Litigation Finance – A Modest Proposal
Many lawyers have heard the one about the consultation with a new client. Lawyer: “You have a pretty good case. How much justice can you afford?” It’s funny but it also distills a troubling reality – high stakes commercial claims are costlier to assert and the likelihood of success more uncertain than ever; clients are challenged to pursue even the most meritorious claims; and claimants often feel pressure to settle prematurely due to a need for cash.
Enter “litigation finance” (or litigation funding). Litigation finance, broadly speaking, refers to a third party with capital that is willing to fund the costs of litigation (up to a capped amount) that an aggrieved party of limited financial means (i.e. the plaintiff) wishes to bring against a defendant. In exchange for making the funds available, the litigation funder will receive a portion of any resultant recovery.
Litigation finance can equalize the bargaining power between plaintiffs, who may lack the financial means to pay litigation costs, and defendants, who may have deeper pockets and may sometimes be better able to shoulder the duration and uncertainties of commercial litigation.
Funds advanced in litigation finance are non-recourse to the claimant (i.e., the claimant need not repay amounts advanced if the case does not succeed or settle) but not inexpensive. Indeed, attorneys at our firm have recently worked on matters where the funder is to be repaid amounts ranging from 1.75 times the amount advanced if settled within 9 months from the date of funding and up to 3.5 times the amount advanced if the case settles more than 18 months from the date of funding. Alternatively, the claimants in each case would not have been able to maintain or mount a meaningful cause of action without the funding. Both matters required forensic accountants and other experts who do not work on a contingency basis.
Claimants seeking funding for a litigation, and the funders who provide it, may wish to consider establishing a minimum recovery for the claimant. Setting a minimum recovery for the claimant may reduce the risk that a court will not enforce a litigation finance agreement on the grounds that it is unconscionable, and may reduce any risk that a remorseful claimant later challenges the fees paid to the litigation funder.
The following examples illustrate why a minimum recovery for claimants may make sense in situations where a litigation funder is engaged:
Example #1: DeepNines, a Texas based security company pursued patent infringement litigation against a competitor and secured $8,000,000 in litigation financing. DeepNines won a $25,000,000 judgment, but after paying its lawyers and litigation funder DeepNines wound up with less than $800,000. The litigation funder’s return was more than 125% and DeepNines received barely 3% of the total recovery.
Example #2. Elwin Francis settled his personal injury case for $150,000 but pocketed only $111. His lawyers took only a customary contingency fee, but Elwin received advances from consumer litigation funders of $27,000. Funders’ fees (the cost of the money) increased the amount to be repaid to $96,000. Principal and fees repaid to the funder totaled 64% of the settlement while attorney fees and expenses totaled a little more than 33% of the settlement.
Example #3. Joseph Gill settled a case for false arrest for $500,000. A $4,000 advance accrued fees that inflated his repayment amount to $116,000. Mr. Gill’s attorney called the amounts demanded by the funder usurious and unconscionable.
A minimum recovery for claimants will be a negotiated point. Contingency fee standards may provide a useful guideline for a claimant’s minimum recovery in litigation finance. Some states have capped contingency fees for attorneys. For example, Connecticut has a sliding scale cap for attorney contingency fees. Attorneys may be paid (a) 33 1/3% of the first $300,000; (b) 25% of the next $300,000; (c) 20% of the next $300,000; (d) 15% of the next $300,000; and (e) 10% of any amount which exceeds $1,200,000. By contrast, New York State has no explicit ceiling, but the Rules of Professional Conduct for New York set forth factors to be considered in determining whether a legal fee is excessive. Courts have found forty or fifty percent contingency fee agreements conscionable in certain circumstances, such as when the litigation is complex, lengthy or specialized in knowledge.
There are instances when a straight contingency arrangement might not be a good fit at the outset. For example, counsel may need to cover certain expenses such as investigation or retaining experts or may be unwilling to work on such a basis. Litigation funders want the attorneys on a matter to “have skin in the game” and may insist, at the very least, on a hybrid arrangement where the attorney bills at a discount presently and defers a portion (plus a premium) until the conclusion of the case or matter. Typically, the litigation funder will propose that the attorney working on the matter agree to a reduced percentage on the contingency portion.
Litigation financing ensures access to justice for claimants with meritorious claims but who lack the means to bring or sustain a cause of action. Negotiated sliding scale caps on returns to funders upon repayment, like the contingency fee limits set in Connecticut, may strike a fair deal for all sides and ensure a litigation funding agreement is enforced or, if challenged, less likely to be disturbed.
John J. Hanley focuses his practice on first and second lien financings; private placements of debt and equity securities; and the purchase and sale of loans, securities, trade claims and other illiquid assets. His clients include business development companies, specialty lenders, investment banks, hedge funds, actively managed CLOs, special purpose vehicles, and other financial institutions. John structures, negotiates and drafts term and revolving credit facilities, commitment letters, consents, waivers, assignments, “big boy” letters, proceeds letters and a range of agreements, including guarantee, intercreditor, subscription, purchase and sale, participation and confidentiality agreements. Read more about John here.
Douglas Schneller handles a broad range of complex transactional matters involving bank finance and lending; restructuring, bankruptcy and insolvency; intercreditor and subordination arrangements, including for mezzanine, leveraged, multi-lien and unitranche financings; claims analysis and reconciliation; and purchases and sales of par and distressed assets such as bank loans, notes, accounts receivable, trade claims, bankruptcy claims, and equity interests. He also counsels clients on a range of other transactional matters, including trade and receivable finance (including default-triggered puts and vendor/account receivable and trade financing); bankruptcy transactional matters including distressed investing, rescue and debtor-in-possession finance, and sales under Bankruptcy Code Section 363; corporate trust and agency; structured products; private placements; portfolio management and monitoring; and securities law matters. Read more about Douglas here.
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