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Evolving trends in litigation funding
| LEGAL & REGULATORY | LITIGATION & DISPUTE RESOLUTION
Financier Worldwide Magazine
Third party litigation funding continues to grow and evolve. The basic business model – funding of all legal and other ancillary costs related to a claim in exchange for a share of the damages if the claim is successfully resolved – has withstood the test of time and is highly attractive for both claimants requiring funding as well as investors looking for above-average returns. There follows an overview of the major current trends that underpin the growth of this fast-moving and still relatively young industry.
Increase in volume of claims requiring funding
The industry has experienced a steady increase in the number of claims requiring third party funding. This increase can be attributed to a combination of factors such as the recognition that funding of claims ‘works’ and benefits all those involved (claimants, funders, professional advisers), an established track record of successfully funded claims by institutional funders and better promotion of the industry through marketing efforts by recognised players who are members of the Association of Litigation Funders of England and Wales.
Another explanation for the increase in the number of claims being presented for funding resides in the cost reforms introduced in England and Wales as of April 2013, also referred to as the ‘Jackson Reforms’. These reforms have altered the landscape of claimants litigating with the benefit of Conditional Fee Agreements (CFAs) and After the Event insurance (ATE).
Under a CFA, a solicitor or barrister in England and Wales will work for the claimant client with no payment during the course of the case and on the basis that he will receive nothing at all if the case is lost. The benefit for the lawyer is that he is rewarded for taking the risk of getting nothing by receiving a success fee if the case is won, which can amount to a maximum of 100 percent uplift on his normal hourly charges. Prior to April 2013, the cost of the success fee could be passed on to the defendant if the case was won.
Under the new regime, claimants can no longer recover success fees from defendants but all claimants’ lawyers are permitted to work on a ‘contingency fee’ basis and thus agree with their clients to structure fees as a proportion of damages awarded. These arrangements, also known as ‘damages based agreements’ or ‘DBAs’, were supposed to facilitate the funding of claims for the claimants by their lawyers. What we are finding is that, due to a total lack of clarity in the regulations governing them, lawyers are unwilling to enter into DBAs as they could win a case and then be deprived of their remuneration as a result of non-compliance with incomprehensible regulations. Lawyers prefer to continue to invoice their clients on an ongoing basis and are increasingly recommending third party funding as the ‘go to’ solution to clients instead of entering into CFAs or DBAs.
The new costs regime has also impacted claimants who chose to take up ATE cover and who are now looking to third party funders to cover the cost of such cover.
An ATE policy is a policy of insurance under which a party to litigation insures against the risk of losing his case and having to pay the opponent’s costs. As was the case with CFAs, prior to the Jackson Reforms a claimant could litigate with the benefit of an ATE policy and, if he won the action, pass the cost onto the losing defendant who had to pay the premium on the claimant’s insurance policy, which the claimant chose to take without consulting him. Since April 2013, claimants other than insolvency practitioners who take out an ATE policy must pay the premium out of their own pocket. The whole premium now comes out of the successful claimant’s damages. As of April 2015, insolvency practitioners will lose their special exemption and also have to absorb their ATE premiums. As some funders are prepared to offer claimants an indemnity to cover the defendant’s costs in case the claim is lost, claimants increasingly see the benefit of third party funding to secure such an indemnity as part of the funding package.
We are also noticing an increase in the volume of claims being presented for funding by insolvency practitioners. Third party funding is well known to them. Liquidators are very often in the position of ‘David’ having to face the ‘Goliath’ claimant whose only hope is that David will not be able to find the money to sue him. If the defendant happens to be a former director of the now insolvent company on whose behalf the liquidator is pursuing the claim, he most probably made sure before the liquidation that the company was thoroughly stripped of all cash and assets to leave the liquidator with little or no money to pursue any claim against him. Third party funding then becomes ‘the only game in town’ for any insolvency practitioner who lacks the funds to pursue the claim.
Higher quality of claims presented for funding
Third party funders have become accustomed to ‘bad claims’ being presented for funding. ‘Bad claims’ come in various forms and guises. First, there are always straightforward unmeritorious claims, often presented for funding directly by the claimant without any supporting documentation. Then, there are cases proposed for funding just before trial or when their limitation period is on the point of expiring. Again, these are usually presented by claimants themselves, either because they have run out of money to pay the lawyers or because they have tried to conduct the case on their own without legal representation. There are also cases that could have been fundable but have been destroyed by the claimants doing them ‘on the cheap’ until they realise that they have ruined their chances of success. They then turn to a funder in desperation, in the hope that the funder will finance a decent legal team to rescue the case. In those circumstances, funders can be forgiven for feeling that they are treated more as maritime salvage companies rather than investors. Finally, there are the cases that are supported by opinions from the legal team who have fallen in love with the case and become unable to spot obvious weaknesses.
