The Weight of Profits on the Scales of Justice
The first third-party litigation financing arrangements condoned by the U.S. Supreme Court were between the NAACP and civil rights claimants. These agreements were permitted only because the NAACP provided the funding and did not take away control of the litigation from the clients. As the Supreme Court noted in National Ass’n for the Advancement of Colored People v. Button, in the NAACP’s arrangement with the civil rights plaintiffs,
no monetary stakes are involved, and so there is no danger that the attorney will desert or subvert the paramount interests of his client to enrich himself or an outside sponsor. And the aims and interests of NAACP have not been shown to conflict with those of its members and nonmember . . . litigants.
Modern litigation financing agreements are quite different and include constraints on a plaintiff’s discretion, indicating a conflict of interest between the litigant and the funder.
The terms of litigation funding agreements are rarely disclosed, but sometimes they come out during litigation. Years ago, while working for the House Judiciary Committee, I handled legislation aimed in part at requiring greater disclosure of third-party litigation financing contracts. The committee report associated with that legislation noted a third-party litigation funding agreement in a class action lawsuit, Gbarabe v. Chevron Corp., which referred to a “Project Plan” for the litigation developed by the funder that included restrictions on the ability of the class action lawyer to deviate from it. In that case, Judge Susan Illston of the Northern District of California ordered the disclosure of the third-party litigation funding agreement because the “funding agreement is relevant to the adequacy [of representation] determination and should be produced to [the] defendant.”
We can see more clearly the stakes involved for adequate representation in more recent revelations. In 2023, The Wall Street Journal reported on a lawsuit alleging price fixing brought by the food distribution company Sysco against its beef and pork suppliers. It was revealed that Sysco got $140 million for its lawsuit from the litigation funding company Burford Capital. During the course of the lawsuit, Sysco grew weary of the litigation and decided it wanted to settle with the defendants, but Burford objected. As it turns out, the financing agreement between Sysco and Burford stipulated that Sysco “shall not accept a settlement offer without [the funder’s] prior written consent, which shall not be unreasonably withheld.” The funder maintained that Sysco was settling for too little. Burford’s chief investment officer even wrote an email stating, “We are going to have to sue [Sysco] it seems. They are about to breach our contract.”
Lawyers’ clients, not litigation funders, are supposed to retain the autonomy to decide how their own cases are handled on behalf of their clients. As legal ethicist and former Yale Law School Dean Anthony Kronman has written of the passion for making money, “like any other passion this one can distort deliberation too—for example, by encouraging a concentration on short-term, easily monetizable considerations to the exclusion of more-ambiguous long-term ones that may have greater importance.” That’s what happened in this case, where a funding agreement created conflicts of interest that violate core principles of legal ethics, to the detriment of the client.
A Bloomberg Law article makes clear:
In litigation funding, law firms that take money from Fortress [a litigation funder] have their bank accounts tracked weekly and their cases monitored closely. One litigation funder said he passed on taking money from Fortress because “they choke you to death.” . . . Jack Neumark, a Fortress managing partner and co-CIO, said[:] “We see where funds go. If you do something you’re not supposed to do, we’re gonna be upset.” . . . One consistent principle is that if Fortress agrees to provide capital to a funder, it will be hands on.
The third-party litigation funder in the Sysco case was also apparently linking a settlement number in that case to future settlement numbers in wholly separate cases with totally different clients. A magistrate judge subsequently observed in the Sysco case:
Burford is trying to prevent these settlements because the Sysco settlements, if they go through, will set benchmarks for other settlements with other defendants. Burford apparently hopes that if those benchmarks can be set at high enough levels, Burford will realize a financial gain on not just its financing contract with Sysco but with other, as-yet-undisclosed financing agreements that seem to be in place in these cases.
Legal ethicist Geoffrey Hazard has written:
[W]hen parties require involvement from lawyers, it is typically because the parties’ understandings and aims are in conflict and beset by confusion. It is the lawyer’s job to facilitate the resolution of these conflicts, by either negotiating an agreement between the parties or counseling their clients about dealing with the unresolved situation.
