Patent Law Unchanged by Microsoft Supreme Court Decision

Despite all of the anticipation surrounding the outcome of the Microsoft v. i4i case, on June 9, 2011, the Supreme Court upheld the current state of patent law rather than change long-held precedent. Specifically, the Court held unanimously that when an accused infringer alleges that a patent is invalid, such an allegation needs to be proven by clear and convincing evidence.

This “clear and convincing evidence” standard has been defined as requiring “evidence indicating that the thing to be proved is highly probable or reasonably certain.” This standard provides a relatively high hurdle for accused infringers to overcome in order to invalidate a patent and, thus, provides a rather stable environment for patents.

The Court based this decision on section 282 of the Patent Act of 1952, which grants to patents a presumption of validity. The Court noted that “Congress specified the applicable standard of proof in 1952 when it codified the common-law presumption of patent validity.” Relying on previous Supreme Court precedent, the Court cited Justice Cardozo, who stated, “There is a presumption of validity, a presumption not to be overthrown except by clear and cogent evidence.”

In this case, Microsoft asserted an invalidity defense to an allegation of infringement which relied on evidence that had not been considered by the United States Patent and Trademark Office (USPTO) during examination. Microsoft alleged that i4i sold a version of the software covered by U.S. Patent No. 5,787,449 (“the ’449 patent”) more than a year before the patent was filed. Microsoft presented evidence that suggested the software at issue was previously marketed and sold to another company. The evidence included various documents describing the software such as manuals, a funding application, and letters to potential investors, etc. However, i4i maintained that the software that was sold did not include the contents of the patent at issue in this case. Unfortunately, the code at issue was destroyed and was not available for a comparison to the patent. The lower courts determined that the evidence presently did not clearly and convincingly show that the software sold was the same as the software described in the ’449 patent. While one might be able to infer that fact from the evidence in question, it did not meet the clear-and-convincing standard of proof. Therefore under the Court’s interpretation the patent remains valid.

Further, the Court determined that the standard of evidence should be consistent regardless of whether the evidence was previously considered by the USPTO. However, the Court also stated that juries may be instructed to give more weight to evidence not previously considered by the USPTO when considering the issue of patent validity. Thus, in cases, such as Microsoft, where some material was not before the USPTO during prosecution, the jury may be instructed to give these materials more weight during consideration. Unfortunately for Microsoft, no such request was made of the district court.

With respect to the policy arguments put forth, the Court found itself “in no position to judge these policy arguments.” The Court relied instead on the almost thirty-year history of interpretation and congressional action regarding section 282 of the Patent Act of 1952. During this time frame, the Court noted that the evidentiary standard has been left “untouched.”

The Court affirmed the current standard of proof for invalidity. Many patent holders are now breathing a sigh of relief.

Now the question is, will Congress take up the challenge set forth by the Court when it stated, “Any recalibration of the standard of proof remains in its hands.”

Supreme Court Upholds “Clear and Convincing” Standard of Proof for Patent Invalidity While Suggesting Juries Be Instructed on the Weight of the Evidence

On June 9, 2011, the Supreme Court in an 8-0 decision authored by Justice Sotomayor, affirmed the long-standing rule that a challenger must demonstrate invalidity of a patent by “clear and convincing evidence.” Microsoft Corp. v. i4i Ltd. Partnership, 564 U.S.__, slip op. at 20 (June 9, 2011).  Microsoft had argued for a more relaxed “preponderance of the evidence” standard in a case where the prior art that formed the basis for the challenge had not been considered by the Patent Office.  While the holding puts to rest speculation over whether the Court would apply the lesser standard of proof, the Court endorsed the use of a jury instruction on the weight to be given prior art evidence that had not been considered by the Patent Office, stating that such an instruction, “when requested, most often should be given.”  Id.at 17.

Section 282 of the Patent Act of 1952 provides that “[a] patent shall be presumed valid” and “[t]he burden of establishing invalidity of a patent or any claim thereof shall rest on the party asserting such invalidity.”  35 U.S.C. § 282. While § 282 expressly places the burden of proof regarding validity of the patent upon an accused infringer, it does not expressly address the standard of proof.  Microsoft argued that the preponderance standard applied generally or, in the alternative, at least where the prior art asserted had not been considered by the Patent Office.  The Court rejected both contentions.

The Supreme Court rejected Microsoft’s first contention by finding that Congress had adopted the heightened standard from the common-law in 1952 when it enacted § 282.  The Court determined that by the time of the 1952 Act, the common law presumption of validity reflected the “universal understanding” that the preponderance standard was insufficient.  That understanding was reflected in the holding of Radio Corp. of America v. Radio Engineering Laboratories, Inc., 293 U.S. 1 (1934). In that case, the Supreme Court held that an accused infringer must overcome the presumption of validity by “clear and cogent evidence.” Id.at 2.  Accordingly, the Court held that the codification of the presumption in § 282 brought with it its common-law meaning, including the heightened standard proof, and there was no reason to “drop” the heightened standard simply because §282 does not explicitly recite it.

In arguing for the lesser “preponderance of the evidence” standard of proof when the prior art was not considered by the Patent Office, Microsoft relied in part on the Supreme Court’s dicta in KSR Int’l Co. v. Teleflex Inc., 550 U.S. 398, 426 (2007), that at least in cases where the invalidating prior art was not before the Patent Office, the presumption of validity “seems much diminished.”

Notwithstanding its earlier observation, the Supreme Court rejected the notion of a variable standard of proof.  The Court acknowledged language found in “numerous courts of appeals” cases before the 1952 Act, that referred to the presumption of validity being “weakened” or “dissipated” when the evidence was not considered by the Patent Office.  However, it explained that such language could not be read as supporting a different standard.  “Instead, we understand these cases to reflect the same common sense principle that the Federal Circuit has recognized throughout its existence—namely, that new evidence supporting an invalidity defense may ‘carry more weight’ in an infringement action than evidence previously considered by the Patent Office.”   Slip op. at 17.  Accordingly, “new evidence” of invalidity may make it “easier” for a challenger to meet the “clear and convincing” standard.

The Court suggested that the weight to be given this new evidence be explained in an instruction to the jury:

[A] jury instruction on the effect of new evidence can, and when requested, most often should be given. When warranted, the jury may be instructed to consider that it has heard evidence that the PTO had no opportunity to evaluate before granting the patent. . .  [T]he jury may be instructed to evaluate whether the evidence before it is materially new, and if so, to consider that fact when determining whether an invalidity defense has been proved by clear and convincing evidence.

Id.at 17.  This language will undoubtedly increase the frequency of requests for a specific instruction on the weight of the new evidence and on the use of such instructions.

Justice Breyer, joined by Justices Scalia and Alito, wrote a concurring opinion which emphasizes the need to pay careful attention to the distinction between fact questions and legal questions, noting that the standard only applies to evidence of the facts.  The Court’s opinion, slip op. at 2, does note that the ultimate question of patent validity is a question of law and that the same factual questions underlying the Patent Office’s original examination will also be present in an infringement action.  Id.  While this language is suggestive, the Court’s opinion never expressly states that the standard of proof applies only to the factual questions.  The concurrence thus raises the question of whether a court should refrain from applying the clear and convincing standard to legal conclusions, such as whether given facts render an invention obvious.  Further, the observations of the concurrence may impact the specific questions put to the jury in the form of a special verdict and instructions regarding the standard of proof.

