Federal courts have recently become increasingly strict in the quality of evidence they require to prove economic damages. One recent case that illustrates this point is Uniloc v. Microsoft, a patent infringement case. While the case was first filed in 2003, it remains under litigation to this day, and the aspect on which this article will be focusing is a 2011 ruling at the appellate court level.

Background

The patent in question involves product activation, the copy-protection system used in many software programs. Specifically, the software is sold with a key code that the user enters during installation. The program then sends this information to the seller’s computer, which applies various computations to it and returns a license key. When the program runs, it applies the same computations to generate its own version of the key, and will only run if they match. This allows the seller to issue only a certain number of licenses per sale. In some cases, ID codes from hardware components are also used in generating the license code; this means that the program will only run on the specific machine where it was activated.

Case Summary

This system was invented by an Australian company (Uniloc) and patented in 1992 (in Australia) and 1996 (in the USA). The dispute centered on whether the version that Microsoft invented for Word 2000 and Windows XP was close enough to what was described in the patent to require a license. This issue has not yet been conclusively answered.

The secondary question, one that has greater potential effects outside of the case at hand, is the question of damages. In other words, if Microsoft did infringe on the patent, how much should they be required to pay? The legal standard is a “reasonable royalty”—in other words, what hypothetical willing parties would have negotiated. Since there was no negotiation involved, this requires various analytical techniques.

Uniloc’s expert used what the court described as a traditional “rule of thumb” known as the 25% rule. This rule suggests that 25% of the revenue from a product may be attributed to its intellectual property. The expert valued a key (on a standalone basis, considering the lowest value of any product on which it was used) at $10, thus setting the royalty at $2.50 and the total damages at $565 million. As a test of reasonableness, he compared that figure to the total revenue from all sales of the infringing products, and found it to be 2.9% (which he deemed reasonable).

Appellate Court Ruling

The appellate court (the Federal Circuit, which hears all appeals of patent cases) ruled all of that evidence to be useless. Specifically, the court described the 25% rule as “fundamentally flawed” in that it does not take into account any of the unique negotiating factors that may exist in a particular case. The court also pointed out that the entire market rule only makes sense when the feature covered by the patent contributes to demand for the product, which it ruled was not the case here.

It is important to note that the jury did not actually award the value the expert proposed as a reasonable royalty, but the appeals court ruled that even allowing them to hear that testimony was enough to throw out their verdict altogether.

This verdict throws a great deal of uncertainty into the field of patent infringement damages. While the court clearly wants to see an analysis more closely tied to the specific case, its decision gave no guidance on how to do so. We can expect continued controversy in this area for some time.                                               

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