This year could be an important one for the litigation finance industry. Although the market has now achieved general acceptance and is arguably approaching maturity, 2018 is likely to bring new challenges for funders as well as increased competition, both from within and outside the industry.
Much of the focus of the litigation finance industry in recent years has been on encouraging usage by larger corporations. Litigation finance has its origins in the distressed litigation space. However, funders were quick to recognize the limitations of this market — the largest claims are often brought by big businesses for which capital and liquidity are not an issue.
To tap into the blue-chip market, funders have had to reinvent themselves, finding new buzz-phrases (“turning legal departments into profit centers”); new structures (portfolio financing, claim monetization); and ways to repackage their offerings as simply another form of corporate finance. The fact that funders have had some success in this regard speaks not necessarily to the suitability of litigation finance to corporate litigation but rather to a gap that exists in the legal services market.
LITIGATION FINANCE VS. ALTERNATIVE FEE ARRANGEMENTS
Challenging traditional law firm fee structures, clients increasingly eschew hourly rates in favor of value-based legal services. In a litigation context, this means a fee structure where the law firm’s remuneration is tied in some way to its success in litigating the case. But this presents a problem. Many law firms are simply not set up to take significant contingent fee risk. Alternative fee structures often mean little more than a lightly discounted hourly rate, or some limited fee cap. This may fall short of what corporate clients are looking for.
“If the last few years have been an educational period for firms in terms of testing concepts, 2018 may see the mainstream application of litigation finance and insurance to alternative fee strategies.”
This gap between what clients want and what law firms can offer has been successfully bridged by litigation funders. Litigation finance in its myriad permutations can be structured to create similar client-side economics to a contingency fee, while giving the law firm the hourly fee income it craves.
End of story? Not quite. Too often, the deals struck have favored the funder — for example, where the law firm agrees to put more “skin in the game” than it ideally would like, while not necessarily receiving a commensurate share of the upside.
There are also conceptual and practical questions. The economics may be similar, but there may be a big difference in the eyes of a client between a law firm backing its own case assessment by risking its fee income on the outcome and a law firm being paid by the hour by an external funder.
Furthermore, to really compete with its rivals, a firm needs to be able to table a fee proposal quickly. The reality is that it usually takes several months for a funding deal to be negotiated; there’s of course a lingering risk that the funder may ultimately decide to pass on the opportunity. A law firm may find itself hamstrung by any client acquisition strategy that relies on obtaining litigation finance before the case can begin.
HOW LITIGATION FINANCE IS COMPETING
Against this background, the litigation finance industry is also changing. Gone are the days when only a handful of funders existed, cherry-picking potential investment opportunities at will. Today, there are countless litigation finance companies and a steady influx of new capital into the market.
And it’s not just competition from other funders. Major insurance companies are now encroaching into the space. Litigation insurance can offer a similar risk hedge to litigation finance, but with pricing and economics that may be more suitable for corporate clients with good liquidity. Insurers are also targeting law firms, offering insurance as a way for firms to hedge contingent fee risk without paying the substantial returns required by funders.
Large financial institutions and hedge funds are also now turning their attention to the space. Whereas they previously played a less direct role, many are increasingly looking at opportunities to invest directly, especially where a large capital commitment is required.
All of this means that the business of financing litigation is getting more competitive. From a user’s standpoint, these are positive developments, increasing the range of options and forcing funders to compete on price and process in ways they previously did not.
For law firms, this offers an opportunity. If the last few years have been an educational period for firms in terms of testing concepts and deals with different funders or insurers, 2018 may see the mainstream application of litigation finance and insurance to alternative fee strategies.
Approaching funding on a reactionary basis and selecting potential funders based upon individual relationships is rarely the best way for firms to meet their revenue and service delivery objectives. To best take advantage of the favorable market conditions, firms must take a more centralized and strategic approach, considering the full and rapidly expanding range of options available.
By James Blick – as published on The Legal Management.