Exploring Litigation Funding in the COVID-19 Era

The following post contains a transcribed portion of the live webinar "Litigation Funding in the COVID-19 Era," hosted and recorded by Womble Bond Dickinson.

The speaking panel included Matt Reason (VP of Investments and Partnerships, LexShares), Ted Farrell (Founder, Litigation Funding Advisers), and Ross Weiner (Legal Director, Risk Settlements), and was moderated by Womble Bond Dickinson partners David Carter and Cathy Hinger. In this partial transcription, which has been edited for clarity and length, Mr. Reason describes LexShares' approach to litigation finance.

David Carter:

Hello everyone, and thank you all for joining us and participating in today's webinar about litigation funding in the COVID era. Today's webinar is part of a series of educational offerings being made available by Womble Bond Dickinson to help businesses respond to and anticipate the changes that the coronavirus pandemic and associated stay-at-home orders are having on the way in which businesses operate. I encourage you to visit the firm's hub on its website that provides a variety of additional resources, including prior webinars that have already been hosted and information about upcoming webinars that may be of interest to you or your business.

Given the economic consequences of COVID-19, businesses across the country are confronting a sometimes bleak new economic reality that requires companies to think carefully about the expenditure of resources and how to protect their vital cashflow from being unexpectedly diverted. Litigation in this environment may present unique challenges that we have not previously confronted. In my practice, where I defend companies in cases involving alleged breaches of the Telephone Consumer Protection Act, we continue to see new putative class actions filed on a daily basis, often with no advanced notice or warning to the companies that will have to defend that litigation.

In an environment in which planning may be the key to some businesses' survival, unexpected class action litigation can have profound consequences. During today's discussion, we will explore third party litigation funding and how it may be a tool that businesses can turn to if they need to pursue litigation to protect their rights, but want to avoid the out-of-pocket expenses associated with legal fees. We will also discuss class action defense insurance, which may help companies defending litigation limit their exposure, or provide greater certainty for budgeting purposes.

We want today's discussion to be both useful and practical. Our panelists will try to provide both an overview of litigation funding, but also specifically address how COVID-19 is impacting the availability of funding and the process to obtain the funding. As the agenda indicates, we will have a brief presentation from each of our three panelists before turning over to Cathy Hinger, who will discuss some of the ethical issues that arise in the course of having or pursuing litigation funding... So to kick us off for the first part of our discussion today, I'm going to turn it over to Matt Reason with LexShares.

Matt Reason:

Thanks to the Womble team for putting this together and thanks for everybody who's joining today. My goal here in 10 minutes is to essentially be as useful as possible in articulating why, how, and when litigation finance can be a useful resource. To give you some context, I will walk through what I'll call basics. I will touch on a little bit about LexShares, who we are, what we've done, and how we're unique in this marketplace. I will then touch on the types of cases we look for and specialize in, what we look for from a criteria perspective, the process of obtaining financing, walk through some examples. And then lastly, I will touch on common structure, what attorneys can expect and what clients can expect from a cost perspective, if and when we ever do get to engage them here at LexShares.

To start, we are providing non-recourse capital to lateralize typically against a single case. So our model, in terms of non-recourse, what does that actually mean? That means the client has no obligation to pay us back if the case is not successful. And in terms of what we're getting for that investment, it's obviously a portion of the recovery and that is bespoke case by case. And then, in terms of how it typically works, the deals we're doing are typically contracted through the client. So these are single case investments where the case itself is the only collateral. And then we are contracting through the client, even though the attorney does acknowledge that agreement with their signature. Most commonly the financing is going to go directly or in a segregated account for the attorney to use for litigation fees and expenses.

Now just a little bit of information about who we are. We were founded in 2014. We are a lean team of 14. We have two offices in Boston and New York CIty. It's important to note that at LexShares, all of our underwriting work is done in-house. We have four former litigators on that team. They are led by our Chief Investment Officer, Max Volsky. And Max has been in the litigation finance industry so long, he's actually wrote a book, which you can search for on Amazon.

I would say by all public accounts, we are now the most active funder in the litigation space. We have funded over 100 deals. We have deployed over $70 million. And there's a few things we're doing that are a bit unique. First is origination. So we have an active team. We have four people that I manage that are solely focused on originating opportunities, cultivating relationships with attorneys and clients. And we rely on our Diamond Mine software, which is actually a proprietary algorithm created by our engineering team that's used to scrape federal and state court dockets. And that is essentially what drives our outreach and pulls from 24 different criteria, which essentially helps us figure out which cases may or may not be worth outreach.

