U.S. Contingency Fees: A Level Playing Field?

By William R. Towns

This article by William R. Towns, a Partner and General Counsel at Novak Druce + Quigg LLP, focuses on contingency fee arrangements in the context of patent litigation in the U.S. Mr. Towns is a seasoned attorney and mediator whose litigation and dispute resolution practice concentrates on IP matters. He is a WIPO Approved Neutral and has served as a WIPO Domain Name Dispute Resolution Panelist since 2003.

A study of the results of patent litigation at the appellate level revealed that patentees only won some 25 percent of infringement cases from 2002 to 2004.³  While these statistics might seem to suggest that the scales are tipped in favor of defendants, the eye-popping cost of patent litigation in the United States – on average $3 to $10 million – can deter many accused infringers from fighting cases in court; it may just be less expensive to pay a licensing fee or royalties than to challenge a patent in court. At the same time, plaintiffs increasingly have turned to contingency fee arrangements to spread the risk of such escalating patent litigation costs, a development that has led some to assert that the scales are now tipped decidedly in favor of plaintiffs.

Contingency fee arrangements have become a standard practice in the U.S. for financing certain types of civil lawsuits. Under such arrangements, attorneys’ fees are determined by the success of the claim, and usually are calculated as a percentage of the client’s recovery. A fee is charged only if the lawsuit is successful or is favorably settled out of court – a “no win, no fee” arrangement.

Often used in personal injury, medical malpractice and commercial collection cases, contingency fees have been widely associated with large jury awards and recoveries and, as a result, have become a focal point for advocates of tort reform. But they have actually been around for at least 100 years, long before the onset of the current liability crisis. Significantly, U.S. jurisdictions generally eschew “loser pays” systems that permit successful litigants to recover attorneys’ fees from the losing party. Proponents of contingency fee arrangements observe, inter alia, that they improve access to the legal system by enabling plaintiffs with limited financial means to obtain legal services they could not otherwise afford.²

Critics of contingency fee arrangements, on the other hand, often attribute the recent “litigation explosion”– the expansion of tort liability – largely to the efforts of lawyers working on a contingency fee basis to increase the return on their investment. Detractors of contingency fees decry the oft-stated goal of improving access to the legal system as misleading, claiming that contingency fee arrangements are motivated by greed and encourage excessive, speculative or frivolous litigation. After all, contingency fee arrangements also finance litigation of upper-income and business clients that could easily afford to pay on an hourly basis.

Controversial or not, there is no question that the use of contingency fee arrangements in U.S. civil ligation has become widespread, expanding well beyond the confines of tort law. In a number of other contexts, contingency fee arrangements have proven an effective means of spreading risk, not only for litigants with resource or liquidity constraints, but also for the well-financed. This includes IP matters, and particularly patent infringement lawsuits, where the substantial litigation costs for both sides may be as significant an influence on the outcome of the case as the merits of the claim itself.

The high cost of patent litigation

The high cost of patent litigation in the U.S. is a major factor contributing to the use of contingency fee arrangements. According to a 2009 economic survey commissioned by the American Intellectual Property Law Association (AIPLA), in patent infringement cases where the amount in dispute is between $1 million and $25 million, total litigation costs average in excess of $3 million, roughly 60 percent of which is incurred during discovery. In cases where the amount in dispute exceeds $25 million, average total litigation costs are roughly doubled. And in smaller cases where the amount in dispute is less than $1 million, the AIPLA survey indicates that total litigation costs in some cases may exceed the amount at stake, with costs through the end of discovery remaining roughly 60 percent of the total litigation costs.

The case for contingency fee arrangements

In light of escalating patent litigation costs, contingency fee arrangements can be seen as improving access to the judicial system for the “little guy” – in this case small inventors and others who otherwise lack the means to enforce their IP rights against larger, better-financed corporate defendants.

But as with other complex commercial litigation, contingency fee arrangements in patent litigation are not the exclusive bastion of small inventors and individuals. For larger, better-funded litigants looking to control litigation costs, contingency fee arrangements may be equally attractive – such arrangements spread the risks of patent litigation for small and large clients alike. Contingency fee lawyers occupy a position analogous to that of business partners or venture capitalists, an investment model that arguably encourages them to screen cases more carefully and to hold down litigation costs.

In contrast, traditional hourly billing arrangements require clients to assume virtually all the risks of litigation. This is certainly a concern for small inventors and other potential litigants with liquidity issues, for whom the high costs of patent litigation may effectively preclude access to the judicial system. And while the need to spread the risks of litigation may not be as pressing for larger, well-funded litigants, controlling the high costs of legal services is an increasing concern. A survey of in-house counsel, recently conducted by the Association of Corporate Counsel and The American Lawyer, reports that 39 percent had increased their use of alternative billing arrangements with outside law firms during the past year. The survey further indicates that virtually all changes from hourly billing arrangements were initiated by corporate law departments rather than external law firms.

Do contingency fees level the playing field?

Proponents of contingency fee contracts argue that they protect the rights of inventors and serve to level the playing field in what are sometimes termed “David and Goliath” battles with big business – perhaps a fitting analogy in cases of small inventors with limited means attempting to enforce their rights against well-funded corporations. Contingency fee arrangements may indeed level the playing field in such situations, thereby promoting not only the interests of small inventors but also those of the justice system and, arguably, society at large.

