"25 Percent Rule Of Thumb" To Estimate Patent Damages Found Inadmissible Under Daubert And FRE 702

Federal Circuit reverses jury damages verdict in patent infringement action based on expert damage testimony using the “25 percent rule of thumb” to determine a baseline royalty rate; arbitrary application of the rule was inadmissible without tying the standard to the facts of the case; case demonstrate necessity of “fit” between expert theory and the facts, in Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292 (Fed. Cir. Jan. 4, 2011) (Nos. 2010-1035, 2010-1055)

For many years, a “25 percent rule of thumb” has commonly been used as a baseline measure to determine a royalty rate for damages in patent infringement cases. In an ongoing patent infringement dispute between Uniloc and Microsoft, concerning a software registration system to deter software piracy, the Federal Circuit considered an open issue on whether the “25 percent rule of thumb” comported with FRE 702 and Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993).

The patent infringement case was brought by Uniloc USA, Inc. against Microsoft Corp. Uniloc claimed that its Product Activation patent, used to combat software piracy, was infringed by Microsoft’s Word XP, Word 2003, and Windows XP software programs. See U.S. Patent No. 5,490,216. Before trial, the court denied Microsoft’s motion in limine to exclude Uniloc’s expert damage testimony which was based on the “25 percent rule of thumb.” See Uniloc USA, Inc. v. Microsoft Corp., 632 F. Supp. 2d 147, 150-51 (D.R.I. Mar. 16, 2009). At trial, the damage expert testified that “a Product Key is worth anywhere be-tween $10 and $10,000 depending on usage.” Taking the conservative value of $10, he “applied the so-called ‘25 percent rule of thumb,’ hypothesizing that 25% of the value of the product would go to the patent owner and the other 75% would remain with Microsoft, resulting in a baseline royalty rate of $2.50 per license issued…. He then multi-plied the $2.50 royalty rate by the number of new licenses to Office and Windows products, 225,978,721, to get a final reasonable royalty of $564,946,803.”
Uniloc, 632 F.3d at 1311. In denying the motion to exclude the estimate based on the 25 percent rule, the trial court concluded the measure was widely used and therefore reasonable. The jury returned a verdict for Uniloc, concluded the infringement was willful, and awarded $388 million in damages. However, the district court granted Microsoft’s motion for judgment as a matter of law of non-infringement and no willful infringement, and in the alternative for a new trial. The trial court denied the motion for judgment as a matter of law on the issue of invalidity. A new trial was ordered on damages. See Uniloc USA, Inc. v. Micro-soft Corp., 640 F. Supp. 2d 150 (D.R.I. Sept. 29, 2009) (“Uniloc II”). The court noted the jury’s award was apparently “the fifth largest patent verdict in history.” On appeal, Microsoft continued to challenge the damage evidence based on the “25 percent rule of thumb.”

The Federal Circuit reversed the trial court’s motion for judgment as a matter of law of non-infringement and order for a new trial. The circuit affirmed the grant of the motion for judgment as a matter on willfulness for lacking evidentiary support, and the denial of the motion of invalidity of the patent. In considering the grant of a new trial on damages, the circuit confronted an open issue whether “the 25 percent rule of thumb is a fundamentally flawed tool for determining a baseline royalty rate.” Uniloc, 632 F.3d at 1315. The circuit explained the operation of the rule:

The 25 percent rule of thumb is a tool that has been used to approximate the reasonable royalty rate that the manufacturer of a patented product would be willing to offer to pay to the patentee during a hypothetical negotiation. “The Rule suggests that the licensee pay a royalty rate equivalent to 25 per cent of its expected profits for the product that incorporates the IP at issue.” The underlying “assumption is that the licensee should retain a majority (i.e. 75 percent) of the profits, because it has undertaken substantial development, operational and commercialization risks, contributed other technology/IP and/or brought to bear its own development, operational and commercialization contributions.”

