Patent Litigation Weekly: How to win $25 million in a patent suit—and end up with a whole lot less

This week: DeepNines collected $25 million when it won an infringement suit against anti-virus software giant McAfee Inc. in the Eastern District of Texas two years ago. But after paying off its Fish & Richardson lawyers and outside investors at Altitude Capital Partners, the small network-security company wound up with less than $800,000 of the $25 million. And now DeepNines is being sued by Altitude, which wants millions more than it's already gotten. A revealing look at how a leading player in the lawsuit-investment trade does business.

Third-party financing of lawsuits—often described as a new and growing phenomenon—has been much in the news lately. But outside investors have been making multimillion dollar bets on patent lawsuits for years. One of the field's leading players is Altitude Capital Partners, founded by investment bankers Robert Kramer and Warren Hurwitz. Altitude, which has been investing in patent lawsuits since at least 2006, boasts of having more than $250 million to spend on such litigation.

Last week, The Prior Art reported on one patent-holding company Altitude has invested in. This week, we offer the story of another Altitude investment—one that resulted in an acrimonious lawsuit between parties that used to be on the same side.

In 2007, Altitude loaned DeepNines Inc. $8 million to pursue a patent infringement claim against leading anti-virus software maker McAfee in the Eastern District of Texas. The case went to trial and DeepNines, a small, Texas-based network-security company, won an $18 million jury verdict. Facing additional potential exposure, McAfee eventually agreed to end the litigation by paying DeepNines what at the time was a confidential settlement, but what documents now show was $25 million.

That settlement allowed DeepNines to repay the Altitude loan, plus 10 percent interest, plus another $700,000 in "participation" cash—Altitude's contingent fee winnings.

But Altitude founder Kramer wasn't satisfied with that amount. In 2008, he told DeepNines it owed Altitude some $5 million more. When he didn't get paid, Kramer hired Akin Gump Strauss Hauer & Feld to sue DeepNines in New York state Supreme Court. Most of the key documents in the case—including the heavily redacted public complaint [PDF]—were filed under seal. But this week, TPA acquired unredacted versions of many of those key documents. Taken together, they provide an intriguing peek into the workings of Altitude's patent litigation-loan business.

Among the highlights:

• The parties on the plaintiffs' side in the McAfee litigation anticipated a much bigger payday than they got. Agreements between DeepNines, Altitude, and Fish & Richardson lawyers show an "estimated damages model" that posited a $200 million win. Such a victory would have translated into more than $50 million for Altitude and more than $100 million for DeepNines.
• Instead, after paying its Fish & Richardson lawyers and repaying Altitude, DeepNines walked away with less than $800,000 of the $25 million.
  
• In total, Fish & Richardson collected more than $11 million for handling the litigation: $4.07 million in hourly legal fees, $3.25 million thanks to a 13 percent contingent stake in the case, and an additional $1.9 million (It is unclear from the court papers what the latter amount was for). The balance went to DeepNines in October 2008. Two months later, company president Daniel Jackson wrote in court papers that he "questioned many of the [firm's] charges" and specifically disputed the $1.9 million took above and beyond its hourly and contingent fees. Contacted this week, lead Fish & Richardson partner Tom Melsheimer declined to comment except to say the firm has "no current disputes" with DeepNines.
  
• Well-known former federal judge Robert Parker of Parker, Bunt & Ainsworth of Tyler, Texas, served as local counsel in the case. Parker had a 5 percent contingency stake in the matter, which netted him roughly $1.25 million. (The figure pales in comparison to the $10 million that Parker—who, according to Stanford University's LexMachina database, has been listed on the docket in more than 100 East Texas cases since 2005—stood to make under the "estimated damages model.")
  
• DeepNines' "out of pocket" legal expenses for the case, including payments to experts and travel expenses, totaled more than $2.1 million.
• The patent lawsuit represented a major gamble for DeepNines, which had less than 40 employees and just $8.4 million in assets in 2006. Only about $1 million of that amount was cash in the bank.
  

The saga began in 2006 when DeepNines sued McAfee for patent infringement. At issue: patent No. 7,058,976, which deals with network security technology. Soon after filing suit, DeepNines borrowed the $8 million from Altitude. The lawsuit paid off when McAfee lost the jury trial and was hit with the $18 million verdict for willful infringement.

Facing additional damages connected to the willfulness and a false marking claim, McAfee ultimately ended the dispute by agreeing after trial to pay DeepNines a settlement that the documents unearthed by TPA reveal to be $25 million. For its trouble, DeepNines walked away with less than 5 percent of that sum.

