Litigation Finance’s Rising Role in Commercial Litigation – It’s All Coming Together
What is litigation finance?
In litigation finance, a party unrelated to the litigation provides money to a party (typically the plaintiff) in return for a portion of any recovery—often a flat fee or a percentage of that recovery. The plaintiff uses this capital to fund the litigation (attorneys’ fees, experts, court costs, etc.) and/or to continue their corporate operations. Funders typically provide the capital on a non-recourse basis, and their return is contingent upon a successful outcome—where they seek some multiple of their investment. Notably, funders do not control the litigation.
Today, when corporate entities sue each other for breach of contract and/or business torts, litigation finance is not commonly used. But, a combination of market forces and an increasing acceptance of the practice among the key players (corporations, law firms, and fund investors) signals that a transformational shift may be underway.
Litigation finance can ease the pressure corporations face on their legal budgets. For example, without litigation financing, a small corporation may abandon a potential, meritorious claim against a larger corporate entity because of otherwise lopsided resources, risk assessments, and bargaining power. With litigation finance, the smaller corporation could pursue the claim (with someone else’s money) both to hold the better-heeled counterpart accountable and to pursue a portion of the recovery that was otherwise discarded before it was even sought.
Litigation finance provides the same and other opportunities as well for a large corporation. For instance, a large corporation could also use litigation financing to cover some of the costs of a more expensive case. This can help in freeing up resources to pursue more case(s), spreading out risk, lowering the cost of individual cases, and potentially improving the legal department’s overall return on investment.
Legal departments are not the only corporate participants more receptive to litigation finance; financial departments are too. Indeed, this year, Burford Capital (a major litigation finance fund) surveyed 500 CFOs and senior finance professionals in the U.S., Canada, and the U.K., and over two-thirds of those interviewed “were ‘very likely’ to use litigation finance in the next two years.” See CFOs Fueling Rise of Litigation Finance, Survey Says, Dan Packel, The American Lawyer, June 27, 2019. This data backs up familiar anecdotal experience, in that where litigation was once viewed mostly as an expense, it is being increasingly viewed as “a lucrative financial resource” and “a new tool to unlock value.” Id.
In response to increased pressure on corporate legal budgets, some law firms have moved away from the billable-hour and toward alternative and flexible fee arrangements. Litigation finance is another attractive tool for firms to offer clients and to mitigate contingency risk.
Representative of this market shift, more and more traditional corporate defense firms are entering into the contingency fee and litigation finance space. Litigation finance not only allows a law firm to compete for this business, it also addresses historical risks of contingency fee work. For instance, a bespoke litigation finance agreement can pay a law firm reduced hourly rates in exchange for the firm sharing in a portion of a potential recovery. While this arrangement caps a firm’s potential fee in a contingency case, it importantly mitigates the downside risk—smoothing out budgets and bottom-line revenue.
Additionally, sources report that the law firms that have tried litigation finance like it and want more of it. See Litigation Finance Users Say They’d Do It Again, Survey Finds, Dan Packel, The American Lawyer, August 6, 2019. As an American Lawyer survey recently showed: “98 percent of law firm lawyers who had used litigation finance would do so again,” and “93 percent said their experience was positive.” Id.
Separately, fund investors are increasingly interested in litigation finance. From an investor’s perspective, this new asset class diversifies an investment portfolio with a product that is not tied to traditional markets. If anything, in times of market downturns, litigation increases and the chance of recovery is connected to the merits of the claim, not the stock market, interest rates, or other asset classes. Thus, at a time where the yield curve recently inverted, the market is in a downturn, and interest rates are low, money is flowing into litigation finance. To illustrate, in 2019, Burford Capital reported that it has over $3 billion committed to the legal market. And, more funds are entering the space looking to put money to work. As a representative sample, Chambers now ranks litigation finance firms, and the most recent top three bands are: Band 1 (Bentham IMF and Burford Capital), Band 2 (Lake Whillans Litigation Finance LLC, Longford Capital Management, and Therium Capital Management), and Band 3 (Parabellum Capital, Vannin Capital LLC, and Woodsford Litigation Funding).
What is not known, however, is how a recent controversy about these funds’ performance will impact this space. In August 2019, short-seller Muddy Waters accused Burford Capital of inflating its returns by misrepresenting the outcomes of its litigation investments. Burford Capital disputes the allegations.
While litigation finance has been around, it is relatively new to commercial litigation. Because corporations, law firms, and fund investors are separately and independently accepting this practice and are further incentivized to do so, this is likely an interesting and transformative moment. Lastly, while this article naturally views litigation finance from the plaintiff’s perspective, defendants should anticipate more litigation and understand how funding may change the game from their perspective too.