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Expert’s Detailed Risk Analysis Bolsters Use of Deep Discount in Law Firm Valuation

Fredericks Peebles & Morgan LLP v. Assam, 2018 Neb. LEXIS 142 (Aug. 3, 2018)

At the root of this buyout dispute is a lawyer’s premature resignation from his law firm. Because he misunderstood a compensation issue, the lawyer voluntarily resigned, only discover later he had made a mistake. When he tried to walk back the resignation, the remaining partners instead offered to buy back his minority interest pursuant to a partnership agreement. Eventually, the firm sued for a declaration of the value of the withdrawing partner’s ownership stake. The trial court heard valuation testimony from a phalanx of experts, including the lawyer himself. The opinions diverged in terms of what the standard of value required, what factors determined the applicable discount rate, and how to treat old accounts receivable worth about $10 million. The court credited the expert with the most experience valuing law firms, noting he was able to communicate to the court how law firm valuations were special and why the risks facing the subject firm were particularly great. On review, the state Supreme Court agreed, calling the expert’s testimony “persuasive and controlling.”

Fair market value requirement. The defendant (departing lawyer) was one of five equity partners in a nationwide law firm that specialized in issues affecting various Native American tribes. It was organized as a limited liability partnership and had offices in many parts of the country; the principle place of business was in Omaha, Neb. One of the issues that concerned the partners was the firm’s significant amount of outstanding accounts receivable, a good number of which were “years old.” The partners reviewed the accounts for which they were responsible and ultimately decided that about $10 million was over four months old and not collectible. Collectively, they decided to write this amount off.

The defendant, a financial attorney whose practice included business valuation matters, had a 23.25% ownership interest in the firm. Typically, he worked on accounts the other partners brought into the firm. He was not a rainmaker. In 2014, over a period of several months, the firm’s partners decided to revise the firm’s compensation structure. Various proposals floated around, including one that would have based compensation on client generation alone. Ultimately, the partners settled on a hybrid of two compensation structures, based on bringing in clients and on equity ownership.

The defendant failed to keep up with the various proposals and began to feel the change might have a negative effect on his compensation. In 2014, he hired a major accounting firm (Eide Bailly) to value his interest in the firm by way of a calculation engagement. In October 2014, the defendant, registering protest, notified the remaining partners via email that he was voluntarily resigning from the firm. Shortly thereafter, he realized that the new compensation structure was not as dire as he had thought and asked to rescind his resignation. The remaining partners rejected the request and offered to buy him out under the existing partnership agreement. When the two sides could not agree on the value, the firm filed a declaratory judgment action. The defendant countersued, asking for an accounting, fair valuation, and a money judgment.

The firm’s partnership agreement provided that the “withdrawing Equity Partner will receive an amount equal to 100% of the fair market value of the Equity Partner’s interest in the Partnership as of the date of such notice of voluntary withdrawal.” In court, the parties agreed that this agreement controlled the buyback of the defendant’s interest. The fair market value standard assumes a willing hypothetical buyer and a willing hypothetical seller, with both parties having reasonable knowledge of the facts and neither side being compelled to buy or sell. The goal of either party is to maximize its economic advantage. Put differently, fair market value assumes an objective hypothetical buyer, not a specific (subjective) buyer.

Abundant expert testimony. The plaintiff law firm offered testimony from one highly qualified expert, who, for over a decade, was a principal in a law firm management consulting group, developing a specialty in law firm mergers and acquisitions. He consulted extensively with law firms of all types and sizes and, throughout his career, performed some 25 law firm valuations. He had testified as an expert seven times and published on valuation topics and served as a speaker on the issue of law firm financial management. Earlier, he had worked as an accountant and auditor.

In testimony, the plaintiff’s expert explained the different valuation methods and said he decided the income approach, focusing on the firm’s future cash flows, was the most appropriate method here. He relied on five years of historical income statements, with the income normalized to remove nonrecurring expenses and to add liabilities that did not appear on the firm’s income tax forms.

