Schnadig Corp. v. Gaines Mfg. Co., Inc.

• Citation: 206 USPQ 202,620 F.2d 1166
• Decision Date: 08 May 1980
• Docket Number: No. 77-1738,77-1738
• Parties: SCHNADIG CORPORATION, Plaintiff-Appellant, v. GAINES MANUFACTURING COMPANY, INC., Defendant-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (6th Circuit)

Page 1166

620 F.2d 1166

206 U.S.P.Q. 202

SCHNADIG CORPORATION, Plaintiff-Appellant, v. GAINES MANUFACTURING COMPANY, INC., Defendant-Appellee.

No. 77-1738.

United States Court of Appeals Sixth Circuit.

Argued Oct. 5, 1979.

Decided May 8, 1980.

Henry T. V. Miller, McDonald, Kuhn, Smith, Gandy, Miller & Tait, Memphis Tenn., John W. Chestnut, Timothy L. Tilton, Chicago, Ill., for plaintiff-appellant.

Roy Keathley, Heiskell, Donelson, Adams, Williams & Kirsch, Memphis, Tenn., Edward A. Haight, Chicago, Ill., for defendant-appellee.

Before CELEBREZZE and ENGEL, Circuit Judges and PECK, Senior Circuit Judge.

ENGEL, Circuit Judge.

In this appeal we are asked to decide whether the infringer of a design patent can use the income taxes and fixed expenses attributable to his infringing activities to reduce the amount of his "total profit" from the infringement which a design patentee can recover under 35 U.S.C. § 289 (1976).

I. FACTS

Plaintiff Schnadig obtained a design patent on a three piece Spanish motif sectional sofa suite. In Schnadig Corp. v. Gaines Mfg. Co., 494 F.2d 383 (6th Cir. 1974), this court affirmed the district court's findings that Schnadig's patent was valid and infringed by Gaines' production and sale of its "suite 495" sectional sofa. Schnadig elected to recover Gaines' "total profit" on the infringement under 35 U.S.C. § 289 in lieu of actual damages. In determining the amount of the award the district court allowed the defendant to use the income taxes and approximately two-thirds of the fixed costs attributable to the infringing production to offset its profit figure. Schnadig appeals from the damage award, claiming that it is entitled to recover the infringer's pre-tax profits, determined without reduction for fixed costs.

II. STATUTORY SCHEME

Although the design patent is not as popularly known as its counterparts, the utility patent and the copyright, design patents perform a distinct function in the federal scheme of legal protection for creative works. The design patent has existed since 1842. Act of August 29, 1842, ch. 263 § 3, 5 Stat. 544. The 1842 statute granted a patent to anyone who by "their own industry, genious, efforts, and expense, may have invented or produced any new and original design for a manufacture . . . ." The current design patent statute differs little from its ancestor, providing that a design patent may be obtained by the inventor of "any new, original and ornamental design for an article of manufacture." 35 U.S.C. § 171 (1976).

By comparison, utility patents protect a different category of invention; they are available for "(w)hoever invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof . . . ." 35 U.S.C. § 101 (1976). Copyright affords a different type of protection to "original works of authorship fixed in any tangible medium of expression," a classification which includes the designs of useful articles insofar as the design features "can be identified separately from, and are capable of existing independently of, the utilitarian aspects of the article." ¹ Both copyrights and design patents can be used in some circumstances to protect the design of useful articles. ² However copyright protection is more limited in scope than the protection afforded by a design patent. ³

The design patent resembles the utility patent in its requirement of novelty, and its grant of a temporary absolute monopoly. ⁴ Both design and utility patentees also share one measure of recovery for patent infringement, that afforded by 35 U.S.C. § 284 (1976), which provides in pertinent part:

Upon finding for the claimant the court shall award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer, together with interest and costs as fixed by the court.

However, the design patentee also has an additional remedy for infringement not available to the utility patentee. This remedy is provided by 35 U.S.C. § 289:

§ 289. Additional remedy for infringement of design patent.

Whoever during the term of a patent for a design, without license of the owner, (1) applies the patented design, or any colorable imitation thereof, to any article of manufacture for the purpose of sale, or (2) sells or exposes for sale any article of manufacture to which such design or colorable imitation has been applied shall be liable to the owner to the extent of his total profit, but not less than $250, recoverable in any United States district court having jurisdiction of the parties.

