Opinion ID: 766357
Heading Depth: 3
Heading Rank: 1

Heading: Calculation of the Infringers' Profits

Text: 50 Section 504(b) of the Copyright Act authorizes a copyright owner to recover the infringer's profits. That section expressly provides that [i]n establishing the infringer's profits, the copyright owner is required to present proof only of the infringer's gross revenue, and the infringer is required to prove his or her deductible expenses and the elements of profit attributable to factors other than the copyrighted work. 17 U.S.C. § 504(b). Put another way, the infringer's profits are calculated as the gross sales of infringing goods minus the costs that the infringer proves are attributable to the production and sale of those goods. 51 In compliance with this statutory procedure, Hamil America submitted proof of GFI's gross revenue from the sale of the infringing dress patterns, and GFI submitted a schedule of its deductible expenses that included both the actual costs of production of the infringing pattern as well as its general, or fixed, overhead expenses. The district court rejected GFI's submission to the extent that it sought deductions for overhead expenses, stating that GFI would have had general administrative expenses of 'X' amount whether [it] sold [the infringing] goods or not. The court also rejected certain specific expenses, such as country club dues, on the ground that they were not incremental costs of producing [the infringing] fabric. The court asked GFI to adduce the actual cost of the goods, what it actually cost [GFI] to manufacture [the] specific items. The district court accepted GFI's amended cost schedule, which showed only the variable costs of producing and selling the infringing pattern, and which excluded general overhead items such as rent, insurance, and depreciation. See Hamil America, Inc., 1998 WL 19991, at . 52 GFI argues that the district court erred in excluding an allocation of general overhead expenses in its calculation of GFI's profits and that we must remand for recalculation of damages. We agree. 53 Our analysis begins with Sheldon v. Metro-Goldwyn Pictures Corp., 106 F.2d 45 (2d Cir. 1939) (L. Hand, J.), in which a motion picture studio infringed the copyright on a certain play. The district court allowed a deduction for overhead expenses based on the ratio that the cost of producing the infringing movie bore to the total costs of the movie studio. See id. at 54. On appeal, the copyright holder argued that the infringers should not have been permitted any deduction for overhead expenses absent a showing that the overhead had been increased by the production of the infringing movie, which was only one of forty produced by the studio. See id. This court affirmed, noting generally that, '[o]verhead' which does not assist in the production of the infringement should not be credited to the infringer; that which does, should be; it is a question of fact in all cases. Id. 54 Turning to the specific facts of the Sheldon case, the court applied its general rule as follows: 55 In the case at bar the infringing picture was one of over forty made by the defendants, using the same supervising staff and organization, which had to be maintained if the business was to go on at all. Without them no picture could have been produced; they were as much a condition upon the production of the infringing picture as the scenery, or the plaintiffs' play itself. 56 Id. The court thus concluded that certain categories of general overhead expenses in this case, those relating to creating and maintaining a supervising staff and organization -- were appropriately deducted from gross revenue. The court then considered various methods of allocating those overhead expenses to the production of the infringing movie, and selected the method that was most fair, accurate, and practical in light of the infringing company's structure and products. Given the impossibility of determining the overhead costs that were directly related to the production of the infringing motion picture, the court permitted a deduction of a portion of overhead expenses based on the cost of production of the motion picture: 57 [T]o make a perfect allocation one would have to examine what part of the time of all the employees whose pay went into the overhead, was given to each picture; and so of the other expenses. That was obviously impossible. It is on the whole more likely that a given picture required that proportion of the general services represented by its cost of production, than that each picture shared those services equally. . . . The [cost of production] solution appears to us as nearly right as was practically possible. 58 Id. at 52-53. 