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Litigation Finance 101: Helping Clients and Law Firms Manage Risk and Maximize Growth

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Litigation Finance 101: Helping Clients and Law Firms Manage Risk and Maximize Growth

As companies look to seize opportunities for growth in 2022, many are facing uncertainty in the broader business environment and on their own balance sheets. Whether a company is thriving or struggling, litigation finance may be a financial solution to transform liabilities into assets, helping businesses and law firms monetize legal claims for working capital or other purposes. Litigators, in-house counsel, C-level executives, and law firm managers might all benefit from understanding how this tool may help their own or their client’s business better manage risk and maximize growth, even while managing active litigation.

Transcript

 Welcome to Litigation Finance 101. My name is Wendy Childress, and I'm an Investment Advisor for Validity Finance. Thank you for joining me today. Before we get started, I'd like to go over the agenda for this program. First, we will discuss what commercial litigation finances for those in the audience who may not be familiar with it. We will discuss how litigation finance benefits both firms and their clients. We'll touch on how the process works, and how a party or a firm can go about obtaining litigation finance. And finally, we'll cover various ethics issues that arise in the context of using funding. So to begin, what is commercial litigation finance? Litigation finance is any transaction in which a litigation claim or an arbitration claim is used to secure financing from an outside party. The financing party comes in and provides capital to a claimant in exchange for an interest in the outcome of the case. The financing is provided on a non-recourse basis. And as such, the funder that finances the claim only receives a return if the case is successfully settled or it results in a collected judgment. If the case is unsuccessful, the client owes nothing. So how do funders invest in litigation? There are primarily five ways. The first, fee and cost funding, is the most common. This involves the financing party providing capital to pay for all or a portion of the attorney fees and costs for a claimant to bring a claim. If that case is successful, the funder receives a return from the proceeds of the case. Along with, of course, its principle. The capital is typically provided across the life of the case. So as fees are incurred or costs are incurred, particularly for expert witnesses, the funder receives the invoice and pays a portion or all of those fees and costs. A second way that funders invest in litigation is through portfolio funding. In portfolio funding, the funder provides capital directly to a law firm or to a client. But rather than just a single case, the collateral for funding is a number of cases. Usually, two or more bundled together rather than just one case. Any of the case proceeds that come in or, if the funding is provided to a firm, contingency fees that come in are what are used to pay the funder's principle and return. And that repayment occurs as those cases in the portfolio resolve. Really whichever case resolves first, the funder is beginning to receive their principle and a return back. And often, the funder is able to recoup its full return in principle from the resolution of the first cases in the portfolio, leaving the law firm or the client to be able to recoup the full amount of the case proceeds as later cases resolve. A third way that funders invest in litigation is by providing clients working capital. Sometimes clients, for various reasons, may need an infusion of capital during the pendency of a lawsuit, which the funder can provide. This enables the company to invest the capital into growing the company or simply sustaining operations during the years long litigation. A fourth way that funders invest in litigation is through defense funding. So like fee and cost funding that we discussed for a single case, here the financier comes in and provides fees and costs to a firm or to a company for a defense side case or to defend litigation. This can be done in several ways. The first would be through a hybrid portfolio, which would contain a mix of defense side and plaintiff side cases. The funder would be able to come in and provide fees and costs across the portfolio of cases, but would negotiate the return of its principle and a return from proceeds that resulted from the plaintiff side litigation. Another way to do this is for the funder to provide the fees and costs in a case where the firm has negotiated a success fee upon certain triggers or milestones in the litigation. And the funder is able to negotiate its return from that success fee, rather than what is traditional, which is the proceeds of litigation. A fifth way that funders invest in litigation is through claim monetization. Instead of a client waiting for a final resolution in a case where they've received, thus, full judgment, litigation finance can monetize or advance a significant portion of the judgment value. This provides immediate capital to a client or company, to put towards its business needs and priorities. And essentially, the company is able to unlock the value of the judgment now or at the conclusion of trial rather than waiting until the appeals are exhausted. And, of course, a client holding a judgment faces the risk of the judgment being overturned on appeal. Or it could turn out that the judgment is partially or entirely uncollectible. But through monetization, that risk is transferred in a large part to the litigation funder financing on a non-recourse basis. The funder's return on its investment only comes from an ultimate success and case recovery. If the case is unsuccessful, the client who has monetized a part of that judgment or award owes the funder nothing. And although these five types of funding are what are traditionally provided by litigation funders, the reality is is that each client's needs are unique. And a good and trustworthy funder can come in and really tailor an investment to the specific needs of a client through bespoke programs. There's no one right way to do this. And clients and firms would be well advised to ask what their options and alternatives are. So what are the types of litigation finance? Litigation finance exists in both the commercial and consumer contexts. And these really represent two different sides of the funding industry. Commercial funders typically fund high value, complex commercial