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Benefits and pitfalls of alternative litigation funding

published in McAfee & Taft tIPsheet | November 4, 2022

Intellectual property litigation is expensive. So much so that many businesses facing the prospect of pursuing litigation resort to making settlement decisions based on the economic burden of a multi-year litigation process, rather than solely upon the strength of their arguments or the risks associated with proceeding to trial. And while such pragmatism has its place, many litigants find themselves wishing there was a way to fund litigation without putting significant financial resources at risk.

Some litigants view alternative litigation funding (“ALF”) as the answer to that wish. While ALF arrangements have been popular in other countries for many years, such arrangements have only gained traction in the United States over the past 10 years. ALF arrangements can take a variety of forms: At their most basic, such arrangements take the form of a loan or even a charitable gift (such as GoFundMe donations or the angel investor who funded Hulk Hogan’s lawsuit against Gawker). In more complicated cases, individual or group investors may offer to cover the costs of litigation in exchange for a share of the company — or a share of the payout if money is recovered. Hedge funds have also noticed the money that often goes unclaimed when cases are settled for pragmatic reasons, and have begun investing in lawsuits.

At first glance, ALF arrangements seem primarily positive: They allow your case to move forward while placing the risk of doing so on someone who is better able — or at least more willing — to carry the cost of that risk. But ALF arrangements do have their drawbacks, and litigants who use such arrangements without care have found themselves regretting their choice when they lose control of the litigation, or find themselves without funding at a crucial point in the litigation.

So how do you protect yourself from the risks while taking advantage of the benefits afforded by ALF arrangements? Start with the following precautions:

First, ensure confidentiality. Understandably, most investors will want to be able to independently assess a case prior to making an investment. To allow a meaningful assessment, it will be necessary for the third party to review sensitive materials. Protect these preliminary disclosures by preparing a strong confidentiality and nondisclosure agreement prior to negotiating any ALF arrangement.

Second, establish that you control the lawsuit. It is essential that control of the litigation remain at all times with the litigant, not the third party funding the litigation. The American Bar Association recommends that parties to an ALF arrangement agree in writing that control of the litigation, strategic decisions, and settlement decisions remains at all times with the party named in the lawsuit, not the ALF entity. Any written agreement should also set forth whether, and to what extent, the third-party funder may participate in investigations, negotiations, and mediations.

Third, delineate how and when the parties can walk away from the arrangement. Even if your agreement provides that you control strategic decisions, the third party funding your case may not want to continue paying for decisions with which it disagrees. Take the time to spell out in your agreement what happens when a disagreement as to strategy arises, what disagreements would give the third party the right to walk away, whether a buy-out must be paid prior to either party walking away from the arrangement, and how much notice must be given prior to leaving the arrangement.

Finally, consider having outside counsel review your ALF agreement. Although you may trust the attorney handling your lawsuit with your case, many attorneys in the United States have limited exposure to ALF arrangements — and some ALF arrangements can create conflicts of interest that are not apparent at first glance. Having another disinterested attorney review your ALF agreement could help you detect and avoid potential conflicts and hurdles that might arise in third-party-funded litigation.

Whether ALF arrangements are the answer to the age-old question “Who is going to pay for all of this?” remains to be seen. But what is clear is that such arrangements come with both risks and benefits. Taking the steps outlined above should help as you try to determine whether you can make ALF arrangements work for you.