Commercial litigation finance has transformed how businesses, law firms, and investors approach legal disputes. Once a niche offering, commercial litigation finance is now a growing, globally accepted tool in commercial disputes like contract breaches, patent litigation, and other business-related lawsuits. But what does it actually involve, and who should consider using it? Let’s unpack what you need to know.

What Is Commercial Litigation Finance?

At its core, commercial litigation finance, also called commercial litigation funding, is when a third-party investor pays some or all of the costs of pursuing a lawsuit. In return, the third-party investor receives a portion of any recovery. It’s almost always non-recourse, i.e., if the lawsuit fails, the funder gets nothing. As Jeremy Waitzman of Much Shelist explains, in this way, commercial litigation finance levels the playing field, especially when a smaller company is going up against a much larger, better-funded adversary.

Who’s Involved?

A typical commercial litigation finance deal includes the plaintiff, the plaintiff’s legal team, and the funder, which may be a dedicated firm, hedge fund, or private equity fund. Law firms themselves may also get funding, especially when they take cases on contingency. Law firms typically seek financing to help smooth cash flow during a case. This strategy also allows firms to invest their time, effort, and money more confidently. Paul Haskel of Crowell & Moring goes further, noting that law firms are also drawn to these deals due to their non-recourse nature.

A Note About Insurers

Increasingly, insurers and funders are collaborating in commercial litigation finance deals via litigation risk insurance policies. These policies seek to reduce risk by providing coverage for events like adverse judgments or delays, all of which can help lower funding costs in a commercial litigation finance deal.

The Benefits of Commercial Litigation Finance

The advantages of a commercial litigation finance deal vary depending on the particular party’s perspective.

For plaintiffs, the benefits include the ability to:

• Pursue valid claims even if cash is tight
• Preserve working capital for growth, not litigation
• Limit downside risk

For law firms, the benefits include the ability to:

• Expand their client base without taking on excessive risk
• Offer alternative fee arrangements to their clients
• Invest in high-potential claims

For investors, the major appeal of a commercial litigation finance deal is the promise of a hefty return that is not correlated to the broader markets. To that end, commercial litigation finance has become a legitimate alternative asset class with attractive risk-reward dynamics. As David Lorry of The Brattle Group explains, litigation funding provides diversification with a non-correlated investment that offers the prospect of higher returns compared to traditional asset classes.

Key Deal Types

Commercial litigation finance generally comes in two main types: single-case funding and portfolio funding.

• Single-case funding: As the name implies, this type of transaction involves one funded lawsuit.
• Portfolio funding: Under this type of transaction, multiple cases are bundled together, often across a law firm’s docket. This approach spreads the risk, thereby making the terms of the deal more favorable for the party seeking funding; it also allows firms to monetize contingent fees while still covering their operating costs. These arrangements are gaining traction, particularly among top law firms exploring alternative fee arrangements.

What Makes a Case Fundable?

As Stewart Ackerly of Statera Capital puts it, “funders aren’t looking to bankroll ‘Hail Mary’ lawsuits. They want clear evidence, realistic damages modeling, and a fair shot at success.” In other words, funders are picky and understandably so. In fact, they typically fund less than 5% of the cases they review.

The following is a list of key criteria funders consider when evaluating a commercial litigation finance deal:

• Strong legal merits and provable damages
• Recovery value that is several times the amount being funded
• Defendants who can actually pay
• Experienced counsel
• A rational plaintiff, i.e., someone who will settle when it makes sense
• A favorable jurisdiction where timelines are more predictable and procedural delays are less common

Duration is a particularly critical metric. Ackerly notes, “We want to know: is this going to be two to three years to resolution, or five to six? That matters a lot for funders trying to model their return and ensure the funder’s return is a small part of the overall recovery.”

The Funding Process

Funding a commercial litigation deal can take weeks or even months. And while the process differs from a common bank loan, there is a clear path, which typically includes the following steps:

1. Execute an NDA, ensuring confidentiality throughout the process.
2. The diligence process, whereby the funder will typically review key case materials provided by the party seeking funding, like a merits memo, budget, and timeline, as well as assess damages and a recovery strategy.
3. Negotiate a term sheet, which outlines how funding will be deployed and repaid.
4. Negotiate and execute the funding agreement, which will typically include a ‘waterfall’ repayment structure.

Important Ethical and Legal Issues

Commercial litigation finance transactions can raise ethical and legal issues, including the following:

• Attorney-client privilege: Most courts say that sharing case information with a funder doesn’t waive privilege, especially with a proper NDA and work-product protections in place.
• Fee splitting: In most jurisdictions, lawyers are not permitted to share legal fees with non-lawyers. However, in most cases, funding arrangements don’t violate this rule as long as funders don’t control strategy or decision-making.
• Maintenance and champerty: These doctrines prohibit outsiders from supporting lawsuits. However, most states now recognize that modern funding promotes access to justice, not abuse of the system.
• Regulation: Litigation funding remains mostly unregulated, but that’s changing as states take up the issue. Several attempts to implement broad, federal legislation have also been made in the past several years.

The American Bar Association (ABA)’s “Best Practices for Third-Party Litigation Funding” report is an incredible resource for navigating these important and complicated issues.

A Strategic Tool, Not a Silver Bullet

Commercial litigation finance isn’t for everyone, and as the space matures, so will the sophistication of its players. However, when used wisely, it allows companies to pursue rightful claims, law firms to smooth operational costs, and investors to realize healthy returns.

To learn more about this topic, view Commercial Litigation Funding -101 / Introduction to Commercial Litigation Finance. The quoted remarks referenced in this article were made either during this webinar or shortly thereafter during post-webinar interviews with the panelists. Readers may also be interested to read other articles about litigation.

This article was originally published on here.

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