Litigation Finance

What is Litigation Finance?

Litigation finance … Litigation funding … Third-Party Funding … Dispute Finance … while there are many monikers for this industry, the premise behind the name is one and the same. Litigation finance provides capital to claimants, law firms, or companies collateralized solely by the future proceeds of their meritorious legal claims. From a public policy standpoint, it provides a means to help make the legal system more accessible on a broader scale.

Consumer vs. Commercial Funding

  1. Two Categories.  Litigation funding comes in two general categories: “consumer” and “commercial” funding. They differ in several ways.
  2. Consumer Litigation Funding.  Consumer litigation funding primarily consists of non-recourse cash advances for personal injury plaintiffs and other individual consumer cases. The risk capital is typically repaid along with financing fees if the plaintiff recovers. These arrangements usually involve individual claimants who have limited exposure to the legal system and who are rarely represented by counsel in the funding transaction. The dollar amounts involved in consumer transactions are much lower than in the commercial litigation finance realm; typical consumer litigation funding amounts are between $2,000-$5,000.   
  3. Commercial Litigation Funding.   Commercial litigation funding generally consists of non-recourse investments for companies, individuals, and law firms for a piece of the ultimate recovery, if any, in virtually any type of large commercial lawsuit. Commercial litigation finance may also be used to support various types of international arbitrations, the monetization of trial awards on appeal, the purchase of law firm receivables and judgment enforcement campaigns. In all events, these arrangements typically involve sophisticated claimants represented by legal counsel, and large commitments of capital by the funder (typically in the multi-million-dollar range). 
    1. Single-Case Funding.  Single-case funding typically provides capital for legal fees or expenses to support a single case or arbitration. It can also include working capital, debt satisfaction and other items—all subject to recovery (if any) from the case. Single-case funding can also include defense-side cases if the funder and claimant can agree on an appropriate, non-recourse return structure. 
    2. Portfolio Funding.  Portfolio funding provides capital for the legal fees to support multiple cases or arbitrations of a law firm or a company. In the case of a law firm portfolio, recovery of the funder’s investment and return will come from the fees the firm collects from any one or more of the portfolio cases. In the case of a corporate portfolio, the funder typically will be paid from any eventual recoveries in the disputes, or according to other arrangements that the funder and company may agree in advance. Portfolio funding may also be used to fund defense-side cases, with recoveries coming from the plaintiff-side disputes.    

Benefits of Litigation Finance

  1. An alternative to loans. Often, the capital obtained from a litigation funder is more attractive than taking out a bank’s line of credit to fund a case. An interest-bearing loan must be repaid no matter what happens in the case. If, for example, the case is lost at trial, the borrower is still obligated to pay back the loan, with interest.

    That is not the case with litigation finance. Because funding is non-recourse, a return on investment is collected only if the case is successful. In addition to avoiding the debt obligation that exists with a traditional loan regardless of the outcome of the dispute, Claimants who use litigation finance also are relieved of the burden of ongoing principal and interest payments. And a funder’s investment is collateralized by the litigation itself, which means in instances of law firm funding, partners’ personal assets are not on the line to return an investment should a recovery fail to materialize.

    Litigation finance also is immune from rising interest rates. Traditional debt is typically tied to the Federal Reserve’s benchmark interest rates and the cost of borrowing money could rise at any time. By comparison, the terms of a litigation finance deal are set according to the size, strength, and collectability of the dispute being funded.

    In addition to reducing risk, using litigation finance rather than self-funding legal disputes delivers immediate accounting benefits to companies and law firms. Loans add to operating expenses and thus, reduce profits. In contrast, funding removes that expense and may, in some circumstances, even be treated as revenue, immediately boosting the financial picture for a company or law firm.
  2. Flexibility. Many claimants are looking for a more sophisticated arrangement that allows them to take advantage of one of the key benefits of funding: its flexibility. Because of its non-recourse nature, funding can be used for litigation and in some circumstances, may be used for any other reasonable purpose the funded party deems necessary. Funding can, for instance, be deployed to defray operational expenses during a long, bet-the-company case, or to fund other contingency litigation that would be too costly to pursue without outside financing.

    Litigation funding also allows lawyers, claimants, and companies the flexibility to withstand low-ball settlement offers on meritorious claims, thus enhancing the likelihood that the dispute will be resolved based on the strength of the legal claims themselves, rather than based on the relative financial strength of the parties.
  3. Unlock value for companies. Dispute finance has the added power to unlock new value for companies. Consider that a company using litigation financing can:
    1. Hire lawyers that it might not otherwise be able to afford.
    2. Remove a portion of a company’s legal spending from the expense column, allowing for more flexibility in its defense efforts—and possible pursuit of meritorious plaintiff-side claims previously left on the cutting room floor. Also, this could release capital for other priorities and help improve the enterprise’s margins.
    3. Potentially turn a company’s legal department into a revenue source instead of a cost center.

