| 15 October 2019

Craig Arnott of Burford Capital looks back at legal finance’s first decade, and shares his thoughts on what lies ahead for the industry

In October 2019, Burford Capital will celebrate its tenth anniversary. We’re understandably proud of this milestone, but we also welcome it as an opportunity to reflect on the progress that the legal finance industry has made in the last decade. [Continue Reading]

Litigation | 06 July 2018

Much of the commentary about litigation finance focuses on its growth—and it has indeed grown. An overwhelming majority—70 percent—of private practice and in-house lawyers in the UK say that their organisations’ use of litigation finance has increased in the last two years, according to the 2017 Litigation Finance Survey.

More interesting than where litigation finance has come from, however, is where it is going. The ongoing evolution of legal finance reflects many of the persistent pressure points and perennial conflicts in the business of law.

Below we have identified five trends in litigation finance—and what it means for litigation teams and law firms in the years to come.

As the UK defends its leading dispute resolution centre title, litigation finance will be a key tool

With Brexit negotiations ongoing and the threat of adverse costs exposure serving as a deterrent to potential claimants, the UK legal market faces competition as other European dispute centres increasingly attract litigation that once would have been pursued in London without a second thought.

The UK currently employs almost a quarter of all the legal workers in the EU and the rule of law remains one of the nation’s most respected exports. Two thirds of the cases fought in London’s commercial court are brought by foreign litigants, the majority of whom are non-EU parties. London’s role as the financial centre of the world is highly publicised, but its role as a truly international dispute centre cannot be understated.

With uncertainty now surrounding the UK’s jurisdiction in Europe under the Brussels I Regulation, however, Frankfurt, Paris, Amsterdam, Brussels and other European courts have taken steps to attract litigation that previously would have been pursued in London, adopting English legal practices, offering proceedings in English and opening international courts. Frankfurt considers its own courts to be cheaper and faster, because written briefs are used as opposed to London’s mandatory oral briefs, which contribute both to the cost and time of litigation. To further attract potential claimants, Frankfurt also is contemplating more extensive court transcripts and a stronger role for lawyers.

In addition to the question of jurisdiction, London faces another considerable challenge in its fight to maintain its position as a leading disputes centre: adverse costs exposure. In competition and class action-style cases with multiple deep-pocketed corporate defendants, the cost of pursuing litigation is already a concern. Meanwhile, the potential for adverse costs further deters would-be claimants.

It’s one thing to not win damages in your case, but an entirely different matter to have to pay the other side’s costs as well, as this can multiply potential exposure from litigation three-, four- or five-fold. The adverse costs risk in the London commercial courts has far outstripped inflationary increases in the last ten years. As just one example, in the RBS Rights Issue litigation, RBS’s costs estimate for the liability phase was £90 million. Whilst that is a truly exceptional number, £5 million for the costs of a defendant to trial is by no means unusual.

To remain ahead, London therefore must develop strategies to address costs concerns for would-be claimants—and external financing offers one potential solution. Burford recently announced an offering designed to meet a need in the marketplace for the significant level of adverse costs coverage that is required to protect claimants’ exposure in the UK. To address adverse costs risk in commercial litigation and arbitration, Burford will offer insurance on Burford-funded matters.

Legal finance can offer relief from this extraordinary exposure insofar as a third party assumes the downside risk in the event of a commercial litigation loss. However, it takes a very well capitalised litigation finance business with significant risk tolerance to handle this degree of risk and also provide cover for costs, meaning claimants will have to do their homework before going ahead.

Portfolio financing will help legal teams move costs off balance sheets and improve accounting outcomes

Finance provided on a portfolio basis—which follows the model of single-case litigation finance but with financing collateralised by a pool of multiple matters—is increasingly popular. A particularly telling number in Burford’s 2017 Annual Report is that: over half (63%) of current committed capital is invested in portfolio arrangements. We anticipate interest in the portfolio approach to continue growing as legal teams increasingly embrace it as a tool to move legal costs off balance sheets and address perennial C-suite complaints about litigation spending.

