“Litigation Finance Comes of Age” made perfect sense as the headline of a December 2016 trade article: The news heralded by the article—Burford’s acquisition of Gerchen Keller Capital—exemplifies the industry’s maturation as its major players evolve, and, as Burford research has demonstrated, the number of US lawyers whose firms have used litigation finance quadrupled between 2013 and 2016.
At the same time, however, such a headline is an imperfect reflection of the state of the industry in 2017, because “litigation finance” is now about financing a lot more than litigation. Indeed, one could argue that it’s time to update terms: “litigation finance” is really evolving into “legal finance,” and “funders” are now more like investment banks for law.
These may seem mere semantics, but words can be meaningful in influencing how lawyers and clients conceive of and use legal finance: Put simply, a too narrow approach can result in missed opportunity. Words also matter in reflecting the ambition of finance providers: An expansive approach to addressing legal finance needs can add value for the firms and clients with whom they work.
With that in mind, we explore below a few of the evolving ways in which lawyers and their clients—as well as specialists in finance, private equity and investment banking—can use legal finance to monetize asset value and hedge risk.
Monetizing legal asset value
Although “litigation finance” is conventionally understood as a means for clients and firms to pay for fees or expenses associated with litigation, the potential to leverage and monetize legal asset value is far greater.
Capital secured by a litigation claim or other legal receivable may be used for purposes beyond paying fees and expenses. Most of the capital that we provide to lawyers and clients is used for purposes other than paying fees and expenses. Litigation or some other form of legal claim or receivable serves as the collateral asset, but clients and firms use the resulting capital for a far broader set of business purposes, about which we are agnostic.
Financing on a portfolio basis can expand firm balance sheets and help clients move legal costs entirely off balance sheets. Among the fastest-growing areas of legal finance is portfolio-based financing, which provides flexibility and attractive terms for firms and corporate legal teams to reduce risk and cost across a range of matters. Portfolios can be built around an identified pool of matters or on a going-forward basis. Law firms that work with Burford often use portfolio financing as a means of expanding their balance sheets—as did a leading firm that worked with Burford to secure a $100 million broad case portfolio. Clients that work with Burford often use portfolio financing to move costs off their balance sheets. A FTSE 20 company did so when we funded current and future profit-enhancing claims with world-class legal counsel with $45 million in Burford financing.
The accounting benefits of moving litigation costs off balance sheets represent added value for clients. For clients, portfolio financing is particularly advantageous for managing the negative accounting impact of litigation on balance sheets and risk profiles—which translates into improved valuations. Without financing, legal expenses immediately hit company profits—often in substantial and long-lasting ways. Worse, large recoveries are often recorded “below the line” as non-recurring items. Thus, the accounting impact of pursuing a successful claim can perversely be to reduce earnings and make the company look less profitable. Fixing this accounting problem adds value far beyond “litigation finance”.
Legal finance applies to defense matters as well as transactional areas of law. Most “litigation funders” know only how to finance high-value commercial claims or plaintiff actions—leaving them unprepared to help companies that rarely bring lawsuits and need options for financing their far-more-frequent defense matters. Finance providers with deeper expertise in finance can structure deals that address defense as well as areas not typically considered for litigation finance—such as contentious tax disputes, mergers and acquisitions, and “success fee” arrangements. Private equity and investment banks are also increasingly aware of the ways in which savvy legal finance providers can enhance the value of their deals.
De-risking legal and regulatory exposure
The non-recourse nature of most legal finance enables de-risking that is compelling even on a single-case basis. For example, the bankruptcy estate for MagCorp. was able to provide creditors a minimum guaranteed return for their $213 million judgment regardless of appellate outcome after Gerchen Keller provided $26.2 million in non-recourse financing.
But there are many other ways beyond a single litigation matter in which legal finance providers can work with lawyers, clients and other stakeholders to de-risk legal and regulatory exposure—and given the combined uncertainties of a new administration in the US, Brexit, political flux in several of the world’s largest economies and unsettled global financial markets, 2017 will be a year in which managing risk should have special relevance for business.
Legal finance can be used to hedge risk associated with M&A and private equity. As discussed elsewhere in this issue of the Burford Quarterly, there is a strong case to be made for private equity to utilize legal finance to optimize the value of their deals. Legal finance can also be used to de-risk M&A in a variety of ways. On the simplest level, law firms that work on a “success fee” basis can share some of that risk with an outside finance provider. Stakeholders in M&A can also remove legal risk from the deal itself to advance discussion, or monetize a legal asset to enhance value. Visa’s 2008 IPO, in which it stripped out legal exposure from the value of the deal, is probably the most high-profile example of such a move.
Legal finance can help deal makers manage regulatory risk. Changed stances on trade, antitrust, corporate taxes, regulation and other areas that impact business seem inevitable precursors to an increase in commercial litigation, and are already creating potential roadblocks to business and investors working to get deals done. Legal finance can provide one means of hedging against the potential impact of litigation on those deals. To cite just one example, CFIUS—a wing of the Treasury Department that examines potential deals from a national security perspective—may deny Chinese investors’ moves to acquire US businesses, at a time when a slowing Chinese economy is creating greater demand for investment opportunities in the US. Given the uncertainty that hangs over such investments in the early days of a new administration, some sellers are requiring larger "reverse breakup fee" if a deal is blocked, according to Business Insider, and there has been a marked increase in CFIUS indemnification policies. Legal finance can play a role in hedging against risk where CFIUS and other regulatory impacts may be felt.
This is but a cursory overview of the many ways in which legal finance encompasses much more than “litigation finance”. Lawyers and clients, investors and deal makers, anyone with legal risk exposure, should conceive of legal finance as investment banking and risk management for law, with the same benefits to law firms and companies that are seen in other areas of the economy.
