A few days ago, all eyes were on Apple (NASDAQ:AAPL) as it reported its sales of $31.2 million iPhones in the quarter ended in June, up 20% over the previous year, beating analysts' consensus of around 27 million units. While the iPhone 5 was the most frequently activated device, certainly the older models contributed to Apple's overall sales. Why is this important? The answer lies in a series of intense and long-running patent litigation battles between Apple and its largest competitor to date -- Samsung (OTC:SSNLF).
First, a bit of history. The initial battle between these two tech titans started off on April 11, 2011, with Apple bringing an intellectual property infringement action in the Northern District of California alleging infringement of 7 utility patents, 3 design patents, trademarks (registered icons, logos, etc.) and trade dress (e.g., design, rectangular shape, rounded corners, silver edges, black face, display, etc.) owned by Apple. The accused products were the Samsung Nexus S, Epic 4G, Galaxy S 4G, and the Samsung Galaxy Tab. The complaint also alleged state-level claims of unfair business practices (unfair competition), unjust enrichment, and common law trademark infringement. Samsung counterclaimed with 12 utility patents and a plethora of registered trademarks of its own. Not only did Samsung fight back in California, but it expanded the litigation from just its California counter suit to new cases in the District of Delaware (stayed pending resolution of the ITC investigation) United States International Trade Commission (ITC) as well as Japan, Germany, Britain, South Korea, France, Italy, Netherlands, and Australia.
By the time the case reached the jury in California, the following patents remained in the case:
7,469,381 - "Bounce-Back Effect" or "Rubber Banding"
7,844,915 - "On-Screen Navigation"
7,864,163 - "Tap to Zoom"
D504,889 - rectangular shape of the iPad with rounded corners
D593,087 - home button, rounded corners
D618,677 - iPhone rectangular shape with rounded corners
D604,305 - "On-Screen Icons"
First California Trial
On August 24, 2012, the California jury reached a verdict mostly in favor of Apple. The jury found Samsung willfully infringed all but one of Apple's patents (the Galaxy Tab 10.1 did not infringe the D504,889 patent), and Samsung was also found to have diluted Apple's trade dress related to the iPhone. Correspondingly, the jury found Apple did not infringe any of Samsung's patents. The damages award to Apple was $1,049,393,540.
Outside of Apple's home turf, the picture was quite different and a full analysis of all the suits and counter-suits is outside the scope of this article. Suffice to say, the results were mixed with both sides scoring victories in different jurisdictions.
On October 2, 2012, Samsung appealed the jury verdict in California decision to the United States Court of Appeals for the Federal Circuit. Apple already lost one appeal in October where a three-judge Federal Circuit panel said that Samsung could continue selling its new Galaxy Nexus smartphones in the midst of its ongoing patent infringement defense. This appeal followed Judge Lucy Koh's denial of Apple's request for an injunction. Apple had already asked the full Federal Circuit to reconsider the three-judge panel's October ruling.
Meanwhile, the battle in the California District Court continued. In March 2013, Judge Lucy Koh reduced the $1.05 billion jury verdict by nearly half ($450.5 million) because the jury's damages calculations incorrectly compensated Apple for sales of Samsung products made before Samsung had notice of the relevant Apple patents. A new "extremely limited" damages trial was ordered to begin on November 12, 2013, while Samsung's motion to stay the new trial pending an appeal of part of the ruling was denied. The "sole purpose of the trial," Judge Koh wrote, is to correct the "impermissible legal theory" the jury used in the first trial to calculate damages for 14 of the Samsung devices at issue.
Second California Trial
Without waiting for its first trial to begin, Apple had also fired off a second complaint in the same court on August 2, 2012 alleging infringement of 8 more utility patents. Some of the major accused products were Galaxy S II Skyrocket, Galaxy S II Epic 4G Touch, Nexus, Illusion, Captivate, Glide, Exhibit II 4G, Galaxy S III, Galaxy Note, Galaxy Tab 10.1, and others. Again, Samsung countered with eight of its own patents -- accusing the iPhone 4, iPhone 4S, iPad 2 and New iPad of infringement and later amending its infringement contentions to include the latest iPhone 5 and the 4th generation iPad.
