Speaking Litigation Finance:
A Lexicon for Lawyers

The losing party is sometimes expected to cover some or all of the winning party’s litigation costs, referred to as the “adverse costs.” In exchange for the payment of a premium or other compensation, a third party agrees to pay any adverse costs awarded up to a pre-agreed amount. It is especially common in the English legal system, where the default rule is “loser pays,” or in arbitrations where the rules provide for it. Litigants in American cases sometimes seek an adverse costs indemnity where the contract being litigated contains a “loser pays” cost-shifting provision.

Parties sometimes seek insurance after the event giving rise to the litigation has already occurred. ATE insurance is most commonly obtained by claimants to protect against an adverse costs ruling, but can also be obtained by either party to cover their own legal fees and disbursements usually up to up to a specified amount in the event that the policyholder does not prevail in the litigation.

AFA is an umbrella term for any alternative to the traditional law firm model of billing by the hour. A simple example is a contingency fee, where the claimholder’s counsel receives a portion of the amount recovered. Other alternative fee arrangements include fixed fee, capped fee, and success fee agreements. Litigation funding can be used in conjunction with an AFA to offer a total litigation financing solution to a client.

In August 2020, the American Bar Association published a report recommending “best practices” for litigation finance. The recommendations cover (1) disclosure, (2) documentation and structure, (3) professional responsibility, and (4) privilege and work product. The report has some shortcomings, but its publication reflects the growing demand for litigation funding and the increased importance of litigation finance to the broader legal profession.

Litigation funding can be valuable at various points in the lifecycle of a case. Even where a claimholder self-funded the trial phase, it may be useful to seek litigation funding for the appellate phase. A funder can finance the costs of an appeal and/or purchase an interest in some or all of the claim. For example, if the claim achieved a favorable outcome at trial but is now facing a potentially lengthy appeals process, litigation finance can offer a way to monetize the judgment immediately and infuse the company with capital while the appeal is pending, while mitigating the risk of the appeal. Bankruptcy trustees can also use this tool to accelerate payouts to estate creditors.

Claimholders in both domestic and international arbitrations routinely turn to litigation finance. Funding by third parties is a broadly accepted tool in both international commercial arbitrations and in treaty claims brought by foreign investors against sovereigns. Third-party funding in arbitration can take the traditional form where a funder provides capital to cover the fees and expenses of an arbitration or claimholders sometimes turn to funders to monetize favorable arbitral awards immediately, rather than bear the uncertainty of lengthy enforcement efforts that may span multiple jurisdictions.

Litigation finance is useful in a variety of corporate liquidation or reorganization scenarios. It can preserve or increase estate resources (including through the sale of the estate’s litigation assets) and enable additional recoveries. Financing can be helpful for creditors in intercreditor disputes and is especially useful for a litigation or liquidation trust seeking to prosecute ongoing claims.

Funders may charge a break-up fee to a claimholder who walks away in the middle of the funder’s diligence process. This term is offered by Lake Whillans instead of an exclusivity arrangement. This fee helps the funder recapture the value of the time and resources it has invested in underwriting the claims in the event the claimholder secures funding from another source or determines not to proceed with the funding.

Champerty is an old English law doctrine prohibiting third parties from maintaining a suit in return for financial interest in the outcome. The U.S. federal law and the law of many U.S. states do not prohibit champerty. Some states, including New York and Illinois, retain prohibitions on champerty but have construed it narrowly, such that the most typical litigation funding structure is allowed (i.e., partial assignment of proceeds in exchange for value). The general trend at the state level is toward abolishing or limiting the champerty doctrine.

Some claimholders prefer to receive a payment earlier in the litigation, rather than waiting out what can be a yearslong litigation and appeals process. In this scenario, the funder will pay a portion of the anticipated recovery directly to the claimholder based on the claim’s expected value and time to resolve. The claimholder can then use the payment for any number of corporate purposes, such as operating expenses or servicing debt. Claim monetization can be partial or complete and used in conjunction with financing of the litigation costs.

The damages, settlement amount or any value received as result of a successful lawsuit are referred to as the claim proceeds. In a claim brought with the assistance of litigation funding, a portion of the proceeds is owed to the funder to cover the cost of its invested capital plus a return.

