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Lord Justice Jackson’s costs review allows for general counsel and their advisers to strike a happy medium in alternative fee structures. Richard Fields examines a shift in the economics of law
Source: © UPPA/Photoshot
The release of Lord Justice Jackson’s final report on the costs of civil litigation late last week is a step forward in addressing the high costs of civil litigation. Much work to address the issues remains to be done, however. Every chief executive and general counsel in the UK knows that civil litigation for solving business problems is too expensive, often takes too long and presents significant risk to the participants.
In both the US and the UK the ‘Great Recession’ has accelerated the demands of general counsel for alternative fee structures and risk-sharing with their lawyers.
In the US, general counsel at multinationals, such as Tom Sager of DuPont and Amy Shulman of Pfizer, have demanded that alternative fee structures be adopted by their outside counsel. On the other hand, the economic crisis has put a spotlight on the limited ability of commercial law firms to share risk with their commercial clients. Corporate claims financing offers general counsel a way to bridge the gap between their need for alternative fee structures and the ability of their lawyers to meet this demand, at least until law firms have direct access to equity capital markets.
Increasing the options
Corporate claims financing provides general counsel and their law firms multiple options for controlling legal costs, managing risk and balancing legal budgets. So what is corporate claims financing? Simply put, it is the provision of capital in exchange for an interest in a very specific class of corporate asset, namely a claim or claims of the business. Like plant, property and equipment, claims are assets of the business that have value and can be monetised, either through civil litigation or other means such as arbitration, settlement or transfer in whole or part.
While no liquid market presently exists to monetise claims, investors provide capital in various ways to business owners and their law firms. Corporate claims financing is much more than ‘litigation funding’, a term used widely in the UK to describe a very specific and narrow type of corporate claims financing that is limited to providing capital for lawsuits. Indeed, litigation funding is an inadequate term for describing the multiplicity of ways that capital can be provided to business for an interest in claim assets.
The same but different
While the US and UK systems of civil litigation have some significant differences, in both markets the key economics drivers of corporate claims financing are similar. In the US, several decades of lawyers using contingency fees in commercial litigation have created a culture of risk taking that may give US lawyers a significant but perhaps temporary advantage in adapting to client demands for alternative fee structures.
If adopted, Jackson LJ’s recommendation that contingency fees be allowed (albeit with restrictions) in civil cases will go a long way towards leveling the playing field.
The UK cost-shifting rules also add complexity to the economics of corporate claims financing; but again Jackson LJ’s recommendations are likely to be helpful in this regard. In particular, the recommendation to abolish the recovery of after-the-event (ATE) premiums may bring economic rationality to the premiums charged for these policies. When the plaintiff is paying the premium in a winning case, they have an incentive to strike the best possible deal with insurers. Notwithstanding the differences between the US and the UK, from the point of view of a capital provider, the key economic drivers of corporate claim financing in both markets provide general counsel with tools for controlling legal costs, managing risk and balancing budgets.
Litigation costs are too high in part because the hourly rate business model creates a misalignment of interest between business and its lawyers. Alternative and contingency fee structures, when used properly and adapted to the claim, go a long way towards solving this problem. Corporate claim financing requires this alignment of interest.
When lawyers have ‘skin in the game’ they change their behaviour, even if only at a subconscious level. If structured properly, alternative fees structures allow the lawyer to maximise profit by shifting the focus to solving the client’s business problem in the shortest possible timeframe for the greatest value. The incentives to ‘bill hours’ are removed. Just as many general counsel have paid too much for litigation, some ‘litigation funders’ have lost money with investments in cases where the lawyers have no economic incentive to control fees and expenses. Prudent investors in corporate claims almost always require that plaintiffs’ lawyers share risk with their business client and have developed multiple deal structures to gear the risk-sharing between client, investor and prosecuting lawyers to potential levels of return. By providing risk capital for claims, investors in corporate claims also allow law firms to leverage their own risk capital, to hedge downside risk and to diversify their investment of risk capital across a larger group of cases to achieve the portfolio effect.
Similarly, general counsel are able to manage risk by capping litigation fees and expenses when an outside investor enables the use of an alternative fee structure. By transferring an interest in the claim or a portfolio of claims prior to settlement, or even before litigation is commenced, a general counsel is able to generate revenue and control the timing of when that revenue is realised by the company.
By taking cash in for a portion of a claim asset prior to completion of settlement or litigation, corporate claims financing enables a general counsel to eliminate the risk of a complete loss through an adverse litigation outcome. Corporate claims financing even allows a general counsel to remove or minimise a particular risk element from a claim asset, for example by transferring an interest in a case that has been won at trial but which still faces the risk of loss on appeal.
General counsel can also use the transfer of claim assets to generate revenue, which can be used to balance the budget of the corporate legal department. As Sager at DuPont demonstrated with his focus on claim economics, the legal department of a major company can even become a separate profit centre where claims are treated like other corporate assets.
Outside capital providers that focus on the economic value of claims, the need to minimise the costs of civil litigation and the most efficient methods for monetising corporate claims in the shortest possible time have a lot in common with general counsel who want to reduce their companies’ spend on litigation.
Richard Fields is chairman and CEO of Juridica Capital Management