CHICAGO

JOHNM.OLINLAW&ECONOMICSWORKINGPAPERNO.534 (2DSERIES)

DamagesforUnlicensedUse
OmriBenShahar
THE LAW SCHOOL THE UNIVERSITY OF CHICAGO
September2010

Thispapercanbedownloadedwithoutchargeat: TheChicagoWorkingPaperSeriesIndex:http://www.law.uchicago.edu/Lawecon/index.html andattheSocialScienceResearchNetworkElectronicPaperCollection.

Damages for Unlicensed Use

OmriBenShahar Abstract: Thisarticleinvestigatesthedistinctionbetweenbreachoflicenseand infringement of property rights, and how damages ought to be measured for each. It identifies two remedial puzzles. First, under current law the line between breach of a license contract and infringementofapropertyrightismurky,andthusminordifferences between violations could lead to major differences in damage measures. Second, damages for infringement are augmented in a subtle but distortive way, by giving owners an option to choose between the greater of two computation measures, each based on differentinformation.Thearticlearguesthattheseexistingremedial patterns are not justified. If provides an alternative framework for determining whether a violation is breach or infringement. In a nutshell, violations involving activities that an owner would want to license in a separate transaction, or not to license at all, should be regardedasinfringementsandsanctionedmoreseverely.

Frank

and Bernice Greenberg Professor of Law, University of Chicago. I am grateful to Lee Fennell, Saul Levmore, Ariel Porat, David Schwartz, and participants at a workshop in Chicago for helpful discussions.

INTRODUCTION
Thisarticleinvestigatesthedifferencebetweenbreachandinfringement.Alicensee whomadeanunlicensedusedidhebreachthecontractordidheinfringeupon thepropertyrightsofthelicensor?Isheliableforbreach,orforinfringement remedies?Itisadistinctionthathasimportantimplicationsformeasuringdamages. Ithasproventobeadifficultlinetodraw,raisingissuesthatareregardedamong theknottiestinintellectualpropertyadjudication.1 Considerthefollowingexample.Acopyrightownerlicensestherighttopublishthe workinaspecificmedium,say,paperbackedition,toalicensee.Thelicenseecommits oneofthreewrongfulacts:(1)helaunchesthedistributionprematurely,therebycutting intotheownersrevenuefromothermediaofdistribution;(2)Hedistributesthework inadditionalmediathatwerenotcoveredbythelicense;(3)hemakeschangestothe textofthework,cuttingchaptersandrevisingthestorysending.Ineachofthesecases, didhecommitabreachofcontract?Ordidheinfringeupontheownerscopyright?Are damageslimitedtotheownerslostprofit,whichmightoftenbeloworhardtoprove, ordothedamagesincludealsotheviolatorsprofit,whicharehigherandeasierto prove? Inthefirstpartofthisarticle,Iexaminetheconceptualstructureofthebreachversus infringementremedialdoctrines.Ihighlighttwopuzzlingregularities.Thefirstpuzzle hastodowithwaythelawdividestheworkbetweenbreachandinfringement,and
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3NimmeronCopyright12.01[A],p.125(2010)

moregenerallybetweencontractandproperty.Iarguethattherulesdetermining whichdamageruleappliesaremechanical,almostarbitrary,anddevoidof normativefoundations.Theydonotconformtoanydiscernablepolicyconcern. Thatis,thechoiceofremedyisnotaproductofoptimalcalibrationofthesanction, butratherafunctionoftechnicalcharacterizationsoftheviolation. Thesecondpuzzleconcernsthemannerinwhichinfringementdamagesare calculated.Inanutshell,thelawallowstheaggrievedownertochooseoneoftwo computationmeasuresofrecovery.Thefirstisbasedonexpostinformation:the actuallostprofit,ortheactualrealizedprofitbytheinfringer,astheyareknownat thetimeofthedisputeresolution.Thesecondisbasedonexantevalues:the expectedvalueoftheinfringedrightpriortotheinfringement,beforetheactualloss orprofitbecameknown.Bothmeasuresaresensible,ifpursuedconsistently,The anomalyarises,Ishow,fromthewaytheyarecombined.Inasubtleway,thelaw entitlestheaggrievedownertochoosethegreaterofthetwomeasures,expostand exanteloss.Iftheexpostlossishigh,itwillbechosen;ifitislow,theownercan choosetheexantevalueinstead.Asaresult,theexpectedrecoveryisbolstered, creatingtwodistortions.First,recoveryexceedstheinjury;andsecond,theexcess recoverydependsonfactorsthatarewhollyirrelevantintheremedialgoals. Surprisingly,theexpectedrecoverydependsonthevolatilityofthevalueofthe infringedright. Afterdescribingthesepatternsofrecoveryforunlicenseduse,thearticleexplores reasonstotreatinfringementmoreharshlythancontractbreach.PartIIofthe

articlefindsthatsomeofthestandardjustificationsforadjustingremedies imperfectenforcementandprecontractualinvestmentsdonoteasilyexplainthe doctrinalregularitiesweobserve.PartIII,then,providesaroadmaptoresolvingthe breachversusinfringementproblem.Itidentifiessituationsinwhichenhanced propertyprotectiontotheownerisefficient.Inthesesituations,aviolationoughtto beclassifiedasinfringement.Breachorinfringement,itargues,cannotbe distinguishedalongdefinitionsrelatingtothenatureofcontractorIP,butrather labelsaffixedtotheconclusionoftheinquiry,whenshoulddamagesbebolstered.

I.TWOREMEDIALDICHOTOMIES
A.Breachv.Infringement:theContract/PropertyBoundary Thefirstremedialdichotomyarisesincasesinwhichthepartiesnegotiateda licensebutthelicenseeoverreachedandmadeunauthorizeduses.Thiswrongful actionbythelicenseecouldbebothabreachofthelicensecontract,givingriseto thecommonlawscontractremedies,andaninfringementofthelicensors intellectualproperty,withtheremediesprovidedbystatutes.Forexample,the authorwholicensedthepaperbackpublishingrightstoalicensee,whoproceeded toviolatethelicensewhichremedyistheauthorentitledto,thelostprofit damagesofcontractlaworthestatutorydamagesofintellectualpropertylaw? Incopyrightcases,recoveringforinfringementcouldbevaluabletotheowner becausetheCopyrightActgrantshimthedisgorgementremedy.2Disgorgement
2

SeeSection504(b)oftheCopyrightAct,17U.S.C.504(2000).

damagescouldbesubstantiallyhigherthanthenormalcontractdamagesthat measuretherightholderslostprofit.Inpatentcases,theshiftfromcontractto infringementremediescouldalsoincreasethemagnitudeofdamages.Further, unlikecontractrecovery,infringementofintellectualpropertyopensthedoorto recoveryoftrebledamagesandattorneyfeesincertaincases,3aswellasalonger statuteoflimitation.Othertime,theownermightprefercontractdamages.Suingfor breachoflicensedoesnotinvolvetheriskofpatentinvalidation;4or,breachof contractmaybeeasiertoprovethanpatentinfringement.5 Thus,inthepaperbackpublishingexample,ifthelicenseeviolatesthetermsofthe licensebydisseminatingthepaperbackeditionprematurely,whatisthecopyright holdersremedy?Thecopyrightholderslostprofitismeasuredbythereducedsales ofthehardcovereditionthatresultfromtheearlylaunchingofthepaperback. Recoveryofthislossistheordinarycontractexpectationdamageremedy.The infringer,however,enjoyedincreasedsalesduetotheprematurereleaseofthe paperback.Recoveryofthiswrongfullyreceivedprofitistheordinaryremedyfor copyrightinfringement.Thetwomeasurescouldbedramaticallydifferent.Thelost profitfromanothermonthofsalesofhardcoverbookscouldbesmallwhilethe increasedprofitfromprematuresalesofpaperbackmightbesubstantial.6

335U.S.C.28385(2000)(patentstatute);15U.S.C.3435(trademark);17U.S.C.

