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Pricing in Litigation Funding

February 22, 2022

Pricing in Litigation Funding

You have a good claim and your client is willing to use litigation funding in the case. But then you receive a question from the claimholder – how much does it cost? How to answer such a question?

Litigation funding, also known as litigation finance, is the non-recourse mechanism or process through which plaintiffs of law firms may finance their litigation or other legal costs through a third-party funding company. In return, the litigation funder receives a portion of what the claimant recovers.

Finding proper pricing is not an easy task for funders. They are trying to create a just equilibrium between the funder’s economic interest and claimant’s award expectations.

Litigation funders consider two main factors when pricing an investment: the level of risk and the timeframe of the case. For a funder, investing in a single lawsuit or arbitration involves significant risk. Funders provide capital on a non-recourse basis, which means that the funder loses its entire investment if the claim fails. The greater the risk that a case will not yield a return, the higher the cost of funding. Decisive for the risk level of a case are the strength of the claim (and any defences), the certainty and amount of damages, and the probability of recovery. When claims are bundled into a portfolio, the risk of loss is usually mitigated to some degree (as long as the claims are not all based on the same risk), and therefore portfolios are usually priced lower than a single claim.

The longer the funder anticipates its capital to be tied up, the higher the yield needs to be to reflect the time value of money. Key factors determining the timeframe of a case include the stage of the case at the time of investment, the nature of the case, and the decision-maker in question (i.e. the court/judge/tribunal ).

All parties need to understand the structure of a fixed multiplier versus a percentage of proceeds. In a fixed multiplier arrangement, if the funder makes a profit, he gets back his entire investment – plus a multiple of its investment amount. In a percentage of profit arrangement, the funder gets back his investment in the event of a win, plus a percentage of the award. Often in this model, there may be a cap on the amount the funder can receive, or the percentage decreases as the size of the award get larger. The decision to use one model or the other is often based on an assessment of risk, the expected length of the case, and the amount of the expected prize.

To better understand pricing, especially in the context of a fixed structure with multiple repayments, it is important to know the difference between the reserved (committed) funds and the disbursed (deployed) amount. Funders do not usually pay out their entire investment in one lump sum, but make a series of payments throughout the case. The committed money is the amount that the funder sets aside to cover its entire (planned) investment. The deployed money is the amount the funder has disbursed at a given time. In a case that is being litigated, the committed money may be equal to the deployed amount. On the other hand, if a settlement offer is accepted at an early stage, only a small portion of the committed money will likely have been disbursed.

From the funder’s perspective, the reserved fund is capital that cannot be used for other investments and is exposed to risk from the moment it is reserved or committed. Thus, if the case settles before a large portion of the earmarked funds has been disbursed, the payment of the multiplier only on the disbursed funds results in a low return for the funder, which may not adequately compensate him for the risk taken. These conflicting objectives are often addressed by pricing based on a multiple of the actual amounts deployed combined with a minimum return for the funder.

The final important concept in a pricing agreement is the waterfall, which is the legal term for the order in which parties receive their funds, including the funder, the claimant, and sometimes the lawyer.

A standard waterfall provides for the funder to recover its invested capital before any other party is paid out. The order of division of the remaining proceeds is a matter of negotiation, but usually involves pro-rata payments to the funder and the lawyer based on their respective claims. The claimant usually receives the balance after the funder and counsel have been paid.


February 22, 2022

Insights