Thus, the development of the patent law may be more affected by dicta from Microsoft Corp. v. i4i Ltd. Partnership than by its holding, which affirms the long-standing “clear and convincing” standard.

Supreme Court Upholds Clear and Convincing Standard for Invalidity but with a Twist

A unanimous Supreme Court has rejected Microsoft’s argument that a lower “preponderance of the evidence” standard should apply to patent invalidity challenges. The Supreme Court, in last week’s Microsoft Corp. v. i4i Limited Partnership decision, reaffirmed the longstanding principle that a party challenging the validity of a patent must present “clear and convincing” evidence of invalidity.

The Supreme Court first established this heightened burden in the 1934 case of Radio Corp. of America v. Radio Engineering Labs, Inc. 293 U.S. 1 (1934). There, the Supreme Court held that invalidation required “clear and cogent evidence” to overturn an issued patent. The Patent Act later codified this heightened burden in 35 U.S.C. § 282, explaining that a patent “shall be presumed valid.”

Microsoft argued that the Court’s settled interpretation of Section 282 was incorrect and that the presumption of validity does not establish the need for “clear and convincing” evidence to invalidate a patent.

Relying on almost a century of precedent, the Supreme Court disagreed:

[B]y the time Congress enacted § 282 and declared that a patent is “presumed valid,” the presumption of patent validity had long been a fixture of the common law. According to its settled meaning, a defendant raising an invalidity defense [bears] “a heavy burden of persuasion,” requiring proof of the defense by clear and convincing evidence.

The Court also disagreed with Microsoft’s alternative argument—that the presumption of validity should be weakened when a party challenges a patent using art not before the Patent Office during prosecution. According to the Court, invalidity of a patent must always be proven by clear and convincing evidence.

An interesting twist comes in the Court’s recognition that “new evidence” of invalidity likely carries more weight than evidence already considered by the Patent Office. The Court references with approval the jury instruction given in the 1993 case of Mendenhall v. Cedarrapids, Inc. that states:

Because the deference to be given the Patent Office’s determination is related to the evidence it had before it, you should consider the evidence presented to the Patent Office during the [] application process, compare it with the evidence you have heard in this case, and then determine what weight to give the Patent Office’s determinations.5 F.3d 1557 (Fed. Cir. 1993).

The Court explained that “[a] jury may be instructed to evaluate whether the evidence before it is materially new, and if so, to consider that fact when determining whether an invalidity defense has been proved by clear and convincing evidence.” Put differently, the Court recognized that a jury may properly give evidence of “new” prior art special weight in deciding whether the clear and convincing standard has been met.

On the whole, the Court’s ruling on the clear and convincing evidence standard can be viewed as a pro-patent decision (contrary to several of the Court’s other recent decisions, like KSR (obviousness), MedImmune (declaratory judgment jurisdiction), and eBay (permanent injunctions)). Yet, its explicit acknowledgement of the role which “new” prior art can have may give accused infringers and their defense counsel some degree of satisfaction. Using “new” prior art not considered by the Patent Office during prosecution, along with the benefit of good jury instructions emphasizing the proper place of this “new” prior art, defendants may improve their chances of invalidating asserted patents.

Supreme Court Unanimously Maintains High Hurdle for Invalidity Defense

June 9th, the Supreme Court unanimously ruled1 that an accused infringer must prove its invalidity defense by clear and convincing evidence. Microsoft Corp. v. i4i Ltd. P’ship, — S. Ct. — 564 U.S. —, 2011 WL 2224428, slip op. at 1, 16 (June 9, 2011).2 In a case of first impression, the Court determined that this standard applies even when the United States Patent and Trademark Office (“Patent Office”) did not consider the evidence of invalidity currently before the jury in the patent examination process. Id. The hurdle for proving invalidity historically has been high and now remains high.

According to Justice Sotomayor (who wrote for the majority), “Congress specified the applicable standard of proof in 1952 when it codified the common-law presumption of patent validity.” Id. at 20. “Nothing . . . suggests that Congress meant to depart from that understanding to enact a standard of proof that would rise and fall with the facts of each case.” This decision thus keeps in place decades of existing jurisprudence and will continue to allow patent owners to value their portfolios based on past practices. Although accused infringers can take certain steps to minimize negative effects of the clear-and-convincing standard, “[a]ny recalibration of the standard of proof” is now solely in the hands of Congress. Id.

Historical Basis of Proving Invalidity

To receive patent protection, a claimed invention must meet the statutory requirements of patentability. The claimed invention, for example, must fall within certain patentable subject matter (§ 101), be novel (§ 102), be nonobvious (§ 103), and be disclosed in the patent application in sufficient detail to meet the enablement, best mode, and written description requirements (§ 112). Thus, the Patent Office issues a patent for a claimed invention only if its examiners determine that the claimed invention meets all of the statutory requirements. Once issued, a patent holder has the exclusive right to exclude others from using the claimed invention for the term of the patent.

An accused infringer, however, can escape liability for infringement by proving that the patent is invalid (i.e., that the Patent Office should not have issued it in the first place). Under § 282, however, “[a] patent shall be presumed valid” and “[t]he burden of establishing invalidity of a patent . . . rest[s] on the party asserting such invalidity.” 35 U.S.C. § 282. For over thirty years, the Federal Circuit has interpreted that section to require “a defendant seeking to overcome this presumption [to] persuade the factfinder of its invalidity defense by clear and convincing evidence.” Microsoft Corp., 2011 WL 2224428, slip op. at 3. According to Judge Rich, a principal drafter of the 1952 Patent Act, “Section 282 creates a presumption that a patent is valid and imposes the burden of proving invalidity on the attacker” by clear and convincing evidence. Am. Hoist & Derrick Co. v. Sowa & Sons, Inc., 725 F.3d 1350, 1360 (Fed. Cir. 1984). “That burden is consistent and never changes.” Id.

Microsoft Unsuccessfully Challenged Federal Circuit’s Long-Standing Precedent

In 2007, i4i sued Microsoft claiming that Microsoft Word infringed its patent for an improved method for editing computer documents. Microsoft Corp., 2011 WL 2224428, slip op. at 4. In addition to denying infringement, Microsoft argued that § 102(b)’s on-sale bar rendered i4i’s patent invalid due to i4i’s sale of a software program, S4, prior to the filing of the i4i patent application. Id. The parties agreed that i4i had sold the S4 program prior to the filing of the patent at issue but looked to the jury to determine whether S4 embodied the claimed invention. Id. Relying on the undisputed fact that S4 was never presented to the Patent Office, Microsoft objected to i4i’s proposed instruction requiring the jury find proof of invalidity by clear and convincing evidence. Id. In its place, Microsoft requested a jury instruction limiting its burden of proof, “with regard to its defense of invalidity based on prior art that the examiner did not review during the prosecution of the patent-in-suit” to a “preponderance of the evidence.” Id. at 6 (internal quotation marks and citation omitted).

The District Court rejected Microsoft’s proposed instruction and instructed the jury that “Microsoft has the burden of proving invalidity by clear and convincing evidence.” Id. (internal quotation marks and citation omitted). Based on this instruction, the jury found that Microsoft had willfully infringed i4i’s patent and that Microsoft had failed to prove its invalidity defense. The Court of Appeals for the Federal Circuit affirmed, concluding that “the jury instructions were correct in light of [the] court’s precedent, which requires the challenger to prove invalidity by clear and convincing evidence.” i4i Ltd. P’ship v. Microsoft Corp., 598 F.3d 831, 848 (Fed. Cir. 2010).