To determine the applicable discount rate, he used the “Ibbotson Build-Up Model.” He analyzed risks specific to the legal environment, government regulatory risks, and risks specific to the firm. Regarding the risks to the firm, he noted that it was the aging partners who generated most of client revenue, that the firm had lower-than-average collection rates, and that it was largely unable to collect outstanding bills because many of the firm’s Native American clients were not subject to federal law and therefore could not be sued. He further pointed out that characteristics specific to law firms in general—the fact that only lawyers are allowed to own law firms, that lawyers must not be subject to noncompetes, and that most law firms have in place partnership agreements that control compensation and admission to the firm—limit the control and marketability of a law firm interest. For all these reasons, the plaintiff’s expert applied a 60% discount to the defendant’s ownership interest. The expert valued the defendant’s interest at $590,000.

Switch to fair value. The defendant offered testimony from three experts: two worked for Eide Bailly, the firm that had prepared a calculation of value for the defendant in 2014, and a third expert served only as a rebuttal expert and did not provide an independent value determination. In the end, the defendant renounced all of these opinions and became his own valuation expert.

Based on Eide Bailly’s 2014 calculation engagement, the defendant’s interest was over $3.4 million. In 2016, after the defendant had resigned, he engaged Eide Bailly to perform a detailed valuation. The valuation engagement produced a $3.1 million value.

Both Eide Bailly appraisers were senior persons in the firm’s business valuation department. One of them was a CPA and credentialed business valuator, who performed a substantial number of valuations per year for businesses in a variety of industries. However, he had performed only one law firm valuation. The other appraiser had a J.D., an MBA, and a background in economics. He also had performed hundreds of valuations but had never done a law firm valuation.

Both of these appraisers’ reports used an income approach, based on only four years of income, instead of five years. The appraisers decided that one year, 2010, showed an income that was lower than the other years and therefore was not representative of the firm’s regular income. They conceded, however, that they typically used a five-year sample. The appraisers also adjusted the valuation upwards to account for the firm’s status as a pass-through entity (PTE). In testimony, one appraiser allowed that, to date, the U.S. Tax Court had yet to accept this approach.

The Eide Bailly appraisers gave great significance to the partnership agreement—specifically, the fact that it provided for a buyback of a withdrawing member’s shares. Even though the agreement specified the use of fair market value, which assumes an arm’s-length transaction, the appraisers assumed a specific hypothetical buyer, the firm. Prior to working on the valuation engagement, the defendant’s counsel had sent a letter to the appraisal firm that said: “[T]he Agreement provides for a market within [the firm] and its Equity Partners. This means the transaction occurs at a fair price and on fair terms, not as if the sale were to a stranger.” The letter talks about an “internal market” and says fair market value in this context should “be understood as the fair value of the partner interest.” This directive guided the Eide Bailly appraisers’ discount analysis and value conclusions.

The defendant’s rebuttal expert was hired to review, compare, and critique the various valuations. This expert was also a CPA, with a J.D. and a master’s degree in professional accountancy. He also was an accredited business valuator, but he had never worked in a law firm and had valued only one other law firm.

The rebuttal expert decided each expert report was flawed. In essence, the Eide Bailly opinions overstated the value of the defendant’s interest by nearly $1.3 million, whereas the opinion by the plaintiff’s expert understated the value by about $1.2 million. The rebuttal expert fundamentally disagreed with the defendant’s own valuation, saying it was not credible “in any respect” and was ‘ridiculous.”

Defendant’s valuation ‘unreliable and not credible.’ The defendant valued his interest at nearly $4.9 million. The valuation was based on the asset approach, the income approach, and the market approach. As for his qualifications as an expert, the defendant said he routinely performed business valuations to assist clients and he had read “some articles” from the American Bar Association and Inc. Magazine in preparation for his valuation. His calculation included the firm’s $10 million in uncollectible accounts receivable, which the defendant claimed the remaining partners had written off in bad faith. Under the asset approach, the defendant also included the value of real estate, automobiles, equipment, etc. Under the income approach, he added 2013 income figures with estimated 2014 income figures and divided the result by two. For the market approach, he determined average annual gross revenue, using the amount from the income approach, and multiplied it by two.

The defendant urged the court to disregard his experts’ valuations and instead adopt his valuation. The trial court declined to do so.

The court found the $10 million write-off was not done to harm the defendant. Rather, the write-off affected all of the partners, and it was a point of discussion among the partners before the defendant resigned.

