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i4i v. Microsoft: Economic Issues Raised in the Federal Circuit's Permanent Injunction Decision

The Federal Circuit’s recent decision in i4i Limited Partnership et al. v. Microsoft Corporation has received attention for, among other things, its affirmation of the total damages award of $240 million and the district court’s issuance of a permanent injunction in a patent infringement case.1 That injunction prevents Microsoft Corporation (“Microsoft”) from selling accused versions of its Microsoft Word software five months after the issuance of the district court’s order. In affirming that injunction, the Federal Circuit discussed the four eBay factors used in deciding whether or not to grant a permanent injunction. This article presents the Federal Circuit’s opinion on those factors and highlights economic aspects of its opinion. In particular, a detailed economic market analysis can be relevant not only for determining potential lost profit and/or reasonable royalty damages, but also for evaluating factors relevant in issuing a permanent injunction.

Case Background

i4i Limited Partnership (“i4i”) is a Canadian software company. It is the assignee of U.S. Patent No. 5,787,449 (“‘449 patent”), which issued July 28, 1998 and covers a “system and method for the separate manipulation of the architecture and content of a document, particularly for data representation and transformations.”2 i4i commercialized software products that practice the ‘449 patent, including an “‘add-on’ software for Microsoft Word, which expands Word’s capability to work with documents containing custom XML” – which is a markup language that tells “the computer how text should be processed by inserting ‘tags’ around text.”3

Microsoft has sold versions of Microsoft Word with XML editing capabilities since 2003. i4i sued Microsoft for patent infringement asserting that the custom XML editor in its Microsoft Word software infringed its ‘449 patent. This case was heard before Judge Leonard Davis of the Eastern District of Texas. On May 20, 2009, the jury found that the ‘449 patent was valid and willfully infringed by Microsoft, and awarded $200 million in reasonable royalty damages.

On August 11, 2009, the district court subsequently awarded $40 million in enhanced damages, $37.1 million in pre-judgment interest, and granted i4i’s motion for a permanent injunction.4 This injunction prohibited Microsoft from selling the infringing Microsoft Word products, including Microsoft Word 2003 and 2007. But, it did not affect users who bought or licensed those products before the injunction would become effective.

Microsoft Appeal

In its appeal, Microsoft challenged the reasonable royalty damages of $200 million on several grounds, including the admission of the testimony of i4i’s damages expert. That expert opined that the reasonable royalty rate was $98 for the ‘449 patent. The Court noted that “We have consistently upheld experts’ use of a hypothetical negotiation and Georgia-Pacific factors for estimating a reasonable royalty.”5 Moreover, Microsoft’s disagreements are with the expert’s “conclusions, not his methodology” and “go to the weight, not admissibility, of his opinion.”6 And, in this regard, the Court noted that the expert’s opinion was “based on sufficient facts or data” and concluded that the district court did “not abuse its discretion in admitting” his testimony.

Microsoft also urged the Court to follow its “recent decision in Lucent, 580 F.3d 1301, and hold that $200 million is not a reasonable royalty.”7 But the Court noted that it could not do that “because Microsoft did not file a pre-verdict JMOL on damages.” Interestingly, it did state that “Given the opportunity to review the sufficiency of the evidence, we could have considered whether the $200 million damages award was ‘grossly excessive or monstrous’ in light of Word’s retail price and the licensing fees Microsoft paid for other patents.”8 Microsoft had argued that the $98 royalty rate calculated by i4i’s damages expert was “exorbitant given the price of certain Word products, which could be as little as $97” and the “$1-$5 million that Microsoft had paid to license other patents.”9

Permanent Injunction

The Court reviewed the decision to grant a permanent injunction as well as the terms of that injunction. It began by noting that the “injunction is narrow” and “applies only to users who purchase or license Word after the date the injunction takes effect. Users who purchase or license Word before the injunction’s effective date may continue using Word’s custom XML editor, and receiving technical support.”10 It then reviewed the district court’s conclusion as to each of the eBay factors considered in deciding whether or not to grant a permanent injunction: 1) the plaintiff has suffered an irreparable injury; 2) remedies available at law are inadequate to compensate for that injury; 3) considering the balancing of the hardships between the plaintiff and defendant, a remedy in equity is warranted; and 4) the public interest would not be disserved by a permanent injunction.11

