A dangerous one-two punch

Right now, patent holders everywhere are warily watching the Patent Reform Act of 2007 (PRA) as it winds its way, perhaps inexorably, through the US Congress. One of its key provisions deals with the proper measure of damages in patent cases - a topic that takes on extra importance after the US Supreme Court’s 2006 decision in Ebay v. MercExchange.

Before Ebay altered the legal landscape, the standard remedy for patent infringement was an injunction against future use coupled, of course, with damages compensating for past losses. Typically, courts gave injunctions for future harms by simply concluding that the “irreparable” harm from patent infringement required injunctive relief. Typically ignored was any consideration of the relative hardship from granting the injunction on the parties, or the overall effect of the injunction on the public interest.

This near-automatic injunction rule neatly put to one side the need to estimate future damages for patents with years to run in rapidly changing technological environments. Now that trial courts have given broader discretion in opening or shutting the injunction door, damage calculations loom ever larger - which explains why the PRA marches off in the wrong direction. The absence of reliable injunctive relief should lead Congress to beef up damages to pick up the slack. Unfortunately, the PRA appears to weaken the damage remedy. The key damage provision states “The court shall conduct an analysis to ensure that a reasonable royalty …is applied only to that economic value properly attributable to the patent’s specific contribution over the prior art.” Thereafter the PRA also instructs courts to exclude from the damage calculations any economic value properly attributable to other patented or nonpatented improvements.

The new damage rule is the second blow in a one-two combination that would dampen patent innovation on the heels of Ebay. The current law states that damage awards should be “adequate to compensate for the infringement but in no event less that a reasonable royalty for the use made of the invention by the infringer, …” For past damages, traditional US patent law left the plaintiff to make the unappetising choice between two remedies: lost profits and a reasonable royalty. Oftentimes, proof of lost profits is excluded as speculative. The traditional patent royalty, although lower, was easier to compute and thus easier to get. There a patentee could benchmark compensation against an infringer on the royalties collected on its nonexclusive licenses. Instead new restrictive rule requires a detailed, fact-intensive inquiry for reasonable royalties that appears to preclude or weaken using the traditional benchmark. Its effect is to depress damages, increase litigation costs and to slow down innovation.

These unfortunate consequences are compounded now that damages may often be the only remedy for future infringements. Projecting lost projects is a risk high stakes game given the pervasive uncertainty over whether the new entry will erode future profits. Plaintiffs will still have to worry about projecting product quantities and prices, even if the high royalty rates in voluntary transactions still seem to be largely off limits. Cut the damages, and lo, it becomes cheaper for latecomers to infringe than to license.

That trend could prove especially dangerous for pharmaceutical patents on key molecular entities which are usually sold as stand-alone products. Their value often increases over their patent life, contingent on favorable safety and effectiveness reports. The injunction automatically preserves those gains, which feeds back to bolster research incentives. It is no wonder that the pharmaceutical companies dread the PRA, because of its potential to slash their returns while increasing their costs.

In contrast, tech companies are far more receptive to this legislation. Most of their new systems embed thousands of components, any one of which could infringe some tiny or obscure patent. Shutting down the large device not only does a disservice to the manufacturer of the finished product, but also harms the holders the holders of other patent components whose royalties are pegged to the sales of the combined product. It is unwise to give them below-market royalties once the holdout power of the injunction is lifted.

So what how do we break the impasse if Congress won’t scuttle the PRA? One simple amendment would cut out pharmaceuticals from the new remedial regime by specifically articulating a favourable stance toward injunctive relief and the traditional standards of damages on pharma patents, which already are subject to special rules in other contexts. On the tech side, the old presumption of irreparable harm might be sensibly jettisoned for small components of large systems, but kept everywhere else. Even if that is not done, the absence of any holdout risk is a reason to strengthen not weaken damages on infringement. Congress should go take PRA back to the drawing boards on its damage provisions.

Richard A. Epstein is a professor of law at the University of Chicago and a senior fellow at the Hoover Institution. He is a visiting professor at NYU law school. He has consulted frequently on both pharmaceutical and high tech issues.