The Patent Royalty 25% "Rule of Thumb"

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A "rule of thumb" used by accounting experts for many years to approximate royalties in patent cases is no longer admissible in the courtroom. The Court of Appeals for the Federal Circuit, the appeals court responsible for all patent cases, has ruled for the first time that a 25 percent "rule of thumb" frequently used by damages experts as a factor in calculating patent royalties does not rise to an admissible level of evidence and may not be relied upon in a patent lawsuit in federal court.  

In the 2011 decision of Uniloc USA, Inc. v. Microsoft Corp., the appellate court determined that this 25 percent rule may not be used even as a starting point for a patent damage analysis bound for the courtroom.  Although the so-called 25 percent rule of thumb may still be used by others in arriving at a proposed patent royalty, such as by parties making proposals for a patent license or experts engaged in patent valuation, the rule will no longer be accepted in court.

For many years reference had been made to a rule of thumb used as either a factor or starting point for assessing or negotiating a patent royalty.  Under that rule of thumb, 25 percent of the expected profit from sale of a patented item should be paid to the patent owner as a license royalty, while 75 percent of the expected profit should be paid to the company that bears the burden of manufacturing and selling the patented item.  That rule of thumb had existed for a number of years and in the last decade several efforts were reportedly made to empirically evaluate the rule and its appropriateness for patent royalty valuation.

In a patent lawsuit a successful patent owner may prove damages to be assessed against the infringer for use of the invention.  Although the patent statute allows for other methods of assessing damages if proven, the patent owner is entitled to no less than a reasonable royalty.  That reasonable royalty is often characterized as the royalty that would be arrived at during the course of a hypothetical negotiation between a willing licensor and willing licensee at the time the infringement began.  Arriving at that reasonable royalty is the challenge facing litigants in a patent suit.  Courts have evaluated an extensive list of potential factors which may be considered in efforts to arrive at that royalty amount.

In addition to the 25 percent rule finding use in valuation of a patent for purchase decisions and in negotiations of a royalty agreement, the 25 percent rule had been used by damages accounting experts in patent cases in arriving at reasonable royalty damages for infringement.  District court decisions in which the 25 percent rule had been relied upon by a party or its expert had previously been reviewed by the Court of Appeals for the Federal Circuit.  The Federal Circuit Court of Appeals however had not squarely considered whether the 25 percent rule was acceptable for use in the courtroom.

In the Uniloc v. Microsoft case the 25 percent rule had been used by a patent owner's expert and a jury awarded the patent owner $388 million in damages against Microsoft.  That jury award was overturned by the trial court for various reasons, including use of the 25 percent rule by the patent owner's expert.  In that setting the appellate court had the occasion to squarely assess the rule of thumb from an evidentiary standpoint for use in a patent infringement case.  After a lengthy review of the history of the rule, the Court of Appeals determined that the 25 percent rule of thumb was not to be used in patent damage evaluation for court cases, even as a starting point.  That rule did not rise to the level of evidence, and therefore was no longer considered admissible.  In the wake of the Uniloc v. Microsoft decision and the court's analysis there discussed, other factors that are more specific to the particular case under consideration, such as those enumerated in Georgia Pacific, remain the factors for analysis in court.

To learn more about licensing and profiting from your patents, see Profiting from Inventions.

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