An Overview of Litigation Finance Brokerage in the USA
Engaging an Experienced Broker when Seeking Litigation Finance
Introduction
Litigation finance is an exciting new practice, offering an expanding range of valuable financial solutions for law firms and corporations.
My experience in the industry has made clear to me, however, that those seeking to access the litigation finance market are often at a considerable disadvantage. Many lawyers who attempt to obtain funding – often for the first time – have an incomplete understanding of the practice or are unaware of existing market standards. These lawyers are at the mercy of the funding companies – who view lawyers and their clients as “counterparties” rather than “clients” – and who are content to maintain their monopoly on vital market information such as pricing, process, underwriting, and other critical aspects of litigation finance.
The role of an experienced broker is to provide market knowledge and expertise to those seeking litigation finance – so that they may properly understand, negotiate, and secure financing. Given the industry’s well-earned reputation for opaqueness, brokers work to make litigation finance transparent to those who seek to partake in it. In short, experienced brokers are fully aligned with the interests of their clients and work to overcome the information asymmetry that presently exists in the market.
While litigation finance is simple in concept, it is often difficult in practice. Selecting the right funding company, negotiating optimum pricing, avoiding oppressive terms, and ensuring that ethical issues are properly addressed are all responsibilities that benefit from prior experience. And because the process of obtaining funding is notoriously time-consuming and onerous, it’s enormously valuable to have a knowledgeable partner who can accelerate the steps necessary to secure financing – from the initial presentation, through due diligence, to final deal approval and contract.
As a means of exploring some of those areas in which an experience broker provides significant value – and as a general introduction to the process of securing litigation finance – I’ve provided answers to 12 critical litigation finance questions below. At Red Bridges Advisors, we stand ready to discuss these and any other questions you may have as regards your pursuit of litigation financing.
1. How many sources of capital are offering litigation financing?
There are more than 40 different sources of litigation funding in the United States, and the number is growing rapidly. While media attention typically highlights the handful of publicly traded litigation finance companies, major inroads are being made by global hedge funds and others, bringing significant amounts of new capital to the market. As a result, competition among funders has never been stronger, and shopping your opportunity among a number of appropriate funders can yield significant cost savings. Care should be taken when choosing from this large field of funders, however, as selecting the right funder can often be the difference between a successful and a disappointing venture into the world of litigation finance.
2. How do I choose the right funder?
Each of the 40-plus US funders is unique, with their own sources of capital, areas of focus, track record, and reputation for fair dealing. Some are publicly traded, some have raised independent funds, and some have sourcing relationships with global hedge funds (which eliminates concerns about capital adequacy but can lead to conflicts, delays, and approval issues). Funders also differ greatly as to the categories of cases they wish to finance. For example, some prefer investments of $3 million or more, while some prefer investments of $1 million or less; some will do only commercial cases while other only support the traditional plaintiffs’ bar. The distinctions can go even further, with some firms specializing in a given practice area – say, intellectual property or international arbitration. Beyond these categorical questions, every funder has its own personality in terms of ease of dealing, underwriting process, and appetite to deploy capital. As should be clear, matching your particular opportunity with the appropriate funder can greatly reduce the time and effort required to secure financing.
3. How large must my opportunity be to attract financing?
Traditionally, funders of commercial litigation have shown an interest in opportunities requiring $1 million or more in financing but, in practice, have focused their time and attention on opportunities requiring at least $3 million. As the market has grown, however, I’ve seen an increasing appetite for the financing of smaller cases. Funding for $1-2 million deals has picked up considerably within the past year, and I am aware of a number of quality funders entertaining opportunities at the $500,000 level. Just as important as the amount of the finance you seek, however, is the size of the judgment you can reasonably expect to receive. Funders are typically looking for a funding/recovery (or more technically, “loan to value”) ratio of 1:10. This is to say that for every $1 million in funding, they will require the expected judgment or settlement to be $10 million. (For clarity, $3 million in funding will usually require an anticipated recovery of $30 million). This issue of “deal economics” is a major stumbling block for many cases – and one that an experienced broker can explore with you.
4. How much does litigation finance cost?
The standard response here is: “it depends on the risk associated with your case(s).” And while this has some truth, it doesn’t help those who are wondering whether to actively pursue financing. In practice, pricing can be negotiated based on historical data, market trends, competitive pressure – as well as the anticipated legal risk and time to resolution. As a general matter, it’s important to know that funders typically use two mechanisms for pricing. The first is akin to debt pricing – where the return (or cost of the capital) is a multiple of the amount to be financed or deployed. Thus, if $2 million is provided against a “multiple” of three (or 3x), the funder would receive the first $6 million of the ultimate case proceeds. The second mechanism – akin to equity pricing – sees the return as a percentage of the ultimate case proceeds. Thus, a funder may request 30% of such proceeds – a figure in keeping with the standard contingency fee for US lawyers. All of this said, the vagaries of pricing are one of the more complicated aspects of litigation finance, and often involve variations on the two mechanisms above, as well as negotiated topics of repayment, different forms of interest rates, complicated “priority” structures, and other elements. An experienced broker can explain the critical details of pricing, and how they will likely apply to your situation.