litigation cases. Typically the minimum investment is around 1 million or more. And the damages at issue in the case are typically 10 million or greater. And this, of course, varies. On the commercial side, you'll typically see sophisticated parties and council. It's usually business to business disputes, rather than individuals. And commercial funding is used in a range of commercial litigation cases. Everything from antitrust to arbitration, both domestic and international, asset and enforcement. Litigation is used quite frequently in the bankruptcy context, breach of contract cases, breach of fiduciary duty as well, copyright and trademark cases. Patent, we see quite a bit of cases in the patent space. And, of course, trade secret misappropriation. And what we've seen in the years since the pandemic began, we've seen an uptick in insurance recovery cases. Cases in the context of bankruptcy, we've seen a steady stream of patent matters, and an uptick in antitrust matters as well. So on the consumer side, which commercial funders typically are not investing in consumer disputes, but there are funders that do. And typically, those consumer funders are financing personal injury claims. And perhaps the proceeds or the capital provided by the funder is used by the claimant to pay medical bills or living expenses during the pendency of the lawsuit. Consumer funders also will finance malpractice claims, consumer class actions, mass tort litigation. And as you would expect, the recipients are typically consumers or individuals. The amounts at issue are typically smaller than in the commercial context. So who uses litigation finance? Litigation finance benefits a variety of businesses and individuals, both clients, and also law firms or council. When the industry first evolved, funding was mostly provided to small or mid-sized companies that were involved in what we call David versus Goliath cases against larger, better capitalized adversaries. These adversaries or defendants could spend more money on attorneys, could sometimes hire counsel that was more effective than the plaintiff bringing the case or their counterparty. And so cases would be decided based on who has more money, rather than the merits. Funding provided a solution to this because it enabled that David, in the David versus Goliath cases, to hire the best council, council of their choice, pay fees and see the case through its conclusion without being outspent by the opposing party. The industry has evolved quite a bit over the last decade. And now what we're seeing, in addition to the smaller companies or the Davids of the world getting funding, we're seeing commercial funders provide financing to larger companies as well. And this is just because in-house council and CFOs are getting a little bit smarter about their legal spend and budget. What funding can do for these larger companies, even ones with a robust litigation budget, is it allows them to free up capital that would otherwise be burdened with the litigation. So they're able to take that cash and rather than paying their lawyers, they can reallocate it away from the legal spend back into the company. There's also accounting benefits for companies because you're able, by obtaining financing, litigation financing, you're able to avoid booking your litigation costs as an expense during the life of the lawsuit. Or let's say you're using traditional financing, you're having to book that as a debt. And by entering into a funding arrangement, you're able to avoid both of those burdens to your bottom line. Funding is equally beneficial to law firms of all sizes. Large firms often have to turn away smaller clients who can't afford their fees, or who want the firm to take outsized risk by doing a case on a contingency. Litigation finance can fill this gap by allowing a client, maybe a smaller client, to have the capital that it needs to pay the firm's fees. Or allowing the firm, the client, and the funder to share and spread the risk out amongst themselves. This risk sharing and the mechanics behind it are some of the things that we'll be talking about as we progress into the program. Another way of looking at litigation finance, as seeing it as providing a third way to access the courts. So traditionally clients have, of course, paid their lawyers by the hour under the hourly fee model. But as legal fees and costs have continued to rise over the years, many clients find that they don't have enough money to cover the full litigation budget that is required by a firm's hourly fees. And so, of course, the alternative to that is a contingency fee. And this is where the lawyer, as we know, works a case and invests in terms of its hours. And then recovers a percentage of the case proceeds if they're successful in the litigation. But this can take years and really put a burden on a firm's budget and its books. And so many lawyers just can't take on that risk. They can't work millions of hours, millions of dollars in hours on a case only to face the possibility that they're not gonna recoup payment for that time. But with the rise of litigation finance, it's essentially providing a third way to go about it. Here a third party, as we've been discussing, can come in and finance the litigation in exchange for part of the case proceeds. And so the client is relieved of that burden that the hourly fee model might present. And the lawyer is relieved of the burden that taking a case on a full contingency might present, or perhaps assuming the contingency fee plus the cost of litigation might present. And instead, you've got a funder who's coming in and helping those parties by alleviating their burdens and then also sharing risk alongside them. So what are some of the ways that litigation funding benefits a firm and its clients? Well starting with clients, as we've been discussing, funding enables a company to manage its litigation risk better. Rather than investing substantial amounts of money to pay their lawyers on either the plaintiff or the defense side, companies can reinvest their capital back into their core products while still pursuing their good cases. And, of course, companies can also avoid putting the legal spend on their balance sheets. They can take that legal spend off the balance sheets during the life of the litigation. And as we've touched on, funding enables a client or company to hire the very best council or the council of their choice. They're not limited in terms of the amount of money that they can spend on fees or needing to hire council that would take the case on a full contingency. And this maximizes the likelihood of ultimate