Getting Serious about
If you’re exploring litigation finance, you likely have a number of threshold questions. To help, we’ve provided the answers to fifteen common queries below. Beyond these, we would welcome the chance to explore any additional questions or concerns you might have. Even if we don’t enter into a formal relationship, we are happy to provide broad guidance on how to best approach the litigation finance market.
You can reach us at email@example.com or 917.715.3771.
1. HOW MANY FUNDERS ARE OFFERING LITIGATION FINANCING? There are more than thirty (30) different sources of litigation funding in the United States, and the number is growing rapidly. While media attention typically highlights the handful of publicly traded litigation finance companies, major in-roads are being made by global hedge funds and others, bringing significant amounts of new capital to the market. As a result, competition among funders has never been stronger, and shopping your opportunity among a number of appropriate funders can yield significant cost savings. Care should be taken when choosing from this large field of funders, however, as selecting the right funder can be the difference between a successful – and a disappointing – venture into the world of litigation finance.
2. HOW DO I CHOOSE THE RIGHT FUNDER? Each of the 30-plus funders is unique, with their own sources of capital, areas of focus, track-record, and reputation for fair dealing. Some are publicly traded, some have raised independent funds, and some have sourcing relationships with global hedge funds (which eliminates concerns about capital adequacy but can lead to conflicts, delays, and approval issues). Funders also differ greatly as to the categories of cases they wish to finance. For example, some prefer investments of $3 million or more, while some prefer investments of $1 million or less; some will do only commercial cases while other only support the traditional plaintiffs’ bar. The distinctions can go even further, with some firms specializing in a given practice area – say, intellectual property or international arbitration. Beyond these categorical questions, every funder has its own personality in terms of ease of dealing, underwriting process, and appetite to deploy capital. As should be clear, matching your particular opportunity with the appropriate funder can greatly reduce the time and effort required to secure financing.
3. HOW LARGE MUST MY OPPORTUNITY BE TO ATTRACT FINANCING? Traditionally, funders of commercial litigation have shown an interest in opportunities requiring $1 million or more in financing, but, in practice, have focused their time and attention on opportunities requiring at least $3 million. As the market has grown, however, we’ve seen an increasing appetite for the financing of smaller cases – funding for $1-$2 million deals has picked up considerably, and we are aware of a number of quality funders entertaining opportunities at the $750,000 level. Just as important as the size of the finance you seek, however, is the size of the judgment you can reasonably expect to receive. For reasons we can explain, funders are typically looking for a funding/recovery (or more technically, “loan to value”) ratio of 1:10. This is to say that for every $1 million in funding, they will require the expected judgement or settlement to be $10 million. (As a further example for clarity, $3 million in funding will usually require a anticipated recovery of $30 million). This issue of “deal economics” is a major stumbling block for many cases – and one that we are happy to explore with you.
4. HOW MUCH DOES LITIGATION FINANCE COST? The standard response to this question is: “it depends on the risk associated with your case(s).” And while this has some truth, if doesn’t help those who are wondering whether to actively pursue financing. In practice, pricing can be negotiated based on historical data, market trends, competitive pressure – as well as the anticipated legal risk and time to resolution. As a general matter, it’s important to know that funders typically use two mechanism for pricing. The first is akin to debt pricing – where the return (or cost of the capital) is a multiple of the amount to be financed. Thus, if $2 million is financed against a “multiple” of three (or 3x), the funder would receive the first $6 million of the ultimate case proceeds. The second mechanism - akin to equity pricing – sees the return as a percentage of the ultimate case proceeds. Thus, a funder may request 30% of such proceeds – a figure in keeping with the standard contingency fee for U.S. lawyers. All of this said, the vagaries of pricing are one of the more complicated aspects of litigation finance, and often involve variations on the two mechanism above, as well as negotiated topics of repayment, different forms of interest rates, complicated “priority” structures, and other elements. With a relatively short phone call, we would be more than pleased to give you a broad sense of how your particular opportunity would be priced in the current market place.
5. WHAT CAN I DO TO TRY TO REDUCE THE COST OF MY FUNDING? Litigation finance can be expensive – and perhaps rightly so, as funders are typically offering their capital on a non-recourse basis. That said, two things can be done to lower your cost. First, if rather than offering a single case, one can package two or more cases into a “portfolio,” most funders will significantly lower their price. Why? The trick is to cross-collateralize the return, such that if one case loses but the other wins, the funder can recoup all of its return from the single winning case. Because the funder has two chances to secure its money, it has less risk, and thus can price lower. (This is the same reason that a basket – or portfolio – of stocks in a mutual fund has a lower risk profile than a single stock, which has a binary outcome.) The second way to reduce your cost of capital is to shop your opportunity to a number of high quality funders. Properly presented, your case or cases should attract interest from at least several funders, allowing you to use competitive pressure to gain a better rate. Such efforts take time and finesse, but can result in the saving of millions of dollars for you or your client.
