First published in Lawerly, 9th April 2020
COVID-19 & Unchartered Waters
Many companies are entering unchartered waters with COVID-19 as the virus has a catastrophic effect on global economies and thus many individual businesses. Even businesses that are otherwise sound and well run are facing difficulties. The challenges are likely to be threefold:
1. The impact of government policy decisions (for example, restrictions on public gatherings and sporting events).
2. Reduced consumer spending appetite (resulting in a fall in consumption which makes up the largest portion of the economy).
3. Supply chain disruption (for example, around 24% of Australia bilateral trade is with China so a disruption impacts both sides of the supply chain).
All the above will severely impact economic growth and as with all “black swan” events where liquidity has become tight, cash becomes king. It is unclear how long the crisis will last and the extent of the effect on the real economy. A combination of drought, bushfires and COVID-19 has led many economists to predict a recession despite government stimulus packages.
Litigation in Strong Economies During periods of strong economic growth there is an increase in the number of litigation claims reflecting a greater number of economic transactions. Firms that have profited from economic growth can afford to fund the litigation when necessary, at market rates. While there is a positive correlation between GDP growth and amount of litigation, there are countervailing forces. Firms engaged in profitable business may be reluctant to sue business partners and seek an alternative “commercial” solution. They may decide that there are better served by seeking other opportunities and ignore the dispute rather than devoting time and money seeking redress.
Litigation in an Economic Downturn
When the economic cycle moves from boom to bust the litigation dynamic shifts in three ways:
1. It is more difficult for economic agents to fulfil obligations;
2. creditors expectations regarding their payment probabilities decline; and
3. the average value of contracts falls in recessions, so the gains from breaking them rise at the margin.
At this point, companies with good claims should seek to monetise those through litigation. However, at this stage of the economic cycle, cash is scarce and is urgently required to support the business rather than to chase an uncertain return that may take several years to resolve. If businesses do decide to litigate, they are faced with the expense of legal bills. There is the prospect of paying the other sides costs if they fail, so they will need to recognise a potential contingent liability in their accounts.
Law firms face similar pressures. Their advisory and transactional work rapidly contracts in an economic downturn. They have traditionally looked to countercyclical work as a hedge to falling transactional revenues. That work includes insolvency, bankruptcy, restructuring and litigation. Although in this instance government initiatives have delayed insolvencies reducing short-term potential legal work.
While it appears this environment should provide a good source of billables for law firms that may not be the case. Businesses may be reluctant to pursue opportunities in litigation as they preserve cash resulting in less work. In addition, in this economic environment, clients may also baulk at standard hourly rates and demand reduced and / or deferred fees, so the quality of revenue is reduced.
Litigation Funding Solution
The advance in litigation funding over the past decade changes the dynamic by providing a win-win solution for law firms and their clients. It does this by enhancing the value of the counter-cyclical hedge through increasing the quantity of litigation and the quality of law firm revenue.
Litigation funding is not only the preserve of class actions. Augusta’s experience in the UK is that most standard funded claims (litigation and arbitration) involve commercial disputes. The majority of those include business to business claims for breach of contract, professional negligence and shareholder disputes.
How Litigation Funding Can Help
With Litigation funding, the funder pays for legal costs, counsel fees and disbursements. A major attraction of litigation funding is that it is non-recourse whereby if the case loses, the funded party pays nothing. The funder covers the adverse cost risk (loser pays the other sides costs) through after the event insurance (ATE). In return the funder charges a commission based on either a multiple of funds invested in the case or percentage of damages awarded upon a successful resolution. Depending on the ratio of costs to damages, the claimant can receive around 70% of the damages.
With funding, businesses can pursue their meritorious claims while benefiting from:
a. Cash: Retain cash to meet immediate business needs;
b. P&L: Keep ongoing litigation costs off their profit and loss as the expense is borne by the funder;
c. Risk: Mitigate adverse cost risk through a funder indemnity or funded ATE insurance avoiding reporting a contingent liability on the balance sheet;
d. Costs: Avoid the need to post security for costs as that is included in the funding terms;
e. Management: the funder acts as a project manager collaborating with the law firm so reducing management time;
f. Diligence: Receive assurance on the strength of their case as a funder’s legal team undertakes thorough due diligence prior to funding to ensure the claim has merit; and
g. Control: Retain control of the litigation.
Law firms can attract more opportunities that benefit their relationship with their clients by introducing non-recourse litigation funding. The funder is aligned with the business as they want a positive outcome and would prefer to spend more on good advice, where required, to achieve a successful resolution. The law firm avoids client conflict over billing as the funder deals with invoices based on pre-agreed budgets. The result is that the quantity of work for law firms should grow to offset falling advisory revenue and the quality of work is attractive as law firms are not forced into aggressive fee caps or fee deferrals. The use of funding shifts the risk from the business and law firm to the funder.
Without funding, the alternative is a lose-lose. Business fails to exploit and monetise good meritorious claims and law firms are left with litigation resources being potentially underutilised. Let litigation funding help you access valuable and scarce cash in these challenging times.