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)

Lucent v. Gateway Dooms Another Damages Award at the CAFC

ResQNet.com, Inc. v. Lansa, Inc., No. 08-1365 (Fed. Cir., February 5, 2010)

Lansa appealed an award of damages for patent infringement from the Southern District of New York, arguing that the evidence and expert testimony relating to damages was erroneous, leading to an inflated 12.5% royalty rate on patents relating to screen recognition and terminal emulation technologies.

The first Georgia-Pacific factor requires considering past and present royalties received by the patentee “for the licensing of the patent in suit, proving or tending to prove an established royalty.”  In this case, ResQNet's expert (Dr. David) based his damages on seven ResQNet licenses, two of which were based on litigation , and five of which were “re-bundling licenses” that furnished finished software products and source code, as well as services such as training, maintenance, marketing, and upgrades, to other software companies in exchange for ongoing revenue-based royalties.  These companies obtained the right to re-brand ResQNet’s products before resale or bundle these products into broader software suites.

The Federal Circuit stated

[N]one of [the re-bundling] licenses even mentioned the patents in suit or showed any other discernible link to the claimed technology. Dr. David tabulated an average of the royalty ranges specified in these agreements, a number substantially higher than 12.5%.

The rates in the re-bundling licenses are not consistent at all with the other two licenses in the record. Those two “straight” licenses arose out of litigation over the patents in suit. One of them was a lump-sum payment of stock which Dr. David was unable to analogize to a running royalty rate. The other was an ongoing rate averaging substantially less than 12.5% of revenues . . . The inescapable conclusion is that Dr. David used unrelated licenses on marketing and other services—licenses that had a rate nearly eight times greater than the straight license on the claimed technology in some cases—to push the royalty up into double figures.

This court finds two parts of this analysis particularly troubling: first, the extremely high rates in the re-bundling licenses compared with the license on the claimed technology, and second, the unconvincing reasons that Dr. David gave for considering these re-bundling licenses at all. On this second point, the trial transcript indicates several instances where Dr. David misunderstood (or worse, misrepresented) the re-bundling licenses as somehow amounting to “patent plus software” licenses when, in fact, the record shows no use in these licenses of ResQNet’s claimed invention.

[T]hus, the district court in this case made the same legal error that this court corrected in Lucent. This trial court, like the one in Lucent, made no effort to link certain licenses to the infringed patent. For his part, Dr. David did not provide any link between the re-bundling licenses and the first factor of the Georgia-Pacific analysis. Without that link, as this court explained in Lucent: “We . . . cannot understand how the [fact finder] could have adequately evaluated the probative value of [the] agreements.” 580 F.3d at 1328.

The Federal Circuit also added:

The district court seems to have been heavily influenced by Lansa’s decision to offer no expert testimony to counter Dr. David’s opinion. But it was ResQNet’s burden, not Lansa’s, to persuade the court with legally sufficient evidence regarding an appropriate reasonable royalty. See Lucent, 580 F.3d at 1329 (“Lucent had the burden to prove that the licenses were sufficiently comparable to support the lump-sum damages award.”). As a matter of simple procedure, Lansa had no obligation to rebut until ResQNet met its burden with reliable and sufficient evidence. This court should not sustain a royalty award based on inapposite licenses simply because Lansa did not proffer an expert to rebut Dr. David.

Judge Newman, Dissenting-In-Part:

My colleagues, in setting strict barriers as to what evidence can be considered, leave the damages analysis without access to relevant information. However, it is not necessary that the identical situation existed in past transactions, for the trier of fact to determine the value of the injury . . . Lansa presented no testimony and proffered no evidence. Although Lansa waived the position on which my colleagues rely, this court fills the gap. For example, my colleagues do not discuss the district court’s reasoning, but state that they find “particularly troubling” that some of the licenses in evidence had “extremely high rates [when] compared with the [litigation-induced] license on the claimed technology.” The district court fully considered this aspect, and factored it into a competent overall analysis in which no flaw has been shown. The court’s conclusion warrants affirmance.

 Read/download the opinion here (link)

District Court Lets 24% Royalty Stand In Damage Calculations

Wyers v. Master Lock Co., 1-06-cv-00619 (COD May 12, 2009, Order)

Plaintiff successfully asserted that Master Lock infringed four patents relating to barbell-shaped locks with removable sleeves, and the jury awarded $5.35M in damages as a reasonable royalty. Master Lock motioned the court for Remittitur, arguing that the jury misapplied the Georgia-Pacific factors.

One issue was that the damage amount appeared to have been reached by awarding Wyers approximately half of the profits they would have received had Master Lock sold the offending locks under the private label agreement they formerly had with Wyers. Despite this, the court viewed that plaintiff's substantial evidence (e.g., reliance on the patented features, non-infringing alternatives, commercial success, etc.) was sufficient to support the jury’s verdict.


Master Lock also argued that $5.35 million—which represented 24% of Master Lock’s
proceeds from the sales of the infringing locks—exceeded its profit margin of 15%. Here, the court responded that,

At trial, [] Wyers presented evidence showing Master Lock’s profits were closer to 60%—a number similar to Wyers’s own profits. As shown by the $5.35 million amount, the jury implicitly found the actual profit margin to be higher than the 15% claimed by Master Lock. The jury was not obligated to believe Master Lock’s expert any more that it was obligated to believe Mr. Wyers. It would be inappropriate, therefore, to override the jury’s verdict based on such a credibility question. The jury could reasonably conclude hypothetical parties in the position of Wyers and Master Lock would negotiate a royalty of 24% in light of an anticipated 60% profit margin. See Rite-Hite Corp. v. Kelley Co., 56 F.3d 1539, 1555 (Fed. Cir. 1995) (holding it was “not unreasonable for the district court to find that an unwilling patentee would
only license for one-half of its expected lost profits and that such an amount was a reasonable royalty”).

Also, Master Lock argued a "damage apportionment" theory that the jury failed to discount the value of the non-patented features of the accused locks. Again, the court sided with the plaintiff:

As noted by Wyers, however, Federal Circuit authority holds that—for purposes of calculating a reasonable royalty—a patentee may recover a royalty based on the value of the entire infringing apparatus so long as the patented feature provides the basis for consumer demand. See Rite-Hite, 56 F.3d at 1549. Evidence presented at trial—including Master Lock’s marketing materials, product packaging, and sales figures, as well as Mr. Wyers’s testimony—showed the sleeve and external seal drove the market demand for the hitch pin locks Master Lock sold. Although Master Lock presented testimony suggesting that customer service, quality, and brand recognition were more important to driving sales than the claimed inventions, the jury was not obligated to find this testimony persuasive over the documentary evidence or Mr. Wyers’s testimony.

Motion for Remittitur denied.

Download the opinion here (link)

(Source: Docket Navigator)