Commercial Arbitration: Avoiding Potholes on Damages

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We have been addressing some of the tricky issues that can come up in commercial arbitration — which I’ve been calling “potholes” — and how to address them. This time, let’s take up damages.

The situation

Consider this situation. You are the arbitrator.  The Claimant is seeking royalty payments under a license agreement on a number of products the other side has allegedly manufactured using Claimant’s intellectual property.   The issue is closer on some items than others.  Some are products that were actually listed in the parties’ agreement as royalty bearing.  Others are variations of those products that the Respondent developed and released after entering into the license agreement.  Claimant believes that they incorporate its patented technology.  Respondent says it specifically chose not to incorporate it in those products.  You will have to go over this product by product and patent claim by patent claim to get the right answer.  At the hearing, the parties presented a great deal of testimony on the technical issues involved.  There are a number of different products, produced at different times.

The law that applies also requires pre-award interest on any amounts awarded.

The Claimant used an expert witness to present its damages calculation. Her report lists all the infringing products each quarter, naming them, but not breaking down the amount of royalty for each.  It also calculates pre-Award interest on the total.  Various schedules are attached to show the details.

It comes time for you to decide the case. It is easy enough to conclude that the products listed in the license are royalty-bearing. There really wasn’t much dispute about that.  You then go over the other products. Some, you conclude, do incorporate the licensed technology.  Royalties should be awarded on those.  Others do not.  A key element of the technology was, you find, purposely excluded in some products, so those products do not use the licensed technology.  No royalties will be awarded on them.

You go on to compute the amount of the award. But, as you look at the report and the background, there really is no way to separate out by time and product the amounts owed other than by going over each sales documents and doing your own calculation. There are thousands of sales documents referred to in the report.

You also consider the pre-award interest amount. To do that, you need to see what was owed when.  That amount, of course, changed just about daily.

The options

You’ve been involved in commercial litigation for decades and have dealt with many damages issues. But you have typically worked with experts.  You are familiar with the issues, but you are not an accountant, nor do you have a staff with software and experience to make complicated damages analyses.  So what do you do to issue an award with a “correct” damages amount?  Do you:

  1. Just award the full amount Claimant seeks since you don’t have the information to do it any other way.  The issues were close enough to just call all them in Claimant’s favor and avoid the problem of how to compute the damages based on the information you have.
  2. Award nothing at all.  Claimant has the burden of proof.  If it can’t provide a  specific amount you can actually put in the award, it hasn’t met that burden.  Damages can’t be based on speculation under the law of your jurisdiction.
  3. Just make a proportional award.  You figure that about one third of the products don’t actually use the technology, so just take a third off.  Close enough.  The law of your  jurisdiction is that once the fact of damage has been proven, the amount need not be absolutely certain.
  4. Issue an Interim Award setting out the products that bear royalties and those that don’t.  Then order Claimant to compute the damages and interest, subject to Respondent’s  review and objection.  Once you have all that, you can decide the exact amount of the  royalties and interest to award.

None of these are very satisfying. You likely will not want to reward the Claimant’s approach by giving it amounts to which you have decided it is not really entitled.  Ease of calculation should not affect the merits of your decision on the substance.

Awarding nothing at all is on the other end of the spectrum. The decision shouldn’t be driven in the other direction by the calculation problem.

Option 3 is tempting. Efficiency suggests that the dispute be decided and over even if there is a little estimating going on.  But is that really fair to the parties?

Finally, Option 4 seems to solve the problem best in providing an accurate means to compute the award. But it is also likely the most expensive, requiring more expense, time and energy for everyone.  Is that really fair to the parties?

The truth is, when this problem comes up at the end of the case, as it sometimes does, there is no perfect solution. The way to solve it is by some fairly simple planning ahead of time.

Planning ahead

If you represent a party, recognize that you may not get everything you are asking for in a close case. Break the damages down in a way that makes sense by product and time together with prejudgment interest for each. The arbitrator can then simply add up the amount due by product in the award. The expert had to do this anyway to get to the answer.  Just make sure to present the conclusion in a way to make things easy for the arbitrator to get to the right amount.

If you are the arbitrator, you can help avoid this problem with a little planning. Well in advance, say at the scheduling hearing, mention the issue of damages and the need to break them up in a way that makes sense.

In the example above, that was by product.  In other cases, it may be by theory of recovery, date, or something else.  It may also be that theories overlap, but have different considerations for calculating damages.  If so, the presentation should be organized in a way the lets the arbitrator intelligently pick and choose depending on the decision on the merits.

In my experience, it is generally enough to simply mention the arbitrator’s preference in this regard early on.  I often mention in the right case that I am generally better at multiple choice questions on computing damages and interest than at essay questions.  That usually makes the point and allows me to get the  information needed.

Avoiding the pothole

This particular pothole isn’t hard to avoid. You just need to see it coming and plan for it.