The U.S. Court of Appeals for the Federal Circuit held that the 25 percent rule of thumb, often used as a tool for determining a baseline royalty rate in a hypothetical negotiation, is a fundamentally flawed. Uniloc USA, INC. and Uniloc Singapore Private Limited v. Microsoft Corporation, Case Nos. 10-1035, -1055 (Fed. Cir., Jan. 4, 2011) (Linn, J.).

Uniloc sued Microsoft for infringement of its patent directed to combating copying of software. After the jury found that Microsoft willfully infringed the patent, the district court granted a judgment as a matter of law (JMOL) to Microsoft on the infringement issue. The jury also awarded Uniloc $388 million in damages, based on the testimony of its expert, Dr. Gemini. Using the Georgia Pacific factors and a hypothetical negotiation between the parties, Dr. Gemini opined that the damages should be roughly $564 million. After determining that a $10 baseline per unit price was appropriate, Dr. Gemini applied a 25 percent rule of thumb. He also determined that the Georgia Pacific factors ultimately did not favor adjusting the resulting $2.50 per unit royalty rate. He then applied to the $2.50 rate to the number of units sold to arrive at the total damages.

To “check” his calculation, Dr. Gemini applied the total market value rule by applying the damage figure to the total market value of all Microsoft products that included the accused “key,” which was more than $19 billion. Dr. Gemini determined that his damages calculation amounted to a royalty rate of 2.9 percent when compared to gross revenue. There was no offer by Dr. Gemini of any specific line between the 25 percent rule and the present case.

Among the issues on appeal, Microsoft challenged the propriety of the 25 percent rule and the related application of the entire market value rule as a “check” on it.

The Federal Circuit considered the Daubert standard for expert testimony, noting that if an expert for a party fails to tie its theory of the facts to the case, the testimony must be excluded. The Court also noted that “any evidence unrelated to the claimed invention does not support compensation for infringement but punishes beyond the reach of the statue.” After reviewing a number of cases that focused on Daubert, the Court stated that “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.” In order to be admissible, expert testimony opinion on a reasonable royalty rate must “carefully tie proof of damages to the claimed invention’s footprint in the market place.”

In view of the legal precedent, the Court determined that evidence relying on the 25 percent rule of thumb is 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. Thus, the Court held that as a matter of Federal Circuit law, the 25 percent rule of thumb is a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation.