law firm financing: looking under the bonnet€¦ · way to combine law firm financing and...

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VANNIN CAPITALLAW FIRM FINANCING: LOOKING UNDER THE BONNET

Yasmin MohammadHead of International Arbitration

VANNIN CAPITAL

David CollinsChief Financial Officer

VANNIN CAPITAL

LAW FIRM FINANCING: LOOKING UNDER THE BONNET

With the increased use of third-party funding has come an evolution and diversification in the forms of financing available. In this article, Vannin’s Head of International Arbitration Yasmin Mohammad, and Chief Financial Officer David Collins, break down the mechanics of law firm financing and introduce portfolio funding, describing in detail the way to combine law firm financing and traditional client funding, as well as the benefits of doing so.

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Traditional client funding

It is probably superfluous to define traditional client funding here, but by way of reminder, it essentially consists of a funder agreeing to advance funds to meet legal fees and costs of the client and its lawyers in the context of an international arbitration or a court litigation. Should the client prevail in its venture, it will have agreed to pay to its financier a portion of the damages recovered. If the client loses, the funder will have lost its investment and the client will not owe any reimbursement to the funder.

We could continue for several paragraphs describing the multiple mutations of this simple definition (recourse funding, equity funding etc) but for the purposes of this article, please bear this simplest definition in mind.

Law firm financing

Law firm financing refers to a funder underwriting the risk that a law firm may be willing to take with regard to its client(s). Across the market of both arbitration and litigation, law firms are exploring ways to use legal financing to secure optimal rates for their clients (often a useful marketing tool) and to benefit themselves from law firm financing agreements.

Let us imagine that a law firm takes a case on a 30% contingency and that that 30% of its fees will benefit from an uplift on success. That 30% contingency fee element can be financed fully or partially.

The funder will advance the law firm all or a portion of the 30% contingent fees and take over the risk from the law firm. In exchange for taking that risk, the funder will require a portion of the success fee negotiated by the law firm. The portion of the success fee is usually proportional to the amount of risk undertaken by the funder for the law firm.

Thus, law firm financing allows the law firm to immediately “monetise” the contingency fee element negotiated and to shift the risk of losing the case and never being paid that contingent success fee element on to the funder. The funder will pay that contingent fee element during the life of the case and against the usual invoices billed by the law firm, thus assuming the risk of losing the case altogether or the risk of failing to recover the amounts awarded through a successful award or decision.

Portfolio funding

Generally, under a portfolio funding arrangement a funder advances funds against a portfolio of cross-collateralised cases.

A law firm that has taken on some risk in several cases could transfer all or a portion of that risk to a funder by having its risk financed in the context of a portfolio.

The cross-collateralisation of the claims allows the funder to offer the best possible terms to the law firm as its return will be safeguarded by the whole portfolio of claims.

Moreover, if the portfolio of cases does not already exist, then a facility can be agreed to constitute/populate the portfolio.

We are seeing a growth in legal finance for portfolios of cases as law firms and clients internalise the use of third-party funding as a risk management tool.

Co-existence with traditional financing

Naturally, both law firm financing and traditional client funding can work in conjunction with portfolio funding. In fact, our experience at Vannin is that the three means of financing are often combined.


WE ARE SEEING A GROWTH IN LEGAL FINANCE FOR PORTFOLIOS OF CASES AS LAW FIRMS AND CLIENTS INTERNALISE THE USE OF THIRD-PARTY FUNDING AS A RISK MANAGEMENT TOOL.

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How it works

In order to break down the mechanism, we have chosen to focus this article on the workings of law firm financing and client funding, which is best illustrated by an example:

Scenario: Client has a case with a budget that amounts to a total of €10 million, of which €5 million is intended for legal fees and the rest is dedicated to other costs (institution, travel, translation etc) and other fees (arbitrators and legal, industry and quantum experts).

Let us assume, for the purposes of this example, that:

• The law firm agrees to take a case on 30% contingency where that 30% of legal fees will carry a success fee of two times the 30%

• The client asks the funder to fund the other 70% of the legal fees plus 100% of the other fees/disbursements/costs

• The law firm asks the funder to fund 50% of its contingency

The funder would then end up funding:

• €3.5million (70% of the legal fees for the client)

• €5.0 million (100% of the other fees/ disbursements/costs)

• €0.75 million (50% of the law firms contingency/15% of the legal fees for the law firm)

• €9.25 million

The funder’s negotiated return on investment

As most will be aware, funding terms are most often calculated as either a multiple of the money invested or a percentage of the damages recovered. These terms are usually tailored to the specific aspects of a case for example, to account for the time value of money for the lengthier cases (investment treaty arbitration, for instance).

It would overly complicate our example to use real-life terms so we have chosen to use a flat three times return to break down the mechanism and illustrate how law firm financing and client funding can and do, work together.

On the basis of a three times return, in our example, the funder would have agreed with the client that its return on investment would be calculated as follows:

1. Reimbursement of the monies invested for the client directly = €8.5 million (€5 million of other costs and fees plus €3.5 million of legal fees discounted)

2. A three times multiple of €8.5 million, which would amount to €25.5 million

As you will recall, the law firm and the funder will have agreed to a separate agreement whereby the funder pays the law firm 50% of its contingency fee (€0.75 million), in exchange for 50% of its success fee (€1.5 million).

