Contingency Fee Litigation Is Only a Last Resort

If you are having to do contingency fee litigation on your patents, you did something wrong.

Contingency fee litigation is a unique feature of American Law, where attorneys perform some or all of the litigation – and they get paid only if they win. Contingency fee litigation is often associated with the “ambulance chaser” attorneys who charge no money up front, but will take 30-60% of the winnings of the lawsuits.

Contingency fee litigation is often used in patent litigation, partly because the cost of litigation *appears* to be very high, but mostly because there can be huge amount of money at stake.

Myth: Contingency Fee Litigation “Aligns Interests” of the Parties

One of the myths around contingency fee litigation is that both parties – the attorney and the client – have the same motivation: to get paid. This is not true.

The math on the client side is that they put up zero money, but they might get a huge payday. There is ‘nothing to lose’ in this scenario, especially when the potential damages are in the tens or hundreds of millions of dollars. Very little risk with huge rewards.

Or so it seems.

The math on the attorney side is different. The attorney needs to put their time and effort into a lawsuit that has the best chance of paying out. As a lawsuit progresses, the amount of investment goes up and up, but the rewards may not.

It is a much better payday to settle a case quickly – and for far less money – than to fight all the way to the Supreme Court and back with the hope of capturing a settlement. In other words, the attorney always has an incentive to settle quickly to avoid risk.

Patent Lawsuits May Have Far Different Incentives

An entrepreneur who has their IP stolen by a competitor is trying to level the playing field. They have a competitor who is piggybacking on their hard work and ingenuity. The entrepreneur had the vision and insight to find an innovative solution, and a better-funded competitor might be taking over the market with better marketing, better distribution, better supply chain, or some other advantage.

I hear countless stories of entrepreneurs who intensely negotiate with larger “strategic” companies, only to have the larger company go quiet. Three months later, the larger company rolls out a copy of the entrepreneur’s invention.

Just last week, I encountered an incident where a large company did an intense due diligence process, all under a Non Disclosure Agreement. The larger company sent their high level engineers to look through the product design and saw drawings of their next set of improvements. 18 months after the ‘negotiations’ suddenly stopped, the larger company had a patent published. The patent included the secret drawing that was only shown during that due diligence process, which proves theft, pure and simple.

The entrepreneur wants a lawsuit to level the playing field. It is not enough to collect a few pennies from each unit sold, the startup company (and their investors) really want to shut down the evil competitor. This might mean having the competitor cease and desist, or hitting them with additional charges, like trade secret theft, violation of a Non-Disclosure Agreement.

The entrepreneur was damaged not just because the competitor is making money on their innovation, but because they did not land the ‘strategic’ deal that would have meant lots of revenue and further success.

Do the Incentives Align for Contingency Fee Litigation?

I have heard two heartbreaking stories of entrepreneurs going down the contingency fee route in the scenario above in the last couple months.

Both entrepreneurs are very angry about the harm done to their company, and justifiably so. They also need to take action for their shareholders, as their investors paid for the innovation and the entrepreneurs have an obligation to do as much as they can.

The contingency fee litigation has drained both companies, not just their bank accounts, but their energy and enthusiasm.

Since they had no money and, even worse, no insurance, both had to go down the contingency fee route.

Sadly, the contingency fee options were a huge problem because the interests of the attorneys and the clients were not aligned.

In one case, the contingency fee attorney elected to assert only a portion of the claims against the infringer. Knowing that there were several avenues of attack on the infringer, the contingency fee attorney chose the lowest cost one to litigate, and avoided the more complex, higher cost claims that could have been asserted.

My guess is that the attorney did the math on damages.

Damages are the potential money that could be collected on an infringement case. With patents, we get to look back six years to find infringement. In the case above, the infringer had only been selling the infringing product for a couple years, so the immediate damages that the contingency fee attorney could collect was quite small. It would have been much better – from the lawyer’s standpoint – to wait 3-5 more years for the competitor to have a huge share of the marketplace and be selling tens or hundreds of millions of dollars.

But the entrepreneur needed to stop the competitor before the startup ran out of money, so the contingency fee attorney did a low budget lawsuit (which they lost, by the way). I don’t know if they would have prevailed by asserting more of their IP, but I am guessing that the contingency fee attorney did not want to put in that amount of effort when the payout was not that high.

