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FEDERAL CIRCUIT REJECTS DAMAGES RULE AS FUNDAMENTALLY FLAWED
- 1/6/2011

On January 4, 2011 the Court of Appeals for the Federal Circuit issued its ruling in Uniloc USA v. Microsoft Corp.  Uniloc had filed suit against Microsoft in 2003 alleging that Microsoft's product activation system used in connection with the Windows XP operating system and Office software products infringed its patent for a software registration system to deter software piracy.  In 2009 a jury in the U.S. District for the District of Rhode Island found in favor of Uniloc and awarded a near-record $388 million in damages.  Microsoft appealed the jury verdict to the trial judge, who overturned the verdict .  The trial judge's decision to overturn the jury verdict was appealed to the Federal Circuit.  
 
Although the Federal Circuit upheld the validity of Uniloc's patent and found Microsoft had infringed the patent, it found that the infringement was not willful and that the award of damages "was fundamentally tainted by the use of a legally inadequate methodology."  Accordingly, the Federal Circuit ordered a new trial on to reassess the quantum of damages to be paid by Microsoft. 
 
The decision throws out the methodology used in the calculation of damages in infringement actions that has long been "passively tolerated" by the Federal Circuit, and will likely reduce the amount of damages that Microsoft will have to pay to Uniloc. The methodology, commonly referred to as the "25 percent rule of thumb," is a tool that has been used to approximate the reasonable royalty rate that the manufacturer of a patent product would be willing to offer to pay to the patentee during a hypothetical negotiation.  The methodology assumes that licensees pay a royalty rate equivalent to 25 percent of its expected profits for the product that incorporates the patented technology at issue.   
 
In rejecting the application of the "rule of thumb," the Federal Circuit held that the rule is "fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation" and that "[e]vidence relying on the 25 percent rule of thumb is thus inadmissible [. . . ] because it fails to tie a reasonable royalty base to the facts of the case at issue."   Thus, according to the decision, "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."  According to the Court, the 25 percent rule does not satisfy that requirement.
 
In evaluating the damages awarded in favor of Uniloc the Federal Circuit concluded that the testimony presented at trial "was based on the use of the 25 [percent] rule of thumb as an arbitrary, general rule, unrelated to the facts of this case."  Accordingly, a new trial was ordered to reassess the issue of damages.  


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