Authored by E. Robert Yoches
The Court of Appeals for the Federal Circuit recently issued several decisions striking damage awards based on reasonable royalties that it found to be too great. In some cases, the court found no support for a royalty base capturing revenues for an entire product. In other cases, the court found that plaintiffs used improper evidence to inflate royalty rates. These decisions are timely, as they may have forestalled legislation to reign in some of the larger damage awards in patent cases.
Proper Use of the Entire Market Value Rule
The entire market value (EMV) rule allows a patentee to recover damages for certain unpatented components. Although the theory has roots in the 1800s, the Federal Circuit has refined the rule as follows: “The entire market value rule has typically been applied to include in the compensation base unpatented components of a device when the unpatented and patented components are physically part of the same machine.” Rite-Hite Corp. v. Kelley Co., 56 F.3d 1538, 1548 (Fed. Cir. 1995) (en banc). The rule only allows recovery from unpatented components in an apparatus if the patented feature forms the “basis for customer demand” for the entire apparatus. Id., at 1549 (Fed. Cir. 1995), quoting State Indus., Inc. v. Mor-Flo Indus., Inc., 883 F.2d 1573, 1580 (Fed. Cir. 1989).
Although the EMV rule traditionally addresses unpatented physical components separate from patented physical components in an apparatus, the Federal Circuit recently used the theory to limit a damage award for infringement of a patent that covered one small feature in a large computer program. In Lucent Technologies Inc. v. Gateway Inc., 580 F.3d 1301 (Fed. Cir. 2009), the jury awarded $385 million in damages for infringement of a patent for picking a date from a pop-up calendar by Microsoft Corp.’s Outlook e-mail program. The jury based its award on revenues from the sales of Outlook. The Federal Circuit remanded for a new trial on damages, finding “the infringing use of Outlook’s date-picker feature is a minor aspect of a much larger software program and... the portion of the profit that can be credited to the infringing use of the date-picker tool is exceedingly small." Id. at 1333. The court also noted, “There is nothing inherently wrong with using the market value of the entire product, especially when there is no established market value for the infringing component or feature, so long as the multiplier accounts for the proportion of the base represented by the infringing component or feature.” Id. at 1339.
Which Licenses Show an Established Rate
To determine the amount of reasonable-royalty damages, courts consider a hypothetical negotiation at the time of first infringement based on factors from Georgia-Pacific Corp. v. United States Plywood Corp., 318 F. Supp. 1116, 1120 (S.D.N.Y. 1970). The first factor requires considering royalties “for the licensing of the patent in suit, proving or tending to prove an established royalty.” Id. at 1120. In ResQNet.com Inc. v. Lansa Inc, 594 F.3d 860 (Fed. Cir. 2010), the Federal Circuit reversed and remanded a damages award, faulting the district court and the plaintiff’s expert for considering several high-royalty “rebundling” licenses that had nothing to do with the patents-in-suit. Id. at 870-72. Instead, the most relevant license seemed to be from a prior litigation, which, ironically, courts often dismiss as heavily influenced by litigation, and occurring after the time of the hypothetical negotiation. Id. at 872.
Shortly afterwards, in Wordtech Systems Inc. v. Integrated Networks Solutions Inc., 609 F.3d 1308 (Fed. Cir. 2010), the Federal Circuit reversed and remanded a case for a new trial on damages because the plaintiff’s expert relied on licenses that did not support the damages award. The Federal Circuit criticized the use of the lump-sum licenses because they merely established a number unrelated to the anticipated use of the invention by the infringers. Id. at 1320. The court criticized the running-royalty licenses because the plaintiff failed to establish a basis for comparing these rates the use of infringing product. Id.
Rejecting the 25% Rule
On Jan. 4, 2011, the court vacated a large jury awarding Uniloc USA v. Microsoft Corp., 2011 U.S. App. LEXIS 11 (Fed. Cir. Jan. 4, 2011). The court had particularly harsh criticism for the “25% Rule of Thumb,” which many experts and courts have used to estimate a reasonable royalty. That rule posits that a manufacturer should give the patentee 25% of the profit from a product as a royalty for use of the invention. Id. at *48-49. Despite the admitted ubiquity of this rule, the court deemed it “a fundamentally flawed tool,” and instructed courts to exclude testimony based on this rule as inherently unreliable. Id. at *56. Because that rule was the basis of the plaintiff’s damages calculations in Uniloc, the Federal Circuit said that the district court erred by not excluding the testimony and granted Microsoft a new trial on damages.
To bring matters full circle, the Federal Circuit in Uniloc agreed with the district court’s rejection of attempts by Uniloc’s expert to use total revenues of Microsoft products as a “reality check” for his 25 percent rule-of-thumb calculation. The Federal Circuit found this attempt to use the EMV rule improper because the patentee failed to prove that the patented feature was the basis for customer demand. Id. at *71. The use of Microsoft’s total revenues, even with a low royalty rate, tended to skew the jury’s appreciation of the value of a license, and was therefore improper. Id. at *72-74.
The message from the Federal Circuit is clear. A patentee must provide compelling evidence to support large damage awards. To capture the value of an entire program or machine, the patentee must provide evidence that the claimed feature forms the basis for the demand for the entire product. To rely on prior licenses to show an established royalty rate, the patentee must show how they relate to the case at hand. Finally, shortcuts like the 25% Rule of Thumb have no place in damages calculations.