On September 16, 2014, in VirnetX, Inc. v. Cisco Systems, Inc., the US Court of Appeals for the Federal Circuit affirmed-in-part, reversed-in-part, vacated-in-part and remanded the district court's decision in a patent infringement suit involving four of VirnetX, Inc.'s patents concerning technology for providing security over the internet used by Apple, Inc.'s "FaceTime" and "VPN On Demand" features in products including the Apple iPhone (No. 2013-1489, (Fed. Cir. Sept. 16, 2014)). Notably, the court vacated a $368 million damage award against Apple based on the district court's erroneous jury instruction concerning the entire market value rule of patent damages and VirnetX's expert's flawed damages theories.

VirnetX is a software development and licensing enterprise that acquired patents for providing security over the internet. VirnetX sued Cisco Systems, Inc. and Apple in the US District Court for the Eastern District of Texas alleging, among other things, that:

Following claim construction and a jury trial, the jury:

On appeal, the Federal Circuit:

In vacating the damages award, the Federal Circuit held that the district court erred in its jury instruction regarding the "entire market value rule" of patent damages. Under the entire market value rule, a patent owner may assess damages based on the entire market value of a multi-component infringing product, but only if the patented feature creates the basis for customer demand or substantially creates the value of the other component parts. The Federal Circuit has therefore emphasized, including in LaserDynamics, Inc. v. Quanta Computer, Inc., that a patent owner should only seek damages attributable to the infringing feature and assessing damages based on the entire market value of a multi-component product is appropriate only in limited situations (694 F.3d 51 (Fed. Cir. 2012)).

With this background, the Federal Circuit held that the district court erred by instructing the jury that it could use an entire market royalty base for Apple's infringing products if either:

The Federal Circuit held that it was legal error to instruct the jury that VirnetX could base its royalty on the entire market value of the smallest saleable units (Apple's iPod Touch and iPhone 4S) without apportioning the base down to account for the unpatented elements of the products that also drive market demand. Because VirnetX's damages expert failed to subtract the value of unpatented hardware and software features from the royalty base, vacating the damages award was necessary.

The Federal Circuit also rejected two other of VirnetX's expert's damages theories based on the "Nash Bargaining Solution," which relies on a number of mathematical premises to attempt to determine how the parties hypothetically would have split incremental profits attributable to the infringing product's patented feature. The court held that the expert's analysis was flawed because, among other reasons, his use of a 50/50 incremental profit split between VirnetX and Apple as a general "rule of thumb" as a starting point and ultimate determination of a 55/45 split in Apple's favor were conclusory and unsupported by the parties' bargaining positions and other facts of the case.

The decision is significant in that it may help accused infringers refute large damages demands based on patent owners' use of an entire market value damages theory against a multi-component accused device. This may be particularly helpful to accused infringers litigating against non-practicing entities asserting patents against products incorporating both software and hardware components, where the claimed invention does not by itself drive market demand for the accused product.