Hear from the Experts: How Patent Litigation Funding is Used to Hedge Risk

IPWatchdog has previously reported on aspects of litigation financing, including a recent article on inventor groups being wary of asymmetrical demands for transparency in revealing funding sources. Last month, IPWatchdog invited a group of experts to LIVE to discuss their experiences with litigation financing, how it works for them, and how it is used to hedge risk.

Third-party funding for patent litigation is a relatively new financial product. Although aspects of such financing have been around since the days of Thomas Edison, until recently people seeking funding have used traditional institutions such as risk-averse banks. The industry began to evolve in 2010, when Burford Capital became the first litigation financing firm in the United States; its first loan for a patent infringement case occurred in 2013. Since then, many other financiers have entered the litigation funding arena, and in particular, patent litigation funding.

Litigation Finance 101

At its core, litigation financing is when a third party pays for some portion of litigation costs in return for a premium on their investment. The panel estimated that an “average” patent case will have costs in the high seven figures and can easily run into eight figures.

The investment is often non-recourse: if the patent claimant does not receive licensing or settlement money, then the lender loses its entire investment. Financiers take large risks with non-recourse loans and only invest in the most promising cases. This unfortunately leaves mid-to-small patent holders without the same access to capital.

For these reasons, the panelists outlined typical investment criteria for patent cases:

• Multiple strong patents
• Thoroughly vetted for infringement and invalidity
• Lawyers willing to work on a partial contingency model
• Potential damages in excess of $75 million

As panelist Brad Close explained, “Some may not realize that the damages must be substantial to secure financing. Patent litigation is one of the most complex areas of civil law, and as such, the expenses involved can be quite high. Therefore, you need high damages, multiple patents, and ideally, multiple infringers.”

Efficiency is Key

Partly because of the large risks taken and partly because damages are hard to estimate before discovery, litigation funding capital is generally expensive. The funder’s recovery can be two, three or sometimes more than four times its initial investment. Because the multiple tends to increase with the length of the litigation, efficiency can be a large cost saver. Texas, for instance, is a popular forum for litigation-funded cases, not because it favors patent holders any more than accused infringers (it does not), but because it is relatively quick.

The panel also discussed other venues, notably the European Union’s new Unified Patent Court (UPC). The EU system permits patent holders to file in patent-savvy German courts, while obtaining protection and possibly an injunction in each EU member country where the patentee has coverage. The EU is an economic area approximately the size of the United States, but the UPC offers a faster pace than US litigation, and significantly lower costs.

The panelists also advised anyone interested in applying for financing to prepare a standard set of materials in advance of the request. These include:

• Fully documented claim charts for each patent
• Third-party prior art searches for each patent
• Accurate estimates of trial expenses, including IPRs and possible appeals
• Forecasts of future damages (beyond the current case(s))

Financiers then put the patent portfolio through a rigorous process. In-house, specially trained patent litigation and financial experts review the opportunity. These experts often retain independent experts to validate the materials and assumptions. Finally, the opportunity is presented to an internal committee, who may have no previous knowledge of it, for approval.

Busting Myths

The panelists rejected the idea that litigation financing can clog courts.

Pinar Gencer noted, “This assertion seems unrealistic when you consider that patent valuation is both expensive and time-consuming. We’re talking about six-figure costs and months of detailed work to evaluate patents properly. Most companies don’t have idle cash lying around to congest the system indiscriminately. These aren’t frivolous pursuits—they require due diligence, involving specialists to conduct thorough evaluations.”

Court congestion appears to be endemic to the American judicial system, with no particular onus on litigation financing. The panelists acknowledged that there are bad actors in the patent space, a phenomenon not unique to patent law.

On the contrary, some “court congestion” appears to be due judicial and legislative reform efforts, like the America Invents Act (AIA). The panelists agreed that the enforcement of patent rights has become more expensive and more time-consuming than before the AIA and subsequent jurisprudence. In particular, the Patent Trial and Appeal Board (PTAB), created as a cost-effective alternative to expensive litigation, now adds yet another level of cost and delay to the enforcement of patent rights.

Far from being a public harm, litigation finance is a net public good according to the panel, because it supports a secondary market for patent rights. R&D investors must own at least part of the technology they invest in to justify the investment. It is no secret that investing in new technologies is risky for reasons too numerous to articulate here. But when enterprises or business units fail, as they do more often than not, initial investors want to recover as much of their investment as they can. A secondary market for patent rights offers that option.

If anything, supply side of the secondary market seems to be flooded. Brad Close remarked, “I wish there were more patents I could buy to help inventors and investments. There are so many individuals trying to sell me patents that I just can’t utilize in the current legal climate.”

Tech Trends and Future Forecasts

The panel agreed that market transactions most frequently involve high-tech patents. To satisfy litigation finance criteria, the market should be characterized by numerous patents (which facilitates portfolio price discovery), significant past damages and rapid market adoption (which implies a significant future royalty stream). High-tech sectors most frequently meet these criteria.

The panel also lamented the patent system’s inability to protect the next generation of American technology. From artificial intelligence and big data to self-driving cars and personalized medicines, these areas suffer from the ongoing lack of clarity regarding patent eligibility, enablement and written description that the patent office and the courts have been reluctant to address.

Turning back to litigation financing, there was a forecast of potential consolidation among litigation financiers, whether through cooperation, merger or attrition. At the same time, new financial services continue to emerge, such as litigation insurance.

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