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Determining the Best Time to Obtain Litigation Funding

Your company has decided to pursue a legal claim. As in-house counsel, your fundamental business role is to maximize the value of that legal claim while containing risk and controlling budget. Myriad options may exist with respect to outside counsel spend: hourly billing, contingency billing, or some AFA in between. It is expected that in-house counsel maximize return on investment, consistent with conducting litigation in a manner that protects and even enhances the company’s reputation in the courts and marketplace.

One such option that is overlooked too often at this initial stage is litigation finance. If your company’s legal claims are strong, litigation finance firms may be interested in covering legal fees and expenses in exchange for a non-recourse investment return in the event of a successful outcome. 

Many companies know that litigation finance exists, but opt to initially self-fund disputes by retaining counsel on an hourly basis. Self-funding can have its advantages. It is simple and straightforward. In addition, spend will be limited, and recovery maximized, in the event of an early settlement.  

However, litigation is often more time-consuming and expensive than initially envisioned and initial litigation budgets are notoriously inaccurate. Cases are frequently more complex than anticipated. Defendants facing significant exposure may employ “scorched earth” tactics to wear down a plaintiff’s resources and diminish its appetite to fight. Litigation budgets are depleted, and in-house counsel must then either allocate more funds or explore other options. 

As a result, companies increasingly seek litigation funding well after the inception of a dispute, at a time when billable hours have exceeded expectations and are projected to grow substantially for the foreseeable future. Indeed, funders frequently encounter companies that owe hundreds of thousands in arrears to outside counsel, and must either obtain funding or walk away from valuable legal claims. 

At the outset of a case, all options are on the table. However, the longer a case progresses, the harder it can be to obtain funding. While a case may have been a strong candidate for funding in its early days, factors such as counsel selection, strategy, and expense may make the case ultimately unfundable at a critical time.  

Accordingly, in-house counsel should consider exploring litigation finance as early in the litigation process as possible. Doing so preserves optionality and positions a case for ultimate success. 

Background: Structuring a funding transaction 

To obtain funding, a company must undergo a rigorous due diligence process that examines the merits of its legal claims. While strong claims are a prerequisite, they are only half of the equation. The other half is the development of an economic framework through which the case will be funded and the recovery will be distributed.  

In developing such a framework, most litigation funders insist upon a structure that aligns the interests of client, counsel, and capital provider. Such structures typically involve the conversion of an hourly billing arrangement to a hybrid contingency. 

Funders seek alignment for two main reasons: 

  • They want counsel to have “skin in the game” so their primary economics derives from winning, rather than billing time. Lawyers who are not interested in risk-taking may drive a divergence of incentives over time that unduly impacts the amount that a company ultimately recovers.  
  • Funders seek to counteract information asymmetry arising from their limited ability to assess the many known unknowns in litigation. Such unknowns arise from privilege issues, protective orders, and the inability to perform exhaustive due diligence in an economical fashion. 

Obstacles to funding ongoing cases 

Companies face two impediments in obtaining funding for later-stage cases. First, existing counsel may not be amenable to entering into a funding transaction. Second, mature cases may have unfolded in an unexpected manner or increased in complexity such that they cannot be underwritten effectively. 

1. Counsel selection 

Litigation funders are routinely approached by parties that have retained risk-averse counsel. This commonly occurs where a company elects to engage its normal outside defense counsel to assert its claims. While defense firms may have strong institutional knowledge and deep benches of good lawyers, they are often unable — or unwilling — to assume meaningful risk in a funded case. This can preclude the ability to structure an aligned transaction, as counsel may: 

  • Insist on billing by the hour in accordance with traditional law firm revenue models; 
  • Budget in an overly conservative manner to protect realization rates; or 
  • Demand an outsized premium for taking contingency risk. 

The more embedded such lawyers are in a case, the fewer options a party has to strike a financing deal with favorable economics, or perhaps any deal at all. That is because the party has either already incurred considerable legal fees, significant fees are outstanding that must be paid when transitioning to new counsel, or current counsel has accumulated substantial institutional knowledge that cannot be easily transferred. 

In addition to economic incentives, alignment also requires the engagement of a well-resourced legal team with specialized knowledge and a track record of obtaining success in similar cases. Not every legal team is the right match for every case. Funders may believe that existing counsel is either unsuited to the task, or unable to devote the time, attention, and resources necessary for success. Frequent issues include: 

  • Lack of specialization and expertise in the relevant legal area; 
  • Insufficient resources to pursue claims; and 
  • A busy docket of other cases that receive higher priority. 

In-house counsel, particularly at companies that predominantly defend rather than prosecute litigation, may be less adept at counsel selection than litigation funders.  

2. Case developments 

Litigation funders are well-positioned to underwrite early-stage cases. Transactions can be structured to account for the many known unknowns of a dispute, and the possibility of early settlement exists.  

When cases progress, they often become more complex and appear to be destined for the long haul. Hundreds of thousands or millions of documents are produced, dozens of depositions occur, and motion upon motion is filed. 

While the development of a case may seem helpful from an underwriting perspective, it can have a detrimental effect. Protective orders typically prevent litigation funders from accessing most discovery.  

And even if they do not, cases with hundreds of docket entries are expensive for litigation funders to underwrite. Unless a funder is willing to devote significant resources to its analysis, information asymmetry can be at its peak.  

Furthermore, while claims may ultimately prevail, developments in the litigation and questionable strategic decisions may give funders pause. When coupled with information asymmetry, a case may be an unappealing candidate for funding, or, alternatively, only fundable in exchange for an extremely high investment return. 

Advantages of pursuing funding early 

In-house counsel should at least explore the possibility of litigation funding in a dispute’s infancy. At a minimum, consulting with a funder will inform decisions such as counsel selection and strategy that will preserve optionality in the event funding is necessary at a later stage.

About the Authors

Andrew LuckingAndrew Lucking is commercial counsel at LiveRamp, a technology company based in San Francisco.

Dai Wai Chin FemanDai Wai Chin Feman is director of commercial litigation strategies and corporate counsel at Parabellum Capital LLC, a litigation finance firm in New York.

The information in any resource collected in this virtual library should not be construed as legal advice or legal opinion on specific facts and should not be considered representative of the views of its authors, its sponsors, and/or ACC. These resources are not intended as a definitive statement on the subject addressed. Rather, they are intended to serve as a tool providing practical advice and references for the busy in-house practitioner and other readers.