(1) Irreparable Injury

The district court “concluded that i4i was irreparably injured by Microsoft’s infringement” and the Court noted that “it was proper for the district court to consider evidence of past harm to i4i.”12 The Court noted that “Although injunctions are tools for prospective relief designed to alleviate future harm, by its terms the first eBay factor looks, in part at what has already occurred” and “Past harm to a patentee’s market share, revenues, and brand recognition is relevant for determining whether the patentee ‘has suffered an irreparable injury.’”

Thus, the “district court properly considered strong circumstantial evidence that Microsoft’s infringement” had (1) caused i4i to lose market share, (2) made its product “obsolete for much of the custom XML market” and (3) forced i4i to change its “business strategy to survive.” Moreover, the Court stated that “i4i was not required to prove that its specific customers stopped using i4i’s products because they switched to the infringing Word products.”

(2) Inadequate Remedies at Law

The Court concluded that it was not “an abuse of discretion for the district court to conclude that monetary damages would be inadequate.”13 The Court noted that i4i had not licensed the ‘449 patent but instead had sought to retain exclusive use of it and was, in fact, practicing it. And, Microsoft’s infringement – as discussed above – had caused i4i, a “small company,” “a loss of market share, brand recognition, and customer goodwill.” Moreover, “Such losses may frequently defy attempts at valuation, particularly when the infringing acts significantly change the relevant market, as occurred here,” where “Microsoft captured 80% of the custom XML market with its infringing Word products, forcing i4i to change its business strategy.”

The Court concluded that “The loss associated with these effects is particularly difficult to quantify” and “Difficulty in estimating monetary damages is evidence that remedies at law are inadequate.”

(3) Balance of Hardships

The Court concluded that “Except on the limited issue of timing” of the injunction, the “balance of hardships favors i4i.”14 It noted that “the district court properly considered several factors in its analysis,” including the “parties’ sizes, products, and revenue sources.”

And, here there was a substantial difference in the significance of the patented technology to each party. It was “central to i4i’s business” with most of its products “based on the ‘449 patent” and, as a result, “i4i’s market share, revenues and business strategy are similarly tied to the patented method.” In contrast, the infringing custom XML editor “relates to only a small fraction of Microsoft’s sizeable business” and was “found to be ‘merely one of thousands of features’ within Word, used by only a small fraction of Microsoft’s customers.”

The Court further noted that the “district court’s analysis properly ignored the expenses Microsoft incurred in creating the infringing products,” i.e., “sunk development costs.” In addition, the costs to Microsoft of “redesigning the infringing products” are also irrelevant. In short, “Microsoft is not entitled to continue infringing simply because it successfully exploited its infringement.”

(4) Public Interest

The Court concluded that “the district court did not abuse its discretion in finding that the narrow scope of the injunction and the public’s general interest in upholding patent rights favor injunctive relief.”15 It noted that “the touchstone of the public interest factor is whether an injunction, both in scope and effect, strikes a workable balance between protecting the patentee’s rights and protecting the public from the injunction’s adverse effects.” That was the case here as the injunction excludes users who purchased or licensed infringing Word products before the injunction’s effective date and thus “minimizes disruptions to the market and the public.”

In evaluating adverse effects, the Court indicated that “relevant ‘public’ includes not only individual consumers, but also companies that license the infringing Word products and manufacturers that are part of Microsoft’s distribution channels.”

Conclusion

Overall, the Court affirmed the district court’s issuance of the permanent injunction.16 The Court did, however, change the effective date of the injunction from 60 days to five months after the district court order.17 Several economic aspects of the Court’s decision should be noted.

