Litigation finance - a powerful tool for creative corporate counsel
A December 2017 survey conducted by Law360 found that only one in 10 in-house counsel had used litigation financing, but more than 80% of all attorneys surveyed who had used it in some fashion held a favorable view of the tool.[i] According to those quoted in connection with the survey, this disconnect may arise because "many GCs lack education and awareness about this type of finance, making them unlikely even to consider it."[ii] Whatever the reason, ignoring what has become a $5 billion investment industry in the U.S. alone could put the unwary in-house lawyer (and her company) at a competitive disadvantage. This article thus aims to close that information gap, and enable more corporate counsel to consider litigation finance in the right circumstances as an option to facilitate otherwise unobtainable results for their businesses.
Litigation Finance is Not a One-Size-Fits-All Solution
Ask anyone in the litigation finance industry to describe their product, and you will likely hear that "nothing is cookie cutter" and "the possibilities are as broad as the client's imagination." But there do appear to be at least a few recurring options that in-house counsel should understand.
Perhaps the most familiar form of litigation funding involves third-party financing of a single case. In exchange for funding the litigation, the financier in this model accepts a multiple of its investment in the event the case is successful, as defined by the parties' agreement, while also accepting the risk that it will lose the entirety of its investment if the client does not prevail in the litigation. In this model, a company gains the ability to use the law firm of its choice to pursue a substantial recovery for a material injury, e.g. as the injured, high-volume purchaser of a product that has been the subject of an antitrust price-fixing conspiracy, but without requiring a contingent fee arrangement or incurring the full expense of the billable hour.
Another option to consider for a lawyer whose company is facing a higher volume of litigation is a portfolio finance deal. Under this scenario, the litigation finance company provides capital to cover a portion of the cost associated with the designated set of litigation matters, and then if - and only if - a favorable judgment or negotiated settlement comes in, the funder recovers a multiple of its initial investment. This portfolio may include affirmative recoveries or litigation defense, and may even involve unrelated disputes. Because the volume involved with the portfolio deal allows for further
diversification of risk, however, the litigation financier may be willing to provide less expensive capital, or alternatively structure the terms of the deal in a way that makes it more attractive to the client, e.g. by enabling the company to realize a portion of its recovery before the cases are completed.
A third litigation finance option is comparable to the first, but involves a case under appeal by an adverse party. In these post-judgment financing arrangements, the funder provides capital to defend a lower-court award in favor of your company with the understanding that it will recover a multiple of that investment if - and only if - a favorable judgment is entered on appeal.
Some Key Elements of Litigation Finance Arrangements
Although the structure of each litigation finance arrangement may vary, there are certain elements of these transactions that should remain constant to help deliver value to your business. First, these funding arrangements should be non-recourse, meaning that the financer does not earn an investment return unless the underlying litigation is successful. Second, the third-party financer should not obtain any right to control the litigation; funding agreements should and do tend to expressly prohibit this involvement - both in connection with litigation and settlement strategy. In this way, financing arrangements avoid running afoul of historical state champerty and maintenance laws that prevented third parties from interfering with court cases by financially backing one of the parties. Third, your outside counsel should safeguard any confidential information related to the matters that are being financed, and require terms in the funding agreement that confirm the investors are not intruding upon the attorney-client relationship or exposing work product to discovery. Courts have generally sustained the ability of litigation financiers to review attorney work product without waiving that protection in the underlying dispute, but that case law is not without exception.
Getting to a Deal
Given the risks involved and the substantial investments they are making, litigation finance firms understandably conduct their own due diligence before extending a financing offer. Under the protection of a carefully worded non-disclosure agreement, this due diligence will likely involve an analysis of the value of the cases being financed, including an estimate of the costs associated with bringing them through trial and appeal. While a necessary exercise for the funder, this due diligence can also benefit the company and its counsel by providing another informed opinion on the merits and challenges associated with the underlying disputes. In order to assure a healthy return on investment to everyone involved - the claimant, its counsel, and the third-party funder - litigation financers typically will only fund cases in which realistic expected damages significantly exceed the size of their investment. They will also require that both the claimant and its counsel retain appropriate amounts of both risk and reward, in order to properly align the parties' incentives.
All this has led some commentators to refer to litigation finance as "expensive money," with funders sometimes requiring a 10:1 ratio between the expected litigation costs and recoverable damages, in order to support the recovery of their investment plus 25% of the net proceeds from the lawsuit if successful. But while critics are technically correct to recognize that litigation finance can cost a company more than it would pay for traditional financing, they must also recognize that (1) the capital is non-recourse, (2) the funder gains no control over the litigation, and (3) banks and other traditional sources of capital are unlikely to be willing to take on the risks associated with litigation finance. As a result, whether to fund a single matter, a portfolio of cases, or as a means of monetizing a litigation asset before it has matured, corporate lawyers would be well served to consider discussing litigation finance as an option with their outside counsel, and potentially to have them arrange a meeting with representatives in the industry to review available options. If you do, you may just find yourself on the other side of those survey results, next time someone asks your opinion on litigation funding.
See Violante, Cristina, What Your Colleagues Think of Litigation Finance, Dec. 11, 2017, available at https://www.law360.com/articles/989204/what-your-colleagues-think-of-litigation-finance.