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# Texona Patent Infringement Damages Case

Module by: Les Livingstone. E-mail the author

Summary: Case calls for calculation of lost profits damages due to patent infringement.

 TEXONA HIGHWAY CONSTRUCTION Texona is a fast-growing state in the American Southwest. The fast growth makes it necessary for the Texona State Department of Highways (DOH) to construct new highways and widen existing highways. The DOH carries out highway construction by means of competitive bidding by qualified highway construction companies. One of the qualified highway construction companies is Salsa Inc. Salsa has developed and registered a patent for containing noise caused by highway construction, which is extremely loud and for which DOH has to pay compensation to homeowners and businesses located near highway construction projects. The Salsa patent effectively contains construction noise, and significantly lowers the amount of compensation paid by DOH to the homeowners and businesses disturbed by the din of highway construction. The Salsa patent is for a containing wall that is built on both sides of a highway under construction. The containing wall is 16 feet high, and consists of reinforced concrete posts that are grooved to accept concrete panels with matching tongues. The patent covers the posts as a product, and also their method of manufacture. The wall is permanent, and remains to reduce traffic noise after highway construction is completed. Both the posts and the panels are manufactured onsite from molds into which are poured liquid concrete, reinforced by steel rebar. The posts are 24 feet long, with 8 feet inserted and concreted into post holes, and 16 feet protruding above ground. The posts are on 16 foot centers, and support the 16 by 16 foot panels. These Salsa walls are known as hushwalls. Since hushwalls have proven very effective, DOH highway construction specifications since 2002 included sound muffling standards that hushwalls can meet, but which no competing product has been able to satisfy. When DOH introduced the sound muffling standards on January 1, 2003, strong protests came from Salsa's highway construction competitors, who feared that they could no longer compete for contracts against Salsa, and would be forced out of business. DOH responded by pointing out that highway contractors still had several options. They could develop new noninfringing hushwalls that met the standards, or they could arrange for Salsa to be their subcontractor for the hushwall portion of highway contracts, or they could purchase licenses from Salsa to use the Salsa patent in exchange for paying an agreed royalty. This satisfied some contractors, but others were resentful, and resolved not to be pushed into using Salsa as a subcontractor or licensor, or to spend money on R&D to invent new methods to muffle construction noise. Starting on June 30, 2003, some contractors won highway contracts by infringing the Salsa patent. Each time, Salsa sent lawyer's letters to the infringers to cease and desist. But none of these letters had any effect. In order to protect its rights, Salsa was compelled to sue the infringers. Salsa sued the infringers for lost profits from lost sales of Hushwall due to infringement. Salsa's lawsuit filing pointed out that the infringers had illegally sold Hushwall at a competitive price, which was lower than the price that Salsa would have commanded as the sole supplier of Hushwall. This is known by the legal term "price erosion." The lawsuit was filed on December 1, 2005 and the infringements ceased by December 31, 2005. After the defendants filed their response, there were the usual written interrogatories, depositions of fact and expert witnesses and pretrial motions. The trial was scheduled to begin on June 1, 2006 and was expected to end on June 30, 2006. Therefore damages awarded by the court would be payable on June 30, 2006. So Salsa would not recover 2003-2005 lost profits until June 30, 2006. You have been asked by Salsa's lawyers to prepare its damage study to be filed with the court. For this engagement you have gathered the following information. Salsa Income Statements All figures in $'000, except percentages. Cost Gross Gross SG&A* Pretax Year Revenues of Sales Profit Profit % Expenses Profit 1996$21,193 $18,387$2,806 13.2% $1,217$1,589 1997 $15,878$14,586 $1,292 8.1%$1,096 $196 1998$14,471 $12,880$1,591 11.0% $1,200$391 1999 $12,056$10,928 $1,128 9.4%$1,081 $47 2000$9,706 $8,593$1,113 11.5% $1,251 -$138 2001 $14,386$13,137 $1,249 8.7%$1,166 $83 2002$16,220 $13,857$2,363 14.6% $1,022$1,341 2003 $9,091$8,424 $667 7.3%$1,061 -$394 2004$3,248 $2,792$456 14.0% $1,018 -$562 2005 $7,761$6,894 $867 11.2%$1,123 -$256 Total$124,010 $110,478$13,532 10.9% $11,235$2,297 * SG&A = Selling, General and Administrative Hushwall Hushwall Hushwall Hushwall Hushwall Hushwall Direct Gross Gross Square Revenue per Revenue# Cost Profit Profit % Feet Square Foot 2003 $987$648 $339 34.3% 59$16.73 2004 $493$393 $100 20.3% 37$13.32 2005 $732$587 $145 19.8% 56$13.07 # The Salsa 2003 hushwall revenue is from a Texona high- way contract awarded on February 12, 2003. Contracts With Infringing Hushwalls All figures in '000, except percentages. Contract Total Total Total Total Hushwall Hushwall Hushwall Hushwall Hushwall Award Contract Contract Gross Gross Hushwall Direct Gross Gross Square Revenue per Date Revenue Direct Cost Profit Profit % Revenue Cost Profit Profit % Feet Square Foot 6/30/2003 $38,371$33,965 $4,406 11.5%$3,931 $3,293$638 16.2% 301 $13.06 12/31/2003$107,063 $97,702$9,361 8.7% $10,373$8,183 $2,190 21.1% 801$12.95 6/30/2004 $33,398$30,001 $3,397 10.2%$3,489 $2,731$758 21.7% 262 $13.32 6/30/2005$38,576 $34,867$3,709 9.6% $3,977$3,281 $696 17.5% 302$13.17 12/31/2005 $678,690$600,560 $78,130 11.5%$70,982 $56,421$14,561 20.5% 5,214 $13.61 Total$896,098 $797,095$99,003 11.0% $92,752$73,909 $18,843 20.3% 6,880$13.48 NOTE: Any damages awarded at trial for lost profits are subject to taxation. Therefore, when calculating damages, you need to do so on a before-tax basis. Salsa cost of equity since 2003 has been 16%, and cost of long-term debt has been 12%. Salsa's tax rate is 35%.x Salsa capital structure is 60% equity and 40% debt. The law on patent infringement used to allow recovery of damages for lost profits on "convoyed" sales. Convoyed sales are items that are usually sold along with the infringed product. For example, sales of desktop computers are usually accompanied by sales of computer monitors and printers. That makes sales of computer monitors and printers "convoyed" sales of desktop computers. By the same token, convoyed sales for cellphones are sales of car chargers, home chargers, earpieces and belt clips for cell phones. This approach was known as the "entire market value" rule. More recently, the courts have restricted damages for convoyed sales to unpatented items that are technically related to the infringed item. For example, unpatented spare parts for a patented machine. A 1995 decision in Rite-Hite Corporation et al v. Kelley Company, Inc.clarified the damages which may be recovered for "convoyed sales." The Rite-Hite decision restricted the patent owner's damages by imposing a new limit on the "entire market value" rule. Rite-Hite's patent was for a levelling device for trucks backed up to a cargo loading dock. Typically, when selling the patented device, both Rite-Hite and the nfringer also sold an unpatented restraining device or hook which secured the truck against inadvertent movement away from the loading dock. This provided substantial safety, e.g. for fork-lift operators driving palleted loads into the truck. Nonetheless, Rite-Hite's claim for damages from lost sales of the restraining devices was disallowed because there was no real "functional" interaction between the two devices. This now appears to be the essential test for application of the so-called "convoyed goods" or "entire market value" rule, rather than a mere marketing or commercial relationship. The 1995 Fonar case involved a patent on a magnetic resonance imaging (MRI) machine component permitting generation of multiple images at different orientations ("multi angle oblique", MAO). The damages award had two components: (1) recovery of $27,825,000 lost profits from 75 MRI sales, and (2)$34,125,000 for another 525 infringing units. Both awards were based on the "entire market value" of the MRI machines, even though only the MAO component was patented. The importance of the "entire market value" rule is illustrated by the finding that the Fonar patent owner had actually sold the patented MAO component as a separate and distinct feature for only about $1,000 to$1,500, or as part of the MRI machines, even though only the MAO component was patented. The importance of the "entire market value" rule is illustrated by the finding that the Fonar upgrade package was worth \$15,000. By basing the damages calculation on the total value of the MRI machine, Fonar's recovery of damages was from 18 to 65 times the established sales price of the patented item when it was sold separately. Assignment 1. Estimate damages for lost operating profit 2003-2005 from lost sales due to infringement 2. Estimate damages for lost operating profit 2003-2005 from margin erosion. 3. Should there be damages for lost profits on "convoyed" sales in this case? This is a complex legal issue, and we are not asking you for a professional legal analysis. We simply want you to apply critical thinking as best you can. Explain your answer clearly and completely, with reasoning to support your points. 4. You should calculate lost profit damages on convoyed sales, so that the court can consider them, if it wishes. 5. Calculate the total value of all the damages as of June 30, 2006, which is the estimated date of the completion of the patent infringement trial. You may assume that profits are earned equally throughout the year, which is equivalent to assuming that each year's profits are earned on June 30 of that year.

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