The court called the defendant’s valuation “unreliable and not credible.” It also rejected the Eide Bailly opinions, noting the defendant improperly had tried to “influence in an upward manner” the firm’s value conclusions. The appraisers worked under the incorrect assumption that, for purposes of this valuation, the defendant’s firm had to be considered the hypothetical buyer of the defendant’s specific interest, even though the partnership agreement required the use of the fair market value standard. The court also noted the appraisers’ lack of law firm valuation experience.

The court rejected the rebuttal expert’s opinion for the same reason.

In the end, the trial court adopted the opinion the plaintiff’s expert offered. The court found the appraiser’s high discount rate was justified as part of a fair market value analysis. The expert correctly assumed a public marketplace and considered a hypothetical buyer’s ability to convert the ownership interest to cash and to control the investment. This expert, the court found, was the only expert who identified and weighed the various risk factors that would influence a hypothetical willing buyer who sought to maximize his economic interest. Accordingly, the trial court determined that, under the partnership agreement, the defendant’s interest was worth $590,000.

Improper PTE adjustment. The defendant appealed this and other trial court findings with the state Supreme Court. He argued the trial court erred when it adopted the value conclusion of the plaintiff’s expert, in part because the expert did not assign any value to the $10 million in accounts receivable and failed to account for the firm’s nonoperating assets and real estate investments.

The high court noted that its review not only was de novo, but also was based on the principle that the trier of fact was uniquely qualified to decide how much weight to give the testimony of experts. Assessing the credibility of a witness is the province of the trier of fact, the reviewing court noted.

The state Supreme Court observed that this case featured many experts whose different value conclusions stemmed from the different considerations the experts gave to facts. The reviewing court found nothing in the record supported the valuation approach the defendant proposed. It noted that the defendant’s own expert had called the defendant’s valuation “ridiculous.”

The high court agreed with the trial court that the Eide Bailly valuations were seriously flawed. They did not accord with the required fair market value standard and improperly used a four-year-income period; they also made an adjustment for “passthrough [sic] entity tax status” that was not supported by the U.S. Tax Court. The high court noted the appraisers’ lack of “significant experience in valuating law firms.” And it pointed out that the appraisers’ decisions all had the effect of increasing the valuation.

The high court observed the rebuttal expert also lacked relevant valuation experience and found he used an industry risk premium for companies that had much larger revenues than the subject company. He used a lower company-specific risk premium but had not reviewed the partnership agreement or other financial statements specific to the company. He, too, used an unjustifiable pass-through entity adjustment, and he included $2.5 million of goodwill in the value of the defendant’s interest based on the unjustified assumption that the goodwill was attributable to the partners, as opposed to the enterprise. The goodwill inclusion resulted in an overstatement of $573,000, the high court said. This expert’s value determination was “not accurate,” the Supreme Court concluded.

The high court agreed with the trial court that the plaintiff expert’s valuation was reliable. This expert had extensive relevant experience, which made his version of the facts the most credible. He also used an approach that valued the defendant’s interest “in the context of a market,” the Supreme Court said. He articulated why the income approach was best suited to value this firm, and his discount analysis properly considered the risks to the industry and the firm. He “was able to articulate why law firms should be valued differently from other professional services industries,” the high court said.

In concluding, the Supreme Court also found it was appropriate to write off the $10 million in accounts receivable. The plaintiff’s expert explained why, in all likelihood, they were not collectible. He found the write-off was a correct reflection of the “net realizable value” of the assets. Finally, the defendant’s argument that the trial court failed to apply value to the firm’s other assets was misguided because all the experts, excepting the defendant, had decided the asset approach was not the best way to value the firm, the high court noted.

The state Supreme Court upheld the trial court’s value determination, confirming the defendant’s equity interest in the law firm was worth $590,000.

Federal Circuit Sharpens EMVR Test Applicable to Multicomponent Products

Power Integrations, Inc. v. Fairchild Semiconductor Int’l, Inc., 2018 U.S. App. LEXIS 26842 (July 3, 2018)

In a patent infringement case involving power supply controller chips, the jury awarded the plaintiff almost $140 million in damages based on expert testimony relying on the entire market value rule (EMVR). The Federal Circuit recently struck down the award and, in doing so, elaborated on the showing a patentee must make to justify damages for the entire value of a multicomponent, infringing product that has numerous other valuable features. The test essentially requires the patent holder to prove a negative—a formidable hurdle—which the plaintiff here could not clear.