First, the Court considered different dimensions of past harm (e.g., lost market share and lost brand recognition) in evaluating i4i’s irreparable injury. These issues can be addressed through a detailed economic market analysis of the accused products and their possible impact on the plaintiff’s business. An economic market analysis can thus be relevant not only for the initial determination of lost profit and/or reasonable royalty damages, but also for the subsequent evaluation of the eBay factors relevant in granting a permanent injunction.

Second, the Court noted that it may be difficult to calculate damages when there is a loss of market share, brand recognition and customer goodwill, especially when the infringing acts “significantly change the relevant market.” This situation may arise more frequently in high technology markets where new products and technologies may be introduced more frequently and market boundaries may be changing.

Third, when evaluating the public interest, the Court noted that the “public” includes not only customers but also licensees and manufacturers in Microsoft’s distribution channels. Many products today are made and distributed through international supply chains and the impact of an injunction can affect many companies in that supply chain. The nature and extent of these international supply chains can be addressed as part of a detailed economic market analysis of the relevant products.

 

1 i4i Limited Partnership et al. v. Microsoft Corporation, No. 2009-1504 (Fed. Cir. Dec. 22, 2009) (“Slip Opinion”). On January 8, 2010, Microsoft filed a “Combined Petition for Panel Rehearing and Rehearing En Banc” with the Federal Circuit (“Microsoft Rehearing Petition”). On March 10, 2010, the Federal Circuit issued a revised opinion, which did not change its original opinion on the amount of damages and the issuance of a permanent injunction (i4i Limited Partnership et al. v. Microsoft Corporation, No. 2009-1504 (Fed. Cir. Mar. 10, 2010)).

2 U.S. Patent No. 5,787,449.

3 Slip Opinion, p. 3.

4 This discussion is based on Judge Davis’ “Final Judgment” and “Permanent Injunction” orders dated August 11, 2009. i4i was also awarded post-verdict damages of $144,060 per day.

5 Slip Opinion, p. 31.

6 Slip Opinion, p. 31.

7 Slip Opinion, p. 36.

8 When discussing the eBay factors, the Court did note that the infringing XML editor was only one of thousands of Word features and was “used by only a small fraction of Microsoft’s customers” (Slip Opinion, pp. 37, 45).

9 Slip Opinion, p. 28.

10 Slip Opinion, p. 42.

11 eBay v. MercExchange L.L.C., 547 U.S. 388, 391 (2006). A recent statistical analysis of district court patent cases since the May 2006 eBay decision found that permanent injunctions were granted in approximately 72 percent of those cases (Ernest Grumbles III, Rachel C. Hughey and Susan Perera, “The Three Year Anniversary of eBay v. MercExchange: A Statistical Analysis of Permanent Injunctions,” Intellectual Property Today, November 2009, pp. 25-9).

12 The discussion below in this section is based on Slip Opinion, pp. 43-4.

13 The discussion below in this section is based on Slip Opinion, p. 44.

14 The discussion below in this section is based on Slip Opinion, pp. 45-6.

15 The discussion below in this section is based on Slip Opinion, p. 46.

16 Its decision is thus consistent with the limited post-eBay empirical evidence indicating that the Federal Circuit affirms district court permanent injunction decisions the majority of the time (Ernest Grumbles III, Rachel C. Hughey and Susan Perera, “The Three Year Anniversary of eBay v. MercExchange: A Statistical Analysis of Permanent Injunctions,” Intellectual Property Today, November 2009, pp. 25-9).

17 The new effective date thus became January 11, 2010. On the same day as the Federal Circuit’s opinion, Microsoft announced that it had “been preparing for this possibility since the District Court issued its injunction in August 2009” and “we expect to have copies of Microsoft Word 2007 and Office 2007, with this feature removed, available for U.S. sale and distribution by the injunction date” (“Microsoft Statement Regarding the United States Court of Appeals for the Federal Circuit Ruling in the i4i Case,” Microsoft News Center, December 22, 2009).