INSIGHT: Litigation Financing Can Fill the Gap During Economic Turmoil

April 2, 2020, 8:00 AM

No industry will be spared from the personal and economic toll of the new coronavirus. Businesses across the world are looking for the most effective means to mitigate the human and financial toll and law firms are no different. For the global legal sector, litigation finance stands as a ready and proven tool to stem losses.

There are billions of dollars of existing committed capital ready for deployment in high-end litigation, with announcements of nine-figure capital raises becoming almost commonplace. Given the current global turmoil, the growing allure of investment in non-correlated assets should sustain the influx of investment for the foreseeable future.

At this extraordinary moment, these monies represent a lifeline that wise firms will use to avoid fiscal pain at both the entity and individual partner level.

Law firms are partnerships, with individual partners receiving monthly draws. While this looks and feels like a salary, and is treated as one from a monthly financial planning perspective, such is not the case. Instead, draws are a portion of the firm’s expected profits for the year. As most firms will be well off their 2020 plan numbers, many partners will be overdrawn and forced to return a meaningful portion of those monies at the end of the year.

Like professionals in all walks of life, partners plan their finances around a certain monthly income, and the requirement to send back six figures at the end of the year is simply untenable. As firm leaders work through downside scenarios and difficult decisions in the days and months ahead, there are multiple ways they can engage litigation finance to address these shortfalls.

Selling Off Existing Risk

The most immediate path to increasing much needed 2020 revenue is selling off existing risk. It is a poorly kept secret in the litigation funding world that large law firms often self fund what they see as the most attractive cases. In a world where 37 law firms have revenues of at least $1 billion, betting $5 million to $10 million per year on a few contingent fee cases that could lead to high eight and low nine-figure firm recoveries is certainly understandable.

This year, with the pending revenue shortfall, firms with strong ongoing contingency cases can sell off some portion of those potential future gains for revenue that will make a difference today.

For funders, this is a tremendous opportunity to buy into appealing matters that would otherwise not be open to outside investments. Many of these cases have survived motions to dismiss and summary judgment such that the risk of loss is lower than at the outset and leverage over defendants that are facing trial is higher.

For these mature cases, underwriting can be done relatively quickly as a developed factual record and existing rulings on matters of law remove much of the educated guesswork required to underwrite a case that has yet to be filed.

One structure that has proven popular is to pool a series of contingency cases (to avoid fee-splitting concerns), calculate the firm’s investment in hourly fees across those matters and invite a third party to make a proportional co-investment.

As an example, imagine a firm that has invested $20 million in three cases and is entitled to 40% of the proceeds. A firm may invite a funder to invest $10 million, half of the firm’s investment, in exchange for half of the firm’s right to payment, 20%. This allows firms to take in a meaningful amount of revenue in 2020 while still maintaining potential upside in the future.

In addition to exploring monetization to keep their fiscal houses in order, firms are well aware that their fates are inextricably tied to the financial health of their clients.

Like law firms that choose to self fund the best contingent fee cases, large companies that use high priced firms for hourly defense work often prefer to pay those same firms to handle large dollar disputes where they are the plaintiff.

Given the financial reckoning, legal budgets will inevitably shrink, and companies may believe that their only option is to turn to contingent fee firms for ongoing or future matters. Firms should get out ahead of these situations, look at their plaintiffs’ side non-contingent matters and identify those where clients’ willingness and/or ability to pay may dissipate.

Where there are signs of trouble, firms should have a straightforward discussion about litigation funding such that they have the best chance to keep existing matters and remain in contention for future matters.

Litigation funders exist to make non-recourse capital available today in exchange for the potential of a risk adjusted premium tomorrow. As firm leaders face unprecedented turbulence over the next few months, those who best utilize the tools at their disposal, including litigation finance, are most likely to weather the storm.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Ted Farrell is the founder of Litigation Funding Advisers, a full service advisory firm that works with claim holders and law firms to run orderly funding processes and advise on all aspects of legal finance. Prior to LFA, Farrell was a managing director at Vannin Capital responsible for originating, underwriting and negotiating transactions. Before his career in litigation funding, he was a partner at RuyakCherian LLP and an associate at Winston & Strawn LLP and Baker Botts LLP.

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