Litigation Finance for Pricing Officers

Woodsford Insight

Pricing professionals/pricing officers (“POs”) are a relatively new innovation in the legal industry, now being utilised in many large law firms around the world. Arising from the corporate context to take a more proactive approach to pricing than merely responding to market conditions, law firm pricing officers work between clients and the firm to define the scope of services needed, the value being provided and how to price accordingly, including whether alternative fee arrangements are appropriate. Internally, POs review past pricing data, contribute to detailed budget estimates, review realisation rates, monitor margins and calculate IRRs on contingency practices. Externally, they communicate directly with clients to help the firm capture and retain these clients while increasing profitability. In litigation practices, POs are increasingly being asked to discuss with clients and partners not only fee discounts, caps and contingencies, but the existence and availability of litigation funding.

What does a pricing officer need to know about litigation finance?

To keep their law firms competitive, today’s pricing officer should be as fluent in litigation funding as they are with their other pricing tools. Potential and existing clients want to know about defraying the cost of litigation with access to third party capital; partners want to understand if and how they can use litigation funding to capture capital constrained clients or de-risk contingent positions. Richard Burcher, founder of Validatum, a specialist legal services pricing consultancy based in London and New York, believes a detailed understanding of funding and close relationships with experienced, well-capitalised funders is critical to drive the funding decisions in law firms:

“Litigation funding is an increasingly important part of the legal landscape and, whereas previously relationships between funders and individual lawyers were personal, the handling of the funding process needs to become more efficient and be driven by firms’ pricing professionals. Few others in a firm will have the time or expertise to undertake this role and get to grips with the variety and complexity of offerings available.”

Our whitepaper, A Practical Guide to Litigation Funding provides an overview of the mechanics of litigation funding. The following are questions we have received from actual practicing pricing officers, answered from the most general to the most specific:

Q & A

Q: What is litigation funding?

A: Litigation funding (or litigation finance) is a rapidly growing form of specialty finance used by claimholders and law firms involved in commercial litigation. In litigation funding, third party investors provide non-recourse capital to claimholders to defray lawyers’ fees and the disbursements incurred in the course of litigating cases.

Providers of litigation funding draw their capital from various sources (dedicated funds, hedge funds, private equity funds, public markets and family offices – sometimes a mix). Without litigation funding, claimholders might not have access to the lawyers of their choice or would have to divert significant capital to legal expenses. Litigation funders are passive; they do not interfere with the lawyer-client relationship, case strategy or settlement decisions.

Q: What can be financed?

A: 1) Lawyers’ fees. Litigators typically bill hourly. Where the fees exceed a claimholder’s ability or willingness to pay, the only way to move forward with representation is to finance them. Law firms are often the first line of financing – offering to hold back some or all of their fees for a share of the recovery in cases they believe in (“contingent” representations). Some firms have the resources and willingness to take the case on a full, 100%, contingency (in those cases, litigation funding is still needed for disbursements), but more often firms are finding that by discounting their fees and working with litigation funders to cover the  balance, they can buoy realisation rates and cover human resource costs while retaining clients and potentially enjoying non-linear financial upsides.

2) Disbursements. Disclosure, experts, counsel fees, travel costs, transcripts, trial bundles, etc, all need to be financed. When the client cannot pay, firms are seldom eager to. A litigation funder can provide cash to cover those costs.

3) Contingency practices. Where a firm is growing a significant contingency practice, a litigation funder can provide capital across the portfolio to de-risk the firm or allow it to bring on more clients, requesting in return a cross-collateralised share of the firm’s contingent proceeds.

Returns on these investments are generally lower than funding a single case, due to the benefit offered by a diversified portfolio and the cross-collaterised nature of the structure i.e. spend on losing cases can be directly recouped from the proceeds arising from the winning cases.

4) Judgements. Sizeable verdicts are often contested. When they are, until any appeal is resolved favourably, the claimant cannot access the award. When the client’s cash needs are immediate, or the defendant is using delay as leverage to settle at a lower amount, litigation funding can provide immediate liquidity.

5) Accounts receivable. End of the year delays in payments on outstanding invoices can distort earnings and delay bonuses and partner pay outs. Funders can provide immediate cash for a percentage of the value of outstanding accounts. For more details, see our whitepaper, Accounts Receivable Finance for Law Firms.

Q: What is the best time to reach out to funders?

A: Build relationships with funders before you need the option. The process will take longer than you think and if you wait to onboard a new matter, you are going to add some delay to the time until you are billing fees. Not only that, but today’s clients expect you to be able to answer basic market questions about litigation funding capital – it pays to be fluent and up to date with a few existing trusted relationships you can turn to.

