Legal Funding 101

Last Updated March 30, 2016

What is legal funding?

Legal funding is the act where a third-party unrelated to a lawsuit provides money to a party involved in a lawsuit in exchange for a financial reward. The financial reward is paid by the party involved in the lawsuit to the legal funder upon either the conclusion of the claim or the refinancing of the original investment. Legal funding unlocks the monetary value of legal claims for plaintiffs by providing capital to plaintiffs while their claims are pending.

By advancing capital in exchange for the promise that the money advanced (together with interest) will be paid back investors access a highly profitable asset class (i.e. the future payout of a lawsuit recovery).

Types of legal funding?

There are three primary types of legal funding: (a) consumer funding (i.e. direct plaintiff funding), (b) litigation cost funding and (c) law firm line of credit.

Consumer Funding (Direct Plaintiff Funding)

In the consumer funding scenario (known as direct plaintiff funding on Trial Funder) a third party makes a cash advance to a plaintiff in an existing litigation. The plaintiff uses the cash advance to pay for their living expenses, and agrees to repay the funder the amount of the advance, together with interest that accrues on the advance until the date of repayment. This is the most developed type of legal funding in the industry, and generally results in the highest returns to investors. Plaintiffs typically accept cash advances of between $2,000 and $15,000, and repay investors the principal amount plus interest accruing at between 3.5% and 7% compounded monthly. The effective annual interest rates on these investments are usually between 51% and 156.52%. Since this type of legal funding is non-recourse, it is not subject to usury laws. It is considered “non-recourse” because the plaintiff is only required to repay the legal funder from the proceeds of a refinancing or any future recovery.

Litigation Cost Funding

In the litigation cost funding scenario the investor advances capital to a plaintiff’s attorney to cover ongoing litigation costs and expenses. The money is typically spent on hard costs of litigation like experts, court reporters, videographers and investigators. In some scenarios the advanced proceeds may also be used to pay for attorney and paralegal fees of the plaintiff's law firm. Investors in this type of legal funding have historically been hedge funds, specialty funding groups and alternative litigation finance funds. Plaintiffs generally apply for funding with the assistance of their attorneys. Once a funding agreement is executed the funder makes periodic advances directly to the plaintiff’s attorneys to cover costs as they are incurred. In exchange for this type of funding, the plaintiff will agree to pay back the funding amount, plus either (a) interest on the funding amount or (b) a percentage of the recovery. Most legal funders require the attorneys to subordinate their attorney lien on recovery proceeds to the legal funder’s lien on the recovery proceeds. Since this type of legal funding is also non-recourse, it is not subject to usury laws. It is considered “non-recourse” because the plaintiff is only required to repay the legal funder from the proceeds of a refinancing or any future recovery.

Law Firm Line of Credit

In the law firm line of credit scenario, a traditional licensed lender will make a revolving line of credit available to a law firm. A revolving line of credit is like a credit card with a maximum amount of credit available. The law firm can use the line of credit to pay for law firm business expenses, or ongoing litigation expenses, as the law firm choses. Just like a credit card, if there is a balance on the line of credit at the end of the month, the law firm will be required to pay interest on that balance. The annual rates charged by lenders for law firm credit lines range from 3.5% to ~22.5% depending on the creditworthiness of the law firm borrower. The lender will assess the creditworthiness of the law firm by reviewing the firm’s balance sheet, and may require credit enhancements, such as personal guarantees or additional collateral (like a mortgage on real property). Law firm lines of credit are typically full recourse obligations, which means that the firm (and usually all of the partners) are personally obligated repay the borrowed amount, regardless of the financial performance of the law firm or their recovery with respect to any particular lawsuits.

Benefits of Legal Funding

Investors
Attorneys and Law Firms
Plaintiffs

High Demand for Capital in Litigation Industry

The demand for capital in the litigation industry is at an all-time high, and driven both by plaintiffs and their law firms. Plaintiff Demand for Capital

Plaintiffs primarily need capital to fund their living expenses while they wait for a recovery in connection with an ongoing litigation. As discussed above, this is known as consumer funding (and alternatively direct plaintiff funding). Injured plaintiffs are typically unable to work and therefore are unable to pay their bills. Sophisticated defendants are aware of this and take actions which delay the outcome of litigation, in order to induce financial hardship on plaintiffs. This makes plaintiffs more likely to accept lower settlement offers. Legal funding to cover a plaintiff’s living expenses reduces the plaintiff’s financial hardship. More sophisticated defendants are using these types of delay tactics now than ever before, and as a result the demand for this type of legal funding has grown exponentially over the last few years. Plaintiffs sometimes need legal funding to cover the costs of litigation. As discussed above, this is known as litigation cost funding. This type of funding is required where the hard costs of litigation (i.e. expert witnesses, deposition costs etc.) are high and a plaintiff firm is not willing to self-finance all of the costs of litigation. The increasing cost of litigation has created a huge demand for capital to fund litigation costs. Attorney Demand for Capital

