Facts > Rules: Estimating Damages in Patent Cases
Facts > Rules
Patent infringement cases can produce some eye-popping damages awards. But, in Uniloc USA Inc. v. Microsoft Corp., the U.S. Court of Appeals for the Federal Circuit made it clear that these awards must be based on the facts of the case rather than an abstract analytical tool such as the “25% rule.”
Closing the Window(s)
Uniloc holds a patent on a registration system that deters the unauthorized copying of software. The company sued Microsoft, claiming that Microsoft’s Product Activation feature — which acts as a gatekeeper for its Word XP, Word 2003 and Windows XP software — infringed its patent. The jury returned a verdict of willful infringement and awarded Uniloc $388 million in damages. But the district court ordered a new trial on damages based on the improper use of the “entire market value” rule, which allows for the recovery of patent infringement damages based on the value of the entire product that contains an infringing component. Uniloc appealed.
Applying the Rule
The jury’s award was based on the testimony of Uniloc’s expert witness, who indicated that damages should be about $565 million. To reach that figure, he applied the 25% rule. As the Federal Circuit explained, the rule is a tool that has been used to estimate the reasonable royalty rate that the manufacturer of a product using the patent would be willing to offer the patentee in a hypothetical negotiation for a license. It suggests the licensee pay a royalty rate equaling 25% of its expected profits for the product that incorporates the patent. According to the Federal Circuit, it had “passively tolerated” the use of the rule in the past when the rule’s acceptability wasn’t the focus of the case. Similarly, lower courts have “invariably” admitted evidence based on the 25% rule, largely because of its widespread acceptance or because its admissibility was uncontested.
Deeming it Irrelevant
Here, however, the court squarely addressed the admissibility of the rule, evaluating it in light of Daubert and other landmark Supreme Court rulings on the admissibility of expert testimony. The Federal Circuit concluded that expert testimony based on the 25% rule is inadmissible because the rule is “a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation.” Specifically, the rule fails to tie a reasonable royalty rate to the facts of the case at issue; it says nothing about the particular technology, industry or parties. Because Uniloc’s expert’s starting point of a 25% royalty had no relation to the case facts, the court deemed it arbitrary, unreliable and irrelevant.
Checking the Estimate
Uniloc’s expert applied the “entire market value rule” to “check” whether his original estimate was reasonable. Specifically, he compared his original estimate with his calculation of Microsoft’s approximate total revenue of $19.28 billion for the infringing Office and Windows products. As a result of this comparison, he testified that his calculated royalty represented only 2.9% of that revenue and was, therefore, reasonable. As the court noted, the “entire market value” rule allows a patentee to assess damages based on the entire market value of the infringing product only where the patented feature 1) creates the “basis for customer demand” or 2) “substantially create[s] the value of the component parts.” It was undisputed that Product Activation did neither. The Federal Circuit found that this case provided a good example of the danger of admitting evidence of a defendant’s entire market value where the patented component doesn’t create the basis for customer demand. The disclosure that a company has made $19 billion in revenue from an infringing product can’t help but skew the damages horizon for the jury — regardless of the patented component’s actual contribution to the revenue.
Establishing a Foundation
Patentees must establish a factual foundation for damages that considers factors that would actually play a role in royalty negotiations. As this case shows, abstract rules alone won’t cut it in court.
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