In Uniloc USA v. Microsoft Corp., 2010-1035, a case involving a patent on a software registration and copy protection system for products such as Microsoft Word, the Federal Circuit squarely rejected the use of this analytical fiction as being improper under Daubert. The Court held that:
This 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. Opinion at 41
In criticizing the 25% rule, the court pointed out that “[t]he rule does not say anything about a particular hypothetical negotiation or reasonable royalty involving any particular technology, industry, or party."
In short, Gemini’s starting point of a 25 percent royalty had no relation to the facts of the case, and as such, was arbitrary, unreliable, and irrelevant. The use of such a rule fails to pass muster under Daubert and taints the jury’s damages calculation. Opinion at 47
The Court also rejected Uniloc’s use of the “entire market rule” as a “check” to show how the royalty rate arrived at using the 25% rule was "reasonable." In rejecting the use of the entire market value rule in this case, the Federal Circuit again emphasized that “damages based on the entire market value of the accused product [are appropriate] only where the patented feature creates the ‘basis for customer demand’ or ‘substantially create[s] the value of the component parts.’” The court found that Uniloc had offered no evidence that customer demand was driven by the patented software registration feature.
The elimination of the 25% rule may make the damages analysis more complicated in many cases, especially for plaintiff's experts seeking an easy way to justify a high valuation for a particular patent. It will, however, help to insure that the royalty rates that are offered by damages experts are based on facts that are applicable to the case at hand and are rationally based on the value of the patented invention.