Presented: Japan Committee of AIPLA AIPLA Mid-Winter Conference January 22-23, 2012 Las Vegas, Nevada Hung H. Bui, Esq. Bui Garcia-Zamor Washington D.C. Recent Federal Court Decisions Re: PATENT DAMAGES & IMPLICATIONS TO PRACTITIONERS

Agenda Patent Damages - 35 U.S.C. §284 Y2009-Y2010: Evolution in Patent Damages Law Recent Federal Court Cases re: Patent Damages Uniloc USA, Inc., v. Microsoft Corp., No (Fed. Cir. Jan. 4, 2011) Schindler Elevator Corp. v. Otis Elevator Co., 1-06 CV (S.D.N.Y. June 23, 2011) Implications to Practitioners © AIPLA

Patent Damages 35 U.S.C. §284 provides “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” Patent damages are calculated either as: (1) LOST PROFITS or (2) A REASONABLE ROYALTY  the amount determined on the basis of a “hypothetical negotiation” between the parties at the time of infringement using the 15 factors outlined in Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F.Supp. 1116, 1120 (S.D.N.Y. 1970), modified and aff’d, 446 F2d 295 (2d Circ 1971), cert denied, 404 U.S. 870, 92 S.Ct. 105 (1971) © AIPLA

Patent Damages Expert testimony is used as an aid to calculate patent damages or “reasonable royalty” under the Federal Rule of Evidence 702 However, expert testimony must be based on a firm scientific or technical foundation; see the Supreme Court’s interpretation of Rule 702 in Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 589 (1993) Issues regarding patent damages: “Georgia-Pacific” 15 factors are difficult to apply consistently Lack of guidance Experts may apply these factors with unlimited discretion Damage rulings are unpredictable and frequently excessive © AIPLA

Y2009-Y2010: Evolution in Patent Damages Law In response to failed efforts to reform patent damages in Patent Reform Act of 2005, 2007 and 2010, the Federal Circuit decided: (1) Lucent Tech., Inc. v. Gateway, Inc., 580 F.3d 1301 (Fed. Cir. Sep. 11, 2009) “Georgia-Pacific” factors as a framework for damages and damage apportionment; however, these factors must be based on facts (not opinions or speculation) The “entire market value” rule requires a showing that the patented feature creates “the basis for customer demand” (2) ResQNet.Com, Inc. v. Lansa, Inc., No (Fed. Cir. Feb. 5, 2010) Proof of damages must be carefully tied to the claimed invention’s footprint in the market place CHIEF JUDGE RADER SITTING BY DESIGNATION (1) Cornell University v. Hewlett-Packard Company, 609 F. Supp. 2d 279 (N.D.N.Y. 2009) Under the “entire market value” rule, the price of an entire product containing an infringing feature can be used in the royalty base only if that feature is the basis for customer demand; otherwise, royalty base must be limited to the “smallest saleable unit” (2) IP Innovation LLC v. Red Hat Inc., 705 F.Supp.2d 687 (E.D. Tex, 2010) Judges as “gatekeepers” for “Georgia-Pacific” factors © AIPLA

Uniloc USA, Inc., v. Microsoft Corp., No (Fed. Cir. Jan. 4, 2011): Rejecting the 25% Rule Used to Calculate Patent Damages Background Uniloc owns U.S. Patent No. 5,490,216 directed to a registration system designed to deter illegal (or casual) copying of software, where users install copies of a software program on multiple computers in violation of applicable software conditions The system allows the software (installed) to run without restrictions (in “use mode”) only if the system determines that the software installation is legitimate Uniloc sued Microsoft in District of Rhode Island alleging that the Product Activation feature in Word XP, Word 2003 and Windows XP programs infringed the ‘216 patent 25-character alphanumeric product key contained within the packaging of MS product © AIPLA

Uniloc’s Calculation of Patent Damages Microsoft Internal pre-litigation document: Product Key is worth between $10 -$10,000 depending on usage 226 million new licenses sold to Office and Windows products (average sale price of $85) Total revenue of MS products: $19 billion = ($85 per product) * (226 million sold) Uniloc’s damages expert, Dr. Gemini: Damages should be $565 million based on a hypothetical negotiation using Georgia-Pacific factors How? Testified that $10 (lowest appraised value) is the isolated value of Product Activation feature Applied the so-call “25% Rule” to $10 value  Baseline royalty rate of $2.50 per license $565 million = ($2.50 per license) * (226 million sold) As a “check” for its reasonableness, $565 million is only 2.9% of total revenue of $19 billion In comparison, industry royalty rates for software are about 10% © AIPLA