Secondly, what we're doing differently is we have introduced litigation finance to what I would call the mid-market. Traditionally folks think that litigation finance is only available at a huge number, a $100 million case seeking $5 to $10 million. That is not true at LexShares. Our minimum threshold is actually $2 million. So we would be investing at a minimum $200,000. I'll talk more about this as we go, but the typical (investment) ratio for litigation funders would be 10:1. So if you had a $1 million budget, we would need to see $10 million (in damages) in order to move forward. And to understand how we initially assess the damages, we're not factoring punitive (damages), or what you may be alleging in the complaint. We are essentially drilling down at a floor, compensatory damages, arguably a settlement value, if and when we can obtain that. And that is what dictates how much we can invest.

Lastly, how we invest, our model is a bit different. We do have our own committed capital, but we are actually the first (funder) to create an online marketplace for litigation finance. We have an accredited investor network of thousands of people. And, on select investments, we will introduce those cases to that investment class. If you've been on our email list or join it, you will notice these investments (are fully subscribed) very, very quickly. It's a fascinating case study and I encourage you to do so.

In terms of what we are typically investing in, I covered this earlier, but our bread and butter, no question, are single case investments, commercial arena, breach of contract, trade secrets, squeeze outs. At an extreme, it's David vs. Goliath, but it certainly doesn't need to be. We do have additional offerings. One worth calling out is how we work with attorneys as the primary signatory. This is where (attorneys) will be essentially providing a portfolio of investments, and we will be collateralizing it across that entire contingency portion of our 100-plus investments... Obviously we're looking for strong merits and I will touch on that a bit further, but you can see that there's a wide array of what we invest in.

I do have a slide moving forward that even breaks down out of our a 100 deals, where we've invested, what types, what stage. How we do invest, for instance, in intellectual property. You'll see international arbitrations. We certainly will fund arbitrations. International arbitrations are maybe a bit dicier in this landscape and you can also see some examples. If you do go to our website, there is a case studies section, which will highlight several investments with more color than what you're seeing here.

Let me get a couple of interesting things to note here. First, the stage of investment. We are agnostic regarding when we can get involved. Almost 50% of our cases are in the discovery phase. That's usually when expenses are starting to ramp. Cases have survived dispositive motions, which we like to see from a funding perspective. I also want to highlight pre-litigation.

We get a lot of interest (in) pre-filing and to be very upfront, that is something we'll happily entertain even without a draft complaint. We would just need a memorandum to get started and I'll walk through what that process looks like in a minute. We've put a lot of focus at LexShares on federal cases. Even a lot of our outreach methods are really focused on federal cases, but we have funded more cases in state court than we have in federal. And you can see (we accept a) wide array of damages. It does not need to be a massive case for us to get involved. And then an interesting array of case types, everything from whistleblower, soft IP, etc.

Regarding the underwriting process, I will begin with the criteria in which we seek. First, I already mentioned the $2 million minimum threshold. Obviously, we're looking for highly meritorious claims if and when possible. Certainly evaluating the strength of legal counsel and, from my view, how much risk legal counsel was willing to put in. And then I would say more than ever, especially in this environment, focusing on the defendant's ability to pay. Collection risk is a very large reason we end up rejecting cases. And now even in this environment also evaluating the plaintiff's (risk of going) bankrupt is something we're evaluating now as well. In order to actually get a claim evaluated, I want to make this very clear: there is not a lot of legwork for counsel or client. With LexShares, arguably, within a week I can let you know if we have interest in that claim and arguably get the client to proposal to review.

We typically begin the process with someone on my (origination) team. That call can last 10 minutes, no more than 30. I am essentially just trying to evaluate the key criteria that I mentioned. From there, ideally, I just need publicly-filed pleadings to get the process in motion. I would show that to our legal folks. They would do a preliminary review. And the outcome of that would really be three thing: sadly we're not interested, yes we're very interested--and I would actually come with a proposal right out of the gate--or we would learn we want to have a call with counsel to figure that out and then get to a proposal thereafter.

At LexShares, we're not leading with LOIs or term sheets. If we are interested, we provide our full agreement. So this is ultimately a purchase and sale (agreement) outlining the terms, the cost, etc. But we also outline all of the fine prints associated with this transaction. If we can get that agreement executed, that would begin a 30-day diligence process. And within that process, we have an obligation to tell you 'yes' or 'no.' If the answer is yes, we would quickly deploy the funds. What does this actually cost clients? What are we expecting from counsel?

In terms of what it really means for the client--again, fully non-recourse (capital), we are taking the risk off the table... So what the client can expect to pay based on what we invest, using a $1 million example, somewhere as low as a 2.0x multiple. If it takes upwards of, let's say four years, maybe that multiple caps at 5.0x... On the counsel side, we are agnostic regarding what we can deal with from a structure perspective, but obviously the larger the risk they're willing to take, typically the more confident we are in the claim. But, again, we're not focused on whether it's a 25% (fee) deferral or a 45% deferral.