success in the litigation, of course. And funding also enables clients to get a higher return on investment in the amounts that they do spend on the litigation. Rather than spending a large amount, and even in the event of a successful litigation, getting a lower return on that investment, clients are able to put less into their legal spend and then get a much higher return on whatever it is that they have invested. So it's providing that financial benefit as well. And, of course, funding enables companies to unlock and bring good affirmative cases that they might otherwise be hesitant to bring. What we hear a lot from in-house council is that they're under a tremendous pressure to keep their litigation budgets low and also predictable. And so sometimes those funds are used to defend litigation. And while the company might have some good affirmative cases, in-house council is hesitant to bring those because it's, of course, going to increase the litigation budget. Which puts pressure on the legal department and potentially leads to unpredictability. And so funding can be used by in-house council to really alleviate this burden. So how does funding help law firms? As we've touched on today, funding enables a firm to reduce the risk that might be presented by a traditional contingency arrangement. But it's still able to participate in the upside. In a single case scenario, for example, a funder might come in and pay just a portion of the firm's fees, say 50% or 60%. And so through the life of the case, the law firm is actually recovering those fees and it's feeding into the firm's revenue. And the firm is not waiting for years for a case to resolve in the hope of a payout. However, by entering into the funding arrangement, while still receiving that steady stream of revenue, the firm is also able to participate in some upside in the case. So rather than perhaps a 40% recovery in which the firm is not receiving any fees along the way, the firm might receive 50 or 60% of its fees along the way, but then still be able to participate in say 20% of the case proceeds. This also enables a firm to perhaps take on more cases on partial contingency. Let's say the firm's risk profile would only allow for a certain number of contingency matters per year. By entering into a litigation funding arrangement, the firm might be able to double the number of cases that they're taking some risk on. While still receiving a steady stream of fees along the way. Another way that funding can help firms is by helping them serve their clients. As we've touched on today, often clients just aren't able to foot the full legal bill to bring their cases. And they may be asking the firm to take a case on a contingency, but the firm isn't able to do so. Maybe because it's just not the right timing, or that the firm has already taken too many cases on contingency and really just can't take another. Or just for various restrictions that the firm has on those type of arrangements. And so lawyers are having to turn away clients and good cases that they otherwise would be happy to litigate. And so what funding can do is it enables a firm to serve these clients, while also recovering their fees along the way. Funding can also help firms recruit new clients. Attorneys who are well versed in the use of funding or have portfolio arrangements with a funder in place, or otherwise have funders that they've worked with before, can come in and pitch to clients that they're able to pursue the client's cases, both defense and plaintiff side, with the use of funding and taking the fee spend off of the client's balance sheet. So when going in for a pitch, in addition to being able to tout firm's deep bench of sophisticated and talented lawyers and the services they provide, you're also able to tell your clients, "look, we're able to bring certain cases for you on a contingency arrangement where the legal spend for the fees is off your books." "The legal spend for the costs is off of your books." "And then you're still gonna recover the majority of case proceeds if we're successful." "Which, of course, we will be because we're a great firm." So it really just enhances a partner's ability to sell himself or herself and her firm to clients. And this is music to clients' ears because as we've been discussing, there's such tremendous pressure to keep those budgets down. So it's really a win-win for the firm and the client. Funding can also help law firms by providing better pricing through the use of portfolios. So as we've discussed, funding can come in the form of single case funding where the fees and costs of just one litigation are being provided by the funding arrangement. And it also can come in the form of a portfolio, where there's a basket of cases that serve as a collateral for the investment. In that latter product, the returns are often lower. Because, of course, the risk to the party providing the financing is much lower by a cross-collateralized group of cases that won't turn on each other's successes. Rather than just one case, that's either going to be successful or fail. And so the firm is able to bring in capital to offset the burden of their time spent on a contingency matter. They're getting paid their fees, but the return is actually much lower across that basket of cases because of that reduced risk. So what do lawyers say? Validity Finance recently conducted a survey with the American Lawyer, in which it looked beyond the dollars and cents of the financing industry to learn about what people and particularly attorneys think about litigation finance. 331 lawyers answered, and these are some of those results. We asked respondents how they are using litigation finance. 93% reported using it to fund a plaintiff's case, which is perhaps the most intuitive use. However, other uses are gaining traction. And as we mentioned before, funding is available at any stage of the litigation. So it can be used to monetize a final judgment, rather than going through the asset recovery process. And 19% of our respondents have used it this way. We saw many firms that have financed one or more portfolios of cases. And in fact, we're seeing more and more of this in recent years. 