Important Damages Opinion: VirnetX v. Cisco and Apple

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.

28 thoughts on “Important Damages Opinion: VirnetX v. Cisco and Apple

  1. 10

    General Pictures Co. v. Electric Co., 304 U.S. 175, 58 S. Ct. 849, 82 L. Ed. 1273 (1938). link to

    What this case stands for is this: A vacuum tube amplifier can have different value for difference uses. A patentee may license others to make vacuum tubes for different end uses that demand different prices for the identical tube.

    It seems to me that the value of a particular invention can be different depending on the use to which the invention is placed. Thus, if the patentee regularly bases his royalties on the underlying value of the larger product actually sold, and this is an established, then this should be sufficient for proof in court.

    1. 10.1

      What if a patentee in fact never wanted and does not want any competitor/infringer to have the benefit of his invention.

      How can a hypothetical licensing model (as a basis for a damage award)address his factual voluntary choices regarding his technology?

      1. 10.1.1

        Anon2, I don’t have an answer. But if the licensee does establish different rates for difference uses, I think damages in court should follow the evidence.


          The evidence is possibly double edged… the larger the amount of evidence of the Patentee giving licenses of different rates for specific different uses to many different parties, then yes the more evidence there would be that there are different classes/rates for would be licensees but also the more the fact that a license agreement was not reached or possibly not even extended to the particular infringer may indicate that Patentee did not, and would not deal with the particular infringer for other reasons.

      2. 10.1.2

        It doesn’t. That is why royalties cannot be used as the basis for damages unless it is an established royalty… that is, royalties given indiscriminately.

        Of course, as courts are searching for a “reasonable royalty rate”, the historical development of patent damages is ignored.

  2. 9

    As a reminder of what courts are supposed to use, the old “Georgia-Pacific Factors” remain controlling law cited with approval by the Fed. Cir. [even though I can’t see how any jury can operate logically on jury instructions merely reciting them, especially since these factors provide rather vague tests that are at least in part alternative or overlapping, and some of them have never even been mentioned specifically in any CAFC decision. (Georgia-Pacific was a district court decision.)] [Even patent attorneys can’t remember all of these Georgia-Pacific factors, so how can lay jurors?] Also it confuses the very situation-limited applicability “lost profits” test with the far more commonly applicable Section 284 “not less than a reasonable royalty” test. But since the “Georgia-Pacific Factors” are what you have to work with, here they all are:
    Georgia-Pacific v United States Plywood Corp. 318 F. Supp. 1116, at 1120 (S.D. NY, 1970). [1] “A comprehensive list of evidentiary facts relevant, in general, to the determination of the amount of a reasonable royalty for a patent license may be drawn from a conspectus of the leading cases. The following are some of the factors mutatis mutandis seemingly more pertinent to the issue herein:

    1. The royalties received by the patentee for the licensing of the patent in suit, proving or tending to prove an established royalty.
    2. The rates paid by the licensee for the use of other patents comparable to the patent in suit.
    3. The nature and scope of the license, as exclusive or non-exclusive; or as restricted or non-restricted in terms of territory or with respect to whom the manufactured product may be sold.
    4. The licensor’s established policy and marketing program to maintain his patent monopoly by not licensing others to use the invention or by granting licenses under special conditions designed to preserve that monopoly.
    5. The commercial relationship between the licensor and licensee, such as, whether they are competitors in the same territory in the same line of business; or whether they are inventor and promoter.
    6. The effect of selling the patented specialty in promoting sales of other products of the licensee; the existing value of the invention to the licensor as a generator of sales of his non-patented items; and the extent of such derivative or convoyed sales.
    7. The duration of the patent and the term of the license.
    8. The established profitability of the product made under the patent; its commercial success; and its current popularity.
    9. The utility and advantages of the patent property over the old modes or devices, if any, that had been used for working out similar results.
    10. The nature of the patented invention; the character of the commercial embodiment of it as owned and produced by the licensor; and the benefits to those who have used the invention.
    11. The extent to which the infringer has made use of the invention; and any evidence probative of the value of that use.
    12. The portion of the profit or of the selling price that may be customary in the particular business or in comparable businesses to allow for the use of the invention or analogous inventions.
    13. The portion of the realizable profit that should be credited to the invention as distinguished from non-patented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer.
    14. The opinion testimony of qualified experts.
    15. The amount that a licensor (such as the patentee) and a licensee (such as the infringer) would have agreed upon (at the time the infringement began) if both had been reasonably and voluntarily trying to reach an agreement; that is, the amount which a prudent licensee — who desired, as a business proposition, to obtain a license to manufacture and sell a particular article embodying the patented invention — would have been willing to pay as a royalty and yet be able to make a reasonable profit and which amount would have been acceptable by a prudent patentee who was willing to grant a license.”

