Using litigation finance to solve for intellectual property risk
In an article first published on the American Bar Association's website, Burford's Katharine Wolanyk addresses the ways in which litigation finance can help mitigate risk in intellectual property matters.
The practice of intellectual property law has become more challenging in recent years. Supreme Court decisions such as eBay, KSR, Alice, Octane Fitness, and Halo Electronics, as well as the new U.S. Patent and Trademark Office proceedings brought into existence by the Leahy-Smith America Invents Act of 2011 (AIA), have increased the cost and risk of patent litigation for patent holders and alleged infringers alike.
With a median cost of $3–5 million through trial ($1–4 million to defend), patent litigation has always been an expensive undertaking. In the wake of Octane Fitness, with more fee-shifting motions being filed and numerous awards above $1 million (about one-quarter of them in favor of patent holders), litigants now have to factor in the possibility of being on the hook for the opposing party’s attorney fees. And Halo has reopened the door to enhanced damages, potentially increasing the motivation to litigate longer rather than settle.
The AIA added further risk and cost to intellectual property (IP) litigation, with the surge of inter partes review (IPR) and covered business method (CBM) petitions creating a parallel track to manage and finance. Although recent data suggest that the Patent Trial and Appeal Board’s petition institution rate has leveled off, when petitions are instituted, some or all of the claims are currently found unpatentable in the majority of proceedings. And as district courts increasingly grant motions to stay cases pending the IPR or CBM outcome, litigation for cases with surviving claims has stretched out.
This new normal exacerbates the budget pressure confronting in-house counsel. In response, clients have become more cautious about initiating litigation. When they do give the green light to a suit, clients are handling more matters in-house and otherwise using lower-cost providers (such as outsourced e-discovery) and seeking fee discounts from outside counsel. According to an industry survey, more than half of clients have shifted work to firms offering alternative fee arrangements, and nearly a third reported not filing meritorious claims because of budget and capital constraints.
Intellectual property practices, which had fared relatively well in recent years, are feeling the effects. According to an analysis by BTI Consulting, the IP litigation bubble has officially popped, with a decline in corporate spending on IP litigation in 2015 (and projected for 2016) after double-digit revenue increases in prior years. With clients implementing strategies to address the heightened risk, law firms are competing for fewer big-stakes IP matters and the premium rates that accompany them.
While risk sharing is a rational reaction to the more challenging environment, there is a tension between clients and law firms as to the best approach. Clients favor fee discounts and contingency arrangements because they shift risk to law firms. But even though there have long been firms willing to handle IP matters on contingency, the current climate means they are accepting far fewer cases and requiring clients to pay litigation costs. And firms that aren’t willing or able to entirely underwrite such risk may feel compelled to do so in order to remain competitive.
Litigation finance provides a compelling solution to bridge this risk gap. Unlike discounted fees or outsourced services, litigation finance creates new law firm revenue streams, bolstering the traditional hourly fee model and providing the opportunity to share in successful outcomes. And litigation finance allows clients to share risk and to finance litigation costs, while gaining access to a wider selection of litigation firms. As a bonus, the disciplined underwriting process of a litigation financier provides both a firm and its client with a second, objective review of the matter, which can enhance the strategy and probability of success.
Increasingly, forward-thinking lawyers and their clients are embracing the application of well-established financial principles to the practice of litigation. Multiple industry surveys have noted the heightened interest in and use of litigation funders, suggesting that if the trend continues, it could reverse the recent decline in the market for litigation services.
Despite its appeal, litigation finance is still relatively unknown, even to lawyers with years of experience. The concept originated roughly 15 years ago in Australia, moved quickly to the United Kingdom, and is spreading rapidly in the United States. As the U.S. industry matures, the major litigation finance firms continue to expand the types of solutions they provide. And each structure brings new advantages to private practice lawyers, particularly in the IP space.
As an introductory matter, there are many ways that litigation finance can come into play. Although litigation finance is typically thought of as funding at the outset of a case, financing is available at every stage of a lawsuit, including pretrial, mid-case, the appellate stage, and post-settlement. Similarly, while litigants can obtain funding to pay attorney fees and costs, parties frequently use litigation finance for other purposes, such as to provide working capital, de-risk a trial judgment regardless of the appellate outcome, or accelerate settlement proceeds. And, third, both clients and law firms can avail themselves of the financing options now available.