The claimholder is the person or entity that alleges injury and has a legal claim for damages based on that injury. Claimholders can be plaintiffs asserting claims, or defendants asserting counter or cross-claims. Litigation funders alleviate the financial burden of litigating the claim, enabling the claimholder to achieve an eventual recovery (or at least mitigating the financial risk of an unsuccessful suit).

Commercial litigation finance refers to the funding of claims brought by one company against another, typically with a claim value in the millions of dollars. This should be distinguished from consumer litigation funding, a different business that relates to lower-value suits brought by individual consumers.

Contingency fees are the most common alternative to the traditional model of lawyers billing clients by the hour. In a contingency arrangement, counsel is paid only if the client’s case succeeds. The law firm receives a portion of the amount recovered in the litigation, often as a percent of the recovery or sometimes as a multiple of deferred fees.

Damages are the amount of monetary harm that a litigant has suffered as a result of the actions at issue in a lawsuit. In a funded claim, the litigation finance provider typically collects its returns from the damages recovered in the suit. The size and certainty of damages affects the amount of funding available and the pricing of the investment.

Most litigation funding agreements provide funding for plaintiffs to pursue their cases. But defendants also engage in litigation finance transactions. For example, litigation finance may be attractive to a defendant when the litigation involves a dispute over rights to a revenue producing asset or contract. In this situation, the funder can provide capital to pay for litigation fees and expenses (and potentially to help support the company’s operations), and the funder collects its returns from the future revenue derived from the asset. Litigation finance may also be useful to a defendant if the defendant has valuable counterclaims that it can assert in a litigation.

After the parties execute a litigation funding agreement, the funder will set aside funds sufficient to cover its entire projected investment (this full amount is called the “reserved facility”). Payments from the reserved facility are disbursed to the claimholder or to the claimholder’s counsel in accordance with the litigation funding agreement.

Prior to making an investment commitment, a litigation funder conducts a due diligence process in which it seeks to verify that the underlying facts and law support the proposed claims. The length of the diligence period varies with the complexity of the case, but 30-45 days is the typical range.

Lawyers typically have a duty not to disclose to others any confidential information received from the lawyer’s client in the course of the representation. Reputable litigation funders will subject themselves to a similar obligation. Confidentiality is a core pillar of the Lake Whillans Code of Conduct.

Some funders require a claimholder to contractually commit, prior to the due diligence process, to negotiating only with that funder for the duration of the due diligence. This is to protect the funder’s investment of time and resources to diligence the claim. This is referred to as a period of exclusivity. Not every funder requires exclusivity (Lake
Whillans does not require it, but would instead negotiate a break-up fee).

The reserved facility is the amount of funding set aside to cover a funder’s entire projected investment in a case or portfolio of cases. (One area for a claimholder to diligence regarding potential funders is whether the capital promised will be there when needed). The size of the facility is important because it has implications for the minimum return that the funder will be prepared to accept in the event of a successful litigation outcome. When the funder commits funds to the facility, it cannot spend them on another investment, so in general, the more funds that are set aside (whether spent by the claimholder or not), the more costly the investment for the claimholder.

Professional ethics rules generally prohibit lawyers from sharing a portion of the fees they receive from their clients with other non-lawyer professionals. Opponents of litigation finance have argued that funding a portfolio of cases litigated by the same law firm is incompatible with the fee splitting prohibition. The claim is that in order to pay the funder its return, the law firm effectively splits fees with the funder. Although some professional ethics bodies have endorsed this argument (including, notoriously, the New York City Bar Association), the majority view is that portfolio funding is not incompatible with fee splitting prohibitions.

Not every defendant promptly pays the damages that a court or arbitration body has ordered it to pay. Instead, there is sometimes an additional round of post-judgment/post-award activity required to enforce and secure a recovery. This stage can be costly and carry risk if the defendant is resisting enforcement, hiding assets, or has assets in multiple jurisdictions. Enforcement of international arbitral awards against sovereigns often require enforcement proceedings. One of the use cases for litigation finance is to fund the judgment enforcement process in exchange for a share of the proceeds recovered. (An alternative for these parties is judgment monetization.)

Where a claimholder has secured a favorable judgment or arbitration award, but is facing a long and uncertain enforcement process, monetization may be an appealing option. In this scenario, a funder will pay the claimholder a portion of the judgment or award immediately, giving the claimholder valuable liquidity in the short term and fund the
enforcement proceedings. In exchange, the funder will be entitled to some or all of the amounts ultimately recovered through the judgment enforcement process.

