A multi-national, well-resourced corporate approaches your firm about a large, cross-border dispute which seems to have strong merits and will keep a litigation team busy for the next few years. That all sounds like a good day in the office until the client starts to ask about managing the costs and risks of running the case. They have the cash to pay legal bills, but they face internal pressures from management to constrain legal spend; there is concern over how to justify to shareholders the drain on the company’s financial resources over the next few years and the inherent risk of that spend not being recovered if the case loses.
The obvious suggestion is to advise the client to move the case “off balance sheet” by seeking funding: a third party will pay the legal bills, leaving the client’s cash available for investing in the business itself, and the financial risk of loss is taken on by the funder. However, lawyers should be actively helping clients to consider other approaches to managing their objectives and internal pressures.
Approaches to funders
If the merits and the economics of the case stack up, funders may well make an offer to finance the case. But there are still variables to consider in terms of any offers. A fairly common structure may be that if the case succeeds, the funder is entitled to a return calculated as investment back plus the greater of, say, 25% of the damages or a 2.5x multiple of the investment made. As set out in the “waterfall”, the funder’s return is generally repaid as a priority before the client takes the balance of damages.
Such an offer meets the client’s objectives of off-loading financial risk, but the structure and pricing may be problematic and difficult to justify to management as well as shareholders. For example, the potential multiple return – effectively a fixed cost to the business – can create an issue if damages awarded are lower than anticipated, leading to a scenario where the corporate itself is not entitled to share in the rewards unless and until the funder has been fully repaid.
Can insurance help?
A recent blog, Beyond adverse costs cover by Robert Warner at our affiliate, TheJudge, outlined the comparable, but less well-known, role insurance can play as well as the differentials in pricing, and is worth a read alongside this piece.
Whilst an insurer will not provide cashflow to meet the legal costs of the case, it may agree to insure the risk of losing those costs should the case not go in the client’s favour. The client is effectively laying off some of the risk of losing its legal spend, rendering far more palatable its internal requests for budget to pay legal fees as the case progresses. The insurance premiums for “own-costs insurance” are generally deferred and contingent, that is to say the premiums are paid at the end of the case and only if the case succeeds (and there are damages in which the insurer can share). And given that premiums are generally lower than a funder’s return, the claimant party is likely to take a greater share of the recoveries under this structure. Corporates may find that more favourable for internal and shareholder justification.
Can the law firm get comfortable taking on risk?
A well-informed client may ask the firm itself to consider sharing in the risk of the case, for example by acting on a conditional fee agreement (CFA) or damages-based agreement (DBA). Whilst firms’ appetite for risk varies, we commonly see that law firms are more comfortable to share in risk when their own downside is mitigated.
In this case, if the client chooses the option of own-costs insurance, there is the certainty of a pay-out of legal costs whether the case wins (through opponent recovery) or loses (via insurance). That in itself may assist the law firm in justifying deferral or some or all of its fees – sharing risk and at the same time building some cashflow assistance to the client into the “package”.
Similarly, should the client choose to take the option of third-party funding, the law firm may be comfortable to share in risk, knowing that an agreed proportion of its fees will have been paid (by the funder) as the case progresses.
(There is the additional possibility that the law firm itself can insure the DBA or CFA risk it takes on, but the key point for this blog is that the client’s own risk-management arrangements might give comfort and additional flexibility on fees to the instructed lawyers.)
The funder’s view
You might wonder why a litigation funder would openly describe the merits of own-costs insurance and how it compares (sometimes favourably) to funding. The answer is that the products are complementary. No case is alike and, even if insurance can meet some of a client’s objectives, we find they frequently still have a need to seek funding for discrete elements (like disbursements), or turn to funding later if they experience costs fatigue or there are unanticipated budget overruns. Reputable funders would far rather take a limited investment which enables the litigant to manage its risk while maximising its potential rewards, and will happily work alongside insurers to achieve that aim.
The crucial take-away from the lawyer’s perspective is that clients benefit from having – and increasingly expect to have – their lawyers explain to them from the outset all of the options for paying for and managing the risks of a case. The best firms will set themselves apart by making sure they are able to evaluate both funding and insurance options and how they might work together to meet a client’s objectives. The converse is that firms who are not adept at explaining these options – or don’t draft in the help of funders and brokers to do so – risk losing out on business, not to mention risk falling foul of professional obligations.
We are in an environment where even the biggest and best-known international corporates are facing financial pressures and uncertainties, so we expect to see more corporates – even those who are well-resourced – actively partnering with lawyers to make sure the way their disputes are financed are fully explored.
This article was first published on the Thomson Reuters Practical Law Dispute Resolution Blog on 5 December 2022