Litigation Finance (or third-party funding) originated in the Australian insolvency industry approximately 20 years ago. From there it has expanded globally and is now available in a wide range of disputes including claims arising from insolvency, commercial claims, intellectual property disputes, class actions and international arbitration (with some jurisdiction-specific limits).
At it’s core, litigation finance involves a third party providing the capital required to prosecute a claim in return for taking a share of any successful outcome if the claim succeeds. This prospect is high risk for the third-party funder, as the finance is non-recourse; if the claim is unsuccessful, the funder will receive nothing and will not be repaid its capital.
If the litigation does result in a successful outcome, the funder will be repaid its capital and will receive a share of that outcome (usually calculated as a percentage).
Generally, when a company pursues a claim, the costs of litigation will be recognised in a company’s accounts as an expense and will negatively impact the operating profit of that company for each year those costs are being incurred. The capital being used to pay these litigation costs is tied up and can’t be used for core business activities, thus reducing the profitability of the company. But a third-party funding arrangement can transfer all of the cost and risk of litigation from the claimant to the funder.
As such, a claimant can participate in litigation with zero financial downside. Instead of having the costs of litigation negatively impacting overall profit, these costs are removed and any profit which is ultimately made as the result of litigation will be generated for zero cost.
For law firms, litigation finance provides a risk-free mechanism to ensure that fees are paid (on time, in full) and a way to generate more work as meritorious claims which may not have been made due to the costs burden, can be pursued. Litigation finance also provides a pathway to justice and compensation for claims which, in the context of ever increasing litigation spend, wouldn’t otherwise see the light of day.
Litigation finance is also rapidly developing in order to provide diversified products as part of its offering.
Rather than just looking at one-off, large cases, third-party funders will also consider litigation “portfolios” for funding. A company may have a pool of claims and would like to partner with a funder to have that portfolio of litigation financially supported. As well as transferring the cost and risk of this pool of claims from a claimant to the funder, this approach also diversifies risk for the funder allowing litigation finance to be provided at a lower percentage of the outcome.
Such arrangements also allow for greater flexibility as the portfolio of claims can include smaller claims (that might not have been funded if considered in isolation) and can even include the funding for the defence of claims. As long as the portfolio as a whole presents a good opportunity, then the third-party funder is likely to be less prescriptive about how its capital is deployed across the portfolio.
There are a number of examples from the past 12 months of third-party funders overseas entering into portfolio funding arrangements. In early 2016, the first of these deals was announced when British Telecom agreed to a US$45 million portfolio funding arrangement. At the time, British Telecom had more active disputes than any other company in the FTSE100.
Litigation finance also presents an opportunity for business development for law firms. Corporate clients are increasingly looking to law firms to demonstrate a better understanding of their business and their commercial drivers. Litigation finance is a tool that enables better management of a company’s balance sheet – by removing the costs of litigation from the balance sheet. This leads to a healthier EBITDA position and healthier share price (for listed companies).
This is a great “value add” discussion for a lawyer to have with a corporate client (in the context of the many discussions about reducing fees or alternative fee arrangements which lawyers are having with their clients around the country every day). And for general counsel it’s a great discussion to have with their business (which traditionally sees the legal department as a cost centre) about the ability to transform the legal department into a profit generating centre.
So, when all the talk at the moment is about innovation, disruption and technology, it might be worth having a deeper look into litigation finance as a tool to have in your kit bag. It just might be that the most innovative, disruptive and differentiating service offering for your firm or company has been sitting right under your nose all this time.