50205(2000)(copyright). 4RobertMerges,ATransactionalViewofPropertyRights,20BerkeleyTech.L.J.1477,1511 (2005). 5 SeeElyLillyandCo.v.Genentech,Inc.,17U.S.P.Q.2d1531,1534(1990) 6 SeeUnitedStatesNavalInstitutev.CharterCommunications,Inc.,936F.2d692(2ndCir.1991), wheretheprofitfromlostsalesofhardcoverwasestimatedatlessthan$35,000,whereasthe profitfromadditionalsalesofpaperbackwereallegedtoexceed,$700,000amultipleof20!

Boththecontractdamageruleandtheinfringementremedyaresensible.Eachis consistentwiththefundamentalremedialprinciplesoftheirrespectiveareasoflaw, contractsandIP.Theproblemintheirapplicationisthefuzzyboundarybetween thetwo.Inanyindividualcase,itisnotclearasamatteroflegaldoctrinewhich measureapplies.Therulesdeterminingwhentheaggrievedpartyisentitledtothe infringementremedyandwhenheisrestrictedtothecontractremedyaretechnical, almostarbitrary,andseeminglydevoidofnormativefoundations.Intheremainder ofthissection,Ioutlinesomeofthedistinctionsdrawnbythelawtosortoutbreach versusinfringement. First,theanswerdependsonwhetherthelicenseisexclusiveornot.Forexample,in theaboveprematurepublishingexample,ifthelicenseehadanexclusivelicenseto publishthepaperbackedition,hiswrongfulactismerelyabreachofcontract.The reasongivenbythecourtismechanical:anexclusivelicenseisregardedasa transferoftheownershipofthecopyrightrights,andtheexclusivelicenseeasa thepersonwhonowownssomecopyrightrightsisincapableofinfringinga copyrightinterestthatisownedbyhim.7Heisonlycapableofbreachingthe contractualobligationsimposedonitbythelicense.8If,instead,thelicensewasnot exclusive,thebreachinglicenseecouldbeliableforcopyrightinfringement damages.9

Id,at695. Id. 9 SunMicrosystems,Inc.v.MicrosoftCorp.,188F.2d1115,1121(9thCir.1999)(Generally,a copyrightownerwhograntsanonexclusivelicensetousehiscopyrightedmaterialwaiveshis righttosuethelicenseeforcopyrightinfringementandcansueonlyforbreachofcontract.)

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AseconddoctrinalwrinklethatdividestheworkbetweencontractandIPremedies isthepromise/conditiondistinction.Ifthelicenseebreachesapromissory obligationunderthelicenseagreement,heisheldinbreachandisonlyliablefor contractdamages.If,ontheotherhand,thelicenseefailstosatisfyacondition precedent,thelicenseeffectivelydoesnotexistandintheabsenceofacontractthe violatorisliableforinfringementremedies.10Forexample,ifalicenseefailsto complywiththecontractualprovisiontoaffixthecorrectcopyrightnoticetothe materialsreproducedunderthelicense,isthisabreachofitslicenseobligationor failuretosatisfyaconditionuponthelicense?Theremaybesomesuperfluouslogic tothedistinctionbetweenobligationsandconditionscontractdamagesare relevantonlywhencontractobligationskickin,whereasasfailureofacondition suggeststhattheobligationsneverarisebuttherulesdeterminingwhencontract provisionsareconditionsandwhentheyarepromissoryobligationsarenotoriously fluid,11inadequatetoprovideasoundfoundationfortheelectionofremedy.Indeed, theabovescenario,inwhichthelicenseefailedtoaffixapropercopyrightnotice, washeldattimestobeafailureofcondition,makingtheviolationaninfringement

Grahamv.James,144F.3d229(2ndCir.1998).See,generally,3NimmeronCopyright 10.15[A][2],p.10116(2010);EdwinE.Richards,DraftingLicensestoGuideWhetherPotential DisputesLieinContractorInfringement,7ComputerL.Rev.&Tech.J.45,51(2002). 11 See,e.g.,Howardv.FederalCropIns.Corp.,540F.2d695(4thCir.1976);HarmonCable Communicationsv.ScopeCableTelevision,Inc.(468NW2d350,358(Neb.1991)(Courtshave struggledforcenturieswithdifferentiatingbetweenconditionsandpromises.)See,generally, Restatement(Second)ofContracts227.

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ofcopyright;12andothertimesabreachofobligation,makingtheviolationsubject onlytocontractbreachremedies.13 Athirddistinctionworkingtomarkoftheelusiveboundarybetweenbreachand infringementisbetweenlimitationsonthescopeoflicenseversusaffirmative covenant.Consider,forexample,aprovisionstating:thelicenseeagreestoengage onlyinspecificuseX.Itmaybecharacterizedasalimitationonthescopeofthe license,andalicenseewhomakesusebeyondXtheredoesnothavealicenseforit, thuscommittinganinfringement.Alternatively,itmaybecharacterizedasa negativepromisebythelicensee,thelicenseepromisesnottomakeusesother thanX,inwhichcasealicenseewhoseusegoesbeyondXwouldbeinbreachofan apromise,subjectonlyofbreachofcontractremedies.14Unfortunately,the distinctionbetweenscopeoflicenseandnegativepromiseisasemanticdistinction, atbest,andmostlicenseprovisionsareboth.15Itisallthemoresuperficialgiven thatcourtscanfindinanylicenselimitationablanketimpliedpromisenottoexceed theboundofthelicenserestrictionortocommitanyinfringement.Thistransforms
CountyofVenturav.Blackburn,362F.2d515,520(9thCir.1976);NationalComicsPub.v. FawcettPub.,191F.2d594,600(2ndCir.1951). 13 FantasticFakes,Inc.v.PickwickIntl.,Inc.,661F.2d479,487(Ga.1981); 14 See,e.g.,SCOGroup,Inc.v.Novell,Inc.2007WL2327587,at40(Utah2007);Sun Microsystems,Inc.v.MicrosoftCorp.,188F.3d1115,112122(9thCir.,1999).Inthatcase,the infringement/breachdichotomymatteredforthepurposeofpreliminaryremedies.An infringementofIPgivesrisetothepresumptionofirreparableharmandtopreliminary injunction,whereasabreachoflicensedoesnot. 15 Itisnotevenclearwhetherthisdistinctionisamatterforcontractinterpretation.Courts recognizethatthequestionwhethertheprovisionisalimitationonthescopeoran affirmativecovenantisamatterforinterpretationofthelicensecontract,buttheyalsosay thatthecannonsofinterpretationfromcontractlawcannotinterferewithfederalcopyright lawandpolicy.See188F.3d,at1122;S.O.S.Inc.v.Payday,Inc.886F.2d1081,1088(9thCir. 1989).
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everyinfringementintoabreachofcontract.16Thus,forexample,whenthelicense statesthatthelicenseesproductsmaynotcompetewiththelicensors,aviolation bythelicenseeisheldtobebothbreachandinfringement,thusallowingthe licensortochoosetheremedy.17 Someoftherulesregardingthebreach/infringementinterfacecomefromjurisdiction disputes.Federalcourtshaveexclusivejurisdictionovercopyrightinfringementactions, whereasstatecourtsadjudicatecontractsdisputes.Acomplaintassertingbreachof licenseandinfringementofcopyrightdoesitariseundercopyrightlaw,orunder contractlaw?Courtsutilizeavarietyofteststodetermineifthecomplaintrequiresa constructionoftheCopyrightActorofthecontract.18Manycourtsholdthatthe complaintarisesundertheCopyrightActifitisforaremedygrantedbytheactawell pleadedcomplaintrulethatgivestheplaintifftheoutrightchoice.19Thischoiceis constrainedbyavarietyoftests:whetherthedisputeisinformedbythesubstantive lawofcopyright,20whetheritiswithinthesubjectmatterofcopyright,21whether thereismorethananaromaofcopyright,22andmore.

16See,e.g.,Shawv.E.IduPontdeNemours*Co.,226A.2d903,905(Vt.1966);PhillipB.C.

