Tough Love in Litigation Finance

Day One of last month’s LF Dealmakers conference finished with a panel of veteran users of litigation finance sharing their experiences (both good and bad), as well as insights they’ve gained over time. The panel also imparted some “tough love” in the form of advice to funders on how they could make improvements to better serve their clientele.

Participating in the panel were:

• Barry Kamar, Managing Director, Westfleet Advisors (moderator)

• Derek Ho, Partner, Kellogg Hansen Todd Figel & Frederick

• Lewis LeClair, General Counsel, McKool Smith

• Erika Levin, Partner, Fox Rothschild

• Charles (Chad) Schmerler, Head of Litigation Finance, Pretium Partners

Conflicts of interests

Barry Kumar noted that counsel are often involved in helping their clients secure funding for their cases, and the funding is ostensibly used to pay that counsel’s fees. Does this create potential conflicts of interest?

• Lewis LeClair was of the opinion that it can create conflicts of interest and emphasised the importance of counsel being very clear and careful in disclosing to the client the relationship with the funder (disclosing that counsel has a long-term relationship with a funder that extends over multiple other cases, disclosing that a funder has referred various other cases to the law firm, etc.). If the relationship is not disclosed to a client upfront, and for whatever reason the client is not thrilled with the litigation finance arrangement, the client may question whether counsel had their best interests in mind if the relationship with the funder comes out later.

• Chad Schmerler emphasised that if a client thinks it is being given advice from its own lawyers on how to handle a funding situation, and the law firm has something to gain from the situation and doesn’t disclose it, it is going to create a problem.

Speed of funding

• Derek Ho noted that funders are proud to emphasise the speed at which they can look at a deal, but argued that this often is not the right pitch to lawyers and their clients. Clients are often companies that have been put out of business because their IP has been stolen or because competitors have colluded to exclude them from the market. What they’re looking for is not just capital to faciliate litigation of their claims, but a partner that really believes in their case and will back them up to the end. He thinks this relationship cannot be formed in a short period of time.

• Chad agreed that the funding process should not be rushed, but for different reasons. He argued that clients want to know that the funder has strong expertise and experience with the subject matter and has taken the time to carefully evaluate the claim.

Funders offering operating funding

• Lewis commented on the recent trend of funders offering operating capital in addition to capital for pure litigation and argued that it significantly raises the complexity of the deal, to the point that often such deals will fall apart altogether.

Exclusivity Clauses

• Erika Levin shared her view that there is a place for exclusivity when a client knows that they have the right funder for their case, but noted that many inexperienced clients will jump on a term sheet and accept exclusivity too soon, which ends up wasting time and hurting their cases if it ends up that the funder and/or the term sheet is not the right fit.

• Derek noted that clients are often puzzled as to why exclusivity is a market expectation in the funding world when there is no similar clause when they run a process to select a law firm for their case. Both situations involve multiple parties competing and investing significant time into a case even though they may not win the mandate. Like Erica, he believes that there is a place for exclusivity, but considers it a red flag if a funder demands exclusivity too early on in the process.

• Chad noted that break fees are often a better option based on the timing of the financing. If the case is close to trial, for example, exclusivity doesn’t really make sense. A break fee would be the better option as it better addresses the possibility of a settlement.

• Lewis addressed the issue of “exclusivity drag” and put the onus on the lawyers to manage the information flow between funders and their clients so that the process moves along as expected.

Misaligned incentives of outside counsel

Barry touched on the situation where a funder retains outside counsel to diligence a deal and shares that there is a perception among some borrowers that the incentives of outside counsel are misaligned with theirs because outside counsel are looking for reasons not to do a deal to justify their engagement.

• Derek sees this argument as a wash. While outside counsel would like to find the “silver bullet” that will impress a client, they also have an incentive to make funders happy, which comes from moving forward on deals.

• Erika added that clients should also keep in mind that outside counsel are usually experts in a particular field and can often help streamline a case and/or identify new strategies.

Standardising documentation

• Lewis shared his experience from 2010 in which he spent six months with a funder negotiating a set of standard documents that he could use with his clients. The process did not go smoothly, as the clients all ended up retaining additional lawyers to review the documents, and they all wanted to renegotiate terms.

• Chad pointed to the differences in the expectations and needs of clients and the differences in deal structures as reasons why he doubts that the industry will get to the stage of having standardised documents. Something he would like to see, however, is more publicly available litigation funding agreements. As the industry grows, a lot of lawyers are dealing with litigation finance for the first time. They are negotiating deals and term sheets with no idea what the actual funding documents will look like down the road. Having some form of standardised or form documents will help lawyers know what to expect and avoid surprises when the time comes to paper a deal. This would be beneficial for the whole industry.

(Editor’s note: if you are looking for example documents, UK-based LionFish has made its standard documents publicly and freely available)