The following is a contributed piece by Ed Truant, founder of Slingshot Capital, and Andrew Langhoff, founder of Red Bridges Advisors.
When we write about litigation finance, we often assume it is easily accessible and that plaintiffs undertake most of the ‘leg work’ to secure financing. In practice, litigation finance is often difficult to obtain, and plaintiffs typically rely quite heavily on their law firms to obtain it. This is a very different dynamic than one sees in other areas of financial services. And because law firms may not have the expertise and bandwidth to properly broker a litigation funding transaction, their involvement in the process may be unintentionally short-changing their clients. With some law firms now entering contractual “tie-up” or “best friends” arrangements with favored funders, we thought this an opportune time to consider the law firm’s proper role in the litigation funding process.
This article will explore common but unexamined efforts by law firms to deal with funders, the practical challenges posed and suggest a preferred approach for law firms and their clients.
Executive Summary
- Law firms may not have the practical expertise and competency to advise their clients on funding partners and terms
- Similar to other asset classes, a specialist intermediary/broker community has emerged to assist plaintiffs/law firms
Slingshot Insights:
- Plaintiffs should assess the potential for conflicts of interest in assessing their litigation finance
- Law firms should ensure their clients are informed of their role and obtain waivers, where appropriate.
- Plaintiffs should consider using an independent advisor to solicit litigation finance commitments for their case
Overview
As awareness of litigation finance grows in the U.S., law firms are increasingly confronted with the question of their appropriate role when engaging with litigation funders. Because law firms are a primary source of new funding deals, top law firms are repeatedly approached by litigation funders in hopes of striking “strategic” relationships. Law firms have responded to these advances in various ways – from informal promises of future consideration to formal agreements to refer their clients to a given funder.
For example, in June 2021 a major U.S. firm announced a “$50 million partnership” with a prominent litigation funder. While it is unclear if any cases have been funded under the deal, the law firm said that the funder’s monies would be used to pay their fees for legal claims brought by their clients. Two months later, a major UK firm stuck a deal with two UK funders to create a new entity that will provide that law firm with access to GBP 150 million in litigation financing for new cases. The very next month, a similar “best friends” deal for the same amount was struck between another UK firm and a UK funder.[1] A Financial Times article describing these and other “tie-ups” highlighted the fact that lawyers are duty-bound to act in the best interests of their clients, and that a partnership between a law firm and a funder adds a potential conflict of interest to the mix.
While no doubt driven by good intentions, efforts by law firms to “help” in the litigation funding process may in fact hurt their client’s interests. As argued below, great care should be taken by law firms to avoid being viewed as “steering” clients to favored funders. Such efforts – especially when a law firm has a public contractual relationship with a funder – may actually interfere with their clients’ chances to obtain funding. Examined closely, practical considerations suggest that a law firm’s best approach is to stay within its role as legal counsel and to avoid any involvement in actively brokering or placing litigation financing. Both clients and their law firms would be better served by working with the growing number of consultants and intermediaries who are dedicated to the litigation finance market.
The Issue
The U.S. litigation finance market is more competitive today than ever before. Over the past ten years, the number of dedicated “litigation funders” has grown significantly and the market has started to specialize. Add to this the increasing number of hedge funds which invest in litigation as part of their multi-strategy approach, and there has never been a better time to shop for litigation finance. Clients are now able – on their own or with an experienced broker – to evaluate a broad array of funders to ensure they receive optimal pricing and competitive deal terms. In this way, classic market forces reward both those seeking and those providing funding.
But this promise of optimal arrangements via competition is increasingly hindered by the efforts of law firms to “assist” their clients with funding. By directing their clients to the firm’s preferred funder (or a limited number of funders with whom it is already acquainted), many law firms may be robbing their clients of the opportunity to survey the broader market, and to thus strike a better deal. In practice, law firms are not ideally suited to the role of assessing the growing number of funders and undertaking the brokering of litigation finance – nor would they wish to be viewed as being in that business, as we will discuss further below.
Background
Most U.S. plaintiffs seeking litigation funding are new to the practice. This is because funding is still relatively novel – and because few clients have successive claims worth tens of millions of dollars while lacking financial resources. While there are exceptions to this rule – particularly in the patent litigation context – most plaintiffs seeking funding are doing so for the first and last time.
As such, these clients are presumably unfamiliar with the arduous process of obtaining litigation finance. Without guidance, they have no notion of which funders to speak to, how to price a proposed transaction, the ‘tells’ that funders communicate when they are assessing opportunities or what other matters to be concerned with. It’s thus natural that these inexperienced clients turn to their law firms for advice on how to secure funding.
