Ruling May Be End for Vonage

Judge Enjoins Use Of Key Technology

With Vonage products, consumers could make phone calls online, a cheaper alternative to traditional phone service. After the ruling yesterday, chief executive Michael A. Syder said customers "will not experience service disruptions." (By Paul Sakuma -- Associated Press)

A federal judge yesterday dealt a potentially fatal blow to Vonage Holdings, the Internet-phone service that offers one of the few alternatives to traditional carriers, by ordering it to stop using a technology that connects its network to the public telephone system.

U.S. District Judge Claude Hilton approved the request by Verizon Communications for a permanent injunction two weeks after a jury in Alexandria found that three of its patents had been infringed by Vonage, including one for the technology allowing the Internet company's 2.2 million customers to call regular phones.

Hilton said the ban would not take effect before he holds another hearing in two weeks on Vonage's request for reprieve through a stay. The company said customers will not be affected by the court's decision, although analysts are skeptical the company will be able to sustain service if the ruling is not overturned.

This is the latest setback in Vonage's troubled history, which has included some regulatory losses and a shareholder suit stemming from its public offering. Vonage, which has never generated a profit, helped popularize online calling as a cheaper alternative to traditional phone service, waging a flashy marketing campaign on prime-time television and over the Internet. But some industry analysts said its flat-rate service was already starting to lose its luster next to new offerings from phone and cable companies selling combined telephone, Internet and cable television services.

The impact of the court's decision on other providers of Internet phone services, known as voice-over-Internet protocol, or VoIP, remains unclear, analysts said. This could depend on whether Verizon wants to shut down Vonage or sell its licenses for the technology.

Vonage, which was ordered by the jury to pay $58 million in damages, has vowed to appeal the verdict and seek a stay from the federal appeals court if Hilton does not grant one.

In his ruling, Hilton said that the financial award alone was not enough because it "does not prevent continued erosion of the client base and customer base" of Verizon.

Vonage's stock lost 26 percent of its value in the hours after the decision, closing yesterday at $3 a share, down $1.05. The company went public last year at $17 a share.

"We are confident Vonage customers will not experience service disruptions or other changes as a result of this litigation," Vonage chief executive Michael A. Snyder said in a statement. Company executives said shortly after the jury ruling that the company could continue doing business by designing a "work-around" technique for connecting Vonage's network, which operates over high-speed Internet connections, to the regular phone network.

Analysts said yesterday that Vonage's public optimism might be ill founded.

"The patent goes to the core aspect of their service. It's not a small bell or whistle they can turn off without disrupting the service," said Rebecca Arbogast, a vice president and analyst with Stifel Nicolaus. "If they don't get a stay, they need very quickly an adequate work-around and that's going to be a challenge for them."

Arbogast predicted that Vonage would find it difficult to design an alternative way of hooking its network to the public telephone system because of the way the judge had interpreted Verizon's patent, leaving the Internet challenger little legal room for maneuver. Vonage had unsuccessfully argued that the patent covered only a small portion of how that connection can be made.