So after the retrial on damages in the first case takes place, Apple and Samsung are scheduled to once again return to the same judge in California for yet another patent trial -- which is set to begin on March 31, 2014. That trial will focus on new products and different patents asserted by both parties. (The Apple patents-in-suit are U.S. Patent Numbers 5,946,647; 6,847,959; 8,046,721; 8,074,172; 8,014,760; 5,666,502; 7,761,414; and 8,086,604. The Samsung patents-in-suit are U.S. Patent Numbers 7,756,087; 7,551,596; 7,672,470; 7,577,757; 7,232,058; 6,292,179; 6,226,449; and 5,579,239.)
Re-Examination of the Rubber-Banding Patent
In the middle of the initial Apple/Samsung California-based court battle, an anonymous third party requested re-examination of Apple's "rubber-banding" patent (U.S. Pat. No. 7,469,381) in 2012. The technology described in the patent is the functionality that causes the content displayed on the iPhone's screen to bounce back when the user scrolls to the top or bottom of a page. The USPTO rejected the claims of the "rubber-banding" in March as anticipated by the prior art. As is typical, to overcome the prior art, Apple made certain arguments to get around the cited references. After an interview with Apple's patent lawyers, the USPTO affirmed the patent in June of 2013. On July 9, 2013, Samsung jumped on the opportunity presented by the USPTO's rejection and argued that Apple "presented a brand new interpretation" of the patent to the USPTO in order to maintain its validity. The consequence was that Apple had thereby "drastically" narrowed the scope of its patent claims.
So Samsung asked the Court for yet another new trial, which according to Samsung, is necessary to determine whether Samsung's products infringe under the new interpretation. Of course, Apple responded that "Samsung's motion is a thinly disguised attempt to make new non-infringement arguments that it could have made at trial but chose not to present" and asked the Court not to give Samsung a "do-over." Apple also argued that it was too late for such a motion since the final judgment in the case was entered 10 months ago.
Given the number of cases and fora in which Apple and Samsung have been litigating, as well as the breadth of mutual patents and products at stake -- on both sides -- investors must keep in mind that determining whether Apple or Samsung is "winning" is a very murky question. Particularly where no side has parted with money (other than hundreds of millions of dollars in legal fees.) Instead, the better question for investors is the bottom line ones -- is either company being stopped from doing or selling anything? For Apple, unfortunately, the answer is yes.
The International Trade Commission
We started this article by raising a very specific issue concerning the sales of the older iPhone models. Due to an ITC patent ruling, Apple's ability to continue to sell these models in the United States may be compromised -- and Apple investors are rightfully concerned. Put another way, the looming 60 day Presidential review of the ITC ruling that older models of Apple's iPhone and iPad infringed a Samsung patent is an important one, considering that the ITC also banned Apple from selling the devices in the United States.
As discussed earlier, the ITC in August of 2011 initiated an investigation into Samsung's allegations that Apple violated the Tariff Act and infringed U.S. Patent Nos. 7,706,348; 7,486,644; 7,450,114; and 6,771,980 by importing into the U.S. and selling certain electronic devices, including iPhones and iPads. Samsung had sought an exclusion order barring imports of three models of the iPhone -- the 3G, 3GS and 4 -- as well as the iPad 3G, iPad 2 3G and iPod Touch.
First, a few words about the International Trade Commission. Patent-based ITC investigations are limited to infringing acts arising from the importation of products into the United States. See Section 1337(a)(1)(B) of the Tariff Act of 1930. ITC's Intellectual Property cases are considered "Section 337" cases, where patent infringement takes up more than 90% of all cases with the rest of the cases related to registered trademark infringement (gray market goods), copyright infringement, mask works, trade secrets, etc. Section 337 cases are assigned to ITC Administrative Law Judges with no jury trial. ITC Judges render "Initial Determinations" that are subject to review by the Commissioners. The ITC is headed by 6 Commissioners who are nominated by the President and confirmed by the U.S. Senate. No more than three Commissioners may be of any one political party.
An important difference between an ITC action and a trial in the district court action is that in the ITC, money damages are not available as a remedy. Instead, the only available remedy is the exclusion of the imported product from the U.S. market. That means, Samsung has no opportunity to collect any money by proving Apple's infringement at the ITC. That said, Samsung can gain relief from the US government ordering Apple to stop importing its products. For phones manufactured abroad, that means they cannot be sold in the US.
Other differences exist between ITC actions and trials at the district court. ITC actions are also faster, with the average time to trial of about 9-10 months, whereas patent cases in the district court can take up to three years before reaching trial. ITC investigations also involve three parties -- the Complainant, the Respondent and the Office of Unfair Import Investigations ("OUII"). The OUII is a neutral party responsible for representing the public interest. Like counsel for the Complainant and the Respondent, a staff investigation attorney from the OUII is directly involved in all facets of the proceeding, and takes a position on the merits of the case at trial.