6. WHAT TYPES OF FINANCING ARE AVAILABLE? FOR CLAIMANTS? FOR LAW FIRMS? At its core, litigation finance is an investment in the outcome of a given litigation or arbitration. Typically, funds are advances on a non-recourse basis, meaning that if the case loses, the funder receives nothing. The most basic form of funding is the advancing of funds to a claimant to pay for its legal fees (lawyers and expenses), in return for some part of a successful judgment or settlement. Over time, different structures have developed beyond this basic funding, to include a growing set of financing products for both claimants and law firms. Claimant products include: the funding of expenses only (typically for contingency fee cases); the monetizing of future judgments (with monies reinvested in the claimant’s core business); and the acceleration and enforcement of judgments once they’ve been received. Law Firm products are focused on the de-risking of contingency fees (often done in a portfolio) and the acceleration of legal fees (either in the context of a mass action, or at year-end to assist with accounting concerns). Each of these products has its own pricing structure and discrete issues that set it apart from basic funding. We are happy to explore the advantage of each product with you.
7. WHAT ETHICAL CONSIDERATIONS SHOULD I BE AWARE OF? As a starting point, we believe that any law firm seeking financing for its own client (i.e., in order to pay that firm’s own legal fees) should engage a broker. This simple step provides a compelling defense against any future claim of conflict of interest – or more relevantly, the appearance of a conflict of interest – in the transaction. (Use of a broker also brings the additional benefits of ensuring optimum pricing, proper terms, and a speedy process.) Our position on this issue has nothing to do with the specifics of litigation finance, but rather with basic issues of attorney-client relationship, good client management, and proper compliance. As to ethical issues pertaining directly to litigation finance, there are critical areas which require attention – however most every concern can be successfully navigated with expertise. First, and most importantly, all arrangements should provide for complete control of the case by the claimant, with an explicit provision regarding settlement decisions. Second, the attorney-client relationship must be acknowledged as sacrosanct, recognizing that the attorney must always act 100% in the interest of her client. Both of these principles require funders to be “hands-off” as regard the prosecution of the claim – and to agree to view the litigation as a passive investor. Third, the current law on champerty and maintenance should be researched for the jurisdiction in which the claim is to be brought. In the U.K. (where these doctrines originated in medieval times) champerty and maintenance have been effectively abolished, and in the U.S., virtually all major centers of commercial litigation either no longer recognize such doctrines or have found ways of easily distinguishing the contemporary practice of commercial litigation finance. (We are happy to provide a list of those few jurisdictions that may be of concern.) Fourth, and finally, it would be wise to check the current rules as regards necessary disclosure of the use of litigation finance. As of this writing, this is only required in one Federal court (the Northern District of California), and even then, it is only mandated in class actions situations. Nonetheless, the issue of disclosure is the subject of current debate and potential legislation, and should be followed closely. We are tracking this topic, and all related ethical issues, and can provide you with the latest information.
8. SHOULD I BE CONCERNED ABOUT ISSUES OF CONFIDENTIALITY? The short answer, of course, is “yes.” But with some care at the outset of your search for funding, these issues can be easily resolved. Not only will you want to put a non-disclosure agreement (“NDA”) in place with everyone with whom you speak (brokers and funders), but you’ll want to include a so-called “common interest” provision in your NDA. Recent court rulings in a number of different jurisdictions (federal and state) have strongly recognized that funders and those assisting the funding process are – in essence – part of your litigation team, and should be treated with the same protection of confidentiality as expert witnesses and other who are not acting in a purely legal capacity. While a number of different theories have been used to protect communications regarding funding, the strongest have utilized the “work product” doctrine, which provides additional protections when a common interest provision has been made explicit in the parties’ NDA. We can provide extensive advice and materials on this topic, including NDAs that have been blessed by the courts.
9. HOW DOES THE PROCESS OF OBTAINING FINANCING WORK? Our standard process involves multiple steps. At the outset, we work with clients to review the opportunity at hand, collect all relevant information, and produce a formal “investment memorandum.” This memo presents a comprehensive view of the case – tailored to the questions that typically concern funders, including our expectations for pricing. We then select a handful of funders appropriate for the type of case involved and – following the execution of NDAs – provide them with the investment memorandum. At the same time, we often provide the funders with access to a virtual data room of helpful documents. Next, we’ll engage in an on-going dialogue with each funder with the goal of engendering a term sheet with headline terms and pricing. Following our review of these submitted term sheets (we seek to have two, if not more), we will select a single funder with which to proceed. Upon execution of the term sheet, we will spend some period of time – typically four weeks – working with the funder through deeper due diligence and the creation of transactional documents. Our goal is to execute the funding agreement and related documents within such time period. In all, the complete process – from initial discussion to funding – can take between two and three months (although see our further discussion on timing in response to question #13 below).
