. Cir. 2011) 82 PTCJ 216, 6/17/11 (affirming jury verdict of 5 percent royalty despite evidence of noninfringing alternative where district court’s finding that “a reasonable jury could have found that the alleged alternatives were either not acceptable or not available” was supported by substantial evidence); Micro Chem., Inc. v. Lextron, Inc., 317 F.3d 1387, 1393-94, 65 U.S.P.Q.2d 1532 (Fed. Cir. 2003) 65 PTCJ 296, 1/31/03 (affirming jury verdict based on lack of evidence that noninfringing alternative implemented three years after the hypothetical negotiation was available to infringer and acceptable to consumers at the time of the hypothetical negotiation). At times, there will be evidence about the availability and acceptability of noninfringing alternatives that is contemporaneous with the hypothetical negotiation. ⁶⁷See, e.g., Riles, 298 F.3d at 1313 (remanding for trial court to entertain additional evidence in light of “conflicting” evidence on availability of noninfringing alternative). Where there is no such evidence, however, courts have looked to ex post evidence that sheds light on the availability and acceptability of a noninfringing alternative at the time of the hypothetical negotiation.

For example, in TWM Mfg. Co. v. Dura Corp., the Federal Circuit affirmed the district court’s rejection of the infringer’s argued existence of a noninfringing alternative based on consideration of the infringer’s “failure to design its own device,” “election to infringe, despite having expended only minimal sums when notified of infringement,” “willful infringement,” “failure to successfully market other allegedly ‘acceptable’ designs,” violation of an injunction, and “withdrawal from the business after enforcement of the injunction.” ⁶⁸789 F.2d 895, 900, 229 U.S.P.Q. 525 (Fed. Cir. 1986). This evidence should be treated like the other categories of ex post evidence: it should be considered only when there is no contemporaneous or conflicting evidence of noninfringing alternatives and the ex post evidence reflects what would have been in the minds of the parties to the hypothetical negotiation at the time of the negotiation.

II. A Response to Arguments for the “All In” Approach

Proponents of the “all in” approach—sometimes referred to as the “outcome” or “ex post” measure of damages—cite three primary arguments in favor of that approach. ⁶⁹See Fact or Fiction?, supra note 10. None of the arguments withstands scrutiny.

A. The “All In” Approach Is Not Consistent With Market Valuation Rules in Other Fields

The first argument in favor of the “ex post” measure of damages is that it “is by far the most common type of damages awarded in commercial litigation.” ⁷⁰Id. at 7. To the contrary, it is well established in the fields of tax, accounting, and estate administration that valuations must be made based on information that was available on the valuation date. Ex post data rarely are considered, and when they are it is only to shed light on the circumstances existing at the valuation date.

For instance, when conducting a business valuation, “the valuation analyst should consider only circumstances existing at the valuation date and events occurring up to the valuation date.” ⁷¹Am. Inst. of Certified Pub. Accountants, Valuation of a Business Ownership Interest, Security, or Intangible Asset, Statement on Standards for Valuation Services 20 (June 2007). Certain subsequent events “could affect the value,” but only to the extent they “are indicative of conditions that were not known or knowable at the valuation date, including conditions that arose subsequent to the valuation date. The valuation would not be updated to reflect those events or conditions.” ⁷²Id.

Similarly, the general rule in federal tax valuation is that “[f]ederal tax valuation matters are based on the fair market value standard of value,” where “[t]he definition of fair market value has generally been interpreted to be based only on information that was known or knowable as of the valuation date.” ⁷³James G. Rabe, Subsequent Events and Multi-Level Valuation Discounts—Ringgold Telephone Company v. Commissioner, Gift and Est. Tax Valuation Insights 70 (Autumn 2010); see also Rev. Rul. 59-60, 1959-1 C.B. 237 §2.02 (defining fair market value “as the price at which the property would change hands between a willing buyer and a willing seller . . . , both parties having reasonable knowledge of relevant facts”). Evidence of a subsequent event may sometimes be considered in tax valuations, “but only to confirm historical trends and market expectations as of the valuation date.’” ⁷⁴Rabe, supra note 73, at 71 (citing Statement on Appraisal Standards No. 3, Uniform Standards of Prof. Appraisal Prac. U-84 (2010-11)). And ex post evidence is useful only for property being valued for tax purposes “having no fixed and determinable market value” as of the valuation date. ⁷⁵See Nachod & U.S. Signal Co. v. Helvering, 74 F.2d 164, 168 (6th Cir. 1934) (reversing Board of Tax Appeals decision refusing to consider ex post profits and assigning no value to patents for lack of evidence); H.H. Miller Indus. Co. v. Comm’r
, 61 F.2d 412, 414 (6th Cir. 1932) (remanding Board of Tax Appeals decision refusing deduction for exhaustion of a patent to consider ex post evidence of cost savings and enforcement success and revenue), overruled on other grounds, New Colonial Ice. Co. v. Helvering, 292 U.S. 435, 442 (1934).