    1. 9.1

      Nice comment, Paul. With respect to an NPE like VirnetX, I thought I’d highlight the GeorgiaPacific factors which would seem to work against this class of patentees:

      The commercial relationship between the licensor and licensee, such as, whether they are competitors in the same territory in the same line of business; or whether they are inventor and promoter.

      6. [T]he existing value of the invention to the licensor as a generator of sales of his non-patented items; and the extent of such derivative or convoyed sales.

      9. The utility and advantages of the patent property over the old modes or devices, if any, that had been used for working out similar results.

      10. The nature of the patented invention; the character of the commercial embodiment of it as owned and produced by the licensor…

  3. 8

    Thanks for the write-up, but what’s a “Novel Laureate?” Is it related to how new of a laureate he is or something about a book?

  4. 7

    From the decision: The district court should have ensured that “only theories comporting with settled principles of apportionment were allowed to reach the jury”

    If strictly followed, does this mean no “new” theories from damages experts would be an issue of an appeal or come to an appeal judge’s attention… so then how do new “damages theories” come to be / become precedent?

    Judges set precedent, but they do not do so in a vacuum…

    1. 7.1

      Justice Story was of the opinion that the whole thing be submitted to the jury, and let the jury figure it out. He reversed course a little bit, but that is because there was a mandatory trebling of the damages.

      Why not just submit it to the jury? If the jury is reasonable royalty rate is too high, well, the very well paid lawyers didn’t frame the story very well of why the rate would be lower if there was a negotiation. You lost a patent case, and they are expensive to lose, feel lucky your profits didn’t get disgorged. If it is way too high, then JNOV.

      If it is too low, then the court can use equity to increase the damages.

      It makes little sense to have a “damage theory” in patent law.

      1. 7.1.1

        It is a question for the jury – and protected under the 7th amendment. What CAFC is doing is striking the expert testimony based on a form a Doubert – not scientifically based or reliable test. SCOTUS knocked out total market value rule, now cafc is saying even ‘smallest salable unit’ needs to be apportioned and apparently the Nash theory is out as well. To be sure, I would be arguing that there is an enormous potential value in the network effect of the free propagation of FaceTime – and that is the game that Apple is playing.


          iwasthere: It is a question for the jury – and protected under the 7th amendment.

          There is no right to a trial by jury for patents. Didn’t you know that the Federal Circuit has held that patents are public rights?


          What is submitted to a jury is overly-controlled by the law in an effort to make a precise determination of the actual damages. Completely unnecessary. What is the basis for this? Why did SCOTUS knock out profit disgorgement in the 1940s? Why not use the total market value rule (and let the infringer argue in front of the jury that it is inappropriate because of the substitutes)? Has anyone really asked why we have to make it so precise?



            1. The award of profits was a statutory change, IIRC.

            2. There is no right to a trial by jury in patent cases according to the Federal Circuit. The court has ruled that patents are a public right.


              1. Notice I said profit disgorgement, not lost profits. And I don’t think that was a statutory change, anyhow.

              2. I’m not going to defer to the Fed. Circ. says about the Constitution and the 7th amendment.

  5. 5

    So what would be permissible? The Federal Circuit’s continuing requirements on arcane rules is driving up the cost of patent litigation. While the legal community is thankful for the FC’s full-employment strategy, they are increasingly raising transactional costs in a way that is bad for business. While the threat of ridiculous IP lit verdicts is not good for innovation, neither is the knowledge-on both sides-that undertaking patent litigation is going to be massively expensive, and should only be reserved for the big guys.

  6. 4

    This was an “Appeal from the United States District Court for the
    Eastern District of Texas in No. 10-CV-0417, Chief Judge
    Leonard Davis.” Judge Davis, along with the other judges of that patent litigation Mecca, has tried numerous patent cases and should have known that you cannot use the entire hardware and software cost of the hundreds of parts and millions of lines of code in a smartphone as the basis of the damages for patent infringement of a very minor portion of that software, when that software was is not the reason the public buys that smartphone [so that the entire market rule does not apply]. Especially when the claimed feature is not even used by many of the smartphone purchasors. This is not new law, it has been the law for many years, and the damages testimony rejected here by the Fed. Cir. should have not been allowed in to begin with.

