Microsoft Wins at CAFC, 25% Reasonable Royalty Rule Dies

Earlier today Uniloc USA, Inc. won a partial victory today in an appeal to the United States Court of Appeals for the Federal Circuit in their case against Microsoft.  See Uniloc USA, Inc. v. Microsoft Corp. Truth be told, while the Federal Circuit ruled that Microsoft did infringe and the patent claim in question (claim 19 of U.S. Patent No. 5,490,216) was valid, it was Microsoft who was the big winner here.  The damages awarded by the jury to Uniloc were $388 million, which was set aside by the district court, a ruling that the Federal Circuit affirmed.  The Federal Circuit also agreed there was no willful infringement.  So while Uniloc has won at least something from Microsoft as a result of its infringement of a valid patent claim, it seems like it will be far less than the $388 million, particularly given the Federal Circuit threw out the 25 percent rule and said the entire market value rule was not applicable in this case.

The Federal Circuit, per Judge Linn (with Chief Judge Rader and Judge Moore also on the panel), ruled that the jury’s verdict on infringement of  the ‘216 patent was supported by substantial evidence, and thus reversed the district court’s grant of JMOL of non-infringement.   However, the Federal Circuit ruled that the jury’s verdict on willfulness was not supported by substantial evidence, and thus affirmed the district court’s grant of JMOL, which ruled there was not willful infringement.  The Federal Circuit also found that the jury’s damages award was fundamentally tainted because of the use of a legally inadequate methodology.  Finally, because the district court did not abuse its discretion in determining that the jury verdict of no invalidity of the ’216 patent was supported by substantial evidence, the Federal Circuit affirmed the district court’s denial of Microsoft’s motion for JMOL of invalidity.  Thus, according to the Federal Circuit, the patent claims were valid and infringed, but a new trial is required on damages.

Uniloc’s ’216 patent is directed to a software registration system to deter copying of software.  The system allows the software to run without restrictions (in “use mode”) only if the system determines that the software installation is legitimate. The only claim asserted by Uniloc against Microsoft was independent claim 19, which reads:

19. A remote registration station incorporating  remote  licensee unique ID generat ing means, said station forming part of a registration system for licensing execution of digital data in a use mode, said digital data executable on a platform, said system including local licensee unique ID generating means, said system further including mode switching means operable on said platform which permits use of said digital data in said use mode on said platform only if a licensee unique ID generated by said local licensee unique ID generating means has matched a licensee unique ID generated by said remote  licensee unique ID generating means; and wherein said remote  licensee unique ID generating means comprises software executed on a platform which includes the algorithm utilized by said local  licensee unique ID generating means to produce said licensee unique ID.

The accused product is Microsoft’s Product Activation feature that acts as a gatekeeper to Microsoft’s Word XP, Word 2003, and Windows XP software programs.  Upon receipt of Microsoft’s retail  software program, the user must enter a 25-character alphanumeric product key contained within the packaging of Microsoft’s retail products.  If the Key is valid, the user is asked to agree to the End User License Agreement (“EULA”), by which the licensor-licensee relationship is initiated.

With respect to infringement, Microsoft argued that because there was no dispute about how the accused products work, infringement should be reviewed de novo.  The Federal Circuit declined this invitation to re-write the law and supplant the jury’s determination for its own.  The Federal Circuit summarized by explaining that the claim construction itself was not contested, but rather that the application of that claim construction to the accused device was contested.  As a result, the Federal Circuit saw no reason to depart from the traditional rule for reviewing jury verdicts.  Infringement being a question of fact the determination of the jury was reviewed for substantial evidence.

In reviewing the infringement aspects of the Federal Circuit decision there is much one would expect to find; namely the parties arguing back and forth about what meant what and whether there was any evidence to support the conclusions the jury reached.  On peculiar aspect of this back and forth that bears some note it that according the the Federal Circuit the district court inappropriately rejecting certain testimony as “incomplete, oversimplified and frankly inappropriate…”   The Federal Circuit noted that First Circuit law, which is the prevailing view among the circuits, is not to allow district court judges in a jury trial to evaluate the credibility of witnesses, resolve conflicts in testimony, or evaluate the weight of the evidence.  The role of the district court under Daubert is to exercise a “gatekeeper” function to ensure scientific testimony is relevant and reliable.