59 The court therefore affirmed the district court's use of an estimate of overhead expenses based on the cost of production -- notwithstanding the absence of particularized findings as to the use of those expenses for things that specifically contributed to the infringing picture -- because of the extravagant labor necessary to determine the incremental contribution of individual property to the infringing picture: 60 It was better . . . to compute this item by assuming that the infringing picture used that proportion of the whole plant which its cost of production bore to the cost of production of all pictures made that year, than to attempt any allocation of buildings and other property according to their actual use for the picture. The second method would have been incredibly difficult in application, involving as it would a different proportional use of each bit of property concerned. 61 Id. at 54. In adopting this pragmatic approach, the court implicitly rejected the need for a detailed analysis of an infringer's ledgers. 62 Sheldon thus contemplates a two-step procedure for deducting overhead expenses from an infringer's profits. The first step is to determine what overhead expense categories (such as rent, business, entertainment, personnel and public relations) are actually implicated by the production of the infringing product. Once a sufficient nexus is shown between a category of overhead and the production or sale of the infringing product, a court need not scrutinize for inclusion or exclusion particular items within the overhead category. For example, if entertainment expenses is a category of overhead implicated in the line of business that produced or sold the infringing product, then country club dues included within that category should not be singled out for exclusion, as they were by the district court here. Rather, the court should limit its inquiry to the sufficiency of the nexus between the expense category and production of the infringing product. 63 The second step is to arrive at a fair, accurate, and practical method of allocating the implicated overhead to the infringement. The infringer has the burden of offering a fair and acceptable formula for allocating a given portion of overhead to the particular infringing items in issue. 4 Melville B. Nimmer and David Nimmer, Nimmer on Copyright § 14.03[B], at 14-39 (1996); see also In Design v. K-Mart Apparel Corp., 13 F.3d 559, 565-66 (2d Cir. 1994). The reasonableness of the proffered overhead allocation formula is a question of fact in all cases. See Sheldon, 106 F.2d at 54. 5 64 Sheldon's approach has been consistently applied by this Court. In subsequent cases, we have assumed that general overhead expenses were deductible and reviewed only the sufficiency of the nexus between the expense and the infringing product and/or the adequacy of the adduced formula for allocating overhead costs to the production of the infringing product. In Design, for example, concerned a copyright holder's challenge to the district court's conclusion that certain overhead expenses (including rent, advertising, payroll, shipping, and store supplies) were deductible from gross profits. See In Design, 13 F.3d at 565-66. Applying the Sheldon rule, we affirmed and held that overhead expenses were appropriately deducted because such expenses are generally deductible, because the expenses were sufficiently related to the sale of the infringing product, and because the allocation formula offered by the infringer was reasonable. See id. at 566. 65 In another case, we rejected an infringer's allocation of company overhead, which was based on the percentage of the company's net sales to the infringing line of goods, on the ground that the proffered allocation was not the most reliable method available to the infringer. See Manhattan Indus. v. Sweater Bee by Banff, Ltd., 885 F.2d 1, 7-8 (2d Cir. 1989). We reasoned that although an infringer need not prove its overhead expenses and their relationship to the production of the contemptuous goods in 'minute detail,' it must still carry its burden of demonstrating a sufficient nexus between each expense claimed and the sales of the unlawful goods. Id. (emphasis added) (quoting Frank Music Corp. v. Metro-Goldwyn-Mayer, Inc., 772 F.2d 505, 516 (9th Cir. 1985)). See also Gaste v. Kaiserman, 863 F.2d 1061, 1071 (2d Cir. 1988) (rejecting a 90 percent allocation of overhead to an infringing song that represented 90 percent of the infringer's sales); Wilkie v. Santly Bros., Inc., 139 F.2d 264, 265 (2d Cir. 1943) (holding that general allocation formula should allocate overhead equally to each song produced by the infringer because there was no evidence that the infringing song contributed more to the overhead costs than the publisher's other 47 songs). 