How to Prove Reasonable Royalty Damages after Uniloc

1. How to Prove Reasonable Royalty Damages after Uniloc March 3, 2011

2. Statutory Basis for Reasonable Royalty Damages and How to Prove Them • 35 U.S.C. § 284: “[T]he court shall award damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer.” “The court may receive expert testimony as an aid to the determination of damages or of what royalty would be reasonable under the circumstances.”

3. Two kinds of recognized patent damages: (1) Lost profits for sales the patentee would have made (e.g., as a competitor) (2) Reasonable royalty for sales the patentee would not have made

4. Reasonable Royalty Methodologies • Three basic types of methodologies have been accepted by CAFC: (1) “Established” royalty (forget this one) (2) Analytical method (TWM v. Dura) (3) Hypothetical royalty negotiation using Georgia Pacific factors (with patent assumed valid and infringed)

5. Recent CAFC Reasonable RoyaltyDecisions • Lucent Tech., Inc. v. Gateway, Inc., 580 F.3d 1301 (Sept. 2009) • i4i Ltd. Partnership v. Microsoft Corp., 598 F.3d 831 (Dec. 2009) • ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860 (Feb. 2010) • Wordtech Sys., Inc. v. Integrated Network Sol’n, Inc., 2010 WL 2384958 (June 2010) • Microsoft v. Uniloc, __ F.3d ___ (Jan. 2011)

6. Lucent Tech. v. Gateway, Inc. • Lucent accused Gateway and others of infringing a number of patents, including the Day ‘356 patent. • 􀂃 Microsoft intervened and its products, including “date picker” feature of Outlook, were accused. • 􀂃 Lucent prevailed against Microsoft at trial and obtained a jury award of ~$360 million. • 􀂃 Validity and infringement decisions upheld on appeal, but damages award remanded as lacking sufficient evidentiary support.

7. Lucent Tech. cont.Reasonable Royalty Analysis • The Federal Circuit considered whether the lump sumjury award of ~$360 million was a “reasonable royalty.” • 􀂃 Lucent had argued for a running royaltybased award (8% of accused products including Microsoft Outlook) totaling ~$562 million. • 􀂃 Microsoft had argued for a lump-sumroyalty payment of $6.5 million. • 􀂃 The jury’s lump sum award was much closer to Lucent’s number but NOT based upon Lucent’s expert’s running royalty theory.

8. Lucent Tech. cont.Reasonable Royalty Analysis • Georgia Pacific Factor 2 -- “[t]he rates paid by the licensee for the use of other patents comparable to the patent in suit” -- weighed against jury award. • 􀂃 There was no evidence in the record to support jury determination that the parties would have agreed to a lump sum payment. The lump sum and running royalty approaches to a license agreement necessarily involve different considerations. • 􀂃 The 4 “comparable” lump-sum agreements were either “vastly different” or were presented with no explanation as to subject matter. • 􀂃 For the 4 running-royalty agreements presented, there was no evidence in the record about why they would have been probative of the amount of a lump-sum payment. • 􀂃 Jury award was 3-4 times average amount of lump-sum agreements in evidence.

9. Lucent Tech. cont.Reasonable Royalty Analysis • Georgia Pacific Factors 10 and 13 – “[t]he nature of the patented invention; the character of the commercial embodiment of it as owned and produced by the licensor; and the benefits to those who have used the invention;” “[t]he portion of the realized profit that should be credited to the invention as distinguished from non-patented elements, the manufacturing process, business risks, or significant features or improvements added by the infringers.” -- did not support jury award • 􀂃 These factors concern how the parties would have valued the patented feature during the hypothetical negotiation. • 􀂃 The record evidence showed that the infringing date picker feature was “but a tiny feature” in the larger Outlook software program.

10. Lucent Tech. cont.Reasonable Royalty Analysis • Georgia Pacific Factor 11 – “[t]he extent to which the infringer has made use of the invention and any evidence probative of the value of that use” – weighed against jury award. • Lucent failed to prove how many Outlook users used the patented method or how often. • Factor 11 cannot be satisfied by use of accused product generally without regard to infringing feature.

11. i4i v. Microsoft • i4i accused Microsoft’s custom XML editor in Microsoft Word software of infringement. • i4i’s damages expert (Mike Wagner) opined that i4i’s damages were in the range of $200-207 million based upon a hypothetical reasonable royalty analysis. Microsoft’s expert opined that Microsoft paid royalties ranging from $1-5 million for comparable licenses. • i4i prevailed against Microsoft on liability at trial and obtained a jury award of $200 million with an additional $40 million of enhanced damages for willful infringement. • Mike Wagner overcame EMVR problems by a novel approach. He applied Microsoft’s overall profit margin of 76.6% to a “benchmark XML editor product” Microsoft bought for $499/unit before the infringement. • He applied the 25% Rule of Thumb to determine the baseline royalty rate ($96)

12. i4i Reasonable Royalty Analysis • Mike Wagner overcame EMVR problems by a novel approach. He applied Microsoft’s overall profit margin of 76.6% to a “benchmark XML editor product” Microsoft bought for $499/unit before the infringement. He applied the 25% Rule of Thumb to determine the baseline royalty rate ($96). He then adjusted the rate upward by $2 using the GP factors and applied the $98 rate to 2.1 million infringing uses (businesses only) as ascertained thru a market survey that determined what portion of Microsoft business customers were using the editor feature.