Jones,ViolationofaPatentLicenseRestriction:BreachofContractorPatentInfringement?, 33J.L.&Tech.(IDEA)225,229(199293). 17SCOGroup,Inc.v.Novell,Inc.2007WL2327587,at3941. 18SeeJamesM.McCarthy,FederalSubjectMatterJurisdiction:WhenDoesaCaseInvolvingthe BreachofaCopyrightLicensingContractAriseundertheCopyrightAct,19U.DaytonL.Rev.165 (1993). 19 T.BHarmsCo.v.Aliscu,339F.2d823(2ndCir.1964);Bassettv.MashantucketPequotTribe, 204F.3d343(2ndcir.2000). 20 SAPC,Inc.,v.LotusDev.Corp.,669F.Supp.1009(MA1988). 21LaResolanaArchitects,PAv.ClayRealtorsAngelFire,416F.3d1195,1199(10thCir. 2005). 22 3NimmeronCopyright12.01[A][2],p.1222.4(2010)

Moreover,thedeterminationofbreachversusinfringementdependsontherulesof contractcancellation.Thelicenseitselfmaycontainareversionclausethat automaticallyterminatesthelicenseesrights.23Or,thelicensecanbeaffirmatively rescindedasaresultofmaterialbreach(e.g.,nonpaymentofroyalties).24Whenthe breachofthelicenseissuchthatgrantstheownerthepowertorevokethelicense, theownerhasaclearpathtoinfringementremedies:hecancelsthelicense,and withthelicensenolongerinplace,theonlyremaininggroundforrecoveryis propertyinfringement.Infact,thesameviolationcangiverisetobothdamagesfor breach(priortothelicensetermination)andforinfringement(pertheperiod followingtermination).25Itishardtoexplain,though,whythemechanicalactof affirmativeterminationshouldaffectthemagnitudeofdamages. Insum,thelawentitlestherightholdertotwotypesofremediestwocausesof actionbutdoesnotdrawaclearandreasonedboundarybetweenthecausesof action.Small,hairsplittingdifferencesinfactsorcharacterizationcouldleadto dramatic,discontinuousjumpsinthemagnitudeofdamages.Attimes,theowner wouldbeallowedtochoosewhichremedytoclaimandcouldwaittopleadthe countthatprovidesthehigherrecovery.26JudgeCardozoexplainedthat

Grahamv.James,144F.3d229,23738(2ndCir.1998);3NimmeronCopyright10.15[A][3], pp.10117(2010) 25See,e.g.,WisconsinAlumniResearchfoundationv.GeneralElectircCo.,880F.Supp.1266, 127476(Wis.1995) 26 SeeMerges,supranote4,at1505.Generally,partiescanjoininthecomplaintaclaimfor disgorgementandaclaimforexpectationdamages,postponingtheelectionoftheremedyuntil itbecomesclear,attrial,whichofthetwomeasureisgreater.Courtevenpermitplaintiffsto amendtheirsuitsandshiftthebasisofrecovery.See,forexample,Mataresev.Moore

23SeeRichards,supranote10,at52. 24

theauthorwhosuffersinfringementofhiscopyrightatthehandsofa licenseemay[]seekredressunderthestatuteinthefederalcourts.Butthat isnotinallcircumstancestheonlyremedyavailable.Ifthesameactisnot merelyaninvasionofastatutoryrightofpropertybutalsothebreachofa contract[]hemaycountupthebreachortheabuseandhaverelief accordingly.27 Othertimes,thereisnochoicetheremedyisdictatedbylegaldoctrinebutfrom thelicenseesperspectivetheremedycouldturnonunpredictableorsuperficial factors. B.ExPostv.ExAntemeasuresofdamages Asecondremedialdichotomyarisesincasesinwhichtheviolationisclearlyan infringement.Theviolatorinfringedbycommittinganunlicensed,unauthorizeduse. Ifdetectedandfoundliableforinfringement,whatisthemeasureofdamagesthat theviolatorowestheowner?PatentlawandCopyrightlawgivetheowneryet anotherchoice. ConsiderPatentlawfirst.OnemeasureofdamageswhichIwilllabeltheexpost measuresetstherecoveryaccordingtotheactualprofitthatthepatenteelostas aresultoftheinfringement.28Itmaybedifficulttoidentifyandprovetheexactlost profit,butiftheevidentiaryburdenisovercome,theaggrievedpatenteemay recoverhisactualloss.Thisisanexpostmeasurebecauseitdependson informationthatbecomesavailablepostinfringement,attrial,regardingthe realizationofbusinessoutcomes.
McCormackLines,Inc.,158F.2d631(2ndCir.1947);FrontierManagementCo.v.BalboaIns.Co, 658F.Supp.987(Mass.1986). 27Underhillv.Schenck,143N.E.773,775(N.Y.1924). 28 35U.S.C.284(2000)

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Alternatively,thepatenteecanforgotheexpostrecoveryandcollectinsteadanex antemeasureofdamages,equaltothevaluethatwouldhaveattachedtotheright priortoinfringement,beforethepartiesacquireinformationabouttheactualvalue ofthelicensetotheinfringerorthelostprofitofthepatentee.Theexantemeasure isestimatedasthehypotheticalroyaltiestheownerwouldhavenegotiatedina hypotheticallicense,hadtheinfringerapproachedhimandsoughttosecurea licenseduse.29Thishypotheticalroyaltymeasureismerelyaneducatedguessan average.Itreflectstheexpectedvalueofthepatenttobothpartiesandtheirrelative bargainingpower.30Itisanintermediatequantumthatdependsmoreonmarket dataandthedistributionofprofitsthanontheactualtruerealizedvalueofthe patent. Boththeexpostandtheexantemeasuresaresensible.Eachconformstoadifferent remedialconception.Theexpostmeasureserveswithgreataccuracythemake wholeprinciple.Theexantemeasuremimicsthebargainthatwouldhavebeen struck.Itisthegapfillerthatprotectsthepatenteesrighttovetononconsensual

Id.(Damagesadequatetocompensatefortheinfringement,butinnoeventlessthana reasonableroyalty.)See,e.g.,GeorgiaPacificv.U.S.PlywoodCorp.,318F.Supp.1116,1120 (SDNY1970)PanduitCorp.v.StahlinBros.FibreWorks,Inc.575F.2d1152,1157(6thCir.1978) (Whenactualdamages,e.g.,lostprofit,cannotbeproved,thepatentownerisentitledtoa reasonableroyalty.) 30 LucentTechnology,Inc.v.Gateway,Inc.,580F.3d1301,1325,1332(C.AFed2009)(The hypotheticalnegotiationtries,asbestaspossible,torecreatetheexantelicensingnegotiation scenarioandtodescribetheresultingagreement;aimtoelucidatehowthepartieswould havevaluedthepatentedfeatureduringthehypotheticalnegotiation).

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transfers.Theprobleminthattheyarebothavailableandthattheplaintiff,whohas achoicewhichonetoclaim,andcanoptforthegreaterofthetwo.31 Tounderstandwhythisprerogativetochoosethegreaterofthetwomeasuresis problematic,letsassesstheexpectedvalueofthecombinedremedy.Atthetimeof infringement,theexpostdamagethatwouldaccruetothepatentee,intermsoflost profit,isuncertain.If,bythetimelitigationoccurs,theexpostlostprofitmeasure turnsouttobehigh,thepatenteewillthenclaimandrecovertheactuallostprofit. If,instead,thismeasureturnsouttobeloworzero,thepatenteewillthenclaimand recovernottheactualloss,butrathertheexantedamageequaltothehypothetical royalty.Thus,ifweanalogizetheexpostprofittoalottery(inthesensethatitis unknownearlyonwhetheritwillbehighorzerovalue),thegreaterofremedial regimegivestheclaimantaninflatedportfolioofclaims.Hecanrecovertheactual prizewhenthelotteryiswon;andhecanrecovertheexpectedvalueofthelottery whenthedrawiszero.Theexpectedvalueoftherecoveryisgreaterthanthe expectedvalueofthelottery/patent!Thatis,thepatentisworthmorewhen infringed,becausetherecoveryrightsexceedtheexpectedstreamofprofitswhen notinfringed.32

BandagInc.v.GerrardTireCo.,704F.2d1578,1583(FedCir.1983)(areasonableroyaltyis merelythefloorbelowwhichdamagesshallnotfall);Panduit,575F.2dat1157. 32 Toillustrate,imaginealotterywith1%chanceofwinningaprizeof$1000,and99%chanceof winning$0.Theexpectedvalueofthelotteryis$10.Underthegreaterofrecoveryregime, theclaimantrecovers$1000ifhewins(withprobability1%),and$10ifheloses(with probability%99).Theexpectedvalueoftherecoverisjustabout$20,twicetheexpectedvalue ofthelottery.

