Parties seeking financing for litigation are often unsure of the steps involved in the litigation funding process.
Choosing a Funder and the Importance of the NDA
To begin with, litigation funders are not interchangeable. One important thing to keep in mind is that a litigation financing relationship typically lasts two to three years, through the resolution of the case, and will need to survive all usual complications associated with any complex commercial dispute. This means plaintiffs seeking funding, along with their lawyers, should look for a funding partner that has both the track record and financial resources to serve as a trusted advisor and a partner who can go the distance when an unexpected turn in the case requires revisiting the litigation budget.
When choosing a litigation funder, it is important to consider not just the funder’s track record for success, but also how long it has been in business to determine whether it has addressed thorny issues. Inquire as to whether the funder has been involved in disputes with claimants or their attorneys. Look at who you will be dealing with at the company. Determine whether interactions with the company will be with an individual who will approach the deal like a banking transaction, or a seasoned litigator who understands the fundamental nature of the litigation at issue and can add value as it progresses. Also consider the source of the capital being provided - is it readily available to draw down from or does the funder need to make capital calls or go through other hoops to access it? Bentham IMF, for example, is comprised of experienced former litigators who understand the cadence of litigation and how to handle its associated obstacles along the often long road to resolution. Bentham IMF also has capital on hand to fund litigation fees, costs and even working capital and debt-satisfaction for claimants as soon as its diligence process is completed.
In addition to gauging a funder’s reputation, history, and capital capabilities, the most successful funding arrangements are achieved when there is a mutuality of trust and respect between the funder, the claimant and the lawyers. Anyone considering litigation financing should have these goals in mind when first approaching a funder, to determine whether the funder is the right fit. It is imperative that all parties involved have a successful multi-year partnership with all interests aligned.
Once the preferred litigation financier is selected, the next step is to reach out with a general description of the case and the funding amount sought. Funders will invariably require a non-disclosure agreement (“NDA”) before any substantive discussions occur. This is critical to the diligence process because it evidences the intent of the parties to maintain confidentiality over shared information under the attorney work-product doctrine. The current state of the law is reflected in the comprehensive federal trial court decision in Miller v. Caterpillar, Case No. 10 C 3770 (N.D. Ill. Jan. 6, 2014).
The Miller court made a number of detailed findings that track and confirm Bentham IMF’s practices, including the following: 1) the litigation funding agreement itself is not relevant to any claim or defense in nearly all cases (apart from cases involving enforcement of a funding agreement), and is not discoverable; 2) the common interest doctrine does not apply in most states to protect disclosures to funders because the parties don’t share identical legal interests; and 3) work product material is protected under a written or an oral non-disclosure agreement.
The decision in Miller followed a similar decision in Mondis Tech. v L.G. Elec., Inc., 2011 WL 1714304 (E.D. Tex. May 4, 2011). In a subsequent decision that addresses Miller, the court recognized Miller to be “comprehensive and well-reasoned,” but performed its own in camera review of the litigation finance materials. Doe v. Society of Missionaries of Sacred Heart, 2014 WL 1715376, (N.D. Ill. May 1, 2014). The Doe court arrived at the same conclusions with respect to the applicability of the work product doctrine when an NDA is in place. Based on this and other legal precedent, the importance of executing an NDA before sharing confidential or work product information with a funder cannot be overstated.
Getting to the Term Sheet
After executing the NDA, one must then turn their attention to the specific deal terms and discuss the best way to get to a signed term sheet with the funder.
At this stage, claimants and their lawyers should expect to have a more robust, but still preliminary, conversation with their litigation funder about the case. In general, the funder will look for:
1) a simple explanation of the case;
2) where the case is pending (to verify there are no champerty or other restrictions in the jurisdiction);
3) the anticipated funding amount sought; and
4) the ideal funding arrangement (i.e., whether the claimant is looking for working capital, litigation fees, costs, or a combination of the three).
During these initial discussions, the funder will look to ensure that the matter meets its basic parameters. For instance, Bentham IMF typically requires a minimum investment amount of $1 million, a realistic damages estimate that supports that level of investment (usually about 8 to 10 times the proposed funding amount in reasonably attainable damages), and a liability theory supported by documentary evidence. Typically, a party seeking funding will approach a funder with lawyers already engaged or with lawyers willing to take the case on a certain contingency/hybrid arrangement pending the ability to secure financing. In situations where a party seeking funding has not already retained an attorney, funders are commonly willing to assist with making introductions and referrals if the matter satisfies the funder’s minimum criteria and the merits appear strong.
From the initial discussions, the funder should be able to generally understand the claims, the amount needed to prosecute the case to completion, and a reasonable estimate of potential recovery. This information allows the funder to gauge its level of interest in moving forward. If that interest is strong, the funder will typically issue a term sheet that outlines the economic terms of the proposed investment and provides for a due diligence period to fully assess the merits of the case and related issues. For Bentham IMF, the term sheet is non-binding except for an exclusivity period, which generally lasts 30 to 45 days.
Funders require exclusivity because the diligence process is time consuming and may require bringing on an outside expert to analyze the specific area of law at issue. Certain funders attempt to lock up claimants with exclusivity requirements as early as the NDA stage, and often ask that claimants reimburse them for costs incurred (e.g., outside legal advice) as part of the diligence. Bentham IMF, in contrast, only requires exclusivity after the parties tentatively agree on terms. We also incur due diligence costs without seeking reimbursement from the claimant.