For estate tax valuation in particular, the Department of Treasury’s regulations provide:

The value of every item of property includible in a decedent’s gross estate . . . is its fair market value at the time of the decedent’s death . . . . The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge. . . . The value is generally to be determined by ascertaining as a basis the fair market value as of the applicable valuation date . . . . ⁷⁶Treas. Reg. §20.2031-1(b).

The Tax Court has permitted use of some ex post data in estate valuations, so long as the data constitute “evidence of value rather than something that affects value.” ⁷⁷Estate of Jung, 101 T.C. at 432; see also id. at 431 (“A distinction may usefully be drawn between later-occurring events which affect fair market value as of the valuation date, and later-occurring events which may be taken into account as evidence of fair market value as of the valuation date.”). For example:

[Although] [s]ubsequent events such as discovery of oil on the property or some physical change in the property which were not reasonably foreseeable at the date of valuation cannot be considered[,] sales after date of death, so long as the sale occurred within a reasonable time after death and so long as intervening events have not changed the value of the property, can be considered. ⁷⁸Estate of Hillebrandt v. Comm’r, 52 T.C.M. (CCH) 1059, 1064 (1986).

Such ex post data constitute evidence of markets that are “comparable” to that at the time of the valuation date, and thus they do not contravene “the normal prescription against consideration of events subsequent to the valuation date.” ⁷⁹Id. (citation omitted).

In sum, commercial practice does not embrace an “all in” approach to ex post data for market valuations. In these other contexts, the touchstone of market valuation is the valuation date. Where ex post data are permitted in these contexts, they have been limited to data that shed light on what the hypothetical parties would have considered on the valuation date. As explained above, those are the very same principles that apply in the patent infringement context.

B. The Case Law Does Not Require Consideration of All Ex Post Data

The second argument offered in support of the “all in” approach is that “[t]here is a wide body of law both in state and federal jurisdictions in claims other than patent infringement that not only permits but requires the damages expert to consider all facts subsequent to the date of the legal violation.” ⁸⁰Fact or Fiction?, supra note 10, at 7. Although at least one proponent of this argument acknowledges that the Federal Circuit in Lucent “qualifie[d] the use of subsequent information by its choice of words ‘under appropriate circumstances,’” this approach ignores the Federal Circuit’s 2001 decision in Interactive Pictures. ⁸¹Id. (stating that the Lucent court wrote the qualifying language “without giving any guidance as to what is appropriate circumstances”).

The court in Interactive Pictures rejected consideration of data concerning the infringer’s subsequent failure to meet sales projections that were formulated essentially contemporaneously with the hypothetical negotiation. ⁸²274 F.3d at 1384-85. The court stated that a failure to meet sales projections “is irrelevant to [the infringer’s] state of mind at the time of the hypothetical negotiation.” ⁸³Id. at 1385.

The very fact that the Federal Circuit has rejected certain ex post data is alone sufficient to refute any suggestion that the law requires the “all in” approach to the scope of the book of wisdom. Moreover, Lucent and Interactive Pictures reaffirm that the crucial limitation on what sorts of ex post data came within the book of wisdom is whether the data reveal what would have been considered by the parties to the hypothetical negotiation at the time of the negotiation. ⁸⁴See discussion supra Parts I.A.2-I.A.3. Interactive Pictures in particular shows that the role of the book of wisdom is to fill an evidentiary gap, such as regarding the parties’ expectations for the future extent of infringing use. Where there is direct evidence of those expectations, such as contemporaneous sales projections, the book of wisdom and ex post evidence of sales should play no role. These precedential cases refute the argument that case law requires consideration of all ex post data.