Though Altitude received $10.1 million on its original $8 million investment, CEO Kramer wrote to DeepNines in October 2008 demanding another $5.3 million, arguing that DeepNines shouldn't have deducted legal expenses before giving Altitude its contingent-fee share. The next month, Altitude hired Akin Gump to sue DeepNines for breach of contract. (The named party in that suit is Altitude Nines, an Altitude Capital subsidiary set up for the DeepNines deal.)

Aware that DeepNines has two new patents suits pending—and worried that it would plow whatever cash it has into those suits—Altitude's lawyers asked the judge in the breach-of-contract case to force DeepNines to set aside several million dollars so that the company's funds wouldn't be "dissipated." DeepNines responded by saying Altitude was unlikely to succeed in the suit, was using bogus math to calculate its fair share of the McAfee winnings, and shouldn't be awarded a preliminary injunction. DeepNines also noted that a second investor in the McAfee suit, venture capital firm Dawntreader Ventures, agreed with DeepNines' calculation even though it stood to gain if it went along with Altitude's calculations.

Ultimately, Justice Richard Lowe ruled that Altitude's lawsuit was a "garden variety" breach of contract case that didn't require an injunction.

Neither Altitude founder Kramer nor DeepNines' Jackson responded to phone calls and e-mails requesting comment this week. Court papers indicate that both were both scheduled to be deposed last month. DeepNines is being defended by Mintz, Levin, Cohn, Ferris, Globsky and Popeo.

This fee dispute aside, Altitude's litigation investments have been getting more ambitious. In January, TPA reported that Saxon Innovations, a patent-holding company set up by Altitude, filed suit against five cell phone manufacturers at the International Trade Commission, seeking to bar imports of several popular phone models into the United States. That's a high-stakes undertaking, because litigating a case at the ITC can cost $10 million or more.

Meanwhile, e-mails between DeepNines' Jackson and his outside investors that are included in the breach-of-contract case documents show reveal frustration with Fish's performance in the McAfee case—and with the firm's bill: "The fact that we ended up with less than expected is because they screwed up the claim construction," wrote Ed Sim of Dawntreader Ventures in one e-mail to Jackson and other investors. Sim also suggested that in the future, DeepNines hire its lawyers on a full contingency basis.

Apparently Fulbright & Jaworski fit the bill. DeepNines has hired the Texas firm for its two pending patent lawsuits: a second one against McAfee filed in May that accuses the software maker of infringing two other DeepNines patents, as well as the '976 patent again, and a suit filed last month asserting two patents against Fortinet, Inc.

• Altitude Nines, LLC v. Deep Nines, Inc. 603268-2008, Supreme Court, County of New York.

Documents:

• Spreadsheet showing DeepNines' and Altitude's differing calculations of "IP Revenue" [PDF]
• Declaration of DeepNines President Daniel Jackson [PDF]
• Declaration of Altitude Capital founder Robert Kramer [PDF]

Image: Wikimedia / FML 

Comments

[Law Student]

Another great report

"Well-known former federal judge Robert Parker of Parker, Bunt & Ainsworth of Tyler, Texas, served as local counsel in the case. Parker had a 5 percent contingency stake in the matter, which netted him roughly $1.25 million."

How exactly does this ED TEXAS local counsel scheme work? Who gets most of this local counsel business?

Mr. Mullen- thanks for the blog. As a law student interested in IP law, this blog is fascinating!

[twitter.com/IPStrategist]

Joe, thanks so much for continuing to dig up this information. It greatly helps those of us who seek to pull the curtain back to reveal that patent litigation is not a viable business model for most startup companies.

[Armchair Economist]

>How exactly does this ED TEXAS local counsel scheme work? Who gets most of this local counsel business?

Seems like 1.25m could be better put to use toward a one time clarification of any local custom/rule inherent ambiguities in order to obviate the need for local counsel.

It seems probable that carefully crafted arguments against this reasoning exist.

[www.facebook.com/profile.php?id=513762461]

Interesting case. The lawyers made more money than the "innovators." Now I know why it was the lawyers who were arguing for bringing software patents in India. So much moolah is absolutely irresistible!

[Tanya Thomas]

Thanks so much for bringing these issues to the Internet.
It certainly gets complicated with a patent suit win re: DeepNines. Everybody seems to have their hand out.

[Gena777]

This case makes it clear that patent litigation has, indeed, become big business and (for major players, at least) potentially a lucrative investment. Maybe suits such as this one will cause more companies to give more consideration to IP and how it fits into their business plans.
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