By Jason Rantanen
VirnetX, Inc. v. Cisco Systems, Inc. (Fed. Cir. 2014) Virnetx v Cisco
Panel: Prost (author) and Chen
Plaintiffs VirnetX and Science Applications International Corporation obtained a successful verdict against Apple based on infringement by its Facetime and VPN On Demand products. The two accused products are programs that run on Apple’s iOS platforms (e.g.: iPhones, iPads, iMacs, MacBooks, etc.). FaceTime is a videoconferencing platform (similar to Skype) and VPN On Demand is a feature that allows iOS users to establish secure virtual private networks. The patents involved were Nos. 6,502,135 and 7,490,151, which were asserted with respect to VPN On Demand, and 7,418,504 and 7,921,211, which were asserted against FaceTime. The jury found the four patents were valid and infringed, awarding damages of $368,160,000. Apple appealed.
On appeal, the Federal Circuit upheld the jury verdict of no invalidity and infringement as to most of the ‘135 and ‘151 claims (i.e.: the ones being asserted against VPN On Demand). However, it reversed as to a doctrine-of-equivalents finding on one claim of the ‘151 and as to claim construction of a term in the ‘504 and ‘211 patents (i.e.: the ones being asserted against Facetime), thus resulting in a remand as to those claims.
The most important legal aspect of the court’s opinion, however, relates to damages. At trial, VirnetX’s expert offered three reasonable royalty theories: one that began with the lowest sales price of each iOS device containing the accused feature and applying a 1% royalty to that base, and two that relied on the “Nash Bargaining Solution,” a mathematical theorem proved by Nobel Laureate John Nash.
“Smallest Salable Unit”: A key issue in calculating the infringement damages for complex technological products is whether it is appropriate to use the value of the entire device in the damages calculation. Generally speaking it is not appropriate to do so: “when claims are drawn to an individual component of a multi-component product, it is the exception, not the rule, that damages may be based upon the value of the multi-component product.” Slip Op. at 27. Rather, “‘[a] patentee may assess damages based on the entire market value of the accused product only where the patented feature creates the basis for customer demand or substantially creates the value of the component parts.'” Id., quoting Versata Software, Inc. v. SAP Am., Inc., 717 F.3d 1255, 1268 (Fed. Cir. 2013) (emphasis added by court). This is due to the general requirement that damages must be actually attributable to the infringing features within a reasonable degree of precision.
However, there is a line of cases suggesting that royalties may be based off of the “smallest salable patent-practicing unit.” It was this line of cases that the district court presumably drew upon when it issued the relevant jury instruction:
In determining a royalty base, you should not use the value of the entire apparatus or product unless either: (1) the patented feature creates the basis for the customers’ demand for the product, or the patented feature substantially creates the value of the other component parts of the product; or (2) the product in question constitutes the smallest saleable unit containing the patented feature.
On appeal, the Federal Circuit held that the “smallest salable unit” case law does not mean that “when the smallest salable unit is used as the royalty base, there is necessarily no further constraint on the selection of the base.” Id. at 28. Rather, “the smallest salable unit approach was intended to produce a royalty base much more closely tied to the claimed invention than the entire market value of the accused products.” Id. at 29. Thus,
“Where the smallest salable unit is, in fact, a multi-component product containing several non-infringing features with no relation to the patented feature (as VirnetX claims it was here), the patentee must do more to estimate what portion of the value of that product is attributable to the patented technology. To hold otherwise would permit the entire market value exception to swallow the rule of apportionment.”
Id. Since the VirnetX’s expert relied on the iOS devices as the “‘smallest salable units,’ without attempting to apportion the value attributable to the VPN On Demand and Facetime features,” the legal error was not harmless. Put another way, VirnetX sought to have the jury use the sales price of an iPhone when calculating infringement of its patents that covered two specific components of that product, without demonstrating that those components drove customer demand for the phones.
Royalty Base * Royalty Rate Theory: For similar reasons, the Federal Circuit reversed the district court’s ruling to allow the expert’s testimony that used the sales price of iOS devices as the royalty base. The accused products included both hardware and software components; the expert “made no attempt to separate software from hardware, much less to separate the FaceTime software from other valuable software components.” Slip Op. at 31. This was particularly problematic, since in his Nash Bargaining Solution approaches, the expert did attempt to break out the patentable contributions to the devices. More, “a patentee’s obligation to apportion damages only to the patented features does not end with the identification of the smallest salable unit if that unit still contains significant unpatented features.” Id. at 32. Thus, it did not matter that Apple did not sell FaceTime separately on many of its iOS products:
There is no “necessity-based exception to the entire market value rule.” Id. at 70. On the contrary, a patentee must be reasonable (though may be approximate) when seeking to identify a patent-practicing unit, tangible or intangible, with a close relation to the patented feature.
Id. Apple also challenged the expert’s 1% royalty rate, which relied on six allegedly comparable licenses and VirnetX’s “policy” of licensing its patents for 1-2%. The Federal Circuit concluded that reliance on the six challenged licenses was permissible.
Nash Bargaining Solution Theories: In addition to its ruling on the “smallest salable unit” issue, the Federal Circuit also rejected the invocation of the Nash Bargaining Solution as a model for reasonable royalty damages. As described by the court, this theorem states that “under the conditions stated in the premises, where two person bargain over a matter, there is a ‘solution’…in which ‘each bargainer get[s] the same money profit.” (The Nash Bargaining Solution). The Nash Bargaining Solution is invoked to support the argument that the parties would have split between themselves the incremental profit associated with the patent technology.
Here, VirnetX’s expert used the Nash Bargaining Solution to support royalty rate that allocated 45% of the profits from the Facetime feature to VirtnetX. (For these calculations, the expert used a much lower valuation of the feature than in the first approach discussed above).
The Federal Circuit held that the Nash Bargaining Solution may not be invoked “without sufficiently establishing that the premises of the theorem actually apply to the facts of the case at hand.” Id. at 38. That was not done here; rather, the use of the Nash Solution was as much an inappropriate “rule of thumb” as the “25 percent rule of thumb” rejected in Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292, 1320 (Fed. Cir. 2011):
The Nash theorem arrives at a result that follows from a certain set of premises. It itself asserts nothing about what situations in the real world fit those premises. Anyone seeking to invoke the theorem as applicable to a particular situation must establish that fit, because the 50/50 profit-split result is proven by the theorem only on those premises. [The expert] did not do so. This was an essential failing in invoking the Solution.
Slip Op. at 38-39. Indeed, “even if an expert could identify all of the factors that would cause negotiating parties to deviate from the 50/50 baseline in a particular case, the use of this methodology would nevertheless run the significant risk of inappropriately skewing the jury’s verdict.” Id.