The Venture Capital Model Applied To Litigation Funding: Misaligned Incentives And The Harm To Innovation

I. INTRODUCTION

The rise of investor-backed patent litigation in the United States is imposing a significant cost on innovation. The venture capital model of funding—where 50% to 70% of investments are expected to fail but the few "hits" account for the bulk of the VC profits—has been an engine supporting the development of early-stage companies and American innovation. When applied to patent litigation funding, however, it is having the opposite effect. It creates misaligned financial incentives resulting in litigation funders who are motivated to bring a high number of lawsuits—many of questionable merit—based on the chance that a small number may succeed and result in large damages awards. Meritless claims stifle existing innovators' ability to grow—exactly the opposite of the patent system's intended purpose. Establishing third-party funder disclosure rules and enforcing fees and sanctions against those who bring meritless cases will help to correct the misaligned incentives in the patent litigation landscape, restoring the appropriate jurisprudential balance that incentivizes meritorious claims while deterring claims that are merely "lottery tickets" in pursuit of a big payday

II. THE RISE OF LITIGATION FUNDING IN PATENT CASES

Litigation finance has grown into a $15 billion industry, driven in part by private investors like venture capital and hedge funds that see it as a new asset class and an investment opportunity.¹ With the financial backing of private investment funds, substantial amounts of capital have transformed the litigation finance sector from small, individualized investments into mature funds dedicated to investing in larger portfolios of active lawsuits. Patent litigation funding has been a key driver of the litigation finance industry's growth. In fact, patent litigation saw cases with funding deals increase 61 percent between 2020 and 2022.² Approximately 20 percent of commercial litigation funding overall in the United States is directed specifically to patent litigation.³ Within the patent litigation ecosystem, estimates suggest that 30 percent of patent cases are backed by litigation funders; a dramatic increase from almost none in the early 2000s.⁴ The secondary patent market, where entities buy up patents from other companies to assert against defendants in the hopes of a big payout, has boomed.⁵ And the high upside of patent cases is attracting venture capital, hedge funds, and general investor funds to the patent-litigation market.⁶

The current dynamics of litigation-funded patent cases may be attributed to the high-risk, high-reward nature of such lawsuits. Litigation funding is high risk to a funder because litigation outcomes are never certain, and the financial investment is non-recourse (the funder cannot recover the investment from a patentee if a lawsuit fails). Litigation funders demand high percentages of any recovery to counterbalance losses sustained in other non-winning cases, which, in turn, pushes plaintiffs to seek even higher (and sometimes astronomical) damages awards.⁷ Damages claims in the hundreds of millions, if not billions, of dollars are now routine.

Adding to this dynamic is the fact that litigation funders can often initiate litigation anonymously—without anyone knowing their role and without the defendant, judge, or jury ever knowing that a significant part of any damages award will go to the litigation funder rather than the patentee. Litigation-funded patent cases are often brought by small non-practicing entity (NPE) plaintiffs that are effectively fronts or shell companies either owned or controlled by litigation funders.⁸ Under this system, the litigation funders can control the case anonymously from behind the scenes while also controlling the distribution of any proceeds from the litigation.

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Footnotes

1. Emily R. Seigel, Four Questions to Keep Litigation Funders Up at Night in 2025, BLOOMBERG LAW (Dec. 27, 2024, 5:00 PM), https://news.bloomber-glaw.com/business-and-practice/four-questions-to-keep-litigation-funders-up-at-night-in-2025; Paloma Castro, Litigation financing as an opportunity in the investment market, DEMINOR LITIGATION FUNDING (Jan. 15, 2024), https://www.deminor.com/en/news-insights/litigation-financing-as-an-opportunity-in-the-investment-market/.

2. Kelcee Griffis, Litigation Finance Gains Traction in Patent Infringement Cases, BLOOMBERG LAW (Oct. 20, 2022, 4:46 AM), https://www.bloomber-glaw.com/bloomberglawnews/ip-law/XESRGQI8000000?bna_news_filter= ip-law.

3. The Westfleet Insider: 2023 Litigation Finance Market Report, WESTFLEET ADVISORS, at 6, https://www.westfleetadvisors.com/wp-content/uploads/ 2024/03/WestfleetInsider2023-Litigation-Finance-Market-Report.pdf.

4. At least 25% of the last 3 years NPE litigation caused by Litigation Investment Entities, UNIFIED PATENTS (Feb. 21, 2023), https://www.unified patents.com/insights/2023/1/4/2022-patent-dispute-report.

5. See Unified Patents, supra note 4.

6. Ellen Milligan & Katharine Gemmell, Hedge Funds Turn Lawsuit Bets into $39 Billion Industry, FL TORT REFORM, (Nov. 16, 2021), https://www.fltortreform.com/news/hedge-funds-turn-lawsuit-bets-into-a-39-billion-industry/; Michael Perich, Profile of Litigation Funders, BLOOMBERG LAW (Jan. 3, 2024), https://pro.bloomberglaw.com/insights/business-of-law/ litigation-funding/#traditional.

7. Forum: Challenges of navigating and negotiating litigation funding, THOMSON REUTERS (Jul. 1, 2024), https://www.thomsonreuters.com/en-us/ posts/legal/forum-negotiating-litigation-funding/; Uniloc, Inc. v. Microsoft Corp., 632 F.3d 1292 (Fed. Cir. 2007) (awarding a $388 million verdict, then the 5th largest in history).

8. Brief for Unified Patents, L.L.C. as Amicus Curiae Supporting Appellant Dish Network, L.L.C., 101 F.4th 1366 (Fed. Cir. 2024) (Nos. 1:13-cv-02066- RGA, 1:13-cv-02067-RGA) at 3.