Supreme Court Rejected Microsoft’s Arguments—Invalidity Must Be Proved by Clear and Convincing Evidence

Microsoft sought certiorari from the Supreme Court as to (1) whether “a defendant in an infringement action need only persuade the jury of an invalidity defense by a preponderance of the evidence” and (2) whether “a preponderance standard must apply at least when an invalidity defense rests on evidence that was never considered by the [Patent Office] in the examination process.” Id. at 5-6. The answer to both of Microsoft’s questions is a clear and unqualified no.

In reaching this decision, the Court started with a common axiom of statutory interpretation: “Where Congress has prescribed the governing standard of proof, its choice controls absent ‘countervailing constitutional constraints.'” Id. at 6 (citing Steadman v. SEC, 450 U.S. 91, 95 (1981)). It then asked the next logical question—”whether Congress made such a choice” when it enacted § 282. To answer this question, the Court first analyzed the plain language of statute. The Court noted that the statute “establishes a presumption of patent validity, and it provides that a challenger must overcome that presumption to prevail on an invalidity defense”; however, the Court recognized that “it includes no express articulation of the standard of proof.” Id. Nevertheless, the Court concluded that Congress used the term “presumed valid” according to its settled meaning in the common law—a term encompassing “not only an allocation of the burden of proof but also an imposition of a heightened standard of proof.” Id. at 7-8.3

“The common-law presumption, in other words, reflected the universal understanding that a preponderance standard of proof was too ‘dubious’ a basis to deem a patent invalid.” Microsoft Corp., 2011 WL 2224428, slip op. at 8. Accordingly, when Congress declared that a patent is “presumed valid,” “the presumption encompassed not only an allocation of the burden of proof but also an imposition of a heightened standard of proof.” Id. Based on this wide-spread understanding of the common law term, the Court refused to conclude “that Congress intended to drop the heightened standard of proof from the presumption simply because § 282 fails to reiterate it expressly.” Id. at 9 (internal quotation marks and citation omitted). Rather, the Court concluded that it “‘must presume that Congress intended to incorporate’ the heightened standard of proof, ‘unless the statute otherwise directs.'” Id. (quoting Neder v. United States, 527 U.S. 1, 23 (1999)). Simply put, “[t]he language Congress selected reveals its intent not only to specify that the defendant bears the burden of providing invalidity but also that the evidence in support of the defense must be clear and convincing.” Id. at 12 n.7.

Notably, the Court rejected Microsoft’s attempts to distinguish nearly century’s worth of otherwise clear case law: “Squint as we may, we fail to see the qualifications that Microsoft purports to identify in our cases.” Id. at 10. Likewise, the Court rejected Microsoft’s argument that the Federal Circuit’s interpretation of § 282 must fail, because applying that interpretation of the phrase “presumed valid” renders superfluous the statute’s additional phrase, “[t]he burden of establishing invalidity of a patent . . . shall rest on the party asserting such invalidity.” Id. at 12. Although Justice Sotomayor (writing for the majority) seems to agree with Microsoft that the Federal Circuit’s interpretation renders some of the statute superfluous, the Court reminded Microsoft that “the canon against superfluity assists only where a competing interpretation gives effect ‘to every clause and word of a statute.'” Id. (citing Duncan v. Walker, 533 U.S. 167, 174 (2001)). The Court thus found the rule inapplicable here, where “no interpretation of § 282—including the two alternatives advanced by Microsoft—avoids excess language.” Id. at 13.

In addressing Microsoft’s second, more limited argument, the Court rejected Microsoft’s request for a variable standard of proof:

Our pre-1952 cases never adopted or endorsed the kind of fluctuating standard of proof that Microsoft envisions. And they do not indicate, even in dicta, that anything less than a clear-and-convincing standard would ever apply to an invalidity defense raised in an infringement action. . . . Nothing in § 282’s text suggests that Congress meant to depart from that understanding to enact a standard of proof that would rise and fall with the facts of each case.

Id. at 15-16.

Accused Infringers Have Options

The accused infringer, however, is not without options. Although the Court steadfastly affirmed the heightened standard of proof, it recognized that “new evidence supporting an invalidity defense may carry more weight in an infringement action than evidence previously considered by the [Patent Office].” Id. at 17. Indeed, the Patent Office’s judgment may lose significant force if it did not have all the material facts before it. Id. In turn, this may make it easier for the accused infringer to satisfy its burden (e.g., to use the new evidence to persuade the jury of a patent’s invalidity by clear and convincing evidence). Id. Accordingly, if faced with new evidence of invalidity, an accused infringer should consider taking the following actions:

  1. Request a jury instruction on the effect of new evidence not considered by the Patent Office. When requested, such an instruction “most often should be given.” Id. “When warranted, the jury may be instructed to consider that it has heard evidence that the [Patent Office] had no opportunity to evaluate before granting the patented.” Id.
  2. If the parties dispute whether the evidence presented to the jury differs from the evidence previously before the Patent Office, seek an instruction mandating that the jury consider that question. Id. at 18. “The jury may be instructed to evaluate whether the evidence before it is materially new, and if so, to consider that fact when determining whether an invalidity defense has been proved by clear and convincing evidence.” Id. (citing Mendenhall v. Cedarapids, Inc., 5 F.3d 1557, 1563-64 (Fed. Cir. 1993)).
  3. Remember that the clear and convincing standard of proof is an evidentiary standard that applies only to questions of fact to the trial court. Microsoft Corp. v. i4i Ltd. P’ship, — S. Ct. — 564 U.S. —, 2011 WL 2224428, at *12 (June 9, 2011) (Breyer, J., concurring). Accordingly, separate “factual and legal aspects of an invalidity claim . . . by using instructions based on case-specific circumstances that help the jury make the distinction.” Id. at *13. In addition, use interrogatories and special verdicts “to make clear which specific factual findings underlie the jury’s conclusions.” Id. “By preventing the ‘clear and convincing’ standard from roaming outside its fact-related reservation, courts can increase the likelihood that discoveries or inventions will not receive legal protection where none is due.” Id.

Conclusion

Despite Microsoft’s valiant challenge, yesterday’s unanimous opinion keeps the hurdle high for parties trying to show that a patent is invalid. Although accused infringers are not without their options, any modification of the clear and convincing standard itself now requires an Act of Congress.

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1All eight participating Justices concurred in the judgment.  Justice Sotomayor delivered the opinion of the Court, in which Justices Scalia, Kennedy, Ginsburg, Breyer, Alito, and Kagan joined.  Justice Breyer filed a concurring opinion, in which Justices Scalia and Alito joined.  Although Justice Breyer joined the Justice Sotomayor opinion in full, he wrote separately to emphasize that the clear and convincing standard of proof applies only to questions of fact, not to questions of law.  Justice Thomas filed an opinion concurring only in the judgment.  According to Justice Thomas, the heightened standard of proof applies because § 292 is silent and therefore does not alter the common-law rule.  Chief Justice Roberts took no part in the consideration or decision of the case.
2This case marks the third patent-law case released by the Supreme Court during the past two weeks.  Earlier this week, the Court ruled that the Bayh-Dole Act does not eclipse inventors’ rights. See Board of Trustees of the Leland Stanford Junior Univ. v. Roche Molecular Sys., 563 U.S. —, 2011 WL 2175210 (June 5, 2011).  On May 31, 2011, the Supreme Court ruled that induced infringement of a patent required knowledge that the induced acts constituted patent infringement.  See Global-Tech Appliances, Inc. v. SEB S.A., — S. Ct. —, 2011 WL 2119109 (May 31, 2011).  Each of these cases affirmed the Federal Circuit.
3Indeed, the Court concluded that by the time Congress enacted the 1952 Patent Act, “a common core of thought” unified the decisions of courts across the country:

“[O]ne otherwise an infringer who assails the validity of a patent fair upon its face bears a heavy burden of persuasion, and fails unless his evidence has more than a dubious preponderance.  If that is true where the assailant connects himself in some way with the title of the true inventor, it is so a fortiori where he is a stranger to the [claimed] invention, without claim of title of his own.  If it is true where the assailant launches his attack with evidence different, at least in form, from any theretofore produced in opposition to the patent, it is so a bit more clearly where the evidence is even verbally the same.”