Litigation history. Both the plaintiff, Power Integrations, and the defendant, Fairchild Semiconductor Corp., produce power supply controller chips that are used in power supplies. The parties have a history of suing each other. In this litigation, Power Integrations alleged Fairchild violated two patents that covered switching regulators and a “power supply controller.” The jury based damages solely on the patent covering switching regulators.

The controller chips are integrated circuits used in power supplies. Switching regulators direct the transistor in the circuit when to turn on and off to send the desired amount of power to the electronic device. The plaintiff’s switching regulator technology addressed problems occurring during low-power periods.

The case first went to trial in early 2014. The jury found infringement of both patents and awarded the plaintiff $105 million in reasonable royalty. The defendant filed a post-trial motion for judgment as a matter of law (JMOL) or a new trial, which the district court denied. However, while the case was still pending, the Federal Circuit (the federal appeals court that hears appeals on patent and certain civil cases) issued a key decision related to the general rule that a patent holder seeking damages for infringement of a multicomponent product must apportion only to the patented feature. Specifically, in its VirnetX decision, the Federal Circuit said that apportioning to the smallest salable unit was not enough to meet the apportionment requirement when the smallest salable unit itself contained noninfringing features. See VirnetX, Inc. v. Cisco Systems, Inc., 767 F.3d 1308 (Fed. Cir. 2014).

Since, in the instant case, Power Integrations had not apportioned to a unit smaller than the smallest salable unit in its royalty calculation, the district court granted a new trial on damages. During the second trial, the court excluded the plaintiff’s expert testimony on apportionment under Daubert. However, the court allowed the expert to show damages under the entire market value rule. The jury then awarded a reasonable royalty of nearly $140 million. The defendant again challenged the verdict in post-trial motions, which the district court again denied.

The defendant appealed the infringement and damages findings with the Federal Circuit. The defendant’s damages argument was that it was improper to use EMVR in this case. The Federal Circuit upheld the infringement finding but agreed with the defendants as to EMVR and damages.

Applicable legal principles. The cornerstone of patent damages is that the patent holder is only entitled to a reasonable royalty capturing the value of the infringing features. The patent holder is reimbursed for the “value of what was taken,” no more. Consequently, a royalty calculation must apportion between the infringing and noninfringing features of the product. See Ericsson, Inc. v. D-Link Sys., Inc. 773 F.3d 1201 (Fed. Cir. 2014). The Federal Circuit has cautioned that, where infringement of a multicomponent product is alleged, the royalty base should not exceed the smallest salable unit that embeds the patented invention. The court also has cautioned against using the value of the entire product, noting that doing so tends to “skew the damages horizon for the jury, regardless of the contribution of the patented component to this revenue.” See Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292 (Fed. Cir. 2011), and LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51 (Fed. Cir. 2012).

The entire market value rule represents an exception to the general rule of apportionment. The overarching goal is to ensure that a reasonable royalty does not compensate for components that the patent does not cover.

EMVR allows the patent holder to obtain damages based on the value of the entire multifeature apparatus if the patent holder can show the patented feature forms the basis for consumer demand. See Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301 (Fed. Cir. 2009). Put differently, the patent holder must “establish that its patented technology drove demand for the entire product.” See VirnetX. In reviewing case law, the Federal Circuit noted that EMVR may be appropriate in circumstances where the other, nonpatented features are “simply generic and/or conventional and hence of little distinguishing character.”

Other valuable features in play. The Federal Circuit noted that, in the instant case, Power Integrations based its royalty rate on one patent’s frequency reduction feature. The plaintiff argued this feature drove consumer demand for the defendant’s controller chips as many consumers considered this particular feature essential because it allowed the products that contained the feature to meet the federal government’s Energy Star program. The plaintiff also showed that some customers asked for this feature, that products that had the feature sold better than other products, and that marketing material promoted the feature.

At the same time, the parties agreed that the infringing products contained other valuable features. The plaintiff did not offer evidence as to the impact of those other features on the value of the products, the Federal Circuit observed. In its post-trial motion, the defendant claimed the plaintiff did not present enough evidence to support the use of EMVR. The district court, citing a string of cases that preceded the Federal Circuit’s LaserDynamics decision, said the plaintiff here offered sufficient evidence based on the earlier cases.