Case law outside the patent infringement context further refutes such an assertion. Other cases that have invoked the book of wisdom have confirmed that the book’s purpose is to fill an evidentiary gap that results from some uncertainty in ascertaining value on a valuation date in the past. ⁸⁵See Sinclair, 289 U.S. at 698 (stating that the book of wisdom is available “to correct uncertain prophecy”).

In the Supreme Court’s United States v. Westinghouse Elec. & Mfg. Co., ⁸⁶339 U.S. 261 (1950). for example, the federal government condemned the lessee’s premises for an initial term that was less than the lessee’s outstanding lease term, with an option to renew the lease annually. Invoking Sinclair‘s book of wisdom, the court held that it was proper to value the lessee’s just compensation award depending upon a contingency, namely, whether the government would exercise its option. ⁸⁷See id. at 267 (”[T]o require a forecast of the possibility that the tenant will have to move back into the premises” would depend on factors “too contingent, too unique for guidance by experience, to permit rational assessment,” so “the law should express ‘a judgment from experience as against a judgment from speculation.’” (quoting Tanner v. Little, 240 U.S. 369, 386 (1916))). Evidence of the government’s subsequent action—to exercise the option to continue its occupation for the entire lease term—could then be used, under the book of wisdom, to fill the knowledge gap created by the contingency.

The book of wisdom similarly has been invoked in a pair of Sixth Circuit cases involving mortgage notes and their fair market value at the time they were received. In Doric Apartment Co. v. Comm’r of Internal Revenue, ⁸⁸94 F.2d 895, 896-97 (6th Cir. 1938). the Sixth Circuit held that in ascertaining the fair market value of the petitioner’s second-mortgage notes at the time of receipt, it was proper to employ the book of wisdom to allow consideration of ex post facts “bearing upon [the notes’] intrinsic worth,” including subsequent payments made on the notes, because the determination of mortgage notes’ fair market value at the time of receipt is inherently speculative. ⁸⁹See id. at 896 (remarking that at the time that the notes are received, the “property has no ready or an exceedingly limited market”). In Miller v. United States, ⁹⁰235 F.2d 553 (6th Cir. 1956). the Sixth Circuit distinguished both Doric and Sinclair, holding that the district court erred when it assigned a fair market value to second-mortgage notes at the time of receipt based solely on evidence of subsequent payments made on the notes. The Miller court explained that because there was contemporaneous evidence that the notes had no market value at the time of receipt, contradictory evidence of subsequent payments could not be considered. ⁹¹See id. at 558 (“Here, [unlike in Sinclair,] we are not dealing with a unique thing, such as a patent, but are concerned with the evaluation of ordinary commercial paper in the form of second-mortgage notes. There was no evidence in the instant case to rebut the positive proof that the second-mortgage notes in controversy, when received by the taxpayer, had no fair market value.”). Together, Doric and Miller demonstrate that under the book of wisdom, ex post data are available merely to fill an evidentiary gap. Where there is no evidentiary gap, such as where there is evidence of valuation at the time of the initial transaction and that evidence conflicts with ex post data, the contemporaneous evidence overrides the ex post data, and the book of wisdom is irrelevant.

Instead of hewing to precedential and other appellate case law, proponents of the “all in” approach cite the district court opinion in Smith Int’l, Inc. v. Hughes Tool Co.
⁹²229 U.S.P.Q. 81 (C.D. Cal. 1986). as a case in which the district court “used the book of wisdom and arrived at a reasonable royalty rate significantly higher than anyone in the actual world would have negotiated at the date of the hypothetical negotiation.” ⁹³Fact or Fiction?, supra note 10, at 7 & n.8. That opinion, however, does not refer to the book of wisdom, and there is no indication that the parties in the case disputed the use of ex post data in calculating a reasonable royalty. To the contrary, Smith re-affirms the same bedrock principle explicated in this article, namely that “[i]n determining a reasonable royalty, the question is examined as of the date of the beginning of infringement.” ⁹⁴229 U.S.P.Q. at 94 (citing Panduit, 575 F.2d at 1158).

