The decision to pursue litigation is often difficult for businesses, especially those at the helm of firms. That is why litigation funding is increasing in popularity.
Commercial litigation is usually time-consuming and expensive, and there’s no guarantee that a lawsuit will eventually result in a monetary award or settlement. Indeed, commercial litigation can present significant, even potentially catastrophic, financial risk not only to the plaintiff but also to the plaintiff’s law firm. Mounting expenses over time can take their toll on a business and practice, and if neither has the capital to sustain the suit, they both risk incurring losses.
To better evaluate this risk, it’s important to understand how litigation has been traditionally financed and how that financing model can affect a business and a practice’s daily operation.
Commercial Litigation’s Financial Risks for Plaintiffs
High Costs of Litigation
When a company decides to pursue a civil lawsuit, they retain a law firm with the talent and experience needed for success. They will also enter into a payment agreement, typically either an hourly fee or contingency fee payment arrangement. With an hourly fee arrangement, the client pays a law firm a flat rate per hour based on time spent working on the case.
In a contingency fee payment arrangement, the law firm only gets paid if and when they win a case. However, typically the business is still responsible for litigation costs, which may include court fees, document acquisition fees, expert witness costs, travel expenses, and more. Many firms also employ partial contingency payment arrangements, where the client pays the law firm a portion of their hourly rate and a recovery fee if the case is won. In large, complex cases however, even a portion of a firm’s hourly rate can amount to a substantial cost.
Time Frames Involved in Litigation
Complex commercial lawsuits can take between three and five years to resolve (with some even taking longer). During that time, a client is obligated to cover litigation expenses, which often grow over time depending on the trajectory of the case. But over such a long span, a business may see a drop in revenue from changing market conditions, strategic difficulties, or regional economic downturns. The impact of supporting ongoing litigation efforts in addition to the company’s day-to-day operations can end up hurting the business’ bottom line. The company may eventually be forced to choose between covering the costs of the next expert witness or making payroll or inventory payments.
Commercial Litigation’s Financial Risks for Law Firms
As the plaintiff’s lawyers work to prepare the case, the law firm may pay for litigation costs, which are then billed back to the client. However, if a client’s payments start to slow or stop, the law firm is placed in a difficult position. If the law firm is working on a contingency or partial contingency basis, they’ll want to keep the case moving towards a successful disposition to maximize their recovery fee.
Ideally, law firm staff should assess a client’s financial history and commitment to the case, as well as their ability to pay. Doing so can help a law firm avoid unwanted surprises when they send their clients invoices years into the litigation. But the practical realities of running a law firm mean that it is often not feasible or practicable to verify the financial wherewithal of all the clients.
If a client is facing economic hardship or becomes insolvent part-way through the course of litigation, the law firm may choose to absorb ongoing litigation expenses if it believes there is a high probability that the lawsuit can be won and the expected award will be substantial. However, doing so can be challenging for small firms without significant capital reserves. It can even force them to make similar choices about paying for litigation costs or basic operating expenses.
Types of Costs Incurred During Litigation
The direct costs of commercial litigation are not the only type of financial pressure a law firm may face. When a case is especially complex, a small law firm may need to devote multiple lawyers to it, delaying or foregoing other cases. This means that the law firm may be delaying or foregoing revenue from other cases that is necessary to sustain the firm’s daily operations.
When small law firms file suits against large corporations that have retained large, well-capitalized law firms, the smaller law firms at times can find themselves at a significant disadvantage. A large law firm can afford the substantial costs required to develop the most effective legal defense. Moreover, they can delay the civil proceedings through any number of legal tactics, putting financial pressure on the plaintiff and their law firm to drop the case or accept a low settlement offer. Therefore it is especially important that a small firm has the financial means to pursue its client’s case in the face of a sustained and aggressive defense.
Not All Funders Are Created Equal
To cover the ongoing costs of complex litigation, some law firms seek financing. However, traditional lenders, such as banks, often shy away from lending to law firms as their cash flow statements show inconsistent income. Further, traditional lenders usually find it difficult to effectively assess the risk of a litigation-related loan, as bankers don’t typically have the legal background to evaluate a civil suit.
Some alternative lenders specialize in offering lines of credit to law firms. However, these firms most often require that every partner of the law firm sign a personal guarantee, effectively pledging all their personal assets like their house and car as collateral for the law firm loan. This places a lot of personal risk on the lawyers and their families if the law firm starts to struggle. Typically, these recourse line-of-credit lenders do not have experienced legal underwriters who understand the value of the lawsuits, so they rely on the personal guarantee to backstop the lawsuit collateral. While some attorneys use these lines of credit, they can bring inordinately high risks compared to non-recourse lending offered by traditional litigation finance firms. Some attorneys have even faced personal bankruptcy as a result of these lines of credit that require personal guarantees.
How Litigation Funding Limits Risk
Unlike personally guaranteed lines of credit, litigation finance provides law firms with a non-recourse cash infusion to help cover the cost of complex litigation. The funder invests in cases brought to them by plaintiffs or their attorneys in exchange for a portion of recovered assets. The litigation financier helps law firms fund disputes ranging from breach of contract to intellectual property theft without the burden of keeping up with litigation expenses and the added personal risk of a traditional loan.
How Litigation Funding Differs from Traditional Lenders
When a law firm uses litigation finance to fund a case, it potentially reduces overall financial risk. The capital provided supports the escalating costs of litigation, increasing the chances of a successful disposition. It also allows the firm to proceed with the case even if the client cannot cover case costs quickly.
Importantly, litigation funders do not require a personal guarantee for full repayment of the loan. This non-recourse structure means that if the litigation turns out to be unsuccessful, the funder is not owed anything, representing a transfer of risk from the plaintiff or its law firm to the litigation finance provider.
Litigation finance ensures a law firm’s operating expenses remain intact and can help keep the doors open while a complex case winds its way through the legal system. Further, the law firm does not have to take on an expensive loan and potentially onerous repayment terms.
Litigation finance funding is not limited to single case transactions. Often, funders support a portfolio of cases and even operating expenses for a law firm. Litigation finance companies are typically composed of lawyers and investment professionals and can assess lawsuit risk effectively.
They also understand that fundamentally, a law firm’s ability to win a case depends on its capacity to function effectively as a business, including retaining talent.
In some cases, small law firms have used a portion of litigation finance funds to support higher salaries and bonuses for top talent, recognizing that a sudden exodus could harm their chances of winning their biggest cases.
Choosing a Litigation Funder
A law firm’s first step is reaching out to a reputable, well-established and well-capitalized litigation finance firm. Managing partners should seek firms capable of providing the funding needed and with the capacity and willingness to bring additional strategic resources to bear.
Law firms with complex commercial litigation cases should reach out to an experienced funder with a successful track record. Before signing an agreement with a funder, a plaintiff should research the organization’s management and underwriters to ensure they have adequate litigation experience. In addition to the capabilities to underwrite complex cases, a funder should demonstrate a willingness to work with the plaintiff and respond efficiently to requests from their potential counterparty. Responsiveness, transparency of the process and a funder’s ability to work through issues and consummate a transaction in a reasonable timeframe are often also important issues.
Ultimately, a plaintiff should feel confident that their interests are aligned with those of their funder and that they are set up for the best chance for success. If you are exploring your funding options for an upcoming lawsuit, contact GLS Capital to learn why so many top law firms and their sophisticated clients use our financing for their commercial litigation matters.