Too often, law firms struggle to win cases, not because of the quality of their work, but because of their finances. Winning a case and being compensated for it is both a time-consuming and lengthy process. Law firms need healthy cash reserves to keep the bills paid while covering various expenses until an award or settlement is issued, which, depending on the complexity of the case, can take years.Financing Cases While Managing Operating Expenses
Unfortunately, too often, many law firms lack the healthy cash reserves necessary to sustain lengthy litigation. Indeed, 76 percent of small law firm leaders cited litigation cost pressures as a high or medium risk to their firm in a recent Thomson Reuters study.1 This challenge followed only pandemic-related economic pressure as the most cited high or medium risk of concern.
The pressures of litigation costs pose significant challenges for law firms for several reasons. The first is the length of time it takes to be compensated for a case, a condition over which attorneys have minimal control. Further, given the lengthy period between accounts receivable, law firms must exercise masterful financial management to ensure the lights stay on and cases continue uninterrupted. In addition, in law school, future attorneys learn the practice of law, not law firm financial management. For some law firms, the accounting and cash flow management knowledge deficit exacerbates the inherent challenge of managing day-to-day costs.
Law firm partners without substantial business experience may also be hemorrhaging cash in other areas, such as inefficiencies, overstaffing, and turnover. Yet, for many well-managed firms, accounts receivable is still their primary pain point. And litigation can be expensive. Presenting the best possible case often requires travel, expert witnesses, and consultations with subject matter experts. Firms also must cover fees relating to filing cases, process service, witness subpoenas, and vital records acquisition, among others. In most cases, client fees offset a portion of these costs, but the law firm must come up with the capital to cover the rest, not to mention pay its attorneys, paralegals, and administrative staff.
Winning a large, complex case with a high potential payout may require work from a firm’s entire legal team. And while they work on the case, smaller cases suffer delays. A smaller firm could potentially sacrifice quicker payouts from smaller cases to service the larger one, exacerbating its cash flow challenges. And there’s no guarantee of winning the larger case, no matter how well it’s presented. Midstream, the client may decide to take a settlement offer that’s substantially less than the expected payout. Even if a law firm wins, the case may be appealed. In these instances, a law firm must swallow these losses while still bearing the costs of its existing caseload.
Litigation finance is one solution that fills the gap between the initial court filing and case disposition. This innovative method of funding provides law firms with the working capital and resources they need to win their cases. Here’s what law firms facing lengthy litigation need to know:
Litigation Financing is Not Law Firm Lending
Historically, many law practices have turned to firms specializing in law firm lending. Law firms have often faced challenges securing loans from banks, as banks typically prefer to avoid issuing loans to businesses with irregular cash flow. However, alternative lenders specializing in law firm funding, also seeking to mitigate risk and maximize profit, may not offer the most favorable lending terms. While a one-time cash infusion may help a firm facing a particular cash crunch, the ongoing loan servicing costs will further deplete their cash flow, and in some cases, can jeopardize their ability to keep their doors open.
By contrast, litigation finance provides non-recourse law firm funding. The litigation finance firm provides funding per an agreement that allows them to collect an agreed-upon portion of the payout when the case is successfully resolved. If the eventual award or settlement is less than what the litigation finance firm anticipated, they only have a claim to the proceeds from the payout, not the law firm’s other assets. Moreover, because litigation finance is not a loan, there are no monthly debt payments or accrued interests.
Financing is Available for Single or Multiple Cases
Litigation finance provides funding for either a single case or a portfolio of cases. In a single complex case, when a litigation finance firm agrees to underwrite it, they’ll usually package the case as an investment asset. Although the funder may lose the entire investment if the case is lost, there is an increasing appetite for such investments as they often yield significant returns.
Litigation finance firms employ elite lawyers who understand that the ability of a law firm to litigate a complex case successfully often hinges on its ability to manage its other cases and its cash flow. To that end, funding may be available for a portfolio of cases, which, for litigation funders can be an attractive option to mitigate investment risk further.
Provides More Than Just Capital
Litigation finance firms have a vested interest in the outcomes of the cases they fund. They stand to gain a portion of the payout per the funding agreement. Therefore, litigation finance firms want to ensure a law firm has everything they need to win a case, which is usually more than just working capital.
Litigation finance firms may also provide strategic guidance and counsel recommendations to the counterparties they fund. Many litigation finance attorneys bring a significant depth of experience, knowledge, and connections to the table that can often greatly benefit a law firm. While litigation finance professionals ultimately defer to the plaintiff and lead counsel’s decisions, they usually build a positive working relationship with the funded party grounded in their shared goal of winning.
Law Firm Funding is Legal
While litigation finance is still a relatively new practice, it is legal in most states. There’s no federal statute prohibiting its practice. And while some states recognize champerty – a doctrine that prohibits third-party financing of litigation, some of those states still hold that litigation finance agreements are enforceable. Not every state recognizes champerty or regulates litigation finance, and such agreements are subject to jurisdictional questions as well.
When seeking funding, law firms should ask questions about their state’s regulations and regulations in the state in which the counterparties are located. Reputable litigation finance firms should easily be able to answer these questions and flag relevant potential pitfalls before delving
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