Id. (citing Radio Corp. of Am. v. Radio Eng’r Labs, Inc., 293 U.S. 1, 8 (1934).  As Justice Cardozo put it, “there is a presumption of validity, a presumption not to be overthrown except by clear and cogent evidence.”  Radio Corp. of Am., 293 U.S. at 2.

Supreme Court: Evidence Of Invalidity Must Be “Clear And Convincing”

On June 9, 2011, the Supreme Court rejected Microsoft’s contention that a preponderance of the evidence should be sufficient to establish patent invalidity in an 8-0 (Roberts abstained) opinion, which affirmed the Fed. Cir.’s opinion (for a change). (The decision can be found at the end of this post.) The Court interpreted Congress’ intent in 35 USC 282 to preserve the presumption of validity of a patent claim unless an attacker can meet the burden of presenting “clear and convincing” evidence of invalidity.

The Court also rejected the notion that some sort of “fluctuating standard of proof” should apply in situations in which the evidence relied upon was not considered by the PTO during prosecution. Even if the primary rationale behind the clear and convincing standard, that the PTO applied its expertise correctly, “seems much diminished’ (citing KSR 550 US 398), the Court held that Congress “codified the common-law presumption of patent validity and, implicitly the heightened standard of proof attached to it” and that standard of proof must still be met. The Court suggested that, in such cases, the jury could be instructed that it could give weight to the fact that the evidence before it is “materially new” when determining if clear and convincing evidence of invalidity had been presented.

Common Sense Variation Is Unpatentable

Affirming the district court’s grant of summary judgment of invalidity, the U.S. Court of Appeals for the Federal Circuit held that a common-sense variation of known technology is unpatentable.   Odom v. Microsoft Corp., Case Nos. 11-1160 (Fed. Cir., May 4, 2011) (Lourie, J.).

In August 2008 James Odom brought suit against Microsoft, alleging infringement of its patent directed to both a method for manipulating groups of “tools” in “toolbars” commonly found in computer software applications, as well as to the ability to use the divider to hide or display selected tools, by Microsoft’s Office 2007, a suite of office productivity software.  During the litigation, Odom’s counsel withdrew from the case and, failing to retain new counsel, Odom moved to dismiss his claims without prejudice.  The district court granted Odom’s request to dismiss but declined to dismiss Microsoft’s declaratory judgment counterclaims.  Microsoft subsequently moved for summary judgment of non-infringement and invalidity.

The district court granted Microsoft’s motions for summary judgment, holding that the asserted claims of the patent were invalid for obviousness and not infringed by Office 2007.   In so finding, the court stated that the asserted claims presented “one of the clearest” cases of obviousness that had come before it because Odom had simply “cobbled together various pieces of what was already out there in a manner … that would have been obvious to anyone skilled in the art at the time of the invention.”  Odom appealed.

On appeal, Odom argues that the district court erred in its obviousness analysis by looking at separate pieces of the claimed invention rather than the invention as a whole, by impermissibly applying hindsight in determining obviousness, and argued that the manipulatable sections of the composite toolbar disclosed in the prior art are very different from the claimed tool groups.  The Federal Circuit disagreed.  The Court found that user-manipulatable toolbars (which can be customizing according to user preferences and which include groups of command buttons’ or toolbars) were known in prior art at the time the patent in suit was filed.  The Court found that the only difference between the prior art and the patent in suit was that the groups of tools claimed in the patent are on a single toolbar.  Citing KSR, the Court held that this difference “is an insignificant advance.”

Since it would have been a trivial change for a person of skill in the art designing such alterable tool groups to add an indicator that could indicate any altered condition of the tool group, the Federal Circuit concluded that the district court did not err in determining that the manner in which patent divides up toolbars into groups, and the claimed manipulation of tool groups, would have been a common sense variation for a person of skill in the art.

The Federal Circuit also rejected Odom’s arguments of secondary considerations and reiterated that weak secondary considerations generally do not overcome a strong prima facie case of obviousness.

Microsoft Corp. v. i4i Limited Partnership et al.: Supreme Court Observations

In Microsoft v. i4i, the U.S. Supreme Court today unanimously (8-0) affirmed the clear and convincing evidence standard for invalidating issued U.S. patents under Section 282 of the Patent Act (1952).  In 2007, i4i sued Microsoft in U.S. District Court for infringement of i4i’s patent. As part of its defense, Microsoft asked for a jury instruction reciting a preponderance of the evidence standard for finding i4i’s patent invalid, rather than the long-standing clear and convincing evidence standard.  The District Court rejected Microsoft’s lower standard of proof, and a jury found that the patent was valid and that Microsoft infringed, awarding i4i a 9 figure damages sum.  Microsoft appealed to Federal Circuit, asserting in particular, that the District Court improperly instructed the jury on the standard of proof for invalidity.  The Federal Circuit affirmed the lower court’s holding and Microsoft petitioned the Supreme Court for certiorari, which was granted.

In its argument to the Supreme Court, Microsoft argued that either (1) a defendant in a patent infringement action need only convince the jury that an issued patent is invalid by a preponderance of the evidence standard, or (2) alternatively, that at the very least, the preponderance of the evidence standard should apply to evidence that was never considered by the PTO during examination.  The Supreme Court in its decision rejected both of Microsoft’s arguments.

In its decision, the Court first focused on the language of Section 282, which specifies that “[a] patent shall be presumed valid” and “[t]he burden of establishing invalidity of a patent … shall rest on the party asserting such invalidity.”  Microsoft had argued that Federal Circuit precedent establishing a clear and convincing evidence standard was not supported by the 1952 Act because Section 282 did not explicitly set forth that standard.  The Supreme Court noted that, while the statute includes no express articulation of the standard of proof, the statute does use the term “presumed valid,” which has a settled meaning in the common law.  Relying on its long-standing decision in Radio Corporation of America (RCA) v. Radio Eng’g Labs., Inc., 293 U.S. 1 (1934), the Court found that the common law jurisprudence dating back to the 19th century reflects that Microsoft’s proposed preponderance standard of proof “was too ‘dubious’ a basis to deem a patent invalid.”  According to the common law, the Court held, “a defendant raising an invalidity defense bore a ‘heavy burden of persuasion,’ requiring proof of the defense by clear and convincing evidence.”

The Court also noted that the Federal Circuit has interpreted Section 282 to require this clear and convincing evidence standard for nearly 30 years. And while Congress has amended the patent laws several times since the Patent Act was passed, “the evidentiary standard in § 282 has gone untouched.”  The Court concluded that Congress is well aware of the Federal Circuit’s treatment of the statute, but thus far has not amended the statute, and further that “[a]ny re-calibration of the standard of proof remains in [Congress’s] hands.”

