New to Litigation Finance? Start Here.

While litigation finance is now commonly discussed and considered in the legal industry, many people still have questions about what it is, how it works, and why it is financially beneficial to claimholders and law firms.  This post will discuss these basic questions for single-case commercial litigation funding, and later posts will discuss certain aspects of such financing in more detail, along with issues involved in portfolio financing. 

What Is It? 

At its most basic, litigation funding involves a third party paying for litigation fees and expenses in exchange for the repayment of its capital and an additional defined return if the litigation is successful. If the litigation is unsuccessful, the third-party funder recovers nothing.  Generally, these single-case funding arrangements are directly between the third-party funder and the claimant, but the investment documentation also often incorporates the law firm representing the claimant and requires the law firm to sign in acknowledgment of that representation. 

How Does It Work? 

Most litigation funders follow a relatively standard process for assessing funding opportunities and then finalizing and tracking the investment once a deal is finalized.  The typical steps involved in a single-case financing transaction are as follows:

Step 1: Protect confidentiality.  As a first step to protect confidentiality during the diligence phase, a litigation funder and the party seeking financing (usually the claimant) would sign a non-disclosure agreement.

Step 2: Evaluate the investment.  The funder would then begin legal and financial due diligence on the potential investment. As part of that due diligence, a funder may ask prospective recipients of financing to provide information such as key court filings, factual background about the claim, a projected timeline to trial, and a budget for the litigation. This is often the most time-consuming part of the process and generally involves input from the lawyers who will represent the claimant.

Step 3: Prepare investment documents.  Once the funder and claimant agree on the material terms of the investment, they will codify this understanding in a signed term sheet.  The funder will then draft the financing documentation to be signed by all parties.

Step 4: Track the investment.  The funder will monitor each investment to assess litigation progress and to understand any adjustments to the timeline or budget.  This monitoring often involves a monthly status call with the claimant, law firm, and funder to discuss progress in the case.  At no point in this process does the funder have any control over the litigation strategy or potential settlement – these discussions are purely informational.

Step 5: Resolution.  If the litigation is successful, the funder will be paid a return based on the calculations agreed upon in the financing documents.  If the litigation is unsuccessful, the funder does not receive a return of its invested capital or other financial compensation.

What Are The Benefits of Single-Case Financing? 

Third-party financing can provide important benefits to businesses faced with the monumental costs often associated with litigation.  It can: 

• Free up capital that would otherwise be used for legal expenses to pay operating costs or allow for investment in the business;
• Allow businesses to hire the best possible lawyers for the case, including law firms that otherwise would have been unwilling or unable to accept a fully contingent fee;
• Provide an additional independent evaluation of the case and litigation strategy;
• Alleviate the burdens of the negative accounting treatment associated with ongoing litigation expenses; and
• Reduce the risk of a negative outcome in the litigation.

In their representation of claimants, law firms often look for ways to help their clients pay for legal fees and expenses and reduce exposure to risk. If a client is interested in considering third-party funding, its lawyers can assist with the litigation funder’s due diligence process by providing information about the litigation, including the strengths and weaknesses of the claims, the budget for the litigation, and likely duration.  The benefits of litigation funding to law firms can include:

• Allowing the law firm to pursue individual cases that would be too costly for the firm to handle without an ongoing stream of revenue;
• Reducing the risk of traditional contingent fee arrangements;
• Bringing in an experienced resource to provide an independent opinion on the viability of a lawsuit;
• Making cash flow steadier and more predictable; and
• Eliminating the pressure for law firm clients to settle early for less than what their cases are worth due to budget constraints.