CAFC Nixes 25% "Rule of Thumb" Application For Estimating Patent Damages

Uniloc USA, Inc. v. Microsoft Corp., No. 2010-1035 (Fed. Cir., January 4, 2011)

35 U.S.C. §284 provides that on finding infringement, damages shall "in no event [be] less than a reasonable royalty for the use made of the invention by the infringer, together with interest and costs as fixed by the court." In litigation, a reasonable royalty is often determined on the basis of a hypothetical negotiation, occurring between the parties at the time that infringement began.

The 25 percent rule of thumb is a tool that has been widely used to approximate the reasonable royalty rate that the manufacturer of a patented product would be willing to offer to pay to the patentee during a hypothetical negotiation. In a nutshell, the application of the rule works like this:

1. Estimate the infringer's (licensee's) expected profits for the product during the infringing period,
2. divide the expected profits by the expected net sales over that period to arrive at a profit rate (e.g., 16%),
3. multiply the profit rate (16%) by 25% to arrive at a running royalty rate (16% X 25% = 4%), and
4. apply the royalty rate to the infringer's net sales to get the royalty payment.

The rule is based on the assumption that the infringer/licensee should retain a majority (i.e., 75%) of the profits, because it has undertaken substantial development, operational and commercialization risks.

According to its proponents, the veracity of the 25 percent rule has been "confirmed by a careful examination of years of licensing and profit data, across companies and industries."  Earlier empirical studies concluded that, across all industries, the median royalty rate was 22.6% and that the data supported the use of the 25% rule "as a tool of analysis."  A survey of licensing organizations in 1997 found that 25% of them used "the 25% rule" as a starting point in negotiations.

In the case of Uniloc, Microsoft was found to infringe Uniloc's patent directed to software "product key" technology that helped prevent "casual copying" of software products.  The jury awarded Uniloc $388M in damages.  The damage award was based on the testimony of Uniloc’s expert, Dr. Gemini.  Gemini opined that the damage calculation was based on the value of a product key ($10) multiplied by 25% of the value of the product (Windows XP, Microsoft Word), resulting in a baseline royalty rate of $2.50 per license issued.

During litigation, Microsoft challenged the 25% rule and attempted to exclude Gemini’s testimony. The district court noted that "the concept of a ‘rule of thumb’ is perplexing in an area of the law where reliability and precision are deemed paramount," but rejected Microsoft’s position because the rule has been widely accepted.

On appeal, the Federal Circuit dismissed the 25% rule outright:

The admissibility of the bare 25 percent rule has never been squarely presented to this court. Nevertheless, this court has passively tolerated its use where its acceptability has not been the focus of the case, or where the parties disputed only the percentage to be applied (i.e. one-quarter to one-third), but agreed as to the rule’s appropriateness.  Lower courts have invariably admitted evidence based on the 25% rule, largely in reliance on its widespread acceptance or because its admissibility was uncontested. 


This court now holds as a matter of Federal Circuit 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.

The 25 percent rule of thumb as an abstract and largely theoretical construct fails to satisfy this fundamental requirement. The rule does not say anything about a particular hypothetical negotiation or reasonable royalty involving any particular technology, industry, or party. Relying on the 25 percent rule of thumb in a reasonable royalty calculation is far more unreliable and irrelevant than reliance on parties’ unrelated licenses, which we rejected in ResQNet and Lucent Technologies.. . . Lacking even these minimal connections, the 25 percent rule of thumb would predict that the same 25%/75% royalty split would begin royalty discussions between, for example, (a) TinyCo and IBM over a strong patent portfolio of twelve patents covering various aspects of a pioneering hard drive, and (b) Kodak and Fuji over a single patent to a tiny improvement in a specialty film emulsion.

It is of no moment that the 25 percent rule of thumb is offered merely as a starting point to which the Georgia-Pacific factors are then applied to bring the rate up or down. Beginning from a fundamentally flawed premise and adjusting it based on legitimate considerations specific flawed conclusion. 