10. WILL I HAVE TO SIGN A TERM SHEET AND GIVE A FUNDER EXCLUSIVITY? Once a funder has determined that it is interested in financing an opportunity, it will typically offer a term sheet – outlining fundamental issues such as pricing, collateral, break-fees (if any), and the period of time during which it will complete its due diligence. It is industry standard for such term sheets request a period of exclusivity (or “no-shop”) while such diligence is undertaken – the argument being that if a funder commits significant resources to reviewing an opportunity, it should be given reasonable time and a clear path to close the deal. Importantly, not only are such term sheets non-binding on funders (as they usually provide an “out” should the funder be unsatisfied with due diligence), but the exclusivity provision can leave those seeking funding flat-footed should funding be denied. We would be please to discuss the issues surrounding exclusivity provisions, and to share several suggestions for making term sheets less onerous.
11. WHAT DOES A FUNDER LOOK FOR WHEN UNDERWRITING? Aside from the size of the financing and the type of claim, funders broadly look at five criteria when underwriting a case. First, they want to understand the legal merits. Most funders won’t finance claims that stand less than a 50/50 chance of winning, and many will insist on a ratio more akin to 70/30. Second, they will want to understand the collection risk. There is no point in funding a winning case if the defendant has no assets to pay the ultimate judgment. Third, funders want to understand economics of the deal. In short, the anticipated judgment to be collected must be large enough to satisfy the expectations of the claimant, the law firm, and the funder (most funders believe the claimant should walk away with at least 50% of the judgment). Fourth, the funder will want to be sure that the claimant is commercial reasonable. Claimants should ultimately have responsibility for determining when to accept a settlement offer, and it’s critical that they will accept a sensible settlement. Fifth and finally, the funder wants to be certain that the lawyer and the law firm engage on the matter has the experience and expertise to bring the case to a successful conclusion. All of these criteria – and more – should be properly presented to proposed funders – starting with the information memorandum that kicks-off the funding process (as described in Question #9).
12. WHAT DOES A LITIGATION FINANCE CONTRACT LOOK LIKE? The funding agreement varies depending on the type of financing to be had. For example, the provisions for an agreement to finance a claimant’s legal fees and costs is somewhat different from an agreement to de-risking a law firm’s contingency fee portfolio. That said, there are certain standard provisions that pertain to any litigation finance agreement, including the definition of proceeds, “waterfall” provisions, early repayment rights, ethical considerations (including the control of settlement), “bad boy” guaranties, the distribution of funds, and the ability of the funder to cease making further payments (if funding is not “lump-sum”). Special attention must also be paid to the tax treatment of the financing, especially if an off-shore entity is being used as a vehicle for the funding. As most litigation financing arrangements create an on-going relationship between the parties that lasts for several years (during the pendency of the claim), it is vitally important that all contractual provisions that govern this extended relationship are carefully considered – and tailored to the needs of the claimant or law firm. As the funder often provides the first draft of the agreement, a review by someone experience in such agreements is strongly recommended.
13. HOW LONG WILL IT TAKE FOR ME TO SECURE MY FUNDING? In all likelihood, longer than you would like. While funders often make noise about their ability to turn a deal around in an abbreviated time (e.g., seven days), transactions can often take as long as three or four months (or longer) from start to finish. Because many using litigation finance are doing so for the first time, they are apt to follow the lead of the funder they have chosen to work. As such, the funder controls the rhythm of the process, which can slow to a crawl during the underwriting process. There are many reasons for this delay, and a great deal that we can be done to shorten the time period. Not surprisingly, we believe that working with an advisor/broker like Red Bridges is one of the keys to moving a deal forward quickly. We understand precisely what funder are looking forward and what they need to progress a claim. And, because we work with many funders on a repeat basis, we are able to insist that our deals move forward swiftly (leverage that an ad-hoc claimant often lacks). Most importantly, however, as our sole function is to secure financing, we are persistent in our daily efforts to obtain funding on the best terms in the shortest amount of time.
14. HOW WOULD WE WORK WITH RED BRIDGES ADVISORS? We have three primary services:
Brokering. In this role, we work side-by-side with clients who are actively seeking financing. Our efforts extend through every step of the funding process – from information gathering and funder selection through deal closing and initial financing.
Advising. Here, we provide expert advice on issues related to litigation finance, including second opinions on deal pricing and related topics. Many such clients are exploring the advantages of litigation finance, without having identified a specific opportunity.
Educating. We are eager to dispel the mystery around our industry. For many years we have been presenting to law firms and other groups on the topic of litigation finance, and are happy to tailor a presentation to your organization.
15. HOW MUCH DOES RED BRIDGES CHARGE FOR ITS SERVICES? We charge the going industry rate for our work. If you have an opportunity for which we can be of assistance, we are happy to discuss the details of our business model. Please be in touch.