Vonage Holdings Corp. dodged a bullet yesterday, but was left gasping for air after a federal judge ruled that it can continue operating - but may not 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 yesterday's ruling fails, the company must either find alternative technology or pull a legal rabbit out of a hat, analysts said.
The court's decision yesterday could force Vonage to close or to install new systems. It follows a jury decision this month that awarded Verizon $58 million and monthly royalties.
U.S. District Judge Claude Hilton agreed to postpone the effective date of the injunction for two weeks while he considers a request by Vonage for a stay pending what could be a lengthy appeal. But later yesterday, Vonage was granted a temporary stay from the U.S. Court of Appeals for the Federal Circuit in Washington, which will allow Vonage to sign up new customers until the court rules on its appeal.
Vonage's lawyers said the compromise crafted by the judge - at Verizon's suggestion - is almost as devastating as disrupting phone service to Vonage's existing customers.
"It's the difference of cutting off oxygen as opposed to the bullet in the head," Vonage lawyer Roger Warin said.
Rather than a patent dispute, the Vonage-Verizon saga has become a David-and-Goliath struggle, 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 in federal court in Alexandria, Va., that found that Vonage had violated three of its patents for 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 Hilton and asked him to bar Vonage's future use of the infringed technology altogether. Judge Hilton indicated he would do that, but yesterday he imposed a ban on new customers instead.
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.
Jon Van writes for the Chicago Tribune. The New York Times and Associated Press contributed to this article.