ENITRE MARKET VALUE RULE

In addition to challenging the 25% rule, Microsoft challenged the calculation of damages using the entire market value of Office and Windows and caomparing the calculated royalty to the total revenue Microsoft earned through the accused products.  Microsoft argued that Uniloc’s use of the entire market value rule was improper because it was undisputed that Product Activation did not create the basis for customer demand or substantially create the value of the component parts. Microsoft also argued that Gemini’s testimony tainted the jury’s damages deliberations.

The court agreed with Microsoft:

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 . . . This case provides a good example of the danger of admitting consideration of the entire market value of the accused where the patented component does not create the basis for customer demand. As the district court aptly noted, "[t]he $19 billion cat was never put back into the bag even by Microsoft’s cross-examination of Mr. Gemini and re-direct of Mr. Napper, and in spite of a final instruction that the jury may not award damages based on Microsoft’s entire revenue from all the accused products in the case." . . . This is unsurprising. The disclosure that a company has made $19 billion dollars in revenue from an infringing product cannot help but skew the damages horizon for the jury, regardless of the contribution of the patented component to this revenue.

Read/download a copy of the opinion here (link)

Google, Yahoo! Skirt Divided Infringement Claim Based on Data Provided "By the User"

PA Advisors LLC v. Google, Inc. et al., Case No. 2:07-cv-480 (E.D. Tex., March 11, 2010, order)

nXn (formerly "PA Advisors") owned a patent directed to Internet searching technology that "reflects the user's cultural, educational, and social backgrounds and the user's psychological profile" based on historic linguistic patterns identified in the user's prior activity.

After the claim construction phase, defendants moved for summary judgment of noninfringement based on 2 separate arguments: (1) the accused products did not "extract . . . at least one segment representative of a linguistic pattern" as recited in the claims, and (2) the accused products did not perform the step of "providing, by the user to the local computer system, search request data . . ."

On the first issue of a "segment" of a "linguistic pattern", nXn argued that this limitation did not require the identification of a particular word as a part of speech, and thus the broad definition would encompass the accused products.  The court strongly disagreed:

The relevant claim constructions reflect this process. “Linguistic patterns” are recognized in “segments” which are in turn extracted from “text items.” “Linguistic patterns” are a combination of various parts of speech (nouns, verbs, adjectives, etc.).” “Segments” are “one or more parts of speech arranged in an order.” And “text items” are “a series of words that can be split into at least one sentence.” Whereas text items refer generally to words, segments and linguistic patterns refer to particular parts of speech.

Despite the relevant constructions, nXn maintains that words in general are parts of speech without reference to whether they may be nouns, verbs, adjectives, etc. Put differently, nXn contends that the claims do not require any identification of a particular word as a particular part of speech but rather only require identification of plain words which also happen to be parts of speech. This theory ignores the plain teachings of the ‘067 patent. In every example or embodiment discussed in the ‘067 patent’s specification, the system must identify and tag words as particular parts of speech. . . . Without identifying and tagging the words as parts of speech, the claimed system would not produce a segment or discover a linguistic pattern. Of course these linguistic patterns then, according to the patent, disclose the user’s cultural and psychological profile. . . . The idea that the system only requires identifying words without reference to parts of speech finds no support in the patent. In fact, the ‘067 patent repeatedly disparages prior art search engines that operate by running “word” searches, referred to in the prior art as “key word” searches.

With regard to divided infringement, the court ran through the rulings of BMC Resources and Muniauction and concluded that

This case presents very similar facts in a claim requiring activity by more than a single party. Independent claim 1 provides in relevant part:

(c) providing, by the user to the local computer system, search request data representative of the users expressed desire to locate data substantially pertaining to said search request data.

col.24 11.45-49. All of the remaining steps recited in claim I are performed by the system - not the user. While Google and Yahoo benefit and invite users to visit their websites and run searches, they in no way “control or direct” them once they are there. Significantly, users are free to search as they please. Neither Google nor Yahoo direct users to search or input specific terms or phrases.