That is, the purpose of litigation is to resolve disputes in which parties on both sides have conflicting aims. But as Kronman has written, “it is hard to see how a lawyer can give intelligent counsel even of a purely instrumental sort until his client’s aims have been clarified.”
As the Sysco case illustrates, third-party litigation financing, when it imposes limits on clients’ autonomy, creates conflicting aims among the very entities supporting the lawsuit, such that there is no longer the sort of clarity of position on one side of the dispute that is necessary for resolving it. Hazard continues, “Legal advice, involved in all lawyer tasks, aims foremost at optimizing a client’s position.” As the Sysco case demonstrates, third-party litigation financing can cut against a client’s position, making resolution of disputes with the opposing party impossible, and thwarting the whole purpose of our civil litigation system. When attorneys enter into litigation funding agreements with third parties that impose restrictions on their independent judgment, they create contractual duties with funders subject to fiduciary duties that conflict with their own duty of loyalty to their clients.
A more extreme example was recently observed during a patent dispute. In November 2023, Chief Judge Colm Connolly of the District of Delaware issued an opinion that referred people associated with the patent litigation funding firm IP Edge to their state disciplinary bars, the Texas Supreme Court’s Unauthorized Practice of Law Committee, the U.S. Patent and Trademark Office (USPTO), and the Department of Justice for their conduct. That conduct consisted of directing several people, including a food truck owner and a surgical assistant, to agree to assume LLC liabilities associated with patent litigation in his federal court without disclosing the interests of IP Edge, which stood to gain 90% of the gross lawsuit recovery from the patents in question.
That was followed by the release of text messages, internal documents, and private communications demonstrating, as Judge Connolly described it, an “obvious disparity in the sophistication of the LLC plaintiffs as opposed to . . . IP Edge.” In one exchange between one of the LLC owners and an IP Edge employee, the small business owner explained that she didn’t feel comfortable testifying in federal court (because she was unfamiliar with the patent and the shell company structure the litigation funders set her up with), texting that “I have nightmares almost every night thinking about it and so stressed.” While the patent owners were promised only 5%–10% of the proceeds of the patent infringement suit, they accepted all the liability, including potential sanctions should they refuse to testify. Keep in mind that this scheme was only revealed after Judge Connelly had issued a transparency order, and so, as explained below, these kinds of litigation funding arrangements may be much more common than we know.
In another dispute between the third-party litigation funder Longford Capital Fund III and the company Arigna, it was revealed that the funder was insisting that lawyers and investors receive over half of whatever settlement proceeds resulted from the litigation. And in another case involving safety earplugs used in the military, the judge noted that the third-party litigation funding agreements included “exorbitant fees and rates of interest,” leading the judge to order the disclosure of any funding agreements to help ensure that plaintiffs were “not exploited by predatory lending practices.”
Imbalances in Patent Law Let Trolls and Their Funders Put Their Thumbs on the Scales
Third-party litigation funders are particularly attracted to patent litigation in America. First, the cost of defending a patent litigation suit can be significantly higher than asserting one. Given that America lacks a “loser pays rule” (a rule that provides that if a person files a lawsuit against someone and loses, they’ll have to compensate the prevailing party for the money that party spent defending themselves), defendants ultimately bear these costs in all but the most frivolous suits. Moreover, patent trolls produce no products themselves, so discovery requests on infringement will relate only to the defendants’ products. Thus, discovery costs are disproportionately large for defendants compared to patent trolls, further incentivizing defendants to settle nuisance cases. Second, certain evidentiary presumptions in patent litigation favor the plaintiff, which puts further pressure on defendants to settle. Finally, patent damages determinations, especially in complex high-technology cases, are made by nonexpert juries that can be unpredictable and result in extremely high damages awards. As a result, our justice system can be gamed to coerce money from noninfringing defendants.