In its review, the Federal Circuit pointed out that none of the pre-LaserDynamics cases “discussed other valuable features that made the application of the entire market value rule inappropriate.” Instead, the earlier cases “merely considered whether a patented feature formed the basis for consumer demand.” However, LaserDynamics and subsequent cases only allow EMVR if the patented feature is “the sole driver of customer demand or substantially creates the value of the component parts,” the Federal Circuit explained.

The test, according to the Federal Circuit, is: “Where the accused infringer presents evidence that its accused product has other valuable features beyond the patented feature, the patent holder must establish that these features do not cause consumers to purchase the product.” It is not enough to show the patented feature is essential, that the product would not be commercially successful without the patented feature, or that consumers would not buy the product without the patented feature, the Federal Circuit explained.

The plaintiff here was not able to pass the test because the evidence showed other features in the power supply controllers were important. In fact, the plaintiff sought damages related to one such other feature (a jittering element) in a separate litigation, the Federal Circuit noted. The court observed that the defendant’s marketing materials highlighted the jittering feature, as well as several other features. “There is no proof that these features … did not affect consumer demand,” the court said. Failing to offer this evidence, the plaintiff did not prove that the patented feature was the sole driver of consumer demand, “i.e., that it alone motivated consumers to buy the accused products,” the Federal Circuit concluded.

The court set aside the jury award and sent the case back to the district court for a new trial on damages.

Expert’s Inability to Defend Income Analysis ‘Is Decidedly Troubling,’ Court Says

Judges are alert to incongruities in valuations, as is clear from a recent condemnation case in which landowners hired three experts to calculate the compensation owed to them. The court excluded all experts under Daubert, and it had particularly harsh words for the valuation expert who was unable to support critical elements of the valuation. The income analysis lacked “any indicia of reliability” and the capitalization rate determination was “entirely suspect,” the court said.

A pipeline reached agreements with most landowners whose property was affected by the construction. However, the company litigated the compensation issue with a couple of property owners who operated a Christmas tree farm on some of the condemned land. They argued the construction altered the soil composition and growing conditions, making it impossible, going forward, to grow the “highly coveted Fraser fir tree.” Also, the construction forced the owners to prematurely harvest their Christmas trees, which resulted in a substantial loss.

The correct measure of damages was the difference between the property’s fair market value immediately before and after the taking, plus any incidental damages to the remaining property. Further, the court declined to exclude, as a matter of law, evidence of lost profits.

However, the court found the loss analysis the landowners’ BV expert offered was fatally flawed. Assuming no trees would ever grow on the property again, she valued the business under the asset, market, and income approaches. The first two analyses resulted in a loss to the landowners of $167,000 and $157,000, respectively. The income approach, which the expert said best captured the loss, increased the amount to $888,000.

Using the build-up method to determine the capitalization rate, the expert relied on Duff & Phelps (D&P) figures for her risk-free rate of return and equity risk premium. But she rejected D&P’s 5.9% small stock risk premium, using a 1% rate instead. The court noted the effect on the loss calculation was dramatic, where using a 5.9% rate would have reduced the expert’s proposed $888,000 loss to about $339,000, leaving all the other inputs the same. The expert failed to explain “why she used the ‘generally accepted’ Duff & Phelps numbers when they raised her valuation but ignored the guide’s suggested number when it lowered her valuation,” the court said. It also questioned other inputs. Even though experts in disciplines requiring the use of professional judgment are generally less likely to be excluded, they are not immune, the court cautioned. Professional judgment alone, without a demonstrated basis in facts or data, is insufficient to support opinion testimony,” the court said. It deemed the expert’s opinion inadmissible.

Underdeveloped Comparability Analysis Means Exclusion of Reasonable Royalty Opinion

Meridian Mfg. v. C&B Mfg., 2018 U.S. Dist. LEXIS 172243 (Oct. 5, 2018)

This patent infringement case in which both parties raised Daubert challenges to the opposing expert’s damages opinions provides a recap of key legal principles informing reasonable royalty and lost profits calculations. Among the contested issues was how an expert may use noninfringing alternatives when developing a hypothetical negotiation and what an expert, relying on prior licenses, must do to establish comparability to the patented technology. The court here, as well as in other cases, makes it clear that an expert’s “superficial recitation of the Georgia-Pacific facts, followed by conclusory remarks” does not make the testimony admissible.