2% of respondents who had used finance used it to fund a defense case. For the 51% of the law firm respondents who had not used litigation finance but plan to in the future, the top three reasons were, number one, the cost of litigation is too high. And so 55% said they would use funding to mitigate this risk. Another reason was to share the risk, to share litigation risk with the funder. And that was 44%. Another reason was to offer clients flexible or partial contingency billing, making the firm more competitive in pitches. And this was 36% of respondents. Other reasons included boosting law firm revenue and profitability, helping law firms build portfolios of contingency cases or expanding portfolios of contingency cases. And also getting an objective third party analysis of the case merits. And to that point, when clients or firms are looking to work with a funder, ideally you wanna work with someone who has trial lawyers on staff. You want funders who have attorneys with deep litigation experience, who will be evaluating the case. And as we will talk about, those attorneys, their role in the process is really to evaluate the case to determine if the funding arrangement makes sense. If the case is likely to be successful, and to evaluate how to move forward. But the lawyer bringing the case to the funder receives the benefit of that analysis. And so some of the respondents to the survey liked that idea, the idea that they're gonna have a third party come in and pick the case apart and evaluate those case merits. So that was another reason that attorneys were excited and looking forward to using litigation funding. So how does single case risk sharing work? A common use of funding is for funders to provide clients with single case risk sharing. And there are a variety of ways that the funding arrangement might be structured. Really, it's tailored depending on the needs of a particular case. But an overarching goal is to look for ways that the funder, the client, and the attorneys can all align their interests and their contributions and their recoveries. So on this single case risk sharing slide, you'll see inputs and outputs. In the middle, you'll see the client and the client is the most important party to the arrangement. We wanna see the client recovering the bulk of case proceeds. In our example, we have a client recovering 60% of the case proceeds and a small portion of the costs. But above the client, you'll see the law firm. And below the client, you'll see the funder. And you'll see the inputs and outputs that are going from the client to the firm and the funder, and from the firm and the funder to the client. So in this arrangement, you've got the funder on the bottom. And they've agreed to invest 50% of the fee budget. And what's not on this slide, but is often also a component of a transaction, the funder is likely paying a significant amount of the case costs. Meanwhile, the firm that you have on top is going to be receiving 50% of its fee budget along the way and then will be investing the other 50% of the fee budget in terms of the firm's time. If the case is successful, the client is recovering 60% of all case proceeds. The firm is receiving a 20% contingency in addition to having received that 50% fee along the way. And the funder is receiving a 20% recovery. So with this arrangement, you'll see that the client has reduced its fee and cost risk really almost entirely. And the firm and the funder's risks and interests are aligned. We also note on this slide that the returns can be tiered. And what this means is that often, a funding arrangement provides for the funder to receive increased returns over time. So if a case is going to resolve quickly, perhaps an early settlement after the motion to dismiss stage for example, the funder's gonna receive a lower return. Then if its capital is tied up in the litigation over a significant period of time, let's say four years or longer, then the funder's really gonna have a higher return as the length of the litigation increases. So it's just tiered, as that timeline of the litigation increases. And one thing to note on this slide, this is what we call a 50/50 arrangement. And this is a pretty standard arrangement in the industry. And part of the reason that a funder is looking for the firm to take on some risk, such as this 50% of the fee budget, is because it really highlights that the firm believes in the case. And it also keeps those interests aligned. If the firm were receiving 100% of its fees, there might be a tendency to spend more time on the case, or perhaps inefficiencies could creep in. But with this 50/50 arrangement, it sort of eliminates that concern or reduces that concern. But the 50/50 is, of course, negotiable. And it's often a different ratio. Sometimes it's 65/35, sometimes 60/40. It really just depends on that particular case and the risks involved. So by way of example, let's take a hypothetical case brought by Tech Company against Giant Corp. Let's say Tech Company and Giant Corp are discussing entering into a business relationship. And they have to exchange sensitive company information to determine if they're going to move forward. So Tech Company has trade secrets that it wants to protect, and it therefore asks Giant Corporation, can you please sign an NDA? Which Giant Corporation does. Discussions proceed, Tech Company shares some of these sensitive secrets with Giant Corporation. And lo and behold, Giant Corporation cuts Tech Company out of the deal, moves along without Tech Company, and uses those very sensitive trade secrets to the detriment of Tech Company. So Tech Company has a viable claim and is looking to its council to bring a lawsuit. Council says, "great." "It's going to cost 4 million in fees and 1 million in expenses to bring this case, which we assume will last from two to three years." Tech Company doesn't have either the capital in its litigation budget to pay 5 million in fees and costs, or really is needing to keep its capital freed up to continue building up the company. A funder comes in, and using the 50/50 ratio that we were just discussing, agrees to provide 50% of that $4 million fee budget or $2 million. And 90% of the case costs, or $900,000. So how does this play out? In our next example slide, how the parties will fare with funding. So looking at the first row for legal fees. With this arrangement, the client pays $0 in legal fees. The funder invests $2 million in the case, in terms of capital. The law firm works $4 million in hours and receives $2 million along the way, as the case progresses. For expert discovery and other costs, the client owes and pays $100,000 in costs. And usually this is at the end of the litigation, with the funder paying the costs upfront for the first 900. So here, the funder pays 900,000 in costs. The case hits a home run. Tech Company is vindicated at trial and receives a large judgment, 100 million dollars. So what happens with this successful termination of the case? The client, who has paid $0 in legal fees and only $100,000 in