Can a settlement license be used to set a reasonable royalty rate?
Sometimes, and the default in the case law is skepticism rather than acceptance. In LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51 (Fed. Cir. 2012), the United States Court of Appeals for the Federal Circuit wrote that the propriety of using prior settlement agreements to prove the amount of a reasonable royalty is questionable, and cited the Supreme Court's decision in Rude v. Westcott, 130 U.S. 152 (1889), for the proposition that a payment of any sum in settlement of a claim for an alleged infringement cannot be taken as a standard to measure the value of the improvements patented, in determining the damages sustained by the owners of the patent in other cases of infringement.
The reason the Federal Circuit gave is structural rather than atmospheric. It described the notion that license fees tainted by the coercive environment of patent litigation are unsuitable to prove a reasonable royalty as a logical extension of Georgia-Pacific Corp. v. United States Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970), the premise of which assumes a voluntary agreement will be reached between a willing licensor and a willing licensee, with validity and infringement of the patent not being disputed. A settlement is by definition an agreement between parties who were disputing exactly those things.
The exception is real and narrow. LaserDynamics acknowledged that despite the longstanding disapproval of relying on settlement agreements to establish reasonable royalty damages, the court had recently permitted such reliance under certain limited circumstances, and pointed to ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860 (Fed. Cir. 2010).
What did ResQNet.com, Inc. v. Lansa, Inc. actually hold about settlement agreements?
It vacated a damages award that rested on non-settlement licenses, and observed along the way that the most reliable license in that record arose out of litigation. ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860 (Fed. Cir. 2010), is not a decision endorsing settlement licenses generally. The patentee's expert had relied on five re-bundling licenses that, as the court put it, did not even mention the patents in suit or show any other discernible link to the claimed technology, and used them to push the royalty up into double figures.
The holding was about comparability. The Federal Circuit said the first Georgia-Pacific factor must consider licenses that are commensurate with what the defendant has appropriated, and that if not, a prevailing plaintiff would be free to inflate the reasonable royalty analysis with conveniently selected licenses without an economic or other link to the technology in question. It directed that on remand the trial court should not rely on unrelated licenses to increase the reasonable royalty rate above rates more clearly linked to the economic demand for the claimed technology.
The settlement license entered that analysis by comparison. It was a straight license arising out of litigation over the patents in suit, in running royalty form, at a rate the court described as substantially less than the rate the expert proposed. LaserDynamics later summarized ResQNet as explaining that this settlement license was the most reliable license in the record when compared with the others, and noted that the court permitted consideration of it on remand while cautioning the district court to consider the license in its proper context within the hypothetical negotiation framework. Permitted, in context, with a caution — not endorsed.
What did LaserDynamics, Inc. v. Quanta Computer, Inc. actually hold about the settlement agreement before it?
That the district court abused its discretion by admitting it, and must exclude the agreement from the proceedings on remand. The agreement in LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51 (Fed. Cir. 2012), was a 2006 settlement with BenQ Corporation, and the court found its probative value dubious in that it has very little relation to demonstrated economic demand for the patented technology, and greatly outweighed by the risk of unfair prejudice, confusion of the issues, and misleading the jury.
The court gave four reasons on the record before it. The agreement was executed shortly before a trial in which, as the Federal Circuit put it, BenQ would have been at a severe legal and procedural disadvantage given the numerous harsh sanctions imposed on it by the district court. Its six million dollar lump sum was, in the court's finding, six times larger than the next highest amount paid for a license to the patent in suit. The patentee had executed twenty-nine licenses for that patent in total, the vast majority of which were not settlements of active litigation and which the court described as far more reliable indicators of what willing parties would agree to. And it was entered a full three years after the hypothetical negotiation date, which in a changing market the court treated as in many ways not relevant.
The mechanism matters as much as the outcome. The exclusion was ordered under Federal Rule of Evidence 403 — the district court had denied a motion in limine brought under that rule — and the Federal Circuit reached it after discussing Rule 408 as background rather than as the operative bar.
What is the litigation-pressure discount problem, and why does it cut both ways?
It is the observation that a settlement price reflects what it cost to stop litigating as well as what the technology is worth, so the number is contaminated in a direction that is hard to measure. The Federal Circuit put it in Hanson v. Alpine Valley Ski Area, Inc., 718 F.2d 1075 (Fed. Cir. 1983), quoted in LaserDynamics: license fees negotiated in the face of a threat of high litigation costs may be strongly influenced by a desire to avoid full litigation, and should not be considered evidence of an established royalty. The quoted language originates in Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F.2d 1152 (6th Cir. 1978).
