Covering Every Contingency – Portfolio Funding of Litigation

 MARKET VIEW – LITIGATION 

Therium’s Neil Purslow examines the different funding options available

Since the introduction of damages-based agreements (DBAs) on 1 April 2013, use of contingency fee arrangements (CFAs) in England and Wales has been very limited, due largely no doubt to the fact that partial DBAs are not permitted and also the flaws in the enabling regulations have created uncertainty as to the efficacy of this new form of agreement. Nevertheless, commercial litigators have shown significant interest in taking litigation risk on their cases in return for a contingency fee upside. While this has, however, been difficult to achieve to date, Therium has now launched a portfolio funding offering which, through using a variation of a typical funding structure, allows law firms to offer contingency fee-based services to their litigation clients,

Damages-based agreements

 

DBAs were intended by Lord Justice Jackson to form one of a number of ways in which the cost and the risk/reward of litigation could be allocated between client and lawyers/third parties with those parties generally being free to agree terms between themselves, providing that those terms fall below a cap on the total amount of the contingent fee. With the potential upside available to the lawyers under a DBA being greater than under a CFA, law firms could see the potential attractiveness of deferring fees in return for a share of the proceeds, even where a CFA would not be attractive. However, the flaws in the damages-based agreements regulations, which arguably force firms to take either all of the risk on their fees or none of it, coupled with the uncertainties over how the DBAs should be drafted to be effective, have deterred firms from adopting DBAs as a major plank of their offering and restricted them to the odd outlying cases among a firm’s book of work.

‘The rationale for many firms to share in the risk/reward of the work they undertake for their clients remains as valid as ever.’

The rationale for many firms to share in the risk/reward of the work they undertake for their clients, however, remains as valid as ever. Surveys of litigation clients continue to show a general trend towards clients looking for alternative fee arrangements and towards risk sharing with their lawyers. Many clients continue to experience budgetary constraints, which make carrying the cost of funding a large-scale piece of litigation challenging or at least undesirable. By being able to offer a contingency fee-based service, the firm relieves the client of this burden and demonstrates alignment of interest with the client. A discussion with the client, which would have focused on the size of the likely costs, becomes one about the strength and size of the claim and whether the firm is willing to take it on. In return for its willingness to shoulder risk, the firm can attract work from a broader base of clients than it could have done otherwise and the firm can share in the upside of the cases that it wins, backing its own judgment and the skill and expertise of its teams in the area in which they are most expert; the litigation itself, and potentially increasing the profitability of its dispute resolution teams.

Nevertheless, in order to do this successfully other than on an occasional basis, a number of challenges fall to be overcome:

1. The firm’s cash flow has to be addressed. Few firms are in a position to carry more than a very few large commercial cases on a contingent fee basis within the law firm business model. Unless each case at least generates sufficient cash flow on an ongoing basis to cover costs, there is a natural disincentive for the firm to take a contingency fee case with the potential upside further down the line and only if the case succeeds where it can take standard fee paying work which will generate immediate revenue into the firm. The economic realities of the position drive the firm back towards the traditional short-term business model unless its cash flow is secure.
2. The risk/reward equation needs to be addressed so that the firm has confidence that, across a book of contingency fee work, recognising that not every case may be successful, the firm can see upside potential in return for sharing in litigation risk.
3. Risk management processes need to be put in place so that the firm’s decision to shoulder litigation risk is taken in a risk-controlled manner across the firm and on the back of an economically rational investment case rather than for the many other reasons why firms may choose to reduce or defer fees.
4. The documentation underpinning the risk sharing needs to be robust so that the firm’s investment generates the return it has bargained for and is not so regularly negotiated away as to undermine the business case for sharing the risk in the first place.

As the DBA regulations currently stand, these objectives are difficult or virtually impossible to address. Partial DBAs are probably not permitted. Typical contingency fee deals based on a pure percentage of damages leave the firm exposed to a loss on its costs incurred even where the client may achieve a recovery, and decision making is often piecemeal on a case-by-case  basis and driven by considerations other than a rational, risk-based, investment case. Even where a hybrid DBA is used to provide partial funding for the case, the law firm’s investment is still reliant on the validity and efficacy of the DBA and the firm remains vulnerable to client pressure on its upside in the event of success.

Therium’s portfolio funding model

The new portfolio funding model launched by Therium addresses each of the issues in a way which benefits the law firm, the client and also the funder.

Therium’s portfolio funding model allows law firms to share risk in the funding of a portfolio of cases in return for a proportionate share in the upside. This is done by Therium making available a funding line to a dedicated vehicle which funds part of the fees and 100% of the disbursements on that firm’s cases. The law firm then shares in the profits of that vehicle. Because of the better alignment of interest and improved diligence process which are made possible by this arrangement, funding decisions can be made more efficiently. The law firm therefore gains stability of funding to enable it to attract and run a pipeline of contingency fee cases, each of which is backed with funding, without an open-ended commitment from the firm to carry the cases to a conclusion whatever the cost. Through the combination of the funding and its profit share, the law firm is able to act on the portfolio for a share of the upside from the funding return, which may be substantial, without putting at risk the entirety of its fee income on that portfolio.

In order to address the weaknesses of the DBA regime, the funding on each case is provided not through the law firm and the DBA (as would typically be the case in hybrid DBA models) but through a typical litigation funding agreement between the funding vehicle and client in a form compliant with the code of conduct of the Association of Litigation Funders. This agreement therefore still contains the checks and safeguards that any funder would wish to see in risking capital on a third party’s litigation, thereby also protecting the law firm’s investments in the cases. The law firm acts on a DBA with its interest in the funding structure fully disclosed (and reflected in the documentation) but protected economically from the risks associated with use of a DBA.

‘The economics of the funding offered by the funding vehicle are negotiated between funder and client in the usual way based on the risk profile of the individual case.’

As far as the client and the funding terms are concerned, the economics of the funding offered by the funding vehicle are negotiated between funder and client in the usual way based on the risk profile of the individual case. As a result, the terms offered can be benchmarked against the funding market more generally or other contingency fee proposals and are no more expensive for the client (and may quite possibly be cheaper) than if the case were funded by a funder on a conventional basis with the fees fully paid.

Clearly the exercise of establishing such a model, given the inadequacies of the DBA regulations, is not simple in its execution but Therium has worked with leading counsel to ensure that the model is fully compliant with the relevant professional and regulatory rules and is robust, defensible, transparent and most of all, fair.

The future?

It is clear that the trend towards success-based forms of remuneration and risk sharing with clients is here to stay. While the regulatory environment lags behind the curve, the standard will be set by the firms that have the structured approach to be able to deliver their services on terms which meet that opportunity without destabilising their established business model or confining their activity to speculating on the occasional outlying case. Through providing a stable platform of financing which manages risk, Therium believes we will see litigation funding and the portfolio funding model play a key role in the next phase of change in how litigation is funded and in the financing of some of the very biggest cases in the market.