Wednesday, January 5, 2011

A Tale of Two Experts

Yesterday the Federal Circuit decided Uniloc USA, Inc. v. Microsoft Corp.  The case is very interesting because of the holding on patent damages, but is personally interesting because it involved two experts I worked with at various times while in private practice.  The technical expert was vindicated in this opinion, while the damages expert -- who wasn't even involved in the case -- saw the Court disapprove a widely-adopted damages theory he had used for many years.

The Technical Expert

I worked with Uniloc's technical expert, David Klausner, in a number of cases starting in the late 1990's.  I liked David and enjoyed working with him.  In April 2009, David told me about a patent case where his side, plaintiff Uniloc, won a big patent verdict against Microsoft.  David provided testimony about how Microsoft's products infringed Uniloc's patent, and the jury agreed with him.  I congratulated David on this good result.  However, several months later, the trial judge threw out the verdict and entered judgment for Microsoft.  The judge's opinion was quite critical of David's testimony.

The case went up on appeal, and in yesterday's opinion, the Federal Circuit sided with Uniloc and David on infringement.  The Court found that David's testimony provided "substantial evidence" to justify the jury's verdict.  In particular, the Court addressed the trial court's criticism of David: "the district court improperly rejected Klausner’s testimony as 'incomplete, oversimplified and frankly inappropriate.'"  Rather, the Federal Circuit stated that "Klausner’s testimony was certainly a simplification of the functioning of MD5, but neither the district court nor Microsoft demonstrate why it was 'oversimplified,' Uniloc II, 640 F. Supp. 2d at 171 n.21, or even why it was inaccurate."

So good news for David Klausner and his client on the infringement issue.

The Damages Expert

Not such good news for a damages expert I once worked with, who didn't even testify in the case.  By way of background, in the late 1980's and 1990's I worked with Robert Goldscheider,  Bob was an impressive and knowledgeable licensing expert.  When I first met him, he told me about a theory of his that could be used to determine a reasonably royalty in patent case, which is now known as the "25 percent rule."  Bob's theory was that a reasonable patent royalty would be 25% of the licensee's expected profits for the product that uses the patent.  The theory is that the licensee gets to keep 75% of the profit (it builds the product, after all), and the patent owner gets the other 25%.  The Federal Circuit describes Bob as the "leading proponent" of the 25% rule, and discusses it at length (see pages 35-38 of the opinion).

Since the time Bob first told me about his theory, it had gained wide acceptance as at least a starting point in calculating a reasonable royalty.  Many other licensing or damages experts considered it.  The Federal Circuit's opinion lists quite a few cases using the 25% rule (see pages 39-41 of the opinion).  Uniloc's damages expert, Mr. Gemini, had used the rule to calculate his royalty rate, which the jury's damage award reflected (perhaps with a reduction).

In its decision, for the first time the Federal Circuit disapproved the 25% rule:

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.
. . .

. . . 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. The rule does not say any-thing about a particular hypothetical negotiation or reasonable royalty involving any particular technology, industry, or party.

Thus, although Bob didn't even get a chance to defend his theory in the Uniloc case, it has now been disapproved after decades of use.

In another part of the damages discussion, the Court disapproved the use of the "entire market value" rule by  Uniloc's expert.  The accused product was a software registration system for Microsoft's other products (such as Office and Windows), but Uniloc's expert also calculated damages as a percent of the sales of those larger products -- not just the registration system.  The Court disapproved this use of the "entire market value" analysis:

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. As the district court aptly noted, “[t]he $19 billion cat was never put back into the bag even by Microsoft’s cross-examination of Mr. Gemini and re-direct of Mr. Napper, and in spite of a final instruction that the jury may not award damages based on Microsoft’s entire revenue from all the accused products in the case.” Uniloc II, 640 F. Supp. 2d at 185. This is unsurprising. The disclosure that a company has made $19 billion dollars 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.

Microsoft therefore got a new trial on damages.

This decision might yet be reviewed further by the entire Federal Circuit, or by the Supreme Court.  If the opinion stands, it operates as a substantial limitation on patent damages in future cases.
Here is further analysis by Patently-O.  UPDATE:  Here is an article by Joe Mullin.

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