Control of the Litigation is Essential to the Entrepreneur

Decision making in the litigation is often lost in a contingency fee arrangement. This can be explicit, where the attorney and their litigation funders have contractual control of strategy and settlements. It can also be implicit, where the contingency fee attorney suggests courses of action to the client (or outright bullies the client) into doing it their way.

A contingency fee attorney will always want to close the lawsuit quickly for a guaranteed settlement rather than go the distance in a risky trial before judge and jury. In high stakes cases, there are often trigger points in the contingency fee payout, where the attorney’s percentage drops at certain price levels.

An example may be that an attorney gets 50% if the settlement is less than $1M but only 40% if the settlement is over $1M. The contingency fee firm will fight tooth and nail to get to $1M, but have a perverse dis-incentive to accept a settlement of $1,000,001. The biggest leverage in negotiating with contingency fee firms is to understand their financial incentives in their representation agreements, as that will dictate the settlement terms more than anything.

What the entrepreneur wants from the lawsuit is to stop the competition, not just get a small royalty.

The Infringer Still Gets To Sell Their Product

At the end of the contingency fee lawsuit – win or lose – the competitor still gets to sell the competing product.

If they lose, they just pay a small ‘tax’ in the form of a royalty. (A typical royalty is about 25% of the profit of the product.) If they win, the uncertainty of the lawsuit frees them up to invest more to market and sell their product. Win or lose, the competitor is still in the game, and either way, the competitor is emboldened to continue.

A competitor who has the litigation monkey off their back is free to focus on growing their market and distribution of the infringing product.

In many cases, the extra “cost” of the royalty is merely the incentive to design-around the patent. In order to design-around the patent, the competitor gets their best engineers together and tries to find different ways address the same customer need. There is always a design-around for any patent, although some may be more expensive than others. In the case where the design-around is too expensive, they merely pay the royalty.

This is not what the entrepreneur wanted when they started the lawsuit. They wanted to have their market to themselves, and they really wanted their competitor to cease and desist.

Unfortunately, the entrepreneurs who chose the contingency fee/litigation financing do not have that option. The contingency fee lawyers and the litigation funders need a financial settlement, and they need ongoing royalties. They do not get paid in a cease and desist scenario, so they need the infringer to be a going concern who will stay in business long enough to pay the royalties.

The contingency fee and litigation funders do not want to put the competitor out of business, they want the opposite.

They need the infringer to be a healthy, strong, revenue-generating business because that is how they get paid.

How to Prepare for Litigation? Insurance

To deal with patent litigation, a company can self-insure or buy patent enforcement insurance. Self insuring means that you pay all the costs yourself, which no startup can afford. So the option is insurance.

IP enforcement insurance is protecting against a risk. Fire insurance protects against the risk of a fire, and IP enforcement insurance protects against the risk of someone infringing your patent.

Every single independent inventor and every single small business that owns a patent should have this insurance. Why get an asset that you do not intent to use?

With IP insurance, the entrepreneur would get to manage the case. They get to choose whether they want the competitor to cease and desist, or whether to pursue royalties. They get to choose how and when to settle.

With IP insurance, the entrepreneur gets something that was missing in the two examples above: expertise.

The IP insurance companies see far more litigation than anyone, and they have deep expertise to the best strategies – and the best settlements – that you can expect. The entrepreneurs above were victims of not having anyone advising them. They were talking to contingency fee attorneys, who had experience in litigation – while the entrepreneur had one. The entrepreneurs did not realize that the person on the other side of the table had very different interests and goals than they did. There was a huge asymmetry in experience, expectations, and motivations between our entrepreneurs and their contingency fee attorneys, and the entrepreneurs did not even realize how severe the asymmetry was, or how to bring experts on their side to help them navigate.

With IP insurance, you have someone on your side with deep experience – and with aligned goals – to help advise you and guide you through the litigation minefield.

In Defense of Contingency Fee Litigation

There are many times where contingency fee litigation makes sense and where the interests align.

The key to choosing this type of litigation is that you must recognize where your interests and the litigation attorney’s interests align – and where they diverge. You need to recognize the asymmetry of investment, asymmetry of risk, and asymmetry of rewards to find a way forward.

Contingency fee/litigation financing is one way to move forward with litigation where you do not want to pay, or cannot afford to pay. Obviously, you have much better control over the attorneys, the strategy, and the settlement if you can pay (either self-funded or through insurance), but often contingency fee litigation is the next best option. Just make sure you have experience on your side to know how to structure and manage contingency fee litigation.