Why your risk management strategy should include litigation funding

Litigation funding’s popularity continues to rise, yet many businesses remain unaware of its benefits. Here, we discuss everything you need to know about this key risk management tool and explore how it could help companies choose – and finance – their strongest claims for the lowest costs.

Few businesses relish the prospect of litigating. It is expensive, protracted, time-consuming, and often unpredictable – all highly undesirable qualities given the current economic climate. Unfortunately, that same climate is precisely why having a solid litigation strategy is now vital if businesses are to reduce the financial burden of disputes and ensure a better return from successful claims.

Developing a strategic approach to litigation is not straightforward, however, and is best done in tandem with lawyers who are experienced at litigating at risk, prepared to put some “skin in the game”, and know and understand the litigation funding market. They can work with you to put in place alternative fee arrangements to enable businesses to pursue claims. They will also provide the advice needed to pinpoint which claims have the best prospects.

What is litigation funding?

Commercial litigation funding is essentially corporate finance for law and comes in different forms. A business can, for example, use its legal ‘asset’ (its claim) as collateral for funding from a third party, to cover legal fees, court costs, or even regular business operations. Alternatively, it can agree a fee arrangement with lawyers prepared to litigate at risk. In this case, the lawyers either receive a percentage of the recoveries (typically around 35% depending on the type of claim) or a success fee which usually comes in the form of an uplift on their fees and is only payable if the claim succeeds. This industry is growing rapidly, with its assets in the UK nearly doubling over the past three years to balance sheets worth £2.2bn in 2022, according to research by RPC.

Different models of litigation funding exist, but almost all will work under the basis that claimant, funder, and other stakeholders share the risks and work towards a common goal. Most are also non-recourse, which means a business can secure funding in exchange for a portion of any recoveries.

What are the benefits of litigation funding?

Litigation funding offers numerous benefits to companies, in-house counsel, and private practitioners. The scope and availability of such benefits will vary case-by-case, however.

1. It levels the playing field.

Litigation funding reduces the impact of complex claims on capital expenditure or cashflow, thus empowering companies to challenge, and sustain claims against, defendants with deep pockets. As such, smaller companies are in a better position to pursue claims against larger organisations if backed by litigation funding.

2. It can improve your strategy.

Assessing a potential case’s merits drains internal resource, particularly if access to relevant information and precedents is limited. Litigation funders and law firms who litigate at risk, however, frequently have access to the knowledge and historic cases required to triage cases, identify the highest potential claims, and avoid less meritorious examples. They are also experienced at creating the leverage needed to force settlement and monetise claims as early as possible, as well as having the experience required to enforce judgments and awards.

Companies with a portfolio of claims are particularly attractive to litigation funders, as they can be monetised to fund the costs, and cross-collateralise the risk, of several disputes – including claims being defended by a company. This presents greater prospects for return on investment than sole cases, which must demonstrate a 60% chance of success.

3. It helps improve EBITDA.

A case financed via internal resource significantly impacts a company’s earnings before interest, taxes, depreciation, and amortisation (EBITDA), with any assets won rarely capable of offsetting this. For publicly-listed companies, this can also translate to reductions in valuations and share price.

Once internal legal expenditure is removed from a company’s accounts, however, the EBITDA of that company also improves, regardless of whether the claim is won.

What are the most common mistakes when it comes to litigation funding?

As with any element of a risk management strategy, litigation funding must be approached with consideration and the right advice to avoid common roadblocks and reap the full rewards.

1. Avoid funding that exceeds the realistic value supported by the claim.

The funder of an over-funded case may take an outsized portion of the recoveries, leaving the claimant with too little to accept what would otherwise be a good settlement. When valuing a claim, it is important to assess how much may be recovered, as this will inform both the budget and the ‘fundability’ of the claim.

2. Develop a strategy for settlement that monetises a claim.

This may require a business to seek advice outside of its usual legal team to ensure that its lawyers have the necessary expertise to evaluate a claim quickly for potential funding, analyse the type of funding that will best suit the case, and help get the case to a fundable state. The right lawyers may also invest some of their time and costs to help a business to navigate this process. Litigating parties will always be at loggerheads, but that does not mean that they cannot create pressure points for settlement. If a legal team is not focused on these issues, a once healthy budget can disappear quickly, as will the economies of the claim. As such, a funder may be reluctant to provide more money.

3. Do your research before you approach a funder.

Make sure you can provide evidence of a claim’s prospects of success and recovery and ensure this is accurate. If it is not, a claim may be priced inaccurately or even rejected. Be careful if trying to handle this internally: the provision of documents and information to a potential funder needs to be handled correctly to avoid inadvertently waiving confidentiality or legal privilege. Should this happen, a business may need to produce the exposed documents and information to its opponent, thus revealing its strategy for monetising the claim against them.

4. Be aware of your jurisdiction’s guidance on funding agreements.

In England and Wales, guidance is extensive and covers:

• the extent to which a funder may control the litigation;
• the level of communication between the funded party and the solicitor;
• the funder’s potential profit;
• the risks of either inflaming damages or distorting evidence; and
• the funder’s regulation.

Not all jurisdictions have the same level of guidance, however, so parties must ensure the right protocols and agreements are in place.

How will litigation funding develop?

In addition to applications across defence-side cases and non-monetary strategies, litigation funding is becoming highly popular for group class actions. Hybrid funding arrangements are also increasing, for example by using third-party funding alongside other forms of funding offered by lawyers or stakeholders in businesses. There are, however, restrictions on which actions may qualify. New EU regulation is in the works, but it is early stages.

Awareness of litigation funding as a commercial risk management tool is increasing, but there are many businesses out there with plentiful portfolios that aren’t using such tools to take legal costs off their balance sheets.

In the current economic climate, diverting cash flow to support long-term claims is something most companies can ill afford. Fully transparent and flexible funding arrangements can help companies unlock value in their claims and resolve disputes on a true no win, no fee basis.