The practical implications of the decisions are many.  First and foremost, the decision preserves the status quo, which in turn maintains the strength of U.S. patents and current patent enforcement mechanisms, particularly as they relate to innovation, business certainty, and job creation.  The Court has also sent a clear signal that, in view of well-established jurisprudence, if the standard is to change, it must be done by Congress, as any such change would have a profound ripple effect on the entire patent system.

Supreme Court Leaves Standard for Patent Invalidity Unchanged

Earlier today, the U.S. Supreme Court issued its much-anticipated opinion in Microsoft Corp. v. i4i L.P. The Court had granted certiorari to consider the question of whether section 282 of the Patent Act, 35 U.S.C. § 282, requires a defense of patent invalidity to be proven by clear and convincing evidence. Contrary to what many commentators were expecting, the Court left the burden of proof for invalidity defenses unchanged-defendants still must prove any invalidity defense by clear and convincing evidence.

The Court focused on early cases cited by the plaintiff/appellee, including a 1934 opinion written by Justice Benjamin N. Cardozo that stated “there is a presumption of validity, a presumption not to be overthrown except by clear and cogent evidence.” Based on such decisions, the Court determined it was well understood prior to the passage of the current Patent Act in 1952 that the presumption of validity could be overcome only by clear and convincing evidence. Accordingly, when Congress enacted section 282, which set forth a presumption of validity, the Court found that Congress intended to adopt the existing burden of proof for overcoming the presumption. The Court held that “[u]nder the general rule that a common-law term comes with its common-law meaning, we cannot conclude that Congress intended to ‘drop’ the heightened standard proof [sic] from the presumption simply because [section] 282 fails to reiterate it expressly.”

The Court did not accept Microsoft’s alternative argument that the burden of proof should be different for invalidity defenses based on prior art references not considered by the U.S. Patent and Trademark Office (PTO) in granting an asserted patent. The Court did, however, recognize the “commonsense principle” that “new evidence supporting an invalidity defense may ‘carry more weight’ in an infringement action than evidence previously considered by the PTO. . . . Simply put, if the PTO did not have all material facts before it, its considered judgment may lose significant force.” Thus, the Court noted that “a jury instruction on the effect of new evidence can, and when requested, most often should be given. When warranted, the jury may be instructed to consider that it has heard evidence that the PTO had no opportunity to evaluate before granting a patent.”

Justice Breyer (joined by Justices Scalia and Alito) also filed an interesting concurrence stressing that the clear-and-convincing standard applies only to factual issues relating to invalidity defenses, and not to legal questions. “Where the ultimate question of patent validity turns on the correct answer to legal questions-what these subsidiary legal standards mean or how they apply to the facts as given-today’s strict standard of proof has no application.” The concurring Justices thus urged district courts to keep these issues separate “by using instructions based on case-specific circumstances that help the jury make the distinction or by using interrogatories and special verdicts to make clear which specific factual findings underlie the jury’s conclusions.” For years, some members of the U.S. Court of Appeals for the Federal Circuit have been urging district courts and litigants to use verdict forms and jury interrogatories that ask for more detail about the factual findings underlying decisions on issues such as obviousness, but those efforts have met with mixed results. It will be interesting to see whether these comments from three Supreme Court Justices will have any significant effect on how patent cases are actually tried.

Updates on Transfers in the Eastern District of Texas

1. Microsoft: Transferred from Texas to Washington State 

In November 2010, the Federal Circuit ordered a case transferred out of the Eastern District of Texas in In re Microsoft Corporation, No. 2010-M944 (Fed. Cir. Nov. 8, 2010). This is one of a line of cases attempting to transfer lawsuits out of one of the most frequently selected forums for patent infringement claims.

Over the course of the last two years, the Federal Circuit has redefined the landscape for cases brought before the U.S. District Court for the Eastern District of Texas by nonpracticing entities (NPEs—sometimes referred to as “patent trolls”). Specifically, since the Fifth Circuit issued its en banc decision providing new guidance on the standard for transferring cases in In re Volkswagen of America, Inc., 545 F.3d 304 (5th Cir. 2008) (en banc), the Federal Circuit has found ample opportunity to interpret that case and apply its holdings to patent infringement actions in the Eastern District of Texas. Based on the Volkswagen case, the Federal Circuit has granted numerous mandamus petitions forcing the Eastern District of Texas courts to transfer cases out of that district.1  The Federal Circuit in In re Microsoft Corporation rejected another argument that plaintiffs have relied on to keep their cases in the Eastern District of Texas.

In the underlying district court case, plaintiff Allvoice Developments (Allvoice) filed a patent infringement action against Microsoft Corporation in the Eastern District of Texas alleging infringement of patented speech recognition technology based on functionality found in certain Microsoft operating systems. Allvoice incorporated its company in Texas just 16 days before filing the suit against Microsoft and maintains a physical office in Tyler, Texas (located in the Eastern District). However, Allvoice has no employees at its Tyler office or anywhere in the United States. Microsoft sought transfer to the Western District of Washington, where Microsoft’s headquarters and a substantial number of employees are located. Microsoft indicated that all of its witnesses knowledgeable with the sales, marketing, and product direction for its accused products reside in the Western District of Washington, and all of the relevant documents and evidence relating to the marketing, development, and design of the accused products are also in that district.

The district court denied transfer based in large part on the fact that Allvoice was incorporated under the laws of Texas and maintained an office in Tyler, Texas. The district court also held that third-party witnesses located in New York, Massachusetts, and Florida would find Texas more convenient thanWashington, and that access to documents only slightly favored transfer because Allvoice’s documents were at its offices in the Eastern District of Texas.

The Federal Circuit disagreed and ordered the case to be transferred to the state of Washington. The Federal Circuit found that Allvoice’s alleged ties to Texas and the Eastern District forum, including incorporating under the laws of Texas just before bringing suit, were clearly in anticipation of litigation and were nothing more than an attempt to manipulate venue. In reaching its conclusion to order transfer to the Western District of Washington, the Federal Circuit again stressed that “courts [should] ensure that the purposes of jurisdictional and venue laws are not frustrated by a party’s attempt at manipulation.” The Federal Circuit again recounted its recent mandamus decisions that help define the boundaries for bringing—and keeping—cases in a particular district, ultimately deciding that the facts in this case favored transfer.

The Microsoft case is another point of reference for companies that find themselves defending patent infringement cases in the Eastern District of Texas. When the plaintiff has no legitimate ties to that district, but attempts to create ties to that district to manipulate a tie to the Texas venue, there is a higher probability that the case can be successfully transferred to a more convenient forum.

A copy of the opinion can be found at:

http://www.cafc.uscourts.gov/images/stories/opinions-orders/2010-m944.11-8-10.1.pdf

2. Vistaprint: No Transfer Out of Texas

In December 2010, after ordering the Microsoft case transferred out of Texas in the In re Microsoft Corporation case (discussed above), the Federal Circuit allowed the pendulum to swing back and declined to transfer a case out of the Eastern District of Texas. In the case of In re Vistaprint Limited and Officemax Inc., No. 954 (Dec. 15, 2010), the Federal Circuit clarified the judicial economy standard set out in the earlier case In re Zimmer Holdings, Inc., 609 F.3d 1378 (Fed. Cir. 2010).

