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Legal finance is smart money

  • Emily Hostage
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Emily Hostage

Emily Hostage

Vice President

Former Vice President, RPX Corporation

Legal finance is smart money

The legal market has adopted third-party legal finance at varying rates, segment-by-segment, but perhaps the earliest adopters are those in the intellectual property space. For decades, IP experts have shared legal cost and risk with third parties by buying and selling patents and by using third parties to finance patent litigation.

On balance, this longer history and broader supply equates to greater price sensitivity. In turn, new or opportunistic IP finance providers often seek to establish their market position by competing on price. Theoretically, this competition is good for consumers of capital.

But, to some extent, you get what you pay for. Pricing is important, to be sure, but law firms and their clients need to understand that legal finance is not “commodity capital” and accordingly their demand should be relatively inelastic. A finance provider’s experience, stamina and qualitative insight matter as much as the quantitative terms of the financing arrangement; it is essential to diligence your capital providers as much as the merits of your case. This added value can make all the difference in achieving a successful litigation outcome.

Cheap capital now may cost you later

Demand for legal finance continues to grow, now accelerated in part by the economic downturn. In turn, we are seeing an increase in utilization of the capital supply, which now comes in part from newer or more opportunistic finance providers in addition to the more established sources of capital. To compete, the less established providers often float inexpensive terms in an effort to win new business and develop their track record.

In so doing, these less established providers almost certainly underprice risk in ways that leave their smaller, younger portfolios more vulnerable to shocks from adverse events in individual cases. Unsurprisingly, then, cheap financing terms often come with powerful conditions. For instance, underpriced capital may be provided by funds with sunset dates that precede the resolution of the litigation—rendering them unable to call capital down the road to fund unanticipated critical expenses. Or the capital may come with exit provisions that let the provider freeze funding and jettison the investment from its portfolio in the event of even minor adverse events in the case. Some finance providers even seek to exert control indirectly over the underlying matters, with things like unfettered veto rights or unilateral approval conditions—conditions that, taken too far, could very well interfere with the patent owner’s legal standing to sue.

Such terms pose more than just a “flight risk” down the road. A half-hearted commitment like this jeopardizes the litigation strategy from the outset.

Intellectual property litigation demands resilience

Underpriced capital is particularly problematic for IP litigation. IP cases are expensive, lengthy, and often full of interim twists and turns that can seem to the uninitiated like catastrophic developments.

Clients must ensure that their finance provider is equipped to handle this reality. For instance: It is rare for a patent case to reach trial with all its asserted claims completely intact. And in most cases of any significance these days, the patents must survive the separate hurdle of IPR challenges before any meaningful settlement discussions occur. But some investors might call the loss of even one claim in IPR an “adverse event” sufficient to break the deal. It is imperative for capital recipients to ensure that their arrangements have no such easy outs. Likewise, law firms must ensure that they partner with a finance provider who won’t leave their clients in the lurch in the middle of the multi-year marathon to which they committed.

The good news: because the IP field has embraced outside finance for some time, there is plenty of “smart money” with a real track record backing good IP cases. Capital users simply must remain discerning and vigilant to find it.

By contrast, legal finance is a relatively newer concept for non-patent cases. History and track records are being made as we speak—meaning there are fewer collective mistakes to learn from, and there is more reliance on individual experience. Finance providers exacerbate the problem in an effort to differentiate themselves by concentrating increasingly in niche claims and market verticals, which leaves them more vulnerable to isolated shocks or black swan events whose damage otherwise could have been contained inside a diversified portfolio. This lack of diversification isn’t just bad for the provider; it also leaves unsuspecting clients and counsel stranded.

Value beyond capital

This is why, at Burford, one of the first things we emphasize is our decade-plus history in the space overall and our extensive bench of litigation experts for each of the many fields in which we invest. We conduct all core diligence in-house and immerse ourselves in case developments throughout the course of our investments. In our experience, this is what it takes to stay on top of the inevitable twists and turns and to ensure that a litigant and its law firm achieve a positive result.

Ultimately, legal finance is smart money, not commodity capital. Price is important, but selecting a finance provider on price alone is a recipe for disaster. Particularly in high-risk, developed markets like the one for patent litigation, it is essential for law firms and their clients to work with finance providers that know what they’re getting into and can add value both before and after the investment is made. Burford stands ready to do just that.