The legal industry is woefully unfamiliar with the wide range of financing solutions offered by litigation funders, resulting in claimants, defendants and law firms tying up more capital and assuming more risk than is necessary during cases. That was the main finding of a survey undertaken by The Lawyer Research Service and Burford Capital late last year.
For those not in the know, litigation funders now offer a variety of finance products to claimants, defendants and the firms representing them, ranging from WIP funding and costs advances to recourse loans and security for costs.
Contrary to common perception, litigation funders are also happy to provide financing for purposes other than paying a lawyer’s fees or other disbursements. In fact, litigants can use their litigation cases as security to secure financing for pretty much any corporate purpose, including international expansion, working capital or research and development, even if it is completely unrelated to litigation. In short, litigation finance has evolved to corporate finance.
How does it work?
The finance is still tied to the case because the funder is repaid a return from the damages recovered. Like standard litigation finance, the funding is still non-recourse, meaning the investment does not need to be repaid if the claimant is unsuccessful. Essentially, the case is treated as an asset and is used to collateralise investment in initiatives that might be completely unrelated to the underlying matter.
It’s important for the legal industry to realise that litigation finance can be used in this way because it immediately makes funding relevant for litigants that can afford to fund the case themselves or who have retained a lawyer on a contingency fee agreement (CFA). Essentially, it enables claimants to secure capital that they might otherwise not have had access to until a claim was successful, or never had access to if the case was unsuccessful.
If you didn’t realise litigation finance could be used in this way you’re not alone. Two-thirds of surveyed in-house counsel and corporate C-level executives that litigated in the last three years were not aware that their cases could have been used as collateral to secure finance for purposes completely unrelated to the case, so didn’t even explore this option.
A further 26 per cent were aware that cases could be used as assets for financing but didn’t think their cases were suitable. Five per cent tried to use litigation assets as collateral for financing but were rejected by funders while only two per cent actually structured finance in this way. Put simply, there is a huge lack of awareness when it comes to how litigation finance can be used.
This misunderstanding is echoed by private practice lawyers. Over 70 per cent of surveyed private practice lawyers stated that most of their clients haven’t explored using litigation as an asset for investment because they didn’t know about it.
Our survey data reveals litigation finance might be used a lot more widely if the product was better understood. Over 90 per cent of surveyed in-house counsel believe that using litigation assets as collateral to fund a company’s business expenses is an innovative idea.
But while there is much enthusiasm for using litigation finance for purposes unrelated to litigation, there are also some hesitations. Nine out of ten surveyed in-house counsel and corporate C-level executives believe there are less complex ways of funding a company’s business expenses than through leveraging litigation assets while around eight out of ten believe there are cheaper ways to raise financing than through leveraging litigation assets.
It’s true that litigation finance can seem expensive – typically between 20 per cent and 40 per cent of damages must be awarded to the funder in the event of a successful outcome – it’s worth remembering that the funder is not repaid anything if the case is unsuccessful.
Some funders offer hybrid solutions, in which part of the investment is directed toward running the case and part is used for unrelated purposes.
Burford Capital is one of these. “We have received lots of interest in the hybrid model,” says Ross Clark, chief investment officer at Burford Capital. “As long as the money is used for sensible and legal means we are happy. Yet a lot of people believe funding isn’t relevant to them because their lawyer is signed up on a CFA.”
Another common misconception is that litigation finance can only be used for single cases. In fact, many funders are prepared to fund multiple claims on a portfolio basis. Portfolios can include related or unrelated matters for one or many clients. It can be used by clients and law firms to pay for some or all fees and expenses, for expenses only, or for purposes completely unrelated to the matter.
If the portfolio is sufficiently large, funders will offer significantly better pricing because their risk is spread over multiple cases. “Burford’s pricing is lower if we provide financing across a portfolio of cases,” explains Nick Rowles-Davies, managing director at Burford Capital. “And that lower pricing also comes with a significant advantage over traditional financing because it’s non-recourse. The litigation financier assumes cost and risk.”
