Navigating the Growing World of Litigation Funding and Contingent Risk Insurance

As 2024 is well underway and we enter the second quarter, the U.S. economic outlook remains mixed, with the economy showing signs of resilience and growth but also facing inflationary pressures, supply chain disruptions and geopolitical uncertainty.

Within this context, the U.S. legal market has fared relatively well, with rates increasing on average 6 percent in 2023 and demand strong in litigation, antitrust, M&A and restructuring. But declining realizations and productivity threaten law firm profitability. And clients, facing an uncertain economy, are putting pressure on firms to keep their budgets and legal costs in check. Indeed, the recent Thomson Reuters “Report on the State of the U.S. Legal Market” reports that clients are increasingly moving work to lower cost law firms or demanding capped or alternative fees from outside counsel.

As firms seek to enhance profitability while clients struggle to control legal costs, litigation finance can serve as a tool to offload legal spend, mitigate risk and increase revenues for both stakeholders. Indeed, as reported in the 2023 “Westfleet Insider 2023 Report on Litigation Finance,” more and more firms in the AmLaw 200 are seeing these benefits and utilizing funding, accounting for 35 percent of new deals in 2023.

Another tool that has emerged in recent years is contingent risk insurance. Over the past few years, contingent risk insurance has risen in prominence in the litigation finance world as an alternative or companion to traditional litigation finance.

This article provides a summary of the ways that clients and their counsel can use these tools to enhance revenue growth while controlling costs and mitigating the risks inherent in litigation.

Litigation finance has become a permanent feature in the U.S. and Texas legal landscape. At its core, litigation finance is any transaction in which a litigation claim secures financing. Funds are provided on a non-recourse basis and the funder’s return depends on the outcome of the litigation. It comes in numerous forms and at any stage of litigation, from pre-filing to post judgment. The most common uses of funding are single-case funding, portfolio funding and claim monetization.

Single Case Funding

Funders often provide single case funding to clients for the fees and expenses associated with pursuing a litigation claim. For a high-stakes commercial claim, this can mean millions in legal fees and costs, including the costs of expert witnesses. Clients often either don’t have the capital to pay a full litigation budget or just as often, they have the capital but need to preserve it to reinvest in their business rather than in yearslong litigation.

Typically, single case funding involves a funder paying the full (or nearly full) amount of the cost budget and a substantial portion of the fee budget with the law firm taking the remaining portion “on risk” or on a partial contingency basis. Or sometimes law firms may elect to take a case on a contingency basis, but their clients seek funding for case expenses. The funder pays the fees and costs as they are incurred (often enhancing realizations for the firm) and receives a return out of the case proceeds upon resolution, but only if the case resolves successfully. If the case is unsuccessful, the funder does not recoup its principal or any return. Meanwhile, the law firm typically receives a portion of the upside or case proceeds from a successful outcome as well, but it will have received part of its hourly fee along the way regardless of case outcome. Most importantly, the client will have received the benefit of a full contingency arrangement with its preferred trial counsel, with little or no out of pocket spend. This structure helps the client reduce risk and litigation costs while pursuing a meritorious claim and helps the law firm represent its good client, mitigate risk and still share in the upside of a successful outcome, enhancing profitability.

Portfolio Funding

Portfolio funding involves financing multiple litigation or arbitration matters in a single transaction. The funding amount is typically still tied to the case budgets, like single-case funding. However, in portfolio funding, funders will invest in a group of cases at once, with any one of combination of those cases serving as collateral for the return. Just as with single-case funding, the investment is nonrecourse and the funded party — either a client or law firm — is not obligated to pay a funder’s return unless the portfolio yields positive case outcomes. Moreover, the law firm handling the cases recoups a portion of its fees as they are billed during the pendency of the lawsuits.

Funders invest in client-side or law firm-side portfolio transactions. For corporate clients, the underlying cases are typically a series of plaintiff-side affirmative claims that the company wishes to pursue, although the portfolio can include defense-side cases as well. For law firms, the portfolio will include cases that the firm is handling on a contingency bases for one or several different clients, with its anticipated fees from the cases serving as collateral for the investment. Such an arrangement allows the firm to offer its clients a full contingency arrangement, while mitigating that risk through a portfolio in which it recovers a portion of its hourly fees as they are incurred. As reported in the “Westfleet Insider,” portfolio transactions accounted for 66 percent of new commitments in 2023.

Claim Monetization

Clients and law firms increasingly are seeking to monetize both pending claims and post-trial judgments and awards. Claim monetization refers to an investor providing capital to a plaintiff in advance of the resolution of its claims — in essence turning a legal claim into a financial asset. Claim monetization accounted for 21 percent of capital commitments in 2023, up from 14 percent in 2022.

Like litigation finance before it, contingent risk insurance has become a prominent feature in the litigation landscape. But, despite an offering of various insurance products, most practitioners know little about what it is or how it can be leveraged. 

Litigators are familiar with general liability insurance policies. Contingent risk insurance policies are something very different. They are bespoke, case-specific policies, tailored to the specific legal issues and facts of specific cases, lawyers, parties and risks involved. They are available to plaintiffs, defendants, their counsel and, as discussed further below, even their funders. These policies not only can provide an efficient mechanism to remove risk but increasingly have become a way to make capital more accessible to litigants and their counsel. 

