Below Mark Klein, General Counsel at Burford Capital, explores five reasons GCs need to take a closer look at litigation finance in order to avoid unexpected surprises.
Litigation finance is becoming an increasingly important part of the commercial litigation landscape: according to a 2017 survey conducted by Burford Capital, the number of lawyers in the US who said their firms had used litigation finance has risen 414% since 2013. Over half (54%) of UK lawyers who haven’t yet used litigation finance expect to do so within two years.
Nonetheless, some General Counsels are relatively uninformed and sceptical about litigation finance. This may at first seem rational: litigation finance was once viewed as a last-ditch tool for claimants that couldn’t otherwise pay their legal fees and expenses, and many GCs serve companies that are not cash constrained and that will most likely be defendants rather than claimants.
But these assumptions are based on a limited and outdated definition of litigation finance. As corporate legal teams are increasingly expected to boost efficiency and improve risk management, litigation finance will increasingly prove to be a vital tool for many GCs.
- Litigation finance is corporate finance for law.
The core concept of litigation finance is a recognition that a legal asset can be used as collateral for financing. A corporation with a legal asset can secure financing today in exchange for a portion of the proceeds from that asset in the future. Typically, financing will be provided on a non-recourse basis, meaning that the financier’s investment return is contingent upon success.
Businesses use finance every day, when deciding whether to spend their own cash or to use outside capital to pay for goods and services. They make strategic and budgetary decisions about financing all kind of assets—from airplanes to office buildings. Litigation finance is no different, except that the underlying assets are legal.
- Financing helps hedge against rate increases and other future risk.
It’s a safe bet that interest rates will remain comparatively low in the short term, but interest rate rises in the long term should be expected in both the US and the UK. This makes any form of corporate finance that is not interest-rate-based an appealing option.
For GCs, litigation finance “locks in” cost and risk regardless of external factors. Legal finance moves risk off corporate balance sheets and provides capital that is repaid only if the underlying matters are successful. This structure protects against a loss in court, while locking in the financier’s return without any correlation to interest rates or broader economic conditions.
- It’s not just for claimants: Legal finance applies to defence matters as well as transactional areas of law.
It’s still a little-known fact that legal finance can provide capital in defence as well as claimant matters. Businesses very rarely – if ever – bring lawsuits and instead play the role of defendant more often than they would like. Litigation finance can enable alternative fee arrangements with law firms that are more flexible than the options that defence-oriented law firms will provide.
Portfolio-based financing, in which a third party provides non-recourse funding for multiple matters on a linked basis, offers even more options for defence-side clients. Increasingly, portfolio-based litigation finance is being used in areas such as tax disputes, mergers and acquisitions, and other “success fee” arrangements.
- Finance changes the accounting treatment of litigation spend—a huge benefit for public companies.
Any GC who manages legal spend is aware of the impact that litigation has on their company’s balance sheet, as legal expenses paid by a company are immediately recorded as expenses, thus reducing earnings.
Additionally, revenue realized from successful litigation isn’t returned to the P&L as operating income but is instead recorded ‘below the line’ as a non-recurring or extraordinary item, because the claim isn’t considered core to the company’s business. This creates a ‘no win’ situation for companies: even if they have winning claims, the accounting impact of those claims can impair the company’s financial performance.
Litigation finance solves this problem: companies shift the expense drag of litigation. This makes litigation finance a particularly powerful tool for public companies—attractive to the CFO along with the GC.
- Finance can convert a company’s litigation department into a profit centre.
GCs who use legal finance in the most straightforward way can pursue profit-enhancing claims without adding cost or risk to the business. But GCs who use legal finance more ambitiously can potentially zero out the cost of litigation altogether.
Last year a FTSE 20 company used $45 million to fund current and future profit-enhancing claims with world-class legal counsel—thereby shifting costs off its balance sheet. Portfolio financing is inherently flexible: capital can be used to finance matters within the portfolio or for broader business purposes, and pricing is generally lower because risk is diversified.
