Traditional Litigation Funders
The best-known litigation funders are traditional litigation finance companies. Traditional funders invest primarily in legal claims and have built up vast experience conducting diligence on cases, structuring agreements, and spotting issues that commonly crop up when investing in a claim or group of claims. These companies are often structured similar to hedge funds and invest capital on behalf of clients, though there are notable exceptions to this rule. For example, a company could be publicly traded and invest its own capital and that of its private investors.
There are many benefits to using a traditional litigation funder. Most obviously, since they invest almost exclusively in litigation assets, they know how to structure a transaction and the various pitfalls to avoid. For example, a traditional litigation funder will almost always require a counterparty to enter an NDA before sharing documents or other information, in order to protect the confidentiality of any information shared. These funders also stay up-to-date on new rulings and developments in the litigation finance field. Finally, these funders will not include terms in their contracts designed to control litigation or settlement discussions.
Additionally, a traditional litigation funder provides the claimant and their attorney with an objective and well-informed assessment of the case. Each traditional litigation funder is staffed by former attorneys who perform thorough diligence on the cases they consider financing. While this process can be time-intensive, it provides a comprehensive review of the merits of a potential case. Even if the funder doesn’t ultimately invest, the claimant leaves the process better off, having a clear understanding of the strengths and weaknesses of its case.
Finally, after an investment is made, traditional funders continue to monitor the litigation and, at the counterparty’s request, help litigation counsel talk through various legal issues that arise. At the litigator’s request, these funders may also moot arguments for the cases they fund and provide input on legal strategy. Importantly, since the funders do not control the litigation, they cannot direct legal strategy. Rather, these funders often fashion themselves like an outside litigation expert that can help the litigating attorneys work through issues they otherwise might not see.
In addition to these benefits, litigants should also consider many of the drawbacks to working with traditional litigation funders. The biggest (and one that should be at the top of every users’ mind) is the cost of their capital. Simply put, money obtained from traditional litigation finance companies is not cheap. Traditional litigation funders typically charge more for their financing than hedge fund or family office competitors, which often have greater pricing flexibility. In contrast to those providers, litigation funders are beholden to demanding investors. Indeed, when working with a funder, it is imperative to understand that the party seeking financing is not a client of the funder. Rather, the funder owes duties to its investors to get the best possible terms.
Another drawback relates to the financing process, which is not customer-friendly. The financing process is byzantine, overly complex, and opaque. Funders are often slow to respond and consistently need to secure internal approvals before providing terms, executing a term sheet, and agreeing on final terms. A simple transaction that should take a few weeks at most can often drag on for months due to these administrative issues. Additionally, given that funders are run primarily by lawyers, the underwriting process frequently gets bogged down in discussions about peripheral legal risks of the case, resulting in a robust back and forth between the funder and litigation counsel. This slows down the transaction and, if a case is not properly presented to a funder, can result in the rejection of a case that might otherwise be suitable for financing.
Another source of capital for litigation finance deals are traditional multi-strategy hedge funds. Over the past few years, as litigation finance has grown in popularity, multi-strategy hedge funds have begun operating in the litigation finance space with regularity. Indeed, many of these hedge funds have dedicated desk space to serve the litigation finance space.
There are several notable advantages to working with a hedge fund that has a dedicated litigation finance desk. First, like a traditional litigation funder, these hedge funds will know the latest developments in the law and will make sure to enter into an NDA before reviewing documents. Second, hedge funds are generally substantially cheaper than a traditional litigation finance company. This is because the hedge fund can access many pools of capital that do not require set returns. Accordingly, unlike some traditional litigation finance providers, the hedge fund can match price to the overall risk of its investment. Finally, most hedge funds have a better litigation funding process—not requiring, for instance, multiple levels of approval before executing a term sheet or concluding a deal. Accordingly, they generally can execute a deal more quickly than a traditional litigation finance company.
Nevertheless, there are some downsides to working with a hedge fund. First, the investment minimum for these hedge funds are generally substantially higher than a litigation finance firm. A hedge fund might want to invest a minimum of $15 million in a transaction, whereas a traditional funder is often willing to make a $1-2 million investment. Second, many of the hedge funds with dedicated litigation finance desks do not publicly advertise their existence, meaning that a claimholder cannot directly approach these hedge funds. Thus, a knowledgeable consultant may be necessary to mitigate this disadvantage. Finally, many hedge funds do not have teams of lawyers tasked with keeping tabs on the cases once the investment has been made. Therefore, the hedge fund will not be as involved as a traditional funder in helping to formulate legal arguments. As such, parties who view the funder as a partner in the litigation rather than a mere source of capital might be better off choosing a traditional funder, despite the significantly higher cost of capital.
Alternative Sources of Capital
Outside of the traditional litigation funders and hedge funds with dedicated litigation finance desks, there are some other alternative sources of capital. Generally speaking, these alternative sources are either wealthy individuals, family offices, or other hedge funds without a dedicated litigation finance desk. These alternative sources tend to be less sophisticated than the other options and far more diverse in their make-up.
While it’s difficult to generalize about this group, there are a few advantages to working with an alternative source of capital. First, they have varying minimums and maximums for litigation finance transactions. Those looking for funding on a smaller investment might have success looking at these ad hoc players. Second, they are open to different financing structures and have more flexibility on pricing, as many do not have a set return they are looking to obtain. Finally, they are, at times, quicker to close a litigation finance transaction than their more traditional counterparts, as they do not require multiple levels of approval to close.
There are also drawbacks to dealing with an alternative source of capital. First, there is a concern that, in the event of negative case developments, they might decline to fund in order to “cut their losses.” Second, these ad hoc sources of capital are generally not familiar with the funding process. Accordingly, before working with these sources of capital, attorneys and claimants need to make sure they enter into an NDA, are up to date on case law developments, and know the problematic terms a party seeking financing should avoid when entering into a litigation funding contract. Additionally, like hedge funds with dedicated desks, these ad hoc sources do not extensively monitor their investments, meaning that they will not offer the same input as a traditional litigation funder might on litigation strategy. Finally, these ad hoc sources do not advertise their existence, making them difficult to identify.
While the traditional litigation funders are well known, sources of litigation financing go well beyond dedicated litigation funders. There are many benefits to using the traditional litigation finance providers, which are often rooted in their knowledge of the market and their ability to conduct diligence on a case. Those same benefits can be obtained by working with someone knowledgeable about the litigation finance space. Given the rapidly expanding nature of the litigation finance space, one thing is clear: claimants and their attorneys have a wealth of options—pricey, confusing, and little-known as they may be—from which to choose.