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What is it?
Settlements from law suits are assets. There – I said it. And once something is recognized as an asset it can be bought, sold, traded and even collateralized.
Litigation Funding is an emerging, growing market that recognizes the asset-nature of settlements – a.k.a. claims. I say ‘emerging’ even though litigation funding in some shape has been around for a while. The classic personal injury, contingency fee firms are examples of this type of funding. Only in these cases, the law firms themselves are the funding sources.
What is actually new and emerging is investment in commercial claims. This is particularly the case in the US, where this has effectively been around for only a few years.
How Does it Work?
A client has a claim against another party. The claim is valued at some number, say $10m. The Litigation Funding Company (LFC) agrees to pay the legal costs for pursing the claim, up to $1m. If the settlement is obtained, the LFC receives a portion of the settlement, much like a contingency fee.
Simple enough? Yet this method creates some ‘issues’ for law firms. Primarily, law firms now have a third party in the mix, with a vested interested in the outcome of the case. It’s easy to say the firm must keep the client’s best interest first, but some times the client may defer to the LFC or even require their input on case decisions, especially when it comes to the settlement. The LFC will have expertise in valuing claims to the point the client will rely on their expertise and judgment. And the law firm will be in an odd spot, taking directions from not-the-client.
Why will clients do this?
In our example above, let’s say the LFC takes a 20% stake in the settlement. Why would a client give up $2m from their claim? For the same reason they would on any other asset. They basically convert the asset into cash – in this case $1m. So instead of spending $1m to get $10m, they spend nothing, shift the risk to the LFC and still potentially come out with $8m. Even if the company has the $1m to spend, they may likely prefer to spend it investing in their core business instead of lawsuits.
Of course with higher risks, the LFC will want larger portions of the settlement. But even then, the clients are shifting risk and keeping their cash for investing in their own business.
In Part 2 we will look at the funders, some challenges presented by this trend and explore the impact on law firms.