A patent is only as valuable as the patent owner's willingness, and ability, to enforce it. But patent litigation is expensive -- and risky. The average patent lawsuit in the United States costs about $3 million in attorney fees alone. Additional litigation expenses, including electronic discovery, expert witnesses and court reporters, can tack on $1 million or more. One patent litigator describes the risk this way: "There are more ways to lose a patent case than any other area. ... Patent cases are harder to predict." Historically, companies and law firms have addressed these cost and risk concerns by pursuing patent litigation through various alternative fee arrangements. Within the last few years, a new solution, "third-party funding," has gained popularity. What is third-party funding? What are its pros and cons? And who might be a candidate for it?

Candidates for third-party funding include those who are unable or unwilling to fund the litigation on their own. Individual inventors, small companies and universities are obvious candidates, as they rarely have the money to self-finance patent litigation. But larger companies with deeper pockets might be candidates as well. Management may not want the impact of litigation expenses on the company's financial statements and may view the investment in patent litigation as being particularly risky.

Before examining third-party funding, it is worthwhile considering what makes patent litigation so risky. As with any type of litigation, if the case is tried by a jury, factors such as which side has more articulate witnesses and the particular personalities of the trial attorneys can influence the outcome of the case, sometimes in seeming contravention of the facts. One reason patent litigation is uniquely risky is that if the defendant in the case can find an obscure piece of prior art previously unknown to the inventor and the patent examiner, a court can find the patent invalid after the patent owner has invested years in litigation.

As mentioned above, companies and law firms have historically entered into various alternative fee arrangements to pursue patent infringement litigation. These fee arrangements vary widely and include, among others, straight contingent fees, mixed hourly-contingent fees, flat fees and not-to-exceed fees with a success component. Possible arrangements have been practically limitless and depend on many variables, including the nature and magnitude of the case, the company's goals (e.g., injunction, monetary damages, business deal), and the company's and law firm's respective tolerances for risk.

Third-party funding is an alternative risk-management tool. Third-party funding is provided by a professional investment entity that, in return for funding the litigation, will demand a success fee or contingency fee to be paid out of the "proceeds" of the claim. In the event of a successful outcome, this fee will be taken from the company's damage award. It is therefore crucial to have sufficient margin between the level of funding required and the expected level of damages. Should the claim be unsuccessful, however, the funder will simply lose its investment without recourse.

Funded patent litigations generally have certain key features, which limit the availability of funding to a relatively small pool of cases. The following criteria provide a good general guide:

  • Strong patent position
  • Clear evidence of infringement
  • Substantial monetary claim
  • Judgment-worthy defendant

There are generally two different types of third-party funding sources. The first type of third-party funding entity will fund all of the expenses of patent assertion, including attorney fees. The other type will pay litigation expenses when there is a law firm willing to take the case on a contingency basis. Often, although a law firm may be willing to take a case on a contingency basis, it is unwilling or unable to pay the substantial litigation expenses required to prosecute the case through to conclusion.

The main disadvantage of third-party funding sources is the cost of such funding. The entities that will fund 100 percent of a patent litigation generally share revenue on a "net" basis. By the time all costs and fees are deducted, however, there may not be much net revenue left for the company. Even financing for only the litigation expenses is usually very expensive money.

Most entities providing litigation financing will require that they get repaid first, before the company shares in any of the money recovered. They will usually expect a five to 10 times return on the money they invest (to compensate for the risk), and it's not unusual for their return to increase dramatically if the case takes longer than a predetermined amount of time to resolve. Setting a predetermined time to resolution, however, is often unrealistic given the unforeseeable delays of civil litigation.

Nonetheless, with costs often in the millions of dollars, companies and other patent owners frequently require some amount of financing to support a patent litigation. For companies confronting the cost of major litigation, under the right circumstances, third-party funding sources may offer a practical solution.

Even organizations that have the financial resources to launch patent litigation may find it economically advantageous to finance the campaign with third-party funding. When a company is spending only its own money, at some point it may be disinclined to take on more risk and to invest more money as litigation fees and expenses accumulate. Third-party funding gives companies more "staying power," making it more likely that they can see litigation through to conclusion and obtain a larger damage award.

A well-crafted third-party funding arrangement creates an alignment of interests in the outcome of the litigation, reflects the expectations of all of the parties, and provides an equitable and ethical distribution of the proceeds. A funding arrangement that achieves these goals gives the patent owner a real opportunity in patent litigation to realize the benefit of any resulting success.