And law firms are generally quite happy to assist their clients in this regard – if for no other reason than they stand to receive millions in legal fees if funding is secured. In fact, it’s typical for law firms and their client to approach third-party funders together: they have established a mutual desire to work together, see themselves as aligned in interest, and simply need financing to pay the legal fees and costs to launch their promising case. In this sense and at a high level, there is great alignment between what is best for the law firm (current and contingent fees), what is best for the client (a potential award with minimal cash outlay) and what is best for the funder (a rate of return on their investment commensurate with the risk they have assumed).
A law firm’s approach to the market – and recommendation of specific funders – will likely depend in part on the firm’s prior experience with funders. This experience may range from:
- Having been pitched by funders, but not having sought financing;
- Having unsuccessfully sought financing on one or more occasions;
- Having successfully obtained financing for its clients from one or more funders;
- Having successfully obtained financing for the firm itself from one or more funders; and/or
- Having executed an arrangement with a funder where the law firm has pledged to send its clients and prospective clients to that funder (a so-called “best friends” arrangement – which is becoming increasingly common).
It follows that the deeper the law firm’s prior experience with funding – especially if it has a direct contractual or working relationship with a given funder – the more likely that firm is to direct its client to such a favored funder (or two). While this may seem practical and helpful – and even advantageous for the client – this “steering” not only limits access to the broader market (as discussed below), but dangerously ignores the lack of alignment in interests between the client and the law firm. While there is general alignment amongst the three parties, as referred to above, the question of whether the alignment maximizes the outcome for the plaintiff should be a significant consideration for the plaintiff.
Lack of Market Experience of Law Firms Raises Practical Concerns
In fairness, most law firms are simply problem solving when they refer a client to a preferred funder. The process of obtaining funding is typically grueling, and the idea of working with a friendly and responsive funder seem obvious at first blush. But even when a litigator takes an active role in the process – which raises many of the issues noted above – they are undertaking a typically uncompensated sideline which is well outside their core competency in the practice of law. The problems with this are severalfold.
First, the litigator working with the client – and it is almost always a litigator – will be at best an occasional and sporadic player in the litigation finance market. As a result, their awareness of the range of options in the market (including hedge funds who do not typically visit her office with marketing literature) will necessarily be limited and may not include other tools such as insurance products or other hedging instruments. It’s unreasonable to assume that a practicing litigator has the time to meet and evaluate the ever-increasing number of capital sources in the funding space. Not only are there more entities offering funding – they are increasingly differentiating themselves. Funders now vary based on the types of claims they fund, the size of investments they seek, and their underwriting process. Critically, these funders also differ as regards the pricing structures they offer. To be properly advised, a client should be made aware of the full range of growing options, which could extend beyond traditional litigation finance.
Second, litigation funding is a distinct form of specialty finance which raises unusual issues. Without a firm grounding in the particulars of the practice, the typical law firm litigator is apt to overlook important questions, including ethical, regulatory, and taxation issues. Not only are these issues unique to litigation finance, but they are often fluid, and require those in the industry to closely monitor developments. It stands to reason that most litigators – who pursue funding only occasionally – will not maintain a constant focus on this dynamic industry. As a result, they may well miss a trick – perhaps a critical one for their client.
Third, obtaining litigation funding takes a significant amount of time and effort. The process will usually take two to three months – but it can often take double this. Properly conducted, the process will involve the creation of introductory materials, initial diligence with at least five funders, the negotiation of deal structures, pricing, and terms sheets, comprehensive final diligence, and extensive deal documentation. The time involved in running such a process should not be underestimated, and – as every deal maker knows – lack of responsiveness at any point in the process can quickly kill the enthusiasm for an investment. Given that this “extra” work by a busy litigator is uncompensated and outside her ordinary practice, it would not be surprising if she is unable to give the process the proper attention demanded.
Before leaving the practical considerations of a law firm’s involvement in the funding process, we should consider one very significant downside of a so-called “best friends” agreement between a funder and law firm. This is the awkward situation arising when a favored funder chooses not to fund a case for a firm’s client. As most cases that seek funding are denied – and as these agreements don’t promise funding unless a funder likes the risk of a given case – this result can occur frequently. When it does, it deals a fatal blow to the client’s efforts to raise funding – for what other funder would choose to finance a case when the favored funder has passed? Thus, what looked like a promising arrangement to a client may have fundamentally damaged his or her chances to obtain funding. The law firm also needs to consider the impact a denial has on the relationship with his client.
In short, aside from potential conflict of interest concerns, law firms and their partners are not practically suited to spend their time orchestrating the pursuit of funding for their clients. There are better options available.
No Need to Reinvent the Wheel
Given the above, what is a law firm and its client to do when seeking litigation funding? Or, perhaps more clearly – how can a law firm and its client gain access to the whole of the market, avoid any potential conflict of interest concerns, and ensure they secure financing with the best possible pricing and terms?
