December 12, 2022 – As economic jitters loom, companies cut overhead and investors emphasize profitability, the traditionally strong investment rigor of the legal finance industry is suddenly all the rage.
Lawyers who have inquired about third-party funding can anecdotally confirm what we have observed empirically: Only a small fraction of parties seeking litigation funding successfully obtain it.
In fact, our data analysis of more than 30,000 cases found that less than 12% of federal and state filings presented great opportunities for litigation funding. This aligns with the consensus among industry players that less than 5% of litigation funding applicants ever walk away with a finalized settlement.
Indeed, litigants and clients may wonder why such a small percentage of opportunities cross the finish line. Although many factors can prevent the consummation of a deal, most can be attributed to a fundamental difference in mindset between the counterparties.
For non-recourse litigation finance providers, each commitment is a full contingency. They are not only looking for a return on their investment but are also very focused on avoiding a total loss. Conversely, for applicants, seeking third-party capital can feel much more like a transactional sales pitch than it really is: a long-term partnership between parties with a common underlying goal.
To navigate the industry’s rigorous due diligence process, potential funding recipients should focus on presenting their core asset, the underlying legal claims, much like an entrepreneur seeking venture capital would position their company.
Framing your ‘tone’
Any viewer of ABC’s Shark Tank knows that most contestants fall into one of two categories: those who come armed with a solid story backed by numbers, and those whose lack of complete preparation makes for good TV but deals. be bad Aggressive valuations, a limited sales history, and ill-conceived growth plans are common reasons an entrepreneur will hear, “I’m leaving.”
Like the businessmen on Shark Tank, parties seeking litigation funding can minimize their chances of hearing “I’m out” by presenting a realistic, evidence-based “argument.” Stated another way, ideal counterparties should not only believe in the merits of the claim, but also demonstrate a sound litigation strategy backed by compelling facts to support their claims and arguments.
How can parties seeking legal funding make a compelling case to a third-party funder? First, be honest about the strengths and weaknesses of your case. Because lawyers are used to being zealous advocates for their clients, discussing the weaknesses of a case doesn’t always come naturally. They may also believe that discussing the faults of a case could decrease their chances of obtaining funding. However, the opposite is often true.
Even the strongest cases have flaws and are usually discovered at some point during a funder’s due diligence. By proactively discussing tactics to address those weaknesses and their contingency plans for sub-optimal scenarios, attorneys demonstrate that they have thought deeply, strategically, and realistically about the case, potentially putting them ahead of the adverse party.
And by surfacing any flaws early in the due diligence process, funders can give claimants faster feedback on whether a claim will receive outside investment.
Consider a typical contract dispute. Many major business agreements contain provisions that will benefit the defendant, such as disclaimers, arbitration clauses, or limitation of damages clauses.
Lawyers who have already considered these issues within the context of your case are less likely to be surprised in court, and they will also gain much more trust from a litigation funder. While hoping for the best but planning for the worst may seem like common sense advice, our experience reviewing thousands of financing inquiries tells us otherwise.
In addition to being candid about the weaknesses of a case, parties should not get lost in the details and should always consider the big picture. The most effective applicants for funding can weave a compelling narrative that speaks to the natural human motivations that underlie any conflict.
For example, if a complaint alleges that the defendant sabotaged a joint financial agreement but does not address why the defendant benefited by doing so, would the judge or jury find that story persuasive? Worse still, could a judge or jury suspect that the plaintiff is covering up the deficiencies of his case and unwittingly view the claims with more skepticism?
thinking about the numbers
Shark Tank’s Kevin O’Leary likes to ask entrepreneurs, “How am I going to make money?” Litigants who specialize in contingency work can empathize with outside funders about the importance of realistically modeling damages and the defendant’s ability to pay. While this may not be a particularly glamorous task, lawyers who take a thoughtful approach to case economics are better positioned to secure litigation funding than their peers who overlook these details.
For a funder, the damages are as important as the merits. Not all claims will have the same strength or value, and some parties tend to over-declare, which risks detracting from the most meritorious claims and complicating negotiations. Many funders, including LexShares, will typically invest no more than 10% of what they determine to be a realistic recovery amount; Inflated damage estimates can prolong this process.
When third-party funding is required early in the litigation, some attorneys may prefer to rely on a damages expert or defer questions about damages to a later stage of the litigation. However, attorneys who have at least formed a working theory of damages, given their track records of litigating similar cases, can expect to have more productive litigation funding conversations than other funding candidates.
It is also essential to think about potential weaknesses in the damages model, such as the lost profit analysis in a trade secret dispute. Litigation funders want lawyers to show how they would combat the defendant’s inevitable argument that damages are too speculative if, for example, the plaintiff has a limited track record of financial performance.
Just as an attorney would recommend to their firm’s contingency committee to accept new contingency work, litigants seeking third-party funding should come prepared with a summary theory of recovery across the full spectrum of punitive, compensatory, and consequential damages.
Similarly, lawyers who have developed even a basic framework for defendant collection, given their financial history and creditworthiness, will merit a closer look by litigation funders, who require confidence in the likelihood that a lawsuit will be successful. or settlement comes out of the defendant’s pockets. .
With a potential recession looming, the defendant’s ability to weather an economic downturn and avoid bankruptcy is vital to litigation funders who may lose principal on their investment, even if the case is highly meritorious.
Crossing t’s and dotting i’s
On Shark Tank, some sources estimate that 40% of accepted offers to air in the show’s early seasons fell through during the stagecoach. While the settlement rate is much lower in the litigation finance industry, the same principles apply to lawyers as businessmen. Even after making a strong impression on potential investment partners with the damages model and case narrative, applicants for litigation funding must back it up with evidence during the final stages of due diligence. Channel, Emily. “We fact-checked Seven Seasons Of Shark Tank Deals. These are the results.” Forbes. October 21, 2016
During final due diligence, plaintiffs and attorneys will be required to complete a request checklist that will allow the litigation funder’s investment team to properly understand the case. These requests are generally limited to non-privileged materials, such as public record entries, complaints, reports, and unsealed hearing transcripts, as well as material information on the merits of the case, damages, liability, and any expert reports that have been prepared. (As a best practice, accredited funders will execute confidentiality agreements as one of the first steps in the investment process.)
Completing final due diligence on a case takes time, and honestly, clients who are late in responding to due diligence requests are a common reason for delays. Packaging due diligence documents in an organized and timely manner can remove an avoidable hurdle at the end of the funding process and put your client one step ahead of other applicants.
In some cases, factors beyond the attorney’s control can also derail litigation funding arrangements during final due diligence. A funder may have the utmost confidence in the merits of the case and the track record of the plaintiff’s legal team but, after further review, may reduce the amount of funding to be deployed up front due to concerns about the defendant’s ability to pay or the damage model.
Conversely, it is not uncommon for litigation funders to provide follow-on funding for cases that require additional capital and have passed key procedural milestones.
As with the deals that ultimately close on Shark Tank, the strongest applicants for litigation funding are those who make a compelling case and back up their “story” with persuasive evidence. With the right mindset and a better understanding of the process involved in obtaining legal financing, we sincerely believe that attorneys can put their clients in a good position to obtain third-party financing.
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