Pricing risk, structuring agreements and the cost of legal finance capital
Law firms and businesses call on Burford to finance commercial litigation and arbitration, and the pricing of our capital reflects the inherently complex, expensive and risky nature of these matters.
This article addresses three key aspects of how legal finance capital is priced. First, we provide an overview of the various factors that affect the cost of capital, and how lawyers and litigants can work with Burford to arrive at the best solution. Next, we focus on common return structures and how we customize these arrangements to align with clients' specific needs. Third, we provide some guidance on legal finance term sheets, including Burford’s approach relative to others in the industry and how law firm and in-house lawyers should think about them.
Burford provides more detail on this topic in our book Commercial Legal Finance, published by PLI in 2023; see chapter three for detailed criteria legal finance providers consider when assessing commercial cases for potential financing, how the financing process works, typical funding terms, pricing and return structures and what to look for in a legal finance firm.
How risk impacts pricing
As a general principle, legal finance pricing is based on risk.
When Burford finances matters, we assume an extraordinary degree of risk. Legal finance is almost always provided on a non-recourse basis, meaning that we lose our capital if the underlying matters are unsuccessful. In addition to that binary risk of loss, we also take on duration risk, as protracted commercial disputes may take years to resolve. Given the combination of non-recourse capital and this high degree of underlying risk, clients seeking legal finance accept the notion of forgoing a portion of their recoveries or fees once their matters have resolved; they recognize that Burford’s capital not only removes the upfront cost to pursue matters but also removes the downside risk of loss, which shifts from the claimant to the funder.
Legal finance capital pricing is on par with the cost of other high-risk finance or risk-sharing arrangements, for example, private equity investments or contingency-based legal fees. Due to the unique nature of each case—varying in facts, applicable laws and jurisdictions—the cost of legal finance capital can fluctuate significantly. Ultimately, it’s priced competitively according to the risks of the individual matter.
Legal finance firms are among the very few capital providers with the expertise needed to assess and put a price on commercial dispute risk. This is Burford’s core expertise. Here are the factors we consider:
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Timing: If a case is about to be filed or has only recently been filed, the legal finance provider does not have the full story of the case—so the case will be considered higher risk.
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Duration: How long the case is likely to take to resolve has an impact on pricing. The time value of capital spent on or otherwise tied up in pending litigation or arbitration matters is an important factor to be considered.
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Damages: The potential damages must be realistic and supported by evidence.
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Risk of loss: How likely the case is to succeed on the merits or to settle will impact pricing. For example, claims that have a higher degree of certainty (e.g., follow-on damages claims in European competition litigation or claims with strong precedents) will be considered lower risk.
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Forum: Pricing is also affected by the risk profile of the litigation or arbitration forum. For example, legal finance providers will prefer if a case is filed in domestic courts in a common law jurisdiction, or in an internationally recognized arbitration center where any decision will have a higher degree of certainty as to outcome.
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Risk diversification: Single case finance will by definition have a binary risk—meaning the finance provider will lose its entire commitment if the case loses—versus a matter that is part of a group of matters financed in a single capital facility or portfolio, where risk is diversified across numerous matters.
In these terms, the highest-risk investment is a single matter financed in the early stages of the case where Burford is paying all fees and expenses. Here, the risk is truly binary: We either recover our entire investment if the case succeeds or lose it all if the case fails. Since the case is still in its early stages, it’s challenging to fully assess the risk. Such a case represents the upper limits of Burford’s pricing, at about 30-40% of recoveries.
Burford can also work with our counterparties to finance multi-case portfolios, which have significantly less risk than single-case investments. Portfolios—which can include as few as two matters—are cross-collateralized so that if we invest in case A, but only case B returns proceeds, we can return our investment dollars for case A from case B. Because portfolio financing arrangements diversify risk of loss for both Burford and our counterparties, they create better economic structures where claimants can have better pricing than our single cases would ordinarily have.
