The Federal Circuit Rejects the 25% Rule of Thumb and Further Addresses the Entire Market Value of Accused Products
On January 4, 2011, the Federal Circuit rejected the 25% rule of thumb in Uniloc USA, Inc. v. Microsoft Corp.1 The Uniloc decision also addressed the issue of whether the entire market value of a product can be introduced as a “reasonableness check” on a royalty rate. As foundation for its opinion, the Uniloc court cited previous decisions that have held: “any evidence unrelated to the claimed invention does not support compensation for infringement but punishes beyond the reach of the statute.”
The Uniloc patent was directed to a software registration system to deter copying of software. At trial, the jury awarded Uniloc $388 million. On post-verdict motions, the District of Rhode Island granted Microsoft a new trial on the issue of damages. Uniloc appealed. The Federal Circuit agreed with the district court that the jury’s damages award was fundamentally tainted by the use of a legally inadequate methodology.
Rejection of the 25% Rule of Thumb
The 25% rule of thumb is a construct that has been used by some damage experts to approximate the reasonable royalty rate that an infringer would be willing to pay to the patent owner for use of the patented technology. It has been suggested that the potential licensee would pay a royalty rate equivalent to 25% of its expected profits for the product that incorporates the patented technology.2 The underlying assumption is that the licensee should retain a majority of the profits (75%) because it has contributed other technology and/or incurred development, operational and commercialization risks in bringing its product to market.
The 25% rule has been criticized as essentially arbitrary because the rule does not account for the importance of the patent to the accused product or consider the actual relationship between the parties.3
The Federal Circuit acknowledged that it had itself "passively tolerated" use of the 25% rule “where its acceptability has not been the focus of the case or where the parties disputed only the percentage to be applied.” However, the Uniloc court concluded that the admissibility of the bare 25% rule had “never been squarely presented to this court.”
The Federal Circuit held as a matter of law that the “25 percent rule of thumb 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.”
After an extensive discussion of the 25% rule, the Uniloc court summarized three categories of criticisms:
- It fails to account for the unique relationship between the patent and the accused product,
- It fails to account for the unique relationship between the parties, and
- The rule is essentially arbitrary and does not fit within the model of the hypothetical negotiation within which it is based.
The Federal Circuit further held that using the 25% rule of thumb as a starting point and then applying the Georgia-Pacific factors to adjust the rate (as Uniloc’s expert did) is impermissible because “beginning from a fundamentally flawed premise and adjusting it based on legitimate considerations specific to the facts of the case nevertheless results in a fundamentally flawed conclusion.”
The Entire Market Value Rule
Another damages issue that the Federal Circuit addressed in Uniloc involved the Entire Market Value Rule. The Entire Market Value Rule allows a patentee to claim damages based on the market value of the accused product only where the patented feature creates the “basis for customer demand” or “substantially create(s) the value of the component parts.”4
Uniloc had conceded customers do not buy Microsoft’s Office or Windows because of the patented technology at issue and agreed that it would not base a royalty calculation on the entire market value of the products.5 However, at trial, Uniloc’s damage expert used a demonstrative pie chart to compare his suggested royalty against the total $19 billion of sales of the accused products as a “reasonableness” check. Uniloc’s counsel also used the $19 billion total sales figure during cross-examination of Microsoft’s expert and in closing argument. The district court concluded that this evidence might have tainted the jury verdict and granted Microsoft’s motion for a new damages trial. The Federal Circuit affirmed, holding that even if the jury’s damages calculation was not based wholly on the entire market value, the award was supported in part by the “faulty foundation of the entire market value.” In other words, if the entire market value of the accused products was not derived from the patented contribution, the “entire market value” of the accused products may not be used as a “reasonableness check.”
Uniloc also argued that the entire market value of the products may appropriately be admitted if the royalty rate is low enough. In Lucent, the Federal Circuit had stated that:
“[T]he base used in a running royalty calculation can always be the value of the entire commercial embodiment, as long as the magnitude of the rate is within an acceptable range (as determined by the evidence).”6
Despite this language in Lucent, the Uniloc court stated:
“The Supreme Court and this court’s precedents do not allow consideration of the entire market value of accused products for minor patent improvements simply by asserting a low enough royalty rate.”
1 No. 2010-1035, -1055 (Fed. Cir. Jan. 4, 2011).
2 Gordon Smith and Russell Parr, INTELLECTUAL PROPERTY: VALUATION, EXPLOITATION AND INFRINGEMENT DAMAGES, 412, Use of the 25% Rule in Valuing Intellectual Property (2005).
3 The Demise Of Junk Science And The 25% Rule, law360.com (July 28, 2010) available at http://www.law360.com/web/articles/181888.
4 Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301, 1336 (Fed. Cir. 2009).
5 Uniloc USA, Inc. v. Microsoft Corp., 640 F. Supp. 2d 150, 184 (D.R.I. 2009).
6 Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301, 1338-39 (Fed. Cir. 2009).