Vonage loses appeal in Verizon patent case

After months of battle, Vonage has lost the bulk of its appeal in the Verizon Communications patent infringement case.

In March, a jury in Virginia found that Vonage had infringed on three patents held by Verizon. And it awarded Verizon $58 million in damages along with future damages of 5.5 percent on the revenue that Vonage was making during the appeal process.

The judge in the case imposed an injunction on Vonage that would force the company to stop delivering a service using technology that infringes on Verizon's patents. But because Vonage has been appealing the case, the injunction has not yet gone into effect.

On Wednesday, Vonage's appeal essentially came to an end. And as the legal dust settles, the small voice over IP company now faces the possibility of paying hefty monetary damages and a total shutdown of its IP telephony service.

But as is often the case in complicated legal disputes, the actual outcome of the case is still far from certain. In its final judgment, the U.S. Court of Appeals threw out one of the three patent verdicts and upheld the other two. And because the total damage award was assessed based on Vonage violating all three patents, the appeals court asked the lower court to reconsider the entire $58 million damage package awarded in March.

On the one hand, this sounds like a partial victory for Vonage. And the company has said as much.

"We thank the appellate court for its thoughtful consideration of the merits of our case," Vonage's chief legal officer, Sharon O'Leary, said in a statement. "We are pleased with the decision to vacate the 880 patent and the damages. However, Vonage remains confident that it has not infringed on the 880 patent--a position we will continue to vigorously assert and look forward to presenting at trial."

But the reality of the situation is altogether different. For one, the two patents the court upheld happen to be the most fundamental to Vonage's service. Essentially, U.S. Patent No. 6,282,574 and U.S. Patent No. 6,104,711 define how phone calls are routed over the Internet, which essentially is the basis of Vonage's IP telephony service today.

By contrast, U.S. Patent 6,359,880, which is the patent the appeals court said would have to be retried by the lower court, has to do with how public wireless and cordless Internet gateways communicate with the Internet. Because this technology is not a big part of Vonage's commercial service today, sending the case back to the lower court will likely have little impact on Vonage's actual business.

And because the '880 is considered less significant, when the lower court reassesses damages, as it's been asked to do by the appeals court, it could just re-enter the same amount without holding an entirely new trial.

The reason is simple. Both Vonage's and Verizon's experts who testified during the original trial, stated that the '880 patent should have little impact on determining damages. This means that the damages that were assessed were based mostly on the cumulative contribution from the two other patents, '711 and '574. And the judge could look at this testimony and re-enter the $58 million for damages.

But in addition to the hefty damages the company will still likely have to pay, Vonage is now facing the possibility of having its service shut down.

During the appeal, the injunction issued by the judge in the case was not in effect. But once the appeals court's decision is final, which should happen within two weeks to a month, the injunction barring Vonage from using any technology that infringes on Verizon's patents goes into effect.

Vonage is adamant that its service will continue.

"It's business as usual," O'Leary said in a statement. "We have had our workarounds for the '711 and '574 patents in place for some time and will remain focused on providing a great customer experience."

But these claims will have to be verified. Right now it's unclear how this will work. Either the court will step in to determine if the new fixes violate the patents as they were examined during the trial, or Verizon will have to challenge the new workarounds.

One thing is certain, Vonage's troubles are far from over.

"I think there is definitely a threat that its service could be impacted," said Rebecca Arbogast, an analyst with Stifel Nicolaus. "Vonage says it has a workaround, but who's to really know? My hunch is that Verizon will likely aggressively challenge these fixes as well."

This latest legal blow comes just one day after a jury in Kansas found that Vonage infringes on six patents held by Sprint Nextel. The jury awarded damages of $69.5 million in that case. All in all, the news looks bleak for Vonage, said Arbogast.

"These are different patents in a different court," she said. "But the damages in the Sprint case are significant, and it's just piling on one more shovel full of penalties on the company at a time when it already has a significant amount of money tied up in escrow over the Verizon case. Plus, there's the threat of an injunction, and it makes investors wary."

Indeed, Vonage's stock dipped another 26 percent to close at 96 cents per share.