Back to the case at hand. Following the hearing, Administrative Law Judge E. James Gildea issued a determination in September of 2012 holding that Apple had not violated any of the patents and that one of the Samsung patents was invalid. That decision was reviewed by the ITC Commission. The Commission went the other way. On Tuesday, June 4, 2013, the Commission reversed Judge Gildea's ruling with respect to one patent. The Commission found that Apple's iPhone 4, iPhone 3GS, iPhone 3, iPad 3G, and iPad 2 3G (only AT&T models) infringed Samsung's U.S. Patent No. 7,706,348, and therefore, violated Section 337 of the Tariff Act. Because of this infringement finding, the Commission issued both a limited exclusion order and a cease-and-desist order barring Apple from importing these devices for sale in the U.S. until June 3, 2015. These devices are Apple's older iPhone models.
A limited exclusion order directs Customs Service to exclude all infringing articles that originate from a specified firm that was a respondent in the Commission investigation. (The Commission also could have, but did not, issue a general exclusion order, which directs Customs Service to broadly prohibit entry of products that infringe the patent, whether or not the products are from actual parties in the ITC investigation.) A cease-and-desist order typically involves inventory already imported into the U.S. If the Respondent is found to violate Section 337, the ITC can order that the Respondent is no longer permitted to sell any of the inventory and must destroy it or return it to outside of the U.S. Unlike exclusion orders, cease and desist orders are enforced by the Commission, not by Customs. See 19 U.S.C. § 1337(f)(2) (which provides for civil penalties for violation of cease and desist orders).
This ruling cannot be underestimated for Apple's future sales. The order has yet to take its full effect. This is because there is additional level of required review. The ITC Commission remedial order must be sent to the President, who then has discretion, within 60 days, to disapprove the order for policy reasons. If the President does not disapprove the Commission's order within the 60 day review period, at the conclusion of the period, Apple's infringing imports may no longer be imported starting on August 4, 2013.
That is why on June 26th, Apple asked the Office of the U.S. Trade Representative (authority designated by the President to review ITC rulings) to veto the ITC order barring imports of older iPhone models found to infringe a Samsung patent. Apple argued that Samsung committed to license its standard essential patents (like the one Apple was found to have infringed) on terms that are fair, reasonable and nondiscriminatory (FRAND), and thus waived its right to an injunction.
The bad news for Apple is that US Presidents rarely disapprove any exclusion order issued by the ITC. This has happened only five times in the agency's history, and the last President to veto an order was Ronald Reagan in 1987.
The next logical step for Apple is to appeal the ITC order to the Court of Appeals for the Federal Circuit. Again, these patent issues present a challenge for investors who may be unfamiliar with the details of all the pending cases. But keeping on top of developments is crucial, particularly when, as here, a patent ruling could have a material effect on the revenue performance of a company.
The stakes are extremely high in this battle of the technology giants, and the cases are getting more and more complicated. That is precisely why, as reported by The Wall Street Journal, settlement talks between Apple and Samsung escalated lately. Each side scored at least one big victory across two crucial venues, but it is Apple who is facing an order that bars it from selling its products. Although that order is limited to the older iPhone devices, it still could have ramifications for Apple's bottom line.
On the other hand, Apple still has opportunities to hit Samsung back. For example, the upcoming second patent trial in California is of far greater scope and potential impact for both Apple and Samsung.
A global settlement to these patent wars would allow both Apple and Samsung to consolidate their status as a smartphone "duopoly" of sorts, and use their patents to keep less-successful competitors at bay. While these companies clearly have (and have exercised) the resources to fight each other to a stalemate, their smaller or less established competitors are unlikely to have the same willpower. So both Apple and Samsung could shift their focus from using their patents in bludgeoning each other to using them to generate revenue or as blocking mechanisms from other smartphone market participants.
Taken together, a settlement of the patent wars points to a brighter future for both Apple and Samsung, one that investors in both these companies should cheer. At the same time, the risks for other competitors in the space will go up as a result, so investors in the sector would do well to monitor (either directly or through patent counsel) closely patent developments in the smartphone space. If there is a lesson that these smartphone patent wars has taught the investment community, it is that these tech giants take their patents very seriously -- and investors looking for an edge should do the same.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.