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Regulations & Trends — Article

4 Trends That Should Define Litigation Finance in 2021

As the close of an unparalleled year draws near, the COVID-19 pandemic continues to affect law firms and corporate clients navigating an uncertain economy. Layoffs and pay cuts remain a possibility for firms attempting to stabilize their balance sheets. Even as clients begin to see growth rebound, they may be slower to pay their legal bills, leaving attorneys caught between the need to collect and the desire to preserve strategic relationships. One survey conducted this year found more than half of law firm executives willing to offer discounts in exchange for early payment.

In reality, many law firms are running up against the same liquidity constraints hindering numerous business sectors. A recent report, in which nearly 50 percent of attorneys claimed they are more likely to seek external capital, shows law firms thinking beyond conventional financial solutions to capitalization problems. As we gradually begin to emerge from the pandemic, we believe third-party litigation funding will help these partners ramp up firm growth and assist clients in securing fair recoveries.

The litigation finance industry remains highly active in terms of demand from funding recipients. Several providers have set ambitious fundraising targets this year, reflecting strong investor interest in the asset class. Meanwhile, courts and bar associations continue to recognize the potential upside of increased access to third-party funding. With an eye toward the pivotal months to come, let us examine how these and other trends may shape the use of litigation finance in 2021.

Steps Toward Market Transparency and Standardization

Skeptics have frequently singled out the opacity of litigation finance. The requisite confidentiality of most transactions precludes the public from knowing which parties have received funding, and at what price and structure. The bespoke nature of litigation finance agreements further complicates matters, as deal terms vary significantly depending on the type of legal claim, the risk associated with the individual matter, and the funder’s investment approach. Estimates of the U.S. litigation finance market’s size even lack consensus.

At the same time, recent developments have given us a glimpse of how the industry might achieve greater transparency. The NYU School of Law’s Center on Civil Justice, for instance, now maintains a dispute financing library that aims to be a “neutral repository for documents and media related to third-party litigation funding,” including statutes, case law, and legislative history. The first large listing of a publicly traded litigation funder on the New York Stock Exchange should lead to greater transparency for investors, as well.

Just as notable is the emergence of a litigation funding working group in Europe, which aims to simplify and expand industry transactions through the use of model documents. The group fuels hopes of U.S. litigation funders relying on more transparent and standardized forms, deal terms, and pricing moving forward. While change will likely come slowly, the assistance of a credible industry association led by its most active participants could one day centralize these efforts. Ultimately, progress in the above areas will equip lawyers and clients with clearer expectations for, and understanding of, litigation finance deal structuring.

The Regulatory Status Quo Persists

U.S. litigation finance is subject to ad hoc regulations that vary from state to state--in some cases greatly. Yet court and bar attitudes toward third-party funding are largely permissive. The events of the past year reinforce this belief, as the practice primarily remains free from federal regulation--despite significant efforts to implement such laws. With state-level decisions continuing to fall in the industry’s favor, we would not expect any dramatic deviation from prevailing regulatory sentiments.

Crucially, legislative attempts to compel court disclosure of litigation funding agreements have stalled, including a bill sponsored by Congressional Republicans as well as the Uniform Law Commission’s yearlong initiative to consider potential litigation funding laws. Defense attorneys seeking to obtain litigation funding documents during discovery have mostly failed as well, with courts typically deeming these materials protected by the work-product doctrine. A high-profile patent case against Google recently saw the Southern District of California deny one such motion to compel production.

Among other significant regulatory developments for litigation finance is the Arizona Supreme Court’s decision to abrogate Ethics Rule (ER) 5.4, which prevents nonlawyers from owning or holding an economic interest in law firms. While the rule change has broad implications for the legal industry, permitting law firms to exchange equity for external capital should enable Arizona attorneys to operate their practices more efficiently and creatively. Litigation finance firms already contract directly with attorneys; in such arrangements, the non-recourse capital received by a law firm is collateralized by the future contingent fees attached to a portfolio of legal claims. The Arizona rule is a further endorsement of such financing models, providing greater momentum to other states seeking to liberalize their legal industries.

Two prominent bar associations also expressed approval of litigation finance this year. The New York City Bar Association, which previously claimed that certain litigation finance deals violate the state’s rules against fee sharing, determined this past February that attorneys and clients benefit from “less restricted access to funding.” The NYCBA’s litigation funding working group also proposed changes to ER 5.4, adding that other measures could address potential conflicts of interest between attorneys and funders. Additionally, the California bar affirmed many of the best practices already employed by litigation finance firms in a recent ethics opinion.

Increasing Participants Leads to Consolidation

Last year, publicly traded Australian litigation finance firm IMF Bentham merged with Amsterdam-based competitor Omni Bridgeway, forming a company with more than $1.5 billion in combined capital. This strategy paralleled that of Burford Capital, another large, public firm that acquired competitor Gerchen Keller Capital in 2016. While both deals are significant, they have been relative outliers in the commercial litigation finance market, even as it expands in the U.S.

Recently, we have witnessed a wave of new players enter the U.S. litigation finance market. Some newcomers have aimed to specialize in certain investment deal sizes or specific types of disputes, such as patent litigation, insolvency proceedings, and cross-border claims. As the number of active commercial litigation funders increases, we believe additional consolidation could occur in our maturing industry, with the market’s largest providers seeking to become “one-stop shops” for attorneys and clients.

Today, U.S. law firms have a number of options when seeking a litigation funding provider. However, this diversity of choice has also created a lack of convenience or consistent expectations for funding recipients assessing potential partners. Expansion of a litigation funder’s geographic reach, in-house expertise, or product offerings could allow growth-minded litigation finance firms to capitalize on these industry dynamics.

As Court Delays Mount, Arbitrations and Settlements Will Increase

The U.S. legal system is not known for its efficiency. Court closures that occurred earlier this year have exacerbated these issues, extending litigation timelines and the already-lengthy waits for trials. With the pandemic ongoing, temporary shutdowns and heightened restrictions remain possibilities for various state and federal courts--even as jurisdictions become more acquainted with new procedures for processing cases and hearings.

These difficult realities have pushed more attorneys to rely on arbitration as a more efficient and cost-effective path toward resolution. In the pre-pandemic world, arbitration may not have been the most expedient option for resolving complex or high-stakes commercial disputes. Amid COVID, however, arbitration has experienced only minor delays, and the entire process can now take place remotely thanks to the widespread adoption of video conferencing technology. Thus, arbitration promises to become an increasingly popular option for litigants moving forward. The number of claimants seeking capital to cover arbitration fees may grow as a result.

As trial delays force litigants to put courtroom animosity on hiatus, settlement may also become more feasible for certain disputes. Clients, forced to put their lives on pause or perhaps dealing with additional financial uncertainty, could reconsider what constitutes reasonable compensatory damages. Plaintiffs, defendants, and their attorneys also have the opportunity to more soberly assess their negotiating positions. This forced pause in acrimony could fuel an increase in settlement discussions.

COVID, Capital, and the Broader Picture

Owing to recent growth, the litigation finance industry possesses a supply of capital that allows law firms and clients to pursue meritorious claims and monetize illiquid assets. We are observing a level of mainstream investor participation in our market that did not exist even three years ago. We anticipate this trend will continue as more investors seek asset classes that could provide returns outside of public capital markets.

Difficult financial decisions lie on the horizon for every industry. As the long-term economic effects of COVID-19 become clear, the need for innovative solutions to traditional litigation cash flow challenges has never been more apparent. The savviest attorneys and claimants will commit to exploring all options, thinking progressively, and acting decisively as they navigate 2021's uncharted waters.