In our last article, we provided our top 5 tips for securing the best funding terms possible from the market. In this second part, we look at 5 pitfalls to avoid when seeking and negotiating litigation finance.
1. Failing to understand the deal terms
This may sound obvious, but it is surprisingly easy for misunderstandings about the commercial or contractual terms of a potential financing agreement to creep into the negotiation process and potentially linger.
The way in which a conditional offer of funding will be formulated varies significantly from funder to funder. Some may provide a detailed term sheet or conditional funding agreement at the outset, while others may start the dialogue with a more casual pricing indication and only refine the details once the initial pricing indication has been deemed acceptable.
For a claim holder, it is vital to fully understand exactly what is being proposed before committing, particularly where the funder requires exclusivity and further due diligence before committing funds, potentially with a break fee applicable if the claim holder decides to walk away.
2. Putting all eggs in one basket
Many funders are looking for similar things when assessing a potential case. However, this doesn’t mean that all funders will reach the same conclusion when presented with the same opportunity.
In fact, the reverse is often true. The decision as to whether or not to fund a case is often a subjective one. It can be influenced by an array of factors that go beyond simply the cold analysis of the legal merits, such as personalities, internal considerations, or individual experiences.
As a result, there is a significant chance that even a good, well-presented case may ultimately not get over the line with a particular funder. In fact, many funders publicly state that they reject the vast majority of cases that are presented to them – a message aimed at reassuring investors, but nonetheless disconcerting for a company that is seeking financing.
As such, limiting the discussion to a single funder or taking a sequential approach when engaging funders (waiting for discussions with the preferred funder to conclude before engaging with others) is a mistake made by many claim holders, which potentially creates unnecessary difficulties if the funding discussion falls through or the terms eventually offered are not acceptable.
3. Undercooking the budget
It is no secret that litigation funders offer expensive capital, reflecting the high-risk, non-recourse nature of the investment. The high cost of funders’ capital often encourages parties to try to reduce the amount of their funding request in an attempt to minimize the net funding cost.
In and of itself, this is entirely sensible. As we discussed in our previous article, taking a creative approach and combining third party funding with other forms of finance, such as litigation insurance and law firm alternative fee structures, is one of the key ways of securing a cost-effective overall financing structure.
However, trying to achieve a similar goal by simply squeezing the budget can be a costly mistake. A situation where the litigation budget is exceeded mid-way through a funded case and where there is no express mechanism built into the agreement to deal with such an overrun can be problematic for all parties. At best, this can require costly renegotiation of the funding agreement, inevitably involving the plaintiff conceding a larger share of its potential recovery to the funder in exchange for additional capital. At worst, it can lead to an impasse between the funder, the law firm, and the claimant if additional funding is unavailable.
In practice, most funders are suitably cautious when it comes to budgets, scrutinizing them carefully for weaknesses, as well as potentially seeking to transfer the risk of a budget overrun onto the law firm.
4. Taking your foot off the gas
Every client considering litigation finance for the first time asks the same question – how long does it typically take to get a deal done? The answer is, of course, one that all lawyers know well, it depends. On a good day, with the wind in the right direction, a deal can potentially be done in a few weeks. A couple of months is more common, but the process can very easily drift out well beyond this timeframe.
While many of the factors may be beyond the control of the claim holder, in practice, the plaintiff’s approach can have a significant impact on timing and speed. Entering the discussion with a clear view as to what terms will (or will not) be acceptable to the company, providing a thoughtful, balanced, and comprehensive case presentation, responding promptly to information requests and most importantly, keeping the momentum going throughout the funding discussions, will encourage funders to take the opportunity seriously and to move expeditiously.
On the other hand, once the process starts to lose momentum, the funder(s) will tend to focus on other more pressing opportunities and allow the process to drift. There is also a clear correlation between speed and conversion rate. Put simply, deals where the parties move quickly have a higher likelihood of getting over the line than those that move more slowly.
Furthermore, while it is always frustrating if a funding deal blows up on the launchpad, if it happens quickly enough, there is usually ample opportunity to reset and consider other options, whereas a failure that occurs after protracted negotiations on a time-sensitive case can be fatal.
5. Assuming the funder will always play nice
The vast majority of corporate litigation funders pride themselves on adding value beyond the provision of capital, encouraging plaintiffs to view them not as bankers, but as sophisticated project partners in the litigation.
However, inevitably, there will be occasions where the interests of the funder and those of the claim holder may diverge, and this should be borne in mind when negotiating the litigation funding agreement. At such moments, the true contractual relationship between the funder and claim holder will be evident, potentially highlighting items in the funding agreement which the plaintiff conceded in expectation of a certain commercial approach, but which in reality favor the funder when unforeseen difficulties arise.
James Blick, principal of TheJudge and head of its U.S. operations, arranges litigation finance and insurance solutions. Erika Levin, Esq., is a senior vice president at TheJudge and specializes in litigation and arbitration as well as international business transactions.