costs, receives $60 million out of that judgment. The funder receives $20 million, which includes the 2 million that it paid for the client to bring the case. And the law firm receives $22 million. This is the 2 million that it received along the way, and the 20% recovery of case proceeds in impartial contingency that was part of the structure as well. Let's say the case is unsuccessful. The client received a judgment, but perhaps loses the case on appeal. That results in the client having only invested $100,000 instead of $5 million in a case that ultimately lost. And the law firm has still received $2 million, or half of its fees. And the client does not owe the funder anything for the money that it received along the way. So another way of looking at this from the client's perspective. Again, let's assume a $100 million judgment and a $5 million fee and cost budget to get there. If that client had self-funded, in other words, paid the full 5 million out of its budget, it would have received a 20X on that $5 million investment. But with funding, the client's ROI is substantially greater. The client has only invested $100,000, yet it has recovered $60 million, which is a 600X on that investment. And meanwhile, the client or the company has 4.9 million that it otherwise would not have had to invest in growth in the meantime, during the pendency of the lawsuit. And its downside risk of loss is covered. So not only does in-house counsel look like a hero to the business side because she has brought in this large judgment, but she has also done so while enabling the company to avoid a large legal spend. And to use the monies towards growing the company. And the partner working on the case also looks like a hero to his firm. So how does this look from the law firm's investment? Under this example, how much in fees will the law firm see? So if the firm had taken this under a traditional hourly arrangement, and the case was successful, the firm would've recovered $4 million in fees. If the case was unsuccessful, the firm would still have recovered $4 million in fees. Let's say the firm took the case on a full contingency. Successful case, let's say the contingency is 30%. Successful case, the firm is bringing in $30 million in revenue, which is a great day. Unsuccessful case, the firm has worked $4 million in hours, but is bringing home $0, not a great day. But with the funded hybrid arrangement that litigation funding can provide, in our example in a successful case, the firm is bringing in 22 million in revenue. 2 million along the way and 20 at the conclusion of the litigation. And even in the event of a loss, the firm has still recovered 50% of its fee, or $2 million. So what is portfolio risk sharing? In portfolio funding, the funder provides capital directly to a law firm or to a client. The portfolio usually consists of two or more cases that are being litigated on a full or a partial contingency basis. Some portfolios will start out with just one case. And the agreement is that as the firm takes on future cases or the client has future cases, they're added to the portfolio. There's really no upper limit to how many cases can be grouped into a portfolio. And in fact, funding can be used to fund dozens or really even hundreds of cases if the claims are meritorious. Cases in a portfolio can be similar or diverse and can be plaintiff side, defense side, or a mix. The portfolio is really constructed to optimize risk in return for the group of cases as a whole, and is often tailored to the specific nature of the cases in the portfolio. It permits the financing of cases that might otherwise be too small or too risky to finance on a standalone basis, which can have a financial and a strategic advantage for the client or for a firm. And cases can be added to a portfolio at any stage of the litigation. So pre-filing all the way through the asset recovery phase is appropriate. So how does it work? On our slide, you'll see a diagram similar to the one that we were looking at for a single case. You've got the law firm on top and the funder on the bottom. And in the middle, you have four cases that have been added to this portfolio. You've got two plaintiff side cases and two defense side cases. So in this arrangement, the funder is providing to the firm a portion of the fees and the costs that it will take to litigate all of these portfolio cases. So the firm provides the funder with a budget for each case and the funder uses that budget to come up with an arrangement where the firm is recovering a portion of that budget for each case. The funding might come in tranches, where the firm is receiving kind of a lump sum based on those budgets, on a monthly or quarterly or a biannual basis. Or it can get paid as the cases, as the fees and costs are incurred and as the cases progress. With a portfolio, it's really up to the firm how they wanna receive the money. And it's actually also up to the firm how they want to use the money. So in a portfolio arrangement when a funder is providing capital to a firm, the firm does not necessarily need to use that capital, those actual dollars, for the fees and costs incurred on the cases. It might invest those dollars in firm programming, or use the money to pay off debt. And the way the funder is paid back is as these cases resolve and the firm is receiving its contingency fee on any particular case, or perhaps a success fee on a defense case, those monies are used to repay the funder. And so this occurs as the cases resolve. And so there may be instances in which the funder recovers its investment and negotiated return early, and the other portfolio cases continue to progress. And at that point, the firm is able to just recoup the entirety of its fee on those other cases as they resolve. And in terms of what return the funder will seek, its risk is reduced because its investment is now spread over multiple cases. And so the returns can be reduced and sometimes capped, depending on the nature of the particular portfolio. Which is really a benefit to the firm because it's able to enjoy more of the upside of these cases. And we at Validity want to see the firm enjoying the bulk of the fees that it's earned on its good cases. We want the firm to do better than us. And a benefit that the firm will enjoy alongside the reduced returns is that the firm will enter into a transaction with the funder one time, sort of putting the portfolio in place. And cases may be added to the portfolio, which are sort of addressed by a quick amendment to the overall investment agreement that established the portfolio to begin with. So what this means for the