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Legal Finance
FAQs
DISCLAIMER: The information contained in the FAQS has been prepared and is offered free of charge to provide illustrative information for those interested in legal finance. Riverfleet accepts no responsibility for any losses suffered in reliance of the information which is for informational purposes only and does not constitute legal, regulatory, financial or investment advice.
The legal finance market continues to have a pivotal role in providing access to justice and altering the power balance for claimants with meritorious claims who without funding would not otherwise be able to compete and meet the legal costs.
However, the market is rapidly evolving from single case “third-party litigation funding” for one off litigants into the use of bespoke legal finance solutions for a broader client base, including multinational corporations, law firms and insolvency practitioners with portfolios of multiple claims.
Legal finance is no longer perceived primarily as a means to fund legal costs. It is used by businesses as an important tool and financial solution to:
- Mitigate the risks of litigation through risk sharing
- Mitigate the detrimental effect of lengthy claims on cash flow
- Increase the capital available for other business purposes
- Remove legal fees as an operating expense from the balance sheet and improve net income and earnings metrics.
Traditionally, funding has been provided primarily on a non-recourse basis where returns are contingent upon a successful recovery, tending to carry more risk for funders but the potential for higher returns. Increasingly, funding is also provided on a recourse basis where less risk leads to lower returns.
Funding, whether as debt or equity, is now commonplace.
Businesses are now embracing the use of funding to unlock so-called “hidden” assets, monetising assets they would not ordinarily monetise. This accelerates into cash a portion of the value of an expected entitlement to recovery, whether from pending claims, or from court judgments and arbitration awards obtained which may be subject to an appeal or enforcement delay.
Litigation finance funds are increasingly using co-investment and syndication techniques to better manage their investment portfolios. This enables them to raise capital by unlocking their portfolios to co-investors, or to manage capital expenditure by pooling resources and sharing risk with other investors in respect of new and existing opportunities. It also has the added advantage of increasing the knowledge pool – more minds working on finding solutions.
There has also been a shift in the legal finance repertoire towards an increase in the adoption of insurance as a means of reducing litigation outcome risk which can make capital more accessible and cost efficient. The insurance policy can be pledged to the funder providing downside protection for the funder in the event the case is not successful. Additionally, companies and law firms are turning to insurance to protect work in progress and judgments which they may or may not seek to monetise.
This evolution creates greater opportunity for businesses to find innovative financial solutions that are tailored to their business needs, and for litigation funders to manage and diversify their portfolios more effectively from an investment management risk and reward perspective.
How the funding deal is structured depends on many different factors.
In its traditional form (where the funding is non-recourse, not debt), in exchange for funding the legal costs, the funder (i.e. investor) receives a share of the proceeds of a successful outcome, typically calculated as a percentage of the amount recovered (known as “damages-based”) or as a multiple of the amount invested.
For example, an investment of £5m in legal fees in a successful claim that recovers £50m by way of settlement or award would generate a return of £15m assuming a multiple of 3x the investment amount.
However, if the case loses, the funding is not repayable, and the funder suffers a complete loss on its investment. Accordingly, the price of the funding reflects the uncertainty inherent in litigation and the risk of an unsuccessful outcome.
Investing in cases which “win” is therefore a prerequisite for generating attractive returns for funders who adopt this funding model, which carries high risk, but the potential for significant returns.
Recourse capital is typically calculated by charging a specified interest rate.
These are arrangements between lawyer and client where the lawyer risks payment of some or all of the fees on a successful outcome of the claim.
Conditional fee arrangements (“CFAs”) are largely a UK phenomenon. Under a CFA, discounted fees instead of standard fees are applied, but in the event of a successful outcome, the lawyer can charge that balance (known as “conditional fees”) plus an uplift (known as a “success fee”) to compensate for the risk of an adverse outcome and for the deferred payment of the balance.
A “contingency fee” is the generic term used to describe fee arrangements where payment of the lawyer’s fees is dependent upon a successful outcome. Often the term “no win, no fee” is used to describe such arrangements.
A Damages-Based Agreement (“DBA”) is a “no win, no fee” agreement between a claimant and lawyer which entitles the lawyer to a share in the proceeds of a claim.
Many law firms operate as cash businesses with limited balance sheet capacity and need the steady stream of income that standard hourly fees provide. Increasingly, their clients are demanding alternative fee arrangements. The provision of capital to law firms helps bridge the gap in cash flow generated by alternative fee arrangements.
All legal finance investments essentially depend on an economic model similar to the one illustrated below, each with different risk/reward characteristics and outcomes depending on the market and strategy.
Example of a successful single case commercial investment:
ATE insurance, also known as litigation insurance, is a policy that covers litigation costs. It is particularly prevalent as part of a litigation funding solution in jurisdictions where the “loser” can be required to pay some or all of the “winner’s” costs.