 
A patent troll – a pejorative term for institutional investors using a business model that involves acquiring patent portfolios not to develop goods and services for market, but only to assert patents in court. (Illustration: Bob MacNeil)

Outside of this situation, however, it is questionable whether contingency fees are needed to level the playing field in U.S. patent litigation, and debatable whether the use of contingency fee arrangements may, in some situations, tip the scales in the opposite direction. Patent infringement lawsuits increasingly are being funded by non-traditional institutional investors, using a business model that involves acquiring patent portfolios not to develop goods and services for market, but only to assert patents in court.³ So-called patent trolls – a pejorative term for entities that acquire IP assets to this end – are a case in point. Contingency fee arrangements are conducive to using this business model, as they allow institutional investors to effectively spread the financial risk involved in patent litigation by partnering with their lawyers.

The notion that a well-funded patent litigant that has hedged its investment through a contingency fee arrangement is merely seeking to level the playing field is difficult for some to accept. Many businesses facing patent litigation are also well funded, but not all such defendants are large, successful corporations and, given the high costs of patent litigation, some would argue that contingency fee arrangements tend to give plaintiffs the edge. For obvious reasons, contingency fee arrangements are not an available option through which such patent defendants can level the playing field, and a defendant lacking comparable risk-spreading options who is otherwise unable to afford the high costs of patent litigation may find itself at a decided disadvantage, notwithstanding the merits (or lack thereof) of the patent claims asserted against it.

Patent reexaminations and alternative fee arrangements

Even though the evidence is largely anecdotal, the conclusion that contingency fees have altered the patent litigation landscape seems unavoidable. Whether or not there is any correlation between the rise of contingency fee arrangements and steadily escalating legal costs in patent lawsuits, there is no question that patent defendants are looking increasingly to control the significant legal costs of fighting patent claims.

To limit the high costs of patent litigation, many businesses are seeking alternatives to the traditional hourly rate model. There are a number of options, including fixed fees, conditional fees or reverse contingency fee arrangements. The latter arrangement can be difficult to implement, as it requires that the client and law firm agree on a potential liability exposure of a certain amount, with the reverse contingency fee a fixed percentage of the difference between liability exposure and any lesser settlement or judgment. Some studies suggest defendants are unlikely to choose contingency fee arrangements over fixed fee or hourly billing arrangements, because they view litigation as a purely negative gamble.⁴ Contingency fee plaintiffs pay attorney’s fees only if they prevail, and then only as a percentage of the settlement or judgment they have recovered in the litigation. A defendant who chooses an alternative billing arrangement as opposed to the traditional hourly rate may succeed in lowering its overall litigation costs, but unlike a contingency fee plaintiff, the defendant does not have a settlement or award from which to pay its attorney's fees.  Even for a defendant who prevails in the litigation, the best result is still a net loss.

Beyond alternative fee arrangements, a growing number of defendants in patent infringement lawsuits are challenging the validity of the patent at issue through the use of administrative ex parte or inter partes patent reexaminations before the U.S. Patent and Trademark Office (USPTO), based on prior art references.⁵ U.S. Federal Courts have the power to stay patent litigation pending completion of reexamination. There has been a significant increase in third-party requests for patent reexaminations since 2003, and the number of patent infringement lawsuits involving parallel patent reexaminations before the USPTO is considerable and increasing.

A chief advantage of challenging the validity of a patent by reexamination before the USPTO is the decidedly lower administrative costs compared to the costs of validity challenges in patent litigation. When coupled with the possibility of obtaining a stay of litigation, the strategic use of reexamination has changed the patent litigation landscape as significantly as have contingency fee arrangements. In fact, there appears to be a strong correlation in time among the use of contingency fee arrangements, the emergence of patent trolls and the substantial increase in third-party requests for ex parte and inter partes reexaminations before the USPTO.

Conclusion

The emergence of contingency fee arrangements as an effective means of spreading risk has noticeably altered the patent litigation stage, particularly in combination with the rise of so-called patent trolls. Whether contingency fees are directly responsible for creating a litigation explosion in patent law is open to question; lawsuit statistics maintained by the U.S. District Courts suggest the number of patent lawsuits as a percentage of total patents has not changed markedly over the past two decades.  And if contingency fees encourage speculative or frivolous patent claims, the strategic use of patent reexaminations by defendants, and the employment of other cost-cutting methods, may well serve to level the playing field, and eventually curb such perceived abuses.

Patent reform legislation has been introduced in the U.S. House of Representatives or the U.S. Senate in each of the last three years. The enactment of patent reform legislation in the U.S. is probable – perhaps inevitable – but it is unlikely to substantially or immediately impact the high costs of patent litigation, or to curtail the use of contingency fee arrangements in such litigation. In the meantime, the debate continues to unfold.

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1 Paul M. Janicke, University of Houston Law Center and Lilan Ren, University of Houston, “Who Wins Patent Infringement Cases?,” American Intellectual Property Law Association Quarterly Journal, Vol. 34, p. 1, 2006
2 See, e.g., Economic Analysis of the Law 615 (7th ed. 2007), Richard A. Posner
3 See Nathan Vardi, Patent Payday, FORBES.COM (Feb. 12, 2008).
4 See Eyal Zamir & Ilana Ritov, Neither Saints Nor Devils: A Behavioral Analysis of Attorneys’ Contingent Fees 50-57.
5 See 35 USC, 301 et seq. (ex parte reexamination) & 35 USC, 311 et seq. (inter partes reexamination).