The idea behind third-party litigation funding is to hedge the downside – which in turn impacts the upside – for a company or law firm in litigation.

Funding litigation has gone upscale from its more modest personal injury roots. With skyrocketing litigation costs, both public and private companies and law firms are turning to litigation funders to soften the short-term hit to financials. Because, when it comes to litigation, legal fees are the biggest issue to manage before the lawsuit can get underway.

Finding a way to cover large out-of-pocket, multiyear expenses can be the only way to make pursuing litigation possible. Lawsuit loans, however, do not come cheap and typically carry strict terms that favor the litigation lender, making it necessary to conduct a comprehensive cost/benefit analysis before locking in funds to hedge against a lawsuit’s future.

Company funding

Litigation funding has been around since the mid-1990s, when lawsuit loans began as a protective measure in personal injury cases where plaintiffs had costs to cover. Individuals and small companies often used the proceeds from financing to pay personal bills — gas, food, lodging — while waiting for their cases to settle.

Litigation financing is typically employed when a company or law firm is looking at years of litigation and wants to avoid having to prematurely settle at a discounted rate. Even though a case looks strong, companies often have investors to consider and must show they are managing their finances responsibly.

A company facing a big case in terms of potential financial reward may find their investors less interested in that upside if the potential reward is years away. When litigation expenses in pursuit of a strong case drag down financials and detract from other business plans, like research or product development, investors can become unhappy.

The prospect of a payday years out may not be enough to garner enthusiasm that overcomes the short-term hit of funding that litigation in-house. But when financing reduces out-of-pocket costs, and therefore the drain on financials, those same investors may be much more interested in supporting the company’s lawsuit than they would be in funding litigation in-house.

Litigation funding presents an opportunity for the company to share the potential upside while shielding the company and investors from the litigation costs in the short-term. Financing is making it possible today for an ever-broadening base of companies to pursue valuable, large dollar contingency cases with more predictability over spending.

Law firm funding

Litigation funding is also being used today by lawyers and law firms who want to offset the risk in contingency fee arrangements. With contingency fees typically hovering around 39%, that means an attorney or law firm needs to be able to be able to pay the lawyers, support staff, and out-of-pocket expenses, including expert witnesses and travel depositions, all of which gets pricey.

A law firm can take out partial contingency fees with a litigation funder to cut their cash outlay. Instead of paying out almost 40% of costs, a firm could pay the 20% cash flow hit, and partner with a litigation funder to fund a part, maybe 50% of the hourly costs. Although the litigation funder may take 20% of the payday, the law firm can move forward with litigation that might otherwise have been cost prohibitive.

Cost of litigation funding

From a purely defense standpoint, many companies have insurance coverage to fall back on and cover attorney’s fees as opposed to having to foot those bills in-house. But as a plaintiff, the company must have a good claim to secure litigation funding. Without one, a litigation funder is unlikely to be interested.

These funders are looking for multiples on the money they put into a case, like five or 10 times, as a recovery when litigation is complete. A company with too small of a claim will find that litigation funding is too expensive (think corporate world loan shark).

The payout at the end of litigation is another consideration. Not all litigation is prudent. Is this lawsuit based on reputation or required to protect an asset and therefore, something the company has to do? If it is, would it be better for the company to budget for legal expenses and keep all potential upside for its investors? Does pursuing litigation appeal to corporate investors or would they prefer to forego a long-term payout for short-term gains? If investors are foreign-based, does litigation present the right optics?

Plaintiffs with strong cases and investor-backing are best positioned to hedge lawsuit costs with litigation funding. But it is not an easy decision to make and a lawsuit is unlikely to get funded unless the expected recovery is high. Consult your litigation attorney to go over the unique circumstances of the case and guide a comprehensive cost/benefit analysis prior to locking in litigation financing.