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Tuesday, April 30, 2013

Norman Siebrasse on Comparative Patent Remedies

Posted by Norman Siebrasse

Tom Cotter’s “Comparative Patent Remedies A Legal and Economic Analysis,” is a beautiful piece of scholarship. Cotter demonstrates a remarkable mastery of the remedial law of multiple jurisdictions. His book is worth reading for its descriptive value alone. It is also very clearly written. Difficult points of both doctrine and policy are described in a way that makes it easy to understand both the fundamental principles and issues as well as details of the law and refinements of the policy debate. His policy analysis is both thorough and judicious, with well-balanced analysis that marries theoretical and pragmatic points. As it happens, I agree almost entirely with the his basic approach, and with most of the details. This is really a pleasure, as always I have the sense that any disagreements will be productive, rather than merely talking at cross purposes. But even those who do not agree as wholeheartedly with his framework will find this book useful, as Cotter is very careful to define and justify his approach. If you do find yourself in disagreement, at least you will know exactly where you disagree, and why. Consequently, this book is an essential foundation not just to comparative patent remedies, but to the policy analysis of patent remedies generally.

Cotter’s book is, as he emphasizes, not just a work of comparative law, but a work of comparative law and economics (p 33). This leads to a tension. Is the focus to be on comparison of a particular facet of the law in different systems in light of economic analysis, or is the focus to be on assessing different systems of law in light of an economic analysis? Put another way, is the analysis to be organized by legal rule, or by legal system? In his introductory chapter Cotter indicates that he will take the first route. He says that his methodology will be “(1) identifying differences and similarities among states with respect to the competing rules, standards, or institutions at issue; (2) positing possible reasons for the relevant features and their differences, if any, from the practices of other states; (3) evaluating the plausibility of posited reasons for the observed features and differences; and (4) where possible, reaching a normative judgment as to the merits of the competing rules, standards, or institutions” (p 35). But as the book is actually laid out, it largely embodies the second approach. Chapter 2 sets out Cotter’s law and economics framework, and Chapter 3 assesses US law in light of this framework, with very little reference to the law of other jurisdictions. Subsequent chapters, focusing on different legal systems, also critique those legal systems primarily in terms of Cotter’s economic framework, though, in contrast with the US chapter, there are regular references to contrasting rules discussed in other chapters. So, despite his introductory statements, I would characterize his methodology as focusing primarily on comparative law and economics, with an admixture of comparative law.

This is not intended as a criticism. Using economic analysis as the tertium comparationis for assessing different legal systems is an entirely legitimate and productive approach. Any kind of comparative law grounded in a systematic normative theory faces a three-way comparison between the rule, the legal system and the normative framework. Indeed, I think the way Cotter has actually carried out his project is preferable to a focus on individual rules. The law and economics focus is often productive in its own right. So, for example, one crucial point emphasized by Cotter is that in assessing monetary remedies it is essential to consider the likelihood that, but for the infringement, the defendant would have competed using the best non-infringing alternative. That is, it is not the patentee’s lost profits that should constitute damages, but the difference between the profits that were actually made and those that would have been made had the infringer competed using the best non-infringing alternative. This may be referred to as the patentee’s “differential loss” (my term, not Cotter’s). Conversely, the infringer’s differential profit is the difference between its actual profit and that which it would have earned using the best non-infringing alternative. It is the differential loss (or profit) that represents the loss (or profit) caused by the infringement (p 9). As Cotter points out, some legal systems are simply deficient in failing to recognize this: see eg the discussion of the English House of Lords decision in United Horse Shoe (p 188).

Moreover, as Cotter’s chapters show, individual rules must be assessed as part of a system. For example, the popularity of an accounting of profits in Canada as compared with Germany may be due to the more limited discovery in Germany making proof more difficult (p 271). While I am not a comparativist by training, it strikes me that the comparative law aspect of the comparative law and economics project must consequently be undertaken at a higher level of generality than the individual rule, though a comparison at the full system level is likely to be too unwieldy to be productive. An intermediate level of generality is required, perhaps focusing on a functional objective. Cotter’s tertium comparationis approach provides the essential foundation for this type of functional analysis.