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Thisgreaterofstructureofremediesisnotuniquetopatentinfringement.33It arisesalsoundercopyrightlaw.Acopyrightownercandisgorgetheinfringers actualprofit,orifthismeasureturnsouttobetoolow(iftheinfringermadeno profit)hecanrecoverstatutorydamagesunderSection504(c)oftheCopyright Act.34 Theeffectofagreaterofregimeisdistortivebecausetheportfolioofdamagesit createsendsupdependingonarbitrary,irrelevant,factors.Thatis,infringements thatcreatethesameexpectedharmatthetimetheyarecommittedwould potentiallyleadtodifferentexpectedrecovery.Toseewhy,considerthefollowing numericalexample: Example1:comparethreepatentswithsameexpectedprofitof$1000.Theydiffer inthedistributionofprofits: Patent1createsa100%chanceof$1000profits Patent2createsa50%chanceof$2000(and50%chanceof$0) Patent3createsa1%chanceof$100,000(and99%chanceof$0). Assumethatinallthreecasesalicenseorinfringementwoulddeprivethepatentee oftheprofit.Theroyaltythepatenteewouldthereforechargeforahypothetical licensetheexantemeasureis$1000.Underthegreaterofregime,the expectedrecoveryforinfringementofPatent1willbe$1000;35forinfringementof

Forageneraldiscussionofthistypeofprobleminvariousareasofthelaw,seeOmriBen ShaharandRobertMikos,The(Legal)ValueofChance:DistortedMeasuresofRecoveryin PrivateLaw,7Amer.L.&Econ.Rev.484(2005);SaulLevmore,ObligationorRestitutionforBest Effort,67S.Cal.L.Rev.1411(1994). 34 17U.S.C.A.504. 35 Forpatent1,theexpostandtheexantemeasureareidentical,$1000,becausethereisno uncertaintyaboutprofits.

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Patent2expectedrecoverywillbe$1500;36andforinfringementofpatent3 expectedrecoverywillbejustunder$2000.37 Inotherwords,thegreaterofregimeentitlesthepatenteetorecovertheactual valueofthepatent(measuredbytheprofithewouldhavemade),bundledwitha putoptiontosellthisrighttotheinfringerforthehypotheticallicensefeeof$1000. Theexcessrecoveryunderthisregimeequalsthevalueofsuchputoption.The morevolatiletheexpostvalueoftheassetPatent3ismorevolatilethanPatent2, whichismorevolatilethanPatent1themoreworthyistheputoption,andthe moresubstantialistheexcessrecoveryenjoyedbythepatentee.Theexpected recoverydependsnotonlyontheexpectedvalueofthepatent,butalsoitsvolatility. Thus,aswiththefirstdichotomy(thelicense/infringementdualilty),heretoothe lawentitlestherightholdertotwotypesofremedies.Heretheydiffernotbythe typeofinterestprotected,butratherbytheinformationinputtedintothe measurement,or,moreprecisely,thetiminginwhichthisinformationissampled. Here,infringementsthatlookthesameexanteintermsoftheireconomicimpact endupbeingtreateddifferentlybythelawofremedies.Again,smalldifferences (here,havingtodowiththevarianceofprofits)couldleadtodramatic, discontinuousjumpsinthevalueoftheremedialoptions.
Forinfringementofpatent2,thepatenteewillrecovertheactuallossof$2000with50% chance,andwillrecoverthehypotheticalroyaltyof$1000with50%chance.Theweightedsum is0.52000+0.51000=1500 37 Forinfringementofpatent3,thepatenteewillrecoveritactuallossof$100,000with1% chance,andwillrecoverthehypotheticalroyaltyof$1000with99%chance.Theweightedsum is0.01100,000+0.991000=1990.Onecanimaginescenariosinwhichtheexpectedrecovery isevenhigher.Apatentthatcreatesa50%chanceof$10,000gainand50%chanceof$8000 losshasanexpectedvalueof$1000,andtheexpectedrecoveryis$5500.
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II.REASONSFORTHEREMEDIALSTRUCTURE
Thissectionexplorespossiblerationalesfortheexistingremedialstructure. Specifically,itlooksattwofeaturesthatthediscussionaboveuncovered.First,that infringementbyalicenseeleads,onaverage,toharsherremediesthanbreachofthe license.Thatis,theoptiontoelectaremedyfromIPlawoperatestoincreasethe burdenofliabilitythatabreachinglicenseefaces.Canthisdamageboosterbe explained?Second,wesawthattherearesomespecificpatternsthataffectthe licensorschoiceofremedyandopenthedoorforgreaterrecovery.Arethesethe rightfactorstouseasdamageboosters? A. ImperfectEnforcement Notallviolationsareenforced.Oneofthemainreasonsforimperfectenforcement, isimperfectdetection:thelikelihoodthattheinfringerwillescapesanction.A familiarfeatureofanoptimaldamagesruleistheimperfectdetectionmultiplier. Theideaisstraightforward:whentheprobabilityofdetectionofthewrongfulactis lessthan1,themagnitudeofthedamageshavetobemultipliedbytheinverseof thisprobability.Thus,forexample,iftheprobabilityofdetectionis1/3,the damagesneedtobemultipliedby3.Whatthewrongdoergainsbynotbeing detectedsomeofthetimehelosesinthosecasesinwhichheisdetectedandfaces augmenteddamages.Thekeyistoinflictonthewrongdoerwithanexpected

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damagepaymentthatisinvarianttotheprobabilityofdetection,soastomaintain optimaldeterrence.38 Whatdoesthisbasicframeworktellusaboutthedichotomousremedialstructures ofIPlaw?Wesawthattheeffectoftheseremedyregimesistocreateasuper compensatorystructure,inwhichtherightholderiscompensated,inexpectedvalue terms,formorethanhisloss.Thus,itmightbeconjecturedthattheexcess compensationisawaytooffsettheunderdeterrencearisingfromimperfect detection.Somerightholdersneverdetectorsue;thosethatdodetectthe infringementsandsueareovercompensated. Consistentwiththisconjecture,thefirstrelevantdistinctionisbetweencasesin whichalicenseexistsandcasesinwhichitdoesnot.Iftheunauthorizeduse occurredinthepresence(andthusinbreach)ofalicense,theprobabilityof detectionbytherightholderislikelytobehigherthaniftheunauthorizeduse occurredintheabsenceofsuchlicense.Ownersknowthepartiestowhomthey licensesomerights.Theyknowwheretolookiftheywanttomonitortheir licensees,andtheyanticipatethetiming,thelocation,andthemediumoftheuse. Unlicensedinfringers,bycontrast,arestrangers.Theycouldbeanywhere,anytime, inanyformatormedium.Detectionoftheirinfringingactivitiesismoreerraticand lesslikely.Thus,withintheuniverseofunauthorizedusers,theprobabilityof detectionishigherwhentheuseralsohappenstobealicensee.
GaryS.Becker,CrimeandPunishment:AnEconomicApproach76J.Pol.Econ169(1968); RICHARDA.POSNER,ECONOMICANALYSISOFLAW218(7thEd.2007);A.MitchellPolinskyandSteven Shavell,PunitiveDamages:AnEconomicAnalysis,111Harv.L.Rev.888(1998).
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Byvirtueoffacingahigherprobabilityofdetection,licenseeswhocommitted unlicensedusesshouldfacelowerdamagemultipliers.Inmanyinstances,itis plausibletoassumethattheprobabilityofdetectingunauthorizedusesbylicensees isactuallycloseto1,inwhichcasetheyneednotfaceanymultiplieratall,forthere tobeadequatedeterrence.Thesedetectedviolatorslicenseesshouldbeliableonly fortheharmcaused(theownerslostprofit),butnotbeyond.Unlicensedinfringers, bycontrast,whoweredetectedagainsttheodds,shouldfaceadamagemultiplier andpaymorethantheharmtheycaused.Accordingly,asimplerulethatawards contractdamagesratherthaninfringementdamagesanytimetheinfringeralso happenstobealicenseegoesintherightdirection. Despitethispossibledeterrencejustificationfortheremedialdichotomy,Iam skepticalwhethertheactualrulesoperateindesirableway.Forone,itisaclumsy waytoachieveamultiplier.Ifthereasontomultiplydamagesisthelowprobability ofdetection,thisandnottheelectionofthegreateramongseveralsanctions shouldbetheexplicitmultiplyingcriterion.Perhapsthedisgorgementremedyisthe bestthelawcandotoraisedeterrence,giventhepracticalconstraints.One constraintistheinformationabouttheprobabilityofdetection,whichcourtsoften donthaveandcannotutilizetosettheperfectmultiplier.Anotherconstraintisthe infringersinabilitytopaythefullpunitivemeasure;alltheyhaveisthemoneythey earnedthroughinfringement,whichcanbereadilydisgorged.Thus,combining remediesandgivingtheaggrievedplaintifftheoptiontochoosethegreatercanbe viewedasaquickmechanicalfixforunderdetection,evenifimperfect.Thisisthe sametechniquethelawusesinothercontexts.Forexample,fiduciarydoctrines 17

