In the recent Uniloc v. Microsoft (PDF), the Federal Circuit made two significant changes to the standards by which a patentee can recover damages from an infringer. First, the court abolished the “25% Rule of Thumb” which had previously been used to calculate reasonable royalty rates, and second, the court emphasized the limitations on using the “entire market value” test.
The patent at issue involved a software registration system, which requires customers to enter the product key supplied by the software manufacturer in order to install the product. The system, patented by Uniloc, is meant to deter customers from copying the software without the manufacturer’s permission. (If you’ve ever used a serial number or product key to activate a copy of Microsoft Word, you’ve used both the patent and the infringing technology at issue.) At trial, the jury found that Microsoft had infringed Uniloc’s patent and, basing its verdict on Uniloc’s expert testimony that the appropriate damages should be $565 million, the jury awarded Uniloc $388 million in royalty rate damages. Uniloc’s expert had used two rules in his calculation, the “25% Rule” and the “Entire Market Value Rule,” both of which the Federal Circuit rejected on appeal.
Reasonable Royalty Rates
Although a reasonable royalty is just one of the remedies available to a patentee, it has become a much more common remedy in recent years. Section 284 of the Patent Act provides that claimants are entitled to “in no event less than the reasonable royalty.” Thus when the patentee is unable to prove entitlement to an injunction or lost profits, he is entitled at least to a reasonable royalty rate. Because of the difficult standards the court imposes for a patentee to obtain either an injunction or lost profits, patentees often bring suit with the primary goal of recovering a high royalty rate.
A royalty rate that is “reasonable” is one that reflects the price the parties would have reached in a hypothetical negotiation before infringement occurred. As Judge Rader explained in Riles v. Shell Exploration and Production Co., 298 F.3d 1302 (Fed. Cir. 2002), simulating this hypothetical situation requires an analysis of “economic and factual predicates” and other real-world constraints. The analysis requires consideration of the bargaining positions of the parties, the patented technology, and a list of other factors, commonly referred to as the “Georgia-Pacific factors,” which the court deems would have been relevant to a licensing negotiation. Ultimately, the goal of the analysis is to determine what price the patentee and the alleged infringer would have negotiated, had they done so before the infringer infringed.
Findings in Uniloc v. Microsoft
The first notable outcome of Uniloc was the court’s rejection of the previously-used “25 Percent Rule of Thumb.” Uniloc’s expert applied this rule as a shortcut to simulating a hypothetical negotiation. The method behind the 25 Percent Rule requires the court to take 25% of the value of the patented component, and multiply that baseline rate by the number of infringing products the infringer sold. The court cited two district court cases: GSI Group, Inc. v. Sukup Mfg. Co., 641 F.Supp.2d 732 (C.D.Ill. 2008) and Bose Corp. v. JBL, Inc., 112 F.Supp.2d 138 (D.Mass. 2000). Here, Uniloc determined that 25% of the lowest value of Microsoft’s product key brought them to a baseline rate of $2.50, and multiplying that price to the number of product keys sold, Uniloc’s expert found total damages of about $565 million.
The Federal Circuit here ultimately reached the conclusion that this rule, which had been “passively tolerated” in past cases, was “a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation.” Consistent with the goal of simulating a hypothetical negotiation, the court emphasized the need for Uniloc’s expert to use facts regarding the parties, technology, and industry to support the applicability of the 25 Percent Rule in this case. Although the court relied on Supreme Court precedents to come to this decision, it seems that the rejection of this rule requires less legal analysis and more common sense. The royalty rate is meant to reflect the price that Uniloc and Microsoft would have actually negotiated prior to infringement, and it is hardly feasible that Microsoft, selling millions of copies of their word processing software, would have even considered paying $2.50 for every copy of their software that used the product key. The court concluded that the 25 Percent Rule is abolished and the appropriate analysis in future cases will require explicit consideration of the case’s facts and circumstances.
In a less significant but nonetheless notable holding, the Court emphasized a limitation on using the Entire Market Value test, which Uniloc’s expert used to “check” his calculations. He found that the estimated damages equaled only 2.9% of the gross revenue from Microsoft’s products that contained product keys, and thus it was a reasonable royalty rate. The Federal Circuit again, however, rejected this application due to the relationship between the patented product key and the infringing word processing software. The court ruled that using the infringer’s total profits as a basis for determining a royalty rate is only appropriate when the patent directly contributes to the infringer’s profits. Again, we can also use our common sense to see that Microsoft’s millions of dollars in profits were not derived from using Uniloc’s product key. Microsoft’s profits came from the software that the product key merely helped to protect, and it seems unfair that the Uniloc would be automatically awarded even 2.9% of Microsoft’s profits, or $588 million. For future cases, the Entire Market Value test should only be applied when the patented component is an integral part of the entire product.
The obvious implications of this case are the importance of facts and the need for experts to provide more proof on how their theories simulate hypothetical negotiations. In the past, overcompensation may have been the problem with awarding royalty rate damages, but Uniloc changes this trend. In a recent lecture for his “Introduction to Intellectual Property” class at Berkeley Law, Professor Peter Menell emphasized that the Federal Circuit holding in this case greatly affects the burden that patentees carry when attempting to recover damages; he suggested that it will likely affect the way that patentees bring infringement suits. The holding will be particularly important for non-practicing entities, which are companies that tend to bring suit primarily for the purpose of obtaining high royalty rate damages, but all patentees bringing suit will inevitably be affected. Whereas in the past, patentees had high hopes to persuade a jury for expensive royalty rate damages, patentees in future cases will not be able to use the rules of thumb discussed above. As a result, patentees may be discouraged from filing infringement suits, or at least from investing money and effort into such lawsuits, knowing that the Federal Circuit has reduced the potential to recover from infringers.
What patentees can learn from this case is clear: facts are necessary and it will be more difficult to recover high royalty rate damages. But unfortunately, what the rest of us can take away from this case is less clear. The inquiry of what is “reasonable” in a “reasonable royalty rate remedy” has just begun. Exactly what facts and how much these facts will weigh is a question for the future, and it will be interesting to find how this inquiry unravels.