Anytime a client seeks to minimize exposure to large, unpredictable litigation expenditures or to monetize a portion of the claim's value or to hedge against the risk of an adverse outcome, commercial litigation financing may be an attractive solution. However, litigation funders are very selective about the cases in which they will invest. Only meritorious cases with demonstrable economic damages in excess of $10 million would even be considered. Financial viability of the claim's pursuit is essential, i.e., the claim's value must greatly exceed the legal budget and/or amount of financing sought (a ratio of 10:1 is a good rule of thumb). Otherwise, any type of commercial claim is eligible for commercial litigation financing at any procedural stage.
The benefits of litigation finance are significant. For companies, litigation financing limits their exposure to uncontrollable, unpredictable litigation budgets; minimizes adverse financial impact of litigation; preserves capital for deployment into core business activities; hedges against the risk of adverse litigation outcomes; and facilitates engagement of preferred legal counsel. For law firms, litigation financing offers expanded options for the firm's clients and can enhance the firm's capacity for alternative, risk-sharing engagements.
The downsides of litigation finance must, of course, be weighed against the potential benefits. Litigation financing reduces a client's potential upside in a successful outcome due to the financial interest of the litigation funder. Exploring and consummating a litigation funding transaction involves a complex, time-consuming process and requires serious involvement by company executives and outside litigation counsel (usually at significant expense), with no assurances that the process will be successful. By necessity, one rule of litigation funding is that confidential information must be disclosed to potential litigation funders as part of their diligence process. Finally, even though litigation funders strive to offer convenience and play a passive role, complexities and burdens and risks may arise whenever a third party (i.e., a litigation funder) is added into the equation.
The diligence process for a litigation funder resembles that of an experienced lawyer evaluating whether to accept a litigation engagement on a contingent fee basis. Much of the information required is either public record (pleadings, orders, et cetera) or will be produced in discovery anyway (key documents, contracts, expert opinions, et cetera). Some confidential information that is protected by the work product doctrine will usually be required (lawyer's assessment of strengths and weaknesses, litigation budget and strategy, models supporting the damages claim, et cetera), however, as long as an NDA is in place, no waivers of confidentiality should occur. Reputable litigation funders do not seek information that is beyond the scope of work product protection and confidential solely due to the attorney client privilege.
Reputable litigation financing providers do not control the management or decision-making in the case, including decisions regarding settlement or disposition of the claim. They are strictly passive investors. Reputable litigation funders explicitly state this lack of control in their litigation financing agreements.
Pursuing a litigation financing transaction without the advice of an expert places a company at significant risk of an inefficient, protracted, and ultimately unsuccessful litigation financing process. An experienced advisor like Westfleet will be familiar with the information a provider will expect to receive and will present it in a manner that will both resonate with the litigation funders and streamline the entire process. Also, an advisor with extensive contacts within the litigation finance industry can bring more potential litigation funders into the discussions and create a competitive environment for the transaction. Using an experienced advisor will substantially reduce the time that company executives and outside litigation counsel must spend pursuing litigation financing and can eliminate inefficiencies and potential risks in the process.
The normal process of financing term negotiation, completion of due diligence by the litigation funder, and execution of financing documentation is 60 to 90 days. Often extenuating circumstances exist which cause delays in this process, but seldom does it take longer than 180 days to complete a transaction. When speed is crucial to the client, some funders are capable of closing a transaction inside of two weeks.
No, litigation finance is available at every stage of litigation, including before a lawsuit has been filed. Litigation finance transactions frequently occur at the inception of litigation (or immediately prior to), however, often a need arises during the course of litigation when the litigation budget increases substantially or when a client begins to experience budgetary pressures. Litigation finance is even available after a judgment has been obtained and an appeal is pending.
For more on this topic, read our article Helping Clients Overcome Financial Hurdles Mid-Litigation
The answer can vary depending on how the transaction is structured. Litigation funding transactions are often structured off-balance-sheet, where financing proceeds are drawn directly to pay outside legal counsel. In that case, the portion of the legal budget that is financed does not appear as an expense in the company’s financial statements (similarly to how these foregone expenditures would not be recognized if a company engaged a law firm on a contingent fee basis). Also, if structured properly, the financing proceeds would not be taxable as income.
In terms of the repayment, on plaintiff-side financings, the repayment liability coincides with an as-yet-unrecognized inflow or revenue item (e.g., a recovery in the legal claim), so the liability to repay the financing provider would be offset by a surplus cash flow; on defendant-side financings, liability to repay the financing is often netted against the reserves already in place for the company’s potential liability in the claim. This offsetting feature means that the sum of the legal budget financed plus the financing costs is significantly less acute than if a company had self-financed the entire legal budget. Of course, the more exotic the litigation financing structure, the more complex the accounting and tax treatment is likely to be.