This would result in the funder receiving a total of €35.5 million.


ACROSS THE MARKET, LAW FIRMS ARE EXPLORING WAYS TO USE LEGAL FINANCING TO SECURE OPTIMAL RATES FOR THEIR CLIENTS AND TO BENEFIT THEMSELVES.

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Once the claim is successful

As you will have heard countless times by now, funders invest in disputes having in mind a very important rule of thumb: we look for a minimum 1:10 ratio between the funding amount required and the serious, likely, conservative quantum to be expected. What is a “serious, likely, conservative” quantum figure? One that is based on documented factual evidence like proven sunk costs or documented and substantiated solid historical cash flows for a claim that is neither speculative nor overly optimistic.

This ensures that even when claimants do not obtain the full amount claimed (which they often do not), the funder has accounted for that eventuality in its assessment of the quantum and has gotten comfortable that the minimum 1:10 ratio still exits. This 1:10 ratio is intended to protect the clients from seeing their lawyers fully paid and their funders walking away with the majority of the damages.

In our example, if the funder has agreed to invest close to €10 million, it is because it has thoroughly checked and satisfied itself that the quantum awarded (or negotiated) is most likely to amount to €100 million at a minimum.

Thus, if the claim is successful and the client is awarded €100 million, the funder would receive a total of €35.5 million. As you will recall, the law firm would have been paid throughout the case (whether it wins or loses) as follows:

€3.5 million (base fees)

+ €0.75 million (50% of its contingency funded)

€4.25 million (from an initial full budget of €5 million)

In addition, upon a successful outcome, the law firm would also receive €1.5 million, which represents 50% of the negotiated success fee (the other 50% being paid to the funder for having financed 50% of the contingency fee arrangement).

The total paid to the law firm upon a successful outcome would therefore amount to €5.75 million.

It is interesting to note that in our example, 26% of the law firm’s total remuneration (or €1.5 million) would be contingent upon success. Therefore, the law firm still participates in the upside of success and does better on success than had it simply been paid 100% of fees with no contingency.


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What if the law firm had not funded part of its contingency fee?

It is also interesting to highlight that without any law firm financing, but with a similar contingency fee arrangement, the law firm would have been paid as follows:

€3.5 million (during the life of the case whether it won or lost)

+ €3 million (success fee if the case was won)

€6.5 million (having shouldered the risk alone on the full €3 million contingent element, which here represents 46% of the law firm’s total remuneration)

Therefore, in the example with law firm financing, the law firm gets more certainty on its fees in exchange for giving away some of the upside of success to the funder.


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Let’s not forget about the client

As demonstrated below, the client retains the majority of the damages, all the while (1) not having taken any risk, (2) not having drained its cash reserves and (3) not having impacted its accounts or EBITDA.

Let’s run through the subtraction:

The award is rendered and amounts to €100 million. We will need to subtract the amounts owed to the law firm and the funder first:

€100 million

€34 million (funder’s share)

€1.5 million (50% of the law firm’s success fee)

- €1.5 million (paid to the law firm from the awarded quantum in addition to the fees received during the life of the case)

€63 million

What if the law firm had not entered into a separate agreement with the funder?

In this scenario, the funder would have funded “only” 70% of the legal fees (€3.5 million) and 100% of the other fees and costs (€5 million), which would amount to €8.5 million.

Upon a successful outcome, the funder would firstly be reimbursed the €8.5 million it expended and secondly, receive three times that as a funding premium, amounting to €34 million in total.

The law firm would have been paid 70% of its fees during the life of the case (€3.5 million) and in the event of a successful award, it would receive an additional €1.5 million in deferred fees and €1.5 million in success fees (€3 million contingent upon success).

Upon payment of a €100 million award (or decision), the client would receive:

€100 million

€34 million (for the funder)

- €3 million (for the success fee of the law firm, bearing in mind that the firm has already been paid €3.5 million during the life of the dispute)

€63 million


So, the client is not impacted by the arrangement between the law firm and funder where the funder funds part of the law firm’s contingency fee.

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The context of a portfolio

In a sequel to this article in the next edition of Funding in Focus, we will address in equal detail the financial model of a funded portfolio where funding is provided either (1) to a series of claims handled by the same law firm with different clients or (2) to a single client with a number of different claims (which may be handled by one or several different law firms).

To begin to understand the benefits of portfolio funding, one should first imagine our example above replicated five to ten times across a portfolio of cases. Second, keep in mind the comfort given to a funder that could cross-collateralise its required return on investment across the cases (and the resulting financial terms of that comfort).

In our next article, we will give a concrete example of how an actual portfolio of cases would be funded and how the returns could be allocated between client, law firm and funder.

In the meantime, please do not hesitate to reach out with any specific questions that you may have.

THE CLIENT IS NOT IMPACTED BY THE ARRANGEMENT BETWEEN THE LAW FIRM AND FUNDER WHERE THE FUNDER FUNDS PART OF THE LAW FIRM’S CONTINGENCY FEE.


law firm financing: looking under the bonnet€¦ · way to combine law firm financing and...

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