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Litigation Finance: New Possibilities for a Maturing Sector

Dec. 9, 2021, 9:00 AM

Litigation finance is going mainstream. The search for non-correlated and equity-like returns has driven investment and resulted in a maturing litigation finance sector poised to increase opportunities for financiers and consumers.

These consumers are typically law firms funding operations by financing claims portfolios, individual plaintiffs financing expensive litigation, and corporate legal departments tasked with controlling legal budgets or reorienting as profit centers by bringing legal claims that generate revenue and support corporate strategy.

Available data indicates the sector grew in 2020. With Covid-19 hopefully abating, litigation finance products are reaching a tipping point where they will become normalized, and consumer education will increase opportunities for financiers resulting in greater specialization and more nuanced offerings.

Going forward, law firms and businesses will likely strengthen relationships with financiers and develop new ways to budget and monetize claims that previously may not have appeared viable or scalable within an organization’s existing budgetary constraints. It’s important to understand the impact of consumers’ growing awareness and use of litigation finance, and how it may affect litigation, the business of law, and the courts.

Litigation Finance Should Result in a Win-Win

“Litigation finance” generally refers to a third-party funding some or all of a plaintiff’s litigation expenses or otherwise monetizing claims prior to their resolution, in exchange for the financier participating in the recovery generated from resolution of the claims. It is typically a non-recourse equity-like investment, unlike traditional lines of credit historically used to fund plaintiffs’ law firms with debt.

Deployed correctly, litigation finance should result in a win-win-win, (1) providing funding to claimants not otherwise able to bring costly litigation, (2) de-risking litigation for law firms by ensuring at least partial payment, allowing firms to satisfy operational expenses while representing clients who otherwise could not afford their services, and (3) providing equity-like returns to financiers.

Society benefits as these arrangements democratize litigation and expand access to justice, leveling playing fields for claimants against well-funded defendants.

While benefits abound, drawbacks include potential conflicts between client interests and those of their financiers, which are not always perfectly aligned. For example, when executing financing agreements, lawyers may simultaneously owe duties to financiers and their clients, in some cases potentially diminishing a lawyer’s undivided loyalty to the clients.

Growth Could Impact Attorney Compensation Structure

Increased competition should result in easier access to financing, improved and diversified products, and more expertise within the industry. Hedge funds and family offices, as well as smaller investors, may increase their exposure to the sector, which could result in less-experienced litigation financiers and less optimal terms for law firms and plaintiffs, but greater diversification of funding sources.

Financiers will continue competing on price terms, the length of due diligence reviews, and time to close a transaction, benefiting consumers. Industry publications reveal conversion rates from applications to closed transactions are in the single digits, with funders typically requiring a 10:1 ratio of collectible damages to deployed capital. That ratio may change if more capital is deployed over a more diverse range of claims.

Proprietary algorithms will likely play a greater role in allocation decisions as financiers study lawyers, claimants, defendants, jurists, and past results, using data that is now more accessible and cheaper to acquire. Specialization and financier differentiation is also likely to accelerate, with institutions, businesses, and law firms forming durable relationships with preferred financial partners.

The net effect may be slightly increased high-exposure litigation, resulting in larger premiums for insurance coverages that typically support the defense of such claims, including class actions.

Law firms may also need to rethink partner and associate compensation models if they begin regularly taking on plaintiffs’ claims that receive funding on a hybrid contingency/reduced hourly fee structure. This is because financiers prefer to align their interests with those of participating counsel, meaning they often require law firms take part of their fee on a contingency basis while receiving a portion of their hourly fees.

Particularly for associates who are regularly compensated based on collections of hourly billings, reduced hourly collections may serve as a disincentive to work on a case that receives financing unless compensation and bonus structures account for contingent fee recoveries. Without accounting for contingent fee awards, compensation and year-end bonuses would be diminished by working on financed cases.

This could change compensation structures at larger firms that historically do not work on contingency fee models and may have a downstream effect on smaller firms. To attract and retain talent, small and mid-size firms will need to ensure compensation remains competitive when litigation is financed.

Courts and Bar Associations Will Adapt

Courts will increasingly grapple with the discoverability of financing agreements, communications between counsel and financiers, and related issues.

Bar associations, and judges presiding over malpractice litigation, will contend with ethical and fiduciary considerations when, for example, lawyers advise clients to contract with a financier to pay attorneys’ fees. Courts have explored these issues with varying results.

For example, in TC Tech. v. Sprint, the court vacillated on whether communications with a prospective funder fell within the common interest privilege.

Bar associations, courts, and legislatures will likely develop opinions and legislation, providing better guidance. Prohibitions on fee-splitting and non-lawyer financial interests in law firms are also implicated. For example, allowing a financier to hold an interest in a majority of a law firm’s cases could be scrutinized and receive disparate treatment in different jurisdictions.

Courts, bar associations, consumers, and financiers will need to become more familiar with these and other issues as the sector expands, which may result in a bumpy but generally more egalitarian environment for claimants and law firms.

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

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Jason N. Goldman is a shareholder at Davis Goldman PLLC, a litigation firm based in Miami focusing on commercial litigation, products liability, medical malpractice, and personal injury litigation. He has successfully financed commercial litigation for clients, and represents litigation financiers in performing due diligence reviews.