What Are the Operational Advantages of Litigation Funding?
As the use of litigation funding continues to grow, an increasing number of lawyers and business leaders are beginning to realise the obvious benefits afforded by legal finance solutions. Below Lawyer Monthly hears from Andrew Jones, Managing Director at Vannin Capital and Tim Allen, Partner at PwC, on the many advantages of financing legal operations.
The financing of claims by professional funders not only shifts the risk of adverse litigation outcomes away from the claimant but it can also improve access to justice for impecunious claimants and reinforce the quality of the legal team and expertise offered to a claimant. Whilst many will be familiar with these advantages, litigation funding also has a number of other benefits that are arguably just as important to well-capitalised corporate claimants.
Litigation funding offers significant benefits in terms of financial reporting and operations. Funding solutions can create immediate improvements in EBITDA and cash flow, bring greater certainty over forecasts of legal expenditure and divert valuable resources into revenue-generating areas of the business. Critically, third-party funding can enable a corporation to pursue claims that it would not otherwise pursue due to budget constraints, at zero risk and at zero cost.
Transforming legal departments from cost to profit centres
There are many good reasons for a corporation to employ a legal team within its organisation – to ensure legal and regulatory compliance, to advise on contracts and transactions, to defend the organisation against claims and, when necessary, to bring claims. In spite of the important role a legal department plays within an organisation, it is rarely profit-generating and is typically viewed as a necessary cost associated with running a successful business. Litigation funding can help turn this logic on its head.
We see many organisations that may decide not to pursue a meritorious claim because of a lack of available budget. This is entirely understandable. The holders of the corporate purse-strings do not wish to commit millions of pounds in legal fees over a number of years where the outcome is uncertain – which it always will be even for the strongest of cases. The use of third party funding to pursue such claims can thereby create revenue that would not otherwise be generated, with no impact on cash flow or EBITDA. With third party funding also providing a catalyst for driving early and more valuable settlements, the legal department can be turned into a profit centre rather than a cost centre.
Litigation funding therefore unlocks value and enables a corporate to monetise its litigation portfolio in a way not previously possible.
The risk associated with bringing a claim also changes when using third party funding, as the entire financial risk shifts from the claimant to the funder. In addition, the funder’s interests as provider of non-recourse finance are fully aligned with those of the claimant. The funder will only receive a return on its investment if the claimant actually recovers proceeds from the litigation – whether through a judgment, arbitral award or negotiated settlement. If the claim is unsuccessful, the claimant pays nothing, and the funder’s investment is written off. In the case of adverse costs being awarded, the claimant still has nothing to pay because a funding package will invariably include ‘After The Event’ insurance.
Improving EBITDA and financial reporting
The self-funding of claims is usually inherently unattractive to a CFO or Finance Director, as they create significant costs (including adverse costs risk) over a substantial period of time, in return for the pursuit of uncertain benefits.
Self-funding a claim will impact on cash flow and EBITDA and, depending on the scale of the costs involved, will depress the company’s market value.
Litigation funding eliminates these impacts by removing costs from the P&L and the contingency from the balance sheet, and providing greater certainty and predictability over future cash flows. Further, it can drive profitability in the business more widely through the diversion of funds away from legal costs and into core business activities that will generate profit and produce a higher return on capital employed. Because the costs required to finance a legal claim are recorded within a firm’s operating profit/EBITDA, whereas rewards resulting from claims are recorded as below the line exceptional items, legal funding bolsters EBITDA by eliminating the costs of a claim from financial reporting. As a result, this can lead to in a higher level of profitability and a higher market value for the business.
Legal funding: a world of possibilities
Whilst an increasing number of Heads of Litigation or GCs of large businesses are realising the benefits that litigation funding has to offer, there are also tremendous benefits that CFOs and FDs ought to consider. By making the most of these advantages, the financial operations of a company can be further improved and in today’s competitive environment, such margins really matter.