Reviewing and rejecting bad claims is part and parcel of a funder’s job. What is reassuring and is evidenced by our more recent experience is that claims of a much higher quality are now being presented for funding.
‘Good claims’ in our industry means claims where the professional funder can clearly understand and evaluate duty, breach, causation and the damage suffered by the claimant. These are claims which are conducted by able legal teams who provide the funders with detailed legal analysis supported by a suitable bundle of relevant copy documentation, a realistic estimate of the quantum of the claim and a well-considered budget. These are what funders want and expect to see in order to offer terms.
New challenges and opportunities
The increased awareness of the availability of third party litigation funding creates both challenges and opportunities. We briefly focus on several opportunities available to the industry and on the main challenge flowing from these opportunities.
Claimants are aware that litigation funding is available and gives them the opportunity of avoiding the damage to their cash flow caused by having to pay monthly lawyers’ bills. Lawyers have accepted that they have to respond to that awareness and demand for alternative funding on the part of their clients by assisting them to approach third party funders. This is precisely the expansion of access to justice which the Jackson Reforms were intended to achieve. As a result, the volume of claims referred for funding is increasing rapidly and we expect this trend to continue.
Litigation funding is now an accepted, viable and alternative asset class for investors who wish to diversify their portfolio. The fundamentals of this asset class are compelling: reputable and institutional funders have an established and proven track record of above average returns, demand far outstrips supply and the asset class is not linked to economic cycles. Based on these highly attractive fundamentals, the industry has managed to attract hundreds of millions of dollars from investors, be they quoted funds on the London Stock Exchange, hedge funds, family offices or private individuals. We expect this trend to continue and believe that more money will become available for case funding over time.
With these opportunities comes an important challenge: namely, how to satisfy the demands of claimants and investors alike, while at the same time maintaining the high level of caution and professionalism required to ensure the industry’s continued growth and success.
As investors are attracted by the high returns offered by this asset class, they are prepared to invest more money but will insist on commensurate returns. The seduction of a much larger funding capacity and that of a potentially much higher personal compensation (often in the form of a management fee and a carry) can lead some funders to invest in claims that do not meet stringent due diligence requirements simply in order to deploy available capital. When a funded claim fails because a judge rules it spurious, everybody gets hurt: claimants, investors and the industry as a whole, because it is still too young to afford bad publicity.
It is the responsibility of each professional and reputable funder to ensure that it avoids the temptation of taking on excessively risky cases simply to deploy investors’ capital. The funders who belong to the Association of Litigation Funders of England and Wales have acquired a justified reputation for professionalism and probity and it is to be expected that they will hold fast to those standards in order to ensure their own and the industry’s continued success.
Top performing litigation financier Bentham, provides these recommendations:
The Benefits of Using Litigation Funding Over Litigation Insurance
By: Allison Chock, Chief Investment Officer US
Litigation funding and litigation insurance are sometimes compared as ways to help litigants reduce their risk when bringing contingency fee-based claims. At first glance, funding and insurance may appear to be similar, however, they are distinct tools with substantially different methods and benefits. Litigation funding occurs when a third party provides non-recourse financing for all or a part of a claimant’s litigation costs while the case is pending in exchange for an agreed-upon share of the recovery. Litigation insurance also covers legal expenses, however, potential payment from the insurance company occurs once a matter has concluded.
While litigation funding and litigation insurance can be used by claimants with any socio-economic background, insurance tends to attract deep-pocketed claimants who can afford to fund expenses through a lengthy litigation process whereas funding appeals to claimants from both sides of the tracks. According to a recent report by The American Lawyer, a standard litigation insurance policy can cover litigation costs between 40 to 70% of attorney fees. Litigation insurance generally works “after the event.” The insurer covers the costs in the event of a loss. Policies also allow the insured to pay premiums when the case is successfully completed.