I will try to illustrate this functional comparison by considering the question of deterrence in Canadian and US law. To do so I need to set out Cotter’s basic approach, and to quibble with it slightly. Cotter’s basic premise is that “courts should take as a given the judgment that patent rights in general. . .generate a surplus of social benefits over costs,” and consequently “patent remedies should be designed so as to preserve the incentive structure and trade-offs that are embodied in the existing substantive law” (pp 50-51). This is a remedial premise; it is not to assert that the existing regime does generate a net social surplus, but rather that if it does not, that shortcoming should be addressed by changing the substantive law rather than by judicial under-compensation in particular cases. Indeed, this is largely a principle of monetary remedies; Cotter notes that existing law relating to injunctive relief requires the court to consider broader public interest considerations, and he does not doubt the propriety of doing so (p 50).

In summarizing the implications of this premise for monetary remedies, Cotter describes five principles. The first principle is that (1) “in order to preserve the patent incentive implicit in the substantive law, the law of damages. . . should ensure that the patentee winds up no worse off. . .than she would have been, but for the infringement” (p 63). His second principle is that, (2) “absent some compelling reason, courts generally should not award the patentee more than would be necessary to restore her to the position she would have occupied, but for the infringement.” Cotter argues that a contrary rule would have two consequences: (2a) “The first is that potential users rationally would be over deterred from engaging in some marginally lawful conduct” (p 64); and (2b) “the prospect of recovering such awards may encourage some patent owners to lie in wait, as it were, rather than to negotiate up front before the user has committed to the arguably infringing design—a type of conduct sometimes referred to as ‘patent ambush’” (p 65). These substantive principles are tempered by subsidiary principles that accuracy may have to be compromised for simplicity, and that ease of administration must be considered.

My quibble is that this framework conflates distinct effects on the patentee and the (potential) infringer. As Cotter emphasizes throughout Chapter 2, the infringer’s differential profit is not generally the same as the patentee’s differential loss. For example, if the infringer competes directly with the patentee but is less efficient at manufacturing, the infringer’s gain will be less than the patentee’s loss. On the other hand, if the infringer sells into markets that would not have been tapped by the patentee, the infringer’s gain will be more than the patentee’s loss. It is therefore useful to consider separately the traditional goal of remedies, namely compensation and deterrence.

Compensation looks to the effect on the plaintiff, which is to say the patentee. In order to preserve the incentive to invent, the patentee should not be under-compensated; that is, the patentee should be placed in a position at least as good as that which it would have been in but for the infringement. This is Cotter’s first principle. Because Cotter’s second principle also looks to the patentee, it amounts to saying that over-compensation should be avoided. The justification for this, based on the effect on patentee behaviour, is that parties may be more inclined to seek patents for litigation value rather than innovation value, and then lie in wait rather than negotiating ex ante; this is what I have labeled Cotter’s justification 2b. But Cotter’s justification 2a, over-deterrence of potential users, does not support his principle 2. Deterrence looks to the effect on potential infringers, not the patentee. A potential user will only be deterred by a monetary award if the user would be made worse off by that award than it would have been had it not infringed (neglecting litigation costs and sunk costs of developing the infringing product). Because the patentee’s loss may be less than the infringer’s gain, an award that lies between the two may simultaneously over-compensate and under-deter. Put another way, there is a difference between an over-compensatory award, which is greater than the patentee’s differential loss, and a punitive award, which is greater than the infringer’s differential profit. So I consider Cotter’s justification 2a to support the distinct principle that the court should not award the patentee an amount that would make the infringer worse off than if it had not infringed; that is, over-deterrence should be avoided.

This leaves an obvious gap in a four-way scheme, namely the principle that under-deterrence should be avoided. Cotter does state and discuss this principle at length, in particular at p 52 where he notes that “Absent litigation and other costs, the minimum damages necessary to deter the unauthorized use by the less-efficient infringer would be (some minute increment above) the infringer’s profit attributable to the infringement.” (I would tweak this to refer to the expected minimum damages.). But in his five summary principles, deterrence as such is discussed primarily in the context of the fifth principle “that courts may from time to time wish to consider damages multipliers or other more extensive remedies to correct for a low probability that the infringement will be detected” (72). To my mind, this is not the same as the principle that under-deterrence should be avoided by ensuring that expected damages are equal to the infringer’s profits. Even with perfect enforcement, damages equal to the patentee’s differential loss will under-deter if the infringer’s differential gain is larger than that loss. Another difficulty is that while the enforcement problem is perhaps the main reason why expected damages may be less than actual damages, it is not clear that a multiplier based on damages, understood as the patentee’s differential loss, will provide the correct deterrence, which turns on the infringer’s differential profit.

