A Peek Inside The Pipeline: How A Litigation Finance Deal Comes Together

Last week, I took a break from following all the news about the Kavanaugh nomination to attend the Inaugural LF Dealmakers Forum, the first in what I expect to be a series of major conferences focused on the rapidly growing field of litigation finance. The conference offered a wide range of programming as well as networking opportunities through one-on-one dealmaker meetings.

One of the most interesting panels I attended was “The Art of the Deal: From Origination to Risk to ROI,” an inside look at how a litigation funding deal comes together, featuring the following panelists:

• Andrew Langhoff (moderator), Managing Director and Founder, Red Bridges Advisors
• Fred Fabricant, Partner and Chair of IP Litigation, Brown Rudnick
• Michael Nicolas, Co-Founder and Managing Director, Longford Capital
• Richard Schirtzer, Head of Complex Litigation, Quinn Emanuel
• Boaz Weinstein, Principal, Lake Whillans

Here’s what they discussed. Let’s start at the beginning, with the underwriting process.

When deciding whether to back a litigation, what does a funder look for? There are three main focal points, according to Boaz Weinstein of Lake Whillans: the merits of the claim, the identity of the claim holder/client, and the identity of the counsel handling the case. The merits are the most important, and they include such factors as the type and strength of the claims, the nature of the evidence, the possible damages, and collection risk (i.e., the difficulty of collecting from the defendant).

But the identities of the claim holder and their counsel matter as well. Why? As Weinstein explained, there needs to be trust between all three parties — funder, claim holder, counsel — in order for the financing to move forward.

Michael Nicolas added an important point about clients: the best clients are not emotional, approaching their claims from a commercial perspective. If there’s an opportunity to settle on reasonable terms, the client should be willing to settle, instead of fighting out a never-ending grudge match. Settlement is generally the funder’s opportunity to exit — and reap a return on investment.

How selective are funders? Very selective — even more choosy than, say, Harvard Law School. HLS has an acceptance rate of 12.8 percent, while Lake Whillans and Longford fund under 5 to 10 percent of the opportunities presented to them.

How do funders pick which cases to back? The process varies from fund to fund. Longford uses a two-stage process. In the first stage, an internal team of former trial lawyers reviews the case. If it passes muster with them, it goes on to the second stage, independent legal review by outside counsel. In this stage, an external law firm with expertise in the subject matter of the case evaluates it for viability as a funding candidate. Only if a case passes both stages does it get funded.

Lake Whillans does things a bit differently. It also has its internal team of former litigators review each case, but it doesn’t use outside counsel unless the matter has an element where Lake Whillans lacks in-house expertise. It prefers to keep things internal to maintain consistency in its assessment of cases. As Weinstein put it, “We want to be the McDonald’s of judgment.”

How does underwriting look from the law firm perspective? Both Fred Fabricant of Brown Rudnick and Richard Schirtzer of Quinn Emanuel had positive things to say about the process.

According to Fabricant, funders often have helpful insights to offer into the cases they review. Underwriting is “a great opportunity for a law firm to learn more about its case,” he said.

As for Quinn Emanuel, it uses a committee to evaluate the cases it will handle on a contingency-fee basis. This committee doesn’t approve cases unless it feels very confident in their merits. As a result, when it does seek to bring a funder into one of its contingency-fee cases, Quinn Emanuel enjoys a very high success rate in terms of passing the fund’s diligence.

Throughout the underwriting process, the parties remain cognizant of the importance of protecting attorney-client privilege and attorney work product. Agreements explicitly provide that the law firms will not share privileged information with the funder, and sometimes information will be communicated orally instead of in writing, to avoid generating a paper trail. (In recent years, efforts to force disclosure of litigation funding arrangements have ramped up — and are likely to increase as the field continues to grow.)

After the case passes underwriting, the parties need to hammer out the terms of their agreement. This negotiation process requires the funder to invest a certain amount of time and resources, and so funders often take steps to protect themselves. For example, Lake Whillans generally requires a “breakup fee” if the potential client walks away in the middle of the process (although it has not yet had to invoke this provision, Weinstein said).

How do funders decide how much money to put into a case? As Weinstein and Nicolas explained, they generally use certain ratios or rules of thumb to determine ceilings for funding. In a single-case funding, it’s typical to fund on a 10:1 ratio — i.e., the litigation financier will fund up to 10 percent of the likely provable damages. In a portfolio situation, where multiple cases are being funded, the ratio might be more flexible (but this will depend on whether the portfolio is well diversified; the less diversified the portfolio, the closer it comes to being just like a single case).

Funding will also reflect the estimated budget for litigating the case. Budgeting can be a challenge for Biglaw lawyers, Nicolas said; Longford urges counsel to try and come up with as comprehensive a budget as possible, covering the whole case and accounting for possible contingencies. While the fund will consider requests for additional funding if its initial commitment is exhausted, it’s under no obligation to do so — which is why counsel would do well to be conservative when developing a budget.

How much will the funding cost, and how is that rate determined? It doesn’t really turn on the type of case. Instead — and this should surprise no one who understands the time value of money — it’s driven primarily by likely time to payout, plus overall risk.

So the procedural posture is important, as Weinstein explained: “What’s the status of the case? Is the case on appeal, or has it not yet been filed? What discovery have we seen?” These are all relevant factors in pricing.

Does the funder care what the client does with the money? Andrew Langhoff posed this colorful hypothetical: “Do you care if the client uses the money to buy a yacht?”

Yes, Nicolas said. Why? Funders seek alignment of interest. They want both clients and the law firms representing them to have “skin in the game,” or some of their own money at risk. Funding agreements will generally specify what the capital can be used for.

It’s possible, Weinstein explained, for a client to use litigation financing for operating purposes — but it the client does that, the funder would like to know that upfront (and it might also affect pricing, Nicolas said).

After funding, what type of control does the funder exert over the litigation? Zero, according to the funders — which makes sense, given the rules of legal ethics that put control of a case squarely in the hands of the client. Funders will receive updates on the litigation, but contractual provisions make clear that control over the case resides with the claimholder.

Any informal “control” a funder exerts over a case comes at the outset, in terms of the funder deciding to back the litigation in the first place. This requires the funder to be comfortable with the claims, the claim holder, and the counsel on the case; if the funder doesn’t have that comfort level, then it can decline to back the litigation, which could be viewed as a sort of “control” or “influence.” But once the funding agreement has been entered into, the funder steps to the sidelines.

Could the funder exert influence over a case by threatening to stop funding midstream? This is difficult if not impossible, given the contractual provisions in place. Contractually, funders generally have a very limited right to withdraw (e.g., if the client made misrepresentations about the case during the underwriting process).

Market forces also discourage unjustified withdrawal. If a fund becomes known for pulling the plug in the middle of cases, then clients and law firms will stop presenting it with possible investments.

In this sense, litigation financing is like litigation and the legal world in general. Reputation is the coin of the realm — and once it’s lost, it’s very hard to get back.

LF Dealmakers Forum: Advancing Litigation Finance [Dealmaker Forums]

Earlier: Coming Attractions: Advancing Litigation Finance

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David Lat is editor at large and founding editor of Above the Law, as well as the author of Supreme Ambitions: A Novel. He previously worked as a federal prosecutor in Newark, New Jersey; a litigation associate at Wachtell, Lipton, Rosen & Katz; and a law clerk to Judge Diarmuid F. O’Scannlain of the U.S. Court of Appeals for the Ninth Circuit. You can connect with David on Twitter (@DavidLat), LinkedIn, and Facebook, and you can reach him by email at [email protected].