Financing costs are negotiated on a case-by-case basis and are based upon a variety of factors, including the risk of an adverse outcome and length of time the litigation financing may be outstanding. Of course, a provider receives nothing in cases that are unsuccessful. Since capital providers assume the risk of an adverse outcome, their profits on successful financings must be sufficient to offset their losses on unsuccessful ones. Capital providers strive to generate private equity-like returns (e.g., 20%-plus annualized returns) for their investors.
In order to achieve these returns, litigation funders are typically seeking multiples of their capital invested in successful cases ranging from 2x to 4x. For $1 million in financing outstanding, a funder might be entitled to a profit ranging from $1 million to $3 million, but the costs are really best viewed as a reduction in the upside in a successful resolution of the claim as opposed to a financing cost.
As long as a nondisclosure agreement is in place prior to information being conveyed to a litigation funder, that information should remain protected by the work product doctrine and not be discoverable by the opposing party. However, disclosure of information that is confidential solely due to the attorney-client privilege (and not also the work product doctrine, which affords a broader and less easily waived protection) is likely to result in a waiver of the privilege. Reputable financing providers do not seek information that is confidential due solely to the attorney-client privilege.
Even though existing case law unanimously supports the position that work product protection extends to any information conveyed to a financing provider (or related third party) as long as an NDA is in place, some opposing parties may be inclined to attempt to obtain such information through discovery anyway, resulting in expenditures on a satellite discovery dispute. These expenses should simply be built into the legal budget and weighed against the benefits of financing.
Financing is available to both plaintiffs and defendants, although the market for defendant-side financing is still in the early stages of development. Plaintiff-side financing is much more common, largely because of the relative ease of defining “success” on the plaintiff-side. Defendant-side transactions are structured similarly to reverse contingent fees, whereby the capital provider receives an interest in the differential between a defendant’s exposure and the amount of the claim that is ultimately paid.
Not typically. In this type of litigation financing the funder needs to know who litigation counsel will be and what their commitment to the case is. The evaluation of the experience and credentials of lead counsel may be the single most important factor in a litigation funder’s underwriting. Therefore, a company seeking litigation financing must have engaged litigation counsel, or have litigation counsel who is willing to engage subject to a litigation financing arrangement.
Yes. In fact, litigation finance contracts directly with law firms are becoming increasingly common. However, these agreements are usually structured as financings of a law firm’s portfolio of contingent fee cases and often have attributes similar to non-recourse debt financing. Depending on the jurisdiction, law firms are permitted to enter into single-case litigation funding agreements where payments to the funder are contingent upon a successful litigation outcome, but careful attention must be paid to fee sharing prohibitions when structuring the funder’s repayment rights.
Nothing. Most litigation funding contracts are structured where the funder’s sole right to be repaid is tied to the successful outcome of the litigation with no recourse to any other assets of the recipient.
No. Well-capitalized companies have many resources with which to finance legal budgets, but the ability to tie litigation expenditures to a successful outcome—to pay based on how satisfied they are with the results—is attractive to most business people, regardless of their company’s size. And aside from contingent fee engagements, this feature is only available in the litigation financing market.
For legal matters that fall outside a company’s routine legal budget, litigation financing enhances the ability to manage these extraordinary expenses and to hedge risk. When a company uses its own capital for these extraordinary expenses, it is foregoing some alternative use of that capital, where the alternative use is usually an investment in its core business. For most companies, litigation is a non-core area where risks and rewards are not well understood, and companies typically do not enjoy a relative informational advantage in making litigation investments versus investments in their core business.
Unless you have aligned your company or law firm with an expert like Westfleet Advisors, you can expect to encounter an opaque, inefficient market. No publication of financing terms occurs, and no centralized exchange exists. With some effort, most of the major litigation funders can be identified, but many smaller, specialty funders who may offer better terms and structures will likely not be visible through conventional research.
Litigation funders are bombarded with low quality financing opportunities, so unless you have a prior relationship, you may encounter difficulty getting a funder’s attention. Finally, until very recently (i.e., Westfleet’s launch in 2013) most funders operated in an environment largely insulated from competitive pressures. This mindset persists with many litigation funders, so a prospective recipient is likely to encounter opportunistic pricing and deal terms from some funders unless it is clear that they are exploring many different alternatives with other litigation funders.