A Brief History of VirnetX, Inc. v. Cisco Systems, Inc
VirnetX (NYSEMKT:VHC) and Apple (NASDAQ:AAPL) just held a hearing in the appeal of the case VirnetX, Inc. et al. v. Cisco Systems, Inc., Case No. 6:10-cv-00417-LED (E.D. Tex.), which was originally filed in 2010. The case was split, and separate trials were held against Apple and Cisco. Cisco won a verdict of non-infringement on March 14, 2013, and VirnetX won a verdict of $368M against Apple in November 2012.
Apple subsequently appealed the verdict. This article discusses the implications of the oral hearing on the appeal held on March 3, 2014, at the Federal Circuit (case 13-1489). The judges involved were Chief Judge Randall Rader, Circuit Judge Raymond Chen and Circuit Judge Sharon Prost.
Some background on the VirnetX/Apple Appeal
As I mentioned in an earlier article ("ParkerVision V. Qualcomm: Why The Bulls Are Wrong About ParkerVision"), the chief judge of the Federal Circuit appeals, Judge Randall Rader, has been publicly stating, at conferences, and in interviews, that he intends to end abusive (mis)use of Nash Bargaining Solution (NBS) and the Entire Market Value "Rule."
I will note that Chief Judge Rader made similar statements about the 25% "rule of thumb" prior to overturning its use in Uniloc. I strongly believe that history is about to repeat itself.
A negative ruling in this appeal will drastically affect VirnetX, as well as other McKool, Smith cases, including ParkerVision v. Qualcomm.
The Oral Hearing on March 3, 2014
After listening to the audio and reading the transcript, I concluded that the hearing went very badly for VHC. Chief Judge Rader is clearly eager to make case law and put an end to current abusive usage of Nash Bargaining (as a new "rule of thumb" - replacing the older and now invalid 25% rule of thumb) and the "Entire Market Value Rule." Below are some quotes from Monday's hearing which back up that contention:
Some quotes from Monday's hearing:
Judge Rader: Thank you. Let's look at Mr. Weinstein's admission that in the Mac[intosh], the invention's only worth 29 cents, and yet, he also finds that it's worth $6.49 when it's put in an iPhone. Why does the same invention get more than six dollars of enhancement just because it's put in a mobile device?
Judge Rader: That's worth six dollars. That's worth six dollars more. This invention is for security features, not for the entire video conference app, right? Where is the differentiation there in any of your work before the jury?
Judge Rader: But there's a big distinction between the invention, which is protecting security within a video conference. You seem to be claiming the entire value of the video conference under the entire market value rule. How can you do that? You are limited to the claimed invention, which is security, not all video conferencing, which you didn't invent.
Judge Rader: Now tell me about the jury instruction, which seems to say the smallest salable unit is a freestanding divorced doctrine from the entire market value rule, which is aggrandized as a rule instead of the exception, which we've made it very clear it is, only when you can show the demand driver. How did you show that?
You have to do two things here for my question show me how this is the demand driver for the entire video conferencing app and how the smallest salable unit gets divorced from the entire market value rule.
Judge Rader: But do you show that demand for the entire product was driven by your small claimed feature?
Mr. Jakes: For some products, yes.
Judge Rader: Show me that evidence. Just give me a quick cite to it and I'll check it later.
Mr. Jakes: Let me explain. This is the expert's third damages theory for FaceTime. There was evidence that, in the form of a survey, that certain people purchased iPod touch because they wanted FaceTime. That was a certain number of customers that said, "I purchased it for a specific feature, and that specific feature..."
Judge Rader: That was over 50 percent? No. It was under 10 percent, wasn't it?
Mr. Jakes: No, it wasn't under 10 percent. It was 18 percent.
Judge Rader: 18 percent. But, of course, to be a demand driver it would be at least over 50 percent, wouldn't it?
Mr. Jakes: Right, instead of allocating all the incremental profit to the patent owner, he split it. He did it in a way that was consistent with the Nash Bargaining.
Judge Rader: Nash Bargaining. Is it ever anything other than 50/50?
Mr. Jakes: It was in this case.
Judge Rader: You discounted it generously by 10 percent.
Mr. Jakes: Right.
Judge Rader: Isn't that a rule of thumb? Didn't we just smack that down in Unilock when you start using 50/50 rules of thumb, even if you start discounting them, which was often done with the Goldscheider Rule?
Judge Chen appears to agree with Rader on the misuse of various damages theories in this case. He also seems ready to overturn on Markman issues. It is important to know that the Federal Circuit reviews the Markman de novo - no deference is paid to the district court's ruling.
Judge Chen: I think we're confusing a couple different theories here. There was one proposed theory where your expert used the smallest salable unit, which, arguably, somehow morphed into something that looks very much like the entire market value exception.
Judge Chen: Then, there's another theory where the expert for the FaceTime patents tried to do some kind of apportionment, but then ultimately used something called the Nash Bargaining Solution to finish off its theory. That's an arguable additional defect, at least for that particular theory.
Judge Chen: All of the math landed at this elegant solution of 50/50 perfectly?
Judge Chen: Just one more time, as I understood it, every theory either relied on smallest salable units or, at some point, Nash Bargaining Solution.
Mr. Jakes: That's true. Another one...
Mr. Jakes: Those are two aspects of security. The question is, are they both required? I point to you in the '504 patent, at column 39, line 24, it talks about a secure communication path and says that with a secure communication path, the IP address could be revealed over the Internet and the path is, thus, not anonymous.
Judge Chen: I guess the problem with that passage, and I'd like to hear your respond to this, as the Gray Brief pointed out, that was really just a conventional type of secure communication path. Then two paragraphs down it talks about this invention, your invention, creates a virtual private network. Therefore it doesn't suffer from this identity concern.
