Contingent Fee Business Lawyers As Venture Capitalists

In the world of venture capitalism, Fred Wilson’s blog, “A VC” is essential reading, and Fred is particularly generous with his insight and information about the field.

I read Fred’s blog partly because it’s darn interesting and partly because there are a lot of parallels between venture capitalism and contingent fee litigation. We both take on a lot of risk and invest a lot of time and money for the potential of a big payoff down the road, as compared to regular and steady income.

Yesterday, Fred wrote an interesting post about the venture capitalism industry as a whole, and how the math doesn’t add up. There are just not enough “exits” (through a merger / acquisition or an initial public offering) to justify the size of the venture capitalism industry as a whole.

So I commented, he responded, and we had a short conversation about the economics of contingent fee litigation and the potential for creating a market for contingent patent infringement defense.

But that’s not what this post is about. At the end, Brad Feld chimed in: 

If they did one-way loser pays (e.g. plaintiff has to cover defendants cost if the plaintiff loses) and they prohibited contingency fee relationships that would solve a lot of problems.

That’s a common sentiment among businesses, from big corporations to entrepreneurs to mom and pop stores, a sentiment that usually disappears the moment they need an attorney but can’t afford the risk of paying for years of litigation without a guaranteed return.

I’ve written before about loser pays and how it’s unfair to penalize the party that bears the burden of proof on an issue from failing to meet that burden, and that loser pays serves as a strong deterrent against meritorious claims.

But let me focus on the contingent fee aspect. As part of my discussion with Fred, I talked about some of the numbers when the plaintiff wins a big case:

[A big win in the litigation business] depends on the resources devoted to it, so let me give some examples based on actual costs and number of attorneys on the case.

(Someone might ask, "why not use billable hours for resources?" Well, contingent fee attorneys almost never devote themselves entirely to one case, and each minute spent on the case instantly becomes a sunk cost, so we generally ignore time already spent on a case and focus on two things: actual costs and opportunity cost due to the lawyer(s) having to turn down other work. I refer to the latter as "bandwidth," i.e. the availability of a lawyer to take on other work. Keep in mind also you’re paying these attorneys (including yourself) a salary, and thus have a significant carry cost, although the salary on a ‘per case’ basis is quite low given how most attorneys have over 10 cases, even those on substantial matters.)

A large-damages personal injury / product liability / medical malpractice lawsuit can be done by one or two attorneys and costs below $250,000, with recovery of $5-$10m within 1.5-3 years. That’s a big win: you put in $250k out of pocket, likely didn’t impair bandwidth, and recovered $2-$4m in attorneys’ fees.

The numbers aren’t too much different for most small business cases, with breach of contract, unfair competition, etc.

A regional-market antitrust / mid-sized patent infringement case can be done with 3-6 attorneys, $1-$5m in costs, with a recovery of $15-$50m in 2-4 years. Another big win: you put in $1-$5m out of pocket, moderately impaired bandwidth, and recovered $7-$20m in attorneys’ fees.

A massive shareholder class action / national antitrust / large patent infringement case can be done with 10-40 attorneys, $10-40m in costs, and a recovery of >$100m in 4-10 years. Think of the Blackberry patent infringement case, which ended with a $612m settlement and over $200m in fees (resulting in profits-per-partner than year over $4m).

Big money, right? Why not file lawsuits all day long?

The difference is, those are the big winners, the venture capital equivalent of starting a company that gets bought out by Microsoft or which enters the public market with a heralded IPO proceeded by weeks of favorable press, like Google. It’s great, but it’s also rare.

Day in and day out, the primary thing a contingent fee law firm does is spend lots of money. In addition to all the normal costs of a business (rent, staff, etc.), you have to pay your attorneys salaries which are competitive in the market, even against hourly billing firms, and you have to dump loads of money and time into cases for experts, motions, discovery, trials, appeals and negotiations, none of which earn you a dime until the very end.

So I’d say it’s no different from Brad’s or Fred’s ventures: we have as strong an incentive against taking frivolous or vexatious claims as they have against investing in unprofitable businesses. The last thing I want to do is spend years of my life and five, six or seven-figures pursuing a case that returns nothing. Like a venture capital fund, our contingent fee law firm turns down far more cases than it accepts.

Do vexatious or extortionate law suits happen? Sure, potentially more for cases which are high stakes and expensive to defend, like shareholder class actions or patent infringement. That’s why I think a limited form of fee-shifting is appropriate, like when the patent being sued upon is declared invalid as a matter of law.

But loser pays and no contingency would close the courthouse doors to all but the wealthiest of parties, since no one would be able to afford pursuing even the best of claims without a massive war chest, particularly in the extremely-expensive shareholder class action, antitrust and patent infringement contexts.

It’d be like stripping venture capital funds of limited liability and restricting them to using secured debt, not equity, to fund investments, forcing them to do little more than invest in the biggest companies in the world.

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  • http://www.feld.com Brad Feld

    I don’t have a strong opinion on non-software-patent litigation.
    In the context of software patents, I think the combination of fee shifting and elimination of contingency would radically change the dynamics of activity across the board. I suppose there are some “single inventor cases” that couldn’t afford non-contingency litigation, but this has always been an edge case in the software patent silliness.
    I realize this is my strong bias since I don’t believe that – in general – software patents are a valid construct.

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  • http://www.dayontorts.com John A. Day

    Great post. I am citing to it on Friday.
    Our firm does 90% contingent fee work, but we keep up with our time in all cases. We measure the profitability of every case against what we could have made by the hour if we worked at our normally hourly rates.
    Another very relevant factor that I think you would agree with is the number of defendants in a case. Other things being equal, an increase in the number of defendants increases the time investment and the length of the litigation. (It can also increase the likelihood of winning because of finger pointing.) For example, we recently tried a four-defendant case for 13 days, got a $1,250,000 verdict (pretrial offer was $100K), and barely covered the cost of our time. I had underestimated the cost associated with the additional defendants.
    I enjoy your blog. Keep up the good work.

  • Sam Ackley

    Contingent fees defeat the fundemental assumption of a fair trial. Using a metaphore of Venture Capitalist brings this home. A venture capitalist invests in equity and becomes an owner. The same is true of a contingent fee attorney. They become co plaintiffs. As co plaintiffs they do not have the same motivations as the actual plaintiffs. I have been on both sides of this formula and find that the attorney’s who have represented me in a contract dispute on contingency become partners and are much more likely to see mediation and settlement negotiations and even trial preparation as tools to maximize their returns. I do not receive advice that is as objective because they have “skin in the game” and want a return on investment. Attorney’s who represented me on a fee basis have given me advice that protects my best interest even when it means the case may end without a large settlement. A contingent fee attorney cannot represent me and themselves without conflicts and unless both parties use a contingent fee attorney it also corrupts the court itself. For example if i do not have a contingent fee attorney but my oponent does why should the contingent fee attorny of my opponent be allowed to attend meetings in judges chambers without me. He/she is in fact a co plaintiff as well as an attorney.

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