66 Despite the clear precedent on the deduction of overhead expenses established by Sheldon and its progeny, the district court here prohibited GFI from deducting any overhead whatsoever unless GFI could show that its overhead was actually increased by its production of Pattern No. 330. See Hamil America, Inc., 1998 WL 19991, at  ([T]he Court must examine the facts to determine those incremental cost[s] of the infringer that were increased as a direct result of the production and sale of the infringing goods . . . and to separate them from those fixed costs that would have been incurred in any event.). The court appears to have based its holding at least in part on the fact that the infringement by GFI was willful, relying on cases from other jurisdictions suggesting that willful or deliberate infringers may not deduct overhead when calculating the profit the plaintiff is entitled to recover. Seeid. at  (citing Jarvis v. A & M Records, 827 F. Supp. 282, 294 (D.N.J. 1993)). See also Saxon v. Blann, 968 F.2d 676, 681 (8th Cir. 1992); Frank Music Corp., 772 F.2d at 515. 67 Unlike the district court, we are not prepared to abandon the teachings of Sheldon in favor of a hard and fast rule denying all overhead deductions to willful infringers. But we share the district court's concern that willful infringers should not be permitted to subsidize the sale of legitimate goods with the sale of infringing goods by passing part of its fixed cost on to the copyright holder. See id. at . We also recognize that a rule of liability which merely takes away profits from an infringement would offer little discouragement to infringers. F.W. Woolworth Co. v. Contemporary Arts, Inc., 344 U.S. 228, 233 (1952). We therefore conclude that Sheldon's two-step approach must be applied with particular rigor in the case of willful infringement. 68 Every infringer shoulders the burden of demonstrating a sufficient nexus between each expense claimed and the sales of the unlawful goods, Manhattan Indus., 885 F.2d at 8, before it may deduct any overhead expenses from its profits. When infringement is found to be willful, the district court should give extra scrutiny to the categories of overhead expenses claimed by the infringer to insure that each category is directly and validly connected to the sale and production of the infringing product. Unless a strong nexus is established, the court should not permit a deduction for the overhead category. See Kamar Int'l Inc. v. Russ Berrie & Co., 752 F.2d 1326, 1332 (9th Cir. 1984) (allowing overhead deduction only when the infringer can demonstrate it was of actual assistance in the production, distribution or sale of the infringing product. (citing Sheldon)). 69 An infringer also bears the burden of proposing a fair and acceptable formula for allocating a portion of overhead expenses to the infringing items at issue. See In Design, 13 F.3d at 565-66. The district court must determine that the particular allocation formula is optimal and sound, and all presumptions are drawn against the infringer. See id. at 564 (Any doubts resulting from an infringer's failure to present adequate proof of its costs are resolved in favor of the copyright holder.) (citing Gaste, 863 F.2d at 1070-71); see also Nimmer on Copyright, § 14.03[B], at 14-40 ([If] the computation of profits and costs is uncertain due to the failure of the [infringer] to keep adequate records of costs, any doubt in the evidence will be resolved in favor of the plaintiff.). The allocation formula of a willful infringer should be held to a particularly high standard of fairness, and the court should not hesitate to reject a formula which allows the willful infringer to deduct more of its overhead than was directly implicated in the manufacture of the infringing product. 70 Because the district court erred under Sheldon in applying a blanket prohibition of all overhead deductions, we reverse on this issue and remand for a recalculation of GFI's profits. In that proceeding, GFI, as a willful infringer, must demonstrate a direct and valid nexus between each claimed overhead expense category and the production of GFI Pattern No. 330 and propose a fair and acceptable formula for allocating a portion of overhead to the pattern's production. The district court, applying the heightened scrutiny appropriate in cases of willful infringement, will have the latitude to adopt or reject certain categories of overhead, and to accept, reject, or amend GFI's overhead allocation formula. Of course, if the resulting calculation causes the district court to reconsider its finding that Hamil America will be fully compensated on its claims, see Hamil America, Inc., 1998 WL 19991, at , the court could award Hamil America its actual damages in lieu of, or in addition to, GFI's recalculated profits. See 17 U.S.C. § 504(b).