entitleaprincipaltochoosearemedyagainstabreachingfiduciaryagent.Ifthe agentembezzlestheprincipalsmoneyandinvestsit,theagentisliableforthe greaterofhisbenefit(equaltohisinvestmentprofits)andtheprincipalscost(the nominalsumstolen).39 Thereisamorefundamentalproblem,however,withtheimperfectdetection rationaleforthedichotomousremedyregime.Ifaviolationscommittedbylicensees aredetectable,theyrequirenomultiplier.Thelawthatgivestheaggrievedownera bolsteredrighttorecovereitherbychoosinganinfringementremedyorthrough thegreaterofexpostandexantemeasuresofdamagesmultipliesthesanction inthewrongsetofcases. Worse,bothremedialdichotomiesworktoincreaseliabilityintheopposite directionthanthedetectionrationalesuggests.Considertheeffectofthegreaterof expostandexantedamages.RecallfromExample1abovethatthemultipliereffect isgeneratedbythevarianceofexpostprofits.Thegreaterthevariance,thehigher theexpecteddamage.(Inthatexample,apatentwith1%likelihoodof$100,000 profitgenerateddoubletheexpectedrecoverycomparedtoapatentwith100% likelihoodof$1000profit,eventhoughbothhavethesameexpectedvalue.)Thereis noapriorireasontothinkthathighvarianceinthepatenteesprofitswould correlatewithlowprobabilitiesofdetection.Forone,iftheprobabilityofdetection dependsoninvestmentmadebythepatenteetodetect,itispossiblethatthe patenteewouldinvestmorewhenthepatenthasthepotentialforextremelyhigh
SeeRestatement(Second)oftheLawofAgency407(1958);BenShaharandMikos,supra note33,at512.
39

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profits.Furthermore,itoftenisthecasethattheprobabilityofdetectionis correlatedwiththeinfringerssuccess,notwiththepatenteesprofits.Themore profitabletheinfringement,themorelikelyitistoattracttheattentionofthe patentee(despiteanyeffortsthattheinfringermightmaketohideitsprofits). Generally,infringementsofpatentsareeasyordifficulttodetectdependingmoreon howtheyareusedbytheinfringerthanhowprofitabletheyaretothepatentee. Thus,thechoiceofremedythatthelawgrantstheownerisworthmoreincasesof highdetectionprobabilitycontrarytothedeterrencerationale. Consideralsothemultipliereffectachievedthroughthebreach/infringement duality.It,too,isinconsistentwithoptimaldeterrencetheory.Thelawgrantsthe aggrievedlicensorarighttorecoverinfringementdamagesevenwhentheviolation iseasilydetectable.Forexample,alicenseewhoviolatedthescopeofthelicense couldbeeasiertodetectthatonewhoviolatedanegativepromise.Itmaybeeasier todetectanegregiousviolationbyalicenseewhoventuresintowhollyunrelated activities(thebookdistributorwhorevisesthebooksending),thanamoresubtle violationthatiswithinthelicensedactivity(thedistributorwholaunchesthebook prematurely). Insum,imperfectdetectionandenforcementdoesnotappeartoprovidea normativejustificationfortheremedialstructureinbreachoflicensecases.We havetolookelsewhere. B. CostlyExAnteSearch

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NotallinfringementsaredeliberateviolationsofrightsknowntobeprotectedbyIP law.Manyinnovativetechnologiesandproductshappentooverlapwithexisting rightsinwaysthatarenotobvious,noreasytopredict.Thus,partiesmayinfringe inadvertently,asresultofinsufficientpriorsearchforexistingpropertyrights.As longaspotentialinfringersareawareofthehazardofinadvertentinfringement,the damagestheywillhavetopayforsuchinfringementswouldoperateasinducement bylawtomakeadvancesearch.Metaphorically,themorelandminesinthepath,and themoredamagingtheselandminesare,themorecautiousthetravelerislikelyto be,andthemorehewillinvestinminedetectors.Sometravelerswillchoosetostay offthepath. Thereisplentyofwritingonthehardship,underexistingsystems,facingparties whowanttocommercializeanideaandneedtoidentifyandnavigatethoughprior rights.Inacrowdedlandscapeofregisteredpatents,forexample,itiscostlyto predictwhetheranyparticularusewouldrunintotheprotectedhalosofother patents.Asubstantialinvestmentinsearchprecautionisrequiredtomaneuverthe tightlinebetweenoriginalandlicensedinnovationononeendandinfringementon theother. Howmuchsearchprecautionisoptimalisimpossibletoidentifyintheabstract,but twoobservationsarerelevanttothecontextofunlicenseduse.First,theeasieritis tosearchandfindpriorrights,themoresubstantialthedamagemeasureoughtto be.Substantialdamagesinduceexantesearch,whichisagoodresultwhensearch ischeapandproductive.Iftheinfringementoccurredinanareainwhichthepatent

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landscapeisbarren,whereitiseasytoidentifypotentialconflictingclaims,and whereinfringementisthereforeobviousorblatantandpresumptively deliberatedamagesmaywellbebolstered.Thereisnoriskthathighdamages wouldleadtoexcessivelycostlysearch,becausesearchischeap.If,instead, infringementoccurredinacrowdedpatentenvironment,orwheremanyregistered patentsarelikelytobeinvalidated,whereinnovativeclaimsvarysubtlyand incrementally,andwhereinfringementisoftenaclosecall,damagesmultipliersrun theriskofinducingsearchthatistoocostly.Thisisaversionofthechillingeffectof patentthickets,butherethedistortionisnotinchillinginnovationaltogether,but ratherininducingexcessiveprecautionsinpriorsearch. Theremaybevariousimplicationstothesocialobjectivetoreduceexcessiveex antesearch,notallimmediatelyrelevanttothepresentcontext.Forexample,itmay yieldausefuldistinctionbetweeninfringerswhocompetewiththerightholders versusthosewhodevelopanewproductormarket.40Theformeraremorelikelyto beawareofthepotentiallyinfringedrightsthoseembeddedintheexisting, competedagainst,productsandshouldfinditrelativelyeasytosearchforexisting rights.Or,thisframeworksuggeststhatdevelopersofproductsthatimplicate

Forarelatedargumentthatinjunctionsshouldbeuniquelyavailabletocommercializing patentees,seeBenjaminH.Diessel,TrollingforTrolls:ThePitfallsoftheEmergingMarket CompetitionRequirementforPermanentInjunctionsinPatentCasesPostEBAY,106Mich.L. Rev.305(2007).

