In 2002, Lucent Technologies Inc., (acquired by Alcatel in 2006), brought suit against a number of companies for infringement of U.S. Patent No. 4,763,356 (the “Day” patent), which is generally directed to a method of entering information into fields on a computer screen without using a keyboard (Lucent Technologies Inc. v. Gateway Inc.). Lucent’s action was initiated against Gateway, and Microsoft intervened. Lucent alleged indirect infringement by Microsoft based on the sales and use of Microsoft Outlook, Microsoft Money and Windows Mobile. On April 4, 2008, a jury found Microsoft liable on all three products and awarded $357,693,056.18 in damages, excluding prejudgment interest.

On September 11, 2009, the Federal Circuit found the jury’s decisions on validity and infringement to be supported by substantial evidence, and affirmed. However, the court remanded the damages award as lacking evidentiary support.

At trial, Lucent had sought a running royalty of 8% of the sales revenue of the accused software products, or some $561.9 million, while Microsoft proposed a lump-sum award of $6.5 million if the patent were found valid and infringed. The jury adopted Microsoft’s proposal for a lump-sum award, but without explanation of its calculation found damages in the very precise sum of $357,693,056.18.

In reviewing the award, the Federal Circuit examined the evidence as it pertained to each of the most relevant Georgia-Pacific factors, and found it wanting. Lucent’s significant problem on appeal was that its damages expert had not argued for a lump-sum payment, and thus there was a dearth of analysis, evidence or opinion in the record supporting such a large lump-sum award.

The more interesting part of the Federal Circuit’s opinion, however, concerns the “entire market value rule.” Microsoft argued that the entire market value rule cannot be properly applied where the patented invention is but one feature of the accused products. It was on this basis that Microsoft calculated damages on the basis of a single lump-sum payment, and it argued on appeal that the jury award must have been derived by applying a royalty percentage to the total sales figures of the infringing products, and was thus an improper application of the entire market value rule.

In its discussion, the Federal Circuit acknowledged that for the entire market value rule to apply, a patentee must prove that the patented feature is the basis for the market demand. But its more substantive discussion concerned the approach used by Lucent’s licensing expert. After being excluded by a motion in limine from arguing a royalty rate of 1% on a royalty base of the entire sales price of computers loaded with the accused software, the expert argued at trial for a royalty rate of 8% applied to a royalty base of the price of the software. The Federal Circuit did not find fault in this base, but did find a lack of support for the rate, and fault in increasing the rate when the initial royalty base was rejected.

As the Federal Circuit stated: “Simply put, the base used in a running royalty calculation can always be the value of the entire commercial embodiment, as long as the magnitude of the rate is within an acceptable range (as determined by the evidence). Microsoft surely would have little reason to complain about the supposed application of the entire market value rule had the jury applied a royalty rate of 0.1% (instead of 8%) to the market price of the infringing programs. Thus, even when the patented invention is a small component of a much larger commercial product, awarding a reasonable royalty based on either sale price or number of units sold can be economically justified.”

In rejecting arguments that have been made recently in the academic literature against the entire market value rule, the Federal Circuit stated: “The evidence of record in the present dispute illustrates the importance the entire market value rule may have in reasonable royalty cases. The license agreements admitted into evidence (without objection from Microsoft, we note) highlight how sophisticated parties routinely enter into license agreements that base the value of the patented inventions as a percentage of the commercial products’ sales price. 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.”

An issue, however, is reconciling this analysis with the requirement that the entire market value rule apply only when the patented feature is the basis for the market demand. As the Federal Circuit seemed to implicitly note, license agreements routinely use running royalties regardless of whether the licensed feature is perceived as the basis for market demand. It therefore seems consistent with the concept of the hypothetical negotiation that such royalties would be used without regard to whether the patented feature is anticipated as being a basis for market demand. Indeed, that a feature is the basis of market demand more logically goes to the value of that feature, or justified royalty rate, and not whether a royalty rate can be applied at all. In the future, how rigidly the Federal Circuit requires proof that a feature is the basis for the market demand will be an issue to watch.