The scope of the cover (whether limited to some or all of the opponent’s legal costs or including own legal costs) and the terms of the premium offered, are tailored to the specific needs of the client, including one-off premiums, staged premiums (which increase as the matter progresses to remain proportionate to the costs incurred), deferred premiums (only payable at the conclusion of the case which has obvious cash flow advantages), and contingent premiums (which are only payable if the case is won but command a much higher premium since no premium is payable if the case is lost).
Contingent legal risk insurance provides cover for loss arising from a legal risk crystallising across a broad range of applications. It encapsulates, for example:
- Adverse judgment insurance (cover for expenses and/or damages in the event of an adverse judgment);
- Contingency fee insurance (reimbursement of fees and expenses for law firms working on a contingency fee basis in the event the litigation is unsuccessful);
- Judgment preservation insurance (coverage for the claimant in the event a judgment is overturned or reduced on appeal); and
- Capital protection insurance (capital protection for investments in cases if the litigation is unsuccessful and the capital is not repaid).
The litigation finance market is, broadly, made up of three major sub-sectors of investments:
(i) Commercial claims
- litigation generally involving two corporate entities engaged in disputes such as breach of contract, intellectual property infringement, antitrust, securities, fraud, bankruptcy and creditor’s rights;
(ii) Mass tort claims
- mass personal injury claims where multiple individuals are harmed by the same act or omission with claims against the same defendants arising from the same circumstances (e.g. product defects, pharmaceutical cases, plane accidents); and
(iii) Personal claims
- generally, individual personal injury, tort, family law, and consumer claims.
Case types have differing underlying characteristics.
The returns and risk are dependent upon:
- a variety of investment structures (resembling traditional debt financing, equity financing, and a hybrid of the two);
- the underlying differing characteristics of the case type; and
- the geographic region, each of which has its own legislation, trends, competitive dynamics and other characteristics which make the outcomes unique.
Non-recourse commercial claim investments tend to carry more risk but the potential for higher returns that are scaled to the likely size of the verdict or settlement and the amount of financing provided.
Mass tort investments typically are investments made in law firms that hold groups of high profile mass tort cases (which can be lower risk settled cases or higher risk unsettled ongoing litigation). The returns are typically a set fixed interest rate, with the loan amount limited by the value of the underlying collateral cases.
Non-recourse investments in personal claims are typically backed by personal injury portfolios comprising hundreds or even thousands of individual idiosyncratic cases. The returns in these cases are dependent on the magnitude of the verdict or settlement and are generally capped by an interest rate.
The timing of a resolution is difficult to predict, but tends to impact the internal rate of return (IRR) and return on invested capital (ROIC) which are the two methodologies by which investment returns are typically calculated and investment performance is measured.
Some investments come with higher risk and potentially longer duration but the prospect of much higher returns upon success. Other investments come with lower risk, shorter duration, and more predictable lower anticipated returns.
Cases that settle often have higher IRRs (because of shorter duration) but also lower ROICs (because settlements often require discounts for the certainty of resolution, or because smaller amounts of capital have been deployed for a shorter period of time). Conversely, matters that go through the whole adjudicative process and win tend to have much higher ROICs (because there is no settlement discount) but lower IRRs because the process can take a long time.
Litigation finance operates in the majority of stable legal systems and arbitration centres globally. However, different jurisdictions take radically different approaches to fundamental legal, regulatory, and ethical issues including:
- Champerty and maintenance
- Confidentiality and privilege
- Conflicts of interest
- Disclosure requirements of funding arrangements
- The enforceability of certain litigation funding arrangements
- The funder’s degree of control over the management of claims
- Permissible alternative fee structures and fee-sharing
- Whether funders can be held liable, and need to provide security, for the defendant’s costs
The PACCAR judgment regarding what constitutes a “Damages Based Agreement” and therefore what agreements must comply with the Damages Based Agreement Regulations 2013 in order to be enforceable, has had an adverse impact on the availability of litigation funding in the UK.
Unless there is a change in legislation following the UK Government’s ongoing consultation on litigation funding off the back of the PACCAR judgment, UK funders will continue to exercise caution regarding the provisions they adopt in litigation funding agreements and whether some existing litigation funding agreements are indeed enforceable.
Monetisation is a concept involving the acceleration of a portion of the expected value of a claim prior to its resolution. It enables a client to convert an intangible claim or award into tangible cash.
It is frequently used to monetise judgments or awards which have been obtained but are subject to an appeal or are uncollected due to enforcement delays.
The concept is broad and extends, for example, to the monetisation of alternative fee arrangements for law firms based on an assessment of the expected value of success fees arising out of the results of a pool of contingent fee matters.
We offer a range of standard and alternative fee arrangements which are dependent on the nature and complexity of the task. Typically, we agree contingency fee arrangements which align with clients’ interests in achieving a successful outcome.
Navigating the Legal Finance Market
Successfully navigating the complexities and idiosyncratic characteristics of the global Legal Finance market requires the trust and confidence of specialist Legal Finance expertise dedicated to meeting clients’ specific requirements which are unique. To discover how we can help you achieve your goals, please get in touch with us.