Types of Contingent Risk Insurance

Although each insurance policy is tailored to the risk at hand, there are some basic policy structures that serve as building blocks to more complex policies.  These are useful in understanding how contingent risk insurance policies can be structured. They include: 

• Judgment Preservation Insurance (JPI)  allows a plaintiff or counter-plaintiff to insure all or part of a damage award while an appeal is pending or, depending on the strength of the case, before judgment is even entered. This can be utilized in litigation and arbitration. 
• Adverse Judgment Insurance (AJI)  is a form of insurance that guarantees a certain amount of coverage to a defendant in the event of a final, adverse judgment against it. A type of this policy is often used to facilitate the completion of M&A transactions when there is pending litigation against the seller and the buyer does not want to assume the risk of an adverse judgment. This type of policy basically ring-fences a certain legal exposure.
• Contingent Fee Insurance  provides a company or law firm with downside protection to prevent a total loss of expenses or work in progress incurred in the prosecution of litigation by insuring some portion of the attorneys’ time and case costs.
• Capital Protection Insurance  can be used to protect the investment capital used to fund a case or group of cases against an adverse ruling in the litigation.

Generally, there can be no loss under these policies unless and until the judgment or award is final or a case is fully resolved and there is no longer any chance of further appeal. If the insured party (or party aligned with the insured) does not prevail at the end of the day, then the policy covers the loss. As with funding, insurance policies can be written for a single case or a portfolio of cases. The premium charged for the policy is a percentage of the overall coverage and is dependent on the contours of the specific risk.  There is no standard market rate. 

How to Know When to Seek Out Funding or Insurance

Armed with the knowledge that both funding and insurance exist, what determines whether one (or both) are appropriate for a particular case or portfolio of cases? Although both funding and insurance seek to shift some of the risks inherent in litigation, they involve different considerations for both the funder and the funded and the insurer and the insured.

In turn, some cases may be more appropriate for funding than insurance or vice versa. And some cases may be appropriate for a combination of funding wrapped with insurance. Having a sense of the differences will help determine which path to pursue. 

For the client and counsel, the most prominent consideration is whether capital is needed immediately or whether they merely seek to lock-in the value of a case or the fees associated with it. If it is the former, funding may be more suitable; if it’s the latter, insurance may be worth considering. At the most basic level, funding is money-in, while insurance is money-out. The trade-off depends on which door one chooses. 

While traditional litigation funding is generally made on a nonrecourse basis, at no upfront cost to the client, insurance policies require that some, if not all, of a policy’s premium be paid to the insurer before coverage is bound. Without money in hand to pay the insurance premium, insurance may not be a viable consideration (unless, as discussed below, the client is able to obtain premium finance which allows the client to obtain a policy at little to no out-of-pocket expense).

In this regard, another key consideration is the overall cost of the capital.  When a case receives funding, the trade-off for the immediate access to funds on a nonrecourse basis is having to share a non-insignificant portion of case proceeds with the funder if the case is successful. This can be up to two to three times the amount of the funding given. Insurance coverage, on the other hand, usually does not involve any sharing of proceeds, or, if it does, the percentage of recovery shared is far less and only occurs in the event the litigation is successful. Instead, for a premium amounting to only a portion of the recovery, insurance preserves the status quo and gives the insured some certainty as to the economic impact of the litigation.   

Another consideration in choosing between funding and insurance is the role the funder or insurer may play in the overall litigation. Generally, litigation funders have no control over how the cases in which they invest are litigated. This is a key characteristic of the funding relationship. The funds are deployed on a nonrecourse basis. Even if the funder disagrees with a case strategy or settlement decision, the funds have been deployed for full use by the client and counsel and the funder has no say. Insurance policies, however, may contain exclusions for coverage such that certain strategic decisions may not be covered. In other words, while insurers also generally have no control over the litigation, certain strategic decisions by the client or counsel may result in there not being coverage in the event of a loss, but that is ultimately the insured’s choice and is determined by the express terms and exclusions of the policy. 

It is also important to note that not all cases or risks are appropriate for contingent risk insurance. First, cases that involve treble or punitive damages may be more attractive to a funder than an insurer. While a funder would share in the upside of such large damages, an insurer likely doesn’t want to share in the downside. Second, while a relatively new case that is in the prefiling or pretrial stage may make for a worthy investment for a funder due to the outsized potential reward, the legal and factual issues may not be sufficiently developed in order for an insurer to guarantee a particular result at the end of the case. Third, while collectability is generally inherent in the risk assumed by funders, insurers are generally not comfortable with collection risks and may exclude the collectability of a judgment from a policy’s terms. Finally, while case duration may be material to a funder’s investment decision since it affects overall returns, it may be likely less significant to an insurer and any durational risks can be built into a policy’s terms. These are just some of the many factors that funders, insurers, clients, lawyers and brokers may take into consideration in deciding how to proceed.

Emerging Issues: Blended Funding Families

One other alternative to consider is combining the funding and insurance.  This emerging solution is being seen more and more in the market and may increasingly become the norm. 

A capital protection insurance policy, for example, can be used as collateral with a third-party lender to create a more efficient cost of capital to the company or law firm utilizing the funding. A funder can obtain a judgment preservation policy seeking to insure recovery in a case or portfolio of cases. A litigant can obtain premium financing whereby the funder provides the capital to pay for the policy premiums and is repaid either through case proceeds or policy proceeds if there is a loss. There is great flexibility and creativity in this market, and it is only growing. 

At the end of the day, both funding and insurance are tools available to clients, law firms and funders to solve for the economic realities in the market. While there are many different considerations involved in deciding whether certain risks are more suitable for insurance or funding, the traits they share are the most critical to watch for. To be insured or funded, cases must be strong on the law and the facts; they must involve strong counsel in a solid jurisdiction; and the interests of all involved (client, counsel, and funder or insurer) must be aligned such that everyone is motivated and invested in a positive outcome for all. 

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This article was originally published by The Texas Lawbook.

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