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Reasonable Royalties and Non-Infringing Alternatives

In an oil and gas patent proceeding, the court ordered a 27% royalty rate for sales made prior to the grant of the patent at issue and did not consider a manual process as being a non-infringing alternative. In a recently issued decision, Frac Shack Inc. v. AFD Petroleum Ltd., 2017 FC 104, the defendant was found to infringe several of the claims in a patent relating to a fuel delivery system used for hot refueling of equipment used for hydraulic fracturing.

If a patent is found to be infringed, the patentee, or person claiming under the patentee is entitled to ‘reasonable compensation’ for activity happening after the patent application was published that would have constituted infringement if it occurred after the patent granted – see Section 55(2) of the Patent Act. Patent applications are generally published by the Canadian Patent Office eighteen months after the patent application is filed.

There are surprisingly few cases that consider the scope of reasonable compensation available under this section but it is generally considered to be a reasonable royalty. The reasonable royalty is determined from what a willing licensor and a willing licensee would have arrived at through negotiations held at the eve of infringement.

In Frac Shack, expert evidence was introduced by both parties as to several factors that may influence a royalty rate. The factors considered, arising from previous decision of the Federal Court, are: presence of competing products in the market; advantages of the patented product over competing products; advantages of the infringing product over the patented product; market position of the patentee; market position of the infringer; market share of the patentee before and after the infringing product entered the market; size of the market before and after the infringing product entered the market; and capacity of the patentee to produce additional products.

The plaintiff’s expert, according the reported decision at paragraph 318, stated that “for patented technology, a commonly considered royalty range is 25% to 33.3%, regardless of the technology at issue.” Noting that the parties were in direct competition, and the high capital cost of the fueling system, the plaintiff’s expert estimated a royalty rate of 29%. The trial judge favoured this evidence and awarded a reasonable royalty at 29%. The defendant’s expert had estimated a 10% royalty rate, including based on the availability of a manual refueling system.

Relying on a ‘rule of thumb’ for royalty rates for patented products was criticized in a 2013 decision of Justice Phelan, where he discussed the “25 percent rule of thumb”. Justice Phelan noted that the United States Court of Appeal for the Federal Circuit had “destroyed this 25% rule” when it had stated “This court now holds as a matter of Federal Circuit law that the 25 percent rule of thumb is a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation.” Justice Phelan concluded it was a “fundamental and overriding flaw in the Defendants’ experts’ opinion” to use the 25 percent rule as a basis for determining a reasonable royalty.

For the financial remedies after the grant of the patent, the judge permitted the plaintiff to elect the defendant’s profits. A significant issue was whether the availability of a non-infringing alternative, namely a manual re-fueling process, ought to be considered.

The defendant’s argument was that it would have made almost as much profit manually re-fueling than using its automated re-fueling system. Therefore the profits causally attributed to the infringement should only be the difference in profit attributable to the use of the invention and the profits that would have been obtained had it used the non-infringing manual system. There was evidence that some companies still found manual re-fueling to be an acceptable method and “that there was no one correct way for fracturing companies to perform a risk matrix and that companies may assess risks differently” when deciding whether to use manual refueling. The court found that the manual process, being more dangerous to the operators, was not to be considered a non-infringing alternative. Since there was no non-infringing alternative, the entirety of the defendant’s profits made from the infringing acts was awarded to the plaintiff.

Since the Supreme Court of Canada’s 2004 decision in Schmeiser, the Federal Court and Federal Court of Appeal have considered a number of cases on the consideration to be given to non-infringing alternatives when assessing the plaintiff’s damages or the defendant’s profits. These cases, primarily arising in pharmaceutical cases, have firmly established non-infringing alternatives as relevant for both assessing the plaintiff’s damages and the defendant’s profits. This decision is another example of the importance of non-infringing alternatives to the calculating of the remedies even though the court in this case did not consider manual re-fueling to be a suitable alternative. The decision also considered and denied the plaintiff’s claim for punitive damages.

With few decisions on monetary remedies in patent cases, it is welcome to have this decision on the scope of reasonable royalty and non-infringing alternatives. The decision is under appeal so we may soon receive the Federal Court of Appeal’s views on the issues in this case.

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