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Intellectual Property Private Credit (Part 2 of 2)

By John Freund |

The following article is part of an ongoing column titled ‘Investor Insights.’ 

Brought to you by Ed Truant, founder and content manager of Slingshot Capital, ‘Investor Insights’ will provide thoughtful and engaging perspectives on all aspects of investing in litigation finance. 

Executive Summary

  • Despite its size, the Intellectual property (“IP”) asset class has eluded the attention of most asset managers due to its underlying legal complexities
  • Litigation finance industry understands the opportunity, but it is solely focused on litigation involving IP
  • A void exists in the financing market, which IP-focused Private Credit managers have begun to fill via credit-oriented strategies designed to drive value maximization

Slingshot Insights:

  • Secular shifts in the economy have made IP assume an increasing share of corporate value
  • IP is an emerging asset class that has begun to garner the attention of asset managers and insurers
  • There are various IP-centric investment strategies that do not involve litigation.
  • IP-focused Private Credit funds approach IP in a holistic fashion, leveraging numerous ways that IP creates value
  • Investors need to be aware that investing in IP presents unique risks that warrant input from operational and legal IP specialists
  • IP Credit provides a different risk/reward profile for investors, as compared to commercial litigation finance which tends to have more quasi-binary risk

In the part 1 of this two-part series, the relatively nascent asset class of Intellectual Property Private Credit (“IP Credit”) was introduced.  That article explored the basic premise of the asset class, discussed some of the financiers in the space and reviewed some of the nuances inherent in the asset class.  In part two, we take all of the knowledge gained in part one and apply it to a specific example by exploring a publicly traded company, which used IP Credit on a couple of different occasions with great success.

Case Study

The details of most IP Private Credit transactions remain private.  An illustrative exception involves two prior financings of the once publicly traded cybersecurity company Finjan Holdings, Inc. (NASDAQ: FNJN) (“Finjan”), known for its technologies related to proactive cybersecurity.  At the time of the financings in 2016 and 2017, Finjan had focused significant effort on the licensing of its patent portfolio — to significant monetary success — in addition to other aspects of its business.  But because the licensing of intellectual property often requires costly litigation to complement the negotiation process, Finjan, through its bankers, ran a process to identify a strategic capital partner.  Potential proceed uses included litigation and general operating expenses, as well as stock repurchases.

Series A Financing (May 20, 2016)

InvestmentSeries A Preferred StockInvestorsHalcyon/Soryn
Amount$10.2 millionTerms
  • Optional and mandatory redemptive provisions
  • Carry participation rights in revenue streams
  • Negative Events – Litigation and Treasury events
  • Consent to declare dividends
Source: https://www.sec.gov/Archives/edgar/data/0001366340/000136634016000051/0001366340-16-000051-index.htm

Series A1 Financing (June 19, 2017)

InvestmentSeries A Preferred StockInvestorsHalcyon/Soryn
Amount$15.3 millionTerms
  • Optional and mandatory redemptive provisions
  • Carry participation rights in revenue streams
  • Negative Events – Litigation and Treasury events
  • Consent to declare dividends
Redemption RightsCompany option to redeem at lesser of:

1.     2.8 X Original Purchase Price
2.     Purchase prices ranging from 1.2375X to 1.575+ times based on time elapsed from date of issuance
3.     Receipt of share of proceeds from litigation or licensing which varies based on time elapsed from date of issuance

Source: https://www.sec.gov/Archives/edgar/data/0001366340/000136634017000059/0001366340-17-000059-index.htm

Based on its prior patent licensing success, Finjan likely had numerous traditional, non-recourse litigation financing offers to choose from. But instead of pursuing the litigation finance route, Finjan pursued the IP Credit path.  Finjan secured almost $26mm in financing, via two highly-structured preferred equity transactions.  These transactions featured share redemptions tied to litigation and/or patent licensing revenue events, and also contained “Negative Event” features that entitled the capital partner to recover all of their shares upon the occurrence of certain, pre-agreed negative events.  As illustrated in the chart above, the capital partner’s potential returns were capped at multiples ranging from 1.25 to almost 3x the original purchase price of the shares, with the range depending mainly on the length of time the capital was outstanding.

Finjan ultimately exited both deals.  While the exact motivations behind the deal cannot be known, it is easily theorized that the highly-structured and downside protected nature of the IP Credit Deal the company ultimately entered into was favorable in a number of respects compared to the higher cost of capital seen in traditional litigation finance arrangements.  Finjan was ultimately acquired by Fortress Investment Group in 2020.

