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Patent Infringement Damages May Now Be Calculated Differently

Insight Michael Moradzadeh Michael Moradzadeh · January 12, 2011

In Uniloc v. Microsoft, an appeals court issued a decision that may change how infringement damages are calculated by precluding the use of the "25 percent rule of thumb" which has been used to calculate damages in most patent cases for the past fifteen years.  This decision marks an important step towards requiring patent plaintiffs to rigorously prove damages with facts connected to the value of the patented invention, and it is likely that future courts will more strictly scrutinize patent damages evidence. 

The ruling by the U.S. Court of Appeals for the Federal Circuit in Washington upheld the validity of a patent owned by Uniloc but ordered a new trial to reassess the amount of damages Microsoft will pay.      

Uniloc, founded in Australia in 1993, owns an early patent covering a mechanism for combating "casual copying" of software.  Simply put, Uniloc’s patent deters unauthorized copying of software by allowing it to run only after a licensing procedure is completed, thereby "locking" the software to one user.
Uniloc launched its suit against Microsoft in 2003 alleging the Product Activation feature for Microsoft's Word XP, Word 2003, and Windows XP software programs infringed its patent.  The jury agreed.  Finding that Microsoft willfully infringed the patent, the jury awarded Uniloc $388 million.  This award was the third-largest jury verdict in 2009 and the second-largest patent verdict, behind a $1.67 billion award that Johnson & Johnson won against Abbott Laboratories.
At trial, the jury relied on the testimony of Uniloc's expert who opined that damages should be approximately $564 million based on a hypothetical negotiation between Uniloc and Microsoft using the 25 percent "rule of thumb."  Commonly used to calculate damages in patent infringement cases, the 25 percent rule of thumb approximates the reasonable royalty rate a manufacturer of a patented product would be willing to offer to pay to the patentee during a hypothetical negotiation.  Under this rule, licensees pay a royalty rate equivalent to 25% of the expected profits for the product that incorporates the IP at issue.  
Using an internal Microsoft document which put the minimum value of each product key at $10, Uniloc's expert applied the 25 percent rule of thumb to obtain Uniloc's royalty rate of $2.50 per key.  Multiplying this value by the number of new licenses to Office and Windows products, the expert arrived at his $564 million value.  He confirmed his valuation by "checking" it against the total market value of sales of the Windows XP operating system and some versions of Word.  Showing jurors a pie chart representing this $19 billion in revenue, the expert noted that his damage figure represented only 2.9% of Microsoft's gross revenue.
On appeal, the court first rejected use of the 25 percent rule of thumb to calculate infringement damages.  Noting that a general theory is only admissible if an expert adequately ties it to the specific facts of the case, the court wrote, "[T]here must be a basis in fact to associate the royalty rates used in prior licenses to the particular hypothetical negotiation at issue in the case."  As "an abstract" and "largely theoretical construct" which "does not say anything about a particular hypothetical negotiation or reasonable royalty involving any particular technology, industry, or party," the court found the rule failed to satisfy this essential requirement.  While acknowledging it had "passively tolerated" the 25 percent rule of thumb in past cases, the court held that the rule "is a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation," thus precluding its use for damages calculations.
The court also rejected the expert's application of the entire market value, stating, "[t]he entire market value rule allows a patentee to assess damages based on the entire market value of the accused product only where the patented feature creates the 'basis for customer demand' or 'substantially create[s] the value of the component parts.'"  Here, however, the court saw no evidence that the patented component created the requisite basis for customer demand.  Siding with Microsoft, the court instead found that Uniloc should not have been able present the pie chart or the $19 billion revenue figure to the jury.  “The disclosure that a company has made $19 billion dollars in revenue from an infringing product cannot help but skew the damages horizon for the jury, regardless of the contribution of the patented component to this revenue,” Circuit Judge Richard Linn wrote for the court.    
While yesterday's decision was directed at the methodology for calculating damages instead of the amount awarded, it will likely reduce the amount Microsoft ultimately pays to Uniloc.  However, it was still a good day for Uniloc as the Federal Circuit’s decision to uphold the validity of its patent may boost Uniloc’s efforts to collect royalties from additional companies such as Symantec Corp. and Adobe Systems Inc.  Since launching its case against Microsoft, Uniloc has taken action against almost 100 other firms including Sony and McAfee.