The BERO Group Publications

Using the "Book of Wisdom"
to Determine a Reasonable Royalty

By James L. McGovern, CPA/CFF, CVA, Fellow
January 2015

A patent owner generally proves loss by demonstrating either an amount of lost profits or a reasonable royalty for the infringer's use of the patent. Where there was an established royalty rate in place at the time of infringement, that royalty rate often forms the basis for a "reasonable' royalty for the infringement. But what happens when there is no established royalty from which to calculate damages?

When that occurs, it's acceptable to turn to a hypothetical negotiation, where the court reconstructs events that may have resulted from the two sides coming to an agreement over the licensing of the infringed patent. The court assumes that each party had access to all the relevant information and that everyone was willing to agree to a license on reasonable terms, and the hypothetical negotiation starts at the first alleged infringement.

Here's where it gets tricky. Though logically it would seem to follow that factors unknown when the infringement began should not be part of the hypothetical negotiation, that may not actually be the case.

Enter the so-called Book of Wisdom. This term originated in a 1933 Supreme Court ruling on Sinclair Refining Co. v Jenkins Petroleum Process Co. (289 U.S. 689), which was actually a breach of contract claim when Sinclair failed to assign Jenkins a patent application. Jenkins wanted to assess the damages related to the extent the patent was used, how many devices were manufactured under the patent, and the amount of product yielded by the device. Although the district court dismissed the claim because the data sought was available before the actual breach, on appeal it was determined that "the commercial use that had been made of the patented device" could be relevant, and that "experience is then available to correct uncertain prophecy. Here is a book of wisdom that courts may not neglect."

The Court set the standard that while market value based on current sales is not always available, it does not mean that the infringer isn't liable. Instead, it's up to the courts to make as full an appraisal as possible of the object in question, including its exchange and use value. As the Court explained it, its purpose was "not to charge the offender with elements of value nonexistent at the time of his offense" but "to bring out and expose to light the elements of value that were there from the beginning."

More than 50 years later, the Book of Wisdom concept was expanded and applied directly to the issue of patent infringement damages in Fromson v. Western Litho Plate & Supply Co., where the court described the hypothetical negotiation as "encompassing fantasy and flexibility; fantasy because it requires a court to imagine what warring parties would have agreed to as willing negotiators; flexibility because it speaks of negotiations as of the time of infringement began, yet permits and often requires a court to look at events and facts that occurred thereafter and that could not have been known to or predicted by the hypothesizing negotiators."

In its decision the court ruled that all circumstances, including the infringer's use of the invention, must be taken into account when assigning royalties.

Like so much in the world of patent damages, the guidelines for using the Book of Wisdom haven't exactly been crystal clear. In Interactive Pictures Corp V. Infinite Pictures, Inc., the Federal Circuit drew a line between the pre-negotiation and post-negotiation data (allowing the former but not the latter), and that barrier was reaffirmed in Riles v Shell Exploration and Prod.Co. and even more strongly in Integra Lifesciences I, Ltd., v Merck KGaA.

But in Honeywell Int'l, Inc. v. Hamilton Sunstrand Corp., when the defendant tried to stop the plaintiff from basing its royalties on sales that did not exist at the time of the hypothetical negotiations (projections for sales increased dramatically post-9-11), the court ultimately concluded that, based on the ruling in Fromson, post-negotiation sales projections can, indeed, be used to calculate royalties.

So we find ourselves asking the question: when is it appropriate to "read" from the Book of Wisdom? The answer seems to be a very non-definitive "Sometimes." Each case must be considered individually, but when dealing with a case that is several years post-patent and where there are reliable sales projections and history to draw from, the Book of Wisdom is definitely worth a look.