More On

IP: The Demise of The 25 Percent Rule and Its Impact on Patent Damages

The Federal Circuit's recent decision in Uniloc USA, Inc. v. Microsoft Corp. continued the court's trend toward increasing scrutiny over the award of damages in patent infringement cases. In Uniloc, the Federal Circuit held that, as a matter of law, the "25 percent rule" is a fundamentally flawed tool for determining a reasonable royalty. The court also clarified that the entire market value of an accused product may only be used to determine a reasonable royalty where the patented feature either creates the basis for customer demand or substantially creates the value of the component parts.

The 25 Percent Rule

A reasonable royalty is the predominant measure of damages in patent infringement litigation. Most often, a reasonable royalty is determined based upon a hypothetical negotiation between a willing licensor and licensee using the so-called Georgia Pacific factors. The 25 percent rule suggests that a willing licensee would be willing to pay 25 percent of its expected profits for the product that incorporates the intellectual property at issue. In Uniloc, the Federal Circuit noted that it had never squarely addressed the admissibility of the 25 percent rule, but the court acknowledged that it had "passively tolerated" the rule's use in numerous cases.

In a detailed assessment of the evidentiary basis for the 25 percent rule, the Federal Circuit concluded that the rule fails to account for the unique relationship between the patent and the accused product by ignoring actual profits, available non-infringing alternatives and other details affecting real-world royalty negotiations. The court also concluded that the rule fails to account for the unique relationship between the parties, such as the parties' relative bargaining positions, or prevailing royalty rates common to the industry or technology at issue.

Ultimately, the Federal Circuit concluded that the 25 percent rule is "essentially arbitrary" and does not fit within the model of a hypothetical negotiation. Accordingly, the court ruled that expert testimony relying on the rule is inadmissible under Daubert and the Federal Rules of Evidence.

The Entire Market Value Rule

The entire market value rule allows a patentee to assess damages based upon the entire value of the accused product only where the patented feature either creates the basis for customer demand or substantially creates the value of the component parts. In Uniloc, the patent at issue claimed a software registration system to prevent unauthorized copying. At trial, the patentee conceded that the system did not create the basis for consumer demand of Microsoft's accused software products. Nevertheless, the patentee's damages expert used the overall profitability of Microsoft's products as a "check" to confirm the reasonableness of his royalty determination. The patentee's expert testified at trial that he had applied this "check" by comparing his $565 million royalty amount to Microsoft's total revenue of more than $19.28 billionearned through sales of accused products.

The Federal Circuit rejected the patentee's reference to the overall profitability of the accused products as a "check." The court explained that even if the jury's award was not based wholly on the entire market value of the accused products, the award was supported in part by the patentee's inappropriate reference to the overall profitability. The court also rejected the patentee's claim that its reference to the overall profitability of the accused products was justified because the patentee claimed a low reasonable royalty rate.

Practical Implications

In addition to the clear prohibition against use of the 25 percent rule to calculate a reasonable royalty rate, the Federal Circuit's decision in Uniloc has several other practical implications for the determination of damages of patent cases:

  • Damage analysis must be tied to the value of the invention in the market. The Federal Circuit's decision in Uniloc is another step in the Federal Circuit's increased scrutiny of the economic basis for damage awards in patent cases. As explained by the Federal Circuit, admissible expert testimony addressing a reasonable royalty rate, must "tie to the claimed invention's footprint in the market."
  • Comparable licenses and customary profitability remain relevant. The court in Uniloc confirmed the use of the Georgia-Pacific factors to determine a reasonable royalty, and expressly held that factors (1) and (2) - addressing royalties paid or received for the patent in suit or for comparable technology; and factor (12) relating to customary profitability in an industry remain "valid and important factors" in the determination of a reasonable royalty. However, parties should strive to fully develop the facts necessary to link the royalty rates in other licenses to the hypothetical negotiation applicable to the patent in suit.
  • Evidence regarding the source of consumer demand is critical. The Uniloc decision also underscores the importance of developing evidence demonstrating whether or not the patented feature drives consumer demand for an accused product. Evidence that a patented feature drives consumer demand not only supports a higher reasonable royalty rate, but, in most cases, is also necessary to support the admission of evidence regarding the overall profitability of the accused products under the entire market value rule.

Read Chris Larus' next column.

Join the Conversation

Advertisement. Closing in 15 seconds.