The Federal Circuit held that denying a transfer in the Vistaprint case was warranted based in part on “more than negligible” gains in judicial economy. In the Vistaprint case, the district court had substantial experience with the patent based on a prior litigation and had issued a lengthy claim construction opinion; there was also a second co-pending case before the court involving the same patent. Therefore, based on the judicial economy and an individualized consideration of all factors, the Federal Circuit agreed that the case should remain in the Eastern District of Texas.

The Federal Circuit also noted that, oftentimes, a transfer analysis may dictate only one correct outcome, and in those cases (e.g., In re Microsoft), transfer may be appropriate. However, in other cases, the transfer analysis may create a reasonable range of choices. And, “[u]nder such circumstances, it is entirely within the district court’s discretion to conclude that in a given case the . . . factors of public interest or judicial economy can be of ‘paramount consideration,’ and as long as there is plausible support of record for that conclusion we will not second guess such a determination, even if the convenience factors call for a different result” (citation omitted). Such was the case in the case of In re Vistaprint.

However, the Federal Circuit also cautioned that its holding is not intended to give patent owners a free pass to maintain all future litigations involving the same asserted patent(s) in the same venue. Instead, a lower court’s decision to deny transfer will be upheld where there are sufficient gains in judicial economy and when the lower court performs a detailed analysis of the other factors explaining why the case should not be transferred.

A copy of the opinion can be found at:

http://www.cafc.uscourts.gov/images/stories/opinions-orders/10-m954o.pdf.

3. Aliphcom: Transferred from California to Texas

In February 2011, just a few months after denying a transfer in the case of In re Vistaprint (discussed above) based on judicial economy, the Federal Circuit refused to vacate an order transferring a case into the Eastern District of Texas from California based on similar reasoning. See In re Aliphcom, No. 971 (Feb. 9, 2011).

In May 2010, Aliphcom received a letter indicating that some of its products were infringing two patents owned by patentee Wi-LAN. One week later, Aliphcom filed a declaratory judgment action in the Northern District of California seeking declarations of invalidity and noninfringement of the Wi-LAN patents. Wi-LAN then requested a transfer of the declaratory judgment action to the Eastern District of Texas where it was currently litigating two previously filed suits involving the same patents.

The district judge in the Northern District of California agreed with Wi-LAN and ordered the case to be transferred to the Eastern District of Texas, finding that although certain factors counseled in favor of keeping the case in California, “the risk of inconsistent judgments and waste of judicial resources must outweigh the equitable concerns of Aliphcom’s convenience in litigating its claims.” Aliphcom petitioned the Federal Circuit to order the judge in the Northern District of California to vacate the transfer order and keep the case in California.

The Federal Circuit agreed with the California district court and allowed the transfer of the case to the Eastern District of Texas. In the wake of Vistaprint, it was no surprise that the Federal Circuit reiterated its analysis regarding judicial economy as a factor in determining whether a transfer should be granted.  In particular, the Federal Circuit stated that “having the same . . . judge handle this and the co-pending case involving the same patent would be more efficient than requiring another magistrate or trial judge to start from scratch.” Therefore, the Federal Circuit ruled that the California district court did not clearly and indisputably abuse its discretion transferring the declaratory judgment case to Texas.

A copy of the opinion can be found at:

http://www.cafc.uscourts.gov/images/stories/opinions-orders/2011-m971.2-9-11.1.pdf

The Federal Circuit Rejects the 25 Percent Rule as Fundamentally Flawed and Reviews the Entire Market Value Rule for Calculation of Patent Infringement Damage

In a decision concerning the so-called “25 percent rule” and “the entire market value rule,” the Federal Circuit in the case of Uniloc USA, Inc. et al. v. Microsoft Corp., Nos. 2010-1035, -1055 (Fed. Cir. Jan. 4, 2011), affirmed the U.S. District Court for the District of Rhode Island’s grant of a new trial on damages on the improper use of the entire market value rule. The Rhode Island District Court allowed Uniloc’s damages expert to proffer testimony on the 25 percent rule, which he did in addition to proffering testimony on the entire market value rule. The jury awarded Uniloc damages of $388 million based on the testimony of Uniloc’s damages expert. On appeal, the Federal Circuit reviewed the propriety of the 25 percent rule, the application of the entire market value rule, and the excessiveness of the jury’s damages award.

Plaintiff Uniloc asserted claims of U.S. Patent No. 5,490,216 (the ’216 patent) against defendant Microsoft Corporation. The ’216 patent relates to a software registration system designed to deter copying of software by allowing the software to run without restrictions only if the system determines that the software installation is legitimate. Microsoft was accused of infringement by way of its Product Activation feature that acts as a gatekeeper to Microsoft’s Word XP, Word 2003, and Windows XP software programs. The feature requires the user to enter a 25-character alphanumeric product key contained within the packaging of Microsoft’s retail products. After entering a valid key, the user is asked to agree to Microsoft’s End User License Agreement, after which the licensor-licensee relationship is initiated.

The district court denied Microsoft’s pre-trial motion in limine seeking to exclude Uniloc’s expert’s trial testimony using the so-called 25 percent rule. In denying Microsoft’s motion in limine, the district court found that the 25 percent rule had been widely accepted in patent infringement cases. The district court judge noted that “the concept of a ‘rule of thumb’ was perplexing in an area of the law where reliability and precision are deemed paramount,” but rejected Microsoft’s request to exclude the 25 percent rule because the rule has been widely accepted. The district court thus considered Uniloc’s expert’s use of the “25 percent rule of thumb” to be reasonable. The district court, however, agreed with Microsoft regarding a second damages issue. Namely, the district court agreed that the Uniloc’s expert’s use of the entire market value rule as a “check” was improper because the allegedly infringing feature of Microsoft’s accused software products was not shown to be the basis of consumer demand for the accused products. The district court, therefore, granted Microsoft’s posttrial motion for a new trial on damages.

On appeal, the Federal Circuit first addressed the 25 percent rule. The Federal Circuit noted that “[t]he 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.” According to the 25 percent rule, the licensee pays “a royalty rate equivalent to 25 percent of its expected profits for the product that incorporates the IP at issue.’” The Federal Circuit went on to emphasize that the rule has “met its share of criticism,” primarily under three categories. First, the 25 percent rule “fails to account for the unique relationship between the patent and the accused product.”  Second, the rule “fails to account for the unique relationship between the parties.” Third, “the rule is essentially arbitrary and does not fit within the model of the hypothetical negotiation within which it is based.”

The Federal Circuit discussed Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 589 (1993), a seminal U.S. Supreme Court case on the issue of using expert testimony, which assigned the responsibility to district courts to ensure that “all expert testimony must pertain to ‘scientific, technical, or other specialized knowledge’” under the Federal Rules of Evidence. As a result, the Federal Circuit rejected the 25 percent rule. Specifically, it held that “the 25 percent rule of thumb is a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation” and, furthermore, held that evidence relying on the rule is 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 Federal Circuit, after striking down the 25 percent rule, reviewed Uniloc’s damages expert’s application of the entire market value rule. It reaffirmed that “[t]he 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 create[s] the value of the component parts.’” Because it was undisputed that the accused Product Activation feature did not create the basis for customer demand, the Federal Circuit affirmed the district court’s ordering of a new trial on damages.

