United States: The Federal Circuit Court of Appeals Requires Damages Experts To Rely On … Evidence?

The Court of Appeals for the Federal Circuit (CAFC) welcomed the new year with a decision that will have damages experts for patent owners and alleged infringers alike rethinking how they calculate reasonable royalties in patent infringement cases. The decision, Uniloc USA, Inc. v. Microsoft Corp., 2010-1035, -1055 (Fed. Cir. 2011), stemmed from an appeal of a $388 million jury award against Microsoft. The CAFC upheld the finding of infringement and of no invalidity, but affirmed the grant of a new trial on damages based on the fact that "the jury's damages award was fundamentally tainted by the use of a legally inadequate methodology."¹ In particular, the CAFC found the "25 percent rule of thumb" approach to reasonable royalty calculations to be per se inadmissible, and "Entire Market Value Rule" evidence to be inadmissible under the circumstances.

Reasonable Royalty

United States patent law provides that on a finding of infringement of a valid patent, 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."² The amount of the reasonable royalty is often calculated based on a hypothetical negotiation between the patent owner and the alleged infringer at the time the alleged infringement began.³

25 Percent Rule of Thumb

To approximate the reasonable royalty rate an alleged infringer would be willing to offer to pay the patentee during the hypothetical negotiation, many damages experts have turned to the 25 percent rule of thumb. Sometimes referred to as the Goldscheider Rule after one of its main proponents – Robert Goldscheider – the 25 percent rule of thumb begins with the premise that the norm a licensee is willing to pay as patent royalty is equivalent to 25 percent of its expected profits. The theory behind the rule is that the licensee should retain a majority (i.e., 75 percent) of the profits because it has incurred substantial risks and costs in the development, operations and commercialization of the alleged infringing products. The 25 percent rule was empirically supported by Goldscheider's review of existing licenses. Goldscheider and others recognized that the appropriate royalty for any particular situation could vary from the 25 percent rule based upon its individual factors. Hence, for many damages experts the 25 percent rule became a starting point to be adjusted up or down according to case-specific facts in a hypothetical negotiation conducted at the onset of infringement.⁴ This approach had long been accepted by the district courts and never rejected by the CAFC.⁵

In Uniloc, however, the CAFC put a sudden and unequivocal end to the 25 percent rule of thumb approach by holding:

The CAFC rejected the 25 percent rule on two different, but complementary, grounds. First, the CAFC found that the rule runs afoul of the Daubert requirement of sufficiently tying the expert testimony to the facts of the case, since the "largely theoretical construct" of the 25 percent rule of thumb fails to take into account: (a) the unique relationship between the patent and the accused product and (b) the unique relationship between the parties. Second, the CAFC found two cases⁸ in its own precedent where the patentee relied on prior license agreements between the parties that were "radically different from the hypothetical agreement under consideration" in the litigation. The CAFC vacated the reasonable royalty calculations in those cases because there were no factual bases to relate the prior licenses to the particular hypothetical negotiation in the litigation. Using the analogy of those cases, the CAFC concluded that any reliance on the 25 percent rule of thumb is "far more unreliable and irrelevant than reliance on parties' unrelated licenses" and therefore should be rejected.

The patent owner in Uniloc argued that the 25 percent rule of thumb was merely a starting point of the royalty analysis and was adjusted to the specific facts of the case by the well-established Georgia Pacific factors. The CAFC flatly rejected this argument, explaining that "[b]eginning from a fundamentally flawed premise and adjusting it based on legitimate considerations specific to the facts of the case [i.e., the Georgia Pacific factors] nevertheless results in a fundamentally flawed conclusion."⁹ The CAFC made clear, however, that it was not rejecting the Georgia Pacific factors¹⁰ but rather making evidence based upon the 25 percent rule inadmissible.

Entire Market Value Rule

Equally important in the opinion is the finding of error in allowing the infringer's net sales of the infringing products to be admitted in evidence. Uniloc's expert purported to "check" the reasonableness of his royalty calculation by considering how the royalty would relate to Microsoft's net sales under the entire market value rule. Calculating his royalty to constitute only 2.9 percent of Microsoft's revenue from Office and Windows, he opined that it was well within the reasonable range for software licenses. The CAFC rejected this argument as well.

The CAFC noted that the entire market value rule allows a patent owner to calculate damages based on the entire market value of the accused product only where the patent owner can show that the patented feature creates the "basis for customer demand" or substantially creates "the value of the component parts."¹¹ Uniloc failed to make this showing, but still argued that the evidence was admissible on the theory that the entire market value of the accused products could be considered if the royalty rate is low enough. The CAFC again flatly rejected that theory, stating that "[t]he 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."¹² Therefore, the evidence of revenue from sales of the accused product was irrelevant and highly prejudicial, and should not have been admitted. Consequently, the district court's grant of a new damages trial on damages was affirmed.

Summary

With the demise of the 25 percent rule, damage experts will need to find a different, casespecific starting point for the royalty calculation. Whatever that point may be, the subsequent application of the Georgia-Pacific factors must avoid any evidence of total revenue from sales of the infringing products (entire market value), unless the patent owner can satisfy a threshold showing that the patented feature is the basis for customer demand for the products

Footnotes

1 Uniloc at p. 3.

2 35 USC § 284 (2010).

3 Wang Labs Inc. v. Toshiba Corp., 993 F.2d 858, 869-70 (Fed. Cir. 1993).

4 The typical adjustments, often called Georgia-Pacific factors, come from a non-exhaustive list in Georgia- Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y 1970).

5 Mindful that a panel of the CAFC cannot overturn its own precedent, the opinion noted "The admissibility of the bare 25 percent rule has never been squarely presented to this court." Uniloc at 39.

6 Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 589 (1993).

7 Uniloc at p. 41.

8 ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860, 869 (Fed. Cir. 2010), and Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301, 1324 (Fed. Cir. 2009).

9 Id. at 46.

10 Including factor 12 – the portion of profit that may be customarily allotted as royalty for similar inventions in the particular industry.

11 Id. at 48.

12 Id. at 51.

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