A Loan Versus Litigation Finance: How They Differ

The litigation finance market has grown substantially over the past decade. Law firms of all sizes have used litigation financing to fund costly lawsuits when they otherwise would not have the resources to win. However, despite the growing popularity of litigation finance, many people, including those in the legal services industry, still misunderstand the difference between a loan and litigation finance. Many believe that litigation finance is synonymous with legal funding loan agreements, which are another form of financing for complex, capital-intensive cases.

If you have a complex commercial litigation case with a high potential payout but need capital to pursue the claim, you may be considering a loan or litigation finance as a funding option. But there are significant differences between the two that you should understand as you evaluate your options.

Loans and Legal Funding Loans

In its simplest terms, loans are transactions in which one party provides property or money to another for a finite period on the condition of return. When money is loaned, the lender usually requires that money (or principal) be returned with interest, assessed as a percentage of the principal, and paid in installments.

Typically, when one party loans money to another, the two parties enter into a loan agreement: a binding contract between a lender and borrower that formalizes the terms of the agreement, including repayment terms and consequences for default. Federal and state laws have established legal thresholds for interest rates which a loan agreement may not exceed without being deemed invalid and unenforceable in a court of law. These laws are designed to ensure that lenders do not take advantage of borrowers, especially borrowers facing financial hardship and under duress.

Legal funding loans are available to small and midsized firms as an advance on the expected payout from the successful disposition of the case. A legal fund lender will typically evaluate the case and its merits, as well as the likelihood and magnitude of a potential payout. If the lender thinks the case will be won if the plaintiff’s firm has the necessary resources, the lender may agree to provide a loan.

In general, legal funding loans are structured for the lenders to recoup their loan proceeds either pre-settlement or post-settlement. If a lender wishes to recoup their funds before settlement, they may provide an advance to the law firm equivalent to a set percentage of the client fees the plaintiff will pay before the case’s disposition. Given that this approach does not hinge on the law firm’s ability to win the case, the lender faces substantially less risk of non-repayment.

Lenders may also choose to loan funds repayable at the point of disposition. Because the potential payout is nearly always much larger than the fees the client pays, lenders will usually advance greater amounts of capital for loans with post-settlement repayment terms than those with pre-settlement terms. However, these loans are less common, given that if the law firm loses the case or the plaintiff settles for a relatively low amount, the plaintiff’s law firm may not be able to repay the loan. A second type of post-settlement loan is available to firms that have won a case but are still awaiting the award. In these cases, a law firm may be looking to move on to their next case, but with their financial resources diminished from the last case, they need additional funding to move forward.

In all three instances, law firms are responsible for the repayment of the principal and interest no matter how the case turns out. As interest is assessed regularly, the longer the life of the loan, the more the law firm pays the lender. Interest payments, and any loan-related fees, reduce the eventual payout amount, sometimes substantially so. If you’re considering a legal funding loan, you must understand your financial obligations in full before signing on the dotted line. Otherwise, after an award is used to repay a loan and cover other past and current costs, there might be little or nothing left.

Litigation Finance

Litigation finance is an alternative method of funding expensive cases. Rather than funding your case with a loan, a litigation finance firm provides non-recourse payments to your law firm in exchange for a portion of the proceeds of any award or settlement. If the award or settlement is less than expected, the litigation finance firm is entitled to a portion of the proceeds but nothing more. And if you lose your case, you owe the litigation funder nothing.

In practice, a litigation finance company reviews the legal merits of your case by examining the lawsuit, your legal strategy, the evidence, and the damages potential, among other factors. Then, they’ll present a term sheet and work to reach a pricing structure that works for both parties.

Once they’ve completed any additional diligence and agree to fund your case, they draw up a litigation finance funding agreement detailing the terms of the investment, monetization terms of the award or settlement, and other salient factors. When you and the litigation finance company have signed, they’ll provide you with the capital you need to win your case. However, because a litigation finance firm has a stake in the case’s outcome, they usually provide funded law firms with strategic legal guidance and other resources throughout the case.

Choosing a Loan Versus Litigation Finance

When determining whether to fund your lawsuit with a loan or through litigation finance, one of the biggest considerations is your financial obligation. If you obtain a legal funding loan, you must repay it no matter what. A lender will require that the partners at a firm seeking a loan sign a personal guarantee, pledging their own assets (such as personal savings, a house, or car) as collateral to secure the loan. If you are advanced funds to be repaid from client fees and the client defaults, you are still obligated to repay your loan. Similarly, if you expect to repay your loan from case proceeds, you remain obligated to repay your loan whether you win or not. While your case and strategy may be solid, there is simply no guarantee that you will win or that your plaintiff will not settle for less than you may have hoped for.

You’re also obligated to make interest payments as per your loan’s terms, which can significantly increase your financial obligations if the client defaults on fee payments or if you lose your case and cannot immediately pay off your outstanding balance. Thus, a legal funding loan can provide needed capital but also comes with risk.

Alternatively, if you work with a litigation finance company, your financial obligations start and end with the award or settlement you receive. This model shifts the risk to the third-party financier, who may lose their entire investment if you lose your case. However, if you do, you’re not legally obligated to pay the financier anything. Further, many litigation finance firms are staffed with lawyers with deep experience in multiple practice areas. By approaching a litigation finance firm with legal experts on staff aligned with your case, you can significantly improve your chances of winning.

Choosing the Right Litigation Finance Firm

When you decide litigation financing is the right option for your case, you’ll want to work with a prominent litigation finance firm that has extensive experience trying complex commercial litigation cases, arbitration cases, and intellectual property cases in the U.S. and overseas.

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