In a down market, such as the current pandemic driven downturn, this is especially important. Previously dependable clients will find themselves facing financial uncertainties that stress cash reserves. In these times, not surprisingly, POs face more requests for discounts, or alternative billing arrangements – even on existing engagements. Instead of risking a pay interruption or being in an uncomfortable position with a firm client, know funders and options before they ask.

Q: What is the process to secure litigation funding?

A: After an executed NDA with the client, a funder reviews the credit worthiness of the defendant, the merits of the claim, the realistic damages, the budget and the team representing the claimant. If the claim looks solid and valuable and the committed capital makes sense relative to the likely recovery, a funder will provide terms. Once those terms are mutually agreed there is a period of diligence to confirm assumptions made about the case, then the drafting and negotiation of transactional documents. Presuming no surprises, the investment is presented for approval. That process can take as little as eight weeks though typically it takes longer for reasons outside the funder’s control (slow to receive answers, lengthy negotiations, etc).

Q: How are fees paid?

A: Most providers of litigation funding pay against funding notices sent by the claimholder which detail legal fees and disbursements incurred. Woodsford pays firm invoices sent to the client and forwarded on a 30-day billing cycle. They are paid to the firm as if the clients had paid them themselves.

Q: How can litigation funding help firms better budget and price litigation?

A: Not surprisingly, litigators prefer to litigate – not budget. POs sometimes face an uphill battle to get lawyers to focus on pricing and budgeting. But funders apply a natural pressure because a thoughtful and reasonable litigation budget is critical to moving forward with funding. A funder needs to see a top line number as well as breakdowns between fees and disbursements by case phase or milestone. Once the capital commitment from the funder is spent, the remaining overages fall on the firm and/or claimholder.

Experienced funders such as Woodsford draw from hundreds of reviewed budgets across dozens of firms and claim types. When a budget doesn’t appear to reflect the litigation strategy, they will pose questions and they can also provide guidance where the firm is struggling to finalise the budget structure and spend.

Where appropriate, funders insert caps at various phases of the case to make sure capital is preserved to last through to trial and encourage sensible case management by the lawyers. Further, litigation funders can help share the burden of monitoring the budget once the litigation gets underway. In firms this responsibility often falls on the PO, but the litigation funder will also keep an eye on the budget and can often be a useful sounding board for discussions on financial case planning and budgeting.

Q: Which clients are good candidates for litigation finance?

A: In most ways, a funder’s estimation of a good claim and claimholder is similar in approach to a law firm that is considering a contingent representation. To start, litigation funding is relevant only to claimants despite long discussions over the years on how to successfully finance defendants. Complex commercial claims are more amenable to funding – where the costs of the litigation are significant and where the merits are not dependent on information in the sole hands of the defendants. Examples are: breaches of contract, shareholder securities actions, class actions, patent and other intellectual property disputes, international arbitrations, whistleblower claims, bankruptcies, etc.

Woodsford and most other established funders usually start with a 10:1 claim verdict value (settlement value tends to track this) to financial commitment ratio to determine if it makes sense to move forward diligencing the investment. While not rigid, a significantly lower ratio compresses the economics to the point that it might be difficult for both the claimholder and funder to get the returns they desire. That, in turn, can lead to misaligned incentives which is a situation all parties seek to avoid.

As far as entities – while there are exceptions and traditions covered here, claimants looking for funding typically fall into the following categories: individuals or partnerships, small entities (including LLCs), insolvency practitioners, startups, classes, and mid to large cap operating companies. Only very rarely do we see cases seeking finance from huge companies.

To unpack the motivations of the above – private individuals and partnerships often need funding for the simple reason that litigation is expensive; venture and private equity funds are reluctant to provide capital for exercises that don’t grow the company (while their capital is dilutive), which includes budget for litigation; in large class actions, the law firm looking to represent the class struggles at scale; mature companies are regular seekers of litigation funding – not surprisingly, enforcing claims is not regularly part of their legal budget, and the decision to move forward creates a drain on present operating capital for uncertain and untimely returns.

Q: What is the typical rate of return for a case?

A: The easy but unsatisfying answer is – it depends. In the end, risk dictates the return. Experience and careful diligence can offset the inherent risk in financing litigations, but even the most careful and experienced funder loses a significant number of its investments, and often after the maximum amount of commitment is spent, i.e. post-trial. That said, there are certain markers, returns and structural elements that might be helpful guideposts.

In some ways US law firms established the market for returns. Historically, these firms when asked to work on 100% contingency as well as cover the costs of litigation received around 50% of the proceeds from a successful resolution. To this day most US law firms use that as a lodestone for their contingent participation in hybrid arrangements. Funders usually slot within that framework to some extent, depending on how much of the litigation expenses they are being asked to cover. That said, funders use features that law firms don’t such as accepting lower returns for earlier resolutions before their cash is exposed, or step down their returns as the cash award gets larger.

