The Benefits of Corporate Claim Financing
Since the dawn of the legal system, capital markets have been kept at arm’s length from the legal system. In the area of corporate litigation, that is now changing. Is this a good thing? If you believe the system should be made more transparent, efficient and cost-effective, the answer is a resounding yes.
The current system for corporate litigation has much to be desired. It is too costly, too inefficient, and claims often are pursued without adequate consideration of risk or reward.
Each year, American businesses spend upwards of $10 billion pursuing claims involving intellectual property, price-fixing, and other disputes with their competitors. In deciding whether to move forward with these claims, CEOs have several important judgment calls to make:
How much is the claim worth? What is the likelihood of winning? How much will it cost to pursue? How long will it take and what is the risk-adjusted internal rate of return? And could that money be more profitably invested in growing the business?
Far too often, these decisions have been made without the benefit of rigorous, market-driven analysis. Indeed, few law firms employ a multi-disciplinary analysis that combines law, economics, and mathematics.
Historically, contingency-fee arrangements with law firms were the only financing option available to businesses – but these arrangements have never been an adequate vehicle to evaluate the threshold questions of risk and return.
Far too often the value questions are addressed only when it is time to settle and after the client has spent millions on legal fees. This does serve the interests of Big Law, especially when fees are paid hourly and the lawyers are not sharing risk with the clients. It does not, however, always serve the interests of business.
It is no wonder then that America’s business community is faced with too much litigation for which they spent too much time and too much money to resolve – which not only hurts the businesses themselves but also is bad for the overall business environment.
Corporate claim finance has the potential to change that
First, let’s be clear what this category is – and is not. Corporate claim finance only involves legal claims between companies. It does not include class actions, personal injuries, mass torts, or speculative claims. Financial relationships always involve an element of trust. That trust cannot be developed with your corporate clients, in our case Fortune 1000 companies, if you are financing claims that are brought against them.
Under this model, an investment firm like Juridica helps finance the cost of pursuing a claim in exchange for a percentage of any settlement or judgment. As a matter of policy and ethics, the funder provides no legal advice and plays no role whatsoever in the strategy or decision-making of the plaintiff.
“But wait,” some skeptics may ask. “Wouldn’t the introduction of outside money just lead to more lawsuits, making the problem even worse?” Actually, the opposite is the case. The most reputable corporate claims investors evaluate the merits and potential value of the claim through a screening process that involves a proprietary network of legal experts, and economic analysis.
And because they are accountable to investors, founders are highly motivated to screen weak or risky claims from their investment pool. Especially in our fund at Juridica where the average investment size is $5.0 million, we have no incentives to invest in frivolous claims. At the end of the day, only a small percentage of the highest quality claims survive this screening process. To make the point, for the 30 cases in our portfolio, we screened more than 1,000 cases.
Needless to say, this type of rigor does not create a friendly environment for highly risky and speculative claims, which are rejected out of hand.
The interests of investors are well aligned with important public policy goals of promoting settlements, reducing the costs of litigation, and reducing the costs to business and taxpayers of administering civil justice. For instance, investors are more likely to push for greater transparency in the system, which would make it easier for the parties to identify and understand the facts and how the law applies to those facts. This is the key to pricing risk – and a cornerstone of reaching a settlement.
So why hasn’t change happened sooner in the U.S.? The simplest answer is that old habits die hard – and the legal system is famous for its adherence to customs and rituals many hundreds of years old. But change is coming.
Although the historical bias against the use of outside capital to finance claims has its roots in 400-year-old English common law, England has largely abandoned this prohibition. Only a handful of states in the U.S. still have bans on corporate law finance in their statutes, many of which are a vestige of the civil rights era when some lawmakers tried to block impoverished plaintiffs from gaining access to the courts in their battle against racial segregation.
The benefits of corporate claim finance are promising – but we must move forward in a thoughtful manner. If we do this right, then businesses and society will benefit from a system that is more transparent, efficient and economically rational.