VirnetX Vs. Apple In Patent Battle: ITC Launches Investigation; Represents Major Shift

| About: VirnetX Holding (VHC)

On November 7th, VirnetX (NYSEMKT:VHC) raised the stakes by filing a complaint with the US International Trade Commission (ITC) against Apple (NASDAQ:AAPL), for patent infringement. (See complaint (.pdf)). The filing alleges that certain Apple devices with secure communication capabilities violate the company’s 8,051,181 patent, titled “Method for Establishing Secure Communication Link Between Computers of Virtual Private Network”. These products include “…iPhone 4, iPhone 4S, iPad 2, iPod Touch, and Macintosh computers with “Lion” operating system”. VirnetX is requesting the ITC to grant both an exclusion order and cease and desist orders, an attempt to halt imports of Apple products.

On Friday, the ITC gave VirnetX the nod and agreed to launch an investigation against Apple, opening up the door to a new and powerful avenue in the company’s litigation and licensing strategy.

The ITC moves much more swiftly than federal court. The case will now be assigned to an administrative law judge (ALJ) who will establish a procedural schedule. The ALJ will slate an evidentiary hearing, and in most cases, will hand over a decision in less than a year of the complaint filing.

The ITC investigation is playing out on top of already ongoing litigation underway in the Eastern District of Texas. Apple, along with Cisco (NASDAQ:CSCO), Siemens (SI), Avaya, and others are wrangling with VirnetX over several other patents for secure communications.

In fact, the new ‘181 patent is a continuation of the company’s 7,188,180 patent and a continuation-in-part of the 6,502‘135 patent, both which are at hand in the Apple federal court cases. (Also, see part of the patent family (.pdf). The ‘181 is shown as application 11/679,416.)

Microsoft (NASDAQ:MSFT) previously failed in a similar case against VirnetX. In 2010, a jury found Microsoft guilty of willful infringement of the patents. They later settled with a $200 million payment and a license to the patents. Following Microsoft’s strategy, Apple and Cisco have requested reexaminations (.pdf) of the related ‘135 and ‘180 patents.

The ‘181 is a unique and very critical component of VirnetX’s intellectual property arsenal. The patent covers a comprehensive chunk of communication security needed for next generation wireless devices. It appears to lay out a method for ensuring security all the way from the device to the network service, including the critical component of cross-network provider certification (for example, how Verizon (NYSE:VZ) customer devices will securely “talk” with user devices from AT&T (NYSE:T) customers).

Most importantly, the ‘181 is listed as essential IP with the 3GPP, the group that is responsible for laying out standards for 4G LTE networks. This means that all future 4G LTE-Advanced compliant products must use, and thus license, VirnetX’s patents, as they cannot be worked around.

This particular patent also causes problem for Apple’s defense. The patent file includes an impressive amount of prior art and technical references. In fact, the patent file includes at least 754 different references, including all prior art from the previous Microsoft litigation and parent patents' reexamination information.

Perhaps most telling is the fact that Apple and Cisco’s current reexamination contentions of the related ‘135 and ‘180 patents from earlier this year are included in the '181 patent file. The USPTO examiner considered these references, and in light of them, still found the ‘181 claims allowable and granted VirnetX the patent. The prosecution of the ‘181 appears quite thorough.

Another problem for Apple may be the timing of the ‘181 approval by the patent office, which came after US patent reform when into effect in September. See the new rules here (.pdf).

One rule heightens the threshold required to grant inter partes reexaminations, from a “significant question of patentability”, to the requirement of demonstrating a challenge that has a “reasonable likelihood of prevailing”. Depending on the interpretation of this, it should make it more difficult for Apple to secure a reexamination, particularly in light of all of the references in the patent file already. Thus far in the overall legal battle, reexaminations have served as a defensive method for Apple. That may be off of the table with the new patent.

Furthermore, the new rules allow for third parties to request a “post grant review”. However, this part of the law does not do into effect until September of 2012, already almost a year after the granting of the ‘181 and presumably after the ITC hearing has been completed.

Even if Apple were to secure a reexamination, the ITC historically waited on nobody and has chosen not to stay cases.

Another reason this case is so unique and fascinating is that VirnetX’s IP goes to the heart of Apple’s core products, particularly those running FaceTime, which enables video calling. If the infringement allegations are upheld, Apple has sold about a $100 billion dollars’ worth of infringing products. A 1% royalty rate to secure these products calculates to $1 billion in damages. Furthermore, the violations involve Apple’s newest staple products, which could be generating an impressive $100 billion of revenue per annum, all of which could add up to substantial kick back to VirnetX if the company is successful.

The ITC agreeing to hear the case represents a major shift in the ongoing legal battle between VirnetX and Apple. The ITC moves rapidly and has the power to stop Apple shipments in their tracks. With a victory over Microsoft in a similar case, VirnetX appears well positioned in this battle. The company put forward its new ‘181 patent, which has the benefit of a thorough current review. Also, Apple’s defenses against the patent are weakened with the higher threshold needed to secure a reexamination.

With the ITC case likely to be completed by late summer 2012 and the federal case slated for next November, the intense patent battle between these companies should finally see its conclusion in the coming year.

Disclosure: I am long VHC.

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