Third-party litigation financing is a topic of increasing interest. The practice has become more common, and federal courts as well as the U.S. Patent Trial and Appeal Board are responding to ensure that the real parties in interest are participating in intellectual property disputes. In addition, a proposal is pending before the Advisory Committee on Rules of Civil Procedure that would revise the Federal Rules of Civil Procedure to require disclosure of third-party funding arrangements affecting all federal patent, copyright and trademark actions. Furthermore, a recent decision by the U.S. Court of Appeals for the Federal Circuit, in Worlds v. Bungie, has tasked the PTAB with conducting an analysis of the real-party-in interest issue where evidence is presented by a patent owner to sufficiently put the issue into dispute.

This article addresses the limits placed on litigation financing by some states via the operation of the champerty doctrine. The law varies substantially from state to state, with some states having strict champerty doctrines and others none at all. That fact may impact venue selection for multi-state or multi-district disputes.

A party, such as a non-practicing entity seeking to embark on a patent assertion campaign, may seek third-party litigation financing to bridge a gap in funding for a claim or as a strategy to hedge against the downside risk of an unsuccessful outcome. TPLF is generally non-recourse, meaning that the funding entity can only collect on the collateral pledged — in this context, a portion of the proceeds of the litigation determined by various factors, such as a percentage of any recovery, a multiple of the deployed funds or the length of the case.

Champerty prohibits outside parties from funding litigation in certain cases to which they are not a party. Its modern application can be traced back to medieval England, where champerty statutes prevented feudal lords from abusing the legal system by encouraging third parties to litigate against their rivals and claiming a share of the property awarded.

By common law or statute, many jurisdictions do not explicitly prohibit champerty or recognize TPLF as such, including Arizona, California, Louisiana, New Jersey and Texas. (See Paul Bond, Making Champerty Work: An Invitation to State Action, a 50-state survey). Other states, such as Alabama, Delaware, Georgia, Minnesota, Mississippi, New York and Pennsylvania, do recognize the doctrine, and explicitly prohibit champertous funding arrangements. In those states, third-party litigation financing arrangements can be found champertous, resulting in the litigation being halted.

Relevant Champerty Statutes and Recent Case Law

It is worth reviewing recent champerty rulings in Delaware and in New York, two of the states with the most fully articulated case law, to analyze how third-party litigation financiers might run afoul of the doctrine.

Under common law, Delaware defines champerty as “an agreement between the owner of a claim and a volunteer that the latter may take the claim and collect it, dividing the proceeds with the owner, if they prevail; the champertor to carry on the suit at his own expense.” Charge Injection Technologies v. E.I. Dupont de Nemours & Company. In a champertous assignment, “an assignee of a cause of action initiates litigation at his or her own risk and expense in consideration of receiving a portion of the proceeds if successful.” However, an agreement cannot be champertous if the assignee has “an interest in the matter in controversy” or “where the assignee has some legal or equitable interest in the subject matter of the litigation independent from the terms of the assignment under which the suit was brought.”

In Charge Injection, CIT’s CEO entered into an agreement with an investment fund to finance their patent infringement action in exchange for any future proceeds from the action. The Delaware Superior Court held that this was not champerty, finding the financier did not encourage or control CIT’s pursuit of the litigation. The court similarly found no champerty in the assignment of a debt to a company that later filed suit to pursue payment in Southeastern Chester County Refuse Authority v. BFI Waste Services of Pennsylvania. Specifically, the plaintiff had an interest “intertwined with the subject matter of the case” and did not acquire the debt simply to pursue litigation: The interest in the litigation pre-dated the assignment. Nor did the court find champerty in Arcoria v. RCC Associates, when a company’s president assigned the company’s lawsuit to himself before pursuing his claim. While no recent cases have found an agreement to be champertous, the doctrine is presumed to be alive and well. In dismissing a case due to a champertous agreement, the court stated in Hall v. State of Delaware that “[i]t is the duty of the court to dismiss a case in which the evidence discloses that the assignment of the cause of action sued upon was tainted with champerty.”

In New York, champerty is prohibited by Judiciary Law § 489 and punishable by fines or even a misdemeanor conviction. However, the statute contains a safe harbor provision for assignments with a purchase price of at least $500,000. Champerty exists if the primary purpose of the purchase is to enable one to bring a suit, but not if the lawsuit is merely incidental. For example, New York’s Supreme Court found no champerty when the plaintiff received TPLF for a claim for the return of stolen art; the financier did not become a party to the suit and only provided financing for the plaintiff to fund his claim. Gowen v. Helly Nahmad Gallery. Certain assignments of mortgage and securities have also been found non-champertous by the courts. In 71 Clinton St. Apts. v. 71 Clinton Inc., the court found that the “plaintiff acquired the assignment for purposes of foreclosure; the law allows for such an acquisition.” Likewise, in Universal Investment Advisory v. Bakrie Telecom the court found an assignment is not champertous where an assignee obtains legal title of securities and the assignor retains beneficial title to their proceeds, though the assignee’s recovery is limited to costs and fees associated with bringing the lawsuit.

However, the New York Court of Appeals found an agreement champertous where a plaintiff acquired securities solely to bring a lawsuit, agreeing to pay $1 million for them if the lawsuit succeeded. Justinian Capital SPC v. WestLB AG. Further, because the plaintiff had not yet paid anything for the assignment, the safe harbor provision did not apply, and the court ruled against the plaintiff.

In states where champerty is a consideration, funding agreements may be scrutinized for the extent of control ceded to the funder. There is a distinction between a financier providing acceptable non-recourse funding so a party can cover litigation costs and a third party who impermissibly uses funding to pull the strings and control the litigation.

In states where champerty applies, the assets encumbered by the funding agreement may also be scrutinized. In those states, third-party financiers should avoid initiating, encouraging or controlling litigation in which they have no direct interest.

There is a finer distinction to be made in the case of assignments of debt or securities. It is common practice to acquire a debt strictly for the purposes of receiving the benefit of enforcing it. If a lawsuit is incidental to that enforcement, the assignee of the debt likely has not run afoul of the champerty doctrine. Assignments of debt acquired strictly for the purposes of the lawsuit can be found champertous, particularly where the lawsuit could potentially exceed the return of the debt, where the assignee has not yet paid for the assignment, or where a clear strategy of harassment or burdening a defended with cost can be shown. Such was the case in Justinian, where the plaintiff had yet to make a payment for assigned securities before filing suit over them. If, however, a party is the legitimate assignee of debt or securities, then it has a legal interest in any suit arising out of them — so long as the assignee does not take over control of the litigation, such an assignment is likely non-champertous.

Considerations for Funders

Funders should remember that champerty provides limits on litigation financing in some states. In those states, the inquiry is on the interest the funder has in underlying assets and whether the funding agreement hands control of the action to a non-party. In fact, champerty concerns may lead some funders to prefer matters to be brought in states that do not recognize the doctrine.