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In Part 1 of this series we looked at what litigation funding is and why clients might really like it. In Part 2, we examine the source of this funding and how it might impact law firms.
Who is funding these claims and why?
This is a classic ‘follow-the-money’ situation. In our example from part one, the Litigation Funding Company (LFC) doubles their money. Hedge funds and other institutional investors are attracted to these types of investments. And they can spread their risk based on volume. If they fund ten deals like this where five pay the full number, three pay half and two go bust, the LFC still makes 30% on their money. Where else can they get this kind of return? And over time, they will get better and better at valuing risk in litigation, further driving up returns.
Many of the founders of these LFCs are former lawyers, with some coming from investment banking and hedge funds. Two of the LFCs, Juridica and Burford, are publicly traded, having raised millions in the financial markets.
Much like e-discovery in the 90’s, the LFC market is a bit of the wild-west right now. Beyond a lack of known rules (more on that later), most LFCs are privately held, so the terms of agreements are not well known and likely vary quite a bit. I understand some agreements include payouts of a multiple of the investment (e.g. 3 times the investment) instead of a portion of the claim. In these scenarios, I understand the LFC is typically paid first.
Bumps in the Road
In addition to valuing risk up front, LFCs will need to monitor risk over time. If one deal was valued at $10m up-front, but $500k of legal fees into the case the value drops to $1m, the LFC may chose to discontinue their funding. One might react badly to this reality, but if you think about it, that is probably what the client would do in the same circumstance. Well, at least the client would if they only saw value in the settlement amount and had no other concerns about the case. An example of other concerns includes setting precedence for future litigation against the same defendant. But even then, the client has the option of self-funding the case going forward.
Impact on Firms
At first blush, law firms may engage in the Dance-of-Joy at the development of litigation funding since this means more work in the market. In reality it may well mean more pressure on fees and higher expectations for success. Firms may now have another party involved in evaluating their fees. And this one cares a lot more about the financial aspects of the case. Meanwhile, firms remain beholden to the wishes of the client in matters of case management. With the client not paying, one possible outcome may be clients making Cadillac-level requests while the LFC is only wanting to make Chevrolet-level payments.
As well, firms who used to have an up-side with contingency fees may see those diminish. These firms will now be competing with LFCs, who will probably be much better at valuing cases and managing risk. So perhaps this is good-bye to big contingency fees and hello to more fee pressure.
In the final segment of this three part series, we will consider the size of this market and where this trend might lead.