Uniloc USA, Inc., v. Microsoft Corp., No (Fed. Cir. Jan. 4, 2011): Rejecting the 25% Rule Used to Calculate Patent Damages Jury awarded damages of $388 million (out of $565 million requested) District court: Granted MS’s motions JMOL for non-infringement and lack of willfulness; but denied motion JMOL for invalidity Granted MS’s motion for a new trial on damages: Improper use of the so-called “25% Rule” Improper use of the “entire market value” (EMV) Rule as “check” when the Product Activation feature did not create the basis for customer demand Issues on Appeal: (1)Whether the so-called “25% Rule” can be used as a starting point to calculate a baseline royalty rate in a hypothetical negotiation? and (2)Whether the “entire market value” (EMV) Rule can be used as a “check” on the reasonableness of damages calculation? © AIPLA

Uniloc USA, Inc., v. Microsoft Corp., No (Fed. Cir. Jan. 4, 2011): Rejecting the 25% Rule Used to Calculate Patent Damages Federal Circuit Issue #1: Whether the so called 25% Rule can be used as a starting point to calculate a baseline royalty rate in a hypothetical negotiation?  The 25% Rule was formulated by economist Robert Goldscheider after an empirical study of 18 commercial licenses in the late 1950s - an average royalty from these 18 licenses was about 25% of expected profits for the product incorporating the IP at issue; also see Goldscheider, et al., “Use of The 25 Per Cent Rule in Valuing IP”, 37 les Nouvelles 123 (Dec. 2002) Holding: As a matter of law, the 25% rule of thumb is a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation  Evidence relying on the 25% rule is inadmissible under Daubert and the Federal Rules of Evidence  Why? The 25% Rule: (1) fails to account for the unique relationship between the patent and the accused product; (2) fails to account for the unique relationship between the parties; and (3) is arbitrary, unreliable and unrelated to the facts of the case © AIPLA

Uniloc USA, Inc., v. Microsoft Corp., No (Fed. Cir. Jan. 4, 2011): Condemning Misuse of the “Entire Market Value” Rule Federal Circuit Issue #2: Whether the “entire market value” (EMV) Rule can be used as a “check” on the reasonableness of damages calculation?  The EMV Rule allows a patentee to assess damages based on the entire market value of the accused product when the patented feature creates the “basis for customer demand” or “substantially create[s] the value of the component parts”; see Lucent Techs MS  the use of EMV Rule was not proper because the Product Activation feature did not create the basis for customer demand Uniloc  the entire market value of MS product ($19 billion) was not used for damages calculation – instead, was only used as a “check” for its reasonableness Holding: Uniloc’s use of the $19 billion “check” was improper under the EMV Rule. Total revenue for an accused product cannot be considered by a jury unless the EMV Rule applies  Uniloc’s improper emphasis on MS $19 billion in gross avenue prejudiced the jury as to the reasonableness of asking for $565 million in damages © AIPLA

Schindler Elevator Corp. v. Otis Elevator Co., 1-06 CV (S.D.N.Y. 2011): Patent Damages Post Uniloc Background Schindler owns U.S. Patent No. 5,689,094 directed to a destination dispatching system installed in an elevator designed to allow a passenger to specify desired floor in the lobby before entering the elevator Schindler sued Otis Elevator alleging that the “Compass with Seamless Entry” system infringed the ‘094 patent At trial, Schindler presented expert testimony on reasonable royalty based on the EMV Rule. Otis moved to exclude the expert testimony On June 23, 2011, the Southern District of New York granted Otis’s motion to exclude the expert testimony on the EMV Rule because Schindler failed to present “competent evidence” that the patented feature alone created the basis for customer demand  Not enough to show that the patented feature was desirable, or even created a substantial basis for customer demand Competent evidence may include econometric studies, customer surveys, regression analyses or other evidence of marketplace-wide demand © AIPLA

