Litigation Funding May Be a Suitable Option

You've probably read about plaintiffs in high-stakes business disputes winning awards in the tens of millions of dollars, or even higher. If a plaintiff loses a case, though, it doesn't just miss out on the damages it had been seeking in the case: it is also out of pocket for all of its legal expenses, which for large lawsuits can be millions of dollars. As a result, the high cost of litigation coupled with the risk of losing can prevent legitimately injured parties from pursuing a legal remedy. But in recent years, a funding vehicle that may make certain lawsuits more financially feasible has come into wider practice: litigation funding.

Litigation funding is a tool for shifting some or all of the financial risk of litigation away from the client (or a law firm that takes the case on a contingency basis) to a third party, an investor. The investor, typically a private equity fund or hedge fund, effectively agrees to finance the litigation. What it gets in return is a significant portion of any monetary award, as well as reimbursement for what it spends on the litigation–as long as the party it is funding wins (in most instances).

This model provides advantages for both the client and the law firm that handles the case. For a client that may not be comfortable with funding an expensive litigation–preferring to keep funds available for things like day-to-day operations or growing its company–litigation funding provides a tap that may be turned on at a certain point. For example, company management may commit a certain finite amount of money toward legal fees and then work with a litigation funding firm to finance fees above that amount, thus limiting the company's financial exposure.

This can provide a powerful tool for companies with legitimate claims to fund their cases where they may not have had viable options before. Litigation funding can be particularly suitable for a small company going up against a much larger, deeper-pocketed adversary. Smaller companies often do not opt to pursue legal remedies against larger companies for fear of being outspent. After all, it is not an uncommon strategy for very large companies to litigate a smaller company into submission, making discovery as long and drawn-out as possible, filing motions aimed at tying up the proceedings, and dragging things on in the hope that the plaintiff will withdraw its claim or settle for a much lower figure than originally sought.

Litigation funding can increase a law firm's options, too. Some clients prefer their lawyers to have "skin in the game," with the lawyers bearing some of the risk by agreeing to take at least a portion of their fees on a contingency basis. While some law firms are set up to operate on a contingency basis and do so regularly, many are not. A firm willing to explore litigation funding as a way to finance the contingency portion of its fees may find itself able to take a case on which it otherwise would have been forced to pass.

Of course, as with any financing decision, there are drawbacks. For an investor to agree to take on the risks associated with funding a litigation, the potential reward must be significant, typically at least $20 million. In addition, the investor has to believe that there is a high likelihood that the plaintiff will win a judgment or settle for a significant percentage of what it is seeking. In other words, it must be a strong case. And then there's the cost. Obviously, investors do not risk millions of dollars for the potential of small returns. They are typically looking for returns on their investments of two or three times the amount they invested. In most arrangements, they only get paid if there is a settlement or a judgment on behalf of the plaintiff. Generally, they are paid back their invested capital plus a percentage of what is left over after that reimbursement.

Ultimately, as with any type of investment, our financial system's free-market engine is the final arbiter of which investments make sense, for which investors, at what level of risk, and at what level of potential returns. For the right type of case, where it would not be prudent to commit the company's own resources to a long, expensive litigation–but where the case is strong–litigation financing could prove a worthy avenue to pursue.