Disproportionate Litigation Costs
In the United States, attorneys who file lawsuits can, by simply filing a complaint at their discretion, immediately subject defendants to the threat of a default judgment (a judgment for the plaintiff entered after the defendant fails to timely answer or otherwise appear). That threat of a default judgment, which is enforced by the government, forces defendants to spend money and resources toward their defense in order to avoid the default judgment. That dynamic results in a situation in which a defendant will be made to pay any amount to the plaintiff in settlement, provided the settlement demanded is less than the defendant’s costs of defense and the plaintiff’s attorney costs for filing the case (which are minimal).
As legal and economic professors have described the situation under current law:
[T]he plaintiff may choose to file a claim at some (presumably small) cost. If the defendant does not then settle with the plaintiff and does not, at a cost, defend himself, the plaintiff will prevail by default judgment . . . . Given the model and the assumption that each party acts in his financial interest and realizes the other will do the same, it is easy to see how nuisance suits can arise. By filing a claim, any plaintiff, and thus the plaintiff with a weak case, places the defendant in a position where he will be held liable for the full judgment demanded unless he defends himself. Hence, the defendant should be willing to pay a positive amount in settlement to the plaintiff with a weak case . . . .
Eran Zur, the intellectual property lead for litigation funder Fortress, wrote the following in an article he authored entitled “Why Investment-Friendly Patents Spell Trouble for Trolls”:
[C]ourts can get valuation wrong—at times awarding damages beyond the scope of the government-granted patent claims. In the technology sector, these oversized awards stem from the sheer complexity of interoperable components and systems sold as part of functional units, if not integrated devices. And because technology invention tends to be incremental, to the extent an individual patent owner can be awarded damages on the price of the entire end product as opposed to their specific patent claim, a litigation incentive arises. . . . A further complication arises from the substantial legal costs to defend a patent infringement suit (recently estimated by PWC [PricewaterhouseCoopers] at approximately $4 million). . . . [A] price floor becomes set by the extreme expense of litigation defense, marked at just under nuisance value . . . .
This problem is particularly pronounced in patent litigation by litigation funders’ reliance on nonpracticing entities (NPEs), so-called “patent trolls”—companies that don’t make any products themselves, but instead seek out and buy up old, low-quality patents that likely shouldn’t have been granted in the first place. These companies do not have actual business operations, which means not only that they have a low risk of facing a reciprocal infringement suit but also that they have relatively low discovery costs.
Moreover, because the United States does not include default fee-shifting in patent litigation, defendants in patent litigation face asymmetric transaction costs. While some may argue that Federal Rule of Civil Procedure 11 might allow some relief to parties who are victims of frivolous patent lawsuits under 35 U.S.C. § 285, Rule 11 only applies in exceptional cases and goes largely unenforced, because the victims of frivolous lawsuits have little incentive to pursue additional litigation to have the case declared frivolous when there is no guarantee of compensation in the end, even when the judge agrees the case is without merit.
Evidentiary Imbalance
Patent cases are harder to defend than other common types of civil litigation. Typically, the burden in civil litigation falls on the plaintiff to muster evidence and prove its case by the preponderance of the evidence. However, that is not the case in patent litigation. Once a patent is granted by the USPTO (including patents that were not properly granted under the relevant rules), it is legally deemed to be “presumed valid,” and “the burden of establishing invalidity of a patent or any claim thereof shall rest on the party asserting such invalidity.” The U.S. Court of Appeals for the Federal Circuit, which hears patent suit appeals, has interpreted this provision to require a party defending against an infringement charge to do so by “clear and convincing evidence” that a patent was improperly granted, which is a much higher standard than the usual preponderance of the evidence.
