How Did They Get That Number? An expert witness talks about the art of calculating damages in IP litigation

Dana Trexler Smith leads EisnerAmper’s forensic services practice in Philadelphia. With an MBA from The Wharton School and a background in accounting, she provides expert testimony on damages in IP disputes. It’s a job that requires her to keep current on changes in the law and court decisions on damages. She compares the work to figuring out what a very complex jigsaw puzzle looks like – based on an incomplete assortment of pieces. The interview has been edited for length and style.

MCC: What are some of the big developments that you've been following that can influence your IP damages calculations?

Smith: Some of the bigger issues are: the U.S. Supreme Court's decision in Apple Inc. v. Samsung Electronics Co. Ltd.; the Northern District of California’s updated local patent rules; and the Defend Trade Secrets Act.

MCC: Remind us what the Supreme Court was looking at in the Apple case.

Smith: It's part of the ongoing cellphone wars. The dispute was whether Apple’s patents covering the design of its smartphones had been infringed. The design patents relate to the look and feel of the phone, such as the shape of the phone, with its rounded edges, and the way the app icons are aligned on the screen. The jury initially awarded Apple $1.05 billion in damages, which was later reduced.

MCC: What did the court rule?

Smith: The damage remedies that are available for design patents are lost profits, reasonable royalties or the infringer's profits. The infringer's profits are unique as a damage remedy to design patents. In non-design patent litigation, infringer's profits are not an available damages remedy. What happened in this case was that an Apple damages expert calculated the infringer's profits on sales of these smartphones based on the profit for the entire phone itself. There's law that governs what a damages expert should consider when calculating an infringer's profit. If you look at the underlying law, there's language that says that the patent owner can recoup the infringer's total profit for the sale of “any article of manufacture.”

So, the question that was posed to the Supreme Court involved clarifying the definition of an “article of manufacture” for the purpose of calculating damages. The question is whether the damages on the “article of manufacture” relates to the profit generated from sale of the whole phone, or profits on a smaller component. The court found that the term “article of manufacture” is broadly used and can relate to a component of a larger salable unit, or to the larger salable unit itself. It did not define a test to apply to determine the “article of manufacture” but remanded this back to the U.S. Court of Appeals for the Federal Circuit. The importance of this case is that the Federal Circuit now has to define what an article of manufacture is, which will leave damages experts to grapple with this issue until further clarity is provided.

MCC: One of the problems here is how you strip out a component of a smartphone and determine its value, right?

Smith: Right. And if you look at this decision in the context of what's happening with patent case law broadly, the courts are looking to really home in on damages that flow from the value of the patent’s claims in dispute, and the product in dispute could be a component of a larger unit. As technology becomes more and more prevalent, and there are more pieces of technology in any given product, the courts are looking for damage experts to work on behalf of the plaintiff and defendant to identify the stream of damages that is related to only the technology at issue, and nothing more. So it does become complicated.

MCC: So the impact of this decision is still very much an open question, but it could very well be huge.

Smith: It could be. And it may provide an additional test that damage experts need to think about as they're coming up with their damage calculations – at least with respect to infringer's profits in design patent matters.

MCC: Let’s turn to the revised patent rules in California that you mentioned.

Smith: In January 2017, the Northern District of California issued revised local rules that include sweeping changes related to the initial disclosure of damage contentions and damage-related documents. Where the previous local patent rules excluded mention of damages, the new rules now require extensive disclosures related to damages very early on in the case – prediscovery – which is going to pose some challenges. And they're looking for an initial computation of damages. So, it's sending a message that the courts are really trying to get their arms around the value of a case early on, before too much time, effort and money is spent in litigating.

MCC: Wouldn't discovery reveal crucial information upon which to base such a value?

Smith: Yes. It will require some back-of-the-envelope calculations. Most notably, the local patent rules are looking for the identification of the damages period early on; early production of certain types of information, including license agreements for the patents in suit; comparable license agreements; settlement agreements; sales revenue; costs; and profits related to the accused products to the extent that lost profits are a measure of damages that are being sought. They're also looking for the plaintiff to identify the categories of damages that are being sought, theories of recovery, the factual support of each damage theory, including a back-of-the-envelope computation based on the information available. And then they're looking to identify required information to enable disclosure. There is an “out” that allows a party to state that it is unable to meet the disclosure of requirements, in the absence of certain information. It will be interesting to see what the courts do with that – if they really hold a party's feet to the fire.

MCC: California is a very important jurisdiction, first because of all of the innovations that have occurred there in recent decades, but also because it can be very influential in many areas of dispute nationwide. How significant is this likely to be beyond the borders of California?

Smith: It will be interesting to see if other jurisdictions pick up on these disclosure requirements. It wouldn't surprise me if they do.

MCC: Is there a way to even guess at the impact that these changes are likely to have on litigation?

