By: Shanna O’Brien

In Uniloc USA Inc. v. Microsoft Corp., decided on January 4, 2011, the Federal Circuit eliminated the so-called “25 Percent Rule”, which often served as a basis for calculating patent damages. The Federal Circuit’s decision, which also limits application of the “Entire Market Value Rule”, significantly alters plaintiffs’ burden to prove damages in patent infringement cases.

As the most common measure of damages for patent infringement, a reasonable royalty is intended to ascertain the results of a hypothetical negotiation between the patentee and the infringer before the infringing activity began. Guiding the hypothetical negotiation are the so-called Georgia-Pacific factors set forth in Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970). Some of the factors considered include the royalties received by the plaintiff for licensing the asserted patent, rates paid by the infringer for the use of the other similar patents, and the commercial success of the patented product. In addition, expert testimony may be considered, and is almost always offered.

Uniloc sued Microsoft in the U.S. District Court for the District of Rhode Island for infringement of U.S. Patent No. 5,490,216, which is directed to a registration system to deter software copying. The allegedly infringing product, Microsoft’s Product Activation software, is a component of Microsoft’s larger software suites (e.g., Windows and Word). After trial, the jury determined that Microsoft’s willfully infringed Uniloc’s patent, and awarded Uniloc a reasonable royalty of $388 million. This award was based predominantly on the testimony of Uniloc’s expert witness, Dr. Gemini. In particular, Dr. Gemini applied the “25 Percent Rule” without offering significant analysis, and opined that Microsoft would have been willing to pay Uniloc a 25 percent royalty based upon the sale of the patented feature (i.e., Microsoft’s Product Activation software). To confirm the “reasonableness” of the 25 percent royalty, Dr. Gemini compared his calculation to the total revenues for the accused products (Windows and Word), even though the patented feature was one of many features. When Dr. Gemini’s calculation based on the 25 Percent Rule was compared to the total revenue, it yielded a royalty rate of approximately 3 percent. Thus, Dr. Gemini asserted his use of the 25 Percent Rule was reasonable. Microsoft appealed the damages award.

For approximately two decades, expert witnesses have relied upon the “25 percent rule of thumb” as a tool 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. The Rule suggests that the licensee pay a royalty rate equivalent to 25 percent of its expected profits for the patented product. The “Entire Market Value Rule” allows a patentee to recover a reasonable royalty based upon the full value of a multi-featured device that incorporates the patented component. The patentee is only allowed to seek damages under the Entire Market Value Rule when the infringing component forms the basis for customer demand, the infringing and noninfringing parts are sold as a functional unit, and the infringing and noninfringing parts are analogous to a single functioning unit.

On appeal, the Federal Circuit squarely rejected the use of the 25 Percent Rule, finding it a “fundamentally flawed tool for determining a baseline royalty rate”, and further held that any expert testimony relying upon the 25 Percent Rule is inadmissible evidence. The Court reiterated that the patentee much sufficiently tie the expert testimony and reasonable royalty calculation to the facts of the case.

The Federal Circuit Court also took the opportunity to address application of the Entire Market Value rule, though Dr. Gemini used it merely to “check” the reasonableness of his royalty calculation. The Federal Circuit noted that Uniloc had failed to prove that the patented feature was the basis for end customer demand. The Federal Circuit agreed that the entire market value evidence was improper, even though it was used merely to “check” the reasonableness of the royalty rate.

This decision ends the debate over applicability of the 25 Percent Rule, and reaffirms the highly factual nature of any damages analysis. Any patentee seeking reasonable royalty damages in the wake of Uniloc v. Microsoft must be particularly cognizant of their burden to tie any reasonable royalty calculation to the facts of the case. Further, a patentee who has not proven that the patented feature is the basis for customer demand cannot rely on the Entire Market Value rule, even merely to confirm the reasonableness of its royalty calculation.