5. What can I do to try to reduce the cost of my funding?
Litigation finance can be expensive – and perhaps rightly so, as funders are typically offering their capital on a non-recourse basis. That said, two things can be done to lower your cost. First, if, rather than offering a single case, you can package two or more cases into a “portfolio,” most funders will significantly lower their price. Why? The trick is to cross-collateralize the return, such that if one case loses but the other wins, the funder can recoup all of its return from the single winning case. Because the funder has two chances to secure its money, it has less risk, and thus can price lower. (This is the same reason that a basket – or portfolio – of stocks in a mutual fund has a lower risk profile than a single stock, which has a binary outcome.) The second way to reduce your cost of capital is to shop your opportunity to a number of high-quality funders. Properly presented, your case or cases should attract interest from at least several funders, allowing you to use competitive pressure to gain a better rate. Such efforts take time and finesse, but can result in the saving of millions of dollars for you or your client. Needless to add, this is one of the key reasons to work with an experienced broker who knows the market.
6. What types of financing are available? For claimants? For law firms?
At its core, litigation finance is an investment in the outcome of a given litigation or arbitration. Typically, monies are advances on a non-recourse basis, meaning that if the case loses, the funder receives nothing. The most basic form of funding is the advancing of funds to a claimant to pay for its legal fees (lawyers and expenses), in return for some part of a successful judgment or settlement. Over time, different structures have developed beyond this basic funding, to include a growing set of financing products for both claimants and law firms. These “claimant products” include: the funding of expenses only (typically for contingency fee cases); the monetizing of future judgments (with monies reinvested in the claimant’s core business); and the acceleration and enforcement of judgments once they’ve been received. Alternatively, the “law firm” products are focused on the de-risking of contingency fees (often done in a portfolio) and the acceleration of legal fees (either in the context of a mass action, or at year-end to assist with accounting concerns). Each of these products has its own pricing structure and discrete issues that set it apart from basic funding. A broker would be happy to explore the advantage of each product with you.
7. What ethical considerations should I be aware of?
As a starting point, I would advise any law firm seeking financing for its own client (i.e. funding for its own legal fees) to engage a broker. This simple step provides a compelling defense against any future claim of conflict of interest – or perhaps more relevantly, the appearance of a conflict of interest – in the transaction. (Use of a broker also brings the additional benefits of ensuring optimum pricing, proper terms, and a speedy process.) This suggested approach has nothing to do with the specifics of litigation finance, but rather with basic issues of attorney-client relationship, good client management, and proper compliance. As to ethical issues pertaining directly to litigation finance, there are critical areas which require attention – however, most every concern can be successfully navigated with expertise. First, and most importantly, all arrangements should provide for complete control of the case by the claimant, with an explicit provision regarding settlement decisions. Second, the attorney-client relationship must be acknowledged as sacrosanct, recognizing that the attorney must always act 100% in the interest of her client. Both of these principles require funders to be “hands-off” as regards the prosecution of the claim – and to agree to view the litigation as a passive investor. Third, the current law on champerty and maintenance should be researched for the jurisdiction in which the claim is to be brought. In the UK (where these doctrines originated in medieval times) champerty and maintenance have been effectively abolished, and in the US, virtually all major centers of commercial litigation either no longer recognize such doctrines or have found ways of easily distinguishing the contemporary practice of commercial litigation finance. (An experienced broker can easily provide a list of those few jurisdictions that may be of any concern.) Fourth, issues of potential “fee-splitting” need to be addressed when dealing with law firm financing and pricing structures. Fifth and finally, it would be wise to check the current rules as regards necessary disclosure of the use of litigation finance. As of this writing, disclosure is required in at least one federal court (only as regards class actions) and at least one state court. This issue of disclosure is currently the subject of ongoing debate and potential legislation, and should be followed closely. Experienced brokers will be fully up to date on all of the latest ethical issues and able to quickly briefly you on relevant concerns.
8. Should I be concerned about issues of confidentiality?
The short answer, of course, is “yes, always.” But with some care at the outset of your search for funding, these issues can be easily resolved. Not only will you want to put a non-disclosure agreement (“NDA”) in place with everyone with whom you speak (brokers and funders), but you’ll want to include a so-called “common interest” provision in your NDA. Recent court rulings in a number of different jurisdictions (federal and state) have strongly recognized that funders and those assisting the funding process are – in essence – part of your litigation team, and should be treated with the same protection of confidentiality as expert witnesses and others who are not acting in a purely legal capacity. While a number of different theories have been used to protect communications regarding funding, the strongest have utilized the “work product” doctrine, which provides additional protections when a common interest provision has been made explicit in the parties’ NDA. Brokers can provide extensive advice and materials on this topic, including NDAs that have been blessed by the courts.