Background. The plaintiff was the owner of a patent for an agricultural trailer that helps farmers transport large boxes of seeds to planters in the fields. The trailer features guide plates that facilitate centering the box on a wheeled bed. The guide plates are a special feature. The defendant, a manufacturer of consumer and industrial products, sold a seed tender that the plaintiff claimed violated its patent. After the plaintiff sent a cease and desist letter, the defendant continued selling its trailers. However, following a hearing in late 2015, the court found the defendant’s seed tender infringed a specific claim of the plaintiff’s patent and the defendant began to redesign its seed tender. The parties continued to disagree over whether the redesign solved the infringement.

Both sides filed pretrial motions, including motions to exclude damages expert testimony under Rule 702 of the federal rules of evidence and Daubert.

Defense expert admissible. The defendant’s expert was an experienced CPA and certified financial forensic analyst who provided a reasonable royalty analysis and a lost profits analysis.

The expert stated that the defendant had advised her that the contested seed tender had a number of features and that the guide plates were a key feature. The expert therefore identified the latter as the “patentable feature,” and, since this feature was only a portion of the tender, she found that apportionment between the guide plates and the tender’s other features was necessary. The expert also determined that she lacked the information she would need for an apportionment analysis. Based on information from the defendant, the expert understood the redesigned seed trailer received a good response from dealers and customers because it was sturdier and less expensive to produce. Considering the difficulty of apportioning, the expert therefore proposed that a reasonable royalty in this case should be based on the production cost differences between the infringing design and the redesign. Put differently, “a reasonable royalty would not be more than the cost to [the defendant] to develop and implement an alternative, non-infringing design,” the expert said. She proposed a lump-sum royalty of $15,000 to $30,000.

The plaintiff argued the expert’s testimony was inadmissible. The expert lacked the qualifications to comment on technical matters, specifically to testify about a “patentable feature,” the plaintiff said. The court quickly dismissed this objection, noting the expert would be able to explain how a particular feature informed her damages analysis.

The plaintiff also claimed the expert used an unreliable methodology in that she tried to limit reasonable royalty damages to the cost of developing a redesigned seed trailer and in that she considered the defendant’s redesigned trailer to be an acceptable noninfringing alternative.

The court first explained the various ways for calculating a reasonable royalty. An expert might rely on an established royalty, the infringer’s profit projections for infringing sales, or develop a hypothetical negotiation between the patentee and infringer. The Federal Circuit has found that there is no law that requires reasonable royalty rates be based on the cost of implementing an available noninfringing alternative. At the same time, the Federal Circuit also has held that, practically, the difference between the infringing product or technology and the noninfringing alternative placed a limit on the reasonable royalty rate because in a hypothetical negotiation the infringer would not have paid more than that difference.

The court in the instant case said that the defendant’s expert did not put an “automatic cap” on damages based on the cost of redesigning the seed trailer. Rather, the expert concluded that, under the specific facts and circumstances, a reasonable royalty would not be higher than the cost of the redesign. This conclusion was admissible, the court found.

The plaintiff’s objection to the defense expert’s use of the redesigned seed tender as an acceptable noninfringing alternative for purposes of her lost-profits analysis focused on whether the redesigned product was “available” at the time of the infringement.

The court explained that, under the law, lost profits are not available to the patent holder if acceptable noninfringing alternatives were available at infringement. “Available,” the court noted, does not necessarily mean the alternative product had to be on the market. Rather, it could be considered “available” if the infringer could have produced an alternative “and would have known it would be acceptable to consumers at the time of the infringement.” Whether an alternative product was “acceptable” is a question for the jury to decide, the court noted.

Here, the defendant’s expert understood from statements by the defendant that dealers and customers were reacting positively to the redesigned trailer and that it would have been possible to develop and build the redesign earlier. “If the necessary equipment, know-how and experience were available at the time of infringement, a substitution may be considered an acceptable, available alternative even if it was not on the market,” the court said. It found that the defense expert’s characterization of the redesigned product was admissible.

The court concluded that all the objections the plaintiff raised regarding the defense expert testimony were appropriate subjects for cross-examination. But they did not require exclusion of the testimony.

