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Damage calculations are always lurking in the shadow of patent litigation. While damage calculations are very important, much of the focus in a patent infringement dispute is on proving infringement, after which the focus turns to damages. 35 U.S.C. § 284 provides that when infringement of a valid patent is determined, 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.” The determination of a reasonable royalty is typically the product of a hypothetical negotiation between the parties during the period leading up to infringement. Each party usually hires a damages expert to opine on the amount resulting from the hypothetical negotiation. A widely used tool by intellectual property valuation experts in doing so is the twenty-five percent rule of thumb (the “Twenty-Five Percent Rule” or the “Rule”).
The Twenty-Five Percent Rule is used as an approximation of the reasonable royalty rate a manufacturer would be willing to pay during a hypothetical negotiation — specifically, it serves as a starting point in many expert analysis. The Rule suggests that a licensee pay twenty-five percent of its expected profits from the product incorporating the intellectual property at issue as a reasonable royalty rate. The remaining seventy-five percent is to compensate the manufacturer of the product for operational and commercialization risks in bringing the product to market. Use of the Twenty-Five Percent Rule has been criticized by many experts in the field for several reasons, including its failure to account for the unique relationship between patented technology and the accused product, its failure to account for the relationship between the parties, and the arbitrariness of the Rule. For instance, the Rule has been applied in cases where only one patent covering one specific component of a product was at issue, as well as those where a portfolio of patents cover a product’s most demanded features.
Although the Twenty-Five Percent Rule has been around for many years, experts have typically viewed it as a “rough tool” to be refined by analyzing the Georgia-Pacific factors (fifteen factors allowing for the customization of the royalty rate in a specific case accounting for the specific technology and parties at issue). However, a recent federal court decision, Uniloc, Inc. v. Microsoft Corp., sounded the death knoll for the use of this “rough tool.” The court outright rejected the Rule, holding that “the Twenty-Five Percent Rule of thumb is a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation. Evidence relying on the twenty-five 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.” In ending the Twenty-Five Percent Rule’s reign in patent damage calculations, the court noted a principle from Kumho Tire, that one major determinant of whether an expert should be excluded under Daubert is “whether he has justified the application of a general theory to the facts of the case.” Providing guidance to future damage calculations, the court notes that expert testimony opining on a reasonable royalty rate “must ‘carefully tie proof of damages to the claimed invention’s footprint in the marketplace.’”
In following this case, courts will likely demand a higher level of precision in an area plagued with ambiguity. For example, the two experts in Uniloc came up with drastically different estimates. The expert for Uniloc calculated damages in the amount of $564,946,803, while Microsoft’s expert determined damages to be a maximum of $7 million. While it seems that removing a widely used guidepost will only result in even more erratic damage calculations (if this is possible), the Uniloc opinion is a step in the right direction given the generic nature of the Twenty-Five Percent Rule. Hopefully, courts continue down this path and further require a more exacting standard from expert testimony in this area.
– Thomas E. Booms
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