Nothing in this section shall prevent, lessen, or impeach any other remedy which an owner of an infringed patent has under the provisions of this title, but he shall not twice recover the profit made from the infringement.

It is this "additional remedy" which plaintiff Schnadig has elected to pursue.

The meaning of the words "total profit" as they are used in 35 U.S.C. § 289 is a matter of first impression in this circuit; in fact, no court has squarely addressed this issue in a published opinion. ⁵ Although Justice Holmes' observation that "the life of the law has not been logic; it has been experience" ⁶ may be true, the lack of judicial experience in this area requires resort to the logic of the various possible interpretations of section 289.

III. THE DEDUCTION OF INCOME TAXES FROM THE AWARD

The statute provides that the infringer of a design patent "shall be liable to the owner to the extent of his total profit." 35 U.S.C. § 289. The district court ruled that the patentee can recover only the infringer's after-tax profit under this section. The court reasoned that "(t)he awarding of defendant's profits on a before tax basis is a harsh penalty, and the usual measure of profits should be after taxes have been calculated."

An award of pre-tax profits may seem harsh because it apparently requires an infringer to pay more in damages than he was able to gain from the infringement. However, this conclusion ignores the ultimate effect of the payment of the award on the infringer's taxes. We must carry the inquiry one step further to appraise the fairness of excluding the amount paid in income taxes from an award of profits.

When an infringer is required to pay damages to a design patentee, the amount so paid is deductible from his income tax. ⁷ To illustrate, if a company earned a net pre-tax profit of $100 by infringing, paid $50 in tax, and paid the remaining $50 as damages to the patentee, the infringer would have no remaining cash, but would have a $50 tax deduction available to him. At our fictional 50% tax rate, this deduction would be worth $25 to the infringer, and if the deduction is fully utilized it would represent a $25 net overall gain on the infringement. The reciprocal of the infringer's deduction of the award is the patentee's inclusion of the award in his gross income. ⁸ Retaining our fictional 50% tax rate, the patentee will keep only $25 of the $50 award, paying the other $25 in tax. In that hypothetical, but very realistic, possibility, the infringer nets as much as his victim, and perhaps even more if the dynamics of the money market are considered.

Although the above illustration is true in theory, the actual dollar impact of a damage award on the taxes of either party will naturally depend upon the party's overall tax situation. Tax rates will vary, and offsetting losses could conceivably bar use of the deduction or negate any tax effect of the award. ⁹ Nonetheless, because a taxpayer can generally utilize a loss during any of the seven years after, or the three years prior to the year the loss was incurred, ¹⁰ the vast majority of infringers should be able to utilize the deduction. If the award was based upon the infringer's after-tax profits, this deduction will allow the infringer to reap a net gain from his infringing activity.

These tax consequences of a patent damage award are not a new development. A Treasury Office Decision issued in 1919 provided that:

(T)he amount which a plaintiff should report as income or a defendant may deduct in the case of an award for damages on account of patent infringement is not affected by the amount of federal taxes which have been paid by the defendant. The amount to be reported or deducted is the total amount awarded by the court.

O.D. 26, 1 C.B. 67 (1919), declared obsolete, Rev.Rul. 72-440. 1972-2 C.B. 649. In Larson Co. v. Wrigley Co., 277 U.S. 97, 48 S.Ct. 449, 72 L.Ed. 800 (1928), the Supreme Court considered this tax effect in determining the amount which could be recovered as profits in a trademark infringement case. Mr. Justice Holmes wrote for the Court:

It would be unjust to charge an infringer with the gross amount of his sales without allowing him for the materials and labor that were necessary to produce the things sold, but it does not follow that he should be allowed what he paid for the chance to do what he knew that he had no right to do. . . . Even if the only relief that the Wrigley Company can get is a deduction from gross income when the amount of its liability is finally determined, the Larson Company will have to pay a tax on the Wrigley profits when it receives them, and in a case of what has been found to have been one of conscious and deliberate wrongdoing, we think it just that the further deduction should not be allowed.

277 U.S. at 100, 48 S.Ct. at 449.

Although the court in Larson held that pre-tax profits should be awarded, defendant Gaines urges that the Court limited such a remedy to cases of "conscious and deliberate wrongdoing." The defendant claims that its infringement did not constitute conscious and deliberate wrongdoing, and therefore an award of after-tax profits is justified. Although the district court's findings could well be read as indicating deliberate wrongdoing, ¹¹ such a finding is not necessary. The...