The direction of the distortion is not fixed, which is what makes it an evidence problem rather than an adjustment problem. LaserDynamics found the BenQ payment ostensibly reflected not the value of the claimed invention but the strong desire to avoid further litigation, pushing the figure up. ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860 (Fed. Cir. 2010), cataloged the opposite pressures, noting that a reasonable royalty can differ from a given royalty where, for example, widespread infringement artificially depressed past licenses, and quoting Fromson v. Western Litho Plate & Supply Co., 853 F.2d 1568 (Fed. Cir. 1988), that a court should not select a diminished royalty rate a patentee may have been forced to accept by the disrepute of his patent and the open defiance of his rights.
Deere & Co. v. International Harvester Co., 710 F.2d 1551 (Fed. Cir. 1983), shows the middle path courts actually take. There, because a license had been negotiated against a backdrop of continuing litigation and infringement, the district court could properly discount the probative value of that license with regard to a reasonable royalty. Discounting is a weight decision available to a fact-finder. What it is not is a license for an expert to apply an unexplained adjustment and call the result a market rate.
How does Rule 408 of the Federal Rules of Evidence bear on this, and can an expert rely on a settlement the jury never sees?
Rule 408 governs what the evidence may be offered to prove, not whether it exists or can be obtained. Rule 408(a) makes evidence of furnishing, promising or offering — or accepting, promising to accept, or offering to accept — a valuable consideration in compromising or attempting to compromise the claim, and of conduct or a statement made during compromise negotiations about the claim, not admissible on behalf of any party either to prove or disprove the validity or amount of a disputed claim or to impeach by a prior inconsistent statement or a contradiction. Rule 408(b) permits the court to admit that evidence for another purpose, such as proving a witness's bias or prejudice, negating a contention of undue delay, or proving an effort to obstruct a criminal investigation or prosecution.
In re MSTG, Inc., 675 F.3d 1337 (Fed. Cir. 2012), worked through the rule at length in declining to create a settlement negotiation privilege. The court read Rule 408 as covering settlements and negotiations involving a third party as well as the parties to the suit, and said that third party settlement negotiations are admissible, but only for purposes other than proving liability or the amount of a claim. It also flagged the open question directly: footnote 4 states that “[w]e note here that we have not yet decided the extent to which evidence of settlement negotiations would be admissible under Rule 408,” citing ResQNet, Vanderlande, Snellman, Medtronic, Hanson and Deere. That was the position as of April 9, 2012, the date of the decision.
Reliance by an expert is a separate question governed by Federal Rule of Evidence 703, which provides that an expert may base an opinion on facts or data the expert has been made aware of or personally observed, that if experts in the particular field would reasonably rely on those kinds of facts or data they need not be admissible for the opinion to be admitted, and that if the facts or data would otherwise be inadmissible the proponent may disclose them to the jury only if their probative value in helping the jury evaluate the opinion substantially outweighs their prejudicial effect. Those two rules can pull apart, and whether a particular settlement may be relied on, disclosed, or both is a question for counsel and the court on the record in the case.
What makes a settlement license more or less comparable in practice?
The features the Federal Circuit actually weighed in LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51 (Fed. Cir. 2012), and ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860 (Fed. Cir. 2010), read as a checklist. Whether the agreement covers the patents in suit or merely adjacent technology. Whether it is a straight patent license or bundles code, services or other rights. Its form — a running royalty the court can read against units, or a lump sum whose derivation is undisclosed. How far it sits from the hypothetical negotiation date, and what changed in the market in between. How it compares with the other licenses to the same patent. And the posture in which it was signed, including how close to trial and against what procedural backdrop.
The pattern across the two decisions is that a settlement license is strongest when it is the closest thing in the record to the technology at issue and weakest when it stands apart from everything else. In ResQNet.com, Inc. v. Lansa, Inc. it was the one document tied to the claimed invention. In LaserDynamics, Inc. v. Quanta Computer, Inc. it was the outlier, and the Federal Circuit described the patentee’s other licenses to the same patent as far more reliable indicators of what willing parties would agree to.
Two practical points follow. First, the work is document review before it is economics: the agreement's recitals, its definition of licensed products and its release language determine what it can be offered to prove. That is the discipline described in what makes a patent license comparable and in the Institute's comparable licenses area, and the consequences of getting it wrong are set out in why patent damages experts are being excluded. Second, this Institute stops at the evidence. What any agreement should move, what a measure yields, and what is recoverable belong to our Economic Damages Institute.