In a law firm portfolio financing, a funder invests in a portfolio of cases to be litigated by a law firm. The firm may be able to use this capital to prosecute the cases, pay the recurring expenses of the firm, smooth cash flow, and/or grow the firm while the cases are ongoing or simply hedge the firm’s risk. The funder recovers its returns from the law firm’s fees earned from the portfolio of cases. This type of funding can be particularly useful for firms litigating cases that could be many years from resolution.

Legal finance is essentially a synonym for litigation finance or litigation funding. It is an umbrella term that applies to a variety of deal structures in which a litigation funder provides capital and collects its returns from the proceeds of legal claims.

Litigation Expense Financing is a specific subset of litigation financing where a litigation funder provides capital to a claimholder or law firm for only the litigation expenses. Litigation expenses include, among other things, discovery costs, expert costs, filing fees, and travel expenses. This type of financing is usually used when the fees of the litigation are covered through a full contingency arrangement.

Responsible litigation funders place ethical considerations at the core of their operations. These ethical considerations include, among other things, maintaining confidentiality, attorney client privilege, and attorney work product protection; ensuring that the litigation funder does not interfere with lawyers’ ethical obligations to their clients; and complying with applicable legal and regulatory rules.

A litigation funding agreement will specify the return on investment that the funder is to receive in the event of a successful recovery. There are various ways to structure a funder’s return on capital: the funder may receive a fixed or increasing multiple of the amount invested (either measured by the facility size or the amount disbursed), or a percentage of the proceeds from the litigation. A funding agreement may specify a combination of both approaches. The risk of the investment and time to return will drive the pricing required by the funder.

Disclosure refers to the voluntary or obligatory revelation to a court, arbitrator or tribunal that a claim is being funded by a third party (and by whom). In most U.S. jurisdictions, such disclosure is not required. But local rules may mandate disclosure in some instances. For example, the Northern District of California requires disclosure of a funder’s identity in a proposed class action, and the rules of multiple arbitration institutions now require disclosure. The scope of required disclosure varies.

A litigation funder is an entity that makes non-recourse investments in legal claims. The investment enables claimholders to cover the costs of litigation. If the claim succeeds and the claimholder achieves a recovery, the funder is entitled to repayment of its investment plus a return.

Litigation funding enables claimholders to pursue their claims without investing their own capital in litigation fees and expenses. In its simplest form, a funder agrees to fund the costs of litigation in exchange for a portion of the proceeds from a successful recovery. If the litigation fails, the funder is entitled to nothing. There are a number of reasons why claimholders turn to litigation funding.

Prior to funding a case or portfolio of cases, a litigation funder negotiates an agreement with the claimholder or law firm that is to receive funding. The agreement specifies the terms of the investment, including details such as how much the funder will commit to the case, when funding will be disbursed, and how the funder’s return will be determined in the event the litigation achieves a recovery, and the
“waterfall” or distribution priority of any proceeds among the funder, lawyer and client. The agreement includes a number of other terms that can differ by funder.

Litigation risk refers to the uncertainties that are inherent in litigation. When a claimholder decides to bring a claim, it cannot be sure how long the litigation will take, how much it will cost, and whether it will yield any recovery. Litigation finance enables claimholders to transfer this risk to the funder. If the litigation is unsuccessful, a funded claimholder does not have to pay back the funder’s investment.

Maintenance is an old English law doctrine similar to champerty. It restricts non-parties to a litigation from intermeddling in the litigation. U.S. federal law and the law of many U.S. states do not prohibit maintenance. The general trend at the state level is towards abolishing or limiting the maintenance doctrine.

When the Professional Ethics Committee of the New York City Bar Association opined that arrangements where funding is provided to law firms to finance a portfolio of cases on a non-recourse basis violate Rule 5.4 of the New York Rules of Professional Conduct, the Committee’s analysis was widely criticized. The Bar Association formed a Working Group to study the issues further, and, in 2020, the Working Group released a report advocating changes to Rule 5.4 to facilitate access to litigation funding.

Litigation funders routinely enter into non-disclosure agreements (NDAs) with claimholders and law firms prior to conducting due diligence on the claims. Such an agreement will prohibit the funder from disclosing to third parties confidential information received from the claimholder or law firm. Courts have held that the existence of an NDA in a litigation funding relationship helps to preserve attorney work product protection.

