Why U.S. patents are now less valuable

March 23, 2011: 2:40 PM ET

A stunning decision in a Microsoft patent infringement case may have made patent royalties more fair, but also made them much more unpredictable.

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By Russell L. Parr and George Hovanec , guest contributors

A January decision by the Court of Appeals for the Federal Circuit had a sweeping effect:  it dropped the value of US patents. Just how much the value has been reduced, overall, is not yet known. Part of the reason we don't know is because the reduction in value is not going to be equally distributed across every patent. Rather, we know that patents owned by individual inventors, universities and research institutes will be hardest hit. Here, we'll explain what happened, and why it matters.

First, here's what happened last month. A frequently used method in determining damages for patent infringement, "the 25% Rule of Thumb," was rejected by the Court in Uniloc USA, Inc. et al. v. Microsoft Corporation. Microsoft was found to infringe Uniloc's patent for a piece of technology. Expert testimony at trial concerning patent damages had, like many cases through history, relied on the 25% Rule of Thumb to determine damages owed to Uniloc.

Microsoft (MSFT) appealed the decision reached by the jury and the Court rejected the use of the 25% Rule of Thumb. Not just for this particular case -- but for forever -- even though it has been used in and out of court to determine royalty rates for decades.

The 25% rule isn't just for court cases, however. Patent owners often license the rights to use a patented invention in exchange for royalties. The royalty is usually a percentage rate (royalty rate) applied to the sales earned by using the patent. The "25% Rule" is a typical starting rate that suggests that 25% of the profits earned from using the invention goes to the patent owner while the remaining 75% stays with the licensee. The thinking here is that the licensee has brought other assets to the commercialization of the patented invention. These can include manufacturing expertise, well established brand names and a distribution network. By retaining 75% of the profits, the licensee is allowed to earn a return on its significant contribution.

This isn't all bad though: blind application of the 25% Rule can and does lead to errors. Many other factors must be considered -- and usually are thoroughly considered -- by most experts. But the rule can be a shortcut in both the good and bad sense of the word.

When the licensed invention is central to the success of a product then the rule is a good starting point, such as when the patented invention is the active ingredient in a cancer therapy. But for example, if a design alternative can be inexpensively substituted without infringing the patent, an entirely different analysis is needed. When 25% Rule has been improperly applied, extraordinary damage awards for seemingly minor improvements to a product have been made. It seems the Court has become frustrated by these abuses of the 25% Rule and used the Microsoft/Uniloc case to react.

Here's where things get complicated, and patent values can potentially go down: Companies whose patents are infringed can often find other ways to calculate damages especially against competitors who unfairly used their patents. But individual inventors, universities and research institutes typically cannot commercialize their inventions, and need to recover damages after the infringement has occurred.  Without being able to rely on the 25% Rule, inventors, universities and research institutes have lost an important arrow in their quiver.

By making the determination of a royalty rate more difficult, it also becomes more difficult and expensive to protect patents from being infringed upon. And that could encourage more infringement to happen. All in all, it just became a lot harder for researchers and inventors to protect themselves in patent fights, especially if big corporations are the ones on the other side of the battle.

-- Russell L. Parr is President of Intellectual Property Research Associates. George Hovanec is a shareholder in the Intellectual Property Section of Buchanan Ingersoll & Rooney, PC.

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