In the course of Burford Capital’s nearly nine years in business and in talking to hundreds of lawyers about financing fees and disbursements associated with commercial litigation and arbitration, it has been our experience that quantifying and comparing the relative costs and benefits of financing models is the most effective way to talk to clients about legal finance. Once clients appreciate that external financing addresses several of the perpetual pain points associated with litigation – such as its negative accounting impact and its potential influence on share price – the decision to use legal finance seems simple. Clients who use litigation finance are united less by their need for cash to pay for legal costs than they are by their understanding of the comparative benefits of paying out-of-pocket versus working with a finance partner.
The many variables associated with complex commercial litigation make it nearly impossible to provide off-the-shelf pricing, and no single comparison will apply to every scenario. However, for the purposes of educating in-house counsel about the relative advantages of self-financing versus outside financing, we offer the following hypothetical comparison.
Case study: ACME Co competition claim
ACME Co is a business engaged in the manufacture, distribution and sale of widgets. Several of the company’s suppliers were acting as a cartel and have infringed on competition laws – so ACME considers whether to bring a claim against its suppliers.
Given the type of case and the jurisdiction, ACME’s general counsel estimates the total cost to litigate the claim to be £5m spread over the course of five years, with an estimated potential recovery of £70m in damages. By all accounts, ACME has a viable, NPV-positive legal claim with strong legal merits, substantiated damages, creditworthy defendants that can pay the judgment awarded, and sufficient cost-to-damages ratio given the expected duration.
ACME’s GC recommends moving forward with the claim. However, the GC’s budget is already under considerable stress, and ACME also needs to consider the negative impact of litigation spending on its P&L and market value. Furthermore, ACME’s GC is concerned with the risk of adverse costs in the event the claim is unsuccessful. She estimates the adverse costs exposure at £10m for all the potential respondents. Thus, ACME’s external counsel recommends the company consider using litigation finance to defer the costs of the litigation. ACME contacts a third-party litigation finance provider, explains its case, and receives the following proposal:
- The litigation finance provider will pay the entire cost of the £5m legal budget and disbursements.
- The litigation finance provider will put in place an adverse costs insurance policy with a £10m cover and pay the upfront premium associated with such policy.
- In exchange, if the lawsuit is successful, the litigation finance provider receives its invested amount back and 25% of the net proceeds.After receiving the proposal, the finance team at ACME conducts the following analysis:
Litigation finance eliminates the need for ACME to choose between sacrificing company profits or foregoing a valuable legal claim that will potentially bring a significant sum of cash into the business. Instead, ACME can pursue a profit-generating legal claim while enabling the company to realign budgets so that more cash can be allocated to value-increasing activities – effectively turning the legal department from a cost centre to a profit centre.
| without litigation finance | with litigation finance | |||
| 1) Creation of a legal claim |
Claim cannot be recorded as an asset on the balance sheet. Stock analysts do not account for potential value of legal claim. |
The legal claim asset worth approximately £70m cannot be recognised. | Opportunity to monetise legal assets.
The proceeds can be redeployed in the company’s core business. |
ACME Co uses the £5m that was eliminated from the legal budget to expand production capacity at one of its factories. |
| 2) Necessary legal expenditures | Costs cannot be capitalised, but must be expensed each period.
Reduces operating profit in each period. |
Annual legal costs of £1m, reducing ACME’s operating profit by £5m over five years. | Up to 100% of legal costs covered. | ACME reports better operating margins than it would if it were funding the legal claim itself. |
| 3a) Successful claim | Seen as an exceptional event that is not core to the company’s business activities.
Excluded from forecasts before a victory, not appreciated afterwards. |
The market reaction to the news is far less than hoped, but the company does have £70m to redeploy in the business. | Upside participation in the outcome if the claim is ultimately successful. | ACME receives net proceeds of £46m, over 65% of the original damages estimate.
In addition, ACME receives a costs award against the claimants. |
| 3b) Unsuccessful claim | Questions from the board of directors about the capital seemingly wasted on the unsuccessful claim.
Substantial adverse costs liability to the defendants. |
ACME must pay £15m – its own £5m legal fees and expenses, plus £10m in adverse costs. | Downside exposure mitigated if the claim is ultimately unsuccessful.
Insurance policy, paid for by the litigation finance provider, answers to any adverse costs liability |
No impact on corporate balance sheet because litigation finance provider bears cost; revenue neutral outcome. |