This article was originally published in Law360 on January 11, 2024, and is republished here with permission.
A recent decision to refer attorneys to the disciplinary counsel of their respective bars and to seek U.S. Department of Justice review in a patent infringement case involving alleged shell limited liability companies and litigation funding entities has raised eyebrows across the legal profession.[1]
Specifically, the U.S. District Court for the District of Delaware was concerned that the plaintiffs in a series of patent infringement cases disobeyed the court’s standing order requiring the disclosure of third-party litigation funding, and also may have made inaccurate statements in filings with the Court; that counsel for the plaintiffs may have failed to comply with the Rules of Professional Conduct; that real parties in interest … may have been hidden from the Court and the defendants; and that those real parties in interest may have perpetrated a fraud on the court by fraudulently conveying the patents asserted in this Court to a shell LLC and filing fictious patent assignments with the U.S. Patent and Trademark Office, all designed to shield the real parties in interest from the potential liability they would otherwise face by asserting in litigation the patents in question.[2]
This Nov. 27, 2023, opinion reminds parties asserting intellectual property rights — and their attorneys — to exercise caution when structuring a litigation financing agreement.
Litigation Financing
Enforcing a patent can be a costly and prolonged endeavor. One way parties can limit the financial risk of litigating their intellectual property rights is to secure litigation financing.
Plaintiff-side financing often takes the form of a nonrecourse investment in exchange for a percentage of any damages recovered from the alleged infringement. If no damages are recovered, then the patent owner is not liable to repay the investor.
In this scenario, the patent owners limit their risk and assert their patent rights in exchange for a share of their potential award. For inexperienced or even just risk-averse patent rights holders, securing litigation financing may be the only feasible way to protect their intellectual property rights.
The champerty and maintenance doctrines generally dictate that parties that receive litigation financing retain control of the litigation decisions concerning their rights. Most litigation financing agreements abide by this rule.
Some, but not all, district courts require parties to disclose third-party financiers. These requirements may be found in local rules, such as U.S. District Court for the District of New Jersey-enacted Local Civil Rule 7.1.1, while other districts have standing orders, as adopted by all of the judges of the Northern District of California.[3]
The Agreement Structures at Issue
The Delaware district court determined that the “de facto owner of the asserted patents” in the related cases is an entity named IP Edge and that the counsel of record for the LLC plaintiffs improperly divided their loyalty and gave the LLC plaintiffs conflicted advice.[4]
The court’s opinion focuses on three LLC plaintiffs — Nimitz Technologies LLC, Mellaconic IP LLC and Lamplight Licensing LLC.[5]
Each of the three LLCs had a single owner who was also the sole member.[6] The three owners were characterized by the court as not being sophisticated patent owners — in Mellaconic’s case, the owner and sole member was a proprietor of a food truck and restaurant.[7]
The only asset owned by each LLC was a handful of patents.[8]
The owners of the LLCs had so little knowledge of the LLCs and their assets that the sole owner and member of the Nimitz entity was unable to recall the name of the patent-in-suit — U.S. Patent No. 7,848,328.[9]
The court heard testimony that the sole owner of Nimitz paid nothing for the ‘328 patent but was aware of paperwork that indicated ownership of the ‘328 patent by Nimitz.[10]
Undisclosed figures began to appear when the court dug into the origin of the LLC plaintiffs’ assets. In Nimitz’s case, the ‘328 patent was originally filed in 2008 and was passed through a number of assignees, including a “sovereign state fund” owned by the French government, before finally being assigned to Burley Licensing LLC — an LLC also owned by the same person who was the sole owner of Mellaconic, albeit using an email address that identified an IP Edge attorney.[11]
Here and with the other LLCs, the court identified numerous discrepancies between the patent assignment agreements filed with the USPTO and the agreements actually governing the relationship between the parties — including provisions restraining the transfer of rights, the consideration paid for the assignments, and revenue sharing from the enforcement of the patent rights.[12]
Court testimony stated that Burley was formed by Mavexar and that the IP Edge attorney was the primary contact with Mavexar.[13] Mavexar formed consulting agreements with the LLC plaintiffs in these cases, and described their services as nonlegal and stated that they are “not a law firm.”[14] The services provided by Mavexar were described in the agreement with language such as “assisting [Nimitz] in monetizing” its patents in exchange for a percentage of the “net proceeds” — net proceeds were defined as gross recovery minus costs and expenses.[15]
For all of the LLC plaintiffs, the consulting agreements did not identify the percentage of the net proceeds flowing to Mavexar, but the sole owner of Nimitz testified that he believed that the LLC received 10% of the recoveries.[16] Therefore, Mavexar was possibly receiving a 90% share of the net proceeds for its consulting services. For Mellaconic’s net proceeds, it appears that Mavexar was collecting 95% of the profits.[17]
The Finding of Misconduct
The district court believed that counsel violated their fiduciary duties to their LLC clients by taking direction from IP Edge and Mavexar because “it is well-settled law, regardless of jurisdiction, that attorneys owe their clients a fiduciary duty”[18] and “the duty includes undivided loyalty, candor, and provision [to the client] of material information.”[19]
The court determined that the counsel of record in the various disputes did not fulfill their fiduciary duty to their LLC plaintiffs, and instead gave their loyalty to Mavexar and IP Edge.
