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Legal finance is underutilized in the insurance field

October 12, 2019
Andy Lundberg

Data breaches. Storm surge. Earth movement. Wildfires. The opioid crisis. The loss and liability environment expands and changes continually, and insurance coverage disputes — as well as subrogation claims by paying insurers — invariably follow. As insurers and policyholders tackle those resulting coverage and subrogation issues, even the most sophisticated insurance lawyers, risk managers and insurers often fail to appreciate how another recent development in the legal landscape — litigation finance — can be an important part of achieving the optimal resolution.

Despite its benefits, legal finance remains underused in the insurance space. Why? Principally, a lack of familiarity. According to the 2018 Litigation Finance Survey, which surveyed 495 lawyers at law firms and on legal teams in the U.S., U.K. and Australia, the vast majority of lawyers say they are aware of litigation finance, but only a minority have personal experience with it. Many lawyers and their clients suffer from a lack of understanding of how and when to use legal finance, or worse, harbor ungrounded fears about the category’s perceived novelty.

Fortunately, research also suggests that with continuing education in the category, lawyers and their clients will increasingly embrace litigation finance as a tool to fuel recoveries. In fact, 70 percent of respondents to the Litigation Finance Survey who have not yet used legal finance expect do so in the next two years — a principal reason why, after 35 years as a policyholder lawyer at Latham & Watkins LLP, I recently joined Burford Capital LLC to show law firms and their clients how today’s financing solutions can remove familiar obstacles that have historically stood in the way of realizing on insurance assets, whether those assets are claims for coverage or claims to recoup benefits paid out.

In my policyholder-side practice, although the large losses and liabilities in play often favored proceeding with coverage litigation, general counsels and CEOs would sometimes find the high cost of prosecuting such cases to be untenable from a current financial standpoint. They would forgo suing on a sound coverage claim, recovering nothing or settling, presuit, for a fraction of the claim’s worth. A large and pricey asset — the company’s insurance coverage — would thus be forfeited because of the prohibitive current expense of realizing on it through an hourly billing arrangement with counsel. These challenges could have been overcome with legal finance.

From the policyholder’s perspective, compared to most commercial disputes, insurance disputes are asymmetrical: Circumstances, resources and motivations typically differ for the insurer and the policyholder. For insurers, the cost of defending against coverage litigation is built into their budgets; for corporate policyholders, most of which have never sued an insurer before, the cost of coverage litigation is usually unplanned. Likewise, as repeat players — with thousands of transactions based on the same contractual language on their books — insurers have incentives to litigate novel coverage issues exhaustively to create favorable precedent, even if such litigation would make no sense on the economics of a particular case. For insurers, developments like climate change and cyberliability loom as “the new asbestos,” and they respond accordingly. And of course, companies that buy insurance do so for a different reason than insurers sell it: A policyholder is not buying insurance to facilitate its everyday profit-making operations, but rather to protect it from an unforeseen and potentially catastrophic loss. The greater that loss, the less equipped the policyholder is likely to be to take on a costly dispute with its insurer at the same time.

Legal finance offers policyholders and their law firms a way to address these asymmetries. On the most basic level, legal finance helps policyholders and their law firms manage legal risk. For companies that have suffered a first- or third-party loss, the prospect of losing a potentially lengthy and protracted legal battle over coverage for that loss may feel like doubling down on a bad experience. By sharing risk with a third party, policyholders can give themselves the peace of mind needed to move forward with meritorious claims.

In addition to reducing risk, legal finance allows policyholders to improve the financial accounting outcomes connected to disputes, which can remove friction between a company’s legal and finance functions and allow strong legal claims to proceed. Because third-party financing is typically non-recourse — the funding entity recoups its investment and premium only from the recovery achieved — the legal spend for a financed case hits the balance sheet only if the case settles or a court victory is achieved. And with their costs of prosecutions financed, companies can allocate the resources they would have spent on litigation to their core business purposes.

In some cases, policyholders have suffered such a catastrophic loss that self-financing a claim is not merely unattractive but impossible. In these instances, legal finance doesn’t just improve risk and accounting outcomes, it is necessary to move forward with the claim at all. For policyholders whose disputed insurance claim may be their only source of liquidity, legal finance becomes an essential instrument to avoid submitting to a low or premature settlement. By providing immediate liquidity, legal finance offers policyholders a business-saving solution in the aftermath of a catastrophic, sometimes enterprise-threatening loss.

These same considerations apply to insurers when they wear the hat of a subrogation plaintiff. Although insurers are virtually always the nominal or functional defendant in coverage disputes, the reverse is true in the subrogation context. Many first- and third-party claims paid by insurers arise from wrongful conduct by persons other than their policyholder, putting paying insurers in the role of plaintiff when they stand in the shoes of their insureds and seek to recoup those payments. Insurers can benefit from precisely the same financial advantages that policyholders enjoy from litigation financing when they find themselves asserting, rather than resisting, claims for substantial damages. Moreover, as repeat players, insurers will often have access to the enhanced economics of financing portfolios of cases rather than just single claims.

Likewise, coverage lawyers on both sides of the aisle can benefit from third-party financing. Legal finance empowers law firms to offer better and faster solutions to clients with disputed coverage or subrogation claims, making it a powerful business development tool. This is true whether the firm is engaged on an hourly or contingent basis. Obtaining financing — especially through multicase portfolio arrangements — allows law firms to approach current and prospective clients with financing solutions already in place, enabling meritorious claims to proceed faster. And when law firms can offer a variety of fee structures that address widely varying client circumstances and objectives, they are seen as business partners who are able to address their client’s and not just their own financial needs — a significant competitive advantage. Ultimately, the ability of firms to grow their insurance practices hinges on the quality, speed and cost of solutions they offer; legal finance allows law firms to improve their performance on all three counts.

For policyholders and insurers alike, and for their lawyers, legal finance is a transformative instrument that allows the aggressive pursuit of recovery on valid claims while reducing risk, improving accounting treatment and maximizing settlements and awards. Of the tools available to level the playing field in a commercial insurance or subrogation dispute, legal finance should be in everyone’s kit.

This article first appeared in Law360 and is available here.