firm is that when you go out and you're pitching to clients, you're able to say to your clients, "I can take your good case on a full contingency." And as far as the client is concerned, the only transaction documents are just the standard fee agreement with the firm. The client and the funder are not having to get involved together to negotiate their own investment agreement, because that's already in place between the firm and the funder. And so it really just reduces transaction time and cost, because the arrangement is already in place. This can provide a competitive advantage to the firm because, as discussed, the firm is able to come in and say, "hey, I've got a portfolio in place." "I'm ready to take your case today, and I can take it on a full contingency with your costs covered." And so that really puts the firm at a higher competitive advantage than some of some of its competitors that are coming in and pitching to the same client without this arrangement in place. And I should also add that, of course, you can replace the firm in our arrangement with a client. And so we at Validity and other funders invest in client side portfolios as well. And again, the money is provided to the client to cover the budget for the cases in the portfolio. Client can use those monies however it sees fit. It can pay its lawyers a partial fee. It can use the money to invest back into the company. And then as the client is recovering in those cases, the funder receives its principle and return from that client's portion of the proceeds. So some of the benefits of a portfolio are that it reduces risk. You can minimize the firm's risk across its contingency fee cases. The firm is able to take on new matters on contingency and add them to the portfolio. It really just helps the firm take on more, while also managing its own risk. As mentioned, there's better pricing. The lower risk of the portfolio means that a funder can offer better terms. Again, the firm is able to serve its clients. You're not having to turn away clients that have good, strong cases but just can't pay the firm. And you're able to recruit clients. You've got a portfolio funding arrangement in place. You've got that edge when you're recruiting new clients. Really portfolios can offer all of the benefits of single case funding along with the additional advantage of scale, diversification, and the opportunity for advanced financial planning. So if you're a firm or a client interested in obtaining funding, how does the process work? The process can be broken down into three steps. The first step is the screening stage. This is where you are bringing your case to a funder to determine whether or not it's gonna be right for funding. At this stage, you're typically getting on the phone with the funder. And it can be either the client and the funder, or client and council and funder, and you're sharing basic information about your case. And before we do that, we'll have you sign a non-disclosure agreement to protect privilege. We're promptly doing an initial screening of the case and so that might involve looking at case documents, hot documents, a memo provided by counsel discussing the case. We might get on Pacer and look at case pleadings, just to get a pretty high level determination of whether the case is appropriate for funding. Once we begin to dig in, in this screening phase, we'll typically hold another few calls with counsel where we might ask questions that have arised as we're looking at the case documents. We're also asking council to provide a fee and cost budget, from which we'll determine the amount of our investment. So that's a very important thing to have during the screening process. And the information about the budget is used to determine the amount of the investment. Overall, the large questions that we're asking at this stage are very similar to the questions that a firm might ask in deciding whether or not to take a case on a contingency. So we're looking at the merits, is the law on your side? Is there a viable claim here? But we're also wanting to get information about the parties. Who is the plaintiff? Who is the defendant? What is the background to the dispute? What are the likely recoverable damages in the case? We want that realistic damages number, as well as the kind of pie in the sky higher number. Are we gonna be able to collect against this defendant? What is the collectability analysis? And then, of course, the amount of the funding request, which is tailored to that budget. One note on patent litigation. For patent cases, we'll also wanna know the information that you have on both validity and infringement. On the validity side, we'll wanna know the prosecution history. Have there been any prior art searches done? And a discussion of why the leading pieces of prior art don't invalidate your patents. And then on the infringement side, you should include detailed claim charts comparing the principle claims in your patents against the defendant's infringing uses. Once we've been satisfied at this initial screening stage that your case is good and that we'd like to proceed with funding, we'll put together a simple term sheet which is sent to the client for a single case or the firm, if we're doing a firm portfolio. And it's a non-binding, simple one page document that really outlines just the basic parameters of the investment. So the investment amount and what portion of the fee and cost budget it represents. The return that we'll be seeking. Usually, as discussed earlier, tied to the timing of the resolution of the case. And the waterfall, the waterfall is really just the structure of how distributions are made to the different parties to the transaction. In other words, as case dollars come in, who is being paid what amount and in what order? It tells you the order in which those case proceeds are distributed to the different parties to the transaction. Usually the funder, the client, and the council. The term sheet is non-binding, except for an exclusivity provision. And this is a period of about 30 days in which we ask that we're given an exclusive look at your case. And the reason for this is really just because funders will typically spend quite a bit of time and money looking carefully at a case before the final investment agreement is signed. And we ask that this period of time be exclusive to us so that we're not incurring those costs, only to lose out to another funder. Once the term sheet is agreed to and signed, we're now in the diligence phase. So we're under the term sheet. And this is a period of time, typically 30 to 45 days, in which the funder is