Those who contend that Smith applies the “all in” approach appear to base their argument not on the decision’s analysis or holding, but on their view of the historical context of the case. The case involved alleged infringement of patents related to oil drill bits. One commentator refers to the 1973 oil crisis and ensuing embargo and states, “After the oil embargo, the price of oil increased dramatically and the demand and subsequent price for oil drill bits rose significantly. . . . In Smith . . ., the date of the hypothetical negotiation was in 1972 and predated the oil embargo, which was not known or knowable as of that date.” ⁹⁵Fact or Fiction?, supra note 10, at 7. Thus, according to this commentator, the judge “arrived at a reasonable royalty rate significantly higher than anyone in the actual world would have negotiated at the date of the hypothetical negotiation.” ⁹⁶Id.

Significantly, however, the 1973 oil crisis and embargo played no express role in the analysis in Smith. As explained above, cases that preceded Smith and that have since elucidated the book of wisdom repeatedly have affirmed that the hypothetical negotiation approach focuses on what the willing licensor and licensee considered on the negotiation date. Assuming the 1973 oil embargo would not have been foreseeable by parties to the 1972 hypothetical negotiation in Smith, consideration of ex post data based on the effects of that embargo would be improper. That said, one need not go so far as to declare Smith wrongly decided because the opinion in that case did not analyze the admissibility of ex post data.

The same cannot be said, however, for a more recent book of wisdom case, Honeywell Int’l, Inc. v. Hamilton Sundstrand Corp., ⁹⁷378 F. Supp. 2d 459 (D. Del. 2005). on which some “all in” advocates rely. Although the Honeywell court was largely correct on the law, ⁹⁸For instance, the Honeywell court rightly affirmed that “[a] reasonable royalty determination for purposes of making a damages evaluation must relate to the time infringement occurred, and not be an after-the-fact assessment.” Id. at 467 (emphasis in original) (quoting Riles, 298 F.3d at 1313); see also id. at 468 (“[T]he ability of post-negotiation information to test the reasonableness of pre-negotiation assumptions depends, at least in part, on the foreseeability of intervening events.”). the court’s application of the law to the facts is inconsistent with the rest of the book of wisdom body of law. In particular, the ex post data in Honeywell—post-negotiation sales projections from 2004-05—followed “the unforeseen and tragic events of September 11, 2001,” which according to the plaintiffs “caused an unexpected increase in the ‘importance of the large regional jet market.’” ⁹⁹Id. at 463. It is difficult to imagine events less foreseeable than those that took place on September 11, 2001. Moreover, the court permitted consideration of such ex post data even though the data conflicted with sales projections that were actually available at the time of the hypothetical negotiation. ¹⁰⁰See id. (noting that the hypothetical negotiation date was on March 14, 2000, and that there were sales projections dating from 1998-99); id. at 470 (“As to [the defendant’s] remaining argument that the 2004-05 projections should not be considered because they conflict with the 1998-99 projections, that is an argument best reserved for the jury.”). As explained above, the book of wisdom and ex post data are irrelevant where there is contrary evidence contemporaneous with the hypothetical negotiation; in such a case, the book of wisdom is not necessary to fill in any evidentiary gaps. For these reasons, the Honeywell court erred by invoking the book of wisdom to allow admission of sales projection data post-dating 9/11.

Even the Honeywell court, however, did not embrace the use of all ex post data. For example, the court stated:

[N]o one would argue that the hypothetical negotiators in this case could have foreseen the events of 9/11, but perhaps the negotiators could have foreseen a general decline in the commercial airline industry. If so, then post-negotiation information might be an accurate test of the reasonableness of the assumptions of the hypothetical negotiators. If not, then the information might not provide an accurate test. Either way, measuring the foreseeability of intervening events is not a proper role for the court. ¹⁰¹Id. at 468-69 (emphasis added).