9. How does the process of obtaining financing work?
Experienced brokers may well have different approaches to the financing process. At Red Bridges, our standard process involves multiple steps. At the outset, we work with clients to review the opportunity at hand, collect all relevant information, and produce a formal “investment memorandum.” This memo presents a comprehensive view of the case – tailored to the questions that typically concern funders, including our expectations for pricing. We then select a handful of funders appropriate for the type of case involved and – following the execution of NDAs – provide them with the investment memorandum. At the same time, we often provide the funders with access to a virtual data room of helpful documents. Next, we’ll engage in an ongoing dialogue with each funder with the goal of engendering a term sheet with headline terms and pricing. Following our review of these submitted term sheets (we seek to have two, if not more), we will select a single funder with which to proceed. Upon execution of the term sheet, we will spend some period of time – typically four weeks – working with the funder through deeper due diligence and the creation of transactional documents. Our goal is to execute the funding agreement and related documents within such time period. In all, the complete process – from initial discussion to funding – can take between two and three months.
10. Will I have to sign a term sheet and give a funder exclusivity?
Once a funder has determined that it is interested in financing an opportunity, it will typically offer a term sheet outlining fundamental issues such as pricing, collateral, break fees (if any), and the period of time during which it will complete its due diligence. It is industry standard for such term sheets to request a period of exclusivity (or “no-shop”) while such diligence is undertaken – the argument being that if a funder commits significant resources to reviewing an opportunity, it should be given reasonable time and a clear path to close the deal. Importantly, not only are such term sheets non-binding on funders (as they usually provide an “out” should the funder be unsatisfied with due diligence), but the exclusivity provision can leave those seeking funding flat-footed should funding be denied. You should discuss with your broker the issues surrounding these exclusivity provisions. At Red Bridges, we are especially focused on efforts to avoid any sort of exclusivity during the process, as we believe this puts our clients at a significant disadvantage.
11. What does a funder look for when underwriting?
Aside from the size of the financing and the type of claim, funders broadly look at five criteria when underwriting a case. First, they want to understand the legal merits. Most funders won’t finance claims that stand less than a 50:50 chance of winning, and many will insist on a ratio more akin to 70:30. Second, they will want to understand the collection risk. There is no point in funding a winning case if the defendant has no assets to pay the ultimate judgment. Third, funders want to understand economics of the deal. In short, the anticipated judgment to be collected must be large enough to satisfy the expectations of the claimant, the law firm, and the funder (most funders believe the claimant should walk away with at least 50% of the judgment). Fourth, the funder will want to be sure that the claimant is commercially reasonable. Claimants should ultimately have responsibility for determining when to accept a settlement offer, and it’s critical that they will accept a sensible settlement. Fifth and finally, the funder wants to be certain that the lawyer and the law firm engaged on the matter have the experience and expertise to bring the case to a successful conclusion. All of these criteria – and more – should be properly presented to proposed funders – starting with the information memorandum that I suggest should kick off the funding process (as described above).
12. What does a litigation finance contract look like?
The funding agreement varies depending on the type of financing to be had. For example, the provisions for an agreement to finance a claimant’s legal fees and costs are somewhat different from an agreement to de-risk a law firm’s contingency fee portfolio. That said, there are certain standard provisions that pertain to any litigation finance agreement, including the definition of proceeds, “waterfall” provisions, early repayment rights, ethical considerations (including the control of settlement), “bad boy” guaranties, the distribution of funds, and the ability of the funder to cease making further payments (if funding is not “lump-sum”). Special attention must also be paid to the tax treatment of the financing – as what is known as a “prepaid forward purchase agreement” is likely the optimal deal structure. (An experienced broker can explain this unusual form of contract.) As the funder often provides the first draft of the agreement, a review by someone experienced in such agreements is very strongly recommended.
by Andrew Langhoff, Founder, Red Bridges Advisors LLC
Andrew Langhoff has worked in litigation finance since 2012. He spent several years as the Chief Operating Officer of Burford Capital and subsequently led origination for Gerchen Keller Capital, at that time the largest litigation funder in the world. He has worked in both the US and the UK, where he served as a Director of the Association of Litigation Funders of England and Wales. Andrew began his career as a litigator with the firm of White & Case in New York. He has held in-house legal positions at Disney/ABC and at Dow Jones & Company as a divisional General Counsel. Andrew is a graduate of the University of Virginia Law School.