The “Finance” in Commercial Litigation Finance

  1. Non-Recourse.  Litigation funders provide non-recourse capital. This means that if the claimant does not recover any litigation proceeds by way of settlement, award or otherwise, it is not obligated to repay the funder (unless otherwise agreed in advance by the parties). Simply put, if the litigant loses, the funder receives nothing, including its invested capital.
  2. Not a Loan.  Because commercial litigation funding is non-recourse, it is not a loan. There is no absolute obligation to repay the principal, there is no guaranteed return on investment and the only collateral securing the cash advance is the proceeds (if any) of the litigation.  For this reason, commercial litigation funding arrangements generally are exempt from state usury statutes.  See, e.g., Lynx Strategies v. Ferreira, 28 Misc. 3d 1205(A), at *2 (Sup. Ct. N.Y. July 6, 2010) (holding that usury laws did not apply to litigation funder because it did not advance loan but took “an ownership interest in proceeds for a claim, contingent on the actual existence of any proceeds”). 
  3. Typical Return Scenarios.  Funding arrangements are bespoke. The funders’ contracted-for returns depend on a host of factors, including the strength of the case merits, the risk profile of the subject matter at issue, the share of risk capital to which the funder is committing, collectability concerns and more.   
  4. Sharing Risk. Risk-sharing depends on a number of factors, including the claimants’ ability to pay all or a portion of the litigation expenses and the willingness of the lawyers to enter into a hybrid (or full) contingency fee arrangement. Certain law firms that rely heavily on the billable hour model, for instance, are reluctant to take significant risk on plaintiff-side litigation. With that said, some litigation funders are willing to forgo a risk-sharing exercise in certain circumstances—i.e., by paying full hourly rates and all litigation expenses—in exchange for a larger portion of the litigation proceeds if the case is successful. Full payment of attorneys’ fees by the litigation funder may even be required in certain jurisdictions that do not permit contingency fees.

What to Expect When Seeking Litigation Finance

  1. Nondisclosure Agreement.  Litigation funders invariably commence the funding process by requiring the parties to execute a nondisclosure agreement (NDA). An NDA is the cornerstone for protecting confidentiality and permitting the free flow of information among the claimant, the lawyers and the funder. It permits the funder to comprehensively assess the merits of the dispute at issue.
  2. Initial Case or Portfolio Analysis.  After gathering initial information and documentation by the claimant and/or lawyers under the parties’ NDA, the funder typically conducts an initial analysis of the case. This analysis is primarily to determine whether the matter fits the funder’s financing criteria, but also includes a high-level review of the case merits. The nature of the initial case analysis varies somewhat based on the funder as well as on the complexity of the matter, the size of the investment, and the parties’ general understanding of how risk-sharing and other factors are likely to work. It can take days or weeks depending on a host of factors. 
  3. Term Sheet.  If the parties share a mutual interest in proceeding, the funder may propose a term sheet outlining what the financial terms of the investment are likely to be if it funds the case.  Again, the nature of the term sheet (and its timing in the process) varies by funding company and regional market. Some funders offer term sheets that are non-binding except as to exclusivity during their due diligence period. Others may not require exclusivity but do mandate break-up fee provisions. There are likely many other permutations. 
  4. Due Diligence.  Regardless of whether the term sheet falls in the process, the funder must conduct extensive diligence into the investment opportunity. This consists of a deep dive into the merits of the claims, potential damages, settlement and collection prospects, and the amount of capital needed to pursue the litigation. It also involves an analysis of the claimant’s background and financial position and the capabilities of the lead litigators handling the case, including their track record of results in handling similar cases. Here too, the process differs somewhat from funder-to-funder, and regional practices around the world may differ as well. Some funders leverage in-house investment teams comprised of senior litigators with experience from elite law firms to perform diligence. These companies also frequently engage trusted outside diligence counsel and economic advisors to provide a second opinion about the likelihood of a favorable outcome. Other funders rely exclusively on outside counsel and other advisors to perform their due diligence. 
  5. Funding Decision and Litigation Funding Agreement.  The diligence period varies so widely among funders and based on the nature of the investment that providing an estimated average time to an investment decision would not be reliable. It is safe to say that the process typically takes weeks, not days. Many litigation funders have an investment committee or other decision-making body that determines whether to invest based on a written and/or oral presentation by the team proposing the investment. The goal of the due diligence period is to drive toward the investment decision if the merits and other considerations support the recommendation. If they do not, the funder informs the claimant that it cannot recommend the investment to the decision-making body and frees the claimant to explore other options. During the diligence period, funders may also provide the litigation funding agreement (“LFA”) to the claimant and lawyers for vetting with the goal of hitting the ground running after the investment decision is secured. The LFA is a binding contract that sets out in detail the terms and conditions of the investment. 
  6. Monitoring.  The post-investment monitoring of matters also can vary somewhat among funders and from investment-to-investment. Typically, however, funders take a “light touch” approach to case management. Funders are not permitted to control the lawyers’ strategy decisions and generally are afforded limited rights under the LFA. The right to be informed, including of settlement offers and major case developments, is a fairly common one. Thus, funders usually check in on a regular basis with the lawyers and claimant and sometimes require periodic written reports of material developments.  Because litigation funding professionals are intimately familiar with the case merits, the lawyers and claimant often seek their non-binding input on strategy and other important issues as the case proceeds. This is especially true if the funding professionals are lawyers. Funders may attend mediations and settlement conferences—not because they control settlement, but rather, to help advise the claimant about how the LFA operates under different settlement scenarios and to provide any pertinent information to the neutral. Funders also may attend major hearings and trial as observers, so long as their attendance does not raise confidentiality concerns for the claimant and lawyers who wish to keep their finances private.