James Blick and Erika Levin (Courtesy photos)
The U.S. and global litigation finance markets have exploded. In less than a decade, third-party funding has moved from the dusty fringes to center stage of the global legal market and the meteoric growth shows few signs of slowing.
It’s easy to see the appeal—every litigation attorney can remember a good case on which they didn’t get hired because the client couldn’t stomach the fee budget. Litigation finance offers a solution to David and Goliath disputes—a lifeline for financially distressed parties that is now making substantial inroads into the corporate litigation market, where blue chip clients may now opt to outsource the cost of litigation to specialist funders, rather than tying up their own capital in legal costs.
From an investor standpoint, it’s a high-risk, non-correlated asset class which offers potentially stratospheric returns, if you back the right horse. Private equity funds, family offices and investors are scrambling to a get piece of the action. And it’s not just new funds: A number of the larger and longer-established players are on their second, third or fourth rounds of fundraising. The steady rise of Burford Capital’s share price since 2016 is a constant reminder that there is money to be made.
All of this tells us one thing—whatever you may think about litigation finance, funders are out there and they are finding good quality, high-value cases in which to invest and charging big returns on the winners.
However, making money from successful, big-ticket litigation is not the exclusive preserve of the litigation finance industry. Law firm contingency fee economics often closely match those of litigation funders—a firm taking a substantial commercial case on contingency can expect to take a similar percentage of the winnings to a litigation funder.
This begs the question: If litigation finance is booming, then why too aren’t law firm profits, buoyed up by a rising tide of contingency fee revenue?
In some cases they are. It was recently reported that Baker Botts had posted record profits in 2016, due in part to some big contingency fee wins. Andrew M. Baker was quoted as saying “one of the many contributors to these results was a favorable return on investments in contingent fee cases.” But the story of an Am Law 100 law firm proudly reaping the rewards of its “investments” in litigation is interesting because it is unusual.
Many law firms of all sizes remain highly conservative in their approach to contingency fees, despite the growing demand from clients for alternative fee arrangements. When presented with a good case by a client looking for alternative financing, firms often turn immediately to third-party funders, potentially agreeing to steep discounts to their hourly rates in exchange for modest upsides to get the deal done.
The problem is that many law firms are not equipped to assume significant financial risk or, to put it another way, to make significant investments in litigation. Day-to-day overhead and cashflow pressures are ever-present, and persuading non-litigation partners to invest their hard-earned profits into litigation may be a stretch for even the most skilled advocates. Law firms are likely to prioritize achieving a minimum (albeit heavily discounted) realization rate at the expense of forsaking a potentially significant windfall that could have otherwise been achieved—often times pushing law firms into the hands of funders. One attorney, who had recently settled a funded case, described feeling a “breeze” as money flew past him into the hands of the litigation funder.
However, law firms should be aware that other options exist. As the market evolves, solutions are emerging that may enable law firms to reap the rewards of substantial contingency fee cases while still securing a portion of fee income to keep the lights on.
One such development is the emergence of contingency fee insurance. Insurance is admittedly not usually a subject to set the pulse racing; however, for law firms that have felt or wished to avoid feeling “the breeze,” it could be interesting.
Contingency fee insurance essentially guarantees the law firm some minimum fee income (usually at a discounted hourly rate) irrespective of the outcome of the litigation. Unlike other types of insurance, the premium is not paid upfront, but rather is only paid to the insurer if and when the law firm succeeds in collecting a substantial contingency fee.
As compared to funding, insurance offers a cheaper hedge and the ability to secure a higher net yield for the firm in the event of a successful outcome. This type of hedge is especially attractive in scenarios where liquidity is not a priority since insurance will not pay out during the life span of the case. Nonetheless, even though the law firm will have to wait until the end of the case in order to receive payment, the firm can still book realizable fee income against a full contingency fee case as well as guarantee the reimbursement of any out-of-pocket costs that it finances along the way. Most importantly, the premium payable to the insurer in the event of success is usually a fraction of what a litigation funder would charge. This means that if the firm has a big win, its net fee income after payment of the premium will not be significantly eroded—the only breeze felt will be a warm, tropical one at the next partners’ retreat.
The emergence of contingency fee insurance is part of a wider development in the availability and sophistication of litigation insurance options. In Europe, corporate plaintiffs have used this type of insurance for many years as a way of hedging litigation risk, either as an alternative to or as a complement to litigation finance. There are also examples of litigation funders using insurance to hedge their capital risk on their funded cases. Now, law firms can do the same—law firms with an existing contingency fee portfolio can use insurance to increase the size of the portfolio, without increasing the firm’s aggregate fee risk. For traditionally conservative law firms, on the other hand, this may be a way to bridge the gap between the increasing demands from clients for alternative fees and the firm’s limited risk tolerance.
So, what does this mean for the future of litigation finance? Will law firms start to compete more directly with litigation funders, cherry picking the very best cases to take on contingency and only showing higher risk opportunities to the funding market? This is probably unlikely. In many cases and for many firms, there will still be a need for cashflow financing, meaning that there will always be an important role for funders to play. However, these developments do mean that the range of options available for law firms just got a whole lot bigger and more interesting.