    1. 4.1

      So how would you propose breaking out the ‘value’ of FaceTime? You are not going to get data from Apple – as the product is not individually sold. At some point you need expert evidence that the jury can use – under the 7th amendment – to determine legal damages. Old case law holds that when you can’t break out the value – and you get no cooperation from the infringer – obviously – you can’t reward the obstrucitonist – and you can put forward a theory to determine the royalty base on what you can objectively determine. That theory so long as not so speculative to be struck under Doubert is of course subject to cross examination and an alternative theory from a rebuttal expert. What do you think consumer survey data?

      1. 4.1.1

        Yes, I think customer surveys, akin to those used in trademark litigation, could make sense, to find out what % of the total software that comes loaded [excluding the hardware] do that attribute a value to compared to other listed software features.

        But the oldest, best, fairest and legally blessed damages test is what license fee would be paid to use the patented software in an arms length licensing negotiation in which validity or infringement is no longer disputable but in which the manufacturor/seller has the opportunity to consider a “design around. ” [Which few do these days, with millions of outstanding patent claims and millions of lines of code in products]. If infringement is willful, the statute allows such damages can be increased up to being trebled.

  7. 3

    This is a jury question under the 7th amendment(legal damages). Appears to me that if a damages report and the sponsoring expert testimony passes muster under dubert – then it is not up to the court of appeals to re-weight the evidence. This is probably the best argument against the expert CAFC.

    1. 3.1

      I don’t think what happened here was “re-weighing” the evidence. It’s more like a hand holding lecture to the judge as to when it’s appropriate to apply a particular damages theory.

  8. 2

    I think the damages in patent law is approached all the wrong way. The reasonable royalty was meant to be a floor, not a ceiling, and certainly not consistently used as in 80% of cases. Attempting to meet the actual damage with reasonable precision is a nice idea, but completely impracticable, as it is based entirely on a legal fiction. The legal fiction is a mixture of “lost profits” plus “reasonable royalty,” using rules to guess at what they would be that would not fly if the parties were trying to prove the actual damages based on lost profits or a established royalty.

    Furthermore, the history of patent damages show that trying to find the precise amount is unnecessary considering the court has discretion to increase damages up to three times the amount the jury awarded, based on the facts of the case. To me this suggests that the reasonable royalty is the actual damages, and the courts should be free to add to that amount based on equity.

  9. 1

    The bit upholding the district court’s exclusion of evidence is interesting. Try to square the reasoning here with the patentee-friendly rewards provided by the presumption of validity:

    VirnetX attempted to show that Apple knew or was willfully blind to the fact that its customers’ use of its products would infringe valid patent claims. In defense, Apple sought to inform the jury that, after learning of VirnetX’s allegations, Apple initiated reexaminations against the asserted patents. Apple’s requests for reexamination resulted in nitial rejections of the asserted claims at the PTO. Apple offered these rejections as evidence of Apple’s reasonably held belief that the patents were invalid.

    [W]e note that this court’s precedent has often warned of the limited value of actions by the PTO when used for such purposes. See, e.g., Hoechst Celanese Corp. v. BP Chems. Ltd., 78 F.3d 1575,
    1584 (Fed. Cir. 1996) (“[G]rant by the examiner of a
    request for reexamination is not probative of unpatentability.”); Acoustical Design, Inc. v. Control Elecs. Co., 932 F.2d 939, 942 (Fed. Cir. 1991) (“[I]nitial rejection by the [PTO] . . . hardly justifies a good faith belief in the invalidity of the claims.”).

    The evidence of rejected claims was excluded here because it would “confuse” or “mislead” the jury and “unfairly prejudice” the patentee.

    Seems like a one-way street. Never mind the fact that this judge directly confused the jury to the tune of hundreds of millions of dollars in the patentee’s favor.

    1. 1.1

      The problem, MM, is that at a minimum, the reexaminations are not complete. Even collateral estoppel requires a final judgment. Imagine the jury was to hear about what went on in another court case that was still pending? That would be highly prejudicial, in my humble opinion.

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