A case study exemplifies this trend. A FTSE 20 company traditionally paid for litigation out-of-pocket—and suffered negative accounting consequences as a result. Without financing, litigation was impairing its financial performance because the accounting rules regarding treatment of litigation expenses and awards. Legal expenses paid by the company were immediately recorded as expenses, thus reducing its earnings. Exacerbating the situation, litigation recoveries were recorded “below the line” as non-recurring or extraordinary items. That was problematic for the large corporate—as it is for many businesses, particularly for EBITDA-based businesses. The accounting result of a successful claim may result in a permanent reduction in EBITDA, because legal expenses reduce EBITDA, but recoveries do not increase it. By self-financing its litigation, the FTSE 20 company was reducing its operating profits, and hence sought a solution that would help take legal costs off its balance sheet.

Litigation finance provided the solution in the form of a £40 million financing arrangement backed by a portfolio of pending litigation matters. This transformed how the multinational subsequently managed litigation expense and provided multiple corporate benefits. Not only did the company have the flexibility to use third-party capital either to relieve legal expense budget pressure or for corporate purposes unrelated to the litigation matters, but because the capital was provided on a non-recourse basis, the corporate was entitled to book it as income received, without waiting for the result of the underlying litigation matters.

As this case study suggests, the portfolio approach to litigation finance offers corporate clients many advantages. One of these advantages is a lower cost of capital: Because risk is diversified across multiple claims, financing is less expensive. In addition, portfolio financing is inherently flexible: Capital can be used to finance matters within the portfolio or for broader business purposes.

Taking that approach to financing on a portfolio basis can enable companies to reinvent their legal departments and budgets, transforming the impact of meritorious litigation from revenue-destroying to profit-enhancing—and that is an area that will undoubtedly drive increased innovation and pickup of litigation finance in the years ahead.

Law firms will use litigation finance to change the subject from alternative fees and discounts

Even a decade after the recession, law remains a buyers’ market, and “alternative fee arrangements” have become the norm—whether that means discounted fees, fixed fees, capped fees or the deferral of fees until success. According to the Georgetown Law Centre for the Study of the Legal Profession 2017 Report on the State of the Legal Market, alternative fee arrangements combined with budget-based pricing “may well account for 80 or 90 percent of all revenues” at many firms.

As the head of global disputes for an international law firm commented in the 2016 Litigation Finance Survey, “The legal departments are under pressure. The firms are under pressure… Anything that can relieve that tension is a good thing. Litigation finance… takes the law firm out of the firing line.”

It’s understandable then why law firms should welcome this shift. Law firms are understandably exhausted by unrelenting pressure to defer payment, discount fees, or arguably worse, engage in race-to-the-bottom competitive bids. And because of their cash partnership structure, even firms that provide conditional or contingent arrangements lack the structure to assume an unlimited amount of client risk. They need a way to bridge that gap and “take the law firm out of the firing line.”

For law firm clients, too, alternative fee arrangements can lead to unintended consequences. For example, if a lawyer is good enough to have continued demand for his or her services, pushing compensation levels below the market will result either in that lawyer not wanting the client’s work, or cutting corners performing it. It’s great to be ferocious when it comes to law firm negotiations, but it is generally short sighted if it costs the result in the case. For commodity legal work it might be fine, but not when confronted with more idiosyncratic, business-critical litigation.

Litigation finance can give firms a better way of keeping the focus on providing clients with top tier service. That may mean talking to a client about third-party financing options for a particular piece of high-stakes litigation, or seeking portfolio financing for the firm that will then benefit the client.

Another case study illustrates this point. A leading law firm wanted to expand its litigation practice, offer more aggressive alternative fees to clients and receive the additional upside for taking risk, but could not take additional alternative fee risk onto its balance sheet. A £45 million going-forward portfolio was created to address this challenge. The portfolio was designed to finance five or more potential matters that would be placed into the portfolio as new case opportunities arose. The assurance of having financing available for future matters gave the firm a competitive advantage over other top firms offering alternative fee options and ensured the firm would not have to turn down a strong case or new client simply because the firm could not absorb additional risk. As a result of this flexible portfolio arrangement, the firm was able to expand its practice and increase its opportunity to earn highly profitable success fees, while limiting its exposure to a loss of its time and out-of-pocket cash investment.

