25% “Rule of Thumb” Rejected in Determining Patent Damages

Over the last several years, we have seen more and more damages experts rely on a so-called "25% rule" as a starting point in determining a “reasonable royalty” in patent cases. The 25% rule was applied as a “rule of thumb” that  allowed an accused infringer to retain 75% of the profits and awarded 25% of the infringer's profits to the patent holder. This 25% figure would typically be used as a starting point that would then be massaged using the Georgia Pacific factors to arrive at some final royalty rate, that was often very close to the 25% value. The problem with this approach is that while it sounds like a “reasonable” division of profits at some superficial level, and is certainly expedient in arriving at some starting point for analysis, it is universally divorced from reality in any specific case. Nonetheless, the 25% rule kept finding its way into articles, court decisions and expert reports...until now.

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."  

The Court recognized that the 25% rule was being used as a "starting point" rather than a final calculation but found that this made no difference: 

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 specifically reaffirmed use of the Georgia Pacific factors as an analytical tool in determining a reasonable royalty rate but emphasized that “there 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.”
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.

Federal Circuit Decides that “Have Made” Rights are Implied, Unless Expressly Omitted

When a patent license grants the rights to “make, use and sell” a patented product, and reserves “all rights not expressly granted to [a licensee],” does the licensee have the right to have the licensed product made by another on its behalf? That question was answered in Corebrace LLC v. Star Seismic LCC, Fed. Cir. 2008-1502 (May 22, 2009)(www.cafc.uscourts.gov/opinions/08-1502.pdf) which held that: “A grant of a right to ‘make, use, and sell’ a product, without more, inherently includes the right to have a third party make the product. A clear intent shown in a contract to exclude ‘have made’ rights can negate what would otherwise be inherent.” Simply stated, “have made” rights are in, unless they are expressly carved out of the license.

Corebrace makes it clear that this implied “have made” right is not a “sublicense” right (which was expressly prohibited in the license granted to Star Seismic). Instead, this implied right emanates from a Court of Claims decision which stated that “[a license to make, use, and sell] is not restricted to the production by the licensee personally or use by him personal or sales by him personally. It permits him to employ others to assist him in the production and in the use and in the sale of the invention.” Carey v. United States, 326 F.2d 975, 979 (Ct. Cl. 1964).

PRACTICE POINTS IN VIEW OF COREBRACE:

As a patentee, if you do not want to extend “have made” rights, the license grant should include unambiguous language that explicitly preclude such rights.

As a licensee, despite the clear holding in Corebrace, it is still good practice to expressly include “have made” rights in the license grant. Patent licenses are contractual rights that are evaluated under state law. In Corebrace, the governing law was Utah. Since the Supreme Court of Utah was silent on this issue, the Federal Circuit looked to its own precedent to decide this issue. A case originating from a different state could end up with a different result.

What about the third-party supplier? In Corebrace, the action was between the patentee and the licensee. The third-party manufacturer supplying Star Seismic was not a party to the action. Although Star Seismic was conferred implied “have made” rights, it is not clear (at least to me) that this implied right would extend upstream and protect the third-party manufacturer who is making the product. Authorized sales by the licensee clearly “exhaust” patent rights with respect to downstream purchasers, but does an authorized purchase have the same effect upstream? If the purchase is authorized, does that imply that the sale is also authorized? Those are questions for another day...please let me know your thoughts on this.