Uniloc, 632 F.3d at 1313 (quoting Robert Goldscheider, John Jarosz and Carla Mulhern, Use Of The 25 Per Cent Rule in Valuing IP, 37 les Nouvelles 123, 123 (Dec. 2002)). While the circuit had cited to the rule it had not squarely addressed the issue of its admissibility. Notwithstanding the general acceptance of the rule, the circuit highlighted three primary criticism:

First, it fails to account for the unique relationship between the patent and the accused product…. Second, it fails to account for the unique relationship between the parties.… Finally, the rule is essentially arbitrary and does not fit within the model of the hypothetical negotiation within which it is based.”

Uniloc, 632 F.3d at 1313 (citations omitted). The Federal Circuit rejected the rule as a measure for damages:

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.

Uniloc, 632 F.3d at 1315. After reviewing the Supreme Court expert testimony cases and other Federal Circuit decisions, the circuit noted:

The meaning of these cases is clear: 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 25 percent rule of thumb as an abstract and largely theoretical construct fails to satisfy this fundamental requirement. The rule does not say any-thing about a particular hypothetical negotiation or reasonable royalty involving any particular technology, industry, or party. Relying on the 25 percent rule of thumb in a reasonable royalty calculation is far more unreliable and irrelevant than reliance on parties’ unrelated licenses…. To be admissible, expert testimony opining on a reasonable royalty rate must “carefully tie proof of damages to the claimed invention’s footprint in the market place.” ...

In this case, it is clear that [damage expert] Gemini’s testimony was based on the use of the 25% rule of thumb as an arbitrary, general rule, unrelated to the facts of this case. When asked the basis of his opinion that the rule of thumb would apply here, Gemini testified: “[i]t’s generally accepted. I’ve used it. I’ve seen others use it. It’s a widely accepted rule.” Upon further questioning, Dr. Gemini revealed that he had been involved in only four or five non-litigation related negotiations, and had recommended the 25% rule only once in a case involving a power tool. He did not testify that the parties here had a practice of beginning negotiations with a 25%/75% split, or that the contribution of Product Activation to Office and Word justified such a split. He did not base his 25 percent baseline on other licenses involving the patent at issue or comparable licenses. 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.

Uniloc, 632 F.3d at 1318 (other citation omitted). The circuit ordered a new trial on the issue of damages.

The Uniloc decision essentially is based on the principle that the expert testimony, and underlying theories, must “fit” the facts of the case. As the Supreme Court noted in Daubert, the principle of “fit” measures how well the expert testimony is tied to the facts of the particular case:

Rule 702 further requires that the evidence or testimony “assist the trier of fact to understand the evidence or to determine a fact in issue.” This condition goes primarily to relevance. “Expert testimony which does not relate to any issue in the case is not relevant and, ergo, non-helpful.” 3 Weinstein & Berger ¶ 702, p. 702-18. See also United States v. Downing, 753 F. 2d 1224, 1242 (CA3 1985) (“An additional consideration under Rule 702—and another aspect of relevancy—is whether expert testimony proffered in the case is sufficiently tied to the facts of the case that it will aid the jury in resolving a factual dispute”). The consideration has been aptly described by Judge Becker as one of “fit.” Ibid. “Fit” is not always obvious, and scientific validity for one purpose is not necessarily scientific validity for other, unrelated purposes. See Starrs, Frye v. United States Restructured and Revitalized: A Proposal to Amend Federal Evidence Rule 702, 26 Jurimetrics J. 249, 258 (1986). The study of the phases of the moon, for example, may provide valid scientific “knowledge” about whether a certain night was dark, and if darkness is a fact in issue, the knowledge will assist the trier of fact. However (absent creditable grounds supporting such a link), evidence that the moon was full on a certain night will not assist the trier of fact in determining whether an individual was unusually likely to have behaved irrationally on that night. Rule 702’s “helpfulness” standard requires a valid scientific connection to the pertinent inquiry as a precondition to admissibility.

Daubert, 509 U.S. at 591-92. While the Uniloc case arises in the patent field, the lesson is that arbitrary standards for damages or other measures are inadmissible unless tied to the facts of the case.

Federal Rules of Evidence