Distinguishing Lost Profits from Reasonable Royalties

Abstract

Patent damages are designed to compensate patentees for their losses, not to punish accused infringers or require them to disgorge their profits. The statute provides for damages "adequate to compensate for the infringement, but in no event less than a reasonable royalty." Courts interpreting this provision have divided patent damages into two groups - lost profits, available to patent owners who would have made sales in the absence of infringement, and reasonable royalties, available to everyone else. Traditionally, patentees want to prove lost profits, because only that measure captures the monopoly value of exclusion of competitors from the market. As the statutory language suggests, reasonable royalties exist as a floor or backstop for those who cannot prove that they have lost profits as a result of infringement. In practice, however, the lines between lost profits and reasonable royalties are blurring. In significant part this is because courts have insisted on strict standards of proof for entitlement to lost profits. Specifically, patentees must prove demand for the patented product, the absence of noninfringing substitutes, the ability to meet additional demand in the absence of infringement, and the proportion of those sales that represent profits. This in turn means that many patent owners who have in fact probably lost sales to infringement cannot prove lost profits damages, and turn to the reasonable royalty measure. The result is that courts have distorted the reasonable royalty measure in various ways, adding "kickers" to increase damages, artificially raising the reasonable royalty rate, or importing inapposite concepts like the "entire market value rule" in an effort to compensate patent owners whose real remedy probably should have been in the lost profits category. In Part I, I explain the strict requirements for proving lost profits, and give examples of patentees who have failed to meet these requirements. In Part II, I explain how relegating these patentees to reasonable royalties has led to problematic changes in reasonable royalty law. Finally, I suggest in Part III that courts should draw a sharp division between the injury suffered by patentees who compete with infringers and those who do not. Patentees who compete should be entitled to the best estimate of lost profits, even if not all elements of proof are available. Doing so will avoid overcompensating patent owners in reasonable royalty cases.