Thus, even in Honeywell, the focus was on the state of mind of the parties to the hypothetical negotiation as a means to ascertain a reasonable royalty. The court’s error was to conclude, as a matter of law, that the ex post data at issue should be deferred to the jury, where the ex post data conflicted with evidence available on the hypothetical negotiation date and were derived from events that clearly could not have been considered by the parties to the negotiation. ¹⁰²Notably, the book of wisdom cases have established that the question of whether certain ex post data are admissible under the book of wisdom is a matter of law to be determined by the court, although the damages themselves are to be determined by a jury. See, e.g., Lucent, 580 F.3d at 1333-36 (holding that certain ex post data were admissible under the book of wisdom, but nevertheless concluding that there was insufficient evidence underlying the jury’s damages award); Fed. Circuit Bar Ass’n, Model Patent Jury Instructions §6.1 (2012) (“If you find that [alleged infringer] infringed any valid claim of the [ ] patent, you must then consider what amount of damages to award to [patent holder].”); id. §§6.5-6.7 (jury instructions on how to determine a reasonable royalty).

At bottom, the assertion that case law supports the “all in” approach finds little in the way of support and in fact is contradicted by precedential case law.

C. The Patent Damages Statute Does Not Envision Use of All Ex Post Data

The final argument in favor of unfettered use of ex post data is that the patent damages statute “talks about damages to compensate for ‘use’ made of the invention. It does not use the words ‘expected use’ or ‘anticipated use.’” ¹⁰³Fact or Fiction?, supra note 10, at 6 (quoting 35 U.S.C. §284). According to proponents of this argument, this statutory “use” term refers to “actual use made of the invention by the infringer,” and thus under the patent damages statute it is “appropriate to use information after the date of first infringement to inform the calculation of a reasonable royalty rate.” ¹⁰⁴Id. This is a misreading of the statute.

It is clear from the statutory language and scheme that the phrase “use made of the invention by the infringer,” as set forth in the patent damages statute, was not intended to authorize or require the use of ex post data in determining the amount of a reasonable royalty. The phrase is simply shorthand for the broad range of conduct that can constitute infringement and for which compensation is properly awarded under Section 284. That necessarily includes the acts identified in Section 271(a) as constituting direct infringement, ¹⁰⁵35 U.S.C. §271(a) (acts by which one “without authority, makes, uses, offers to sell, or sells … within the United States or imports into the United States”). in Section 271(b)-(c) as constituting indirect infringement, ¹⁰⁶35 U.S.C. §271(b) (acts by which one “induces infringement”); 35 U.S.C. §271(c) (acts by which one “offers to sell or sells within the United States or imports into the United States a component of a patented machine, manufacture , combination or composition, or a material or apparatus for use in practicing a patented process, constituting a material part of the invention, knowing the same to be especially made or especially adapted for use in an infringement of such patent, and not a staple article or commodity of commerce suitable for substantial noninfringing use”). and in Section 271(f)-(g) as constituting extraterritorial forms of infringement. ¹⁰⁷35 U.S.C. §271(f)(1) (acts by which one “without authority supplies or causes to be supplied in or from the United States all or a substantial portion of the components of a patented invention, where such components are uncombined in whole or in part, in such manner as to actively induce the combination of such components outside of the United States in a manner that would infringe the patent if such combination occurred within the United States, shall be liable as an infringer”); 35 U.S.C. §271(f)(2) (acts by which one “without authority supplies or causes to be supplied in or from the United States any component of a patented invention that is especially made or especially adapted for use in the invention and not a staple article or commodity of commerce suitable for substantial noninfringing use, where such component is uncombined in whole or in part, knowing that such component is so made or adapted and intending that such component will be combined outside of the United States in a manner that would infringe the patent if such combination occurred within the United States”); 35 U.S.C. §271(g) (acts by which one “without authority imports into the United States or offers to sell, sells, or uses within the United States a product which is made by a process patented in the United States”). Interpreting “use made of the invention” in Section 284 to refer to actual use would read out of the statute all the other types of infringing conduct for which compensation is awarded, including offering, selling, importing, inducing, contributing or supplying. This plainly was not the legislative intention. In other words, the “use made of the invention” shorthand for compensable conduct neither limits the patentee to damages caused by the infringer’s use of the invention under Section 271(a) nor requires that damages be based on such “use.”