40

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numerousexistingpatents,forwhomitiscostlytoidentifyallpotentialconflicting claims,shouldfacelowerliability.41 Itdoesnotappear,though,thattheexcessivesearchconcerncanjustifydifferent treatmentofinfringerswhoexceededandbreachedtheirlicenses.Withinthe populationofinfringers,thosewhoalsohappentobelicenseesandwhobreached thescopeoftheirlicensearesystematicallymorelikelytoknowandanticipatethe conflictingrights.Alicenseeisonewhoalreadyidentifiedtherightholder, acknowledgedtherightholdersvalidclaim,andcompletedanynecessarysearchof thescopeoftheright.Ifthislicenseenowengagesinanunlicenseduse,itisnot becausehewasunawareoftheconflictingright,norbecauseverifyingthisrightwas toocostly.Adistributorwhobreachesthelicensebymakinganunauthorizeduse doesnotneedtomakecostlysearchtoknowthatheiscrossingaboundary.Thus, thelawthatuniquelyexemptsthebreachinglicenseefromsupercompensatory damagesisinconsistentwiththesearchrationale. C. IncentivestoNegotiateaLicense

41MarkA.Lemley,DistinguishingLostProfitsfromReasonableRoyalties,51Wm.&MaryL.Rev.

655,671(2009);MarkA.LemleyandCarlShapiro,PatentHoldupandRoyaltyStacking,85Tex. L.Rev.1991(2007).Noticethatthisrationalefordifferentiatingtheremediesavailableto commercializingversusnoncommercializingpatenteesisdifferentfromtheoneinvoked bycourtsandcommentatorsintheaftermathoftheSupremeCourtsdecisionineBay,Inc.v. MercExchange,LLC,547U.S.388(2006).There,theconcernwaswithgrantinginjunctions infavorofnonpracticingpatentees.Injunctionswouldenablethemtoexpropriatea greaterchunkofthesurplusgeneratedbytheirlicensees.SeealsoSee,e.g.,RichardEpstein, TheDisintegrationofIntellectualProperty?AClassicalLiberalResponsetoaPremature Obituary,62Stan.L.Rev.455,485495(2010).Here,incontrast,theconcernisthathigher liabilityburdenwoulddivertpartiestochoosevoluntarytransactionstoooften,evenwhen itisthecostlier,inefficientmodeoftransfer.

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Acanonicalrationaleforsupercompensatoryremediesistheincentivetheycreate forconsensualtransfers.Toavoidtheharshsanction,sogoestheargument,a potentialviolatorwouldcontractfortherightwouldnegotiateandsecureapaid forlicense.Whenthecostsofnegotiatingalicensearelowerthanthecostofdispute resolution,suchincentiveisdesirable. Unfortunately,thisperspectivedoesnotexplaintheremedialrulesforunlicensed use.Specifically,itdoesnotexplainwhyalreadylicensedparties,whoexceedthe scopeoftheirlicenseandcommitunauthorizeduse,sometimesfaceasmaller expectedremedyrelativetoinfringersthatneverhadanylicenseinthefirstplace. Licenseesarepartieswhohavegreaterproximitytotherightholders.Theyknow whotherightholderisandtheyhavecontractedsuccessfullybefore,suggestingthat transactionscostsarenotprohibitive.Ontheotherhand,infringerswhoare strangersandarenotlicenseesmayfinditcostlytocontractwiththerightholders. Thus,theideathatpartiesshouldfacestiffremediessothattheywillbeinducedto negotiateandtransactismorepowerfulanddesirablewhensuchpartiesarelikely tohavelowtransactionscosts.Itwouldimplythatlicenseesoughttofaceharsher remediesforunlicensedusethantheonesstrangersfacetheoppositeofwhatthe lawdoes. Still,itmaybearguedthatwhiletransactionscostsarehigherforstrangercase, adjudicationscostsarealsohigher.Courtscouldhavegreaterdifficultyassessingthe rightremedyinstrangercases,relativecasesinwhichapriorlicenseexists.Whena licensealreadyexists,theremaybesomemetricforascertainingthevalueofthe

23

righttotheownerandthelicenseeandtherelativebargainingstrength.The difficultycourtscontinuetofacewhenassessinginfringementremediesfurther suggeststhatitwouldbedesirabletoinducepartiestotransactbythreateningthem withhighdamages.Iamskeptical,however,whetherthisexplanationcanaccount forthedoctrinaltechniquebywhichlicenseesreceivemorelenienttreatment. Recallthatexclusivelicenseesfacelowerdamagesrelativetononexclusivelicensees. Whentherearemanylicensees,itiseasiertoquantifydamagesbyreferencetothe thickermarket.Thus,ifassessmenterrorsweretheunderlyingreasonforusingstiff remedies,theywouldbeusedlessoftenincasesofnonexclusivelicenses.

III.BREACHORINFRINGEMENT?
Whydosomeviolationsbythelicenseeconstitutebreachwhileothersconstitute infringement?Whatistheprincipledeterminingwhichiswhich?Iargueinthis sectionthattheexistinglegalrulessearchingforthelinetodrawbetweenbreach andinfringementaremethodologicallymisguided.Thereisnonatural, technological,boundarybetweenthetwothatcanbeidentifiedbyinvoking principlesofcontractandproperty,thereisnoaromaofcopyright,norcanthe problemberesolvedbyrelianceonabstractcontractinterpretationcannons. Instead,thelinebetweenbreachandinfringementhastocomefromamorebasic inquiry:whatisthebestwaytoprotectanownersentitlement.Breachor infringementisnotthetestbutrathertheconclusionthelabelweshouldaffixto theresultofananalysisofoptimalremedies.Characterizingaviolationasan infringementusuallymeansthattheremedyisaugmented,todetersuchviolationin

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thefirstplace.Incontrast,characterizingaviolationasbreachofcontractusually meansthattheremedymerelyactsasaprice,givingtheviolatoranoptiontobreach andpaydamages.Sometimesthelawwantstodeteronesidedtakingofthe entitlement,topreservetheownersprivilegetochooseitscounterpart.Othertimes thelawmerelypricestheentitlementandgivestheviolatoracalloption. Thereisbynowamatureliteraturestudyingthechoicebetweenthetwovehiclesof entitlementprotectionthefamiliardivisionbetweenpropertyrulesversus liabilityrules,pricesversussanctions,marketsversusinvoluntarytakings,andthe like.Breachversusinfringementisyetanothermanifestationofthisfundamental divide.Withinthismethodology,thechallengeistodeterminewhendoesthe presenceofacontractanIPlicensechangetheprotectiontotheownerfroma propertyruletoliabilityrule,andwhenitdoesnot. A. ShouldAllViolationsbeBreach? Wecanbeginbyaskingwhyarentallviolationsbreach?Whynotapplyasimple rulethat,oncealicenseisenteredinto,allviolationsarebreach,suchthatthe licenseecannevercommitinfringements?Anyunlicensedusebyalicenseewould involvecontractdamagesandnothingmore.Thelicensedpaperbackpublisher,for example,wouldonlybeinbreachnotinfringementregardlessofthenatureof hisviolation,beitawrongfullytimeddistributionofthecopies,orpublicationof unlicensedmedia,ortheoutrageousrewritingoftheendingofthestory.The magnitudeofdamagesmightvaryaccordingtothegravityofbreach,butineither

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casetheywouldfollowthestandardcontractmeasureequaltotheownerslost profit. Thisrulewouldconstituteacalloptiongrantedtothelicenseetotakeanyelement oftheentitlementandpayforit.Itwouldmakelicenseschunkiergettinga licensewouldnowamounttogettingasetofcalloptionsonotherrights,whichnon licensedpartiesdonthave.Forone,licenseswouldbecomemoreexpensive.More importantly,though,thischunkylicenseregimeisobjectionableforthesame reasonsthatauniversalcalloptionregimeisobjectionableinanyothercontext, involvingstrangers.Strangersdonthavecalloptionsovertheintellectualproperty entitlementsofowners,oroveranyotherpropertyrights. Why?Wecansaythatasystemofoptionseithertobuyortosellwithoutthe consentofthecounterpartysubjectspeopletodisruptionoftheirfreedomtobe leftalone.Evenifthestrikepriceofthecalloptionthecompensationtobepaidto theowneriscorrectlyassessed,andeveniftheresultisconsistentwithexpost efficiency,namely,moreefficientusersofthepropertyendupowningit,thereare goodreasonstoobjecttotransfersbasedoncalloptions.Theideathatpeoplewant tobeleftaloneandtochoosetheircounterpartiescanbebasedonwhatsomerefer toasautonomy,butitmayalsobegroundedinfamiliareconomicreasoning.The abilitytochoosetheidentityofthebuyer/transfereeenablesanownertomake valuabledeterminationsthatwouldbeforfeitediftheownerweresubjectedtocall options.

