ASSESSING IP DAMAGES
Posted on Jan 1, 2023 4:00am PST
Based upon a Federal Circuit Court of Appeals ruling, damage experts can
no longer rely on a “25% rule of thumb” to support a reasonable
royalty rate. This 25% rule had been accepted by Courts in prior cases
as an appropriate means to allocate value to the owner of the IP.
What is this “25% rule of thumb”? It is an arbitrary amount
accepted by the courts for many years. This norm concluded that the royalty
rate to be paid by the IP licensee should not exceed 25% of the licensor’s
operating profit. Most licenses of IP are based on some percentage of
revenues or operating profits. The “rule” became lore, and
an easy way to assess a license royalty rate. Our senior professionals
were never bound by the “25% rule”. Rather, we always research
the market to determine an appropriate rate or range of rates.
The U.S. Federal Court in Uniloc USA v. Microsoft Corporation (Uniloc)
criticized the 25% rule as:
- Not accounting for the unique relationship of the patent and product.
- Inadequate to include differing levels of risk between licensor and licensee.
- Not representing a hypothetical negotiation, but rather an arbitrary benchmark.
The lessons learned from the Uniloc court decision follow:
- Regardless of whether an accounting firm blessed the 25% rule under SAS
73, a detailed analysis of the allocation in a litigation context is required.
- There is no one “rule of thumb” for all IP, no matter the industry,
product and market share for the related IP.
- Real world frameworks exist for assessing the relative importance and value
of IP. In addition to prior case factors (Georgia Pacific), other analytical
tools are “rating / ranking methods”.
- The “25% rule of thumb” is not a substitute for royalty rate
searches of comparable IP (database), as well as discussions with licensing
professionals. While relief from royalty is an accepted approach, a direct
calculation of IP generated cash flows may evolve from an analysis of
price premiums or cost savings available from use of the IP.
- Careful consideration of a relative profit split between a hypothetical
licensee and licensor may provide insight into a reasonable royalty rate.
Blanket application of the “25% rule of thumb” does not.
The Mentor Group has analyzed numerous licensing agreement and royalty
rates for IP, within the context of a business and as standalone assets.
Refinements to valuation assumptions are also produced by extensive use
of Monte Carlo simulations.