Litigation funding is typically provided on a non-recourse basis. This means the funder recovers its returns only from proceeds from the litigation. If the litigation does not produce proceeds, the funder does not collect any returns. The non-recourse nature of funding transfers risk from the claimholder or law firm to the funder.

An advantage of litigation funding is that it enables a corporate claimholder to eliminate litigation expenses from its financial statements. When a company funds litigation costs itself, it may be required to report those expenses on its income statement as an expense against profits. The value of a litigation is typically not reflected on the company’s balance sheet. By financing the litigation, a company can eliminate litigation expenses that drag earnings.

The most basic way to structure a funder’s return is as a percentage recovery. Some litigation funding agreements provide for the funder to receive a percentage of the amount recovered in the litigation (either on a gross basis or net of the return of disbursed amounts also repaid to the funder) as the funder’s profit on capital. The funder’s share of proceeds may be subject to a maximum dollar amount, or the percentage may decrease as the award size increases.

In a portfolio financing deal, the funder invests in a set of claims either held by the same claimholder or litigated by the same law firm where financing is provided to the claimholder and law firm respectively. The funder’s return depends on the success of the portfolio as a whole. By aggregating claims, a claimholder can generally obtain funding at a lower cost of capital: the funder is willing to accept a lower return because investing in a portfolio is less risky than investing in a single claim with a binary outcome.

Some litigation financing agreements provide for the funder to receive a multiple of its investment amount as the funder’s return on capital. For example, if the funder invested X and the litigation achieves a recovery, the agreement may entitle the funder to the return of its capital (X) plus a multiple of 2X. The parties may agree that the amount invested (X) is measured by either the facility size or the amount disbursed.

Litigation finance enables the risk that would typically be borne by the claimholder alone (in an hourly fee arrangement) or counsel alone (in a contingency fee arrangement) to be shared with a third-party funder. By
sharing some of their risk, claimholders and/or counsel can narrow their range of potential economic outcomes, trading some upside for a reduction in downside risk.

In a Lake Whillans transaction, the claimholder generally retains full freedom to decide whether to accept any settlement offer. As part of the diligence process, Lake Whillans estimates and discusses with the claimholder what a reasonable settlement might be and only makes an investment if the economic terms of the deal allow the claimholder to share the benefit from such settlements. Most reputable funders will seek to control settlement directly. However, some may include punitive economic terms or “hammer terms” if reasonable settlements are rejected by the claimholder as incentive to accept settlement offers.

Some alternative fee arrangements include an additional amount to be paid to the lawyers upon success of the litigation. The success fee is usually coupled with a full or partial discount provided by the law firm of its hourly billing rates. For example, a firm may discount its fees by 20% in exchange for a success fee of 2x the amount of fees not paid due to the discount in the event the case is resolved favorably. Where litigation funding is used by the claimholder in these arrangements, the litigation funding agreement will specify the priority or parity of payment between the funder’s return and the law firm’s success fee from any litigation proceeds.

After an initial review of a case, but before conducting full due diligence, a funder will typically provide a term sheet to the claimholder or law firm. The term sheet will detail the key terms of the transaction that the parties would enter into if diligence confirms the funder’s preliminary understanding of the case. The term sheet ensures that both funder and claimholder are aligned on the structure of the investment prior to undertaking due diligence.

Third-party funding is a synonym for litigation funding or litigation finance. Third-party funding is a term typically used in relation to funding of claimants or respondents in international arbitrations.

A funder may not disburse its full commitment to the claimholder or counsel in a single upfront transfer. Disbursements may be made in smaller blocks, known as tranches.

The waterfall is the order of payments to be made to different parties (i.e., funder, counsel, claimholder) in the event of a recovery in a litigation or arbitration.

Work product produced by or at the direction of a party’s counsel in litigation may be protected from disclosure under the attorney work product doctrine. If the work product is shared with a third party in a manner that makes it substantially more likely that the work product will fall into the adverse party’s hands, the work-product protection may be waived. The trend among courts that have analyzed work product shared with a litigation funder pursuant to a non-disclosure agreement is to hold that there is no waiver of the work product protection.

Some litigation funding deals will fund more than just litigation expenses. Where the claimholder or law firm needs working capital to pay expenses associated with general business operations, the funder may in appropriate circumstances provide that working capital. Even though the working capital may be used for non-litigation expenses, the litigation funder will recover its returns solely from the proceeds of the litigation or arbitration.