With that in mind, here are three ways lawyers are using litigation finance to spur growth and generate revenue.
Financing Legal Fees and Costs
A client can obtain funds to pay some or all of the fees and costs in connection with a litigation matter. In the post-AIA world, where patent litigation is often accompanied by an IPR or CBM petition (or multiple such petitions), the related costs can significantly increase the case budget. Such costs, along with those for appeals, can also be addressed by litigation funding, which can allow specialists to be added to the team if desired. Many litigation funders will also become involved later in a case, to supplement a budget that has been strained by AIA proceedings.
Such funding is typically nonrecourse, meaning the client owes nothing if the case is unsuccessful; and if the case is successful, the litigation finance provider receives part of the underlying judgment or settlement. This arrangement effectively replicates contingent-fee economics for the client while allowing the law firm to retain its traditional billing approach. This is a particularly valuable tool for firms that do not favor contingent fees, as it allows clients to work with their choice of counsel regardless of cost or fee structure. And it helps clients assert rights in areas that are typically deemed prohibitively expensive or risky, such as international arbitration and intellectual property.
Even companies that are capable of self-funding litigation can benefit from using litigation finance. When a client pays for litigation fees and costs, they are treated as an accounting expense. This reduces earnings before interest, tax, depreciation, and amortization (EBITDA) and, over the long duration of a typical patent suit, can have a negative effect on enterprise value and the balance sheet. If the litigation is successful, the award or settlement is usually considered a nonrecurring event and does not benefit EBITDA. Thus, using litigation finance can serve the financial as well as legal needs of the company.
De-Risking Contingent Fee Arrangements
Even the most traditional law firms are willing to explore contingent or partial contingent fees to appeal to clients and capture potential upside invaluable cases. At the same time, those firms can look to reduce their exposure in such cases by sharing risk with a litigation finance company.
This approach has two important advantages. First, the firm can generate predictable revenue through a partial contingency in which the finance company shoulders some of the risk, while the client still enjoys a fully contingent fee. Second, as mentioned above, by partnering with an experienced litigation finance company, the law firm gets the benefit of a second opinion from an independent observer when selecting its contingent-fee cases. By “de-risking” individual contingency cases or portfolios of cases, firms are making smarter and safer use of this increasingly important source of revenue.
Additional de-risking options come into play when there is a trial judgment pending appeal or a case resolution that is to be paid out over a period of time. In the former case, clients and firms with a contingent interest can use legal finance to monetize a portion of their success, regardless of the outcome on appeal. A litigation funder can also structure large settlements and accelerate settlement and licensing proceeds—again, for either clients or counsel.
Accelerating Legal Fees
Unfortunately, law firm revenue risk does not end once the engagement letter is signed. Slow-paying clients create earnings drag and increase collection cost. This may lead firms to bargain away profit by offering significant discounts in exchange for an agreement to pay.
Some litigation finance providers can advance fees using arrangements that are not visible to clients and do not constitute debt. By accelerating a portion of their fee receivables, firms can meet year-end revenue projections, enable partner distributions, and ensure that revenue-based rankings reflect actual performance. Fee acceleration also reduces the need to offer larger discounts to clients in exchange for payment, or to undermine valuable client relationships with an unseemly push for collections.
For a relatively low cost of capital, fee acceleration is available for hourly as well as contingency fees, which frequently are subject to extended delay due to administrative proceedings and the risk of objectors. Acceleration is increasingly common, and had become a tool used by several Am Law 25 firms at the end of 2015.
Conclusion
The structures outlined above are just a few of the litigation finance alternatives that will help law firms and clients navigate the riskier IP environment. Indeed, although slow or flat growth in the legal industry is widely expected this year and next, financing can provide short- and long-term revenue benefits to many firms and their clients.
When the practice of IP litigation has become more complex than ever, the strategic use of litigation finance may be the best new solution for many of the challenges faced by clients and their law firms. Some litigation funders have more IP experience and expertise than others, however, so it pays to seek out a funder that can add value to your legal team throughout the financing relationship.
