By Erika Levin

Law360 (April 28, 2020, 1:25 PM EDT) --

Erika Levin

In a rather short period of time, the novel coronavirus has had an extraordinary impact on the lives of millions of people around the world. The business community is no exception.

Businesses are closed, supply chains are disrupted, workers are being furloughed or laid off, and no one is quite sure when things will return to some semblance of normal. As we brace for the continued global economic consequences of the pandemic, it is important to think proactively, mitigate risk, and take advantage of the resources that are available to assist.

In the weeks and months ahead, businesses will continue to face a variety of challenges as a result of the pandemic. With constrained budgets and mounting economic pressures, many will be forced to make difficult decisions about how to spend their precious resources.

While no panacea exists for the coronavirus-related constraints imposed upon businesses, litigation finance certainly offers a considerable benefit in that it allows businesses to allocate their resources to address core business needs and utilize money from the funder to pursue their meritorious claims. By using litigation finance to assist with the monetization of their legal claims, businesses can minimize their legal risk and generate cash flow.

While no one knows exactly what lies ahead, it seems safe to assume that as disputes increase and businesses tighten their spending, the demand for litigation finance will grow. Litigation finance is a valuable tool that businesses should strongly consider adding to their arsenal as they weather the economic storm caused by COVID-19.

What remains to be seen is how the pandemic will affect the availability and deployment of capital in this space. Will we see a continued expansion of the litigation financing market? Will additional money be deployed? Will the investment parameters change? Will the cost calculus for litigation finance capital change? Will the time frame from initial inquiry to the closing of a litigation funding agreement vary?

For businesses that are considering the use of litigation finance to assist them in monetizing their legal claims during this time, here are three recommendations to bear in mind.

1. Understand the Basics

Litigation finance generally refers to a commercial transaction in which a private funder provides capital to a party (usually the plaintiff or claimant), in exchange for a share of any damages that are eventually recovered in the underlying litigation or arbitration. This funding is typically provided on a nonrecourse basis, which means that the funder's recourse for repayment of its investment is limited only to the damages that are recovered from the lawsuit. In other words, the funder only gets paid if there is a win, and no money will be owed to the funder if the case is lost.

Every funding deal is unique and tailored to suit the specific facts and circumstances of a given case. While these arrangements have grown in complexity over the years, the basic economics remain the same.

Funders, like all investors, are interested in ensuring healthy returns on their investments. As such, the first step in any funding deal is a due diligence review.

While there are many factors that may be considered depending on the specific nature of a claim or dispute, funders will generally evaluate the following when deciding whether to fund a case: the expected value of the claim (anticipated recovery), the legal and expense budget associated with pursuing the claim, the merits of the claim (including the strategy and judgment of the legal team), and the length of time until recovery (including considerations with respect to the enforceability and recoverability of any resulting judgment or award).

Surprising to many, having a case that is strong on the merits is not enough. In order to move forward, a funder will need to see that there is both a sound legal claim and a healthy, recoverable margin between the anticipated recovery and the anticipated budget for legal fees and costs. 

2. Think Long-Term as You Select Your Funder

When choosing a funder to approach, it is important to do your homework and search for a funder that has an appetite for your particular type of dispute. Your goal should not be to just obtain capital, but to find a funder who you are comfortable working with, who has experience with the type of dispute at hand, and who will make a good long-term partner for your case.

Not all funders are the same, and those who are new to the litigation funding market will benefit from the guidance of those who are more experienced. There are countless resources available to help you navigate the funding world (i.e., brokers, independent counsel, online resources). For instance, the Association of Litigation Funders of England and Wales provides some very useful guidance.

For those unfamiliar with the process, after the first inquiry, the funder will usually commence an initial assessment of the case. During this phase, the funder will ask you and your claim counsel (if retained) for information. It is important to be cognizant of the legal implications of your interactions and ensure that you assess what is required in the jurisdiction(s) involved and adequately protect yourself and the confidentiality of your information. 