The funder’s term sheet will invariably describe its proposed return structure. Returns typically (but not always) increase over time as the funder continues to invest risk capital in the litigation. There is no single way to establish up front what an acceptable return will be if the case is successful, and approaches vary widely. But it is often calculated as a multiple of the disbursed funding amount, a percentage of the litigation proceeds, or the greater of the two. One thing to look for is whether the funder proposes to take a multiple of the committed funding amount (as opposed to the amount deployed as of the date of any resolution). Often committed funds are not fully drawn upon if the litigation does not go the distance, in which case committing to paying a multiple of the committed amount is inadvisable. Bentham IMF’s business is focused on certainty and fairness. As such, we welcome early resolutions of the matters in which we invest – if fair to all parties.
Claimants should also look at the proposed return priority structure. Generally, the funder will require a first-priority position to receive, at minimum, the return of its principal. If the claimant’s lawyers have agreed to a full contingency arrangement and the funding is for working capital, the lawyers may want input in such an arrangement. Addressing issues like these sooner rather than later will benefit all parties and help facilitate the positive relationship necessary to make a litigation financing partnership work.
Presenting a Matter for Funding
Once the NDA and term sheet are agreed upon, the funder will begin the all-important due diligence process.
Litigation funders put each potential investment through rigorous diligence, which typically takes 30 to 45 days. Given that a typical case might last two and a half years and involve a commitment of a few million dollars, the funder’s in-depth review is essential. This process includes meeting with the party seeking funding, reviewing relevant documents, and possibly hiring outside experts (especially if the case revolves around a highly-specialized area of law).
Claimants should prepare for this process early. The funder will ask for pleadings that best summarize the legal and factual arguments from each side, and documentary or other evidence that both supports the claims and refutes any facially strong arguments from the adversary. A legally sound and objectively measurable theory of damages – even if preliminary – is important, and a pre-litigation damages analysis conducted by the lawyers or their consultants is a huge plus from a funding perspective. If materials are voluminous, a claimant should set up a data room or file sharing account with this information and provide it soon after the term sheet is signed. The funder will invariably seek access to the legal team to discuss liability and damages issues in depth. If the case involves a niche practice area that requires the funder to engage outside expert consultation, ask whether this additional expense will be borne by you or the funder when negotiating the term sheet. Bentham IMF incurs all such costs as part of its diligence process.
Preparing for and assisting with the funder’s diligence process may be tedious for a claimant and its lawyers. But it can be very helpful to strengthen the merits of the case, including identifying and shoring up any perceived weaknesses. The funder often reduces a case to somewhere north of its “worst-case scenario” and seeks an explanation of the best arguments available. Lawyers are often very appreciative of the process because it forces them early on to analyze the pitfalls in the case, identify the best evidence available, and crystallize counter-arguments sooner than they otherwise would do in the litigation process.
While each case presents a unique set of issues, funders at a minimum look for the following in any investment opportunity:
1) a cogent liability theory supported by documentary evidence, indicating strong prospects of success;
2) a sound damages theory that results in sufficient damages to cover the funder’s return, the lawyers’ contingency stake (if any), and (in Bentham’s case) enough remaining for the claimant to recover at least 50 percent of any award or settlement; and
3) a high likelihood of collectability.
Being frank, realistic and dispassionate during the diligence process is important. Litigation finance is a multi-year partnership. Thus, it is best for all parties involved if the funder has the essential information to make an accurate underwriting decision. Once an investment decision has been made, you can expect to finalize and execute a funding agreement.
Closing and Monitoring a Litigation Finance Transaction
Finally, the parties will begin to consider the funding agreement itself.
The funding agreement represents the funder’s contractual obligation to finance litigation expenses or working capital in exchange for a portion of any award or settlement. This contract is the only protection the funder has over its investment because funders typically do not take any other security interest or collateral. Thus, they likely may not be willing to diverge substantially from the terms that impact returns and return priority.
Claimants should be wary, however, of litigation finance contracts allowing the funder to exert control over decisions otherwise held by the lawyer (and in some instances, the claimant). Such control may take the form of veto power over litigation strategy, ultimate sign-off on settlement, and the claimant’s ability to choose counsel. Further, such provisions run contrary to legal ethical rules forbidding third parties from interfering with an attorney’s independent professional judgment. A claimant and its lawyers should carefully review and analyze any control provisions under the legal professional responsibility rules of the jurisdiction in which the case will proceed.
A reputable funder will typically ask to be apprised of settlement negotiations and may offer non-binding views on the same. Of course, good faith acceptance or rejection of a settlement offer typically remains fully within the client’s purview. But the claimant should understand exactly what portion of the litigation proceeds it must turn over to the funder in exchange for the capital the funder has provided as of the date of that decision. It is also important to understand that the funder may require approval of any substitute counsel, but will often agree that such approval will not be unreasonably withheld. While substitution of counsel may be appropriate, any new attorney joining a financed case will have to be comfortable with 1) the deal terms, including priority; 2) the budget and contingency arrangements; and 3) consulting with and updating the funder. If the new counsel is not comfortable with the fundamental deal arrangements, then the underlying partnership with the funder simply will not work.
Once the transaction closes and the case is funded, the claimant’s partnership with the funder begins. Many lawyers question the level of involvement a funder should have when it monitors its investment. Will the funder require weekly reports? Justification for strategy decisions? Review and approval of briefs? The answer is nothing quite so involved.
Bentham IMF subscribes to a “light touch” monitoring process involving regular updates on the progress of the case and notification of any critical events. The frequency of these discussions often depends on the level of activity – which varies over the course of any litigation – but is typically once per month. In addition to monitoring substantive case developments, the funder will carefully monitor the litigation budget to make sure there is sufficient capital committed to the investment.
Maintaining an open dialogue about both successes and unanticipated obstacles that arise during the litigation process is critical to the long-term success of the litigation finance partnership. When a case takes an unexpected turn, the funder can help right the ship by offering advice or helping the legal team identify the resources needed to get the case back on track.