Pricing risk, structuring agreements and the cost of legal finance capital

Since joining Burford, one of the most common questions posed to me by lawyers is this: How much does Burford’s capital cost? It’s a sensible and understandable question—but one that lacks a simple or one-size-fits-all answer.

It should be no surprise that answering the question of legal finance capital cost is complicated—of course it is. Lawyers and corporate executives call on Burford to provide capital for commercial litigation and arbitration—which is by definition highly complex, expensive and risky.

In this article I’d like to address three topics that shed light on this question. First, I will provide an overview of the various factors that affect the cost of legal finance capital, and the various ways lawyers and litigants can work with Burford to arrive at the best solution.

Second, I will address head-on the notion that legal finance capital is “expensive”. It’s not quantitatively wrong that legal finance typically costs more than transactional forms of financing—but that is not the whole story. The more fruitful way in which we engage clients around the cost of capital is to explain the various ways in which we can structure agreements to deliver what matters most to them. To that end, I’ll provide an overview of some of the most common structures we offer.

Third, I will provide some guidance on legal finance term sheets—how Burford structures them relative to others in the industry, and how law firm and in-house lawyers should think about them.

 

How risk impacts pricing

Any lawyer who has spoken to a litigation financier has heard some version of this simple truth: Legal finance pricing is based on risk. Let’s unpack what that means.

When Burford finances matters, we assume an extraordinary degree of risk. Typically, legal finance is provided on a non-recourse basis meaning that we lose our capital if the underlying matters are unsuccessful—and there are very few capital providers with the expertise needed to assess and assume that risk. We take on that risk and the inherent uncertainty of matters that may take years to resolve. When considering an expensive, protracted legal matter, our clients accept the notion of forgoing a portion of their recoveries or fees once their matters have resolved because they know that Burford’s capital not only provided them the means to pursue the matters in the first place but also because our agreement gave them “downside cover” and shifted risk from their business to ours.

So how do we price risk? In many ways we act just like lawyers considering matters to take on contingency. Lawyers recognize that every case is different—understanding the particular client, the circumstances of the matter and the jurisdiction is crucial. The cost of our capital ranges, but ultimately it’s priced competitively according to the risks of the individual matter.

When assessing and pricing risk, we consider a number of factors:

  1. If a case is about to be filed or has only recently been filed, we don’t have the full story of the case—so the case will be considered higher risk.
  2. The damages must be realistic and supported by evidence.
  3. Risk diversification. A single-case investment will by definition have a binary risk—versus a matter that is part of a portfolio, where risk is diversified across numerous matters.

In these terms, the highest-risk investment is a single matter financed in the early stages of the case where Burford is paying all fees and expenses. Because there is only one case, the risk is binary (meaning the finance provider would lose its entire investment if the case loses); and because the case has not progressed, it’s difficult to understand the entire story and fully assess the potential risk. Such a case represents the upper limits of Burford’s pricing, at about 30-40% of the recoveries.

Burford can also work with our counterparties to finance multi-case portfolios, which have significantly less risk than single-case investments. Portfolios—which can include as few as two matters—are cross-collateralized so that if we invest in case A, but case B returns proceeds, we can return our investment dollars for case A from case B. Because portfolio financing arrangements diversify risk of loss for both Burford and our counterparties, they create better economic structures where claimants can have better pricing than our single cases would ordinarily have.

Most lawyers first work with Burford to finance a single case. Under the right circumstances, we work hard to offer them opportunities to transition to larger financing arrangements that can result in additional savings down the road.

 

Creating economic structures to match client needs

Setting aside the question of cost, we can also structure deals to reflect specific client needs. For example, some clients value certainty and so we structure deals accordingly. The starting point for any engagement is listening to our clients to understand their needs so that we can offer the right economic structure. An assumption for any deal we structure is that the litigant should receive the bulk of the damages in the event of a successful resolution to the case.

We frequently gravitate to a few consistent structures. These structures exist on a spectrum, with variable returns on one end, and fixed returns on the other.

Variable returns

A variable return is comparable to a contingency fee arrangement, where a law firm will advance the cost of litigation out of pocket, and then recoup those costs “first-dollar” out of the return, in addition to taking a percentage such as 30-40% of the net remaining proceeds. In other words, the firm’s repayment will vary depending on the ultimate recoveries. In such an arrangement, that percentage of damages recouped represents the risk the firm takes in forgoing all of its fees and advancing costs.

Burford can similarly structure a variable return consisting of our investment back, plus a percentage of the settlement or award. This structure is most attractive to our clients (whether law firms or litigants) when the potential for recovery isn’t inordinately large in relation to Burford’s investment commitment. That’s understandable: If the expected recovery is especially large, you would be less happy to give up a percentage of the upside and would prefer instead a fixed return structure.

Fixed returns

At the opposite end of the spectrum is a fixed return structure, where the finance provider’s return consists of an investment back, plus a multiple (or fixed) return of that investment, as opposed to a percent of the net proceeds.

Hybrid structures

In most cases, the needs of our counterparties are such that the return structure falls somewhere in the middle of the spectrum, resulting in a hybrid structure. Burford will get its investment back, then some fixed return—albeit a smaller multiple than if we were relying on that entirely—and then also a percent of the net proceeds—again, likely a lesser amount, given that we have both a fixed return and a variable return element.

Return waterfall

In addition to working with clients to find structures that meet their needs and match our view of the risk, we also work to structure an appropriate return waterfall—in other words, to lay out the order in which and the increments by which we and our counterparties earn returns from matters in which we invest. Again, each matter is unique and we work hard to adjust waterfalls to clients’ needs—but the important point to appreciate is that while Burford may earn its investment back on a first-dollar basis, further recoveries are often split on an incremental basis. In essence, Burford and its counterparties “take turns” earning returns.

 

Understanding term sheets

A critical step in the process of finalizing a legal finance investment is the term sheet, which is the medium in which Burford expresses our proposed structure and terms. We have a unique view on term sheets which bears some explanation.

After nearly ten years in business, Burford’s team has reviewed thousands of cases, and we’ve concluded that we can best meet the needs of our counterparties if we complete a substantial amount of diligence before we provide term sheets. This gives us an opportunity to listen to our counterparties’ needs and offer realistic terms informed by our understanding of the risk. During this initial period, we do not seek exclusivity.

Some other finance providers take a different approach, preferring to propose term sheets along with a 60-day exclusivity period at the beginning of the process, before they’ve invested in a significant amount of diligence. While other funders’ intentions may be good, we caution (and it will not be a surprise) that often their initial proposed terms ultimately change during the diligence process to something that is more appropriate for the case.

 

Conclusion

In the end, how we price an investment is flexible to meet the needs of our counterparties. The cost depends on the risk appetite of the claimant and the law firm, in addition to all the circumstances of the merits of the case. When we make an investment decision, we’re not just investing in the underlying merits of the litigation, we’re investing in and trusting the litigation counsel the claimant has chosen to execute a strong legal strategy—we’re investing in the entire potential of that case and the people who are going to run it. It’s crucial that we have discussions with the claimant’s legal team to understand what they think is likely to happen, what they want to happen, and what they don’t want to happen so that we can price our capital accordingly.


Additional reading

Disclaimer

This section of Burford’s website is intended for the use of Burford’s public investors and is required to be provided under AIM Rule 26. Burford also maintains a separate private funds business. Information presented here is not intended for the use of private fund investors, nor is it presented in the appropriate form for such investors. Moreover, Burford does not present this information as a solicitation of private fund investment, which occurs only through appropriate offering documents.