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First,anownerwantstodeterminetheprivatelydesirabletimingforthetransfer, ratherthanhavethatdictatedbythetaker.Thisisparticularlyvaluableinamarket withvolatileprices,orwhentherearetaxconsequencestotherealizedtransaction. Forexample,ownershipofafinancialsecurityisoftennothingmorethanarightto selectthetimingtobuyandsell.Thevalueofassetsstrippedofthetiming prerogativecoulddeclinesubstantially. Second,anownerwantstofittogetherthedesiredportfolioofdiverseassets,soas tobalancerisksandreturns.Substitutinganassetforcashwouldchangethe characteroftheportfolioandtheexposuretorisk,anditcouldaffectthevalueof holdingontootherassets,inwaysthataredifficulttoassesscompensate.Moreover, assetsareassembledtogethertocomplementeachotherandattainextravalue withintheassemblage.Acollectorofart,forexample,wouldlosemorethanthe marketvalueofapainting,whichsingularlycomplementedtheentirecollection. Third,anownermaywanttochoosetheidentityofthetransferee,togenerate additionalbusinessandtobolsterinvestmentsinrelationships.Thesalemaybebut oneelementofanongoingenterprise,anditisthevalueofthisenterprisethatisat stake.Forexample,sellinglandadjacenttooneshomeinvolveschoosingones neighbor,whichcouldbequitevaluable.Or,therighttochooseapatentlicensee wouldaffectthepatenteesdesignofthetechnologyinthefirstplace. Fourth,ownersmaycarewhoownstheassetorsomerightsinitbecausethey continuetohaveapropertystakeinit.Ahotelproprietor,forexample,wantsto controlwhooccupiesanysingleroombecausethetenantsbehaviorcanaffectthe

27

valuethatcanbederivedfromotherpartsoftheproperty.Or,afranchisorwantsto controltheuseofthebusinesstrademarkbecausethelicenseesuseofitaffectsits valuetootherfranchisees,andtothebusinessasawhole. Therearesurelymoreeconomicreasonswhyanownerwouldwanttocontrolthe transferofproperty.Theownermayhavepriorconflictingcommitmentsand contractsregardingtheuseoftheproperty;or,theownermayhaveaninterestto punishsomepoorbehavingindividualsandpastviolatorsbyexcludingthemfrom theproperty;or,theownermaywanttofreezetheassetinordertoincrease demandandmarketpriceforotherassetsheowns;and,ofcourse,anownermay attachidiosyncraticvaluetothepropertye.g.,keepitinthefamilysuchthat cannotbeaccuratelyassessedindamages. Subjectingownerstocalloptionswouldleadtotheselosses,butitcouldalsoleadto anothereffect:ownerstakingmeasurestopreventthetakingoftheirproperty buildingfences.Ifyoucanmoveintomyhomewithoutmyconsent,myrightto recovercompensatorydamagesmaynotdissuademefrominstallingpreventive measures:locks,fences,dogs,andthelike.Ifyoucanusemyintellectualproperty withoutmyconsent,Iwillinstalldigitallocksandaccessrestrictions,design productsthatcreatesmallerexposuretosuchunilateraltakings,ortrytobribeyou tocease.Thesewastefulactivitiesaresparediftheremedyoperatestodeterthe encroacherfromonesidedaction.Thisisthesamereasonwhypeoplecommonly objecttotheothertypeofoptionsputoptionsthatenablesellerstoimpose unsolicitedsalesuponbuyers.Thinkofallthespamemailsandjunkmailoffersthat

28

consumersget.TheyareenoughofanuisancethatDoNotCallmechanismsneed tobedevised.Butifsellershadputoptionsiftheywereallowedtodeliverthe productwithoutthebuyerssayingyesandchargethebuyersalegallysetprice peoplewouldhavetoconstantlybeonguardtododgetheseunsolicitedsalesand avoidgettingstuckwiththewrongsetofbenefits. Nevertheless,weknowthatcalloptionsareusedoccasionally,insituationsinwhich theseconsiderationsarenotpresent.Themostprominentapplicationofcall optionsisdamagesforbreachofcontract:thecontractualentitlementcanbetaken forapriceexpectationdamages.Butnotallbreaches:somearesubjecttothecall optionregime,othernot.Amailcarrierwhofailstodeliverthepackagecontaininga spareshaftintime,orwholosesit,wouldhavetopayexpectationdamagestothe client.Butacarrierwhoopensthepackage,appropriatestheshaft,andusesitfor profit(e.g.,sellsittoanothermill)wouldbesubjecttoharsherremediesincluding disgorgementofprofit,42intendedtodeterratherthanpricetheinfraction.Thetwo breachesaredifferentbecauseonlythelatter,butnottheformer,givesrisetothe setofconcernsthatunderlietheownersrighttochoose.Theclientalreadydecided toshiptheshaftandalreadychosethecarriertoperformtheshipping,buthedid notyetchoosewhethertoselltheshaftandtowhom.Ifthecarriagedelivery promiseisbroken,theclientsonlylossisthedirectadvantageheanticipated.If,on theotherhand,thepackageweretobesoldbythecarrierwithoutpermission,the clientwouldsufferadditionallosses.Hemightprefertosellitbyhimselfandfinda highervaluingbuyer;orhemightbearanunwantedoruninsuredriskbythe
42Restatement(Third)ofRestitution39.

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prematuresale;orotherassetsoftheclientwouldlossvaluethemillmightbe worthless,hisclientrelationshipwouldsuffer;or,othercommercialinvestmentsthe clientmademaybesquandered.Theconsequencesfromthesaleoftheshaftare onesthattheclienthasnotyetelectedoranticipated.Forcingthemonhimwould bringabouttheinefficienteffectsofcalloptions. B.DistinguishingBreachandInfringement Thisaccountcanshedlightonthedividinglinebetweenthedifferentviolationsof anIPlicense.Returntothepaperbackeditionpublisher.Hisprematuredistribution ofcopiesisacostlybreach,butitdoesnotimplicatetheownersrighttochoose,or anyofthecostsofunwantedcalloptions.Theowneralreadydecidedtocarveout thisrightandalienateit,andchosethispublishertorunthepaperbackbusiness. True,theownersinteresttosynchronizethepaperbacklicensewithother licenseshere,thehardcoverdistributionwaspartiallythwartedbythe unfulfilledpromise.Butthelossispecuniaryanditisfullycompensableby expectationdamages.And,importantly,thepotentialoccurrenceofsuchbreach wouldnotdrivetheownertotakepreventivemeasures,tobuildvirtualfences. Ontheotherhand,ifthepaperbackpublisherweretoviolatetheowners entitlementby,say,rewritingthebooksending,orbydistributingtheworkinother media,theauthorownersotherconcernswouldbeimplicated.Eveniftheowner doesnotsufferanyimmediatepecuniarylossofsales(therevisedendingmay generateincreasedsales!),hemaylosesomepotentialvalueofthecreation.Hemay haveplannedasequelbasedontheoriginalplot;orhepreferstolicenseother

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mediadistributiontootherparties,moresuitabletoadvancesomegoalsor investmentsoftheowner;oranaestheticvaluehasbeencompromised;His reputationmaybeaffected,nottomentionhismoralrights.Ifalicenseehadthe privilegetocommitanyviolationandbesubjectonlytocontractdamages,then ownerswouldlosetheabilitytocarveoutdifferentrightstodifferentparties.Once thefirstlicensewasgiven,thelicenseewouldhaveachunkycalloptiononall additionalrights.Thepotentialbenefitsfrompartitioningdifferentrightsto differentlicensees,fromcreatingnumerouslicensingrelationships,andfrom harnessingadiverseportfolioofspecializations,wouldbesquandered. Further,anownerwhocanonlygetlostprofitsagainstthistypeofviolationwould likelytakeselfhelpmeasurestopreventsuchtakings.Hewouldselfpublish;or licensethepublicationonlytotrustworthyandreputablepublisher(forgoing discountsofferedbyentrants);orusecontentdisseminationmediathatcannotbe altered;oralterthetimingofthevariousdistributionmodes;orchargehigher prices. Thus,forthesamereasonsthatstrangersshouldnothavecalloptionsonthe ownersIPrights,licenseestooshouldnothavetheoptionstotakerightsthatgo beyondwhattheyacquiredthroughthelicenserightswhichtheownerswould wanttolicenseseparately.Infact,thereisareasontotreatviolationsbylicensees evenmoreharshlythanviolationsbystrangers.Stiffpenaltiesfornonconsensual takingwouldinducetheviolatortonegotiatetheadditionaluserightwiththe owner.Whenthereisalreadyapreexistingnarrowerlicense,thisincentiveto

