Appeals Court Turns 25% Rule on Its Head

Yesterday the U.S. Court of Appeals for the Federal Circuit in Uniloc USA, Inc. v. Microsoft allowed for a new trial on damages, “because the jury’s damages award was fundamentally tainted by the use of a legally inadequate methodology,” namely, the 25 percent “rule of thumb” for calculating a reasonable royalty rate for infringement damages.

In effect, the 25-percent rule has been tossed on its head. “The 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.”

Analysts will want to check page 34 of the slip opinion, as the expert’s methodology is fully explained. Without citing specifics, the expert also claimed industry royalty rates for software were generally above 10% or 11%. Microsoft challenged the expert and the use of the 25% rule at the District Court level, to no avail, the District Court dismissing the challenge becasue the rule is widely accepted.  Well, not any more.

The court’s discussion of Section 284 of Title 35 of the US Code where parameters of patent infringement damages are set at not “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.” A reasonable royalty is the predominant measure of damages in patent infringement cases. The court further stated that “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.”

Here’s what the court said is wrong with the 25 percent rule of thumb:

1.  It fails to account for the unique relationship between the patent and the accused product.

2.  It fails to account for the unique relationship between the parties, the different levels of risk assumed by a licensor and licensee.

3.  The rule is arbitrary and may be appropriate only as chance allows.

Georgia Pacific

The decision reaffirmed the requiremnt to satisfy the Georgia Factors in introducing a reasonable royalty rate, stating the “rejection of the 25 percent rule of thumb is not intended to limit the application of any of the Georgia-Pacific factors.  In particular, factors 1 and 2 – looking at royalties paid or received in licenses for the patent in suit or in comparable licenses – and factor 12 – looking a the portion of profit that may be customarily allowed in the particular business for the use of the invention or similar inventions – remain valid and important factors in the determination of a reasonable royalty rate.

This case points out the changing law and how locating true comparables and having the full text of the license agreements used in any analysis or report is now critical. Business valuation analysts have the best tool available for searching the full text of over 8,000 license agreements for reasonable royalty rates that match comparable circumstances right here at BVR.