Morse on Using Tax Transfer Prices to Inform Patent Damages

In a recent essay titled, "Seeking Comparable Transactions in Patent and Tax," in the University of Texas Law School Review of Litigation, Professor Susan C. Morse discusses the merits of whether tax transfer prices can help inform patent damages.  The introduction of her article states:

Most business firms do not go around licensing their crown jewel intellectual property to unrelated third parties.  This presents a problem for both patent law and tax law.  In patent litigation, setting damages for a reasonable royalty under Georgia Pacific[1] invites the use of a benchmark royalty rate that would have been agreed to had the litigating parties negotiated a market rate in advance.  This counterfactual analysis repeats in tax law when firms allocate taxable income among affiliates located in different tax jurisdictions.  Transfer pricing rules similarly seek a price, such as a royalty, that would have been agreed to had the related affiliates negotiated a market rate as adverse, or “arm’s length,” parties.[2]

In their article, Tax Solutions to Patent Damages, Jennifer Blouin and Melissa Wasserman argue that tax transfer prices can provide some of the data needed to set patent litigation damages.[3]  One could also ask the converse, which is whether patent litigation outcomes can provide some data that tax transfer pricing needs. If patent law looks to tax transfer prices, it sees the advantage that the tax transfer prices are set ex ante when IP developed by one affiliate was first used by another affiliate.  This roughly aligns with patent law’s touchstone of a “hypothetical negotiation” that produces an “ex ante” license.[4]   If tax law looks to patent law, it sees the advantage that patent damages emerge from an adversarial process.  Patent damages may be set ex post, but their validity is bolstered by the fact that they are contested.

Blouin and Wasserman argue that parties and courts should make use of the large body of tax transfer price information to help support reasonable royalty calculations in patent damages cases.  Perhaps so.  But transfer pricing data is messy.  Using tax transfer prices sets for parties and courts the challenging task of understanding the prices in context.[5]  The risk exists that the analysis will fail because of the weight of its own complexity.

She concludes:

Tax transfer prices are imperfect. They are motivated by the incentive to reduce tax, not by the incentive to get the prices right.  Theory, doctrine, and constrained administrative resources limit the quality or truth of transfer prices.  But this does not mean that tax transfer prices are irrelevant to the problem of patent damages.  It means that the prices are contextual.  If they are used, they should be used with attention to comparability of terms, taxpayer incentives, and government enforcement. Patent litigants may have ample incentive to engage with questions of comparability, but understanding the interaction between the complex tax system and the complex patent system as applied to transfer pricing data would not be easy.  It could be so hard that the transaction costs would exceed the benefit of any increase in the quality of patent damages awards.

The essay can be found, here. A draft of the Professor Blouin and Professor Wasserman paper, titled, "Tax Solutions to Patent Damages," is available, here.  

U.S. Court of Appeals for the Federal Circuit Affirms Two Large Patent Damages Awards: $70 million and $371 million

The U.S. Court of Appeals for the Federal Circuit affirmed two large patent damages awards recently.  The first case is Stryker Corp. v. Zimmer (December 19, 2014), a decision authored by Chief Judge Prost, which affirmed a jury verdict of $70 million in lost profits.  The decision did reverse an award of treble damages for willful infringement.  The second case is another Chief Judge Prost opinion, Bard Peripheral Vascular v. W.L. Gore and Associates (January 13, 2015), which affirms a finding of doubled damages for willful infringement from $185,589,871.02 (jury verdict) to $371,179,742.04.  That is quite a win for former federal appellate court judge and Stanford Law School professor Michael W. McConnell, also of counsel for Kirkland and Ellis. 

Patent damages as an incentive to transact

I spent a couple of hours this afternoon talking to Professor Paul Heald in Oxford. Paul is an enthusiast/expert in the field of damages for patent infringement. In brief, on the assumption that all systems of remedies are designed to influence behaviour, Paul thinks that patent remedies should be designed to induce the optimal amount of transacting between inventive firms and those who need inventions. He rejects the commonly-made assertion that damages can be calibrated to induce the optimal amount of investing in R&D. Looking at the patent world through the transactional lens lets him to solve (or claim to solve) serious practical questions such as when an injuntion should issue, how and to what extent an infringer's intent or knowledge should effect damages, and when an accounting is appropriate.

Paul has authored a very impressive paper, "Optimal Remedies for Patent Infringement: A Transactional Model". The abstract reads as follows:

"In a world of zero transaction costs, one should observe optimal invention and innovation. As long as a system of enforceable contracts were in place, firms with inventive capacity and firms requiring inventions would negotiate for the optimal production of new creations. With adequate information, an observer could accurately predict which transactions would occur between firms and which transactions would not, thereby permitting description of the conditions for optimal inventiveness. Patent remedies in a world with transactions costs can be calibrated so that real firms behave as ideal firms, providing incentives for real world transactions to mimic those in a world without transactions costs. The goal of remedies for patent infringement should therefore be to provide incentives for efficient transactions to occur, while minimizing the cost of transacting. This approach sets the framework for a comprehensive revision of current patent remedies and resolves current debates over the relevance of an infringer's knowledge, independent invention, and the proper scope of injunctive relief."

You can read this paper in full here.

Damages for observing patent injunction

From the 3rd edition of LECG's UK Newsletter comes this little insight into the deployment of a financial consultancy in intellectual property litigation, in Les Laboratoires Servier and another v Apotex Inc and others [2008] EWHC 2347 (Ch), heard on 9 October by Mr Justice Norris and briefly summarised here and here:

"... Our UK case highlights include being instructed by Taylor Wessing to calculate Apotex UK Limited’s damages as a result of an injunction they had observed. For a period of 11 months, Apotex was injuncted from selling a particular generic drug, because of claims of patent infringement brought against it by Servier, which manufactured the branded version of the drug. Apotex had always contended that the patent was invalid, and when this assertion was subsequently validated by the Court, Servier was liable for the damages suffered by Apotex as a result of the injunction.

Apotex won a substantial damages figure of £17.5M. ... The amount of interest awarded was also a matter of contention, and in a separate hearing, Norris J awarded a further £2.1M in interest. In respect of the interest calculation, Norris J deemed the Apotex parties ‘substantially right’.

Of particular interest in this case were the market dynamics, which were specific to the industry in question. The interaction between ‘branded’ drugs, ‘generic’ drugs and ‘authorised generic’ drugs (sold as generics under authorisation of the original patent holder) played a part in the formation of the ‘but-for’ scenarios. The market dynamics were important to every aspect of the case, but in particular (i) the role of potential market entrants, in the (hypothetical) absence of the injunction and (ii) the extent to which the injunction affected Apotex in perpetuity".

This looks like a great victory for LECG, but it should not be forgotten that the calculation of damages for failure to be allowed into a market still remains a largely conjectural exercise. As the judge said at para. 60:

"Recognising the imprecision inherent in the exercise but the precision of some of the assumptions used I have then stood back and compared that sum with the £74 million Servier earned during the period of the injunction to which it was found ultimately not entitled, to the £11 million which it paid to AG2 to keep it out of the market, and to the $20 million paid to G4; and I have asked myself whether in the round this sum overcompensates Apotex for the loss that it has suffered, reminding myself that the jurisdiction is compensatory not punitive. The range of figures presented for my consideration went from £400,000 (Servier) to £27 million (Apotex). I am satisfied that my figure is broadly right, though I would propose to round it down to £17.5 million to underline the fact that one can only do broad justice where there are so many significant variables. £17.5 million is accordingly the figure which I award as compensation on the enquiry".