Dispelling the Myths of Litigation Funding

Litigation finance, or the practice of providing capital using legal claims as the underlying asset, is a growing industry. Its use by law firms alone grew four-fold between 2013 and 2016, according to Burford's 2016 Litigation Finance Survey. However, the more a new industry grows, the more it is talked about — and, inevitably, misunderstood. So it goes for litigation finance in 2017. And while litigation finance can be a useful problem-solving tool in a variety of circumstances, to optimize its use, the legal and corporate industries should first collect the facts.

Here, I dispel three of the most common misconceptions about litigation finance.

Myth #1: The growth of litigation finance is driven by outside investors. Fact: The growth of litigation finance is driven by demand from clients and lawyers.

You've probably seen headlines that litigation finance is becoming more common as large law firms and companies increasingly explore sophisticated transactions that can run into the tens of millions of dollars. With such numbers, it's easy to see why some believe that the growth of litigation finance is supply-driven (due to supply of investment dollars) rather than demand-driven (with demand created by the needs of clients and law firms).

On the contrary, litigation finance is growing based on demand in the marketplace. In an environment where, according to the Litigation Survey, more than nine out of 10 clients (94%) say that increased pressure on legal budgets, staffing, and spending is a significant challenge today — up from 80% in 2014 and 73% in 2013 — it makes sense that these parties would seek a solution through outside financing. This demand, combined with litigation finance's applicability to a variety of client and law firm needs, is what has fueled the rise of the largest players in the industry. Most major litigation financiers provide solutions to clients that span startups to the Fortune 100, and firms of every size, from boutiques to the AmLaw 100.

To illustrate, litigation finance can usually be applied in all of the following circumstances:

• A litigant or law firm seeking financing engages with a finance provider that will consider commercial legal receivables as financeable assets.
• Financing can be provided at any stage of the proceeding — for pending claims, claims on appeal or legal receivables awaiting payment.
• The finance provider uses the value of legal assets and receivables to craft financial solutions, including structures that are based on financing a single case or portfolios of cases, or a custom solution for the client or law firm.
• Terms and structures vary. With large commercial funders, financing can range from $1 million to more than $100 million, most often on a non-recourse basis (meaning the investor's return is tied to the successful outcome of underlying cases).
• Capital provided by the financier may be used to pay fees and expenses associated with a case or for entirely different business purposes.
• Litigation finance products range from the simple to the complex. Straightforward arrangements include financing a single case where a client needs capital to proceed or a law firm wants to offer an alternative fee arrangements without taking on additional risk., monetizing receivables to help clients or law firms recognize a legal asset according to their needs, or developing portfolios to help clients and law firms address a range of broad business needs.

Myth #2: Litigation finance is unethical. Fact: Litigation finance is commonly accepted as within ethical rules.

As the litigation finance industry has developed, numerous Bar associations and professional groups have accepted it — acknowledging that ethical concerns surrounding certain types of financing are addressed by current rules.

However, litigation finance is not without its critics, including the U.S. Chamber of Commerce (see, “U.S. Chamber Pushes Rule to Expose Litigation Funding,” Law.com (June 2, 2017). Yet despite its vocal opposition, the Chamber remains in the minority. For example, at a recent gathering of the American Bankruptcy Institute, an on-site poll of hundreds of lawyers attending a “debate” featuring a Chamber lobbyist showed that 80% approved of litigation finance.

To observe that litigation finance is uncontroversial does not minimize the reality that lawyers without direct experience may have questions about the application of the ethical rules and the role of the finance provider. Specifically, while the legislative and judicial trend is toward acceptance of litigation finance, many lawyers are unsure about the role of the litigation financier and how financing products interact with the doctrines of work product. To clarify:

The term “litigation finance” describes transactions with passive, outside investors who in no way alter the attorney-client relationship. Litigation financiers have no rights to manage the litigation in which they invest, and they do not seek to stand in clients' shoes. Nor do they obtain any rights to control settlement of the litigation, which remains wholly in the litigant's purview.

As part of the due diligence process, litigation finance firms often review litigation details that are protected from disclosure by the work product doctrine. Such review is pursuant to a strict confidentiality agreement, and a long line of judicial decisions confirms that work product shared under these circumstances remains protected.

Some might also ask about champerty, maintenance and barratry — terms they likely have not encountered since the bar exam, if at all. However, even in jurisdictions where these common law doctrines still exist in some form, they do not interfere with litigation finance as practiced by large commercial funders. (For a more in-depth assessment, see, “Litigation Finance Is Not Champerty, Maintenance or Barratry.”)

Myth #3: Litigation finance is only for plaintiffs. Fact: Litigation finance helps both plaintiffs and defendants manage risk.

Litigation finance is mostly perceived as a tool to help plaintiffs pursue meritorious commercial claims. But litigation finance also works for defendants. Many companies rarely (if ever) bring lawsuits, but nearly all companies find themselves as defendants. Likewise, firms face intense competition to secure high-value defense clients, and even firms with institutional clients that are routinely engaged on transactional matters find it difficult to cross-sell the firm's litigation services.

In its simplest form, litigation finance for a defendant involves the financer's advancing capital to pay legal fees and costs related to defending a case. In return, the funder receives a negotiated return if and when the case is successful. Defense financing ideal for the portfolio-based approach, and companies with significant litigation portfolios thus are the typical candidates for this form of financing.

For instance, Grant Thornton, a leading professional services company, used portfolio financing for defensive matters. Insolvent estates often need to secure financing to manage and maximize the value of their claims, but complex insolvencies are not always good fits for simple case financing. The £9 million facility backed by one insolvent estate's litigation portfolio, enabled Grant Thornton to finance all costs of the bankruptcy estate, including defense costs, declaratory matters, administration costs, IP fees and expenses.

The majority of lawyers polled in the 2016 Litigation Survey predicted that litigation finance will continue to grow over the next five years. As the legal marketplace evolves, both in-house and firm lawyers will seek to use outside financing in increasingly innovative ways to meet their needs. Like with any new tool — whether it's legal tech, big data, or litigation finance — lawyers must first dispel myths and old ways of thinking to best utilize the most up-to-date problem solving techniques.

***** Travis Lenkner is a Managing Director of Burford Capital. He co-founded Gerchen Keller Capital and as Managing Director helped steer its growth to $1.3 billion in assets under management prior to its acquisition by Burford. His experience includes roles as in-house counsel at a Fortune 50 company, a litigator and a law clerk at the Supreme Court of the United States.