Expert’s Royalty Calculation Invalidated

In a patent dispute, the plaintiff alleged that two of Facebook’s features infringed its patents and presented expert testimony as to reasonable royalty damages. Facebook attacked both the royalty base and royalty rate determinations under Daubert, alleging a host of improprieties, including violations of the entire market value rule (EMVR) and flawed apportionment. One attack “misse[d] the mark,” the court found, but the other was “fatal.”

The plaintiff was a nonproducing limited partnership that had acquired two of the patents in suit by way of assignment. In its suit (E.D. Va.), it claimed that Facebook, the globally recognized social networking service, infringed the patents when it introduced two new features to its website: BigPipe and Audience Symbol. The plaintiff admitted that no violation occurred without those two features. It sought damages covering the period from February 2009 to February 2013.

Two levels of apportionment. The damages claim rested entirely on testimony from a notable expert, who calculated a reasonable royalty based on a hypothetical negotiation between the parties and the Georgia-Pacific framework. He performed three steps.

(1) Royalty base. For the base, he first considered Facebook’s entire revenue stream during the alleged infringement period. Next, he decided to exclude 50% of that figure because it represented the amount of revenue attributable to the use of Facebook’s noninfringing mobile applications. Then he considered three customer and advertiser surveys that asked survey participants to rank a number of Facebook features in order of importance to the user. Importantly, four of the tested features could be used independently, without BigPipe and Audience Symbol, and thus without infringing. Also, the surveys did not test the importance the BigPipe and Audience Symbol features themselves assumed for the survey takers.

For his second apportionment, the expert first assumed that the weighted importance of any given feature corresponded exactly to the percentage of advertising revenue Facebook received from it and then excluded revenue attributable to features that did not cause infringement. However, he did not try to calculate how much revenue actually was attributable to BigPipe and Audience Symbol, the features responsible for the alleged infringement. The court’s opinion redacted the final claimed royalty base amount but stated that, by the expert’s estimation, it was 65.19% of Facebook’s total revenue stream.

(2) Royalty rate. For the rate, the expert first considered prior license agreements involving similar technology. These contracts did not involve the plaintiff, but the original patent holder and two other companies, and they licensed rights not to the patents in suit but to a complete and operational product and related services. Based on these licenses, the expert determined a “lower bound” of 2.3%; this was the minimum that the patent holder would accept in a hypothetical negotiation, he stated. Based on revenue he thought stemmed from the infringing features, he set an “upper bound” of 21.99%; this, he believed, was the maximum amount Facebook would pay for use of the patents. Next, he applied the 15 Georgia-Pacific factors to the bounds to arrive at a final royalty rate of 5% to 6%. Finally he multiplied the royalty rate by the royalty base to arrive at his total royalty, a figure the court opinion redacted.

Problematic use of surveys. Trying to exclude the testimony, Facebook challenged both the expert’s royalty base and royalty rate calculations on multiple grounds. The court considered the arguments in turn.

(1) EMVR violation. Facebook claimed use of Facebook’s entire revenue stream as a starting point for the royalty base violated the EMVR.

That attack “misses the mark,” the court said, because the expert did not use the entire value for the royalty base. Rather, he began his calculation of the base with the entire revenue but then performed two separate apportionments. The EMVR did not come into play.

(2) Flawed apportionment. Facebook argued that, in calculating the royalty base and royalty rate, the expert failed to apportion revenue to the two features that caused the alleged infringement, that is, BigPipe and Audience Symbol.

This argument was lethal to the plaintiff’s claim, the court found. Because the accused technologies represented only a small improvement to an existing technology, the plaintiff only had a right to a royalty based on the “incremental value provided by that improvement” (citing Lucent v. Gateway, 580 F.3d 1301 (2009)) (available at BVLaw). Here, the expert’s apportionment did not properly represent the amount Facebook would have been willing to pay to license the patents in suit. Allowing the expert to use as the royalty base the entire value of four features that could function without infringing, on Facebook’s mobile platform, while not using the value of the allegedly infringing features, BigPipe and Audience Symbol, “would be a mistake of the same kind as allowing [the expert] to use the entire value of Facebook,” the court said. For this reason alone, the testimony was inadmissible.

But, the court continued, the improper apportionment based on the four features also affected the expert’s royalty rate calculation. To calculate the upper limit of the rate (21.99%), he also took into account the three market surveys that listed the four features while not ranking BigPipe and Audience Symbol. Because he failed to use only the portion of the revenue stream attributable to the infringing features, his entire damages analysis was unreliable, the court concluded.

(3) Improper use of surveys. Facebook further contended that the way the expert used the customer surveys to calculate the royalty base was unsound. He simply assumed that a certain rating of a feature directly translated into the percentage in advertising revenue the feature generated for Facebook. The court agreed. The record showed that the surveys only tried to determine what features most drive Facebook’s usage but did not claim there was a direct link between usage data and revenue, the court pointed out. The expert should have analyzed the correlation between usage and revenue but failed to do so. Therefore, his methodology was unreliable.

In sum, because the expert overcompensated the plaintiff for the alleged violation, the opinion was inadmissible, leaving the plaintiff with no support for its damages claim.