Interplay with IP litigation

Of note, and particularly with respect to patents, enforcement litigation is often a necessary tool to resolve licensing disputes or negotiations between IP owners and potential licensees.   The reason is that without litigation, a patent owner has no means to force a party that it believes is infringing its IP to the negotiating table.

Litigation scenarios thus remain part of the broader IP Private Credit strategy.  But such litigations can take different shapes and risk profiles.  On one end of the risk spectrum are single event litigations, involving a small number of patents, that represent unattractive and binary risk profiles.  On the other end of the spectrum are multi-venue disputes, involving a significant number of patents, brought by entities owning much larger patent portfolios than what is asserted in litigation.

These types of situations (shown above to the right of the arrow) resemble business negotiations moreso than binary litigation, and can be modeled to resolve in a more predictable fashion.  By the nature of a credit-oriented investment strategy, an IP-focused Private Credit fund targets the latter opportunity set, whereas the litigation finance market has shown a willingness to fund what we characterize as the riskier, more binary type enforcement situations.

Accordingly, while litigation is not necessarily an outcome that results from such an investment, a manager that invests in the sector does need to expect, plan and prepare for litigation as a potential outcome, or at the very least as a means to an end. The idea, as with most litigation, is that ‘saner heads will prevail’ and that a commercially reasonable settlement will be achieved by both parties prior to embarking on expensive litigation.  Of course, this means that the onus is on the investor to understand the merits of the case and the plaintiff’s strategic position, potential defenses, procedural activities that could frustrate or delay litigation, and the costs associated therewith.  The complexities associated with understanding the value of intellectual property assets, and the complexity of the litigation process, make the sector a highly specialized area for investors who are often best served by investing with or alongside specialist managers.

 Slingshot Insights

Secular shifts in the economy should be forcing investors to think about value in different ways.  It’s indisputable that intellectual property is clearly the basis for technology company valuations, and therefore value must be attributable to IP when considering financing alternatives.  While understanding the value inherent in intellectual property can be difficult, fund managers with specific expertise exist to allow investors to allocate capital in an appropriate risk adjusted manner.

The fact that the insurance industry is now providing insurance products geared toward intellectual property is a testament to how far the industry has come and how significant the opportunity is, and perhaps much less risky than one would think, if approached prudently.

I believe the IP Credit asset class has a bright future, as existing players have had great success producing consistent returns in a sector that one might otherwise believe to be volatile.

As always, I welcome your comments and counter-points to those raised in this article.

 Edward Truant is the founder of Slingshot Capital Inc. and an investor in the consumer and commercial litigation finance industry.  Slingshot Capital inc. is involved in the origination and design of unique opportunities in legal finance markets, globally, investing with and alongside institutional investors.

Soryn IP Capital Management LLC (“Soryn”) is an investment management firm focused on providing flexible financing solutions to companies, law firms and universities that own and manage valuable intellectual property (“IP”) assets.  Soryn’s approach employs strategies, including private credit, legal finance, and specialty IP finance, which enable it to invest across a diversity of unique IP-centric opportunities via investments structured as debt, equity, derivatives, and other financial contracts.  The Soryn team is comprised of seasoned IP and investment professionals, allowing the firm to directly source opportunities less travelled by traditional alternative asset managers.

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Commercial Regulatory Issues

Legislation to ensure the enforceability of LFAs is progressing smoothly through Parliament

By John Freund |

The following is a contributed piece by Tom Webster, Chief Commercial Officer at Sentry Funding.

So far, the Litigation Funding Agreements (Enforceability) Bill has been passing through Parliament without a hitch.

The government is bringing the legislation in response to the Supreme Court’s decision last summer in PACCAR Inc & Ors v Competition Appeal Tribunal & Ors [2023] UKSC 28, which called into question the enforceability of LFAs.

The Bill was briefly introduced into the House of Lords on 19 March, and was debated at second reading on 15 April. During the debate, while some peers discussed the need for regulation of the litigation funding industry and for careful consideration of whether the retrospective nature of the legislation was justified, no peers opposed the Bill – and many welcomed it.

More recently, during scrutiny at grand committee on 29 April, the relatively small number of peers who attended the session broadly supported the Bill, and several spoke in favour of the need for its provisions to be retrospective.

In terms of the Bill’s drafting, the government proposed some small changes at committee stage, which were waved through by peers. The most significant was to address a potential problem with the original drafting where the LFA relates to the payment of costs rather than funding the provision of advocacy or litigation services.

The problem was that, in the original wording, it could be argued that the Bill only applied to the funding of costs that relate to court proceedings, but not those relating to arbitration, or settlements. This has now been resolved by new wording to make clear that an LFA may relate to the payment of costs following court, tribunal or arbitration proceedings, or as part of a settlement. An LFA may also relate to the provision of advocacy or litigation services.

