Use of the "25 % Rule" in Calculating Intellectual Property Infringement Damages

Business Advisors|Litigation Support

By Stephen Thimons

It is hard to ignore the increasing role technology is playing in our lives. Just walk down the street or through the mall and count the number of people with their head buried in a smart phone, hand-held video game system or some other piece of technology.

Given the importance of technology, businesses are becoming more mindful of protecting their intellectual property (“IP”) assets, often through legal enforcement of intellectual property ownership. In fact, Apple was recently awarded $1 billion related to a patent infringement lawsuit against Samsung (which was discussed in a recent Insight. However, quantifying the economic damages associated with the infringement of a patent or other intellectual property asset is no easy task.

Patent infringement damages are generally calculated in one of two ways: (1) the profits a patent owner lost due to the infringement (i.e., “lost profits”); or (2) a royalty for the use of the patent by the infringer (i.e., a “reasonable royalty”).

Recently, one of the methodologies damages experts use to calculate a “reasonable royalty” was scrutinized by the United States Court of Appeals for the Federal Circuit (“Federal Circuit”) in a patent infringement case between Uniloc and Microsoft.

In this case, Uniloc sued Microsft for patent infringement related to a technology that combats software piracy and was awarded nearly $400 million in damages. However, on appeal, the Federal Circuit granted a new trial related to damages because the $400 million award was “tainted by the use of a legally inadequate methodology.”

The “legally inadequate methodology” referenced by the Federal Circuit was the “25% Rule.” The rule states that a royalty rate should be equivalent to 25% of the expected profits from the product that incorporates the IP. For example, if Microsoft earned a 20% profit margin from a product using the Uniloc patent, under the “25% Rule,” the appropriate royalty rate Microsoft should pay to Uniloc would be 5% (i.e., 25% of 20%).

The Federal Circuit, in a rather detailed examination of the “25% Rule,” concluded that, “Evidence relying on the 25% rule of thumb is thus inadmissible…because it fails to tie a reasonable royalty base to the facts of the case at issue.” Essentially, what the Court said was, because the “25% Rule” fails to explicitly consider the circumstances of the case (e.g., Are the licensor/licensee competitors? Are there are other factors that drive sales beyond the patented technology at issue?), its reliability should be questioned.

This ruling has left damages experts to consider whether or not the “25% Rule” has any applicability in the calculation of damages for litigation. Damages experts may have to move away from this rule and focus their analysis on the specifics of the case in order to determine a reasonable royalty rate that will stand up to legal scrutiny.

Schneider Downs has significant expertise in calculating economic damages for a variety of purposes, including intellectual property infringement. For more information about Schneider Downs’ litigation support and other business advisory services, please contact Joel Rosenthal at 412.697.5387 or jrosenthal@schneiderdowns.com or Tom Claassen at 412.697.5330 or tclaassen@schneiderdowns.com.

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