Federal Circuit Finds 25 Percent Rule "Fundamentally Flawed"

For years, many trial courts have relied on the 25 percent rule of thumb, which calls for a 25 percent royalty rate in calculating patent infringement damages in cases such as Uniloc v. Microsoft, in which one party (in this case Microsoft) is accused of using a patented device as a component in one of its products. Calling the rule "fundamentally flawed," the Federal Circuit put an end to its use with the Jan. 4 ruling in Uniloc v. Microsoft.

The 25 percent rule relied on the supposition that the licensee would be willing to give up 25 percent of profits for the right to use a patented technology or device, keeping 75 percent. Although it was convenient and widely used, application of the 25 percent rule took little into consideration aside from the projected value of the products. Important facts of the case, such as the relationship between the parties in dispute and the value of the patented component in the offending product, were not considered.

The unanimous panel decision reverses a district court ruling granting Microsoft's motion for Judgment as a Matter of Law (JMOL), meaning there was no dispute of the facts of the case, of non-infringement. The Federal Circuit's reversal reinstates a jury's infringement verdict, bringing the issue of damages calculations to the forefront.

"From a damages standpoint, because of the sheer high volume of Microsoft products, that put a lot potentially in play," explains Matt Woods, a partner at Robins, Kaplan, Miller & Ciresi. "Microsoft made a Judgment as a Matter of Law motion, essentially to take the case away from the jury saying that there should have been a finding of no infringement and invalidity, and the damages were completely overstated."

Although the Federal Circuit sided with Uniloc in reversing the district court's JMOL on the issue of infringement, it agreed with Microsoft's assessment of the damages as excessive and, in addition to throwing out the 25 percent rule of thumb used to calculate the damages, it excluded expert testimony that "checked" the suggested damages using the "entire market value rule." The court made clear that damage calculations should not be based on an infringing product's entire market value unless "the patented feature creates the 'basis for customer demand' or 'substantially create[s] the value of the component parts.'"

Rule of Thumb

In Uniloc v. Microsoft, the patented technology in question is a product activation key. The patent Uniloc owns covers a mechanism that combats copying software by requiring a unique activation code, limiting the number of computers a licensed piece of software can be installed on. Microsoft uses these activation codes in much of the software it sells, including the popular Office suites.

At trial, Uniloc's expert testified that, based on the 25 percent rule, appropriate damages in the case would total nearly $565 million. He arrived at this number by applying the 25 percent rule to an internal Microsoft document that valued the product keys at a minimum of $10 each. Assuming a royalty rate of $2.50 per use, the expert then multiplied that amount by the number of Office and Windows licenses that use the product activation key. Finally, he "checked" his findings against the $19 billion total market value of Microsoft products, noting that his damages recommendation represented just 2.9 percent of the products' gross revenue.

Microsoft objected, arguing that total revenue was an invalid test because the patented technology didn't drive consumer demand.

"At the end of the day, the Federal Circuit said you can't use rules of thumb because they fail to account for the relationship between the patent and the accused product, and they also fail to account for the unique relationship between the parties, and they're essentially arbitrary," says Chris Renk, a shareholder at Banner & Witcoff.

The court stressed the importance of these unique relationships in determining damages. Going forward, parties seeking damages for patent infringement will need to carefully connect their damages theory to the facts of the given case.

Leveraging Licenses

One way to establish damages, which will likely become more common, is through licensing agreements. Experts warn that those looking to establish a royalty rate through a licensing agreement should aim for agreements that address the patented technology specifically, steering clear of licenses that address large patent portfolios.

"When entering into a licensing agreement, you should consider whether the agreement is going to be usable in litigation to support a similar royalty rate," says Tom Fisher, a partner at Oblon Spivak. "You're trying to determine what a willing licensee and a willing licensor would have arrived at. If you can show that a license agreement to a similar feature was negotiated between similarly situated parties, then that agreement will be persuasive in the litigation, and a similar value should be arrived at."

The Uniloc decision emphasizes the importance of relevance and specificity--two things that experts predict will be vital in licensing agreements as well. The more specific and similar the license is
to the patent for which damages are being sought, the more likely courts are to
rely on it.

"Relying on license agreements that are unrelated to the facts of the given case and are void of any economic tie or analysis correlating it to the facts in the case are equally as unreliable," Renk says. "They won't withstand scrutiny at the appellate court, just like the 25 percent rule didn't withstand scrutiny."

Kayleigh Roberts

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