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Managing legal cost and risk in the new normal

May 18, 2020
Emily Slater & Greg McPolin

The world has been abruptly upended by COVID-19. While the primary challenge we all face is health related, the economic impact of this global pandemic has created significant business and legal challenges, and the financial pain is being felt across the business community. Given this reality, companies and law firms are bracing for significant economic headwinds in the year ahead, including constrained access to capital and reduced legal budgets.

Despite reduced legal budgets, the continued economic fallout from COVID-19 also means that there will be an increase in litigation—because when times are bad, companies very often end up at odds with their suppliers, vendors, insurers and other business partners. Expectations are that business disputes arising from the pandemic and subsequent downturn will anchor around four main areas: breach of contract, D&O claims, insurance claims and insolvency claims.

The first coronavirus claims to surface will likely be contractual disputes concerning force-majeure and other clauses as companies falter in their ability to make payments and breach agreements made with third parties. D&O claims will follow as shareholders identify directors’ failure to uphold their fiduciary duties including failing to take steps to prepare the business from the negative impact caused by the disruption to markets and fallout from consumer activity. And there will be an inevitable explosion—already beginning as we write this article—of insurance claims for losses resulting from business interruptions and nonpayment. Finally, as revenue and income suffer from falling consumer activity and ailing markets, many companies are going to wind up filing for bankruptcy protection in the courts.

There are significant sums tied up in all these claims—both for the companies whose businesses were harmed and for the law firms that wish to represent them and help them to be made whole. And in order to proceed, these claims require an ample supply of exactly what is likely to be in short supply: cash. These types of complex commercial litigation are inherently expensive and lawyer fees and discovery and expert expenses can quickly escalate.

During the 2008 global financial crisis, the lack of capital and the cost of litigation meant that companies were hesitant to head to court. But out of necessity, a solution evolved: Legal finance, in which a third party assumes the cost and risk of a commercial claim in exchange for a portion of the award if the matter is successful, filled that gap by providing capital on a non-recourse basis to those with meritorious claims but a lack of cash to enforce them. In addition to helping companies enforce their rights, legal finance can help companies “unlock” the value of their legal assets and bring cash into the business—another solution that took hold in the wake of the last recession.

Fast forward to 2020: Legal finance is now widely known—although not always well understood—and has evolved to offer a range of solutions instead of the one-size fits all product it once was. Today, legal finance is used by both companies with meritorious claims and the law firms that represent them to fund strong individual claims and, through capital facilities, multiple affirmative claims and even mixed portfolios of affirmative and defense matters. And it has a big role to play in the present downturn.

For companies seeking working capital, legal finance provides a means to convert legal assets into cash. By working with a legal finance provider to monetize a portion of a pending claim, judgment or award, companies can obtain immediate capital—on a non-recourse basis—that would otherwise be unavailable until that claim, judgment or award is fully adjudicated and enforced. This provides an influx of cash and helps businesses de-risk their litigation portfolios and achieve greater control over the timing of their recoveries. Even companies with large cash reserves to pay lawyer fees and expenses often prefer immediate liquidity to waiting years to unlock the captive value of claims, judgments and awards—especially given declining business revenues and increased capital constraints.

And legal finance helps law firms retain clients and generate new business. When clients’ ability to pay becomes constrained, hourly firms can continue to serve their clients without interruption, and contingency firms can continue to generate business without added risk. Law firms can also use legal finance to hedge against the impact of a downturn on their clients—most immediately the prospect of clients that become unable or unwilling to pay their fees. In its most basic form, legal finance provides firms the ability to continue working with clients on meritorious claims when clients’ ability or desire to pay legal fees is impaired.

In the last downturn, many law firms suffered when clients cut corporate work and they were unprepared to offer other services to compensate for this loss of revenue. In the last year, potentially in anticipation of looming client budget cuts and a recession now well underway, some firms have opted to invest in building highly profitable business disputes practices for plaintiffs and taking those matters on contingency. Legal finance in the form of a portfolio-based capital facility—in other words, a pool of capital tied to a pool of existing or future matters—means that these firms can take on a significantly greater number of cases without increasing risk to the firm. Now, rather than waiting to react to client budget cuts, firms are being proactive by diversifying their practices and using legal finance to share risk as they do so. Law firms that do not have a legal finance process and partner in place will be more limited—especially in a downturn—in their ability to compete for profitable new business and hedge against the client budget cuts to come.

This pandemic has sharpened companies’ and law firms’ focus on managing costs and maximizing available cash. As the economic fallout from this pandemic continues, and firms and clients adjust to the current environment, that focus will only become more acute—and legal finance is an available solution for both the near-term and long-term business challenges faced by those firms and the companies they represent.

This article was originally published in the New York Law Journal