Plaintiff’s expert partly admissible. The plaintiff’s expert performed a reasonable royalty calculation that produced a range of reasonable royalty rates, from 3% to 10% of sales. The analysis was based on the Georgia-Pacific factors and particularly on the second factor that considers rates the licensee paid for use of other patents comparable to the patent in suit. The expert explained that he “examined market rates for similar royalties paid in the industry,” using the RoyaltySource database to search for rates “in the machinery, agricultural, forestry and fishing industries.” He acknowledged there were limitations regarding the data but did not explain what the limitations were or how they affected the rates he chose for his analysis. Ultimately, the expert chose six licenses and developed a chart in which he briefly described the licensed technology, but he did not explain how these technologies related to the patented technology. He said he chose the six licenses based on his judgment.

In addition, the plaintiff’s expert mentioned other Georgia-Pacific factors, describing what these factors focused on. But he did not specifically tie the factors to the facts of the case. “Based upon the factors previously noted, I have identified four potential reasonable royalty rate data points,” the expert concluded.

The court found this expert opinion was inadmissible because the expert failed to provide sufficient support for his conclusions. Under case law, prior licenses that do not mention the patent in suit or that “show[] no other discernible link to the claimed technology” are not comparable, the court noted. Further, while those other licenses may cover more patents that the contested patent(s) and include additional terms or cover foreign property rights, the expert drawing on the licenses must account for any distinguishing facts. The court must consider to what extent the expert testimony might “skew unfairly the jury’s ability to apportion the damages to account only for the value attributable to the infringing features.” See Ericsson, Inc. v. D-Link Sys., Inc., 773 F.3d 1201 (Fed. Cir. 2014).

The court noted that here the expert did not show how the six licenses he claimed were comparables were in fact similar to the patented technology or how they differed and how the differences affected a hypothetical license negotiation in this case. Citing prior case law, the court said “alleging a loose or vague comparability between different technologies or licenses does not suffice.” See LaserDynamics, Inc. v. Quanta Comput., Inc., 694 F.3d 51 (Fed. Cir. 2012).

Regarding the expert’s treatment of the other Georgia-Pacific factors, the court said the expert failed to “complete the crucial step of explaining how those factors would influence the parties in a hypothetical negotiation to reach agreement as to his proposed reasonable royalty rates.”

For these reasons alone, the court found the plaintiff’s expert opinion on reasonable royalty was inadmissible.

All was not lost for the plaintiff, however, because the expert also performed a lost profits analysis based on a market share analysis that was sufficiently reliable to be admissible.

Relying on the industry analysis by the Line of Sight Group (LOSG), internal plaintiff and defense statements, and other studies and documentation, the expert assumed the plaintiff would have made about 24% to 44% of the defendant’s sales but for the defendant’s infringement. This translated into about $2.4 million in lost profits, the expert concluded. The combination of reasonable royalty and lost profits damages amounted to total damages in a range of $3.7 million to $5.7 million, the plaintiff’s expert asserted.

The defendant argued that the expert’s lost profits opinion was unreliable because there were available and acceptable noninfringing alternatives. Moreover, the market share analysis was unreliable primarily because the expert “blindly relied” on a third-party analysis and plaintiff information. He failed to perform an independent analysis, the defendant claimed. Also, the profit margins he assumed were unreliable because they included profit margins for other products and certain margin changes.

The plaintiff countered that the market share analysis was permissible under the law and the third-party analysis was the best available evidence. This was the kind of analysis experts in the relevant field typically rely on, the plaintiff said.

The court explained that one of the elements a patent holder claiming lost profits must satisfy is that there are no acceptable, noninfringing alternatives to the patented technology. If there are such alternatives, a patent holder may show this element by proving, with reasonable probability, that the patent holder would have made sales the infringer made but for the infringement.

The court noted that experts routinely rely on the opinions of other experts the retaining party hired. Here, the expert explained what sources he used and said he had discussions with the plaintiff’s management; he also relied on “public information about the industry.” The court said the expert appeared to have done his own financial analysis of the plaintiff and the defendant. The expert’s opinions on market share and lost profits were not so “fundamentally unsupported” that they had to be excluded. Moreover, the court found that the expert’s decision to apply a historical average profit to the hypothetical sales absent infringement, instead of the actual profit margin for sales alleged to be affected by the infringement, did not make his opinion so unreliable as to be inadmissible. All of these objections can be explored on cross-examination, the court decided.

In conclusion, the court excluded the plaintiff expert’s reasonable royalty determination but admitted his lost profits analysis. The court admitted the defense expert’s reasonable royalty and lost profits analyses.

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