The Federal Circuit’s Decision in Uniloc: A Death Knell for the 25% Rule of Thumb

January 05, 2011

In its recent decision in Uniloc USA, Inc. v. Microsoft Corporation,[1] the U.S. Court of Appeals for the Federal Circuit rejected the so-called “25% rule of thumb” as a means for determining damages in a patent infringement case, calling the rule “a fundamentally flawed tool” and declaring evidence relying on the rule inadmissible under the principles of Daubert [2] and the Federal Rules of Evidence.

The 25% rule of thumb presupposes that, in a hypothetical negotiation, a licensee will pay a royalty rate of approximately 25% of its expected profits for the accused products. Over the years, the rule has been widely used as a way to arrive at a baseline royalty rate for purposes of patent infringement damage calculations.[3] As a result, many courts, including the Federal Circuit, have passively allowed its use in instances where the applicability of the 25% rule of thumb was not questioned by the parties. [4] The Uniloc court noted that “[l]ower courts have invariably admitted evidence based on the 25% rule, largely in reliance on its widespread acceptance or because admissibility was uncontested.” Uniloc is the first case in which the Federal Circuit was squarely presented with the issue of whether the rule was an appropriate means by which to calculate damages in a patent case.

The court began its analysis by reiterating the principle espoused in Daubert and its progeny: that in order to be admissible, an expert’s application of a general theory should be sufficiently tied to the facts of the case.[5] The court then applied this well-founded principle to some of its more recent rulings—including ResQNet and Lucent [6]—concluding that “there must be a basis in fact to associate the royalty rates used in prior licenses to the hypothetical negotiation at issue in the case. The 25 percent rule of thumb as an abstract and largely theoretical construct fails to satisfy this fundamental requirement.”[7] Where, as in Uniloc, there is no evidence that the expert made any effort to tie the application of the 25% rule of thumb to the facts of the case, the expert’s methodology is considered to be “arbitrary, unreliable, and irrelevant.”

The court also considered the expert’s application of the so-called Georgia-Pacific factors,[8] which are universally accepted as a legitimate basis for determining damages in a patent case. However, this methodology was also rejected because the expert applied the Georgia-Pacific factors only to adjust up or down from his starting point of 25% (based on the “rule of thumb”). “Beginning from a fundamentally flawed premise and adjusting it based on legitimate considerations specific to the facts of the case nevertheless resulted in a fundamentally flawed conclusion.”

Of further note, the court also considered the Uniloc expert’s use of the entire market value to perform a “check” on his damage calculation based on the 25% rule of thumb. In that regard, the court reiterated its previous cautionary holdings that the entire market value rule should only be applied when the patented component creates the basis for customers’ demand of the product as a whole.

Thus, the implication of the Federal Circuit’s holding in Uniloc is that parties, particularly plaintiffs in patent cases, should be careful to ensure that their damages analysis carefully considers the facts surrounding the hypothetical negotiation. Mere application of abstract principles to calculate or even “check” a damages analysis will be met with increased scrutiny.

If you have any questions or would like more information on any of the issues discussed in this LawFlash, please contact any of the following Morgan Lewis attorneys:

Louis W. Beardell, Jr.
Kell M. Damsgaard
Kenneth J. Davis
John V. Gorman
Christopher I. Halliday
Thomas B. Kenworthy
Eric Kraeutler
Colm F. Connolly
David W. Marston Jr.
Winn D. Carter, Jr.
Lucas T. Elliot
C. Erik Hawes
David J. Levy
Rick L. Rambo
Todd W. Esker
Victor E. Johnson
Jeffry S. Mann
Brett M. Schuman
Robin M. Silva
Robert B. Beyers
Dion M. Bregman
Douglas J. Crisman
Andrew J. Gray
Michael J. Lyons
Gary S. Williams
Robert W. Busby
J. Kevin Fee
Robert J. Gaybrick
Collin W. Park
Robert Smyth
John D. Zele

[1] . Nos. 2010-1035, 2010-1055, 2011 WL 9738 (Fed. Cir. Jan. 4, 2011).

[2] . Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 589 (1993).

[3] . See, e.g., Bose Corp. v. JBL, Inc., 112 F. Supp. 2d 138, 167 (D. Mass. 2000); GSI Grp., Inc. v. Sukup Mfg. Co., 641 F. Supp. 2d 732, 745 (C.D. Ill. 2008).

[4] . See, e.g., Fonar Corp. v. General Elec. Co., 107 F.3d 1543, 1553 (Fed. Cir. 1997); Inline Connection Corp. v. AOL Time Warner Inc., 470 F. Supp. 2d 424, 432 n.38 (D. Del. 2007).

[5] . Uniloc, Slip Op. at 41–43 (citing Daubert, 509 U.S. at 591; Kumho Tire Co. v. Carmichael, 526 U.S. 137, 153–54 (1999)).

[6] ., Inc. v. Lansa, Inc., 594 F.3d 860 (Fed. Cir. 2010); Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301 (Fed. Cir. 2009).

[7] . Id. at 45.

[8] . See Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F.Supp. 1116 (S.D.N.Y. 1970).