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Litigation Funding – What Is It and How Does It Work?

November 22, 2022 by BPM Team

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Money and justice concept

Litigation financing is a service that enables a corporate claimant to pursue commercial claims through litigation or arbitration by providing financial resources on behalf of a third party (the funder). The funder covers all legal fees and isn’t paid or given anything back unless the claimant wins and receives compensation. 

If there is a recovery, the funder gets a portion of the capital. However, if the legal action is unsuccessful, the funder forfeits its investment, and the claimant owes nothing. A settlement funder may additionally provide litigation management & support services in addition to litigation funding, subject to legal limitations in some jurisdictions.

Gains from Litigation Funding

Litigation funding gives plaintiffs who might lack the finances to pursue meritorious cases access to justice. Additionally, claimants with the necessary resources might favor allocating their working capital to their primary line of business. Finally, when working with a funder, you can take advantage of their financial services that handle complicated litigation projects across more than a dozen different jurisdictions.

The Fundamentals of Commercial Litigation Financing

In most commercial disputes, plaintiff-side funding is a non-recourse investment. In contrast to a loan, which must be repaid regardless of the outcome, the funder recoups only if the claimant recovers.

Understanding the role of the funder is also essential. A funder should be a passive investor, meaning that the claimant retains control over how the case is litigated and that funding has no impact on the attorney-client relationship.

The following are the two most common models for funding a plaintiff-side case:

1) The Conventional Model

In exchange for a share of the recovery, the funder pays all litigation expenses and a portion of the attorneys’ fees. Outside counsel frequently works on a contingency basis and shares in the recovery. This model, which uses catch-up payments, can be used at any stage of a case, meaning the funder pays amounts the claimant has already incurred.

2) The Model of Monetization

In anticipation of future recovery, the funder makes one or more lump-sum payments to the claimant. This ensures the claimant a return on its asset (the claim) in the form of immediately bookable revenue.

The needs of each case and claimant determine whether one of these models—or a different solution—is the best fit. 

Agreement

Funders must evaluate the case before investing, so a written nondisclosure and confidentiality agreement is required. This is a best practice for obvious reasons, and it reduces the likelihood that information shared with a funder will be subject to discovery.

Most courts have ruled that sharing materials with a funder do not waive the work-product doctrine’s protections. However, claimants should not provide privileged attorney-client communications or documents that cannot be disclosed under a protective order to illegitimate firms.

The Diligence Process: Kicking the Tires

Typically, funders want to assess key case factors such as liability, damages, budget, collection risk, and time to recovery. However, well-prepared claimants and their counsel can help to speed up the diligence process:

Perform your own due diligence

Preparing a memo outlining the evidence supporting the liability and damages theories will keep things moving and may result in faster funding.

Remember that a well-thought-out damages theory is just as important as the total amount of damages. Even if detailed calculations for an estimated sum are not yet available, the funder must understand the types of damages and remedies that will be available (e.g., recovering lost profits or reasonable royalty vs. disgorgement of profits).

Be forthright about the risks involved in the case

Before investing, most funders will have an experienced litigator—whether in-house, outside diligence counsel or both—do their own analysis. No claim is perfect, and being open about the challenges allows the funder to assist the claimant and counsel in overcoming them. Transparency about the case’s flaws builds trust and can save time if the problem proves insurmountable.

Due diligence should be viewed as a two-way street 

Parties seeking funding should also ask themselves some probing questions. For example, it may be necessary to comprehend the source of the funder’s capital.

Sometimes a funder will have capital available for immediate deployment. At times, the funder may rely on capital from partners, whose decision-making processes may differ.

Aside from the usual advantages of litigation finance, the diligence process provides an opportunity to collaborate with an experienced litigator who is approaching the case with fresh eyes and creative ideas. Claimants and their counsel frequently discover that the process adds value in multiple ways, similar to going through a mock trial. The case should be stronger than it was previously.

How Will the Return Structure Look in Detail?

The short answer is that it depends on the situation. Nonetheless, a few fundamental principles apply in most cases. With few exceptions, the funder will receive at least the amount of its invested capital in proceeds as “first money out.”

You may also like: Preparing Your Business for Litigation

Image source: Depositphotos.com

Filed Under: Featured Posts, Finance, Legal Tagged With: Featured Article, finance, legal tips, litigation

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