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ANALYSIS: Litigation Finance Ready for Post-Covid Challenges

May 18, 2020, 8:40 AM

Although focused on other issues just a few short months ago, all eyes in the legal industry are now on the Covid-19 pandemic and its economic effects. For the litigation finance industry, the question of the moment is how the crisis will impact the type, volume, and size of deals that are sought and funded. Despite probable negative impacts on the larger legal industry, the litigation finance industry is arguably well-positioned to maintain its momentum as a growing industry even through the economic downturn.

What’s Bad for Most...

There is little doubt that the pandemic and accompanying financial downturn will leave lasting marks on the legal industry, and on the broader economic and business ecosystem as well. Whether certain practice areas, firms, or industries will be harmed by the crisis—and if so, how much—depends on a variety of factors. Practice areas that are correlated with the market will be more negatively impacted. Mergers and acquisitions have slowed, and IPOs have stalled. Overall appetite for business and economic risk is undoubtedly lower.

At the same time that businesses and firms are more risk-averse, litigation sometimes becomes more necessary for cash-strapped clients. Disputes that business counterparties may have worked through and considered a normal part of doing business in pre-pandemic times might now be worth going to the mat over. And at this juncture, where risk aversion and necessary litigation meet, litigation finance can step into the spotlight.

...Is Good for Litigation Finance

Litigation finance is, by its nature, designed to help hedge the economic risk of litigation. Obtaining financing in normal times can make pursuing an expensive claim more feasible. In times of economic turmoil, litigation finance allows clients the bandwidth to bring a big claim and risk losing—a risk they otherwise couldn’t afford to take. In addition, law firms that were previously willing to take cases on contingency can now turn to litigation financing to spread their risk.

Simply put, because of litigation funders’ role of sharing and therefore reducing risk, there will be an increased demand for funding as a result of the downturn.

Changes to Deal Specifics

The types of financing deals that funders are approached about will shift during this time. Funders will see more activity in certain practice areas and deal types that will increase due to the economic downturn, including bankruptcy, insurance coverage, and contract litigation.

Funders will also see more requests for claims monetization, which often comes up when a case is on appeal or awaiting enforcement of a judgment and allows the client access to cash that is otherwise inaccessible until the legal claim is resolved. Portfolio arrangements with law firms also will become more frequent, so that firms that have already invested in contingency fee cases can sell off a portion of the risk to a litigation funder in exchange for cash they need for their balance sheets on a more urgent basis.

Not All Roses

The downturn won’t be all roses for the litigation funders. The crisis will bring complications to their practice as well. Delays in court proceedings may complicate deals, since funders often structure their deals to include specific time components—when certain time benchmarks pass, the funders’ return grows. While delays in the resolution of cases could mean higher returns for funders, it could also mean facing contract disputes with clients who are unhappy about losing a portion of returns to funders over pandemic-related court delays that are beyond their control.

Another potential complication is whether the funders’ capital will be held up or harder to obtain. Smaller funding companies without committed capital might see this issue when delays in court proceedings result in delays in their expected returns. This will impact the cash that those funders have available to invest in more cases. Additionally, hedge funds, which have been a big source of new funding in the market, might not want to invest right now during this uncertain time. (On the other hand, they may be more inclined to invest in opportunities that are not directly correlated with the market.)

Overall, bigger companies with established pools of capital may be best equipped to take on some of the new cases flowing from the crisis. But smaller funders will still hope to benefit from the simple fact that the value of litigation claims is not directly correlated with the market.

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