The Vringo (NASDAQ:VRNG) versus Google (NASDAQ:GOOG) patent infringement case has been heating up. It has been an interesting few weeks with Google claiming to have a runaround implemented, and Vringo asking for enhanced royalties up to 7% of the 20.9% base of US Adwords revenue. Now is the hard part as investors wait for the final decision from the judge. There are some very important points that were brought up in the response filed by Vringo, which I would like to give my take on.
Issue 1: Google's workaround
Vringo's attorneys point out multiple times that the motion for ongoing royalties was not the proper time for Google to present the notion of a runaround, as Google has already been adjudged by a jury to have infringed upon (and continuing to infringe upon) the patents owned by Vringo. This snapshot from page 19 could have very easily been glanced over, but provides a very important insight as to how the process will play out:
If Google's allegedly modified system is later determined to be colorably different, the ongoing royalty rate would not apply to the revenues derived from that system. See Soverain Software v. Newegg, 836 F. Supp. 2d at 484 ("If Newegg proves successful in designing-around the shopping cart claims and hypertext statement claims, it will be freed of the obligation to pay ongoing royalties.").
Notice how in the Soverain Software v. Newegg case that the court reasoned: "If Newegg proves" that its system is different and does not infringe it will be freed of having to pay ongoing royalties. This applies very importantly to the case at hand, as it would clearly help to lead to the conclusion that similarly Google would bear the burden of proving that the workaround system does not infringe. This is contrary to Google's argument in its memorandum in opposition in which Google seems to assert that Vringo would bear the burden of proving that Google's new system still infringes. Google starts the portion of its motion, talking about how Vringo would have to prove that it is still infringing, with the heading: "II. I/P Engine fails to meet its burden of proving that defendants' current system is no more than colorably different than the accused product." Google seems to believe that for some reason Vringo would have to prove that the system is still infringing.
Personally, I would lean towards Vringo's argument. First of all, Vringo would seem to have the case law on its side of the argument. And secondly, simple logic would point to the idea that a company which is now adjudged to have infringed would bear the burden of proving that it is no longer infringing. Otherwise Google could release an update every day claiming that it is no longer infringing, which would cause for even more trials and legal delays. The case law not being on Google's side, coupled with the logical fallacy inherent within Google's argument, would seem to point that the judge will not agree with Google on that issue. Even more importantly is how Vringo constantly reminds the judge that the motion is not at all about a proposed work around from Google, but rather about ongoing royalties in the case, even calling Google's claimed workaround a "red herring." I also agree with the idea presented through Vringo's brief that if there really was a work-around, that Google would want a running royalty (as they would not have to pay after the infringing system is shut down and their new system is adjudged to be not infringing) rather than a lump sum. This would help to make me skeptical personally as to whether Google would win the argument that its new system does not infringe upon I/P Engine's patents.
Issue II:Google's claim that the royalty base used by the jury was not the 20.9% royalty base.
While this argument is actually a valid one by Google (if you do the math, the royalty rate assigned for Google in terms of past damages was incredibly low), the 20.9% royalty rate was the only rate presented to the jury at the trial. It is apparent that there would be no legal basis for the judge to say that the jury did not want the 20.9% royalty rate, as it was properly applied to all of the other Defendants in the case. Furthermore, Google seemingly rolled the dice when it did not counter with what it thought would be an appropriate royalty base. Google instead went with the lump sum argument, one which was rejected by the jury. In that light, Google decided to roll the dice and ultimately lost. Had Google argued at trial for a royalty base consistent with what the jury assigned to Google, this could be a very different discussion. Thus, Vringo has also addressed another steep concern of investors about what royalty base is going to be used.
Issue III: What the royalty percentage is going to be
This would seem to be a much harder issue to resolve. The absolute worst case scenario for Vringo would be that the judge simply comes out with 3.5% as the royalty percentage. This is definitely not too shabby of a scenario for Vringo as Vringo would still receive a substantial amount of money until the expiration date of its patents. However, Vringo makes the argument that the judge should consider that post-infringement, given that the changed bargaining positions of both companies that a reasonable royalty rate would have been 5%. This is given the hypothetical negotiations which would have taken place, which Vringo points out is substantially different now that Google has been adjudged to have infringed upon Google's patents. Also, as Vringo pointed out, Google would have to be negotiating with I/P Engine, not with Lycos, and this is a very important distinction. If Google got its way that it would have been negotiating with Lycos, the court would have reasonably taken into account the fact that Lycos was not doing very well financially and was cutting off a large amount of its patent enforcement activities. Instead having to negotiate with I/P Engine, which is financially solid, and solely devoted to monetizing its I/P assets, the negotiations would have been a very different ballgame. Vringo then asks the court to apply the Reed test and enhance the royalty rate up to 7% due to Google's continued willful infringement on Vringo's patents. The test comes out overwhelmingly in favor of Vringo, and helps to suggest that instead of 5% it is very possible for the judge to grant a 7% royalty to Vringo.
My take: Given the overwhelmingly positive Reed test coupled with the factors pointed to by I/P Engine about the new negotiations under a Georgia Pacific Analysis, the court will likely award Vringo at least five percent and possibly even 7% in ongoing royalties. It is becoming very clear for Vringo just how important the testimony of Dr. Becker was throughout the trial, and they are continuing to lean upon his analysis even after the trial.
An interesting tidbit is that Vringo frequently cites the case ActiveVideo v. Verizon. Now, this case is arguably the best case for determining what Judge Jackson is leaning towards in terms of enhancing Vringo's royalty rate, as Judge Jackson was the presiding judge in the case. This clearly shows that Judge Jackson is not afraid to enhance royalty rates, given the shifted position of the companies, as Google is now an adjudged infringer. The appeals court ultimately agreed with Judge Jackson's royalty determination.
Vringo has a bright road ahead of it, and has helped to make me more skeptical than ever about a possible work around by Google. I used to be leaning in the direction that there might be some merit to Google's argument of a workaround, however, with Google having to prove that its workaround would not infringe upon Vringo's patents, it seems as though the verdict for Vringo would be secure. So where do we go from here? The appeals should be interesting, if Vringo is able to get laches overruled by the Court of Appeals, the stock should run as that would add hundreds of millions of dollars more into the pot for Vringo. Let's not count Quinn Emmanuel out though, these guys do know what they are doing and I would expect a fierce argument on appeal. As to whether or not Google will ultimately win on appeal only time will tell, but for right now things do seem to be positive for I/P Engine and Vringo.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in VRNG over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.