One of the holy grails of litigation funding has long been for funders to convince CFOs to view litigation through a commercial lens, and unlock the value of their legal assets. While straightforward and practical, the evolution of the CFO mindset on this issue has been slow to materialize. Many in the litigation funding community blame cultural norms—old habits are simply hard to break, which is especially true when things are going swimmingly. But with inflation upon us and a recession looming, the time is ripe for CFOs to reconsider their firm’s relationship to litigation funding.
Research from Burford Capital in June of 2021 found that 75% of companies with over $1 billion in annual revenues reported unenforced judgments worth $20-$100 million in FY 2020, while at the same time, just 24% said they apply quantitative financial modelling to make decisions about litigation, as they do in other areas of the business. That research is now a couple of years old, but it underscores both the need for litigation funding, and the challenge that funders face when trying to convince CFOs to think differently about litigation. Change may finally be afoot.
A recent global survey of CFOs conducted by Everest Group found improving cash flow continues to be a priority for a large majority of CFOs. As one respondent noted: “As the business environment continues to throw up shocks prompted by geopolitical uncertainty and sector disruption, CFOs should ensure that, as well as technological evolution, change management becomes a culture rather than a one-off exercise.” Indeed, macroeconomic constraints are forcing CFOs to re-prioritize.
Gartner recently identified the Top-10 priorities for CFOs in 2023, based on Deloitte’s Autumn 2022 European CFO survey. The Top-5 among those are:
- Coping with complex systems
- Protecting margins and balance sheets
- Acquiring and retaining talent
- Raising capital
- Finding focus
The second point stands out in relation to litigation funding—“protecting margins and balance sheets” is exactly the pitch that funders have been making to the CFO community for years now.
PricewaterhouseCoopers conducted its own survey, and highlights the main topics on the CFOs agenda for 2023:
- Navigate economic uncertainty
- Enable growth
- Take action on ESG
- Accelerate transformation
- Cultivate finance talent
- Build trust and purpose
Responses such as ‘navigate economic uncertainty’ and ‘accelerate transformation’ should be music to every litigation funder’s ears. It’s clear based on the above data that litigation funding maintains a product/market fit, in that it addresses some of the core pain points CFOs are currently facing. That said, many CFOs still need to be brought to the table as to how their firms can benefit from the use of litigation funding.
Advantages of Unlocking Capital Buried in Legal Claims Susanna Taylor, Head of Investments at
Litigation Capital Management, highlights what she considers to be four core benefits of litigation funding for CFOs:
- Protecting the value of the business from the cost impact of litigation
- “If the same case was financed by a third-party funder, then the business will not carry these legal expenses […] The operating profit in each year will be higher and the accounts will be a more accurate reflection of actual business performance.”
- “Further, once the claim is successful, the company will be able to include the proceeds as profit which has been generated at zero cost.”
- Protecting the business from significant litigation risk
- “The funder carries 100% of the financial risk involved in pursuing the claim and if the claim is unsuccessful, the funder will receive nothing. […] Litigation finance can include the offer of an indemnity against adverse costs and an agreement to meet an order for security for costs.”
- “Using third-party litigation finance also removes uncertainty in forecasting legal spend, which can be highly variable and difficult to predict.”
- Insulating the business from unexpected claims
- “Litigation brought against a company is an unwelcome consequence of doing business. These claims are almost always unexpected, unbudgeted and require action.”
- “Importantly it offers the corporate client the opportunity to offset the costs and risks involved in defending claims, as well as allowing the business to apply its capital into growth operations rather than on uncertain litigation.”
- Unlocking the value that resides in claims
- “Litigation finance allows companies to recognize the value in a piece of litigation at a time which suits them best.”
- “These funds provided to the company can ‘plug the gap’ in expected EBITDA at no cost to the company.”
