ALERT - Federal Circuit Bars "25% Rule of Thumb" Analysis for Patent Damages

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January 13, 2011

Continuing a trend of tightening the standards governing damage awards in patent cases, the Court of Appeals for the Federal Circuit has rejected the “25% Rule of Thumb” for assessing reasonable royalty damages in patent infringement cases. According to the Court, any “[e]vidence relying on the 25 percent rule of thumb is . . . inadmissible under Daubert and the Federal Rules of Evidence . . .” Uniloc USA, Inc. v. Microsoft Corp., No. 2010-1035 (Fed. Cir., January 4, 2011). In light of the Federal Circuit’s ruling, any pending damage opinions, testimony, calculations, evaluations or assessments relying in whole or in part on the 25% rule of thumb need to be reviewed and revised accordingly. 

Prior to the Uniloc decision, the 25% rule of thumb was considered an acceptable, albeit often criticized, method for assessing reasonable royalty damages in patent infringement cases. The rule was based on the notion that it is “reasonable” for an infringer to retain a majority of its profits (75%) considering it undertook substantial development, operational and commercialization risks. The 25% figure has its origins in studies finding the median negotiated royalty rate across all industries to be in the range of 25%. Despite the general non-industry or product-specific nature of such studies, courts routinely allowed the 25% rule as an analytical tool for assessing reasonable royalty damages in patent cases. 

Departing from the practice of several district courts, the Federal Circuit held that the 25% rule of thumb is “a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation.” In rejecting the 25% rule, the Federal Circuit looked to established principals regarding the admissibility of expert testimony. Specifically, the Court explained that expert testimony must be based on “firm scientific or technical grounding.” According to the Court, a conclusory “25% rule” based on general studies having no relationship to the facts at hand fails to meet this stringent standard. The Court explained:

The 25 percent rule of thumb as an abstract and largely theoretical construct fails to satisfy this fundamental requirement. The rule does not say anything about a particular hypothetical negotiation or reasonable royalty involving any particular technology, industry, or party.

The Federal Circuit’s ruling overturned a $388 million damage award against Microsoft which was based on the 25% rule. As noted, this continues a Federal Circuit trend of tightening the standards governing damage awards in patent cases.  Of note, the Federal Circuit also criticized plaintiff’s reliance on the “entire market value rule” as a “check” on the reasonableness of the 25% rule of thumb. The “entire market value rule” allows recovery of damages based on the “entire value” of an infringing product even when the patented component comprises a small portion of the product. Consistent with recent authority criticizing and narrowing the entire market value rule, the Federal Circuit reaffirmed the rule is only applicable when the patented component is the basis for customer demand. 

The Uniloc decision reaffirmed that a reasonable royalty calculation should be determined based on a case-specific analysis of the factors set forth long ago in Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970) without reference to any “rule of thumb” as a starting point.

Should you have any questions or concerns regarding this or any other intellectual property issue, please contact any member of Briggs and Morgan's Intellectual Property Practice Group.