Reasonable Royalties: Customizing Expert Opinions For Case Facts
Every lawsuit involves unique facts and circumstances. CPA experts must connect the dots from relevant case law, regulations and financial principles to the facts of the specific case.
An expert who failed to connect the dots found her opinion excluded from evidence in a recent patent infringement case. Here’s more on why the U.S. Court of Appeals for the Federal Circuit ruled that the expert’s opinion was inadmissible and remanded the case to the district court for a new trial on the damages. (Exmark Manufacturing Company Inc. v. Briggs & Stratton Power Products Group, LLC, No. 2016-2197, 879 F.3d 1332, January 12, 2018)
Dueling Mower Makers
The case involves two commercial lawnmower manufacturers: Exmark and Briggs. Exmark alleged that Briggs had infringed its patent on a mower with improved flow control baffles (devices under the mower deck that direct air flow and grass clippings).
A financial expert hired by Exmark estimated damages at roughly $24 million, using a royalty rate of 5%. The expert argued that her royalty rate adequately and reliably apportioned damages between the improved and conventional features of the mower. She claimed that the 5% royalty rate had been based on the incremental value that the patented invention (the baffles) added to the end product, after factoring in the Georgia-Pacific factors for determining reasonable royalty. (See “15 Georgia-Pacific Factors” at right.)
Based on her testimony, a jury awarded Exmark $24 million in compensatory damages, which the U.S. District Court for Nebraska doubled as enhanced damages for willful infringement.
Briggs appealed to the Federal Circuit. Among other things, the defendant argued that the district court erred by denying its request for a new trial on damages.
Factoring Professional Judgment into the Equation
The appeals court determined that apportioned damages could be calculated either through the royalty base or the royalty rate (or both), as long as the royalty rate is discounted for the product’s unpatented features.
However, it also found that the expert’s report was inadmissible. Why? When evaluating reasonable royalties, experts must not only analyze the applicable Georgia-Pacific factors, but also carefully tie those factors to the proposed rate or base. While mathematical precision isn’t required, some explanation of both why and generally to what extent the factors affect the royalty calculation is needed.
Exmark’s expert concluded with “little explanation” that the parties would have agreed to a 5% reasonable royalty rate on sales of the lawn mowers as the value for the improved baffle. She claimed to have considered the Georgia-Pacific factors — including the benefits of the patented technology, sales and profitability, and the competitive relationship of the parties. But the expert’s report failed to tie the relevant factors to the 5% royalty rate or explain how she calculated a 5% royalty rate using these factors.
The Federal Circuit’s opinion states that to be admissible, expert testimony must “sufficiently” tie the expert testimony to the facts of the case. “If the patentee fails to tie the theory to the facts of the case, the testimony must be excluded,” the court concluded.
Here, the expert addressed the Georgia-Pacific factors and then “plucked the 5% royalty rate out of nowhere.” As a result, the case has been sent back to the district court for a new trial on damages.
In Exmark and similar cases, the Federal Circuit has disallowed expert opinions that are based on a “superficial recitation of the Georgia-Pacific factors, followed by conclusory remarks.” A reasonable royalty analysis requires that an expert “carefully tie proof of damages to the claimed invention’s footprint in the market place.”
15 Georgia-Pacific Factors
When performing a reasonable royalty analysis, experts calculate damages using the following 15 factors:
1. Existence of an established royalty.
2. Rate paid by licensee for comparable patents.
3. Nature and scope of the license.
4. Licensing policy.
5. Business relationship of licensor and licensee.
6. Effect of selling the product to promote other products of a licensee.
7. Duration of the patent and term of the license.
8. Established profitability, commercial success and current popularity.
9. The utility and advantages of the product over older ones.
10. Nature of the patented invention and benefits to those who used it.
11. The extent the licensee used the product and the value of that use.
12. The customary industry portion of the profit or selling price.
13. How much profit should be credited to the invention.
14. Hypothetical license negotiation when the infringement began.
15. Testimony of qualified experts.
(Georgia–Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116, S.D.N.Y., 1970)
DOUGLAS P. SOSNOWSKI, CPA/ABV, ASA, CFF
Douglas P. Sosnowski provides business valuation, forensic accounting, and litigation support services for Brisbane Consulting Group. He has extensive valuation experience and has served as an expert witness, testifying in courts of law throughout the state of New York. Doug has experience consulting with publicly traded entities and valuing a variety of closely held companies in connection with mergers, acquisition and divestitures, business combinations, estate and gift tax planning, ESOPs and purchase price allocations. He also has experience in the quantification of lost income in determining business interruption claims for insurance adjusters. Doug is a member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and the American Society of Appraisers. Doug is a licensed financial advisor holding Series 7 and 66 securities licenses. He graduated with honors from the State University of New York at Buffalo earning his Bachelor of Science degree in business administration with concentrations in accounting and finance.