October 16, 2019
Litigation can blindside a small or mid-sized company, particularly one that is young but has grown quickly. There is not always a connection between a company’s size and the size or complexity of a commercial dispute it encounters. For instance, a small business can have an IP infringement claim worth millions, or a breach of contract case against a foreign counter-party that requires international arbitration and enforcement.
Understandably, such a company may have focused its resources on running and expanding the business, rather than building out a team of in-house lawyers. And many companies do not have the budget to fully cover the costs of an unexpected commercial dispute or the experience to handle it. This can be disastrous when the company’s counter-party has a legal budget that is multiples of the company’s revenue. In such an instance, even the process of assessing the company’s strategic options can seem overwhelming.
There are plenty of law firms available to help a company in such a situation. But, even the initial case assessment – before filing suit - can be costly, as can getting a second opinion. And often the budget for pursuing a commercial case to judgment is many millions of dollars.
So what do you do if you’re David facing a Goliath-sized dispute?
Litigation funding may provide the answer. Litigation funding provides access to capital for companies litigating meritorious claims, but the benefits for small or mid-sized companies go beyond financial. The top funding companies in the U.S., including Validity Finance, are founded and run by experienced litigators who can be a priceless source of perspective and expertise as a company navigates uncertain legal territory.
Litigation Finance 101
Litigation funders advance capital to a company that has a claim or potential claim against a defendant. Contrary to popular perception, litigation funding is not a traditional loan and litigation funders do not charge interest. Instead it is non-recourse finance in which the funder’s investment is secured by the potential damages award in a particular case or group of cases. If the case turns out as anticipated, the funder’s return is typically calculated as either a multiple of the amount it invested or as a capped percentage of the company’s recovery. If the case is unsuccessful, the funder loses its investment and the company does not have to pay back the funder’s capital.
Companies working with a reputable litigation funder retain full control over legal strategy, choice of counsel and any settlement decision. However, the structure of the funder’s investment aligns its interests with those of the client in the sense that they both want to maximize and collect damages owed in a meritorious case. The funder is thus incentivized to support the client throughout the litigation.
Advantages Over the Contingency Billing Model
Companies needing to minimize up-front legal costs may look to firms that offer contingency billing. Unfortunately, not all firms accept cases on a full contingency basis, which can limit a company’s choice of counsel. Moreover, law firms can only offer savings or deferrals on billing for legal fees—they cannot offer working capital.
Litigation funders, on the other hand, advance cash to a company based on the funder’s assessment of the potential case outcome. The company can use the proceeds of a litigation funding deal to pay legal fees and costs related to litigation. Alternatively, it can treat the money as working capital, spending it on any business purpose. Third-party funding can be a crucial lifeline for a company whose litigation is devouring cashflow.
Adding Value during Case review
The first step in funding is diligence, during which the funder assesses case merits, likely outcome, range of potential damages, obstacles to recovery, and potential strategies to address those obstacles. The next stage of diligence involves an analysis of the case’s economics, including budget, capital needs, and risk-sharing among the client, outside counsel and funder.
Funders differ in how they handle diligence. At Validity we pay for our diligence out of our own pocket, and we use our own experts. Even if we do not invest in a case, we share the results of our diligence with the client. Simply going through the process with a collaborative funder offers a company an objective third-party evaluation at no cost. Sometimes the funder may even spot an issue or a new theory of liability that neither the company nor counsel have explored.
More than dollars….
ALM recently published a survey of litigation finance users in which 100% of in-house counsel prioritized a funder’s willingness to invest not just money, but also the time necessary to get to know the company and the claim. These results suggest that in-house counsel view funding as more than just a financial transaction. Those who have direct experience using it seem to value a funder who can be a trusted partner throughout the litigation.
It makes sense. Many funders—including all of the investment managers at Validity—are former litigators with 10-20 years of experience, and also have proven expertise in valuing complex claims. They can help determine reasonable expectations for an expected recovery, recommend an expert witness, help stress test an argument, and act as a sounding board on strategy. Importantly, funders don’t bill by the hour. They will only receive a return if the case is successful.
The bottom line is that for small or mid-sized companies faced with daunting litigation, funding can be an opportunity to add trustworthy allies to your team without the upfront costs typically associated with hiring outside counsel. The right litigation funder will have the expertise and incentive to help achieve a positive outcome in the case.