Smith: Certainly the parties will need to involve their damages experts earlier, so the expert can work with the limited facts and information that's available alongside the client to develop economically sound damages calculations and theories. As you noted earlier, discovery is obviously key to getting some of that information, but it sounds like the court's going to compel the parties to produce that information earlier in the case. I think some of the thought behind this change is that it may force the parties to really streamline the process and get into discovery around these issues earlier in the hopes of creating some efficiency throughout the discovery process, and possibly pushing parties toward settlement sooner, rather than later. Oftentimes what I see is that parties engage the damages experts toward the end of a litigation, and once they start getting their arms around the numbers, that's when settlement discussions begin. So it may be that the courts thought, “Let's lead with the damages, at least to get a broad brush of what the damages could look like earlier on, and it may effectively settle the dispute sooner in the process.”

MCC: On to the Defend Trade Secrets Act, which took effect in May 2016. What does that law do?

Smith: It authorizes equitable remedies, and the award of damages is consistent with the Uniform Trade Secrets Act. The remedies available under the act are the trade secret owner's actual loss, and that could be lost profits, it could be additional expenses that they've incurred, etc. Both of those would fall under actual loss. The trade secret owner could also recover under a theory of unjust enrichment, basically saying that we're going to recoup the defendant's profits because the misappropriation is inadequately compensated by actual loss. And the trade secret owner could also recover under a theory of reasonable royalty for the unauthorized use of the trade secret. The act also provides for exemplary damages of up to double the compensatory award in the case of willful or malicious misappropriation, and then reasonable attorney fees could be brought in as well.

MCC: One fear that companies have is that an employee who leaves will take trade secrets with him. The employer’s recourse is to go to court and wait a long time, and meanwhile that trade secret may find its way into a competitor’s products. How does DTSA contemplate dealing with that situation?

Smith: There is a provision under the DTSA that provides for injunctive relief to prevent actual or threatened misappropriation. In exceptional cases the court may condition future use of the trade secret on the payment of a reasonable royalty rate. But the court can provide injunctive relief, and sometimes the damages experts become involved.

MCC: What are likely to be the long-term effects of this new law?

Smith: Prior to this law, the states had a lot of jurisdiction over how damages were calculated in trade secret cases. There was a fair amount of variation from state to state. Now that the DTSA has federalized trade secret protection, I think we're going to start to see case law that that has more definition around it – around the analyses that are needed in order to prove the various damage remedies. We've really seen this in patent laws, where there have been some guiding principles in case law that govern damages in patent infringement cases, and over time, especially over the last five to seven years, the Federal Circuit has really drilled into those underlying cases. And I think we'll start to see that here.

MCC: Speaking of which, what about at the state level? What effect does the federal law have on state laws?

Smith: My understanding is that the state is still empowered to interpret the law at the state level with respect to the Uniform Trade Secrets Act.

MCC: When you are hired as an expert consultant in one of these cases, do you usually write reports?

Smith: That depends on how we're being hired. Often we are hired as the testifying witness, expert witness, in which case yes, we do issue expert reports. We can also be hired as a consultant, and in that case we may or may not be hired as the testifying expert witness as the dispute progresses.

MCC: You are not a lawyer. Does that mean that your analysis is not always protected by attorney-client privilege? Or is that privilege the province of the lawyers who hire you, and does it extend to you?

Smith: It's a good question. In December 2010, the Federal Rules of Civil Procedure, Rule 26, was amended, and it made certain types of information that were previously discoverable nondiscoverable. For example, if an expert writes a draft report, under the new rules, drafts of the report and expert-attorney communications would no longer be discoverable if prepared in contemplation of litigation. And, to the extent that it is prepared in contemplation of litigation, the draft reports and the attorney-expert communications are not discoverable. There are a few exceptions to that. To the extent that an expert relies on the attorney communications, they could then be discoverable.

MCC: But that isn't your problem. You're hired, you do your job, you let the lawyers and their clients worry about that, right?

Smith: For the most part. I do have a discussion with counsel from the outset just to make sure that we understand the rules under which we're operating. Because sometimes, even though you're operating under the new rules, the parties have the ability to negotiate how they want to proceed in the litigation. And maybe they've agreed that they do want to exchange drafts. Or they've agreed not to follow certain aspects of the new rules.

MCC: I presume that in the usual course of your business, you're not posting enthusiastic status updates on Facebook talking about what you just figured out about particular cases you're working on.

Smith: No, we tend to work under protective orders. We can't tell anybody about the information that we're looking at.

MCC: Sounds like an interesting niche to find yourself working in. When we think about people with an accounting background, we don't necessarily think about this kind of job, which sounds like it's taking you pretty far into the legal realm.

Smith: There's a nice blend. I don't practice law, but I get to work with lawyers, so I have to understand certain aspects of case law as they relate to damages. I like to describe to people that I'm essentially a professional puzzle solver. People hand me a lot of pieces, and I never have the picture on the box. I'm missing some of the pieces. Sometimes somebody mixes pieces into mine that belong to another puzzle, and I have to sort through it all. And at the end of the day, I need to take the pieces that I have and be able to explain what the picture on the box would look like if I had it. 

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