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  In a case reinstating a patent infringement verdict against Microsoft Corp. but tossing the jury’s damages award, the U.S. Court of Appeals for the Federal Circuit rejected a widely used damages calculation rule. The court found that Microsoft infringed a Uniloc USA Inc. patent, but it called the jury’s original $388 million damages award “fundamentally tainted” by legally inadequate methodology. The unanimous Jan. 4 panel ruling in Uniloc USA Inc. v. Microsoft Corp. reversed a September 2009 ruling by the District of Rhode Island,  which had vacated an April 2009 infringement verdict for Uniloc.  Although the Federal Circuit ruled that Microsoft infringed Uniloc’s patent for a software registration system designed to curb software copying, it determined that the evidence didn’t show willful infringement. It therefore affirmed the lower court’s judgment overturning the jury’s finding of willful infringement. The Federal Circuit also granted a new damages trial. Judge Richard Linn wrote the opinion. Chief Judge Randall Rader, who is known for rulings vacating or cutting high damage awards, and Judge Kimberly Moore joined the ruling. The opinion tackled two key damages areas. First, it rejected the 25% “rule of thumb,” which is frequently used in patent cases as a starting point for determining the reasonable royalty rate a licensee would offer the patent holder during a hypothetical negotiation. The rule calls for a rate equivalent to 25% of expected profits from products incorporating the patent. Second, the Federal Circuit detailed why Uniloc’s expert testimony violated the “entire market value rule,” which allows a patent holder to base damages calculations on an infringing product’s entire market value if the patented feature is critical to consumer demand or the value of the product’s component parts. In his analysis, Linn explained that while the admissibility of the 25% rule “has never been squarely presented to this court,” the Federal Circuit has “passively tolerated its use where its acceptability has not been the focus of the case.” Linn went on to announce: “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 [the] Daubert [rule concerning admissibility of expert witnesses in federal cases] and the Federal Rules of Evidence, because it fails to tie a reasonable royalty base to the facts of the case at issue.” Linn later spelled out 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,” Linn wrote. “The rule does not say anything about a particular hypothetical negotiation or reasonable royalty involving any particular technology, industry, or party.” Another section of the ruling repudiated Uniloc’s use of the entire market value rule. The Federal Circuit agreed with the lower court that Uniloc’s damages expert’s reference to Microsoft’s approximately $19 billion in revenue for Office and Windows, during the infringing time period, was an improper variable for “checking” the expert’s damages calculation. U.S. Supreme Court and Federal Circuit precedents “do not allow consideration of the entire market value of accused products for minor patent improvements simply by asserting a low enough royalty rate,” Linn wrote. “This case provides a good example of the danger of admitting consideration of the entire market value of the accused where the patented component does not create the basis for customer demand,” Linn later elaborated. “The disclosure that a company has made $19 billion in revenue from an infringing product cannot help but skew the damages horizon for the jury, regardless of the contribution of the patented component to this revenue,” Linn wrote. “The bottom line is the patent is valid and the accused product infringes; the only thing left is the damages issues,” said Paul Hayes, an intellectual property partner at Boston’s Mintz, Levin, Cohn, Ferris, Glovsky and Popeo. Hayes was chief trial counsel for Uniloc at the district court and of counsel on the Federal Circuit appeal. On the damages question, the Federal Circuit “took this opportunity to effectively narrow the application of the 25% rule of thumb,” Hayes said. “I don’t think it’s gone, but it’s on the way out,” Hayes said. “Uniloc is obviously pleased that the court found liability and is looking forward to retrying the case on damages,” said Donald Dunner, a partner at Washington’s Finnegan, Henderson, Farabow, Garrett & Dunner who argued Uniloc’s case before the Federal Circuit. “To get a reversal on the liability issue is very pleasing,” Dunner said. As for the 25% rule of thumb, “that rule is used in many, many, many damage cases,” Dunner said. “Obviously the court is basically setting forth additional guidelines in terms of what is appropriate and inappropriate in a damages case.” Microsoft’s lawyers at Fish & Richardson did not respond to requests for comment and referred inquiries to the company. In an e-mailed comment about the ruling, David Howard, Microsoft’s deputy general counsel – litigation, said: “This is an important and helpful opinion with respect to the law of damages, and it may signal the end of unreasonable and outsized damages awards based on faulty methodology.” “For example, the Federal Circuit found that product revenues cannot be admitted unless the accused feature is first determined to be the basis for consumer demand,” Howard stated. “Expert testimony relying on the 25% rule was determined to be ‘fundamentally flawed’ and inadmissible. Moreover, the Federal Circuit reinforced the basic concept of the trial court as gatekeeper by emphasizing that once a court determines an expert’s methodology is faulty, the court must exclude that testimony. We look forward to the new trial.” Sheri Qualters can be contacted at [email protected].

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