taking a deeper dive into those same issues that we looked at, at a higher level during the screening stage. So again, we're assessing the parties, doing background checks, collectability assessment. Doing a deeper dive into the legal issues, both with our in-house legal expertise and then sometimes using outside counsel, in which we'll go and hire a law firm to look at the case with us. We're looking at the damages and whether or not they can be collected. Talking to council about case strategy, what is their plan of attack? And just doing an overall analysis on the likelihood of recovery, looking at the venue. What is the judge's track record, and how do parties fare in that particular court? We try to make the process as non-intrusive to client and counsel as possible, but we are typically asking for calls throughout the diligence period in which we can further vet the case and ask questions as they come up. Once we've concluded the diligence process on our side of things, we're typically presenting the investment to an investment committee within the company to get approval to move forward. We've also, during this diligence period, been negotiating with the client the investment agreement, which mirrors the terms in the term sheet but is a little bit more fleshed out. The idea is for the investment agreement to be fully negotiated and ready to be signed upon approval by the investment committee. So that there's approval, the deal closes quickly thereafter, and then funding can begin on day one. And the client is able to bring their litigation or continue litigation if it's already filed and has progressed. At this point in the process, this post-approval phase, we're really acting as a passive investor. But because we're not counsel to the case and not involved in case strategy, we ask for periodic monitoring calls with counsel so that we can stay apprised on the progress of the case. Just to make sure that it's generally progressing along the lines that we anticipated at the time of making the investment. But this is a relatively passive role, in which we're watching the case and asking for a periodic 30 minute quick call, not a full written report, not a lengthy discussion, just periodic reporting as the case progresses. Once the case is close to being resolved, perhaps it's close to trial and there's a scheduled mediation or there are other settlement discussions, we ask to be kept apprised of those. We don't control those discussions, but we do ask that we're kept in the loop as they progress. And we're happy to provide our analysis and recommendations if asked. So is your case a candidate for funding? As discussed already, there are several things that we're looking for that make a case good for funding. Liability, we'd like to see strong liability on at least one of the core claims or causes of action. Understanding no case is perfect, but we like to see a 65% or more likelihood of success. On damages, we're looking for about a 10 : 1 ratio between the expected damages and the amount that we'll be funding. The reason being that we want there to be enough room for the claimant or client to collect the bulk of the case proceeds. We're looking at collectability. We want a reasonable time to resolution, two to four years versus some types of litigation that can take longer to resolve. And then for patent matters, we wanna see strong infringement reads, prior art search and analysis that dispels validity concerns, limited IPR risk and indicia of success. So in terms of what to submit to a funder so that we're able to get this information. The best way to go about it is a memo that really covers all of these points. We wanna know the background facts. What are the primary documents, contracts, and hot docs? What do they say? A case analysis on liability, damages, collectability, your litigation strategy, including how you're going to pursue the case in a particular jurisdiction, likely time to recovery. And, of course, the budget. Overall, the practice pointers that we provide to clients and to councils is to be prepared in those initial calls to answer these questions. You wanna be prepared on damages because that's gonna be one of the first questions you're asked. You wanna avoid over advocating for your case or your client, just be candid. We all know that cases have wrinkles and it doesn't help the process to hide negative aspects of your case, because we're gonna find them anyway. You wanna make sure that you've got your client's permission before you're sharing confidential documents. Do not share with the funder attorney-client communications, but do provide your analysis and mental impressions of the case. You wanna be prepared to give that budget, as we discussed. And you wanna make sure you're working with a funder you can trust because the relationship is going to be a lengthy one, likely through the course of the litigation. And so you wanna work with someone where there's a good relationship, and that trust is established. So is funding ethical? There are a number of ethical issues that come up and common questions that we're asked related to the use of litigation funding. These can be broken down broadly into two categories. Gating questions, which are, can I enter into this arrangement at all? And process questions, which is how does it work? How can I work with the funder well, while meeting my ethical obligations as a lawyer? So the first gating question is, does litigation finance constitute champerty and maintenance? Challenges to funding agreements are often rooted in these doctrines. These are doctrines that originated in the common law, and they are meant to preclude frivolous litigation. Maintenance is the meddling of a disinterested party to encourage a lawsuit. Champerty is the maintenance of a person in a lawsuit on the condition that the subject matter of the action is to be shared with the maintainer. Although these doctrines are still on the books in some states, the modern trend is for states like New York, California, Illinois, and Texas, to move away from the common law doctrines of champerty and maintenance in favor of the development of modern legal ethics. Courts are recognizing that litigation funders do not exercise control over the litigation. And given the non-recourse nature of the investments, have no incentive to fund frivolous lawsuits. It is currently permissible to engage in litigation finance in 30 states. In the 20 or so states where funding is either questionable or prohibited, funders are typically careful about funding cases. But it's noteworthy that in those cases, champerty and maintenance are not a