IP: Federal Circuit Flags the 25 Percent Rule and Penalizes the EMV End Run

The rousing cheer that erupted coast-to-coast on Jan. 4 had nothing to do with a college bowl game. It was actually the patent defense bar heralding the Federal Circuit's recent pronouncement on patent damages in the Uniloc v. Microsoft decision. In Uniloc, the Federal Circuit struck down two "trick plays" that had become part of every plaintiff lawyer's game plan on damages: the 25 percent rule and the Entire Market Value (EMV) End Run. In doing so, the Federal Circuit went a long way towards leveling the playing field in patent cases.

Flagging the 25 Percent Rule

The 25 percent rule is a "rule of thumb" that stands for the proposition that a licensee would typically be willing to license a patent for 25 percent of the profits the licensee would derive from the patent. The 25 percent rule was originally based on a mid-90s study of licenses entered into by a Swiss subsidiary of an American company. Over the years, expert after expert has relied on the 25 percent rule, adding to its apparent validity. Unfortunately, the 25 percent rule never made much sense for general application. The patent statue prescribes a reasonable royalty as an appropriate measure of damages for patent infringement. Under Federal Circuit case law, a reasonable royalty is determined by looking at a hypothetical negotiation that would have occurred between the parties at the time the infringement commenced. While past licensing practices of the parties would certainly be relevant to this hypothetical negotiation, it is hard to see how the decades old practices of a Swiss company should fit into the mix. Despite the obvious flaw of this "tool," many courts accepted its use simply because it appeared to have achieved widespread acceptance.

In Uniloc, the Federal Circuit did not mince words in benching the 25 percent rule. The Court held "as a matter of Federal Circuit law that the 25 percent rule is a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation. Evidence relying on the 25 percent rule of thumb is thus inadmissible under Daubert and the Federal Rules of Evidence, because it fails to tie a reasonable royalty base to the facts of the case at issue."

Penalizing the EMV End Run

Under the prevailing patent jurisprudence, a plaintiff cannot claim damages based on the entire market value of an end product unless the patented technology creates the basis for the market demand for the product. For example, a plaintiff holding a patent on an automobile battery can not claim damages on the value of the entire automobile, without first showing that the battery created the market demand for the car. Because plaintiffs typically cannot meet this burden, they are unable, under the law, to use the entire market value of a product in damage calculations. Over the years, however, wily plaintiffs lawyers have developed a number of end runs around the EMV rule. One typical practice is to use the value of the end product as a "check" on the plaintiff's damages number. For example, a plaintiff's expert may calculate a damages number based on an appropriate royalty base and then compare that number to the EMV in an effort to show the "reasonableness" of the expert's result. Another end run is to use the EMV to criticize the defendant's expert. That play usually goes something like this:

  • Q: Now you understand that the defendant made XXX billion dollars on sales of the infringing products?
  • Q: And you are telling the jury that they should only have to pay XXX thousand dollars in damages?
  • Q: And you understand, don't you that your number amounts to .000001% of the money the defendant made from this product?

Neither of these end runs were fair for the defendant, because they both interjected the EMV into the jury's deliberation without first establishing that the patent was the driver for the product sales.

Again, the Federal Circuit was swift in calling a penalty on these tactics. Per Uniloc, these tactics "are in clear derogation of the entire market value rule, because the entire market value of the accused products has not been shown to be derived from the patented contribution.

Although there was no trophy awarded on Jan. 4, I think most members of the patent defense bar will agree that the good guys won the "Uniloc Bowl."

Mark Scarsi is a partner in the Intellectual Property Group of Milbank, Tweed, Hadley & McCloy, LLP, resident in the Los Angeles office.

Read Mark Scarsi's previous column.

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Mark C. Scarsi

Mark Scarsi is a partner in the Intellectual Property Group of Milbank, Tweed, Hadley & McCloy, LLP, resident in the Los Angeles office.

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