Clients will seek new ways to finance defence matters

While defending a claim is every bit as vital to business growth and survival as bringing a claim, given the choice, any company would prefer to invest in business-advancing endeavours. And yet, because misconceptions about the role that litigation finance can play on the defence side persist, these matters are often overlooked as potential candidates for financing.

In its simplest form, a litigation finance provider advances capital needed to pay lawyers’ fees and other costs related to a case. In return, the funder receives a negotiated return if and when the case is successful. In a defence context, this means the litigation finance firm advances costs to defend against weak claims in exchange for a multiplier or uplift based on predefined success, and cases can run on full or partial CFAs, as well as DBAs, or indeed a combination of these.

Defence financing is ideally suited to the portfolio-based approach described above—and therefore companies with significant litigation portfolios are ideal candidates for this form of financing.

How does it work? Most corporations have at least a few high-value affirmative litigation matters (large commercial disputes with counterparties, patent enforcement cases, financial products disputes, etc.). In essence, clients secure financing to pay for all or partial fees and expenses across a pool of cases—with these affirmative plaintiff cases offsetting the cost of their defence dockets.

The appeal of defence funding within a portfolio is clear for businesses that want to mitigate risk and cost across a range of cases. As one example, Burford helped Grant Thornton, a leading professional services company, use portfolio financing for defensive matters. Insolvent estates often need to secure financing to manage and maximise the value of their claims, but complex insolvencies are not always good fits for simple case financing. Burford provided a £9 million facility backed by one insolvent estate’s litigation portfolio, enabling Grant Thornton to finance all costs of the bankruptcy estate, including defence costs, declaratory matters, administration costs, IP fees and expenses.

While defence matters are most commonly funded as part of a larger portfolio, the economics can also work on a single-case basis and can help level the playing field when resources are asymmetrical. For example, when cash-strapped start-up ShaveLogic sought a means of financing its defence against the world’s largest razor company, Burford provided the resources ShaveLogic needed to mount a vigorous defence as well as to pursue its counter claims on a non-recourse basis. Under the terms of the agreement, Burford would earn its investment back and a return from a combination of a settlement, if any, and/or future razor sales.

Law firms and clients will increasingly use finance at any stage, even after the successful resolution of a matter

The scenario out of which a typical, single-case funding arrangement arises is likely a familiar one: A client is unwilling or unable to pay a firm’s hourly rate, but the law firm’s business model can’t support an alternative fee arrangement. The firm may then work with a litigation finance provider to secure non-recourse capital to cover ongoing legal costs—bridging the financial gap between client and firm, while moving the risk from the firm to the funder.

While financing pre-settlement commercial litigation and arbitration matters remains a cornerstone of legal finance (both on a single-case and portfolio basis), financing can also address the problems law firms and their clients may face even after the successful resolution of a case.

When settlements are subject to court approval or other claim administrative processes, legal fees and awards can be delayed for years. That can cause frustration for both clients and law firms—which have better uses and more immediate needs for their capital.

Non-recourse financing from Burford helps claimants and law firms avoid this problem and—instead of waiting for compensation–speeding receipt of fees and awards by immediately monetising these outstanding legal assets.

Post-settlement financing enables law firms to monetise completed litigation and client work as early as possible. This helps them lower their contingent risk on fees and also reduces their exposure to variables outside of the firm’s control, like unanticipated delays in the litigation process, uncertain claims requirements, and clients’ financial health. Clients can use financing to accelerate their receipt of settlement payments. Instead of expending years of additional effort and ongoing cost and risk to collect their due, clients can monetise their legal assets and begin using capital immediately.

Law firm capital needs don’t follow a court schedule. Litigation finance provides a tool that can help clients and law firms monetise their legal assets and optimise their cash flow at every stage. And with over $3.3 billion invested in and available for legal finance, Burford is well positioned to help throughout the process, from pre- to post-settlement.