It’s important to realise that multiple cases can be funded on a portfolio basis because it opens litigation finance up to a huge number of claimants whose cases might be too small for funding individually. One example is subrogated claims by insurance companies. “In this structure the insurance company pays out and pursues the claim as the claimant,” explains Julian Connerty, a partner at Signature Litigation. “They might have hundreds of claims that individually are too small, but combined would be worth tens of millions. So a funder might fund the whole block of claims as a single transaction, because on their own the individual case would be too small.”
Portfolio funding can also be structured when there are multiple claimants, such as in group actions where group litigation orders (GLOs) have been made. According to Sue Nash, managing director of Litigation Costs Services, one class of GLO that is particularly suitable for funding is shareholder actions.
“There is also huge potential for funding to be used in GLO actions such as nuisance/loss of value actions,” she says. “Lots of this work is done through CFAs and sometimes law firms even carry the disbursements, so there has to be a demand for this type of funding.”
Funding security for costs
Another common misconception is that the entire case must be funded right from the outset. In fact, litigation financiers are very willing to fund individual aspect of litigation.
One example is security for costs. If defendants are successful in applying for security for costs – a delaying tactic often used to defeat valid claims – the claimant is required to set aside sufficient funds to pay the defendant’s costs if they lose, effectively doubling their exposure and the amount of capital that can’t then be used for other needs.
For financially weak claimants, security for costs funding can be a godsend because it might allow a costs application to be met that otherwise might be unaffordable. This type of finance is still relevant for claimants that can afford to meet a security for costs application as it means their money isn’t tied up for the duration of the case.
Security for costs finance can sometimes be so powerful that it triggers a settlement. “We had a case where the claimants had strong merits but difficulties funding the litigation,” says Ashley Hurst, a partner at Olswang. “Meeting a security for costs order through third-party financing paved the way for settlement because the other side knew our client was protected financially.”
But yet again, despite the obvious advantages of security for costs finance, a significant proportion (39 per cent) of surveyed litigation lawyers have never heard of it. Fewer (15 per cent) have ever used it.
Funding can also be secured post-judgement. On the surface this may seem nonsensical. Why secure funding when you already have a successful judgement? As Clark of Burford Capital explains, it may still make sense to talk to funders at this stage if there are enforcement risks or if claimants simply want to access their claim earlier than is otherwise possible.
“If your claim is against an insured UK entity you will almost certainly be paid, but enforcement is a big issue in the commercial world,” he says. “A lot of businesses and lawyers don’t appreciate this because they only really care about the merits of the case, rather than how they get paid once the case is won. This structure means we provide money more quickly than if you follow standard process and procedure. However, it is also worth noting that in certain instances there is sometimes a real risk of not getting the money at all. Sometimes the judgement could end up being just a piece of paper that is actually worth very little.”
Other options for law firms
Another huge misconception is that litigation finance can only be secured by claimants. Infact, a variety of litigation finance products are available to law firms, particularly those undertaking lots of CFA or damages-based agreement (DBA) work.
A prime example is work-in-progress (WIP) funding. How does it work? A financier will evaluate a series of CFA or DBA cases the law firm is pursuing and provide capital in return for a percentage of the fees if and when those cases are successful.
As part of the deal the law firm is free, within reason, to invest the capital however it wants. That might mean taking on new CFA cases, expanding its team, opening a new office or simply providing working capital. Once again the financing is non-recourse, meaning the firm is not required to repay the funder if it loses the cases that are being used as security.
“For many firms that have large exposure to WIP or perhaps large claims for which their bills cannot be paid quickly, WIP funding is a very attractive option,” says Guy Harvey, a partner at Shepherd & Wedderburn. “The larger the portfolio, the more competitive the rate funders will offer.”