Litigation is expensive. The expense of litigation is high for defense law firms, but the potential costs are even higher for plaintiff law firms that typically get paid only from successful outcomes. Plaintiff law firms cannot afford to lose, especially if the firm has invested significant amounts of time and money in the litigation. Law firms prefer litigation cost funding over high interest lines of credit that are typically personally guaranteed by the partners of the firm and secured by the firm’s assets. The increasing cost of litigation, together with the lack of institutional sources of capital, has created a huge demand for capital to fund litigation costs.

Parties involved in Legal Funding

Investors

Investing in legal claims allows investors to buy a stake in the future payout of a litigation. Trial Funder connects investors with pre-vetted investment opportunities. For more information about how Trial Funder helps investors invest in legal claims click here.

Plaintiffs

A plaintiff in a lawsuit is a party that has claims against the defendant. Plaintiffs want funds to finance their living expenses, and in certain cases the costs of the litigation. For more information about how Trial Funder can help plaintiffs click here.

Attorneys and Law Firms

Attorneys are the first parties to a legal funding transaction to underwrite a lawsuit. Attorneys also assist investors in the lawsuit underwriting process by providing investors with information about claims. When a settlement is reached the settlement proceeds are deposited into a client trust account controlled by the attorney. The proceeds are then disbursed to investors on the recovery, and then to the plaintiff once the liens are paid back. For more information about how Trial Funder works with attorneys and law firms click here.

Ethical Considerations: Is investing in litigation permissible?

Investors have been investing in legal claims for many years. The majority of states allow litigation investment and permit attorneys to abide by contracts creating a lien on the plaintiff's recovery from litigation funding companies.

There is no federal law prohibiting investment in litigation, and it is a relatively under-regulated industry at the state level.

Attorney Fee Sharing

When structured properly, investors are not engaged in attorney fee sharing, which is prohibited by attorney ethical rules. A proper investment provides for the investment returns to be specifically taken out of sums which are separate and distinct from attorney fees, so as to not implicate fee sharing.

Champerty and Maintenance

Historically, alternative litigation financing was prohibited by the champerty doctrine, which broadly defined is financing someone else’s litigation for profit. It is a holdover of English common law, and arose in medieval England as a way to protect small property owners from the predations of feudal lords, and it was based on the idiosyncratic political economy of the time. However, in recent years many states have specifically discarded the doctrine. In particular, it is universally accepted in most jurisdictions that while there may be prohibitions to the assignment of the claim itself, this prohibition does not apply to the assignment of the proceeds of the claim, which are freely transferrable. Most states currently allow champerty and maintenance.

Attorney-client Privilege

The attorney-client privilege requires the attorney and his/her law firm to keep confidential all communications between client and attorney. It applies to the attorney and their staff who work on the case. Courts have recently held that the privilege also applies to litigation finance transactions. In Mondis Technology, Ltd., v. LG Electronics, Inc., 2011 WL 1714304 (E.D. Tex.) a court refused to compel production of documents provided to investors. In Devon IT,Inc., v. IBM Corp., 2012 WL 4748160 (E.D. Pa.), a Pennsylvania court held that discussions by attorneys and litigation investors are subject to the work-product doctrine, protecting them from disclosure.

Trial Funder employs highly skilled and experienced attorneys to review cases brought for investment. We keep the information confidential and are often able to evaluate a case without the need to access confidential or privileged information. Our team of legal experts are careful to limit the disclosure of information so that only information that is already publicly available is displayed on our website when a case listed.

Approximately 30 states have issued ethics opinions approving of legal funding. Here are some:

  1. California Bar
  2. Florida Bar
  3. Los Angeles County Bar
  4. New York State Bar 2003
  5. New York City Bar 2011

Additional Resources

As the legal funding industry continues to grow, prominent legal scholars have considered the business, legal and ethical considerations of the field. Below are included some of the preeminent examinations of the legal funding industry.

  1. Steven Garber, Alternative Litigation Financing in the United States
  2. American Bar Association Commission on Ethics 20/20 White Paper on Alternative Litigation Finance
  3. Anthony Sebok, The Inauthentic Claim, Vanderbilt Law Review (2011)
  4. Maya Steinitz, Whose Claim Is This Anyway? Third Party Litigation Funding, Minnesota Law Review (2011)