Another consideration is rate of recovery. Most funders require a 100% cash sweep until they are made whole of their invested capital. To do otherwise would make it possible that the claimant and even the firm might make a profit while the funder suffers a loss. But once that amount is recovered, the remaining proceeds are split with the claimant, with the funder’s return often stepping down over time.

Q: Provide examples of where you have funded larger companies and why have they chosen to go down the litigation funding route?

A: Operating companies are preferred partners in many cases. They tend to be reasonable, have valuable claims and the disputes typically involve relationships with competitors about which there is much information. Without giving the satisfying details that would comprise the identity of the companies seeking funding, some recent motivations have been – the acquiring parent company wanted its subsidiary to focus its cash on developing products rather than fund a trade secret action; a property developer couldn’t swallow the eight figure cost of pursuing a whistleblower claim; an electronics manufacturer’s investors had reached the limit of their willingness to provide capital; a chip company contemplated a broad enforcement of its patents and wanted to scale litigation globally beyond the capacity of its legal budget.

Q: How are you underwriting agreements in the following categories:
a. Shared Legal Outcome Risk (50% funded with a fixed budget for the law firm),
b. Budgeted Risk (100% funded but with a fixed budget for law firm),
c. Cashflow Easing (100% funded with no budget)?

A: Woodsford does invest in jurisdictions where contingencies are not permitted; we also work with conservative UK/US practices that under no circumstances handle work on any contingency basis. However, when a reputable law firm with a track record of winning high stakes litigation proposes to share risk, it sends a strong signal about the strength of the case and the conviction of the attorneys. The more risk a firm proposes to absorb, the more impact that has on the underwriter and underwriting. Conversely, when a firm is not proposing to take on meaningful risk, this also sends a signal about the case – although it is important to put this into context, for example whether the law firm has a culture or track record of taking risk is clearly relevant.

A firm proposing to discount their fees by 50% generally makes a favourable impression on the underwriting, particularly in cases with lower damages. 50% discounts are perhaps the most common fee proposal we see today. The understanding is that a 50% discount brings the firm down to its cost basis, but that absent a successful result, they will not make much or any profit.

This of course must be viewed in context; national firms with higher billing rates often have higher profit margins built into rack rates to give them headroom to negotiate with clients. Boutique practices not only have lower hourly rates, but often also lower margins. A boutique taking on a 50% discount is both taking on more risk but also providing the funder with less absolute financial exposure on a cash on cash basis than a larger law firm with higher billable rates.

Fee caps also send a signal and are attractive for budget containment to funders. Caps, either on the case or on phases of the case, offer meaningful cost containment and certainty for the funder. Furthermore, they evidence that the firm has considered the action and is willing to take the risk of a pure contingency if the battle stretches on.

Uncapped, full fees are usually an indication that the firm or lawyers do not have faith in the claim. The law firm has no direct financial incentive to either win or to litigate efficiently and it begs questions about how thorough their diligence has been. That said, some of the best litigators are at firms that will not allow them to take a contingency position. We scrutinise these investments more closely, but do not reject them out of hand.

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Litigation funding can be a powerful and subtle tool for PO’s to use to stretch their firm’s abilities to land clients and to profit from the representations. Having a few tight relationships with trusted funders gives options that a firm wouldn’t otherwise have. The industry itself is fast evolving, and so it makes sense to get up to speed and to check in on what an experienced and established provider of litigation funding, such as Woodsford, can do for your firm and your clients.

About the author

Michael Kallus is a Senior Investment Manager for Woodsford based in San Francisco with a background in complex IP litigation and finance. He joined Woodsford from international alternative investment manager Fortress Investment Group, where, as Vice President, he supported the IP finance group in sourcing IP backed litigation finance, debt and private equity investment opportunities, maintaining relationships with law firms and claims owners, aiding in asset valuations, directing drafting of transactional documents and managing investments post financing. Prior to Fortress, Michael was a director in the Client Development and Acquisitions teams at RPX Corporation maintaining relationships with in-house legal teams, tracking and analyzing market patent risk and negotiating litigation buy outs with plaintiffs’ counsel of claims on behalf of RPX clients.

As a litigator, after clerking for the Honorable Chief Judge Roger Vinson in the Northern District of Florida, Michael practiced in the Boston office of Fish & Richardson. Michael also worked for the Palo Alto office of Morgan Lewis and later helped found fixed fee litigation boutique, Confluence Law Partners. In addition to IP litigation, Michael has handled trade secret and antitrust claims, drafted technology transfer licenses, and provided M&A support to multi-billion dollar acquisitions. Michael has practiced before a variety of federal and state courts as well as the International Trade Commission and the US Court of Claims.

Michael earned a BA in political science from the University of California Berkeley in 1997 and a juris doctorate from the University of Virginia School of Law in 2003. He is a member of the California and Massachusetts bars.

For further information, or to discuss a matter for funding, contact Michael directly