Ruling Cuts Off Vonage Recruiting

Apr 06, 07:30 PM

Current Headlines: CHICAGO _ Vonage Holdings Corp. dodged a bullet Friday, but was left gasping for air after a federal judge ruled it can continue operating but cannot recruit new customers during its patent dispute with Verizon Communications Inc.

The Internet phone service pioneer, which has 2.2 million customers but continues to lose money, has bet its future on increasing its customer base. If Vonage's appeal of Friday's ruling fails, the firm must either find alternative technology or pull a legal rabbit out of a hat, analysts said.

Rather than a patent dispute, the Vonage-Verizon saga has become a David-Goliath struggle, and one that Goliath is winning.

"In an ordinary patent suit, the point is compensation," said Richard Koch, co-founder of RNK Communications Inc., a Dedham, Mass., competitive local phone service company. "This is no ordinary patent case. It's not about money for Verizon; it's a warning shot fired loud and clear."

Last month, Verizon won a jury verdict that found that Vonage violated three of its patents concerning voice over Internet protocol, or VoIP, technology. The jury ordered Vonage to pay $58 million in damages, plus future royalties of 5.5 percent on revenue related to the infringed patents.

Not satisfied, Verizon went back to U.S. District Court Judge Claude Hilton, based in Alexandria, Va., and asked him to bar Vonage's future use of the infringed technology altogether. Judge Hilton first indicated he would do that, but Friday he imposed a ban on new customers instead.

"It's the difference of cutting off oxygen as opposed to the bullet to the head," said Vonage's attorney, Roger Warin.

Vonage vowed to appeal the decision immediately.

"What this shows is that Vonage has gotten big enough to be a threat," said Rich Tehrani, editor-in-chief of Technology Marketing Corp., which publishes Internet Telephony. "That's what Verizon is showing us. This is one way to compete, through patent litigation.

"The hidden challenge to Verizon is that by crippling Vonage, they may strengthen the cable companies, which are doing more damage to the phone companies with VoIP than Vonage is. What Verizon might be doing is cutting off its nose to spite its face."

Steve Titch, a telecom analyst with the Chicago-based Heartland Institute, a free-market think tank, said Judge Hilton "evidently feels strongly that Vonage infringed. They have to pay a royalty and cannot market to new customers. That's a very strong penalty. I cannot recall anything like this before."

Another industry analyst, Jeff Kagan, said the judge's order raises the question: "Will this be the beginning of the end for Vonage?"

Since the judge indicated two weeks ago he would sign an order hampering Vonage's ability to do business, the company's executives have tried to calm the firm's customers and investors. They stressed their confidence that legal appeals will reverse findings that any patents have been violated.

Daniel Berninger, an analyst with Tier 1, said that there are no fundamental patents on VoIP and the claims at issue in Verizon's case are broad and vague. He said Vonage faced a similar situation a few years ago when the Federal Communications Commission ordered VoIP carriers to stop recruiting customers until they fixed problems with their 911 emergency calling service.

"Vonage kept adding new customers and never stopped marketing," said Berninger. "They felt the FCC overstepped its authority with that order."

In the current situation, Berninger said, Vonage might have a technical work-around ready to implement to avoid Verizon's patents. Or it might have a new legal wrinkle ready to spring on the appeals court, he said.

"Vonage doesn't want to tip their hand to Verizon," he said. "But Vonage has $500 million on its balance sheet, which is enough to finance the legal fight and stay in business."

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