Meanwhile another government amendment was aimed at avoiding problems for litigants-in-person, by ensuring that the definition of LFAs in the Bill includes agreements to fund the expenses of LiPs, for example where they need to pay for an expert’s report.

During grand committee, peers also expressed their approval of the broad terms of reference that have now been published by the Civil Justice Council for its review of litigation funding, which will include an examination of whether the sector should be regulated; and if so, how. Peers commended the speedy timescale that the CJC has set itself, aiming to produce an interim report by the summer, and a full report by summer 2025.

As the Litigation Funding Agreements (Enforceability) Bill continues its journey through Parliament and the CJC begins work on its review, there are clearly significant changes on the way for the litigation funding sector in the UK.

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Commercial Regulatory Issues

Rowles-Davies: Retrospective Provision in Litigation Funding Bill is ‘Fundamentally Flawed’

By John Freund |

In an article shared on LinkedIn, Nick Rowles-Davies, founder and CEO of Lexolent, makes the case against the retrospective aspect of the UK government’s Litigation Funding Agreements (Enforceability) Bill. Whilst acknowledging that many within the industry disagree with his position, Rowles-Davies argues that ‘the Bill should be prospective only and that the retrospective element is fundamentally flawed.’

Rowles-Davies summarizes his extensive article into the following key points:

  1. ‘The starting point for any consideration of the Bill must be firstly to correct the various inaccurate Supporting Documents (to the Bill) such that the law as it stands, and has always stood, is properly reflected. 
  2. The Government has put forward no credible justification to support the retrospective provision in the Bill.
  3. When considered under the true set of facts, this legislation appears to be incompatible with the ECHR. 
  4. The justification for the Bill’s prospective elements and its (arguably unprecedented) retrospective aspect must be considered separately. The Supporting Documents grossly misrepresent the position. Save for pure value transfers from previously funded parties to existing funders, what the Bill properly seeks to achieve can be accomplished through prospective only legislation. 
  5. If retrospectivity survives, it is likely that the matter will come before the courts quickly thereafter in relation to the ECHR.’

Rowles-Davies argues in the article that ‘the Supporting Documents to the LFA Bill provide absolutely no evidence of legal precedent to support the retrospective aspect of the Bill.” He goes on to say that not only is this bill ‘unprecedented’, but it also fails to provide ‘credible “public interest” justification for the retrospective aspect.’ 

In the conclusion of the article, Rowles-Davies calls on both chambers of Parliament to ‘take proper time to explore the foundation upon which the Bill rests and then test its contents after it has been repaired.’ Furthermore, he argues that ‘the positioning of the Bill is disrespectful to a busy Parliament tasked with addressing far more pressing global, social, and public interest matters.’

Commercial Regulatory Issues

Bills Targeting Litigation Finance Disclosure and Foreign Funders Make Progress in Louisiana

By John Freund |

Reporting by Bloomberg Law covers the campaign to introduce new rules governing litigation funding in the state of Louisiana, with proponents of the legislation sensing an opportunity to make progress since the state elected a new governor, Jeff Landry. The two bills making their way through the Legislature are: HB336, which would create a Litigation Financing Disclosure Act, and SB355, which would enact ‘transparency and limitations on foreign third-party litigation funding’. 

In an interview with Bloomberg, Representative Emily Chenevert ,who brought HB336, explained that the turnover in elected representatives provided a fresh opportunity, saying: “The appetite was there already within the legislature and so now it’s like, let’s attempt this and let’s see with a new House and some new senators what could happen.” Dai Wai Chin Feman, managing director at funder Parabellum Capital, spoke out in opposition to Chenevert’s bill but said that SB355 was “acceptable to our industry.”

HB336 would require any party in a civil action to disclose the existence of a litigation financing agreement, whilst redacting the financial details of the agreement, and would make all financing arrangements ‘permissible subjects of discovery’. The bill also prohibits funders from controlling or making any decisions in the proceedings, stating that ‘The right to make these decisions remains solely with the plaintiff and the plaintiff's attorney in the civil proceeding.’

SB355 requires any foreign litigation funder involved in a civil action in Louisiana to disclose its details to the state’s attorney general (AG), and to provide the AG with a copy of the funding agreement. Similarly to HB336, this bill would prohibit the foreign funder from controlling the legal action in any way and also prohibits the funder from being ‘assigned rights in a civil action for which the litigation funder has provided funding’.

HB336 has been approved by the state House and was referred to the Senate Judiciary Committee, whilst SB355 has cleared the majority of procedural hurdles and now awaits a vote by the House.