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negotiateisdesirablebecausetransactionscostsarecomparativelylow.Byvirtueof havingnegotiatedtheoriginallicense,thepartiesareknowntobeabletoreach agreement:theyidentifyeachotherandcanovercomecontractinghurdles. Onewaytoidentifytheoptimalreachofcalloptionsistomimicthelinesparties drawthroughtheuseofliquidateddamages.Whentheviolatorisintendedtohavea calloption,weoftenfindthatpartiesincludealiquidateddamageclauseintheir licensecontractstoaccountforsuchoption.Manycontractscontaindefinitionsof materialbreachandassignadamagesfigure.Timelyperformanceisoneofthemore commontriggersofliquidateddamagesandlatefees.Infact,courtscorrectly interpretthepresenceofacontractedforremedyschemeasindicationthatthe violationtowhichthisschemeappliesismerelybreach,notinfringement.43Thatis, anticipatingthatsuchbehaviormightoccur,thepartiesstipulatedtheremedial consequence,anddidnotdeemitnecessarytotakeanyotherprecautionagainstit. Alawthatassessesexpectationdamagesfortheseoffensesmerelymimicswhat manypartiesalreadydo. Butpartiesdonotwriteliquidateddamageclausestodealwiththedistributors changeofbookcontent,becausetheydonotwanttosetapriceforsuchbehavior: theywanttoeliminateit.Theymaytakesomeprecautionsagainstsuchviolations (e.g.,bycheckingthepublisherspageproofs).Butmostly,theyrelyonthelawto deterthemaltogether. Conclusion
43SeeSunMicrosystems,Inc.v.MicrosoftCorp.,81F.Supp.2d1026,1032(N.D.Cal.2000).

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Thisarticleidentifiedtwodistortionsthatemergefromtheunclearboundaries betweenlegalrules.Thefirstfuzzyboundaryisbetweenbreachandinfringement. Twoconductsthatarealmostidenticalincircumstancescouldleadtodramatically differentremedialconsequencesbybeingclassifieddifferently,oneasbreachof contractandtheotherasinfringementofpropertyright.Thesecondfuzzyboundary isbetweentherighttorecoverexpostversusanexantemeasuresofdamages.As informationaboutthelossemerges,therearedifferentwaystocalculateit.But,it turnsout,theprobabilisticnatureofthelosscreatesaportfolioofremediesthat overcompensaterightholders. Theseproblemsarenotuniquetoremediesforunlicenseduse.The contract/propertyboundaryisafundamentaldesignfeatureinprivatelaw.For example,thelawapplyingtophysicalneighbors,andspecificallythelawthat assessesrecoveryforbreachofneighborsrights,hastomakesubtlechoices betweencontractualversusdisgorgementmeasures,betweencostbasedversus benefitbasedmeasures.Or,thelawofprecontract,applyingtopartieswhoentered anegotiation,searchesforsanctionsthatwalkadelicatelinebetweencontractand property,betweenharmandbenefit. Likewise,theproblematicinterfacebetweenexpostandexantemeasuresof recoveryisageneralproblemthatcomesupoften,anytimethelawhastoassess recoveryforprobabilisticharmorbenefit.Actionsthatappearidenticalexante maylikelotteryticketsorinsurancepolicieshavedifferentexpostvaluations. TheanalysisinthisarticlefocusedonthestochasticvalueofIPrights,butitcan

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shedsimilarlightonremediesforotherprobabilisticentitlements:investmentsin improvingotherspropertyorininsuringit,appropriationofchances,assessmentof unrealizedvalue,andthelike.Invariousareas,thelawofremediesallowspartiesto chooseamongseveralrecoverymeasures,effectivelygrantingthemsuper compensation.

Readerswithcommentsshouldaddressthemto: ProfessorOmriBenShahar UniversityofChicagoLawSchool 1111East60thStreet Chicago,IL60637 omri@uchicago.edu

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ChicagoWorkingPapersinLawandEconomics (Second Series)

Foralistingofpapers1475pleasegotoWorkingPapersathttp://www.law.uchicago.edu/Lawecon/index.html

476. 477. 478. 479. 480. 481. 482. 483. 484. 485. 486. 487. 488. 489. 490. 491. 492. 493. 494. 495. 496. 497. 498. 499. 500. 501. 502. 503. 504. 505. 506. 507.

M.ToddHenderson,CreditDerivativesAreNotInsurance(July2009) LeeAnneFennellandJulieRoin,ControllingResidentialStakes(July2009) DouglasG.Baird,TheHolmesianBadMansFirstCritic(August2009) DouglasG.Baird,TheBankruptcyExchange(August2009) JonathanMasurandEricA.Posner,AgainstFeasibilityAnalysis(August2009) LeeAnneFennell,TheUnboundedHome,PropertyValuesbeyondPropertyLines(August 2009) BernardE.Harcourt,HenryLouisGatesandRacialProfiling:WhatstheProblem? (September2009) StephenJ.Choi,MituGulati,MiryaHolman,andEricA.Posner,JudgingWomen(September 2009) OmriBenShahar,OneWayContracts:ConsumerProtectionwithoutLaw(October2009) ArielPorat,ExpandingLiabilityforNegligencePerSe(October2009) ArielPoratandAlexStein,LiabilityforFutureHarm(October2009) AnupMalaniandRamananLaxminrayan,IncentivesforSurveillanceofInfectiousDisease Outbreaks(October2009) AnupMalani,OliverBembomandMarkvanderLaan,AccountingforDifferencesamong PatientsintheFDAApprovalProcess(October2009) DavidGiloandArielPorat,ViewingUnconsconabilitythroughaMarketLens(October2009) DavidWeisbach,InstrumentChoiceIsInstrumentDesign(October2009) M.ToddHenderson,JustifyingJones(November2009) EricA.Posner,ProCDv.ZeidenbergandCognitiveOverloadinContractualBargaining (November2009) RandalC.Picker,AntitrustandInnovation:FramingBaselinesintheGoogleBookSearch Settlement(November2009) RichardA.Epstein,AgainstPermititis:WhyVolunteerOrganizationsShouldRegulatetheUse ofCancerDrugs(November2009) RichardA.Epstein,HellersGridlockEconomyinPerspective:WhyThereIsTooLittle,Not TooMuch,PrivateProperty(November2009) RichardA.Epstein,NRAv.CityofChicago:DoestheSecondAmendmentBindFrank Easterbrook?(November2009) RandalC.Picker,EasterbrookonCopyright(November2009) OmriBenShahar,PreClosingLiability(November2009) RandalC.Picker,AssessingCompetitionIssuesintheAmendedGoogleBookSearch Settlement(November2009) SaulLevmore,AmbigiousStatutes(November2009) SaulLevmore,InterestGroupsandtheProblemwithIncrementalism(November2009) TomGinsburg,TheArbitratorasAgent:WhyDeferentialReviewIsNotAlwaysPro Arbitration(December2009) NunoGaroupaandTomGinsburg,Reputation,InformationandtheOrganizationofthe Judiciary(December2009) EricA.PosnerandAlanO.Sykes,EconomicFoundationsoftheLawoftheSea(December 2009) JacobE.GersenandAnneJosephOConnell,HidinginPlainSight?TimingandTransparency intheAdministrativeState(December2009) RichardA.Epstein,ImpermissibleRatemakinginHealthInsuranceReform:WhytheReid BillisUnconstitutional(December2009) TomGinsburgandEricA.Posner,Subconstitutionalism(January2010)

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