Moreover, even if the patent statute required consideration of ex post evidence of use—and both the case law and statutory language shows that it does not—that would not mean that a fact-finder must consider all ex post evidence. This “all in” argument is based on a false dichotomy between allowing consideration of no ex post data and allowing consideration of all ex post data. ¹⁰⁸In particular, see Fact or Fiction?, supra note 10, where the author notes that §284 refers to “use” made of the invention, then asks, “So why do some courts and damage experts believe that it is inappropriate to use information after the date of first infringement . . . ?” No courts of which this author is aware contend that it can never be appropriate to use any ex post data whatsoever, but this is not the same as saying that all ex post data are therefore properly considered. This straw man, however, is used by other proponents of the “all in” approach. See John C. Jarosz & Michael J. Chapman, The Hypothetical Negotiation and Reasonable Royalty Damages: The Tail Wagging the Dog, 16 Stan. Tech. L. Rev. 769, 799-803 (2013) (“Many courts and commentators have attempted to hold true to the parameters of real-world license negotiation in implementing that hypothetical negotiation construct by allowing for the consideration of only ex ante information.”). That the patent damages statute ties the reasonable royalty to “use made of the invention” suggests nothing about whether or when it is appropriate to use ex post data generally.

Conclusion

Some of the parties and experts who advocate reading the book of wisdom most broadly to permit an “all in” approach to ex post data—or who candidly advocate dispensing entirely with the hypothetical negotiation date and its temporal limitations—may seek to ease some of the constraints of the more painstaking damages analysis the Federal Circuit increasingly has demanded over the past decade. And there is no question that the more rigorous standards established by the Federal Circuit have required damages experts on both sides of a patent infringement dispute to engage in more intellectually and economically rigorous analyses. But the Federal Circuit properly has rejected the suggestion that patent damages rules or methodology should be eased to permit a more facile analysis. ¹⁰⁹See LaserDynamics, 694 F.3d at 69-70 (rejecting argument that “practical and economic necessity” justified use of the entire market value rule to calculate reasonable royalty damages where the legal test for applying the rule was not met).

Indeed, the Federal Circuit Bar Association has acknowledged the limited nature of the book of wisdom. The Association has provided the following model patent jury instruction for determining a reasonable royalty:

The reasonable royalty you determine must be a royalty that would have resulted from the hypothetical negotiation, and not simply a royalty either party would have preferred. Evidence of things that happened after the infringement first began can be considered in evaluating the reasonable royalty only to the extent that the evidence aids in assessing what royalty would have resulted from a hypothetical negotiation. ¹¹⁰Fed. Circuit Bar Ass’n, Model Patent Jury Instructions §6.6 (2012) (“Reasonable Royalty—Definition”); see also id. (“Although evidence of the actual profits an alleged infringer made may be used to determine the anticipated profits at the time of the hypothetical negotiation, the royalty may not be limited or increased based on the actual profits the alleged infringer made.”).

This characterization of how to use ex post data in a reasonable royalty analysis is consistent with the case law addressed above. That instruction, however, is premised on the parties and the trial court ensuring that the only evidence of later events that is put before the jury is that which helps to clarify what the parties would have considered in determining a reasonable royalty at the time of the hypothetical negotiation, and not evidence of later events that contradicts evidence available at the time of the hypothetical negotiation. ¹¹¹The American Intellectual Property Law Association has provided similar model jury instructions. As stated in its 2012 model instructions:

A reasonable royalty is the royalty that would have resulted from a hypothetical license negotiation between [the Plaintiff] and [the Defendant]… . Although the relevant date for the hypothetical license negotiation is just before the infringement began, you may consider any actual profits made by [the Defendant] due to its infringement and any commercial success of the patented invention or the infringing products after that date. You may only consider this information, however, if those sales and profits were foreseeable just before the infringement began.

Am. Intellectual Prop. Law Ass’n, Model Patent Jury Instructions §§11.14-11.20 (2012) (further permitting consideration of “evidence concerning the availability and cost of non-infringing substitutes for the patented invention”); see also Federal Jud. Center, Patent Case Management Judicial Guide §5.7 (2009) (“In this trial, you have heard evidence of things that happened after the infringing sales first began. That evidence can be considered only to the extent that [add appropriate limitations on consideration of later occurring events].” (brackets in original)).

We surely can expect the Federal Circuit to continue to refine, clarify and rationalize the law of patent damages, with an eye toward ensuring that, when awarded, patent damages reflect the true value and impact of the patented technology in the marketplace. An important step in that process is confining the book of wisdom to its proper contents.