Most lawyers first work with Burford to finance a single case. Under the right circumstances, we work hard to offer them opportunities to transition to larger financing arrangements that can result in additional savings down the road.
Creating economic structures to match client needs
Setting aside the question of cost, we can also structure deals to reflect specific client needs. For example, some clients value certainty and so we structure deals accordingly. The starting point for any engagement is listening to our clients to understand their needs so that we can offer the right economic structure. An assumption for any deal we structure is that the litigant should receive the bulk of the damages in the event of a successful resolution to the case.
There are a few common structures that reflect different return scenarios for clients.
Variable returns
A variable return is comparable to a contingency fee arrangement. In this approach, a law firm will advance the cost of litigation out of pocket, and then recoup those costs “first-dollar” out of the return, in addition to taking a percentage such as 30-40% of the net remaining proceeds. Essentially, the firm’s repayment will vary depending on the ultimate recoveries. The percentage they receive reflects the risk they take in forgoing all of its fees and advancing costs.
Burford can similarly structure a variable return where we get our investment back, plus a percentage of the settlement or award. This structure is most attractive to our clients (whether client claimants or law firms) when the potential for recovery is not inordinately large in relation to Burford’s investment commitment. That’s understandable: If the expected recovery is especially large, you would be less happy to give up a percentage of the upside and would prefer instead a fixed return structure.
Fixed returns
At the opposite end of the spectrum is a fixed return structure. Here, the finance provider gets back their investment plus a predetermined multiple of that investment or a fixed amount, rather than a percentage of the net proceeds.
Hybrid structures
In most cases, the needs of our counterparties are such that the return structure falls somewhere in the middle of the spectrum, resulting in a hybrid structure. Burford will get our investment back, then some fixed return—albeit a smaller multiple than if we were relying on that entirely—and then also a percent of the net proceeds—again, likely a lesser amount, given that we have both a fixed return and a variable return element.
Return waterfall
In addition to working with clients to find structures that meet their needs and match our view of the risk, we also work to structure an appropriate return waterfall—which outlines the order and increments by which returns from recoveries are distributed among Burford and our counterparties. Again, each matter is unique and we work hard to adjust waterfalls to clients’ needs—but the important point to appreciate is that while Burford may earn our investment back on a first-dollar basis, further recoveries are often split on an incremental basis. In essence, Burford and our counterparties “take turns” earning returns.
Understanding term sheets
A critical step in the process of finalizing a legal finance investment is the term sheet, which is the medium in which Burford expresses our proposed structure and terms. We have a unique view on term sheets that bears some explanation.
In the decades we have been in business, Burford’s team has reviewed many thousands of cases, and we’ve concluded that we can best meet the needs of our counterparties if we complete a substantial amount of diligence before we provide term sheets. This gives us an opportunity to listen to our counterparties’ needs and offer realistic terms informed by our understanding of the risk. During this initial period, we do not seek exclusivity.
Some other finance providers take a different approach, preferring to propose term sheets along with a 60-day exclusivity period at the beginning of the process, before they’ve invested in a significant amount of diligence. While other funders’ intentions may be good, we caution (and it will not be a surprise) that often their initial proposed terms ultimately change during the diligence process to something that may be less palatable to the client. Meanwhile, the client has been locked into the deal and has lost valuable time.
Conclusion
In the end, how we price an investment is flexible to meet the needs of our counterparties. The cost of legal finance capital is influenced not only by the risk appetite of the claimant and the law firm but also by the specific circumstances and merits of the case. When we make an investment decision, we’re not just backing the legal merits of the litigation; we’re also placing our trust in the litigation counsel selected by the claimant to execute a robust legal strategy. In other words, we’re investing in the full potential of that case and the people who are going to run it. That’s why it’s essential to have in-depth discussions with the claimant’s legal team to gain insight into their expectations, goals and concerns. This understanding allows us to price our capital in a way that aligns with the case’s overall strategy and objectives.
This article was originally published on Burford’s website on October 11, 2019 and was updated on October 24, 2024.