When discussing nascent markets, it’s often instructive to look at other, more mature markets to see how they have dealt with similar situations in the past, either voluntarily or in response to regulation. In the context of litigation finance, we think there are a number of similar – yet more mature – financial markets that can usefully be compared.
If we look at private equity (venture, leverage buy-out, real estate, etc.) as a proxy, there is and has been a well-established network of advisors (investment bankers and brokers) that serve to increase the efficiency of the marketplace by connecting investors / lenders with shareholders / borrowers in a way that increases transparency and ensures that the best interests of the advised party are being met.
Similarly, if we look at commercial real estate, there are networks of licensed brokers that are hired to represent the best interests of the sellers by forcing them to adhere to industry standards and practices and run sale processes to ensure the market is being adequately canvassed for buyers on behalf of the seller.
The same solution exists for litigation finance in the form of independent advisors who are knowledgeable in litigation finance, and whose interests will be solely aligned with the client. This option is often overlooked, however, because the relationship between the law firm and the client is one of ‘trusted advisor’, and clients naturally assume the law firm will look after their best interests. While that is often the case, plaintiffs can seek to eliminate the appearance of any potential conflict of interest by engaging a specialty advisor. These advisors will canvass the litigation finance market and other funding sources for financial alternatives and present them to the client for consideration. One of their objectives is to create competitive ‘tension’ in the market by running a process that ensures the best alternatives are presented, and the commitment is obtained in a timely manner.
The value of the advisor is typically inherent in their industry experience, the knowledge they possess (including relevant legal/litigation experience), the relationships they foster, the efficacy of the processes they run, the timeliness of receiving a commitment and their reputation in the marketplace. Some of the benefits of using an advisor are as follows:
- Ensuring that the full market of potential funders has been canvassed;
- Having the client’s opportunity strategically presented to appropriate funders (based on the advisors’ knowledge of each funder’s diligence criteria);
- Knowing what the “market” price is for different types of funding transactions;
- Creating ‘tension’ in the capital raising process to produce the best outcome – for pricing and material terms;
- Gaining support for negotiations of term sheets and deal documentation; and
- Utilizing (if necessary) the advisor/broker as “bad cop” to obtain the optimal deal.
Perhaps as importantly, the use of an advisor will likely be more efficient and more economical for all parties involved. This efficiency is a function of the advisor’s dedicated service to putting funding in place – which, as noted above, is a multi-month, multi-disciplinary undertaking. As better advisors typically operate on a contingency model (i.e., they are not paid unless and until funding is secured), they are incentivized to move deals along briskly. And while advisors will charge a contingent price for their services (typically paid by the funder in the first tranche of financing), this additional cost is usually more than made up in cost savings to the client – the result of lower pricing made possible by the advisor’s market knowledge and creation of a competitive process. Advisors for litigation finance are more easily found, as they are now rated by Chambers & Partners and other service providers to the legal community.
To be clear, law firms must continue to play a critical but discrete role in the funding process. Working closely with an advisor, it is essential that the lawyers involved in a matter speak to the merits of the case, the potential damages to be gained, as well as issues of procedural posture, timing, and collection. Moreover, every potential funder will be keen to assess the lawyers and law firm litigating the case to insure they have the experience and expertise required. But by staying within their role as legal counsel – and allowing advisors to run the funding process – law firms will not only avoid any appearance of ethical conflict, but will save themselves time and money.
This article has been co-authored by Andrew Langhoff and Edward Truant.
Slingshot Insights
As the litigation finance market evolves, new issues will arise that will give pause for consideration. The partnering of law firms with litigation funders is one of those issues that requires deep consideration by law firms, plaintiffs and funders, as inappropriate disclosures, lack of waivers and insufficient canvassing of the market may result in a series of unintended consequences which may result in litigation, ironically enough. As this issue is relatively recent, we don’t have sufficient insight and precedent to determine how it will be viewed by the judiciary and law societies, but we can see how it differs from other industries and we can identify the potential for conflicts of interest. As an investor in this sector, due diligence should include understanding the relationships the funder has with law firms.
As always, I welcome your comments and counter-points to those raised in this article.
Andrew Langhoff is the founder of Red Bridges Advisors LLC and has been active in the litigation finance industry for more than a decade. Following his time as COO of Burford Capital and Principal at Gerchen Keller Capital, Andrew founded Red Bridges to advise those seeking to obtain litigation finance.
Edward Truant is the founder of Slingshot Capital Inc. and an investor in the consumer and commercial litigation finance industry. Slingshot Capital inc. is involved in the origination and design of unique opportunities in legal finance markets, globally, investing with and alongside institutional investors.
[1] Interestingly, in yet another situation where a law firm created its own funding arm, it explicitly prohibited the use of such monies for the funding of its own cases.
