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Calculating Damages of Early Stage Intellectual Property Infringement

April 18, 2013

William F. Murray, CPA/ABV, CFF, ASA
Senior Manager 

As technology advances and its usage becomes even more widespread, intellectual property law and the related litigation becomes more relevant. Intellectual property is generally categorized and protected as follows:

  1. Copyrights (protected under the Copyright Act),
  2. Trademarks (protected under the Lanham [Trademark] Act,
  3. Patents (protected under the Patent Act)
  4. Trade secrets (protected under state law through the adoption of the Uniform Trade Secrets Act). 1

Damages for the infringement of intellectual property rights are typically measured based on lost profits “which the plaintiff would have earned but for the infringement.”2  Measurement of these damages is commonly estimated by the use of a reasonable royalty.  However, it is not always possible to measure the value of early stage intellectual property, specifically for a product that has yet to produce revenue.

An alternative is the cost approach, which measures damages by the amount of research and development (R & D) that was historically expended to create the intellectual property. The courts have generally precluded the use of the cost approach with respect to damages involving established technology.  In Applied Hydrogel Tech., Inc. v. Raymedica, Inc.,the court rejectedthe measurement of damages based on the cost approach, noting that “such costs do not bear a necessary relation to the market value of the research once developed.” However, in cases involving the theft or disparagement of early stage intellectual property such as trade secrets, the courts have relied on the cost approach.

One of the most notable cases related to early stage intellectual property is Telex Corp. v. Int’l. Bus. Mach. Corp.4  This case involved International Business Machines (IBM) employees that left the company to join Texel Corp midway through a development project.  IBM claimed that these employees, upon leaving IBM, provided Telex Corp. with certain trade secrets that enabled it to bring its product to market in a significantly shorter time frame.  The court awarded damages that were, in part, calculated using the cost approach.

In a more recent case, W.L. Gore & Associates, Inc. v. GI Dynamics, Inc.5 (May 2012), GI Dynamics, Inc. (GID) developed a medical implant device. Medical devices have a significantly longer development cycle compared to many other technologies. These devices are subject to a series of clinical trials and ultimate approval by the Food and Drug Administration. GID engaged in trade discussions with W.L. Gore & Associates, Inc. (Gore) that ultimately became discussions about the potential acquisition of GID.

During these discussions, GID disclosed certain trade secrets and clinical trial data to Gore, which GID alleges Gore used to develop its own product. Gore filed a motion for summary judgment to deny damages calculated, in part, under the cost approach. The court rejected the portion of Gore’s motion related to damages, noting that GID’s R&D costs could serve as a “basis of a recognizable trade secrets claim.”6

Elements of Cost to Consider in Calculating Damages

There are a number of elements of cost that relate to the development of intellectual property. Each element should be evaluated in the calculation of any damages:

  • Labor – costs or expenditures related to employees (salary and wages), contractors and consultants that were directly related to the development efforts.
     
  • Materials – costs or expenditures related to the tangible elements, such as prototypes, software, components, etc.
     
  • Overhead – costs or expenditures related to the support and supervision of the development team, such as management and supervisory personnel, payroll taxes, fringe benefits, support and secretarial staff, utilities, equipment rentals and operating expenses.
     
  • Legal costs – costs or expenditures related to register or otherwise obtain legal protection for the intellectual property.

It is important to fully document each cost and show how it relates to the development of the intellectual property asset.

William F. Murray, CPA/ABV, CFF, ASA is a senior manager with BlumShapiro’s Litigation Services and Business Valuation Group.  BlumShapiro is the largest regional accounting, tax and business consulting firm based in New England, with offices in Connecticut, Massachusetts and Rhode Island.  The firm, with 340 professionals and staff, offers a diversity of services which includes auditing, accounting, tax and business advisory services.  In addition, BlumShapiro provides a variety of specialized consulting services such as succession and estate planning, business technology services, employee benefit plans, litigation support and valuation and financial staffing.  The firm serves a wide range of privately held companies, government and non-profit organizations and provides non-audit services for publicly traded companies.

1 Four states have not adopted the Uniform Trade Secrets Act

2 Lindy Pen Co., Inc. v. Bic Pen Corp., 982 F.2d 1400, 1407

3 Applied Hydrogel Tech., Inc. v. Raymedica, Inc., CV-06-2254, 2008 WL 5500756

4 Telex Corp. v. Int’l. Bus. Mach. Corp., 510 F.2d 894, 931 (10th Cir. 1975)

5 W.L. Gore & Associates, Inc. v. GI Dynamics, Inc., 2012 U.S. Dist. LEXIS 75055

6 W.L. Gore & Associates, Inc. v. GI Dynamics, Inc., 2012 U.S. Dist. LEXIS 75055


 

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