There were a couple things in particular that seemed to irk the Federal Circuit regarding the district court characterizing the expert’s testimony.  First, the district court criticized the use of the analogy of a digest to a “reader’s digest,” but the Federal Circuit pointed out that this wasn’t improper because Microsoft did not object at trial and has itself used the same analogy.  Second, the district court discounted the expert’s testimony because it was viewed by the court as  a simplification of the functioning of one of the two algorithms in play, but neither the district court nor Microsoft ever explained why it was oversimplified or even inaccurate.

With respect to willfulness of the infringement on the part of Microsoft, the district court concluded that no reasonable jury could have found that Microsoft’s conduct fell under either Seagate prong.  Under Seagate, in order to establish willful infringement, a patentee must show by clear and convincing evidence that the infringer acted despite an objectively high likelihood that its actions constituted infringement of a valid patent. In ruling the Federal Circuit determined that Uniloc failed to meet the threshold objective prong of Seagate and agreed with the district court.  More specifically, the Federal Circuit explained that Uniloc did not presented any evidence at trial or on appeal showing why Microsoft could not have reasonably believed it was engaging in non-infringing activities.  Thus, in the absence of evidence relating the knowledge and belief on the part of Microsoft, there could be no supportable finding of willful infringement on the part of Microsoft.

With respect to damages, the jury awarded Uniloc $388 million, based on the testimony of Uniloc’s expert, Dr. Gemini, who opined that damages should be $564,946,803.  Gemini based his opinion on a hypothetical negotiation between Uniloc and Microsoft, relying on the  Georgia-Pacific factors.  The damages appeal presented three specific issues for the Federal Circuit to consider; namely: (1) the propriety of using the 25 percent rule; (2) application of the entire market value rule as a “check”; and (3) excessiveness  of damages.  Notwithstanding, because the Federal Circuit affirmed the district court’s conditional grant of a new trial on damages, the last issue was not reached.

The 25 percent rule of thumb is a tool that has been used to approximate the reasonable royalty rate that the manufacturer of a patented product would be willing to offer to pay to the patentee during a hypothetical negotiation.  The Court explained that the rule has its supporters and its critics, and observed that the rule itself has previously never been squarely at issue; the Federal Circuit only passively tolerating its use where its acceptability has not been the focus of the case.  As one read the “tolerates” language of the panel it wasn’t hard to see what was about to happen, which was the uncerimonious dismissal of the 25 percent rule.

After discussing Daubert and the Supreme Courts admonition that damages must be tied to the facts of a case, the Court ruled:

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 Daubert and the Federal Rules of Evidence, because it fails to tie a reasonable royalty base to the facts of the case at issue.

The panel went on to say:

It is of no moment that the 25 percent rule of thumb is offered merely as a starting point to which the Georgia-Pacific factors are then applied to bring the rate up or down.  Beginning from a fundamentally flawed premise and adjusting it based on legitimate considerations specific to the facts of the case nevertheless results in a fundamentally flawed conclusion.

At least for now, the 25 percent rule is dead!  But what about the entire market value rule?

The entire market value rule allows a patentee to assess damages based on the entire market value of the accused product only where the patented feature creates the basis for customer demand or substantially creates the value of the component parts.  In this case the patentee’s expert relied up a figure of $19 billion for the entire market, which they claimed encompassed the entire market value of Office and Windows.  The district court stated, and the Federal Circuit agreed, that customers do not buy Office of Windows because of a product activation feature that protects against unauthorized copies, and as such the entire market value of Office and Windows was irrelevant and tainted the jury’s award.

The Federal Circuit explained:

The Supreme Court and this court’s 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… 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.

So the entire market value rule continues, it just wasn’t proper for this case.