In certain types of intellectual property (IP) litigation, plaintiffs are entitled to recover (in addition to or in place of their own lost profits) damages based on the profits the defendant enjoyed as a result of its infringement. Generally, this measure of damages is available in cases involving nonpatent IP (such as copyrights, trademarks and trade secrets), as well as certain design patents.
The theory behind awarding an IP owner the infringer’s profits is straightforward: 1) It prevents the defendant from being unjustly enriched by its wrongful act, 2) it deters infringement by making it unprofitable, and 3) it ensures that the plaintiff is fully compensated even if its own lost profits are difficult or impossible to prove. Estimating these damages, however, can be a challenge.
Apportioning sales
The IP owner has the burden of proving the defendant’s gross sales of infringing products. Then the burden shifts to the defendant to prove, if possible, that a portion of its sales were attributable to factors other than the infringement.
For example, an infringer may have the ability to generate greater sales than the plaintiff as a result of a stronger sales force, superior distribution channels or better pricing. In addition, the quality of the infringing product may be enhanced by features supplied by the defendant.
Apportioning sales among infringing and noninfringing activities can be difficult. In some cases, the impact of infringement on sales is more readily quantified.
Suppose, for instance, that an IP owner sues a company for infringing its trademark in print ads. If the defendant uses the infringed trademark in 25% of its ads (assuming that all of the ads are similar in terms of location and readership), then one might argue that 25% of the defendant’s sales resulting from the ads are attributable to the infringement. On the other hand, the IP owner may argue that the infringing content’s impact on sales was disproportionate to its frequency of use.
Often, the impact of infringement on sales is more qualitative. Say a defendant publishes a compilation of 30 short stories that contains one story published without the copyright owner’s permission. One story may be a small component of the overall work but, if it was written by a prominent author and the other stories are by lesser known authors, the infringing work may be the predominant factor driving the defendant’s sales.
Financial experts can use a variety of techniques to quantify apportionment of sales, including market surveys; analyses of the defendant’s revenues and profits before and after the infringement; and comparisons of infringing sales with the defendant’s sales of similar, noninfringing products.
Allocating costs
The defendant also bears the burden of proving which costs should be deducted from infringing sales to arrive at lost profits. Unfortunately, IP law doesn’t explicitly define lost profits, and costs are treated differently from court to court.
Some courts allocate a percentage of a defendant’s total costs (both fixed and variable) to infringing sales. The percentage is typically based on a ratio, such as total costs to total sales. Other courts apply an incremental approach — that is, they permit the defendant to deduct only the increased cost that’s directly attributable to production of the infringing product.
The distinction is critical because the incremental approach produces significantly larger damages awards. Some courts reserve the incremental approach for cases of willful infringement.
Gaining an advantage
Whether you represent a plaintiff seeking to recover an infringer’s profits or a defendant trying to minimize its exposure, it’s to your advantage to involve a financial expert in the case as early as possible. In addition to evaluating damages issues, an expert can help you draft discovery requests designed to elicit financial records and other evidence that supports your damages calculation.