Judge Chen: I guess when it comes to divining something from this spec to get the best understanding of "secure communication link", the best thing you have to point me to is Column 39.
Notice that Judge Chen seems to understand the patent specification far better than the VirnetX attorney, and points out the reference Mr. Jakes claims is about their invention is actually describing the prior art, totally undercutting Mr. Jakes argument.
Judge Prost asked fewer questions but was not friendly to VirnetX. A neutral observer at the appeal hearing said that she was nodding at Rader's and Chen's questions, and seemed to be in agreement with them.
Judge Prost: Let me ask you a logistical question. If we were to agree with you on claim construction, on either the domain name or the one you haven't gotten yet, but it's obviously in your brief - your secure communication link.
Mr. Lee: Yes, Your Honor.
Judge Prost: That just involves a new trial. I know you say in your briefs, while there's no infringement under our construction, but the other side tells us, "Not so fast."
Mr. Lee: I understand we have a disagreement on that. The answer, Your Honor is, you are correct. Now, one important aspect of that is that the damage award was undifferentiated. It wasn't by patent. It wasn't by product. It wasn't by theory.
If the court reversed, and had a new trial on any issue, it's all going to have to be retried. Even setting aside the first part of the argument of the entire market value ruling construction, there would have to be a new trial, because of the undifferentiated single damage claim.
Judge Prost: But that was also infected is a loaded word. But that survey evidence and that percentage was also part and parcel what the expert said. He then applied the 45 percent so called Nash numbers in his analysis of that data.
Judge Prost specifically asked Apple if there would be a retrial if the appeals court agreed with Apple's Markman requests. Apple seemed to agree. This is significant because if the appeals court adopted any of Apple's proposed changes to the Markman, and found no infringement, there might not be a necessity to reverse the damages or to make new case law. I think the appeals court is eager to rule on damages to make a precedent just as they did in Uniloc, in addition to ruling on the more narrow case-specific issues such as Markman, invalidity and infringement.
Given all of this questioning, as well as the other legal errors not discussed in the oral hearing, but described in the written filing, I estimate at least a 90% chance that Fed Circuit will reverse on damages. There is also a high likelihood of significant reversals on the Markman and related issues - my best guess is greater than 50%.
Any reversals would most likely result in a remand for new trial, with the district judge deciding on possible summary judgments or a new trial.
Inter Partes Reviews
RPX has filed petitions for Inter Partes Reviews (IPRs) against the patents asserted in this case (VirnetX, Inc. v. Cisco Systems, Inc.). By law, a decision to accept a petition must be made within six months of the petition filing date of November 20, 2013. In this case, decisions on accepting the petitions are due by May 20, 2014.
VirnetX is doing everything possible to stop or delay this process, including filing subpoenas in the Eastern District of Texas. Given that there is a process for such discovery at the patent office, I find it interesting that VirnetX is trying to get around the patent office process and instead wants to use subpoenas issued from an unrelated court case against an unrelated party - the Magistrate in the request to quash the subpoena made this exact observation during the hearing in San Francisco on February 26, 2014.
After acceptance of the IPRs, the law mandates a twelve-month resolution of the IPRs issues, which are limited solely to validity, either by anticipation or obviousness. As noted above, we can expect final results from the RPX petitions by May 20, 2015, which is very likely before any possible new trial from a remand (from the current appeal), and well before any possible appeal from a new trial.
If the IPRs result in the invalidation of the claims-in-suit, and the invalidation is upheld by the Federal Circuit, these invalidations will be binding on VirnetX - thus ending any Apple lawsuits, and the possibility of new lawsuits on these same patents against other companies.
I expect similar IPRs to be filed (if necessary) against any additional VirnetX patents that VirnetX is claiming are required to implement future 3GPP standards.
As a practical matter VirnetX will probably not sue any additional large companies prior to resolving its dispute with Apple - any new lawsuit would likely lead to the immediate filing of IPRs to invalidate the asserted patents, with (almost certainly) a two year stay of any new litigation while the IPRs are in process, and a very high probability of the patents being invalidated. This is why VirnetX has sued Apple and Microsoft repeatedly instead of suing new companies - neither Apple or Microsoft are eligible to file IPRs on the patents-in-suit as IPR law does not allow new IPRs after one year from commencement of litigation.
ParkerVision has nearly all of the same issues as VirnetX
ParkerVision has exactly the same issues as VirnetX has in this case: reliance on Nash Bargaining (both VirnetX and ParkerVision asked for roughly 50/50 split of entire profits - Rader was very sarcastic on this point, as I pointed out above) and the Entire Market Value Rule, where they did not proportion damages to contribution of invention or show that the patented invention was the primary driver of demand, and, finally, many glaring Markman errors. None of this should be surprising, since both companies used the same trial attorney (Doug Cawley) and both used very similar damages theories and experts.
For this reason, I find it likely that any eventual ParkerVision v. Qualcomm appeal will have the same result - a very high probability of reversal, and, in the best case, a remand for new trial, in the worst case, judgment as a matter of law (JMOL) of either no infringement or invalidity (depending on Markman changes).
ParkerVision vs. Qualcomm Hearing on May 1, 2014
Judge Dalton has scheduled an oral hearing on May 1 covering outstanding motions. He was clearly concerned about ParkerVision's damages testimony (use of NBS) and fact that no evidence was presented for 18 of 19 products found infringing, including one that ParkerVision had agreed to drop from the case, and said so publicly during the trial.
If the Fed Circuit rules against VirnetX on damages before the oral hearing, then Judge Dalton will have to follow the (new) Fed Circuit ruling. In my view, he would almost certainly have to grant most or all of Qualcomm's JMOL on damages - or at a minimum order a new trial on damages.
Disclosure: I am short PRKR, VHC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am long a small amount of QCOM.