We're going to look at it case by case, depending on who counsel is, but it is important that counsel, let's just say we do a $1 million investment, agreeing not to withdraw from the case if and when our funding runs out. So that is the real expectation from counsel. We're looking for partners who are going to align our interests. And we need them to take on the risk if and when the case is not resolved within our funding amount.

To recap, I would say from the client perspective, incredible resource to de-risk. Obviously keep some capital on the balance sheet and focused on what you'd like to spend it on and not litigation. And from the attorney perspective, no question, a valuable resource to take on claims you might not otherwise take on for avoiding sticky situations, especially in this environment where clients who might have been able to pay are no longer able to. And I will pause there. I'm sure there will be questions soon, but I hope that was helpful. Thank you.

David Carter:

Thank you, Matt. I'm going to ask a couple of follow up or clarifying questions that I think might be useful for the audience. You discussed the attorneys or law firms bearing part of the risk of a case. Are there situations in which that is a requirement? Is that a desirable, but not a necessity? What type of risk you would look for if you considered the case to be a strong case with a high likelihood of success and a sizable damages pool? Would you still require the attorneys and law firms to bear part of the risk?

Matt Reason:

That's a great question, and I can flesh that out further. I would say the most common structures we're seeing are either counsel was fully contingent on time and our funding would cover the expenses, or council would be partially contingent on time and our funding would cover that discounted fee plus expenses. That said, that is not necessary in every case. Essentially it comes down to the damage model and the budget. So back to that 10:1 ratio, if we're looking at a $50 million case with a $1 million to $2 million budget, we're a lot more flexible regarding what that risk essentially needs to be.

So even in a situation where we would potentially do what I would just say is pure hourly. If the case is strong enough and the damage model supports it, we would entertain that structure. Again, just understanding if the funding runs out, we would need counsel to defer above that investment amount. That is really the cornerstone of litigation finance transaction with counsel. You know, whether we're paying at $600 an hour, $700 an hour, we're less concerned about that as long as we believe in the case and counsel itself.

David Carter:

That's helpful. Thank you. And you talked a little bit about, if I understood the process correctly, you would do an initial examination of a case. You would express that this is a case that you're either highly interested in, or maybe potentially interested in, and that you might put a contract on the table, but that the execution of the contract would only serve to kick off a 30-day due diligence period. So could you talk a little bit about what happens in the time period between when a client has signed a letter of intent or a contract and the time in which they actually know whether the funding will in fact be made available to them for the case?

Matt Reason:

Absolutely... In terms of what the process looks like, step one, we will get underwriters assigned to the case. So we'll dig in for maybe two to three days after the agreement is executed. The (investment team) will ultimately spin out a diligence checklist. 'We've already reviewed X, we need Y in addition' to really begin and complete this process. Some of that is going to be stock: we'll run background checks on the clients and then others will be custom to the case itself strategy, etc. We will put that checklist in client and counsel's hands. Ideally they revert with that information quickly.

And once they do, we'll spend a couple of days reviewing it. And then that really begins the dialogue. We'll do a phone call with counsel. We'll do a phone call with the client. If it's straightforward and we have all the information we need, we certainly don't need the full 30 days. That is typically a max time period. Let's just assume we get everything quickly. Clients are fast through the process. After a few phone calls, we can give a notice of approval or not. And if the answer is yes, funds are deployed within seven to 14 business days. And if the answer is no, we try to say it as quickly as possible.

David Carter:

And during that time period in which the contract has been signed and you're performing the due diligence, is the client or the firm able to continue soliciting offers from other funders during that time period?

Matt Reason:

Technically they would not. The agreement would imply exclusivity over that diligence period. The justification is we don't want to be spending our resources and putting that much time into something, if and when there's other conversations going on. So that's why we'll put all of our fine print out. While we're negotiating the agreement, it is not exclusive, but once the client decides these terms, these rates, etc., are amenable to my team, we would want to be exclusive over that final diligence period. And if we declined to move forward, the exclusivity period will end even if we're on day 17.

David Carter:

So to recap: for LexShares, which seems like it maybe moves faster than other (funders) in the ecosystem, you're probably looking at a period of approximately 60 days for a successful funding from the time they first expressed interest to the completion of the contract and then the diligence period, and then ultimately funding. Is that about right? 60 to 75 days?

Matt Reason:

Exactly. I typically say 60 to 90 just to (provide) a full ballpark.

David Carter:

Excellent. Thank you for that. We'll come back later with some questions around how COVID-19 is impacting this process for LexShares and others in the industry.

You can listen to the full webinar recording below. To learn more about third-party funding, download our complimentary litigation finance guide here.