The common misconceptions about litigation finance

Righting the Wrongs.

If you’ve been following the investment industry over the last few years, you’ve likely encountered litigation finance. But while many are familiar with the term, lots of investors are still put off by concerns that have not been addressed. For example, does using litigation finance, also known as litigation funding, encourage frivolous litigation, or does it allow meritorious claims to see the light of day? Is it too complicated for investors to make a sensible assessment of the level of risk and reward? Does it enhance the legal process, or hinder it? 

Each of these questions have to be taken seriously, but more often than not, their answer depends on who you ask, on the form of litigation funding and on the facts of the matter itself. Overall, these concerns need to be addressed head-on along with a case made for the compelling reasons for engaging in litigation funding. 

Common concerns

“Corporations don’t need litigation finance” 

That might have been true 20 years ago, but a recent Thomson Reuters survey shows that increasingly controlling outside counsel costs has become a general counsel’s top priority. Many GCs are tasked with turning their legal departments into value-generation engines, a great prospect for the investor, and litigation funding can be a powerful means to extract revenue from legal claims while holding down outside-counsel costs. 

Funding can also provide independent validation, enabling the GC to file a claim that could bring a big payoff but would be expensive to litigate and requires buy-in from other executives. Senior executives don’t always grasp the risks and rewards in those scenarios, and they may want assurances of success that the GC can’t provide. Obtaining funding suggests that an outside expert has positively assessed the claim and potential damages, which may help persuade other key decision makers. 

“It encourages more and frivolous litigation among companies” 

That’s half-true. Litigation finance can generate more lawsuits by allowing companies to file claims where they might not otherwise be able to, but those cases are anything but frivolous. Be aware that funders shoulder significant levels of the risk, but also that they don’t invest in cases unless their due diligence shows that the claims have merit. If anything, litigation funding leads to more high-quality litigation.

“It’s too complicated” 

In its essence, the idea behind litigation funding is quite simple. The funder, and often the law firm, takes a large cut from potential proceeds in exchange for covering funded costs, but if the legal case you have backed loses, you make no return on investment. 

“Do we get access to the best cases?”

Plenty of GCs still often prefer to finance their strongest claims themselves, rather than give up a portion of the proceeds to funders. However, this does not mean that they doubt the success of the cases they do receive funding for. Rather, there are many situations when it makes more sense to defer the costs of litigation and shift some of the risk, even with claims that have obvious merit. 

Compelling reasons to use litigation finance

“It lets lawyers focus on lawyering” 

Under the traditional hourly rate format where the law department chooses an external law firm, GCs have to spend countless hours quibbling over budgets during the litigation process. 

Securing litigation funding typically reduces many of those burdens, allowing in-house teams to focus on collaborating with its law firm on legal strategies and tactics. Moreover, because the law firm isn’t financing the case itself, the external legal team is less likely to cut corners or push for premature settlements. Funding typically isn’t unlimited, so costs must still be managed, but adding a financing partner helps to let the lawyers focus on the lawyering. As such, investments of this kind help to improve processes within the justice system. 

“Expert damage assessments” 

Litigation funders bring a significant level of discipline and professionalism to damage assessment, often using experts who can assess the merits of a case and provide independent insights into how it might progress. The funders do this because their business depends on the premise that they fund successful cases. In doing so, they add a layer of assurance for their investors. 

“It changes the arithmetic on litigation expenses” 

Litigation finance is also a useful tool for can help dull, if not nullify, the short-term financial hit of legal cases for companies. This is because, if a litigation funder covers most of the litigation costs, the company’s financial statements are unaffected; resulting proceeds, while reduced by the funder’s payout, amount to a bottom-line windfall. 

Here, again, litigation funding provides an innovative tool that can help relieve potential tension between GCs and CFOs. It allows the legal department to pursue a meritorious claim without drawing resources away from the core business.

“Increasing competition”

Whilst the legal world is still showing some apprehension about litigation finance, investors are rushing in with abandon. Not just for the novelty but also because it’s truly uncorrelated to other asset classes and has lately outperformed them as well. Even within a single funder’s portfolio, cases are uncorrelated - an enticing attribute for investors. 

Unsurprisingly, the demand is giving rise to more funding firms, which promises to create greater competition for meritorious claims and thus more attractive pricing for the claimants. 

More funders also means more funding activity. In just five years, the share of law firms using litigation finance has risen from 7 percent to 36 percent, according to a 2017 survey by Burford Capital. That pace can’t continue forever, but there’s still plenty of room to grow - and plenty of reasons for investors to get involved sooner rather than later.