That evidentiary imbalance incentivizes jurors without technical backgrounds to find for patent troll plaintiffs following the route of least resistance. Think about it. Today, a typical patent trial, involving a host of complex issues, will only last a couple of weeks, and much of the trial will have to involve educating the jury about the relevant technology, the patented invention, the product or method that is accused of infringement, and any prior art that allegedly invalidates the patent. Confused jurors in patent infringement lawsuits will find it much easier to find for the patent troll, simply because doing so requires meeting a much lower evidentiary standard, especially when the jury’s verdict must be unanimous. If jurors are confused about a technical patent issue, they’ll find it difficult to reach any decision, but since they would have to reach much further to get to “clear and convincing evidence” (allowing the defendant to prevail), they’ll tend to “tap out” at the much lower “preponderance of the evidence” standard (and decide in favor of the patent troll). Under those circumstances, it’s easy to see why even innocent innovators have to settle lawsuits—and in doing so, settle for an injustice.
Unpredictable and Unreasonable Risk of Damages
As William Lee and Mark Lemley write, patent trolls’ “damages demands frequently have little or no relationship to the actual value of the patents”; and in 2022, patent trolls “filed eighty-eight percent of all high-tech patent cases and sixty percent of patent cases overall; and twenty-nine percent of NPEs were backed by third-party funding.” Further, patent trolls “have been permitted to seek billions of dollars in damages for patents whose value is nowhere near that in the real world. And operating product companies face the risk of being forced to pay excessive damages capturing the value of technology the patentee did not invent.” The higher risk of unfounded damages awards in patent litigation further increases the pressures on defendants to settle.
Foreign Third-Party Funders Can Be Motivated by Strategic Advantage and Profit
Even worse, patent trolls and their funders can take the form of foreign adversaries, who can fund patent litigation not for profits’ sake alone but as a means of siphoning resources away from American industries, including defense industries, for strategic advantage. A 2023 report by the House Select Committee on the Strategic Competition Between the United States and the Chinese Communist Party recommended that Congress “[d]etermine, and then establish, what guardrails are needed to address the possibility of foreign adversary entities obtaining sensitive IP through funding third-party litigation in the United States.” The Foreign Agents Registration Act (FARA) unit chief at the Department of Justice specifically mentioned the risks of “undisclosed and undiscoverable” third-party litigation funding in U.S. litigation, including the risks of foreign entities doing business in the United States seeking to create a competitive advantage over their U.S. competitors by tying up U.S. companies in lengthy and expensive courts cases, and the risks that foreign funders of U.S. litigation may gain access to proprietary and sensitive commercial information through litigation discovery.
As Bloomberg Law has reported, “A Chinese firm is financing four intellectual property lawsuits in US courts . . . . PurpleVine IP, a Shenzhen, China-based company that touts itself as a provider of one-stop patent solutions, is paying the cost of the lawsuits against Samsung Electronics Co. and a subsidiary . . . .” Thanks to Judge Connolly’s disclosure order, early in that case it was revealed that two former in-house lawyers had stolen privileged and confidential analyses of the patents that were sent to both PurpleVine and its associated law firm, and PurpleVine had used that information in deciding to fund the case.
Right now, China and other countries can use third-party litigation financing to disrupt American industries important to our economy and national defense and use any coerced money settlements to fund other anti-American plans of their own. We just don’t know the extent of such activity, because there is no uniform rule requiring the disclosure of third-party litigation financing contracts when money damages are at issue. As former Secretary of Defense Donald Rumsfeld said, “there are known unknowns—that is to say, we know there are some things we do not know”—and the issue of third-party litigation financing by foreign enemies is a known unknown of a most dangerous kind.
