Demarco: “Litigation funding can help balance the scales of justice”
Litigation funding firm Stonward’s director and head of legal assets Guido Demarco explains the sector’s growth and dispels some of the misconceptions surrounding it.
LL: What sort of trends or innovations in litigation financing have you seen in the market recently?
Demarco: Litigation funding (LF) or legal finance is an industry that is growing for many reasons: there is more awareness of the practice among law firms and companies, and the increase in litigation due to the pandemic has meant more opportunities for the industry, as well as new areas to explore, such as breaches of contract, employer responsibility, and supply chain-related claims.
At the same time, this growth is generating concern among policymakers about its impact. During 2021, many jurisdictions regulated the industry or expressed their intention to do so, for better or worse. In some cases, like in Singapore, the regulations have broadened the list of proceedings that can be subject to LF; in others, like in Australia or the state of New York, the new proposed bills try to regulate the fees that funders can charge clients. In the same line, the EU proposed a draft directive that includes extensive regulation of fees, conflicts of interest, adverse costs, the disclosure of the content of the agreement and void clauses, and regulatory authorities, among other things.
We expect that 2022 will bring more regulatory developments, and although stakeholders usually welcome regulation to bring clear rules and transparency into the equation, there are concerns that over-regulation could affect the industry, including access to justice for the claimants. On this issue, the International Legal Finance Association suggested that the regulations proposed by Australia “will add barriers, delays and costs” to the legal system.
A second trend is the rise of antitrust cases, which will also increase demand for LF. The fact that LF can help support the pursuit of class action lawsuits shows that litigation funding can help balance the scales of justice, including consumer and environmental claims.
Finally, the relationship between law firms and litigation funders will continue to develop deep roots. Portfolio finance is already a reality and will only become more entrenched in 2022, with similar cases being combined into “bulk litigation”, which can increase efficiency from a budgetary standpoint, or combine different cases to increase risk diversification.
Are more law firms starting to establish “best friend” relationships with litigation financing firms?
Yes, no doubt this is happening, and we will increasingly see this. Law firms and funders are both in the process of setting up long-term relationships. These partnerships are already a reality in the US and UK. For example, Bench Walk Advisors provided the UK firm Gateley a litigation funding facility, Longford Capital teamed up with Willkie Farr & Gallagher, and Harbour announced a funding venture with Mishcon de Reya. These deals will probably allow the firms to offer flexible fee arrangements to clients and a streamlined due diligence process for the cases, without risking the firm’s budget.
These types of arrangements can definitely bring benefits to clients, but lawyers should also strike a balance to avoid conflicts of interests.
What are some of the misconceptions about litigation financing that you come across?
The first that comes to my mind – because it was recently highlighted by a study on Responsible Private Funding of Litigation carried out by the European Parliamentary Research Service in March 2021 – is the idea that litigation funding can increase “frivolous claims.” This is simply not logical.
The basic argument to dismantle this idea is that no investor wants to lose money. Frivolous means “having no useful or serious purpose.” The industry is and will continue to be highly selective when it comes to investment decisions and funding a frivolous claim means funding a claim without strong merits, which would be like investing in a company that you know will not succeed. Moreover, a party that has received funding will have greater leverage to force a settlement.
Another misconception that fortunately is being debunked is the idea that LF is only for companies that face insolvency or lack liquidity, but the reality is that this tool is also used by companies that prefer to prioritize their financial resources for their core business activities.
How can companies use litigation financing as a tool to help manage cash flows?
Companies use legal finance to help with liquidity problems and/or cashflow allocation, while transferring the risk of complex and long-term litigation, improving the company’s overall financial health.
There are limited resources. When involved in a legal dispute, the CFO and legal director have to decide whether to invest cash in legal services, sometimes with upfront costs, to pay law firms, experts, arbitration tribunals, or legal fees, without being certain that the claim will prevail, or to invest this cash into their main economic activities. Commercial claims can empty a company’s coffers, even in the case of strong and solvent entities. The duration of legal proceedings is also uncertain. Even if companies can make accurate predictions about how long a dispute might last, they can last longer than expected, and usually do.
Litigation finance allows companies to hedge these risks. It also helps improve the financial health of a company, because the expenses incurred by a legal proceeding are usually categorized, as their name indicates, as expenses on the balance sheets of any company.
Litigation financing is relatively new in the Spanish market. What should law firms know about the practice?
Litigation funding is a modern legal tool, but law firms and clients usually expect it to be an expensive one. Once clients and law firms come to understand the true benefits of this tool, this perception starts to change.
Litigation funding allows law firms to offer flexible fee arrangements in a world where clients have started to look at hourly billing practices differently. Operationally, this can be a problem for many law firms that have billing targets for partners and associates. At the same time, it is difficult for a law firm to create an accurate fixed budget for litigation proceedings that are expected to last a long time. Unexpected events could drag a case out for many more years than originally estimated. Clients have also started to demand law firms take their case on a contingency basis pending the result of the case. All of these can be problematic.
Undoubtedly, law and justice have become expensive. This is not new. Adam Smith anticipated this more than 200 years ago when he said that only one law student out of 20 might end up making a living as a lawyer, and one lawyer out of 20 might earn more than the other 19 combined. A lawyer that starts making a profit at age 40 will charge clients not only based on the amount they have invested in their legal education, but also to recoup the costs of the non-profitable lawyers at their firm.
Litigation funding helps clients and law firms breach this gap, allowing clients to retain top law firms in cases where it would otherwise be impossible to do so.
Soon, law firms open to litigation financing will have a competitive advantage over more traditional firms.
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