How to manage and finance collection risk beyond the courtroom

"Are we going to get paid?"

This isn’t a purely academic concern in high-value disputes: A 2023 survey of general counsel revealed that over 70% of them held an unsatisfied award or judgment of greater than $20 million, reflecting a real risk that after investing substantial time and funds, corporate claimants may find themselves unable to collect from a recalcitrant or impecunious judgment debtor. Properly assessing this collection risk is therefore a crucial consideration for any claimant prior to initiating a dispute.

I address below the concept of collection risk, its components and how legal finance can help claimants mitigate this risk.

Understanding collection risk

Collection risk accounts for the possibility that the opposing party will not honor a judgment or award and can be measured in two interrelated but distinct ways: The debtor’s ability to pay and a creditor’s ability to enforce. 

Ability to pay

“Ability to pay” is an assessment of the debtor's financial capacity to satisfy a future debt. Mirroring a more traditional credit risk assessment, determining a future debtor’s ability to pay requires detailed financial analysis, with a focus on cash flow, existing leverage and the ability to operate as a going concern. It may also necessitate the ability to forecast a debtor’s future economic performance. Given the often-lengthy duration of proceedings, the credit risk posed by a judgment debtor can be compared to indirectly investing in the future of debtor and, by extension, their medium-term prospects.

Such an analysis should be able to answer some fundamental questions: 

• Can the debtor satisfy a judgment debt from existing cash reserves without negatively impacting its ongoing operations?
• Can the debtor service the debt from cash flow—often measured as free cash flow to firm (FCFF) —as part of a structured settlement?
• Is the debtor capable of taking on additional debt or leveraging unencumbered assets to satisfy the judgment?
• Does the claimed sum represent a manageable cost of doing business, or does it pose an existential threat to the defendant, potentially leading to insolvency?

A critical factor here is the availability of reliable financial information for the respondent. The transparency and reliability of financial information will vary considerably from jurisdiction to jurisdiction and especially between publicly traded companies and closely-held private or offshore companies. While the former are required to publish audited financials, it can often be quite difficult to obtain reliable financial information for the latter.

Ability to enforce

An “ability to enforce” analysis builds on the ability to pay and is predicated on compiling a comprehensive asset profile of the debtor, as well as determining whether there is a meaningful path to recovering those same assets.

This starts with traditional investigative work and legal disclosure and discovery to identify realizable assets. Key considerations include:

• Asset identification: Are there sufficient unencumbered assets to satisfy the claimed amount?
• Asset class: What is the nature of the identifiable assets? Are you expecting to recover highly liquid publicly traded equities and prime New York real estate, or shares in a closely-held private corporation and factory facilities in rural Cambodia?
• Asset valuation: How are you valuing known assets? A claimant that is over-optimistic about the value of potential recoveries may find they’ve spent more on the claim than the amount ultimately recovered. It is therefore always prudent to adopt a conservative approach to valuing potential recoveries.

If the asset outlook is positive, the next step is to consider the legal “route to goal,” i.e., a definable legal strategy to reach those assets. Factors to consider include:

• Enforcement mechanisms: Is the breadth of relief available to claimants in relevant jurisdictions fit for purpose? For instance, if a debtor has transferred assets out of their own name or otherwise dissipated the value of their holdings, can these transactions be unwound? If the debtor holds valuable assets through a corporate entity, can a claimant lift the corporate veil or effectively monetize that shareholding through a court-led process?
• Jurisdiction: The geographic location of assets plays a significant role in determining the viability of recovery actions. Assets located in jurisdictions with weak rule of law or lacking more nuanced enforcement mechanisms can be challenging to recover, despite their potential value.
• Duration: This is particularly relevant in a sovereign context, where enforcement can be protracted and uncertain, as seen with creditors who have spent decades pursuing unsatisfied awards.
• Preservation: Are claimants able to secure pre-action or ex parte restraints to preserve the value of known assets while claims are pending? Are you able to establish priority vis a vis potential competing creditors?
• Realization: At a practical level, how will the claimant realize value from the identified assets? Will it require a forced sale by a court officer or specialized expertise for disposal?

Mitigating collection risk with legal finance

Burford regularly helps clients in evaluating the enforceability of claims, identifying potential obstacles and developing tailored recovery strategies to properly assess and mitigate collection risk. This proactive approach to managing collection risk ensures that clients are fully informed of the potential challenges and costs associated with pursuing litigation, allowing them to make well-informed decisions.

Burford’s innovative legal finance solutions further help claimants mitigate collection risk by addressing concerns over both the ability to pay and ability to enforce:

• Ability to pay: Shifting credit risk to the funder can alleviate concerns about the debtor's financial capacity. For instance, the monetization or assignment of pending claims allows claimants to lock in a recovery and take money off the table without exposing themselves to the debtor’s credit risk.
• Ability to enforce: Access to deep expertise, specialized advice and substantial financial resources empowers claimants to craft comprehensive litigation and enforcement strategies. Legal finance enables claimants to fund centrally coordinated campaigns across multiple jurisdictions, leveraging financial strength to engage preferred counsel and pursue essential ancillary actions. These may include pre-action or ex parte measures to restrain assets, securing disclosure from offshore respondents and undertaking targeted enforcement actions to maximize recovery outcomes.

Ultimately, understanding how to properly assess and mitigate collection risk can increase the likelihood of converting legal paper into cash. Legal finance offers a valuable solution to manage collection risk, providing expertise, financial firepower and strategic support to achieve successful outcomes.

This article was originally published in TL4 Magazine here.