In my view, the two primary principles are that under-compensation and over-deterrence should be avoided. Adequate compensation goes to the heart of the patent incentive. But I would argue that over-deterrence – not under-deterrence – is the other major problem. As Cotter explains, over-deterrence is a consequence of incomplete information (p 64). With perfect information a monetary remedy could not over-deter because the potential infringer could avoid being made worse off by avoiding infringement in the first place. Put another way, with perfect information the optimal remedy would be punitive. But information is not perfect, so punitive remedies may deter non-infringing conduct. While Cotter refers to this as “marginally lawful conduct,” the downside is not necessarily marginal. First, the “margin” may be very large, but as importantly, we do not want to discourage potential infringers from challenging the validity of patents, as there is a large positive externality to doing so. The current trolls debate highlights the crucial importance of avoiding over-deterrence. In contrast, under-deterrence is certainly a concern, but so long as under-compensation is avoided, the patent incentive is not impaired. The argument for under-deterrence turns on the degree to which damages that are in principle compensatory are actually under-compensatory in practice.

With this framework, consider the different treatment of deterrence in the US and Canadian systems. In the US, an accounting of profits is no longer an available remedy, but treble damages may be awarded for wilful infringement, while in Canada, a patentee can normally elect an accounting, but punitive damages are very rarely awarded (both are discretionary in principle.)

The difficulty with the US approach is that while compensatory damages alone may not provide an adequate deterrent, treble damages is a crude instrument that risks doing more harm than good. Because of the risk of over-deterrence, it is confined to cases of wilful infringement, but information costs mean that the wilfulness line is imperfect. If it is too narrowly drawn, it will not provide adequate deterrence in cases where wilfulness is not established; but if it is too broadly drawn, the risk of treble damages will result in over-deterrence.

In contrast, in the Canadian approach punitive damages are rarely awarded, thus avoiding the risk of over-deterrence and the need for a difficult wilfulness inquiry. The accounting remedy provides adequate deterrence because it deprives the patentee of its differential gain, without being punitive, in the sense that it does not make the infringer worse off than it would have been had it never infringed: see the discussion by Zinn J in Monsanto Canada Inc v Rivett 2009 FC 317 ¶¶22-27 (var’d 2010 FCA 207). This means an accounting avoids both under- and over-deterrence. The goal of avoiding under-compensation is also achieved because a patentee is always entitled to elect damages. The only drawback of the accounting remedy is that it may be over-compensatory, which, as explained above, is a relatively minor drawback. In this analysis I have to disagree with Cotter’s remark at p 149, in discussing the US system, that “If the analysis presented in chapter 2 is correct, this decision [to abolish the accounting remedy in utility patents] may have been correct, if such awards pose a substantial risk of overdeterrence of lawful conduct.” In my view, an accounting does not present a risk of over-deterrence, because it is not punitive. Cotter points out at p 197 that any risk of over-deterrence is largely avoided if the profits are assessed as differential profits over what would have been earned by the infringer using the next best alternative. That principle is now well-established in Canadian law: Monsanto Canada Inc v Schmeiser 2004 SCC 34 ¶ 102. The risk of over-deterrence therefore arises only from litigation and sunk costs (and the latter depends on how sunk costs are treated in the accounting calculation, which is too complex to discuss here). The other objection to an accounting, which led to its abolition in the US, is the purported complexity of this remedy. However, there is no reason in principle why calculating differential profits should be any more difficult than calculating differential costs; the mechanics are exactly the same, and the only difference is whether the inquiry is focused on the patentee or the infringer. The Canadian experience bears this out.

This is by no means to say that the Canadian remedial system is perfect. It is to say that comparative economic analysis of patent remedies has the potential to improve patent remedies everywhere. As the debates over patent trolls and standard-essential patents show, improved remedies is one crucial part of the pressing task of improving the global patent system. Cotter’s book is the essential foundation for this project.

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