Dispelling the 10 Myths about Alternative Litigation Finance

While Alternative Litigation Finance (ALF) has been in broad use in the U.K. and Australia for over a decade, it has only become a common tool for funding lawsuits in the United States in the past few years. American lawyers and businesses are growing more sophisticated in their understanding of the practice, but misconceptions still abound. Here, we address 10 of the most common concerns.

Misconception 1: ALF encourages frivolous lawsuits

Cases that pass muster with funders must meet rigorous standards during the course of due diligence. The most significant areas of consideration by funders are:

  • The legal merits of the case. Models for vetting these merits involve analysis of each matter by legal experts hired as consultants and, in some instances, by former judges and carefully selected jury pools.
  • Recoverability of assets and the perception of risk. Even the strongest case isn’t worth pursuing if it doesn’t provide a return. Funders will check carefully that a particular defendant has sufficient assets to pay a claimant, and that it will be possible to obtain a damages award following a successful verdict.
  • Track record of the potential client. If the client has had historic success with similar cases, this makes the client more attractive to funders.

The bottom line is that funders only want to invest in solid cases with a strong chance for a favorable outcome. In the United States, of the thousands of cases filed each year, only a small fraction are deemed worthy of external financing by the commercial funding industry. This counters the notion that ALF is causing a surge in litigious activity.

Misconception 2: Funders influence legal proceedings

Funders are not involved in any way in the day-to-day proceedings of lawsuits, nor do they interfere in the attorney-client relationship. A litigation funder’s role in a funded matter typically involves a stipulation that legal counsel must notify the funder of any settlement offers from the opposing party. Both the ABA Commission on Ethics 20/20 Working Group and the New York City Bar Association have considered issues around transfer of control as it relates to litigation funders at great length, and neither body found a fundamental issue to exist.

Misconception 3: Litigation funding is a loan

ALF is nonrecourse, meaning that if the case does not result in a settlement or award of damages, the party who received the funds to pursue the claim does not have to repay those funds.

Misconception 4: Commercial litigation funding is the same as consumer legal funding

In the United States, legal funding has historically referred to funding related to plaintiff personal injury claims, which make up a significant portion of civil litigation.

Commercial litigation financing (as opposed to consumer legal funding) is available only to businesses and law firms in connection with commercial litigation or arbitration. It addresses complex, meritorious claims in business disputes where the costs of pursuing such cases are extremely burdensome. Unlike consumer funding, commercial funders provide capital for all or a portion of the legal expenses. And again, commercial litigation finance is nonrecourse: Once an ALF company has deemed a case worthy of funding, it does not require repayment on its investment should the case eventually fail.

Misconception 5: ALF is one-size-fits-all financing

Like any other financing vehicle, ALF is flexible. Broadly speaking, it is a way to finance litigation assets. The combination of downward pressure on in-house legal budgets and the continued rise in fees for outside counsel will likely lead to more companies becoming increasingly sophisticated in their understanding of alternative means to finance litigation.

The process of ALF is effective in aligning the interests of clients, their counsel and those of funders. Agreements can be tailored to the estimated length of the litigation and to provide funding in tranches so additional capital is made available at particular milestones in the litigation life cycle.

Misconception 6: ALF is not for companies who can afford to pursue legitimate legal claims

ALF allows companies to pursue meritorious claims without tying up corporate funds in expensive, protracted litigation. This makes ALF an attractive proposition even for well-capitalized companies, as it removes accrued litigation costs from balance sheets and litigation costs from income statements. Thus, pending claims can be viewed just like any other corporate asset that can be financed. As a result, capital can be allocated in ways that contribute to the economic health of the corporation.

Misconception 7: Big Law doesn’t need ALF

Large law firms can realize a number of advantages from using ALF. Practice growth is chief among them: Lawyers can take cases from existing clients who otherwise could not devote the financial resources to pursue legitimate claims. In addition, ALF provides the firm with opportunities to serve new clients with meritorious litigation that otherwise could not be pursued with adequate financial support.

Misconception 8: ALF is only available before litigation begins

Litigation financing ensures that lawyers can pursue the best outcomes for their clients while maximizing their firm’s investments. ALF may be an ideal solution for firms and their clients faced with financial shortfalls in a number of phases:

  1. Pre-Complaint Phase. At this point, a litigation funder can fill a dual role. First, through due diligence, it can provide an objective, scientific assessment of a claim’s merit, anticipated jury or arbitration verdict, and potential damage awards. Second, it can fund the litigation as it moves forward.
  2. Complaint Filed. Only after a firm has been retained and fees advanced for initial filings do many clients confront the serious financial commitment required by commercial litigation legal budgets. Client hesitation brought on by a lack of funds at this stage can result in forfeiting a potentially winning case. Introducing third-party funding to provide nonrecourse financing can help the client avoid the financial risk inherent in facing a large, financially strong litigation opponent.
  3. Discovery. A variety of factors can cause litigation costs to expand unexpectedly during litigation. Hiring the necessary experts and/or wasteful defense strategies can accelerate costs and deplete budgets. Litigation financing can be used to continue the fight and send a message to opposing counsel that a war of attrition will not be successful.
  4. Pre-trial. After discovery, parties must be capable of proceeding to trial, or face deeply discounted settlement offers based on the perception that parties cannot afford a trial. ALF at this stage can support protracted battles where they are necessary. With ALF, attorneys can pursue a full judgment while limiting the client’s financial risks.
  5. Trial. When trials drag on beyond expected timelines, even the most conscientious clients may find that funds allocated for litigation have been exhausted. ALF provided at this phase can help attorneys bring the matter to a final judgment or the greatest settlement offer possible. An added advantage of obtaining funding in later stages of a dispute may be greater room to negotiate rates and terms based on the substantial investment already made by the firm and client.

Misconception 9: Funders provide capital but no other value proposition

ALF provides benefits far beyond the injection of cash to a case. Tremendous value is offered when funders provide to counsel and their clients a sophisticated third-party’s impartial and critical review of the claims at issue. Such an early case assessment provides numerous benefits including:

  • An acceleration of the case learning curve, allowing for crucial information to be obtained before the law firm agrees to assume the financial and reputational risk of the representation.
  • A data-driven analysis of and insight into a claim’s viability.

Once the firm accepts the case, the process of ALF continues to be advantageous. Each funding firm may offer a unique value proposition that could help strengthen the case.

Misconception 10: Using outside funding reduces the chance of settling a case.

The cases funded by third parties are able to proceed long enough for their true merit to be demonstrated, meaning clients are receiving fairer settlements than they otherwise would.

Those that receive money are able to fight—and fight longer—in meritorious suits against opponents with seemingly inexhaustible resources. ALF supports exactly what the American judicial system should encourage and promote: access to the courts and a fair chance to prove a claim in dispute.