Commercial disputes are a fact of life in every industry. From counterparties that fail to honor contracts, to companies that use deceitful tactics, to individuals who misappropriate proprietary information for their own benefit, running a business regularly requires consultation with an attorney and frequently involves the business in litigation. Historically, businesses faced with a legal conflict had just three options: fight a lawsuit by hiring counsel on expensive retainer, instead find a lawyer who offers “no win, no fee” contingency billing, or abandon the case (by either paying a settlement or giving up on a claim). More recently, third-party litigation funding has given attorneys and their clients a powerful alternative to these traditional solutions.
The costs of hiring a lawyer, discovery procedures, arranging depositions, and retaining experts can snowball quickly—especially in cases that span several years. Wrongdoers know this. They therefore can, and often do, weaponize any financial superiority in court, much to the detriment of plaintiffs who cannot, or prefer not, to pay full litigation costs upfront. It is no surprise, then, that corporate legal departments are frequently perceived by management as cost centers necessary to put out legal fires—not as the strategic revenue sources they can become.
With litigation finance, however, businesses can lift the financial burden of litigation, reduce financial risk, build a stronger case, and achieve fairer legal outcomes in court.
What, exactly, is litigation finance?
Litigation finance is the practice of a third party providing capital to a plaintiff, such as a business or individual. This third party, known as a litigation funder, is a specialty finance firm that is otherwise unrelated to the lawsuit in question. The litigation funder invests in the action and, in return for this investment, is promised a portion of any monetary recovery. Typically, this is structured either a multiple of the original investment, or a percentage of the gross recovery.
Commercial litigation finance is almost always a non-recourse arrangement wherein the only collateral for the investment is a single case or portfolio of cases. If the case does not resolve favorably, the recipient of the funds owes the litigation funder nothing. If the claim is successful, the litigation funder will usually receive first dollar in until it is repaid, while the remainder of the proceeds will be divided between the claimant and the attorneys as agreed between them.
How can businesses use litigation finance?
Litigation finance investments are highly customizable, rendering them suitable for a wide variety of needs. Bespoke agreements are common, especially as the size of the investment increases and the relationship between funder and company deepens. In that vein, businesses can use funding to pay for case-related legal expenses, including attorney fees, expert witness fees, depositions, court reporter fees, arbitration filing fees, discovery, appeals, and more.
In addition, as litigation progresses, companies can also use the funds received to cover business operating expenses when existing sources of working capital are insufficient. This option can be critical for companies that have been actively harmed by the actions of the defendant(s) and would otherwise find it challenging to continue doing business while the lawsuit is pending if not for additional sources of capital.
Thus, litigation finance can support both the pursuit of meritorious litigation and ensure the financial survival of thinly capitalized commercial claimants.
How can litigation finance help manage corporate balance sheets?
Under Generally Accepted Accounting Principles, litigation costs are reflected as expenses. Carrying and reporting such expenses can negatively impact a company’s financials and quarterly performance. This is especially true for public companies that are valued on earnings or cash flow or require certain financial criteria to be met to comply with credit obligations.
For companies in that position, litigation costs paid from company funds must be recorded as expenses when incurred, thereby diminishing reportable earnings. Moreover, even if litigation results in a favorable outcome (whether via judgment or settlement), such outcomes sometimes take months or years to enforce and actually pay out, leaving a temporary gap in a company’s cash flow despite obtaining a ruling in their favor. Worse yet, recoveries from successful legal matters may not offset the adverse impact of lawsuit-related costs because such recoveries are generally treated as below-the-line items that do not increase earnings. General counsel and in-house legal departments can shift both the risk and financial burden of litigation to third-party funding specialists in exchange for a portion of any recoveries.
For instance, litigation finance companies can make funds available in a segregated account so that law firms bill against those funds, rather than through the business, keeping the ongoing expenses off the company’s balance sheets until resolution of the matter. In this way, businesses do not have to carry and report expenses on an ongoing basis but will only have to do so at the end of the dispute. Further, once the matter resolves, the company incurs the liability of having to repay the investment but can then simultaneously report the funds received from resolution of the matter. This simultaneous reporting creates a more accurate accounting of the events because the payment to the litigation finance company (which subsumes the expenses) appears on the claimant-business’s financial statements at the same time as any recovery realized from the underlying litigation.
Ultimately, securing third-party funding for operating expenses can transform otherwise illiquid liquid claims into a valuable source of capital.
What types of cases do litigation funders invest in?
Litigation finance companies invest in a wide range of cases that varies based on their particular risk profile, expertise, and available capital. Whether a company’s dispute revolves around trade secrets, contracts, shareholders, IP, or some other matter, litigation finance can support virtually any claim type.
In October, LexShares published “The Litigation Funding Barometer,” an analysis of the types of cases that are often best suited for non-recourse financing. The data presented in the Barometer report was based on data produced by the firm’s proprietary Diamond Mine software, which in 2021 scored more than 30,000 state and federal cases based on several different factors. Among other conclusions, the report found that a higher percentage of strong funding opportunities existed among federal cases than state cases. Federal trade secrets, antitrust, and contract disputes also presented some of the strongest funding opportunities across jurisdictions. While this data represents the investment potential of various case types, we feel it is nevertheless a valuable gauge of how the funding industry generally views the U.S. litigation landscape.
Notably, litigation finance companies are also not limited to investing in contingency cases. Financing can be made available to hourly representation, usually requiring deferral of a portion of the hourly attorney’s rate and ongoing billing against segregated amounts.
What are some attributes of reputable litigation finance companies?
Evidently, the idea of receiving funding—at some times substantial amounts of funding—from a third party can raise some concerns. Attorneys seeking out and recommending litigation finance to their clients should watch for the following things:
First, a reputable litigation finance company will implement a demanding due diligence process. While this is frustrating while already dealing with the litigation process, a robust underwriting process signals a serious partner. The old adage holds true: if something is too good to be true, it probably is.
Second, a litigation finance company should never attempt to control or direct the litigation. There are a number of reasons for this, including rules of ethics pertaining to an attorney’s duty of loyalty. If a litigation finance company attempts to insert itself into the actual litigation, this is a sign that another funder may be a better choice.
Reputable litigation finance companies are an excellent resource for savvy businesspeople and their legal advisors. Careful vetting and selection of that tool is of paramount importance.
In-house legal departments leveraging a powerful new tool for accessing justice.
Maya Steinitz, a legal scholar and University of Iowa College of Law professor, refers to litigation finance as “likely the most important development in civil justice of our time.” As founders and executives grow more familiar with commercial litigation finance as a useful financial resource, the potential appeal of offsetting litigation risk and optimizing corporate balance sheets for legal action stands to become more mainstream. For CEOs and founders weighing the prospect of litigation, the ultimate question is no longer why they should be using litigation finance. The real question is: why not?