As the Federal Trade Commission reported under the Obama administration, patent trolls “can deter innovation by raising costs and risks without making a technological contribution.” Researchers have also found that “[patent troll] litigation has a real negative impact on innovation at targeted firms: firms substantially reduce their innovative activity after settling with [patent trolls].” Other researchers examined how patent troll litigation affected the field of health care information technology in light of litigation over medical imaging software patents, and concluded:
No new variations of existing products or new models of imaging software were released by the affected vendors during the period of litigation. An explanation for this lack of innovation is that the vendors did not want to run the risk of being found guilty of “willful infringement” in the patent suit and being liable for treble damages. Therefore, one explanation of the slow-down in sales is that the product release and attendant sales cycle was halted as a result of litigation. This emphasizes that even if patent-assertion entities [patent trolls] do not prevail in the courtroom, their actions can have significantly negative consequences for incremental innovation while litigation is ongoing.
Coming to Terms with the Need to Disclose Terms of Funding
We can go a long way toward solving the problem of the “known unknowns” of third-party litigation financing with the simplest policy imaginable: transparency. Judge Connolly, through his own disclosure orders, has shown just how potent transparency can be. A few years ago, the chief judge, who handles a lot of patent cases, began to get the impression that the lawyers in cases before him often seemed unable to give him straight answers to questions, as though they needed to check with someone else first. Consequently, he issued standing orders in April 2022 mandating the disclosure of any third-party litigation financing contracts that applied to any party in his courtroom. As he explained in a November 2022 memorandum, this was an attempt to address potential “abuse of our courts,” and he had concerns about the “lack of transparency as to who the real parties before the Court are, about who is making decisions in these types of litigation.”
Judge Connolly’s simple disclosure requirement has already had dramatic results, as a third-party litigation financing company sought to dismiss its own cases, which it had funded over many years in Judge Connelly’s court, simply because it didn’t want to reveal its financing arrangements. As reported on Law.com:
The Fortress Investment-backed company spent 3 1/2 years litigating patent infringement claims against Intel in Delaware, but elected to walk away as Chief Judge Colm Connolly insisted on more disclosure into its ownership structure. . . . [VLSI] agreed with Intel on Tuesday to a stipulated dismissal of its Delaware claims, rather than submit to further inquiry from Connolly into VLSI’s ownership structure.
Let that sink in for a moment. Judge Connelly’s simple act of requiring that these arrangements be made public caused the funders of the lawsuit to dismiss the cases they had been funding for years.
But Judge Connolly is just one judge, and his disclosure rule only applies in Delaware. In the meantime, patent troll litigation in the United States is “up by 24% in the first quarter of 2024, with the bulk of those cases filed in the Eastern District of Texas after developments in . . . the District of Delaware . . . reduced their appeal for such plaintiffs.” The good news is that Congress can help dispel this perfect storm by simply exposing third-party litigation funding agreements to the light of day. Representative Darrell Issa’s proposed Litigation Transparency Act of 2025, for example, would mandate disclosure of third-party litigation financing agreements for money damages in civil lawsuits.
Funding Contracts as Blinders for Lawyers
When lawyers fund their own cases, they do so with one eye on their ability to cover their costs and make a profit, and the other eye on achieving what their clients view as a just result. But today, funding contracts are acting as blinders for lawyers, obscuring the desires of clients. Lawyers are entering into agreements with third parties to fund their lawsuits under a fiduciary duty to maximize not justice as understood by their clients, but adequate profits as understood by outside investors, using contracts that condition funding on the lawyer and their client’s losing some degree of control over the case.
Lawyers aren’t supposed to sign away their clients’ autonomy in cases to some third party whose financial interests may diverge at one point or another with how the client wants to handle their case. As Kronman writes, for a lawyer to properly deliberate on their client’s behalf:
[A] lawyer must be able to lose himself in that other person’s situation . . . . This demands that he temporarily suspend his own interests, for only by doing so can he clear an affective space in which his client’s interests may be entertained with real feeling. But the more preoccupied a lawyer is with money, . . . the more difficult he will find it to suspend his self-interest in this way.
Yet that’s the situation in which lawyers increasingly find themselves when they make agreements with third-party funders. To what extent this is happening, and under what conditions, is largely unknown, but that could change if Congress or the federal courts required the disclosure of third-party litigation financing agreements.