defense that can be raised in the litigation itself to defend against the claims. It's just a defense against the enforceability of the funding agreement. And the case cited on the slide on champerty and maintenance, Anglo Dutch Petroleum, is one of many cases in which a court has determined that litigation finance does not equal champerty. So the prohibition against fee sharing is another issue that has been raised in the context of litigation financing. Specifically, whether a funding arrangement is subject to rules prohibiting fee splitting between attorneys and non-attorneys. Most jurisdictions have rules regarding fee splitting, as does the ABA and its model rules of professional conduct. Rule 5.4 prohibits fee splitting between a lawyer and a non-lawyer. The purpose being to protect the lawyer's professional independence of judgment. Rule 1.8 does not allow a lawyer to be paid for representing a client by someone other than the client, unless the client has given informed consent. There's no interference with that independent professional judgment or with the client lawyer relationship and information relating to the representation of a client is protected. So how these rules play out in the context of litigation finance. For individual cases, a funder is typically contracting with a claimant and not a lawyer. And so therefore the fee sharing issue doesn't really arise because the funder is receiving its principle and its return from the client, not from the firm's fees. In the case of a law firm portfolio, a funder is contracting with the law firm, but ethicists have concluded that the funding is really more analogous to a bank loan. And because funding is typically collateralized by a number of cases, that independent professional judgment of a lawyer is not really being affected by the arrangement. And thus, the arrangement doesn't run afoul with ethical issues. So does litigation finance implicate usury laws? Again, the answer is no usury is defined as a loan made at an unlawfully high interest rate with an absolute obligation to repay. But because litigation finance, it comes in the form of a non-recourse funding, usury laws are not implicated. And there's a case on this slide, Anglo Dutch Petroleum again, which discusses that a finance agreement was not usurious because there was no absolute obligation to repay. And that obligation was instead contingent upon the funded party receiving a sufficient monetary recovery in the lawsuit. Does litigation finance compromise legal privileges? This is another question that comes up quite often, where attorneys and clients are concerned about the waiver of privilege, such as attorney client-privilege and work product. Better on state rules, of course, prohibit the disclosure of confidential information shared between an attorney and a client, unless the attorney first receives the client's consent. So to avoid waiver, there are a number of steps that lawyers and funders should take to avoid waiving the applicable privileges. First, the lawyer discussing a case with the funder should not reveal confidential information without first obtaining its client's consent. And even then, the funder should avoid reviewing attorney-client communications when evaluating a case in order to prevent a waiver of that privilege. But unlike attorney-client privilege, work product is important for the funder to see to evaluate a case. The body of law that has developed around this allows a lawyer to share work product material with the funder as long as confidentiality provisions, such as an NDA, are in place. The reason being that work product is not automatically waived by disclosure to a third party. It is only where that information is treated in a way that substantially increases the likelihood that an adversary will obtain the material that you have a waiver. Because funders have an inherent interest in maintaining confidentiality, courts have held that there's no waiver with an NDA in place. Disclosure, must lit against disclosed funding arrangements and communications. This is an important question evolving in the courts as well. Generally, funders and clients prefer for the funding relationship to remain confidential. Although the presence of a funder can have the benefit of signaling to a defendant that the plaintiff intends to fully prosecute the case. But it often, if there is disclosure, it often leads to excessive and unnecessary discovery. For the most part, courts do not require disclosure of the existence, nature, or terms of a litigation funding transaction. Most courts find that this is irrelevant to the litigation and likely to unnecessarily increase the costs of discovery. However, it should be noted that there are some jurisdictions in which the local rules allow for limited disclosure of funding arrangements. We've seen this in the district of New Jersey, as well as in Delaware District Court. And because this is something that's continuing to evolve, we would just caution attorneys to check the local rules in which they're trying cases, just to make sure that they're adhering to the disclosure rules in there and plan accordingly. Finally, do funders control litigation? Unlike an insurance company funding defense costs, funders do not control the litigation that they fund. We do not interfere with the trial attorney's professional judgment or that independent decision making. And counsel and clients should be aware, any contractual provisions that you see in a draft funding agreement that limit a client's right to make decisions regarding settlement, these are strongly disfavored and really rarely included in agreements. So while a funder may make recommendations regarding council, a funder is generally not going to restrict a client's right to hire or discharge council. And funders cannot ethically provide legal advice to clients, even if the funders are licensed to practice law. We do not represent the clients in a traditional attorney-client relationship, when it's a funding transaction. And although funders can use their experience to provide input about a case to the client and its attorneys when requested, this is not provided in the form of controlling, in any way, the strategy of a case or settlement at the conclusion of the case. And that is left to the discretion of the client. And that concludes our program. I appreciate your time today. And if you have any questions or thoughts about the presentation, please don't hesitate to reach out to me. Thank you so much.

Presenter(s)

Wendie Childress
Investment Advisor
Validity Finance, LLC

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