If the initial assessment is positive, the funder will then offer a term sheet and will likely ask for exclusivity prior to undertaking a deeper dive into diligence. Subsequent to the funder completing its due diligence, if all remains positive (i.e., the investment committee or board approves of investing in your case), the negotiation of the litigation funding agreement will commence.

Just as a funder will conduct a thorough review before investing in any potential new claims, litigants seeking to procure funding should likewise conduct their own due diligence before partnering with a funder. As part of this process, it is important to verify that the funder is adequately capitalized and has sufficient funds to dedicate to the dispute throughout the life of the case.

While most funders retain capital on hand that can readily be deployed, others may have to undertake additional fundraising activities or other similar steps to secure sufficient capital. This can be critical information, particularly in the context of the current pandemic, which may make such fundraising exceedingly difficult. The last thing that any litigant wants is for their claim to grow stale while they are trapped in an exclusivity arrangement with an undercapitalized funder.

It is also important to assess the funder's track record in the performance of its past obligations. Has the funder complied with the terms of its litigation funding agreement and made its payments on time? Does the funder respect that the control of the case remains with the client and its legal team? Has the funder previously terminated or withdrawn from a funding arrangement? If so, why?

The well-established funders pride themselves on maintaining a proven track record of reliability. To the extent that you are dealing with a funder that is a new entrant, make sure to carefully evaluate any relevant prior experience.

Additionally, be sure to undertake an analysis of the current legal landscape with respect to funding in the applicable jurisdiction(s). Things like confidentiality and privilege considerations, third-party funding disclosure obligations, and enforcement concerns (i.e., champerty) can and do vary significantly from jurisdiction to jurisdiction. These considerations once again highlight the need for litigants to seek out the guidance of experienced professionals who are well versed in the nuances of litigation finance.

From all perspectives, it is imperative that a mutuality of trust and respect exists. Open and frank conversations at the outset will help to achieve the best outcome for all involved and are especially important in helping to manage and align expectations. After all, a "win" may be interpreted differently among the various stakeholders. The sooner alignment is achieved, the better.

3. Seek Assistance to Navigate the Process and Negotiate Wisely

As noted above, funders overwhelmingly reject more cases than they take. The statistics are far from perfect, but the declination rate for funders has been described to be as high as 90%. And, it may go higher as applications for litigation finance increase under the current backdrop.

So, what does this mean for litigants who are considering litigation finance as a way to vindicate their legal or contractual rights? The biggest takeaway must be that preparation is absolutely key to successfully navigating the litigation finance market.

First impressions matter. It is critical to organize and present the relevant information from your case succinctly and accurately. The better prepared you are from the outset, the smoother and more efficiently the process will go, and the more likely you are to obtain a favorable outcome.

Make no mistake about it, the cost of capital is expensive and the terms of your litigation funding agreement matter. Although litigation funding agreements vary considerably from deal to deal, some of the key terms to pay close attention to include: the pricing and other terms related to the capital that is being provided, the priority and distribution of payments among the stakeholders (waterfall agreement), terms regarding settlement and withdrawal or termination, governing law, and dispute resolution.

It is essential that the economics of the litigation funding agreement make sense. An analysis of the pricing and the priority of payments is crucial and should include modeling of hypothetical scenarios to enable the parties to fully understand the economics involved.

With respect to pricing, funders will typically require a return of their initial investment plus a multiple of the capital invested and/or a percentage of the recovery. Funders may also incorporate a durational aspect to the pricing of the capital, which ties their returns to the length of time that their capital is deployed with respect to your claim. This is an especially sensitive point to address currently since COVID-19 has caused delays in court and arbitral proceedings, which might have an impact on the returns owed to the funders.

For economic, ethical and practical reasons, it is highly advisable to ensure that you have someone on your legal team that is well-versed in the litigation finance market and the corresponding legal landscape. It is especially important to be cognizant of the specific legal issues that can arise in the litigation finance context and work with someone who will proactively guard against issues such as conflicts of interests and waiver of confidentiality and applicable privileges.  

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Erika Levin is a partner at Lewis Baach Kaufmann Middlemiss PLLC.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

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