Implications to Practitioners At trial: Georgia-Pacific factors shall be used to calculate damages (“Reasonable Royalty”  Royalty Base + Royalty Rate) and damage apportionment – Judges shall act as “gatekeepers”  However, the hypothetical negotiation must be based on “facts” and not opinions or speculation The 25% Rule: No longer usable as a matter of law after Uniloc  Starting without the 25% Rule  Lower royalty rates  However, the 25% Rule can still be used if the 25% Rule is based on related and actual arms-length license agreement(s) entered into by a party to the hypothetical negotiation, rather than the industry rule of thumb; see Convolve, Inc., Dell, Inc., et al., Case No. 2:08-CV-244, July 8 Order from Judge Charles Everingham IV of the Eastern District of Texas, denying Dell’s motion to exclude expert testimony using the 25% Rule © AIPLA

Implications to Practitioners At trial: The EMV Rule can be used to allow the patentee to claim damages based on the entire product only if: (1) The infringing component is the basis for customer demand for the entire machine; (2) The individual infringing and non-infringing components are sold together; and (3) The individual infringing and non-infringing components are analogous to a single functional unit or a part of a complete machine; (see Lucent Tech & Cornell University) Otherwise, damages must be apportioned to the patented feature. However, the value of the entire product can still be used as the basis for a reasonably apportioned royalty. “Competent evidence” is required to show that the patented feature alone creates the basis for customer demand. It is not enough to show that the patented feature is desirable or creates a substantial basis for customer demand  Lower royalty rates (see Schindler Elevator)  Econometric studies  Customer surveys  Regression analyses or other evidence of marketplace-wide demand sensitivity to the patented feature © AIPLA

Implications to Practitioners At trial: More challenges (via, Daubert Motions) to exclude damages expert testimony that is “conjectural or speculative” or fails to tie to specific facts of the case More summary judgment motions to address damages issues and lack of evidence thereof, including issues related to:  Apportionment, or  The EMV Rule © AIPLA

Implications to Practitioners Federal Circuit Review - Expect greater level of scrutiny of evidentiary and economic basis of patent damages The setting of proper royalty base (see Lucent Tech) The calculation of appropriate royalty rate (see Cornell University & ResQNet.Com) The application of the EMV Rule (see Lucent Tech & Cornell University) Damages awards must be clearly supported by the evidence License agreements may be used to support damages  Must be comparable to a hypothetical negotiation  Must have a discernable link to the technology of the asserted claims  Licenses going beyond the license of the patented technology, such as software products, source code and services, such as training and maintenance are not comparable (see ResQNet.com)  Licenses entered as a result of litigation may be considered as evidence of a reasonable royalty © AIPLA

QUESTIONS Contact Information: Hung H. Bui, Esq Bui Garcia-Zamor Intellectual Property Attorneys 1250 Connecticut Ave., NW, Suite 200 Washington DC Tel: Website: © AIPLA

Appendix: “Georgia-Pacific” 15 Factors for Determining “Reasonable Royalty” 1. Royalties patentee receives for licensing the patent in suit 2. Rates licensee pays for use of other comparable to the patent in suit 3. Nature and scope of license in terms of exclusivity and territory/customer restrictions 4. Licensor’s established policy and marketing program to maintain patent monopoly by not licensing others to use the invention 5. Commercial relationship between licensor and licensee, such as whether they are competitors or inventor and promoter 6. Effect of selling the patented specialty in promoting sales of other products of the licensee; the existing value of the invention to the licensor as a generator of sales of his non-patented items; and the extent of such derivative or convoyed sales 7. Duration of patent and term of license 8. Established profitability of the products made under the patent, its commercial success and its current popularity 9. Utility and advantages of patent property over old modes and devices 10. The nature of the patented invention; the character of the commercial embodiment of it as owned and produced by the licensor; and the benefit of those who have used the invention 11. The extent to which the infringer has made use of the invention and the value of such use 12. The portion of profit or selling price customarily allowed for the use of the invention 13. The portion of realizable profit attributable to the invention as distinguished from non-patented elements, significant features / improvements added by the infringer, the manufacturing process or business risks 14. Opinion testimony of qualified experts 15. Outcome from hypothetical arm’s length negotiation at the time of infringement began © AIPLA