Contents

• Can You Take it With You? Court Revisits Family Limited Partnership Discounts



• Court Questions Expert's Objectivity, Methodology in Reasonable Royalty Valuation



• IRS Expert Attacks Key Assumptions in Inflated Appraisal



• Finally, a Tax Court Considers a 'Good Facts' Family Limited Partnership



• Double-Dipping Rationale May Have Prompted Court To Prefer Asset Approach



• Working with Appraisers to Solve Problems in Valuing The Very Small Business

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Valuations Insights, Third Quarter, 2008

Court Questions Expert's Objectivity, Methodology in Reasonable Royalty Valuation

Bowling v. Hasbro, Inc., 2008 WL 717741 (U.S. Dist.)

March 17, 2008

Most attorneys understand how important it is that financial experts maintain objectivity and support their conclusions with sound application of valuation standards and methodology. They also realize the weaknesses that might open up in the other side should an opposing expert fail to remain independent and/or analytically sound. This new Daubert decision from the U.S. District Court (Rhode Island) serves as fair warning for what happens when an the expert's damages opinion lacks credibility on both counts.

Did the defendant have an unfair 'Monopoly?'

The plaintiff patented a design for a type of "polyhedral dice." In 1999 the defendant Hasbro, a leading toy and game manufacturer, began selling the "Monopoly Millennium Edition" board game, which included a die with similar characteristics to the plaintiff's— and the plaintiff sued for patent infringement.

At trial, Hasbro challenged the plaintiff's damages expert under Daubert. It first attacked the expert's qualifications, claiming that he lacked sufficient experience, specifically in the area of game-component licensing. Hasbro believed this posed an absolute bar to the expert's testimony, but the court disagreed. Although it might prefer industry-specific experience in conducting a reasonable royalty analysis, the court explained, the applicable standard requires only that the expert "should have experience placing value on patents and license agreements."

The court also noted that the expert was a CPA and a partner in a large accounting firm who had testified as an expert on licensing matters several times over his more than thirty-year career. Further, he had never previously been disqualified as an expert.

Qualifications do not create reliability

However, "credentials and qualifications alone do not render [an expert's] opinions automatically reliable for Daubert purposes," the court said. Rather, the opinions must be based on reliable methodology—and this was where the expert's luck began to run out.

In a patent infringement case, if a plaintiff proves infringement but cannot establish actual lost profits, then federal law requires determination of a reasonable royalty. If no royalty rate exists in the relevant market, then the plaintiff may project a hypothetical, arms-length licensing agreement between the patent holder and infringer at the time of the alleged infringement. Although federal courts have not prescribed a specific methodology to calculate a reasonable royalty rate, most look to the fifteen factors established in Georgia-Pacific Corp. v. U.S. Plywood Corp. (2nd Circuit, 1971).

In his damages assessment, the expert concluded that $0.5825 per die was a reasonable rate for calculating the defendant's infringement. He apparently used the "simple mathematical calculation" of subtracting Hasbro's per die manufacturing cost ($0.0575) from the plaintiff's per die sales price ($0.64—the highest price charged by the plaintiff). He reached these numbers by characterizing the hypothetical relationship between the plaintiff and Hasbro as supplier and customer rather than as licensor and licensee. The importance of this distinction could "hardly be overstated," the court said."Indeed, it is the single most important finding supporting [the expert's] ultimate opinion."

Could it possibly be that in a hypothetical negotiation between one of the largest toy and game companies in the world and a tiny sole proprietor that the little guy would hold all the cards and have all the leverage?

While that scenario might conceivably occur under some circumstances, in this case the expert provided no explanation why, given Hasbro's ability to manufacture and supply the dice on its own, the parties would have negotiated with the plaintiff as supplier and Hasbro as customer willing to pay "top dollar" for the dice.

Expert cannot change sow's ear to silk

Although the expert claimed to have accounted for all Georgia-Pacific factors, the court found this to be "simply untrue." In particular, it discussed his analysis of three factors:

1. Nature and scope of the license. The expert assumed that the plaintiff would have granted an exclusive license, thereby increasing the royalty payments. When pressed at trial, however, the expert could not offer any data or practice to justify this assertion, and in fact admitted that the plaintiff would not have discontinued selling the die to other customers.


2. Licensor's established policy. In his report, the expert stated that the plaintiff did not operate a licensing company and had not licensed his patent to the die; these factors tended to increase the reasonable royalty. When Hasbro's attorney revealed this to be untrue, the expert once again "backpedaled."


3. The parties' relationship. Similarly, the expert failed to explain why the parties would have entered into a supplier/customer relationship, "thereby tilting the royalty rate heavily in [the plaintiff's] favor."

Overall, the exper's report and testimony revealed that "no rigorous analysis was performed here," the court said. Rather, "the witness engaged in a superficial and result oriented application of the Georgia-Pacific methodology," which was marred by an "obvious bias" to the plaintiff. The expert's conclusion that twelve of the fifteen Georgia- Pacific factors favored an increased royalty to the plaintiff—while the remaining three were neutral—surprised the court, "and frankly defies reason." His analysis lacked sufficient reference to facts, data, or relevant information. Although a certain amount of speculation is acceptable and appropriate in determining a hypothetical reasonable royalty rate, "mere reference to the Georgia-Pacific factors cannot change the sow's ear of rank speculation into a silk purse of reliable expert opinion," the court said, and disallowed the expert's report.

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