“Practice Innovations” is a quarterly, online newsletter that examines best practices and innovations in law firm information and knowledge management. In this installment, we discuss the status of litigation funding in the legal arena.
Recent surveys indicate an increased use of and interest in litigation funding from both the law firm and client sides. So now is a good time to take a step back, see where this is and talk about where it might be headed.
Litigation funding (or litigation finance) occurs when a third party provides funding to cover fees and/or costs related to litigation. The funding company gets paid with successful case outcomes. There are a growing number of these companies in the market with significant financial backing. Most typically the financings are for plaintiff-side representations, where the payouts (settlements or judgments) are sources to repay the companies, where they are paid some portion of the payouts. But the options for “legal financing” are expanding quite a bit beyond the single case, plaintiff-based options.
Initially most financing was done on single case litigation. This meant the provider had to do deeper due diligence as the risk was all tied up in one case. They needed a high degree of confidence in both the case and the litigating firm before deciding to fund a matter.
More recently these providers have shifted towards funding portfolios of plaintiff litigation. This allows for less risk, easier diligence and higher levels of funding. The providers in these scenarios will provide a set amount of funding to cover multiple cases, with stakes in each case outcome. This obviously mitigates the risk of any one case becoming a loss. And they can add funding when new cases are taken on by the funded firm.
More recently these providers have shifted towards funding portfolios of plaintiff litigation. This allows for less risk, easier diligence and higher levels of funding.
From market surveys, it is apparent that law firms are more aware of funding as an option than clients, however awareness is growing in both sectors. Litigation funding is also more prevalent in the UK and Australia than in the US. And the number of providers is increasing. One article estimated that more than 50 companies are working in this space. That being said there are probably seven or eight larger players, with a mix below that. Some hedge funds and private equity groups are dipping their toes in the litigation funding water too. The market has reached a critical mass to the point that the first stand-alone litigation funding conference was held in September 2018.
Other areas that these providers fund include some basic, law firm operations options. They can lend money against accounts receivable, work-in-progress, pending judgments or other needs. These loans are more equivalent to banking options, where they lend against financial assets. Firms can find these options attractive typically at year-end when they want to pull highly confident revenue into the current year. This also allows the firm to spread its borrowing across different types of sources. Since so many firms are risk averse when it comes to bank debt, new borrowing options like this provide them with tools to manage their financials more like a regular business.
As noted above, there is growing competition in the market for these services. More providers are entering the market, current players have larger capital bases and new types of entrants are joining in. Private equity firms and hedge funds are seeing litigation funding as a new and potentially highly lucrative investment. However, the non-traditional players have a steep learning curve on how to value litigation and manage risk around that.
Litigation funding companies get paid, obviously, by taking a share of proceeds which usually takes the form of a percentage of a contingency payout on a plaintiff’s case. Following from the simple concept, the shapes of these deals can take many forms. They can be highly tailored to each situation. For instance, funding companies can engage at the beginning of a case, somewhere in the middle, on the eve of trial or even just for an appeal. Sometimes they only fund expenses and not legal fees. The other factors include the amount of payout in question, perceived risk, and the length of time a case might go. Putting all of the variables into play makes it obvious why each deal will be unique.
Some funding companies are exploring options for funding litigation on the defense side as well. Predictions are that this option will become more prevalent as the market matures.
The marketing pitch to firms for utilizing litigation funding is centered on winning more business, but also focuses on how funding shifts and shares the financial risk with a third party. For clients, the marketing message is hedging and mitigating their risk. It also allows clients to pursue claims they would not have otherwise been able to do.
The marketing pitch to firms for utilizing litigation funding is centered on winning more business, but also focuses on how funding shifts and shares the financial risk with a third party.
Both of these messages imply the obvious: another party has a stake in some litigation. This raises some ethical issues. Funding companies are aware of these concerns and the smart ones require non-disclosure agreements (NDAs) prior to any conversations that could include confidential or privileged information.
The main ethical concerns raised so far center on the possibility that the funding companies might exert influence over the management of the case. Again, smart providers are very strict about not exerting influence over any litigation they fund.
That being said, bar regulators and courts are expressing concern about these and other issues. Regulators are studying the problem and considering changes to ethical rules and regulations. A stated challenge is the complexity of this topic given the types of funding that occur. One option being suggested is requiring disclosure of funding to the courts. The concern this rule would potentially address is over the growth of frivolous litigation. Per the publicly available litigation funding company reports, this concern seems unfounded since there is no return for them on frivolous litigation.
But even a court rule like this becomes problematic in the way it interacts with ethics rules, especially when those rules will differ among jurisdictions. At this point, it is unclear what if any rules will emerge around litigation funding, but firms and clients utilizing these tools will need to keep an eye on this front.
Given the amount of money in play on the litigation funding market, it is already a force and embedded in the legal market. Also, given the number of new entrants, we should expect to see continued growth and maturity in this space. Firms and clients would be smart to explore and research these options.