Businesses have begun to adopt litigation finance as a tool to protect their interests without sustaining the outlay of litigation costs. But what is litigation finance?
At its core, litigation finance is the recognition of a business’ legal rights as assets, which can then be used as collateral for financing. Businesses use financing to sustain their day-to-day operations all the time; why should businesses not utilize the same for their legal needs?
For example, you’ve started a company: you have obtained the venture capital, developed the product, formed an advertising campaign, and started selling. Your company is growing but suddenly you discover that a large corporate competitor has infringed on your trademark and has engaged in unfair competition. Even though you have a strong case, lawsuits can take several months to reach a resolution, meaning you will be racking up legal fees out of pocket, and the large corporation may have deeper pockets to win the war of attrition.
But your company could secure financing in exchange for a portion of the proceeds from your legal claims (should you prevail). Litigation finance shifts the risk inherent in litigation off of your company’s balance sheets by providing capital that need only be repaid if your claims against the large corporation are successful.
Litigation finance may also provide a similar benefit to defendants. Maybe your company is named as the defendant in a lawsuit by a competitor, but you fear that your business cannot handle the costs of defending a lawsuit. Instead, you may be able to secure financing to defend that lawsuit and continue to operate your business, which would then be repaid with interest if you successfully defend the lawsuit.
Moreover, due to the accounting treatment of litigation costs, larger companies—like the defendant in the first example above—may prefer litigation financing even if they can afford the upfront legal costs. Companies record their legal costs as expenses, which negatively impacts their earnings. In addition, successful judgments are often recorded as non-recurring or extraordinary items. Thus, litigation finance may help avoid the negative impact to a company’s operating performance.
Interestingly, Ohio is considered by litigation funders as one of the most attractive states for litigation finance according to one article. Ohio law restricts arrangements between parties and funders but also includes some important consumer protections.
Below are four tips businesses should keep in mind before pursuing litigation finance to meet their legal objectives:
1. Litigation finance is not a panacea.
Litigation finance may not be appropriate in all cases (especially when the potential damages to litigation expenses ratio is relatively low). Your lawyer should be prepared to make a recommendation to you as to whether litigation finance is in your best interest based upon the facts and circumstances unique to your legal matter and discuss practical considerations such as costs and alternative methods of pursing your objectives.
2. The attorney/client privilege may, or may not, apply.
With few exceptions, communications with your attorney for the purposes of legal advice may not be disclosed to other parties without your consent. The interplay between litigation finance and these doctrines is a complex and evolving issue so it’s impossible to make any guarantees. But overall, courts generally have shielded materials regarding litigation finance arrangements from disclosure (including a recent ruling from a federal district court sitting in Ohio).
3. Clients, not financial backers, control litigation strategy.
Litigation financiers will understandably wish to monitor the cases they fund. Monitoring, however, is much different than controlling, and litigation financiers should have no post-investment control regarding the direction of a case or settlement decisions. Clients control those decisions and lawyers’ professional rules to ensure that control of the litigation remains in the hands of parties, not their financial backers.
4. Ensure the confidentiality of your business’s financial information.
Before financing your claim or defense, the funder will likely need to evaluate several components of your business. Some of this information may be highly proprietary and generally not shared outside of your business. Discuss with your lawyer whether or not the information requested from a funder includes your company’s trade secrets and make sure that the funder is willing to sign a non-disclosure agreement before you receive any funds.
Barnes & Thornburg LLP is a large, full-service law firm that seeks to take a more entrepreneurial and cost-effective approach both to client service and its own business.