In for a penny

Litigation funding for larger value cases is in good supply at present. Indeed, the prospectuses for any litigation fund in their fundraising stage reveal that the statistics and assumptions applied to their anticipated portfolio relate to large disputes where the funding returns are significant.

However, at the other end of the dispute resolution spectrum capital demand is high but supply is low. Three main reasons account for the shortage. The economics do not fit with the funder's model. For example, if the damages are worth £4m and the funding requirement is £750,000, a funder charging a 2.5x multiple on their investment (i.e. £1.875m) still leaves the client with just over half their damages. Whereas if the case is valued at £300,000 and the funding requirement is say £100,000, a 2.5x multiple would leave the client with £50,000 which is very little by way of recovery.
The economics would clearly be unacceptable to a claimant. Equally most funders would not entertain such a deal as they would not knowingly want to contract for a majority interest in a case.

Most funding companies are relatively small businesses. The actual number of full-time members assessing cases is often small (between two and four individuals on average). When faced with ten large value cases and ten smaller value cases, time will be applied to where the funders can make the largest return. Some smaller cases can require substantial due diligence for a much smaller potential reward.

Most funders are under pressure to deploy their capital. Investors in litigation funding companies do not want their money sitting idle. This places pressure on fund managers to deploy capital swiftly but without compromising the quality of the risks. A funder could fund 20 smaller value cases, which notionally sounds positive, but if those 20 cases only utilise a small share of the investors' capital the fund managers won't be praised at year end.

Investment savvy

There is a market to fund smaller cases but lawyers have to be smart about how such cases are presented to ensure the best chance of securing funding.

The first hurdle is to understand the economics. If the damages are modest then clearly requesting full funding is unrealistic, indeed the fact it is even suggested may put off prospective funders. We have seen applications where lawyers have requested funding of £200,000 for a claim worth £200,000 at best; the request is totally unworkable.

Where margins are tight there may be a different way of structuring a package which makes the deal work. For example, using our previous £300k claim value example, a workable solution may be possible using a combination of the following:

restricting the funding request to £30,000 to cover the most pressing cash calls (e.g. expert fees);

using an alternative billing arrangement to make an element of the solicitor's own fees conditional upon success; and

ATE insurance to cover the element of own fees or disbursements that is not funded by the client or the funder such that they can be deferred until damages are recovered or paid by the insurer if the case is lost.?

Clearly the solution is not as ideal for the law firm as a fully-funded option. Unfortunately the funders cannot change the economics.

The next difficulty is finding a funder willing to commit such a small deployment. This is where further thought must again be given to the presentation. A well-presented application which minimises the need for further questioning by funders, perhaps with the confirmation of interest from ATE insurers, may be enough to tempt some funders into quick consideration of the case.

You might argue that if funders were not so greedy the economics might work better but, unfortunately, the truth is perhaps best summarised by one prominent funder who told a conference recently, 'We don't exist as a substitute for legal aid, we exist to make a return for our investors

For the funding market to become mainstream for smaller value cases, two things need to occur:

1) law firms need to be more realistic at the application stage; and

2)wyers and their clients need to encourage competition between funders. This will put pressure on price.

Portfolio arrangements

Portfolio funding solutions have been the subject of much hype lately. Conceptually, there is some sense in financing a basket of cases to reduce the overall cost per deal. However, if the funder's security is non-recourse, the significant challenges over the economics remain. There are additional problems for funders:

most firms will not have maintained or been able to maintain a suitable track record that will apply sufficiently to the dynamics of the new regime;

there will be uncertainty over case profiles;

funders themselves lacking experience of funding cases on a 'basket' basis.

?As it's an emerging market, law firms have the additional conundrum of not knowing whether they are locking themselves into a deal prematurely, when a more suitable option might be just around the corner.

We are some way off having a stable and tested model for portfolio funding.

The funding market for smaller value cases does exist. It is at an early stage of development. Lawyers would be best advised to keep a watchful eye on market activity and be careful not to lock in to any arrangement without a thorough analysis of all the options.