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Funding Insights — Article

Law Firm Funding Offers Path to Client Acquisition, Retention

In recent years, legal industry pundits have frequently commented on “the death of the billable hour.” While many commercial attorneys do utilize engagement structures that cater to undercapitalized clients, the hourly model persists because it is profitable, familiar, and less risky.

In fact, traditional billing has sharpened at U.S. law firms according to a 2018 Reuters report, which found that partners’ average hourly rates have increased three times faster than inflation over the past two decades.

Current market turbulence has perhaps made the billable hour even more attractive to law firms, considering the attendant risk of alternative fee arrangements (AFAs). However, the threat of protracted economic recession has also made cost certainty a priority among commercial clients, who may scrutinize the traditional law firm business model when facing budget constraints.

Projections shared by Thomson Reuters already forecast MidLaw and BigLaw demand to fall 8% and 15%, respectively, relative to Q1 2020. A decline in economic activity, coupled with the expensive, time-intensive, and unpredictable nature of litigation, will compel legal claimants to consider new methods for reducing their financial risk, if it has not already.

Instead of resisting this powerful dynamic, law firms should view it as an opportunity to fortify existing client relationships and outmaneuver their competitors. Working with a third-party litigation funder can position forward-thinking partners to meet both goals by accommodating a broader range of clients and improving litigation outcomes, while also reducing law firm risk exposure.

Client Preferences Amid Economic Recession

In the face of significant business disruptions, corporate spending has contracted in several industries, prompting legal departments to seek rate discounts, fee deferrals, and AFAs from outside counsel.

Competition in the legal industry should continue to grow as firms vie for potentially high-value breach of contract, bankruptcy, and insurance litigation work related to COVID-19. As social distancing measures hinder attorneys’ abilities to travel and make regular court appearances, and as jurisdictions grapple with case backlogs, justification of hourly rates becomes more difficult.

These realities promise to strain reliance on the traditional hourly model as it did during the Great Recession of 2008, when corporations turned increasingly to AFAs to reduce legal expenses. According to an ALM Intelligence survey, 62% of law firms increased AFA billing in 2010-11, with roughly three in four law firms using some form of contingent fee arrangement at that time.

In the same report, 91% of law firms cited “attracting or maintaining clients” as a key driver of AFA usage. Considering the cost transparency, predictability, and risk-sharing benefits these billing structures can provide, we can reasonably anticipate that AFA adoption will accelerate in the coming months.

While experience shows clients prefer AFAs during economic downturns, the transition away from the traditional billable hour can be difficult for law firms. Agreeing to deferred payment of any kind requires counsel who possess confidence, competence, and capital. Law firms providing these arrangements, however, can use bespoke litigation funding solutions to lessen AFA-related risk exposure.

A Partnership With Litigation Funders

Typical litigation finance arrangements provide capital to plaintiffs, who use funding to cover legal fees or business operating expenses. However, law firm funding allows funders to offer non-recourse capital directly to attorneys. The investment is collateralized against a group of lawsuits or the firm’s entire collection of cases, enabling law firms to reduce financial uncertainty and bridge the gap between client engagement and collection.

Historically, bank loans and other conventional lines of credit have proven time-consuming and costly for law firms to obtain. In addition, banks largely will not accept unearned contingency fees as collateral in exchange for credit, instead requiring mainstream collateral as well as personal guarantees from the partners of the law firm. Law firms are therefore left without efficient access to capital, which they could use to litigate more cases or reinvest into their practice.

For decision-makers who prefer to avoid saddling the firm with traditional debt, non-recourse litigation funding—where the funder only receives a return following a successful recovery—enables law firms to operate on a current cash basis without fixed payments or absolute obligation to repay the principal.

For example, a firm representing several promising but costly contingency matters could shift an interest in those cases to a litigation funder, which would receive a portion of the portfolio’s financial recovery. In return, the firm receives capital to cover key client expenses, including those associated with protracted cases or costly expert witnesses.

Non-recourse funding thus allows attorneys to navigate cash flow uncertainties associated with contingency fees and other AFAs, even if every case in the portfolio resolves unsuccessfully. Additionally, partners may reinvest third-party capital into the firm, using it to fund new practice groups, recruiting, marketing, and client retention strategies.

Competitive Differentiation and Client Satisfaction in 2020

Because litigation funders operate on a “no recovery, no pay” basis similar to contingent fees, agreements with the proper safeguards in place allow for alignment among the funder, the law firm, and the involved clients.

All three parties have a common, vested interest in the outcome of the litigation, allowing attorneys to pursue damages that truly reflect the merits of their clients’ legal claims. Fairer recoveries lead to more satisfied clients, which in turn can produce long-lasting client relationships and referrals.

In this way, law firms that thoughtfully leverage AFAs and litigation funding can position themselves to win new engagements from competitors that cling to the traditional and familiar, fueling growth in 2020 and beyond.

Download LexShares' complimentary litigation finance guide to learn how funders make investment decisions, the current regulatory environment in the U.S., the investment process, and more.

Reproduced with permission from Copyright [Year] The Bureau of National Affairs, Inc. (800-372-1033) www.bloombergindustry.com.