Funding, on the other hand, covers costs as they are incurred, maximizes the value of claims, and, for corporate litigants, can improve the bottom line. Here are a few key points on how litigation funding differs from litigation insurance:
• Investment. The fundamental difference between litigation funding and litigation insurance is that funding provides up-front capital to help cover the costs of pursuing a claim. For law firms and companies, the cost of litigation can be prohibitive. Even when there are meritorious claims that could produce substantial returns, claimants are sometimes forced to settle for pennies on the dollar or abandon cases entirely because of the associated legal expense of continuing to a trial. Litigation funding solves this problem by financing cases and generating a return on its investment only if, and when, the matter is successfully resolved.
• Higher Stakes. To ensure that the claimant receives the lion’s share of a successful resolution, Bentham IMF funds only meritorious, high-stakes cases that are likely to generate substantial settlements or judgments and are supported by a strong legal team. While insurers sometimes offer policies on smaller cases, to be eligible for Bentham’s funding, litigants must request more than $1 million. In addition, the anticipated settlement or judgment must exceed $10 million (exclusive of punitive damages), the defendant must have a clear ability to pay, and the litigation must have strong prospects of success. Bentham also has the flexibility to fund a portfolio of cases, giving litigants the ability to finance a number of cases while spreading their potential risk across multiple claims.
• Maximizing Value. With funding, litigants have unique opportunities to evaluate the viability of their claims and to maximize their potential value. Bentham does extensive due diligence into cases that it may fund, and in so doing, provides valuable insight for claimants about the strengths and weaknesses of their claims. If a case is funded, the money can be used to help hire the best possible counsel to effectively combat delay tactics by a well-funded opponent, and to allow the claimant to withstand low-ball settlement offers.
• Accounting Benefits. Litigation (including any associated insurance premiums) appears as an expense—a costly one—on corporate books, and a large piece of ongoing litigation can have a significant, negative impact on a profit and loss statement. On the other hand, litigation cannot be recognized as a potential asset, even in situations where the company may have a strong likelihood of a substantial recovery. The unfavorable accounting rules and the resulting drag on profits can sour companies on the prospect of pursuing litigation, even when it is meritorious and potentially lucrative. When funding is used to finance litigation, however, legal spending is removed from the books. The company’s bottom line brightens and executives may be more likely to pursue legal claims.
HOW IT WORKS
We own the exclusive rights for certain high-ticket litigation opportunities
- Litigation funding is litigation finance
- In this option we deploy transactions where the asset value of our litigation claims is used to secure financing from outside investors
- Third-party investors provide funds for our cases on a non-recourse basis. This means that the return of capital is tied to a successful outcome in the litigation via settlement or court award
“Litigation finance can be used by one company to sue another, so that the general counsel’s office can become a revenue generator instead of a cost center...” — Above the Law
Commercial litigation funding partnerships solve the following industry problems:
- Mitigating the existing costs of an existing ultra-expensive legal system
- Management problems with the hourly billing model
- Budget uncertainty for investment concerns. Back-up must be provided when the budget runs out
- Legal fee expenses on a corporate balance sheet are problematic
- Litigation for the smaller entity must become less risky
- The market demands a need for risk mitigation and risk/upside sharing
In a typical opportunity the court cost will be $2 to $7M or 2.5 to 4 years for an affirmative and elective litigation with targeted rewards of 4 to 7+ times the $2M to $7M investment.
This opportunity facilitates recovery of lost revenue and provides access to capital for meritorious claims. It provides risk-sharing and reduces budget uncertainty while delivering the resources to retain top tier counsel. In this process company and counsel interests are aligned while changing off-balance sheet legal items into profit centers.
The ways that Funders can invest in our litigation opportunities:
- Directly paying full hourly fees to approved law firms
- Risk Sharing
- Direct legal costs funding
- Working capital accounts and credit cards
- Appeals risk reduction support
- Risk Sharing with lawyers
Option #1 Risk Sharing: 50/50 (Full Contingency)
Invest 50% to 75% of Hourly Fees + discount and recover 20% to 35% of proceeds
Law firm invests discount on hourly fees and gets paid 50% to 75% of normal fee rate plus 10% to 15% success bonus from our cases
Option # 2 – Hybrid
Law firm produces fee budget and investors invest 50% of that fee budget in exchange for 20% recovery.
Law firm invests 50% of fee budget billings in exchange for 20% of recovery
Over 30 other risk sharing finance opportunity structures exist. Let’s discuss!
The investor/financier steps:
1. NDA execution
2. Drafting of a term sheet
3. Due diligence review and approval of law firm
4. Funding agreement production
5. Monitoring of the case
6. Resolution via settlement or court award