Case Study

Case study: Two ways to valuate intellectual property damages

Feb 11, 2018
Financial consulting

Intellectual property litigation can arise when the intellectual property (IP) is allegedly infringed upon. This litigation can involve complex valuations due to the difficulty of estimating the profit that would have been earned.

The following is a fictional case study of an infringed patent. The study illustrates two options for plaintiffs, profit loss and accounting of profits, and the implications thereof, as seen by the authors in various past cases.

Chemical engineer and avid cross-country skier, Petra, has always been interested in combining her two greatest interests. This culminated into a ski wax formula that she developed that had excellent kinetic and static friction characteristics. This wax improved skiing speed for all levels of skiers.

Petra patented her invention and arranged to have the wax manufactured overseas and distributed throughout Canada via her newly founded company, Petra Winter Sports Ltd. (P Ltd.).

P Ltd. was enjoying its success for many years, until De Facto Monopoly Co. (D Co.) started to distribute an identical product at a lower price. D Co. is known for aggressively entering markets and pushing out smaller competitors. D Co. has been selling the allegedly infringing product since early 2017 and P Ltd. has noticed a significant decline in profit.

While P Ltd. will certainly seek an injunction against D Co., Petra is also curious what her damages might be.

Petra’s accounting expert has put together an estimate of their profit loss. Beginning with P Ltd.’s sales volume, they estimate that revenue of $400,000 was lost during 2017. Since P Ltd. did not incur the direct costs to produce, ship and sell these products, these costs must be deducted to arrive at an estimate that $150,000 of profit was lost.

After further inquiry, it was discovered that P Ltd. was forced to reduce its prices or risk customers purchasing from D Co. instead. Comparing the selling price to customers in 2016 versus 2017, it was determined that approximately $500,000 of discounts were given. Considering both the lost sales volume and discounts provided, P Ltd.’s profit was $650,000 less than expected.

The question of damages does not end there. Instead of calculating lost profits, the plaintiff (P Ltd.) can elect for restitutionary damages, specifically, accounting (or disgorgement) of profits. The court will not necessarily allow an accounting of profits, however, it is an attractive option for many plaintiffs.

After a couple rounds of productions, P Ltd.’s accounting expert was able to determine that D Co. earned $550,000 of profit on the allegedly infringing product sales.

Of note, D Co. actually sold more dollar value of the product than P Ltd., however, since it was selling it at a lower price, its actual profit earned is less than the profit that P Ltd. lost.

Would there be any reason why P Ltd. would elect for the accounting of profits method given that the amount is $100,000 less than the loss of profit method? There are some possible reasons:

  1. By selecting an accounting of profits method, the focus is turned to the defendant. Therefore, if any financial information becomes public record in the court filings, then it will be the defendant’s information, not the plaintiff’s.
  2. If D Co. does not stop its infringing sales, it may earn even more profit next year. It appears that D Co. has a greater sales and distribution network than P Ltd. Therefore, if the case is not settled for some time, the accounting of profits method might end up exceeding P Ltd.’s loss of profit.

P Ltd. will have to confer with counsel to determine the appropriate method in the context of its litigation strategy. The amount of final compensation can depend on various legal arguments or the presentation of an alternate approach produced by the defendant’s accountant. Petra just hopes this debacle will be over soon so she can get back to gliding through some fresh powder in the forest.

RSM contributors

  • Dawson Coneybeare
    Senior Director

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