The court highlighted that counsel violated both Model Rule 1.2(a) and Rule 1.4 by failing to communicate with their LLC clients before filing, settling and dismissing the clients’ cases.[20]
And the court found it clear that the LLC plaintiffs assumed liability independent of Mavexar and IP Edge’s interests — including the liability of possible attorney fees of any defendant that prevails in an infringement case brought in the LLC plaintiff’s name, the liability of any sanctions imposed by a court, and in some cases any attorney fees and costs advanced by Mavexar as detailed in at least one of the consulting services agreements.[21]
While the plaintiffs’ counsel argued that a client can delegate to a third party all litigation decisions, the court responded that even if a client could delegate to a third party the authority to approve the lawyer’s filing and settling of the client’s lawsuit … [u]nder the Model Rules, a client’s informed consent to a proposed course of conduct can only be obtained “after the lawyer has communicated adequate information and explanation about the material risks of and reasonably available alternatives to the proposed course of conduct.”[22]
Here, the record indicates that counsel never discussed potential conflicts with their LLC clients.[23]
The district court believed that Mavexar and IP Edge actors engaged in the unauthorized practice of law on behalf of the LLC plaintiffs. The court found that attorneys at Mavexar and IP Edge engaged in lawyer activities relating to the LLC plaintiffs’ cases — including drafting and editing legal filings, preparing witnesses for depositions, and performing legal research.[24]
The court explained that Mavexar and IP Edge were Texas entities and that the attorneys engaged in the alleged unauthorized practice of law were Texas citizens.[25] However, “[i]n Texas, in ‘general[], a corporation can employ attorneys in-house to represent its own interests but cannot engage in the practice of law by providing legal representation to others with different interests.'”[26]
The district court believed that the USPTO should investigate whether IP Edge agents filed false and inaccurate assignments. The court did not express an opinion about whether it believed the assignments at issue were false and inaccurate, but reminded parties that Section 261 of the Patent Act requires the USPTO to “maintain a register of interests in patents and applications for patents and [to] record any document related thereto upon request.”[27]
While there is no requirement to affirmatively file an assignment with the USPTO, all assignments that are filed must be true and accurate.[28] The court also encouraged the DOJ to investigate “whether the strategy employed by IP Edge to hide from the defendants in these cases and the Court real parties in interest, including France Brevets, violated any federal laws.”[29]
Thoughts for Future Practice
The district court’s memorandum decision includes potentially serious consequences for all of the parties involved in the IP Edge cases and clarifies what at least one court thinks about elusive litigation structures. Regardless of how the court’s referrals shake out, this memorandum opinion identifies some key areas where patent infringement plaintiffs and their counsel should exercise caution.
First, parties engaging in litigation financing agreements should draft transparent agreements where all of the parties involved are represented by their own counsel. Take heed not to split consideration and duty of loyalty between the parties entering the agreement.
Second, assignments filed with the USPTO should match the terms agreed to in the financing agreements. Here, the court determined that there were inconsistencies between the assignments and the agreements actually entered into between LLC plaintiffs and the assignors.
Guidelines on what should be included in an assignment can be found in Chapter 300 of the USPTO’s Manual of Patent Examining Procedure.
Moreover, it bears noting that litigation financing can be accomplished without requiring any assignments or shell entities.
Third, if a district court judge makes a lawful order to disclose all parties with an interest in the litigation, then do it! The potential disciplinary action in this matter stems from an alleged failure to adequately abide by the court’s Nov. 10, 2022, memorandum order requiring each LLC plaintiff to produce documents and communications with Mavexar, IP Edge and related individuals even after the court’s order was upheld by the U.S. Court of Appeals for the Federal Circuit.[30]
Litigation financing is a legitimate and sometimes necessary mechanism for patent holders to gather the necessary resources to assert their intellectual property rights.
However, the potential consequences facing the parties and their counsel in these cases serve as a cautionary reminder of the responsibility that attorneys owe to their clients and to the courts before which they appear.
The convoluted nature of many arrangements in this matter may prove detrimental to the parties involved, reinforcing the age-old mantra to keep such arrangements simple and transparent. Basic steps, such as an arms-length review by a law firm’s internal ethics counsel, could be beneficial in avoiding the pitfalls highlighted here.
[1] The court issued November 27, 2023 memorandum opinion laying out its decision to make the referrals – Case 1:22-cv-00413-CFC.
[2] Id. at 2.
[3] See standing order no. 17 for the Northern District of California.
[4] Memorandum opinion at 101.
[5] Id. at 1.
[6] Id. at 6-7, 33, and 55.
[7] See id. at 101, 33.
[8] Id. at 7, 34-35, 56-57.
[9] Id. at 7-9.
[10] Id. at 7-9.
[11] Id. at 10-11.
[12] Id. at 10-14.
[13] Id. at 10.
[14] See id. at 22, 92, and 96.
[15] Id. at 22.
[16] Id. at 23.
[17] Id. at 43.
[18] Id. at 81-82 (citing Huber v. Taylor, 469 F.3d 67, 81 (3d Cir. 2006).
[19] Memorandum opinion at 81-82 (citing Huber v. Taylor, 469 F.3d 67, 81 (3d Cir. 2006).
[20] Memorandum opinion at 85-88.
[21] Memorandum opinion at 88-89.
[22] Id. at 93-94.
[23] Id. at 93-95.
[24] Id. at 97.
[25] Id. at 97-98.
[26] Id. at 98 (citing Unauthorized Prac. of L. Comm. v. Am. Home Assur. Co. , 261 S.W.3d 24, 26 (Tex. 2008)).
[27] 35 U.S.C. § 261; Memorandum opinion at 98-100.
[28] Id. at 98.
[29] Memorandum opinion at 100.
[30] See Memorandum opinion at 2-6.