WIP funding is also attractive because it enables law firms to de-risk and monetise contingency fee work. “Many law firms have entered into multiple alternative fee arrangements, from old-style CFAs, to DBAs and therefore have a bundle of risk spread across a range of different cases,” explains XXIV Old Buildings barrister Michael Black QC. “It might be attractive to lay off that risk in return for a share in the upside through litigation financing.”
But again it’s a familiar story. Some 39 per cent of surveyed private practice litigation lawyers have not heard of litigation finance. Only 11 per cent have actually used it.
Financing individual DBAs
Funders also work with law firms on an individual case-by-case basis. One example is by funding a DBA such that a law firm is paid a percentage of their fees before a case is concluded. Current law only enables law firms to offer complete DBAs to claimants, where all their fees are at risk.
DBA financing enables law firms to de-risk a DBA by paying a proportion of lawyers’ fees in return for a percentage of the damages attributed to the firm. Funders are typically prepared to pay between 25 per cent and 75 per cent of lawyers’ fees in return for a percentage of the damages.
Burford Capital offers a specific Hybrid DBA product. It is typically only relevant for cases when the ratio of costs (including legal fees and disbursements) to expected damages is over 1:4.
“The DBA regime still needs some work as currently only 100 per cent no-win no-fee DBAs are allowed between solicitors and clients. Unfortunately this creates a problem for those law firms that do not want to take on the full risk,” explains Olswang’s Hurst.
“Burford’s Hybrid DBA product is an excellent solution to that problem because it allows the funder to take on all the risk vis-a-vis the client. The law firm can enter into a separate arrangement with the funder whereby it can take on some risk (as with a discounted CFA) and share in any upside. So for example, Burford might pay us 70 per cent of our fees on a monthly basis in return for a percentage of their slice of the damages if the client wins. This way the client doesn’t pay unless successful but the law firm gets paid a good proportion of its fees on a monthly basis.”
Another type of funding available for law firms is cost advancement. Put simply, this enables law firms to recover their costs payable by the other side after winning or settling a case ahead of when they might otherwise be paid. Many funders are prepared to advance law firms a percentage of their costs in return for an interest payment on the sum advanced.
“In certain sets of litigation such as personal injury, clinical negligence or professional negligence, the defendant will be backed by an insurance company and therefore the other side knows the damages and legal fees will be covered when the case is won or settled,” explains Burford’s Rowles-Davies. “Burford Capital is prepared to advance a law firm around 70 per cent of the drawn bill assuming the invoice has been drafted by one of our approved cost lawyers. So the lawyers get 70 per cent of their fees as soon as the bill is drafted. We typically offer this on a 90-day revolving credit facility and we charge an interest rate.”
Cost advancement also enables cost lawyers to distinguish themselves from their competitors. “This solution is a great way for cost lawyers to set themselves apart from the rest of the market,” continues Rowles-Davies. “It’s a compelling proposition for lawyers to be able to say that if you give us your cost work we can provide 70 per cent of the fees up front as soon as we have drafted the bill.”
Litigation funding has evolved into corporate finance. From WIP funding and costs advances to recourse loans and security for costs, litigation financiers offer an increasingly diverse range of financing solutions for litigants and law firms. Many of these financing products do not require the financing to be used to fund litigation at all.
The problem is that not enough people really understand the versatility of litigation financing. A quarter of surveyed UK-based litigation lawyers had not heard of disbursement funding, 37 per cent were unaware of security-for-cost bonds and 39 per cent did not know about work-in-progress financing. Less than 15 percent had actually used any of these structures.
This lack of knowledge has serious consequences. Not fully appreciating the range of financing structures available means law firms and their clients are using their own capital and assuming more risk than is required when litigating.
This article was originally published in The Lawyer and can be found here.
CJEU’s Annual Report: Manufacturers, Climate Change & Chemical Substances – Sylvie Gallage-Alwis and Gaëtan de Robillard
Aug 04, 2020