Lost Profit Damages Require Actual Sales by PatenteeMarch 12, 2015

The award of damages in patent infringement cases is governed by 35 U.S.C. ยง 284. The statute provides “[u]pon finding for the [patent owner] the court shall award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer, together with interest and costs as fixed by the court.” The statute does not define what “adequate” damages are, but two main theories of damages have been applied in making this assessment—a reasonable royalty, representing the floor for what is adequate, and lost profits. Lost profits are awarded to make a party whole based on profits that were lost as a result of the infringement. In contrast, a reasonable royalty is intended to compensate the patentee for the value of what was taken.

In the recent case of Warsaw Orthopedic v. NuVasive, the Federal Circuit affirmed the finding for both patent owners, but reversed the lost profits award to Warsaw—and vacated pre- and post-verdict royalties—on the basis that Warsaw does not practice the patented technologies.

Warsaw owns two patents which it licenses to a third party, Medtronic. Warsaw and Medtronic sued NuVasive for infringement of the Warsaw patents. NuVasive counterclaimed for infringement of its own patent. A jury in the Southern District of California found all patents valid, and awarded damages for infringement to both parties, including lost profits to Warsaw. Both parties appealed.

The Federal Circuit affirmed the district court’s findings of validity and infringement, but reversed the lost profits award and vacated the pre- and post-verdict royalties to Warsaw and ordered a new trial on damages, holding that none of Warsaw’s activities warranted an award of lost profits.

Warsaw does not practice the patented technologies. Instead Warsaw licenses the technologies to two related Medtronic entities, which manufacture and sell the patented products to a third related Medtronic entity for a profit. The two related Medtronic entities that manufacture and sell products pay Warsaw a royalty on those sales. Warsaw also manufactures fixations, such as surgical rods and screws, used in conjunction with the patented devices during surgery. The fixations are also sold to the third Medtronic entity. The third Medtronic entity combines the patented products and fixations, which are sold together in medical kits to hospitals and surgeons. Warsaw argued that it has three sources of income derived from the patents: (1) revenue from the sale of fixations to the third Medtronic entity; (2) royalties from the other two Medtronic entities for their manufacture and sale of the patented products; and (3) a payment from the third Medtronic entity resulting from an inter-company transfer pricing agreement (“true-up payment”). At trial Warsaw argued that all three income sources represent potential lost profits. The jury awarded $101,196,000 in total damages to Warsaw, $101 million of which was for “Lost Profits Damages (with royalty the remainder).” The verdict form also provided royalty rates for each patent.

In reversing the award of damages to Warsaw, the Federal Circuit held, “a patentee may not claim, as its own damages, the lost profits of a related company.” Further, “[t]o be entitled to lost profits, . . . the post profits must come from the lost sales of a product or service the patentee itself was selling.” Thus, the court found the lost profits based on the royalty payments received from the related Medtronic companies’ sales of products, did not qualify for lost profits damages for the plaintiff.

Warsaw argued that its lost profits from the sale of fixations to the related Medtronic company qualified as convoy sales. The Federal Circuit clarified that to qualify as convoy sales, the related products “must be functionally related to the patented product and losses must be reasonably foreseeable.” The Court distinguished this from the mere sale of items together for convenience of some business advantage. Thus, if the items for the convoy sales have independent use apart from the patented technology, that would indicate that are not functionally related. The Federal Circuit held that the fixations could not qualify as convoy sales because Warsaw failed to prove a functional relationship. Thus, Warsaw was not entitled to lost profits based on the sale of fixations.

With respect to the true-up payments, the Court found that Warsaw had failed to establish what percentage of true-up payments received from the related entities was attributable to payments for the patented products to hospitals and surgeons as opposed to unrelated transactions. The evidence indicated that the true-up payments are valued based on company-by-company basis rather than technology-by-technology or product-by-product basis. As such, the Federal Circuit held that the true-up payments were also not a recoverable lost profit.

The Federal Circuit noted that its holdings denying Warsaw’s ability to obtain lost profits does not preclude it from other recovery. The cjillourt indicated that Warsaw may be entitled to a reasonable royalty and remanded the case for a new trial on damages.

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