Too often, law firms struggle to litigate successfully, 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, small-to-midsize law firms lack the healthy cash reserves necessary to sustain lengthy litigation.
Litigation expenses 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, small-to-midsize law firms must exercise masterful financial management to ensure the lights stay on and cases continue uninterrupted. However, in law school, students learn the practice of law and 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, through inefficiencies, overstaffing, and turnover. Yet, for many well-managed firms, accounts receivable is still their primary pain point. And litigation can be quite 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.
Costs of Winning Versus Resource Allocation
Winning a large, complex case with a high potential payout may require work from a firm’s entire legal team. While a firm’s entire team works on the case, smaller cases suffer delays. A small-to-midsize firm could potentially sacrifice quicker payouts from smaller cases to service the larger ones, 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 – and less than a law firm’s expenses to date. Or, even if a law firm wins, the counterparty may appeal and succeed, overturning the original result. In these cases, a law firm must swallow these losses while still bearing the costs of its existing caseload.
Litigation finance can reduce that risk and alleviate the financial burden of litigation. This innovative method of law firm 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 law firm facing a particular cash crunch, the ongoing loan servicing costs will further deplete its cash flow, and in some cases, jeopardize its ability to keep its 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 successful. 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 interest.
Financing is Available for Single Cases or Portfolios of Multiple Cases
Litigation finance provides law firm funding for either a single case or a portfolio of cases.
Where single-case financing is explanatory, portfolio funding is financing arrangements where a funder provides capital to a law firm in exchange for a return on fees expected from multiple cases. The arrangement comes with various benefits, including funding of cases that would not otherwise qualify for third-party financing, access to larger funding amounts, and diversification and mitigation of risks. Litigation portfolios provide all the benefits of single-case funding with additional advantages of diversification, scale, and access to more capital than would be available on a single-case basis.
Litigation finance firms employ 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 as well as its cash flow.
Firms Provide More Than Just Capital
Litigation finance firms have a vested interest in the outcomes of the cases they fund, as 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 successfully litigate and win a case, which is usually more than just working capital.
Litigation finance firms also provide strategic guidance and counsel to the law firms they fund. Many litigation finance staff attorneys bring a 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 the case.
Law Firm Funding is Legal
While litigation finance is still a relatively new practice, it is legal in all fifty US states and many countries around the globe. There’s no federal statute prohibiting its practice in the US, and while some states recognize champerty – a doctrine that prohibits third-party financing of litigation, those states still hold that litigation finance agreements are enforceable.
Reputable litigation finance firms should easily be able to answer questions regarding regulations and disclosure and flag relevant potential pitfalls before delving into the specifics of a case.
How to Choose a Litigation Funding Firm
When seeking funding, law firms should inquire with litigation finance firms with proven track records of funding complex cases, expert lawyers on staff, and significant assets under management. Find a firm that has successfully financed numerous commercial litigation and arbitration cases, as well as intellectual property lawsuits, and can close transactions quickly to ensure litigation expenses don’t deplete the business.
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