[W]hile it is true that searches initiated by Google or Yahoo could be relevant to infringement, neither accused system “initiates” any search. Notably, Google and Yahoo only offer suggestions and spelling changes after the user has begun a search query. In other words, even where search suggestions or spelling changes are provided by the system, the user is still first required to initiate a search query. Moreover, the user continues to choose the course of the search without the “control or direction” of the accused search engines.

In a last ditch effort, nXn resorts to arguments in equity. nXn first highlights that claim 1 could have easily been written to avoid this whole divided infringement issue and therefore it would be unfair to make it an issue now. But the Federal Circuit already rejected the same argument in BMC Resources . . . any fault only lies with nXn’s prosecuting attorney. Although BMC Resources and its progeny came long after the ‘067 patent issued, the general principles and rules propounded therein were well settled. Regardless of the equities, the Federal Circuit’s precedent is clear in compelling a finding of noninfringement.

Summary judgment of noninfringement as to all asserted claims is therefore GRANTED.

Note - the opinion was written by Judge Rader, who was sitting by designation in the E.D. Tex.

Download a copy of the opinion here (link)

Source: Docket Navigator

See also: "Big Tech Shouts 'Yippee!,' Patent Bar Chattering as Rader Heads to Texas" (link)

Specification and Claim Language Helps Patent Escape "Divided Infringement" on SJ

Level 3 Communications, LLC v. Limelight Networks, Inc., E.D. Va., 2:07cv589 (December 29, 2008)

Level 3 sued Limelight over a number of patents related to a Content Delivery Network (CDN). The patent described a CDN as "a system that supports delivery of information, such as video, music, games, and software, to computer users or computers on behalf ofits subscribers (typically content providers). A CDN can have multiple servers distributed at various locations around the U.S. and/or the world. A content provider such as a website operator can subscribe to a CON service and then use the CON for delivery of that content provider's information to computer users or computers."

During litigation, Limelight moved for summary judgment of noninfringement, claiming that the CDN in the patent was different from the accused network.

Limelight argued that the term "origin server" was not provided or controlled by the defendant, thus vitiating infringement under Muniauction and BMC v. Paymentech. The district court disagreed with Limelight:

The Court finds Defendant's arguments to be unconvincing . . . [a]lthough the language of this portion of the definition of "origin server" is admittedly drawn from the Farber patents' specifications . . . the specifications immediately thereafter also provide a broader definition: "[m]ore generally, the origin server ... is any process or collection of processes that provide resources in response to requests from a client" and can be "any off-the-shelf Web server." . . . "Originate," as it is used in these contexts, does not mean that an origin server must be the server on which all subscriber resources are actually created. In other words, it need not be the ultimate origin of the subscriber resources.

[I]n keeping with the thrust of Plaintiffs arguments, the Farber patents do not purport to invent origin servers, but instead simply assume their existence as components of the system or network in which the methods of the patent are implemented. Since they are not innovations ofthe Farber patents, but instead nothing more than "off-the-shelf Web server(s)" onto which subscriber content has been loaded . . . their role in the claims is little more than that of mere presence: they are simply . . . the places from which subscriber resources can enter the CDN.

Limelight also argued against the term "subscribers", claiming that they could not be "subscribers" to their own system, and did not control the actions of actual subscribers. Again, the district court was not persuaded:

Like origin servers, subscribers are undoubtedly contemplated by the Farber patents' claims as components ofthe system in which the methods of the patents are implemented, but they are not discussed by the specifications or the steps numerated in the Farber patent's method claims in such a way that they can be read as requirements that somehow limit the scope ofthe claims.

As discussed above, the claims of the Farber patents are drafted in such a way as to allow infringement to be claimed on the basis of the actions of a single party, rendering jurisprudence regarding infringement by multiple parties in Muniauction and BMC inapposite. Although, logically speaking, the CDN must, of course, have subscribers that seek to publish content in order for there to be subscriber content for the CDN to serve using this technology, this is simply another way of saying that a business has to have customers. Obviously the Farber patents do not purport to invent the concept of customers; they purport to invent a dynamic method for serving the content of those customers over the Internet in response to client requests.

Motion for summary judgment denied.

Read/download the opinion here.