Inside counsel are still reluctant to embrace external funding
Attend any litigation funding conference and someone will drop the term “profit center” into the discussion surrounding in-house legal departments. But is the suggestion practical or simply hype instigated by litigation funders?
The benefit of third party funding is that it is non-recourse, meaning the funder carries the risk of losing the case, thus making the funding off-balance sheet from the company’s perspective. Only when the case succeeds and recovers sufficient damages does the funder receive its capital back plus its contingency fee for having taken the risk.
Feasibly external funding might enable the company to pursue further cases without needing to use additional funds, which is particularly beneficial when budgets are limited. If a case loses, it has cost the business nothing except for time, whereas if the case succeeds the company receives recovery of damages albeit with a share being passed to the funder. So if 70 percent of something is better than 100percent of nothing, why have corporate counsel been reluctant to embrace external funding options?
A number of barriers may apply:
1. Concern over funder’s control
Putting economics to the side, large businesses like to control their own affairs. Their motives for litigating might extend beyond the damages at stake. For example, a judgment in favor of the company might be more beneficial than receiving damages via a settlement. This potentially puts the company and funder on a collision course, as the funder would rather not run the risk of a trial if there is a settlement on the table which ensures all stakeholders walk away with an upside.
However, funders promote themselves as being non-interventionist in the running of cases, and this is generally true. The key to addressing such concerns is for the parties to agree at the outset on the true goals of pursuing a given case. If the parties are not aligned from the beginning then it is clearly not appropriate to progress discussions.
2. Lack of awareness
One the main sources of in-house department awareness is their external lawyers. Fortunately, comments such as “my clients have deep pockets and aren’t interested in hedging their risk or entertaining alternative fee structures” is becoming less commonplace. Such cynicism has done little to encourage commercial discussions around funding. Funding knowledge among law firms remains patchy. Most lawyers could name two or three funders, but many struggle to name more, despite the existence of a much wider market. Lawyers’ knowledge of available deal structures also varies greatly, and is often limited to their own experience.
3. The cost of funding
Whilst the notion that it is better to have 70 percent of something than 100 percent of nothing is compelling, quite often that 30 percent difference itself becomes the barrier. There have been occasions where corporate counsel investigate external funding only to opt for self-financing. Why? The notion of using external funding may have been the catalyst to speed up the decision to pursue a given case, but once there is board approval for the litigation and due consideration is given to the deal, companies sometimes decide that giving away a 10 percent to30 percent share of a $400 million claim, for example, is simply not palatable for a $5 million funding requirement.
This is a price sensitivity issue. While the 20 percent to 30 percent contingency fee might be perfectly acceptable to impecunious clients, it is often too aggressive for large businesses.
Fortunately the market is adjusting. With more funders competing to win business, deals based on a flat percentage of damages are becoming less common. Many funders now entertain a pricing model that is directly linked to the amount of their commitment rather than the value of the case. So clients and their lawyers alike should, as a matter of prudence, ensure they tender between multiple funders to get the best deal.
4. Are funders too selective?
Another criticism levied by in-house counsel is that funders are too selective. If the aim is to have a whole portfolio of cases funded (a program of patent enforcements for example) but a funder only offers to support the very strongest cases, this might not be attractive. The company might expect that the trade-off for making the strong cases available for funding is that the cases with less certain merits are also funded.
The conflict is probably not actually between funder and company but more between the funder and their investors. Most funders have yet to prove their concepts with a portfolio of closed cases. Caution is often due fund managers’ concern over investor perception of their ability to pick winners from losers. Once funders have a sufficiently high volume of successfully closed cases, acceptable loss ratios will probably be readdressed in a bid to close more business.
In summary, the concept of making in-house legal departments “profit centers” is not a myth. There are barriers, although these often stem from misconception and this is preventing mainstream uptake. Adjustments need to be made, both by in-house legal departments in terms of their willingness to discuss creative funding options and by the funding community which must recognize that to attract blue chip interest in a meaningful way, leaner pricing must apply to support GCs’ internal “concept sell” to the board.