The Jockey in Third Party Finance
By Selvyn Seidel
Posted: 29th July 2015 09:08To many investors in third party finance, if not most, the magnet attracting them to a claim is not any specific aspect of the claim itself. Rather, it is the prosecuting lawyer. The lawyer is the jockey mounted to ride the claim to success. An experienced and skilled rider can make the difference. That is particularly the case when U.S. lawyers are involved, and U.S. lawyers are the focus of this article.
Long before riding the race, and at the investing stage, the lawyer is critical. He or she has done the all-important analysis of the claim’s evaluation and mapped its strategy. The investor must trust that analysis and the lawyer doing it. While the investor will most likely eventually bring in its own lawyers and experts to diligence the case, that expensive and time consuming investigation is only undertaken if the investor believes enough in the claim.
The belief very much turns on the persuasiveness of the prosecuting lawyer’s analysis. All that goes into an investor’s trust and belief in the lawyer’s analysis — such as the lawyer’s reputation, responsiveness, and commitment to the claim; the lawyer’s credibility, conscientiousness, distinction, plus those of the lawyer’s law firm; and the chemistry between the lawyer and investor — come into play here.
Early on especially, the investor places great weight on the time the lawyer and firm have spent reviewing the case. This indicates how reliable the analysis is. Indeed, if for no other reason, this exercise reveals the depth of a lawyer’s commitment to the case, since it is usually done on a contingency or partial contingency basis, reflecting the lawyer’s willingness to put “skin in the game.” Some investors will not even take a peek at a case unless a lawyer has been actively involved.
Shapes and Shades
Jockeys come in many shapes and shades. Each must be evaluated and retained in light of that specific shape and form, and how they fit with: the unique claim and claimant at hand; as well as the unique investor involved and that investor’s preferences or requirements.
Within this context, we also see a quite – limited number of lawyers, and law firms, taking active affirmative steps to become user-friendly to attract financing to their cases, as well as to attract new clients and cases needing funding. They see the benefit to their clients and their business. They are going up the experience and skill curve in their mission to achieve a solid competitive edge in a new world.
That task is a full time job. Law firms are working within a developing and changing context — often dramatically, virtually day by day. It is no small chore for each of the stakeholders to stay abreast. The law service industry’s ability to keep up, let alone excel, is indispensable. That ability will determine whether a law firm and lawyer will make the grade so far as the investor is concerned.
Risk and Cost
The lawyer’s willingness to share the risk though its fee structure is key. A lawyer prepared to discount fees such that a loss in the case means at least a partial loss for the lawyer, is perhaps the most tangible evidence of that lawyer’s faith in the case. Of course the flip side of a discount is a serious premium if the case is successful. The premium is considered by the investor as well as the discount, in measuring the lawyer’s belief in the case. Some investors will not even consider a claim where the lawyer is not prepared to take a risk with the investor.
The lawyer’s fee is usually divided between the investor and the claimant. That division holds its own importance in the investing world. Typical questions and factors resulting in sharing agreements are in summary form illustrated below.
First question: what fee-discount will be accepted by the lawyer and investor? In the past, lawyers typically were asked (usually required by the investor) to work with a discount in the range of 25% of standard rates, and to settle for that fee if the claim were unsuccessful. If the claim were successful, the lawyer would receive the balance of the fee, plus a premium of about 25%.
This structure has the attraction for a lawyer in that even in a loss situation, the lawyers should make a profit from the work, while the lawyers could look forward, based on their analysis and choice of the case, to earning a premium with every win. In the end, this situation, properly managed, should result in higher returns for the lawyer than simply charging the lawyer’s standard rates.
This attractiveness was and is heightened in an environment where law firms have weathered a stormy economy, leaving them on the lookout for work. The storm, while partially abated, is a ways from being over. It is leaving behind changed financial and legal industries.
Earlier on — perhaps five or six years ago — lawyers were by and large wary of litigation funding. That attitude has changed markedly with increased knowledge, understanding, and acceptance, of third party finance, coupled with the ongoing lack of sufficient legal work.
As time has passed, the funding basic fee platform has changed. Investors have sought a deeper discount, often in the 35% to 40% range (if not higher), with a corresponding increase in the premium on success. At the same time, and perhaps in some ways as a result of the deeper discount required, law firms are more frequently now asking for something beyond a premium, but also a percentage of the recovery. That percentage has a wide range — as illustrations: it can easily be between 3% and 10%.
The investor usually does not object to this percentage but can support it. Why? Because the percentage is something the claimant, not the investor, is asked to pay. Receipt by the law firm of this percentage might also, as indicated above, contribute to the law firm’s willingness to take a steeper discount, all to the investor’s benefit.
The percentage can, in addition, support an investor’s requiring the lawyers to agree to other contributions. In this sense, there are two common potential concerns that investors, and claimants, always face with lawyers’ fees.
First, there is a runaway-fee hazard. Neither the investor nor the claimant wishes to be a victim here. Investors typically ask for and get strict budgets for the work, and the lawyers’ agreement to meet them. If exceeded, that is work the lawyers agree to absorb, without charge to the investor or claimant. Ceilings on fees are, in one form or another, imposed.
Second, we see the “waterfall issue”: On distributions from a success, a waterfall is set governing who gets paid first and as a priority, who gets paid second, and so on. Investors will want that distribution to be first and entirely to them, until at least a certain healthy profit is assured. This is a safety net crucial to investors. It protects them from a disappointing recovery, since they can still do well, while little or nothing is left for the lawyers or the claimant.
This issue is especially acute when the law firm is a “contingency law firm” working on a full-contingency base as to fees (and with some firms, also as to out - of - pocket expenses). That firm is usually committed and used to getting paid first out of any recovery.
The tension can be expected in many if not most cases. It is more severe when the investor is particularly concerned about security in getting the investment back, plus a reasonable profit, rather than an outsized return. The tension naturally becomes less severe as the likelihood increases of a recovery that will be enough to satisfy all the stakeholders.
One important caveat to this should be self-evident, but is worth emphasizing: lawyers need to be able to perform and compete as jockeys, but they should as a rule stay away from also trying to assist in finding and negotiating financing for their client. That is usually outside their competence. Trying to assist on the financing side also draws them into the complicated land of lawyer’s ethics, and duties owed by a lawyer to a client. Potential and actual conflicts alone present a scary land-mine of fault areas.
See e.g.,Selvyn Seidel and Sandra Sherman, Lawyers’ “Competence” in the Funding World, New York Dispute Resolution Lawyer (Fall issue, 2014); See generally, Information Report to the House of Delegate, American Bar Association Commission on Ethics 20/20 (February 2012); For a significant Bar Association opinion on Legal Ethics in Funding, see N.Y.C. Bar Ass’n Comm. on Prof’l and Judicial Ethics, Formal Op. 2011-02 (2011).
The litigating lawyer is of dead-centre importance to the financing industry. In ways, that lawyer is the “straw that stirs the drink”. The more this is understood, and the better the stirring, the better off for all.
Selvyn Seidel is the Founder, and Chairman of Fulbrook Capital Management LLC; and the Co-Founder, and former Chairman of Burford Group Inc. Neil Mitchell, the President of Fulbrook, provided valuable assistance for this article.