Longford Capital made big news in the litigation financing world when it announced it had closed its second investment fund, raising $500 million – the largest fund of its kind in North America. The firm has been providing financing for commercial litigation since 2013, but the new funding round makes it the largest privately held commercial litigation funder in North America. William P. Farrell, Jr., the firm’s managing director and general counsel, spoke to Corporate Counsel Connect about the appeal of litigation financing and how innovative general counsel are thinking differently about funding lawsuits.
Farrell: Investors are increasingly enthusiastic about allocations to commercial litigation finance, for several reasons. The outcomes of litigation-financing investments are uncorrelated to the broader investment universe, providing much sought-after diversification. Outcomes depend on lawyers, judges, applicable law, and facts – not on things like interest rates or economic growth. And, from an investor’s perspective, litigation finance is an inefficient market. There is a large and growing demand for capital among leading law firms and corporate litigants, but a relatively small supply of capital. Those characteristics are attractive to institutional investors.
Like other investment strategies, such as private equity or hedge funds, we believe investors will increasingly include litigation finance in their allocations as the strategy matures and continues to grow in service of the massive legal industry.
Farrell: Awareness and acceptance of litigation finance among leading law firms and corporate litigants is increasing before our eyes – demand increases every year, especially among GCs, CFOs, and CEOs. Our clients have shared numerous reasons for their interest in outside financing. Risk transfer and risk sharing is a common rationale. But the most basic explanation is that companies are constrained by budgets and, rather than pay legal fees, they prefer to deploy capital toward core business operations, invest in research and development, expand plant and equipment, or return it to shareholders.
Let’s say a company has $500 million in revenue and in a good year generates profit of $50 million. The general counsel would be hard-pressed to add $5 or $10 million in litigation expense to pursue a meritorious breach of contract claim, even if damages are estimated at $100 million. But, the other options are equally unattractive. Choosing to ignore a breach of contract that harmed the company is akin to abandoning a valuable corporate asset. Settling for less expensive lawyers who are not the first choice and who may be less qualified introduces a different risk to the company. These types of challenges have led many forward-thinking general counsel to use litigation financing.
At publicly traded companies, where quarterly earnings are so important, the desire to avoid litigation expense is even more pronounced. Public companies see a use for litigation finance to protect their balance sheets and P&Ls without foregoing meritorious legal positions. The same desire to avoid expense exists among portfolio companies of large private equity firms, where the focus is on maintaining and growing EBITDA.
Farrell: That is correct. Litigation finance provides options for GCs. It removes that choice between the organization’s liquidity and pursuing a meritorious claim. So, when a general counsel concludes that her organization has been the victim of a breach of contract, she can contact us to evaluate the case. Our team of senior litigators and finance professionals evaluate the claim; if we believe it has a strong likelihood of success, we will advance the funds to pay legal fees and other costs incurred in pursuing the claim. This enables the company to hire the outside lawyers of its choice and to turn them loose to do their work without the persistent cost pressures that characterize a lot of commercial litigation today.
If the company achieves a favorable outcome, Longford Capital receives a portion of the proceeds agreed upon up front. If the case is unsuccessful, Longford Capital shoulders 100 percent of the loss. Most companies would gladly share a portion of proceeds from a successful outcome in exchange for reducing downside risk and protecting their liquidity during a lengthy and uncertain litigation process.
Farrell: The simple fact that GCs are using litigation financing is progressive because, while the numbers get bigger every day, only a small percentage of companies are using litigation financing right now.
The use of litigation finance is only a part of the way general counsel are starting to rethink their role in their companies. As part of the leadership team, GCs are realizing that their job includes identifying ways for the legal department to contribute directly to shareholder value – rather than settle for being a cost center.
Innovative GCs have seen that one way to make that contribution is to treat legal claims as corporate assets that can be financed without a short-term hit to profitability. If a vendor violates its contract and the GC believes it owes her company $50 million, the right thing to do for her shareholders is to go collect that money, through the courts if necessary. And, if she can recover a portion of that $50 million with no strain on the P&L, she has added tremendous value.
Farrell: There’s no single category or industry – we see increased demand across all sectors. But there are definitely industries where a few large-cap corporate defendants use their financial might to deter smaller companies from pursuing claims even where the larger company is clearly at fault. In those situations, litigation financing helps level the playing field, so well-heeled defendants can’t use their superior resources to beat up on other companies.
We also find that litigation financing is particularly well-suited for research universities, especially public research institutions that often face financial challenges but are producing ground-breaking research. When universities find their intellectual property in commercial use, without the proper licensing arrangements, litigation financing allows them to collect what they’re owed, using lawyers of their choice, and enables the reinvestment of the proceeds into more innovation and research.
We also see potential in bankruptcy proceedings. Bankruptcy is another situation where a company has restricted access to capital, but may also possess a strong legal claim. If the company in bankruptcy can pursue strong legal claims – for example, against a customer that stopped paying on a contract – without using its remaining cash, it can return more to creditors.
William P. Farrell, Jr. is responsible for the overall operations of Longford Capital, with a particular focus on transaction sourcing, investment selection, and portfolio management. He has more than 20 years of complex litigation experience, including extensive trial and appellate experience as both a government prosecutor and as a partner in the commercial litigation departments of two national law firms.