13. i4i cont.Reasonable Royalty Analysis The CAFC viewed Microsoft's disagreement with i4i's damages expert as an issue with conclusion not methodology. "Daubert and Rule 702 are safeguards against unreliable or irrelevant opinions, not guarantees of correctness.“ • Unfortunately for Microsoft, it did not file a pre-verdict JMOL on damages, so the CAFC refused to review whether there was a sufficient evidentiary basis in Wagner’s analysis to support the jury's award. • To add insult to injury, the CAFC observed that "had Microsoft filed a pre-verdict JMOL, it is true that the outcome might have been different.“ (Oh boy, here is the template for Microsoft’s strategy in Uniloc!)

14. ResQNet.Com v. Lansa • ResQNet accused Lansa’s terminal emulator program of infringement. • ResQNet prevailed at trial on one of the patents and obtained a jury award of ~$500,000 based upon a hypothetical royalty of 12.5%. • Validity and infringement decisions upheld on appeal. • The CAFC vacated and remanded the damages award.

15. ResQNet.com cont.Reasonable Royalty Analysis • ResQNet’s expert relied upon 7 licenses – 5 rebranding/re-bundling licenses with no relation to claimed invention and 2 licenses that arose out of litigation relating to patents-in-suit. • CAFC rejected reliance on rebranding/ re-bundling licenses because they did not cover the asserted claims and included irrelevant services and other items such as code. • CAFC criticized lower court’s refusal to rely on litigation settlement agreements covering asserted claims stating the district court “must consider licenses that are commensurate with what the defendant has appropriated.”

16. Wordtech v. Integrated Networks • Wordtech accused Integrated Networks and 2 officers of infringing patent for automated duplication of CD’s. • Wordtech asked jury for 12% royalty on $950,000 in sales ($114,000) through non-expert testimony of its president. • Integrated Networks calculated damages at $17,114. • Wordtech’s President relied on 13 patent licenses (2 lump sum and 11 running royalty) granting rights to some or all of its patents (including the patent found infringed). • Jury awarded $250,000 in damages. • CAFC determined that Wordtech licenses suffered similar flaw as in Lucent and ResQNet and was “little more than a recitation of royalty numbers” and remanded case for a new trial on damages (CAFC couldn’t figure out how jury came up with $250K verdict).

17. Microsoft v. Uniloc • Uniloc alleged Microsoft (ironically) copied its patented product activation (“PA”) key invention used to deter “casual copying” of software and used it in Microsoft’s Windows XP and Office XP products. • Uniloc sought damages of $565 million based on a reasonable royalty. • Uniloc’s expert calculated the damages using the low end appraisal amount ($10) for product activation keys contained in a Microsoft document and applying the “25% Rule of Thumb” to derive a $2.50 unit royalty. This royalty was applied against 225,978,803 Microsoft Windows and Office products. • Microsoft’s expert calculated damages based on a lump sum royalty to derive a royalty of $3-7 million. • The jury found Microsoft willfully infringed and awarded damages of $388 million. • The trial court granted JMOL of no willful infringement. • The CAFC affirmed the trial court’s finding of no willful infringement and vacated the jury’s damages award. CAFC concluded as a matter of law that the “25% Rule of Thumb” is a “fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation” and is inadmissable under Daubert standards “because it fails to tie a reasonable royalty to the facts of the case in issue.”

18. The Remand – What’s the Strategy Now? What Uniloc should consider doing: • Dump its discredited damages expert and hire a new one. • Uniloc’s new expert should hopefully not come up with the same number as the prior expert (like happened in Lucent) • Continue to use the Microsoft appraisal but support it with other evidence if possible. • Consider avoiding EMVR problems by not relying on a royalty base in the damages calculation (use “analytical approach”). Alternatively, use the Microsoft appraisal to value the “Product Key” and make the Product Key (as opposed to the entire software product) the royalty base. • Don’t rely upon a “hypothetical negotiation” methodology as the only approach. Instead, determine the incremental revenue received by Microsoft due to installation of PA software resulting in reduction in “casual copying” piracy by legitimate software purchasers (thru survey or other market study). • Use 100% of the incremental revenues (Microsoft estimated this at $5 billion) to derive incremental anticipated net profits under the “analytical approach” approved by the CAFC in TWM Manufacturing Co. v. Dura Corp., 789 F.2d 895, 899 (1986) as the high number in a damages range (could use the “hypothetical negotiation” number as the low number in the range).

19. The Uniloc Remand – cont. What Microsoft should consider doing: • Dump its discredited damages expert and hire a new one (preferably credible, if possible). • Settle – if possible. A new trial doesn’t benefit Microsoft because this time around the jury will be instructed that Microsoft has already been found to infringe, so no opportunity to mix in any liability defenses. • Interpose Daubert challenges to Uniloc’s new damages expert on “junk science” methodology grounds. • If a “hypothetical” lump sum license cannot be supported by comparable lump sum licenses, seek a running royalty damages award based on EMVR rule to establish a really small royalty base linked to the PA (“product activation”) component of the overall product and apply a hypothetical negotiation scenario to derive a royalty percentage to be applied against that royalty base. • Apportion the royalty between Uniloc’s patented invention and Microsoft’s patented PA invention (a survey might be used here).