If a litigated patent has previously been licensed to a third party, the courts generally adopt the terms of the prior agreement as the best measure of damages. However, while administratively convenient, this “licensing-based damages” standard creates problematic incentives and undermines the efficient commercialization of patented inventions. It rests on the trivialized (and generally false) presumption that a patent license is like a commodity, with the patentee charging a common price to all comers. As a consequence, patentees distort their future recovery prospects—and, by extension, the outcomes of future licensing negotiations—whenever they license their patents, whether or not today’s agreement will be a good proxy for tomorrow’s dealings or disputes. Knowing this, patentees are discouraged from licensing at anything less than a high royalty rate, even if they could reach many additional mutually beneficial agreements on more modest terms. The result is that patent holders rationally cut off the bottom segment of the licensing market, creating substantial deadweight loss. This injures not only patentees but also prospective licensees and their consumers. The standard creates additional problems by encouraging secrecy and gamesmanship in patent licensing.
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