DEFINITION of the 25% rule
The 25% rule is the idea that the long-term debt of a local government should not exceed 25% of its annual budget. Any debt beyond this threshold is considered excessive and poses a potential risk, as the municipality may find it difficult to repay the debt.
The 25% rule also refers to a royalty determination technique which states that a party who sells a product based on the intellectual property of another party must pay him a royalty of 25% of the gross profit made on the sale, before taxes. The 25% rule applies to trademarks, copyrights, patents and other forms of intellectual property.
BREAKING THE 25% RULE
25% rule for municipal debt
Municipal governments seeking to finance projects through bond issues must make assumptions about the income they expect to generate, which will allow them to support the payment of the bonds. If revenues do not meet expectations, these municipalities may not be able to make bond payments, which could cause them to default on their obligations and affect their credit rating.
Municipal bond holders want to make sure that the issuing authority has the capacity to pay without going into too much debt. Bondholders are therefore cautioned against purchasing bonds from local governments or states that violate the 25% rule.
Tax-exempt private activity bonds – bonds issued by municipalities on behalf of private or non-profit organizations – also have a 25% rule applied to the proceeds of the bonds. This rule states that no more than 25% of the proceeds of the bonds may be used for the acquisition of land.
25% rule for intellectual property
Patent owners use the 25% rule as a criterion to define a reasonable amount of royalties. The rule assumes that a licensee should retain at most 75% of the profits of a patented product since he / she has assumed most of the risks associated with the development of the product and the placing on the market of the intellectual property. The patent holder takes the rest as a license fee.
Defining the value of intellectual property is a complex issue. Although royalties are generally assessed on the basis of income, the 25% rule applies to profits. Furthermore, the 25% rule does not precisely define what is included in “gross profit”, which creates ambiguity in the calculation of the valuation. Because it is a strict and fast rule, it does not take into account the costs associated with marketing the product. For example, the copyright owner will receive a royalty of 25%, although the party making the sale generally incurs the cost of creating a market demand through advertising.
In the 2020 Uniloc USA, Inc. v. Microsoft Corp. court case, the Federal Circuit Court of Appeal ruled that the 25 percent rule could not be used as a starting point for an analysis of damages to the courtroom. The Court of Appeal concluded that the rule did not reach an admissible level of evidence and could not be invoked in a patent proceeding before a federal court. Although the 25% rule can still be used by other parties to estimate a proposed patent royalty, it should not be considered as the basic rule.