The Federal Circuit found that use of the entire market value rule by Uniloc’s expert as a “check” was improper. For the entire market value rule to apply, “‘the patentee must prove that the patent-related feature is the basis for customer demand.’” During the district court trial, after having heard Uniloc’s damages expert testify about the entire market value of the accused products being $19 billion, the jury was instructed that it could not, however, award damages based on Microsoft’s entire revenue from all the accused products in the case. Nonetheless, “[a]s the district court aptly noted, ‘[t]he $19 billion cat was never put back into the bag.’ Because “the entire market value of the accused products has not been shown to be derived from the patented contribution,” its consideration here by the jury at the district court was in “clear derogation of the entire market value rule.” Therefore, “the district court did not abuse its discretion in granting a conditional new trial on damages for Uniloc’s violation of the entire market value rule.”

A copy of the slip opinion can be found at: http://www.cafc.uscourts.gov/images/stories/opinionsorders/10-1035.pdf.

CLS Bank Int’l: DC District Court Drives Stake into “Heart” of Business Method Patents

In CLS Bank v Alice (D.D.C. 2011),  the District Court for the District of Columbia found four patents (U.S. Patent No. 7149720; U.S. Patent No. 6912510; U.S. Patent No. 5970479; and U.S. Patent No. 7725375) owned by Alice Corporation invalid under 35 U.S.C. Sec. 101.   In short, the district court found that the “heart” of the patented invention in suit, as claimed in its various forms (including method claims, system claims and Beauregard claims) was a business method ”directed to an abstract idea of employing an intermediary to facilitate simultaneous exchange of obligations in order to minimize risk.”  The court found this idea was “a basic business or financial concept” much like that struck down in Bilski v. Kappos, 130 S. Ct. 3218 (2010)

In distinguishing Research Corp. Techs. v. Microsoft Corp., 627 F.3d 859 (Fed. Cir. 2010), the district court noted that  “[u]nlike the concrete and palpable blue noise mask and pixel-by-pixel comparison method which resulted in a higher quality halftone digital image all while using less processor power and memory space which was before the Federal Circuit in Research Corp., see 627 F.3d at 865, Alice’s method claims are hardly limited to “specific applications” of an fundamental concept.”

As to the system claims of the ’720 patent, the court found the claims, “as written, would wholly preempt the use of the abstract concept in any computer.”  The court further noted that “[d]espite the fact that the ’720 Patent system claims and Alice’s asserted method claims are directed to different patent eligible categories under § 101, their preemptive effect would be largely one and the same.”

The Beauregard “article of manufacture” claims, in the court’s view, fared no better than the system claims:  ”Lastly, the three program claims in the ’375 Patent are also directed to the same abstract concept despite the fact they nominally recite a different category of invention under § 101 than the other claims asserted by Alice.”

While the court’s decision gave little or no heed to the system or article of manufacture claims of the CLS patents, it did recognize that under some circumstances the application of an abstract concept can be patentable:  “To be sure, the application of an abstract idea does not render a claim unpatentable under § 101, see Diehr, 450 U.S. at 187, however these claims seek to claim the fundamental  concept itself, and not a limited or specific application of the concept.” 

As the courts, patent practitioners and industry all struggle to understand the contours of the “abstract idea” exception to Section 101 subject matter, it is helpful to have a somewhat broader construct in which to understand this evolving legal doctrine.  Here are a few of my thoughts on the subject:

1) All inventions begin as “ideas,” since, at least at the instance of conception, all inventions arise as a thought in the human mind.

2) Not all inventive ideas, however, despite existing only as thought, are considered “abstract”, so as to fall within the judicially created exceptions to Section 101 subject matter, for if all inventive ideas were considered “abstract”, all claimed inventions would require analysis to determine if they “wholly preempt” the abstract idea from which they were born.   In other words, every invention would have an “abstract idea” component that could not be “wholly preempted.”  Since this type of analysis, so far, has not been applied to all inventive ideas, we can deduce that only certain types of “abstract ideas” are considered objectionable under the judicially created exceptions to Section 101 subject matter.

3) Accordingly, the judicially-created exceptions to patent-eligibility under Section 101 implicitly sorts ideas into those that are “abstract” and those that are not.

4)  Based on the exceptions explicitly enumerated by the Supreme Court to date, it is not clear if scientific principles, laws of nature and mathematical algorithms are not considered abstract ideas, but rather are excluded from Section 101  for separate reasons.

5) Precisely why financial and/or contract-based ideas are considered excluded “abstract ideas”, while other ideas, although existing only in the human mind, are somehow considered “not-abstract”, is unclear based on jurisprudence to date.

6)  If we accept the proposition that some ideas are not considered abstract, and therefore do not have to be analyzed as a judicially-created exception to Section 101, and others are abstract, and therefore cannot “wholly preempt” the ideas, then we need one or more rules to logically separate objectionable abstract ideas from non-objectionable ideas.

7) One can argue that the Research Corp. case, introduced the “technological arts” test to determine if an idea is abstract and therefore subject to the restrictions governing the patenting of abstract ideas, or are not, and therefore not subject to those restrictions.  (“Indeed, this court notes that inventions with specific applications or improvements to technologies in the marketplace are not likely to be so abstract that they override the statutory language and framework of the Patent Act.” (emphasis added) Research Corp., Id. at 869.)  

In the instant case, the court in CLS seems to acknowledge this test by finding that there were no technological innovations described in the CLS patents — that only routine, non-innovative application of technology was described for implementing the judicially excluded abstract ideas.

So, what’s the practitioner to do?  I would say, for now, that if you are patenting inventions related to a financial or contractual idea, consider claiming first those aspects of the innovation that involve non-obvious implementations of the idea.  You might also consider filing at least one application that avoids discussing the financial or contractual aspects of the innovation at all, instead treating the data representative of such financial or contractual aspects generically as “processed data.”  If there is no point of novelty left after subtracting the financial or contractual limitations from the claims, then be forewarned that the claim may not pass muster under Section 101 if the logic used in CLS holds up on appeal.

Federal Circuit Breaks the 25 Percent Rule of Thumb

Last week, in Uniloc USA, Inc. v. Microsoft Corp., Nos. 2010-1035, 2010-1055 (Fed. Cir. Jan. 4, 2010) (hereinafter, “Uniloc“), the Federal Circuit declared that the “25 percent rule of thumb,” which has been widely used for calculating damages in patent infringement cases, is “fundamentally flawed.” Accordingly, the Federal Circuit held that any evidence relying on the 25 percent rule is inadmissible as a matter of law. This holding represents a significant shift in Federal Circuit precedent. Indeed, the Federal Circuit upheld a jury verdict based on the use of the 25 percent rule as recently as March 10, 2010. Although the underlying technology that is the subject of Uniloc deals with a software registration system to deter copying of the software, the decision will be felt across all industries.

In calculating damages for patent infringement, a reasonable royalty rate should reflect the anticipated result of a hypothetical negotiation at the time of first infringement. The 25 percent rule suggested that a licensee would pay a royalty rate equivalent to 25 percent of the expected profits from products that incorporate the intellectual property at issue. Consequently, when the 25 percent rule was used, an alleged infringer’s profit margin (profits divided by net sales) was multiplied by 25 percent to arrive at a reasonable royalty rate. That royalty rate was then multiplied by the royalty base (revenue from the sale of infringing products) to arrive at an alleged reasonable royalty.

