• Federal Circuit Rejects 25 Percent Reasonable Royalty 'Rule of Thumb'
  • January 10, 2011
  • Law Firm: Skadden Arps Slate Meagher Flom LLP - New York Office
  • On January 4, 2011, the Federal Circuit issued an opinion in Uniloc USA, Inc. v. Microsoft Corp., No. 03-CV-0440, rejecting the long accepted 25 percent rule of thumb for reasonable royalty calculations. In presenting its damages case, Uniloc’s damages expert had opined that a hypothetical negotiation between the parties would have resulted in a reasonable royalty of 25 percent of the value of the accused product. Id. at 34. He testified that he reached this figure by applying the “25 percent rule of thumb” then considering whether the Georgia Pacific factors would favor either party sufficiently to move this 25 percent figure up or down (he concluded that they did not). Id.

    On appeal, the Federal Circuit examined the 25 percent rule and rejected it as failing the Daubert standard, holding that the rule fails under the Daubert standard “because it fails to tie a reasonable royalty base to the facts of the case at issue.” Id. at 41 (“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.”). The Daubert standard requires expert testimony to be grounded on a firm scientific or technical basis that relates specifically to the facts of the case. As the Supreme Court stated in the Daubert case, “[e]xpert testimony which does not relate to any issue of the case is not relevant and, ergo, non-helpful.” Daubert v. Merell Dow Pharms., 509 U.S. 591 (1993). With regard to the 25 percent rule, the Federal Circuit found that this rule of thumb, as an abstract concept, fails the Daubert standard because it is, in essence, too abstract and generic. If, as in the case here, an expert fails to specifically justify why the 25 percent rule applies to the particular facts at hand, then his analysis will not satisfy the Daubert standard. In other words, a generic rule of thumb will no longer suffice as a starting point for a reasonable royalty analysis. Instead, the rate applied must be chosen in view of the specific facts of the case.

    In reaching this conclusion that a generic rule of thumb is not sufficiently relevant to the facts of a specific case, the Federal Circuit looked to its prior decisions ruling on the relevance of particular license agreements to royalty calculations. The court looked back to its decisions in ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860 (Fed. Cir. 2010); Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301 (Fed. Cir. 2009); and Wordtech Sys., Inc. v. Integrated Networks Solutions, Inc., 609 F.3d 1308 (Fed. Cir. 2010), writing that these cases stand for the proposition that in calculating a reasonable royalty a patentee only can rely on license agreements that are sufficiently comparable to the hypothetical license at issue in the case. Uniloc at 45. The court stated that “[t]he 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.” Id. From this, the court extrapolated that

    [t]he 25 percent rule of thumb as an abstract and largely theoretical construct fails to satisfy this fundamental requirement. ... 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, which we rejected in ResQNet and Lucent Technologies.”

    Id. The court’s reliance on the ResQNet, Lucent Technologies and Wordtech Systems cases in its analysis of the 25 percent rule is particularly interesting because it implies that this holding may be more far reaching than merely the court’s rejection of the plain use of the 25 percent rule. The court’s discussion of these cases implies that going forward it will be necessary not only to start a reasonable royalty analysis from a point more tied to the case than a generic rule of thumb, but also that any consideration of additional licenses must sufficiently connect those licenses to the facts of the hypothetical negotiation at issue. It will likely no longer be adequate to rely on other license agreements simply because they involve the same patents or parties. Instead, a discussion of why those license agreements relate specifically to the facts at hand should be included.

    While it remains to be seen whether the Federal Circuit will follow up on its discussion of the ResQNet, Lucent Technologies and Wordtech Systems cases to establish particular criteria determining when a license agreement is relevant to a reasonable royalty analysis, one thing appears clear both from the court’s reasoning and its ultimate rejection of the 25 percent rule of thumb: the Federal Circuit is continuing its trend of requiring a more concrete and specific connection between an expert’s damages calculation and the particular facts of the case at issue.