UPDATE: Court Reverses Microsoft Win In Patent Case, But Offers New Law On Damages

A federal appeals court Tuesday restored a jury verdict that Microsoft Corp. (MSFT) infringed a patent related to combating software piracy, but ruled that the software giant was entitled to a new trial on damages.

Though Microsoft lost on the patent at issue in the case, it may have won a larger legal battle because the court's ruling could be used to limit the size of monetary damages in patent-infringement cases.

"This is an important and helpful opinion with respect to the law of damages, and it may signal the end of unreasonable and outsized damages awards based on faulty methodology," said David Howard, Microsoft's deputy general counsel, in a statement.

The U.S. Court of Appeals for the Federal Circuit ruled in a 59-page opinion that the jury's verdict in favor of the patent holder, security software maker Uniloc USA, was supported by substantial evidence. It said a Rhode Island federal judge erred in 2009 when he tossed out the jury's verdict and ruled for Microsoft.

Uniloc USA Chief Executive Brad Davis said Tuesday's decision "illustrates how large corporations like Microsoft have knowingly infringed on our technology for financial gain."

However, the appeals court also said the jury's $388 million award to Uniloc for Microsoft's infringement was "fundamentally tainted," making it necessary to conduct a new trial on the amount of damages Microsoft has to pay.

In a lengthy legal discussion, the court found fault with a method, known as the "25% rule," that is commonly used by plaintiffs to approximate the amount of damages owed in patent infringement cases.

The rule suggests that a company practicing someone else's patent should pay a royalty rate that is equivalent to 25% of its expect profits on the product that incorporates the patented technology.

The court said the method was "fundamentally flawed" and inadmissible because it failed to tie a reasonably royalty rate to the facts of a given case.

Edward Reines, a patent attorney with Weil, Gotshal & Manges LLP, said the ruling "is a huge change in the law that overturns existing precedent and calls many existing damages verdicts into question."

"The Federal Circuit has been moving toward confining excess damages in patent cases and this is another step in that direction," said Reines, who is not connected to the case.

Uniloc's patent deals with technology for software registration systems that deter the copying of software.

The Irvine, Calif.-based company filed suit against Microsoft in 2003, alleging the product activation feature on Windows XP and other Microsoft products infringed its technology.

It initially sought $560 million in damages.

Uniloc's Davis said the company has similar lawsuits pending against Adobe Systems Inc. (ADBE), McAfee Inc. (MFE), Symantec Corp. (SYMC) and Sony Corp. (SNE, 6758.TO).

He expressed disappointment at the appeals court's rejection of the $388 million damages award, but said the company would work with the court's ruling.

The case is Uniloc USA v. Microsoft, 2010-1035.

-By Brent Kendall, Dow Jones Newswires; 202-862-9222; brent.kendall@dowjones.com

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