The criticism of the 25 percent rule did not begin with Uniloc. Indeed, the rule had previously received criticism as an arbitrary and crude tool. Specifically, scholars criticized the rule because it did “not take into account specific circumstances that will determine the actual value of the patent at issue[,]” and because “multiplying by an arbitrary fraction to derive the value of a patent is an exercise in arbitrary business analysis.” Nevertheless, the Federal Circuit had tolerated its use in calculating damages for patent infringement. For example, in i4i Ltd. Partnership v. Microsoft Corp., the Federal Circuit affirmed the district court’s admissibility of a damage expert’s opinion based on the 25 percent rule because it met the “minimum standards of relevance and reliability.” In support of his opinion’s admissibility, the damages expert “testified that the 25-percent rule was ‘well recognized’ and ‘widely used’ by people in his field.”

Notwithstanding the 25 percent rule’s prior use, in Uniloc, the Federal Circuit directly addressed the admissibility of the rule for the first time. The Federal Circuit started its analysis of the 25 percent rule by addressing the rule’s previous criticisms, placing them into three general categories: (1) it fails to account for the unique relationship between the patent and the accused product; (2) it fails to account for the unique relationship between the parties, such as the different levels of risk assumed by the licensor and licensee; and (3) it fails to fit within the model of the hypothetical negotiation within which it is based due to its arbitrary characteristics. With these criticisms in mind, this ruling of the Federal Circuit puts a definitive stop to the use of the 25 percent rule in calculating damages for patent infringement:

as a matter of Federal Circuit law[,] 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.

If this was not clear enough, the Federal Circuit further held that even when the 25 percent rule is “offered merely as a starting point[,]” any opinion derived therefrom is still inadmissible because “[b]eginning 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.” In support of its holding, the Federal Circuit stated that “the 25 percent rule of thumb as an abstract and largely theoretical construct fails to satisfy” the fundamental requirement that “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.” In other words, a damages calculation “must be tied to the relevant facts and circumstances of the particular case at issue and the hypothetical negotiations that would have taken place in light of those facts and circumstances at the relevant time.”

The Federal Circuit did not leave litigants without a mode for calculating damages in patent infringement cases, however. Indeed, the Federal Circuit reaffirmed the use of the Georgia-Pacific factors for determining a reasonable royalty rate. Specifically, the Federal Circuit pointed to Georgia-Pacific factors one and two, “looking at royalties paid or received by in licenses for the patent in suit or in comparable licenses[,]” and factor twelve, “looking at the portion of profit that may be customarily allowed in the particular business for the use of the invention or similar inventions[,]” as still “valid and important factors for determining a reasonable royalty rate.” The Federal Circuit further stated that it requires “evidence purporting to apply to these, and any other factors,” to be “tied to the relevant facts and circumstances of the particular case at issue.”

The total impact of this decision on the “size” of future damage awards may be uncertain, but it is certain that the Federal Circuit is sending a clear message that abstract methodologies for calculating damages are not acceptable. By forcing damage calculations to be tied to the relevant facts and circumstances of the particular case, the Federal Circuit continues its efforts to require damage awards in patent cases to bear a direct relationship between the claims of the patent at issue and the accused products.

Patent Litigants — the 25% Rule is Dead!

In patent infringement cases, damages are often calculated by determining a reasonable royalty rate for the use of the protected invention.  Typically, such damages are calculated based upon a hypothetical negotiation for a license between the patent owner and the infringer at the time the infringement began.  For many years, patent litigants and courts alike have attempted to calculate such a royalty by using the “25% Rule” to approximate the reasonable royalty rate that the infringer/licensee would be willing to offer to pay to the patent owner during the hypothetical negotiation. Generally, the 25% Rule suggests that the infringer/licensee pay a royalty rate equivalent to 25% of its expected profits for the product that incorporates the intellectual property at issue, with the remaining 75% belonging to the infringer/licensee for its development, operational and commercialization risks, contributions of other technology / IP, etc.

On January 4, 2011, however, the Federal Circuit issued a decision in the Uniloc v. Microsoft case.  While the decision involves a wide variety of issues, one stands out as having the most potential impact. In short, the Federal Circuit held that the 25% Rule is no longer acceptable for damage calculations.  The Court noted that the Rule “is a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation.”  Evidence based upon the Rule is now inadmissible at trial.  Accordingly, the 25% Rule is dead!

Background

Uniloc is the owner of Patent No. 5,490,216 (the ‘216 patent), a patent directed a software registration system to deter copying of software.  In the suit, Uniloc alleged that Microsoft’s product activation feature that acts as a gatekeeper to Microsoft’s Word XP, Word 2003, and Windows XP software programs infringed the ‘216 patent.  The jury agreed, finding that Microsoft not only infringed the patent, but did so willfully.  The jury also awarded Uniloc $388 million in damages, relying on the testimony of Uniloc’s expert, who opined that damages should be $564,946,803 based on a hypothetical negotiation between Uniloc and Microsoft as a starting point and later relying upon certain factors first set forth in Georgia-Pacific Corp. v. U.S. Plywood Corp. (the Georgia-Pacific factors).

Using an internal Microsoft document relating to the value of product keys, Uniloc’s expert applied the 25% “rule of thumb” to the minimum value reported ($10 each), obtaining a value of $2.50 per key.  After applying the Georgia-Pacific factors, which he concluded did not modify the base rate, he multiplied it by the number of new licenses to Office and Windows products, producing the $564,946,803 million amount.  He then confirmed his valuation by using the Entire Market Value Rule, i.e., checking it against the total market value of sales of the Microsoft products (approximately $19 billion), noting that it represented only 2.9% of the gross revenue of the products.

In various post-trial motions, Microsoft asked the District Court to reverse many of the jury findings and asked for a new trial on the issue of damages based upon the alleged improper use of the 25% Rule and the Entire Market Value Rule.  In a lengthy decision, the District Court granted Microsoft’s motion with regard to the Entire Market Value Rule, but denied Microsoft’s motion with regard to the use of 25% Rule.  Both parties filed appeals on different grounds to the Federal Circuit.

Damage Calculations

On appeal, the Federal Circuit rejected the use of the 25% Rule to calculate patent damages even though it acknowledged that in the past the “court has passively tolerated its use where its acceptability has not been the focus of the case.”   The Court held:

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 court based its reasoning on Fed. R. Ev. 702 and the Daubert standard for expert testimony, concluding that general theories are only permissible if the expert adequately ties the theory to the specific facts of the case.  Under the cases of Kumho Tire Co. v. Carmichael and General Electric Co. v. Joiner, the Court noted that “one major determinant of whether an expert should be excluded under Daubert is whether he has justified the application of a general theory to the facts of the case.”  According to the Court, the application of the 25% Rule is improper because there was no link between the rule and the specific case.  The Court noted:

The 25 percent rule of thumb as an abstract and largely theoretical construct fails to satisfy this fundamental requirement. The rule does not say anything about a particular hypothetical negotiation or reasonable royalty involving any particular technology, industry or party.

In addition to the above, the Court pointed to the lack of testimony by Uniloc’s expert suggesting that the starting point of a 25% royalty had any relation to the facts of the case, and thus the use of the rule was “arbitrary, unreliable and irrelevant,” failing to satisfy the Daubert standard and tainting the jury’s damages calculation.

Based upon the forgoing, the Court granted Microsoft a new trial on damages.  The ultimate result remains to be seen.  Notwithstanding, litigants and their experts are now advised that mere reliance upon “rules of thumb,” such as the 25% Rule, are no longer acceptable. Care should be taken when performing damage calculations to ensure that the conclusions made correspond to the facts of the case, and that the evidentiary burdens are met.