When is litigation funding the right choice for in- house counsel?

Dispute Resolution analysis: Ayse Lowe, director at Bench Walk Advisors, details the benefits of litigation funding to in-house counsel and advises on funding portfolios.

This analysis was first published on Lexis®PSL on 18/12/2020 (subscription required).

Interviewed by Halima Dikko.

+ What are some of the biggest advantages to litigation funding to an in-house lawyer/legal department?

Litigation funding is usually advertised as a means of giving access to justice, but, particularly in times of economic uncertainty, it also provides a unique range of other advantages for companies by allowing them to structure their balance sheets more efficiently, to provide available cash and to monetise contingent assets that might otherwise be treated as having zero value by most companies. There are substantial benefits of litigation funding for in-house counsels:

• they can choose the best (not necessarily the least expensive) counsel to represent them in a case
• it enables them to sustain a complex lawsuit over a longer time without requiring funding from the business
• third-party funding is off balance sheet—in house counsel can pursue more meritorious cases without increasing legal budgets and without using up existing credit lines or grossing up the company’s balance sheet as would happen with traditional borrowing
• it turns legal departments into profit centres and frees up capital for the business’s growth and expansion
• without in-depth due diligence, companies may pursue less promising litigation while leaving cases with strong potential recoveries on the table. Funders do more than relieve corporations of financial risk and cost-cutting pressures. Rigorous pre-engagement case analysis can help companies reduce legal costs (and internal staff time) by helping them choose cases with the strongest potential for timely and favorable settlements
• eliminate risk—that is the risk of having to pay a significant amount in legal fees in the event of losing a case on top damages

• monetize claims—this means taking money from a funder against a claim but, unlike traditional funding, without any requirement that the money be used to finance the legal costs of the claim. Another way to think of this is as selling some or all of a claim or judgment or award to a funder. For example, say you have a case against a sovereign state or kingdom. You have been successful in arbitration and have received an award. It may take you a few years to enforce your award and there are likely to be substantial financial costs associated with the enforcement process, which can be complicated. Selling an award to a funder effectively enables to you to monetize it quickly. This enables immediate access to a proportion of the settlement funds on a case without going through and taking the risk on the enforcement process. Settlement funds can be used to:

  • reduce other debt
  • pursue more cases
  • invest in new business opportunities
  • support company or law firm growth

Following this approach also frees up management and general counsel’s time to focus on other areas of the business:

• improve company financials—instead of keeping some money in reserve during the litigation process, one can use the company’s money for investments while someone else is funding the litigation
• because they have no other funds available, when companies run into financial difficulties for whatever reason, counterparties to contracts and other interested parties may seek to take advantage of the situation, for example, by breaching agreements knowing that the struggling company is not in a position to counter. Knowing that a struggling company can access third-party funding to litigate may deter such hostile opportunism.

+ What should inhouse lawyers be looking for from their funders and on what terms?

In-house lawyers should seek flexibility, speed, creativity and certainty from litigation funders.

There will always be risks on a case and there will often be complexity. For many funders, once a risk is identified, the claim is rejected, but a more imaginative funder will try and to accommodate the needs of a company, to take a more balanced ‘risk-adjusted’ approach and to structure around the risks.

A quick decision process is important for in-house counsel. Some litigation funders take many months to complete due diligence and review a case. This can be a gruelling, time-consuming and, ultimately, an expensive process with no guarantee of a positive outcome at the end of the funder’s review. An in- house lawyer should make sure that he or she knows the funder’s internal due diligence process prior to committing to work with a funder.

Certainty is also important. Even where a review or execution process may be gruelling and expensive, it may be acceptable provided there is a high degree of certainty that, ultimately, the case will be funded. An in-house lawyer who is agreeing to a long period of exclusivity and/or to a protracted due diligence and execution process should expect to be given some reasonable level of comfort (for example, confirmation that the claim has passed some initial level of approval or screening) or other protection before agreeing to a formal or informal lock-in. A higher degree of assurance that the transaction with the funder will close successfully will enable internal counsel to decide how and whether they need to use their internal funds to pursue case.

+ What are litigation funding portfolios and what do they mean for a potential in-house client?

Portfolio financing gathers multiple matters in a single funding structure or entity. Capital can be used to fund legal costs associated with the underlying matters or for operating capital for the company. Capital is typically provided on a non-recourse basis, meaning that a funder assumes downside risk and earns its investment back and a return only in the event of the successful resolution of the disputes. The matters within the portfolio can be a mix of claims and defence matters, and cross-collateralisation generally lowers the cost of capital.

Portfolio-based capital facilities equip companies to fund high value recovery programs and give firms a robust tool to develop business areas and pitch and win new business. They usually mean:

• access to flexible capital at lower cost—portfolio finance gives companies access to capital that can be used to finance matters within the portfolio or for broader business purposes; flexibility that would be unusual in single-case financing. In addition, because risk is diversified across multiple claims, a portfolio arrangement may deliver a lower cost of capital
• create budget certainty—companies increasingly use portfolio finance both to relieve legal expense budget pressure and to shift downside risk away from the business. Because capital is typically provided on a non-recourse basis, legal departments have no downside risk exposure if the disputes resolve negatively, and if matters take longer than expected, there is no extended drain on the company’s cash resources
• pursue affirmative recoveries—in-house counsels can use portfolio finance to support affirmative recovery programs; pursuing potentially valuable claims that the company otherwise would not have the resources to pursue without adding expense or risk to corporate balance sheets

+ Most funders now are looking for portfolio arrangements with a business/businesses so they can broaden their investments and apply a basket of risk approach, but what does this mean in practice?

Since financing is usually non-recourse, businesses retain the funded amounts even if the portfolio cases ultimately are unsuccessful. When contingency fees are collected from one or more of the cases, businesses pay a return to a funder, with the amount depending on the terms of the financing agreement.

This approach allows businesses to avail themselves of opportunities to earn more than they would earn in hourly-fee matters while lessening the risk of taking cases on contingency.