In an article for
Global Banking and Finance Review, Ellora McPherson, Managing Director & Chief Investment Officer of Harbour Litigation Funding, points to the need for CFOs to consider alternative solutions in order generate value, which is especially true during today’s tumultuous economic climate. According to McPherson: “The macroeconomic lifecycle has no bearing on the outcome of disputes and litigation as an asset class itself it has little correlation to the wider market. This means that litigation funders have the capital to pursue meritorious claims at difficult times even when the businesses with the claims do not.” Commercial disputes are often worth tens or hundreds of millions of dollars. These legal claims are simply too valuable as assets not to be leveraged during times of economic upheaval.
“It is now no longer a question of whether CFOs can afford to advance these claims,” says McPherson, “but whether they can afford to ignore these assets on their books any longer.”
How CFOs Should Approach Funders If CFOs are to be swayed by the high-level arguments posed by funders as to the advantages of legal finance, they must first get comfortable with frontline interactions—what exactly should CFOs expect from a litigation funding partnership? What should they be on the lookout for, and what sets one funder apart from another? The lowest-hanging fruit answer here is cost of capital, but that is obvious. Beyond mere capital requirements, lies a plethora of differentiators which CFOs must account for when approaching and selecting the most appropriate funder for their legal claim (or portfolio of claims):
- Flexibility. CFOs should select a litigation funder who will be their partner, not just their capital provider. Similar to an agreement with a lender, CFOs don’t want a funder who will balk the moment a curveball is thrown, especially if that curveball comes from somewhere out of your control (as is often the case with legal claims). Funder flexibility and adaptability is an important trait when considering the long-term relationship at stake.
- Funder Capitalization. Per the aforementioned point, legal claims often take longer than anticipated, or tumble down rabbit holes no one saw coming. Does your funder have enough liquidity to backstop unforeseen circumstances? What is their policy during such a contingency? These are critical questions to ask.
- Legal Sector Expertise. This is important for two reasons: firstly, so the funder understands the bespoke challenges posed by a given sector and doesn’t get cold feet should the case run up against those issues along the way, and secondly, so the funder can help consult on case strategy, should the claimant and law firm request (most funders are ex-lawyers, after all).
- Enforcement. Winning a case is one thing, but collecting on the reward is quite another. Does the funder have a track record of enforcing victories—either via a third-party or in-house enforcement team?
- Reputation. CFOs should consult with past clients to get a sense of how the funder interacts with both the client and the law firm. This is a triangular relationship, and it’s important that all sides work together towards a successful outcome.
Ultimately, Litigation Finance offers an opportunity to monetize what would otherwise remain an illiquid asset, and deploy that capital into a core business activity, thus increasing the enterprise value. That is an invaluable tool for any CFO looking to unlock value without having to resort to traditional capitalization methods, such as approaching lenders or equity partners.
The CFO Roadmap Even companies with ample cash to cover attorney fees and expenses can benefit from the instant liquidity provided by litigation funders. Why wait years to unlock the value of a legal claim, when that capital can be put to work immediately? What’s more, the prevalence of litigation funding permits corporations to pursue litigation that they would otherwise leave on the table, and also to reject low-ball settlement offers which they might otherwise accept due to concerns over duration risk and case expense. For CFOs who want to understand if their firm is a strong candidate for litigation funding, there are several steps they can take:
- Review the company’s litigation history. Have prior legal costs or outcomes influenced management’s thinking about pursuing potential legal matters? Perhaps it is time for a reevaluation of the firm’s approach to litigation.
- Consult with internal legal staff to identify any matters that may have been deferred for one reason or another, and assess whether those prospective claims might represent strong candidates for litigation funding.
- Speak with litigation funders or advisory firms to determine a full cost/benefit analysis, including estimates, milestones, duration risk, IRR/ROI potential, and more.
- Understand the internal resource commitment your team is making, should you take on additional litigation with the help of a funder.
CFOs who follow the above roadmap stand to benefit by repositioning their legal department from a cost center to a profit center. This simple shift in mindset will help strengthen the balance sheet by producing higher net income, lower expenses, and an advancement of business strategies—all without the onerous conditions of a traditional loan.
