Defining Direct Legal Funding
In direct legal funding, the financing is advanced by a funder directly to a plaintiff or claimant in connection with an ongoing or anticipated piece of litigation and/or arbitration. The advance will be either secured or unsecured, and so works in a broadly similar way to a traditional loan. The difference with this sort of financing is that it is paid by funders to individuals directly, rather than a lawyer as they continue to act as the intermediary, so they get the benefit of some real independence from any ongoing matter, including no conflict of interest concerns. Funds can be used to pay any sort of disbursement , including, for example, medical reports, drafting fees and other professional fees. In essence, the cash advance provided under a direct legal funding agreement is an unsecured advance to the plaintiff that is intended to be repaid out of the proceeds of the matter (if successful) or otherwise forgiven (if not successful). In such situations, a purchaser of conditional fee agreements ("CFAs") should be aware that the definition of "unsecured" may impact enforceability of a third-party funding agreement in the event of insolvency.
Mechanics of Direct Legal Funding
Assessing the Legal – The "How To" of Direct Legal Funding
Before any funds are dispersed, the lender must thoroughly review the case and assess the potential risk factors. Generally speaking, the most reprehensible risks for the lender are large awards or judgments, defense counsel fees being paid under a POC agreement, and a factor against the Plaintiff or plaintiff’s subrogation claim. Even if these do not exist, the lender will still require a litigation update from the Borrower and/or their counsel on the duration of the case and potential issues that may delay the case or impact the potential award.
The lender will then conduct its own due diligence in verifying all claims made by the Borrower. This will mean personally contacting the Borrower’s counsel to confirm, in writing, that they have been retained and are working on the case. Furthermore, depending on the circumstances, it may even mean conducting searches to confirm the Defendant’s Plaintiff’s insurance policy to ensure they have adequate coverage. A worthwhile lender will do whatever is necessary to limit their risks, including contacting defendants’ counsel and insurers.
Another key procedure is obtaining copies of all legal documents associated with the case. The lender will identify strengths, weaknesses, and points for potential settlement and insist that if the Borrower is to proceed forward on the case, they must keep payments current. In this respect, direct legal funding takes the place of contingency fees for Plaintiffs and their respective attorneys.
Advantages of Direct Legal Funding
Direct legal funding offers a multitude of advantages for plaintiffs embroiled in litigation. Primarily, it provides critical financial relief during otherwise lengthy litigation proceedings. Not only do many lawsuits take years to resolve, oftentimes defendants employ various tactics to lengthen the process and avoid a fair settlement. Direct legal funding can provide the plaintiff with the financial comfort necessary to sustain their case through the litigation process. It can even assist plaintiffs who, though they have good cases, are faced with difficult-to-collect judgments against judgment-proof defendants.
Even in cases where a plaintiff receives financial compensation for their injuries, the amount is often not enough. Even after a settlement or award, plaintiffs can be left in difficult financial positions since it can take months, or even years, to collect on a settlement or award. Direct legal funding can also allow plaintiffs to pay any legal fees and expenses that law firms hold back; plaintiffs can receive their full settlement without firms inserting a deduction.
Another benefit of direct legal funding is that it levels the playing field in negotiations. Defendants can hold out and delay settlements (or pay them out over time), knowing that plaintiffs struggle financially and with time constraints. Funds from an advance can be used towards living expenses or investments that help supplement income during the lengthy litigation period. In this way, plaintiffs have the leverage they need to ensure a fair settlement or award.
In addition, the funding does not have restrictions on its usage. A plaintiff can use the funds as they choose to help them sustain their case, whether that means using the funds for transportation, housing, food, or other daily essentials. Unlike traditional loans, where funds are given based on a plaintiff’s credit, direct legal funding companies only look at a plaintiff’s eligibility in relation to their pending litigation.
Overall, direct legal funding can be beneficial to any plaintiff who needs comfort, stability, and fairness throughout their litigation. A plaintiff who qualifies for direct legal funding can make use of it to provide options, comfort, and security during otherwise perilous litigation proceedings.
Potential Risks and Caveats
Understanding the terms and conditions of the funding is essential in order to understand any potential risks, costs and other considerations that may affect the outcome of your case. To begin with, like any form of finance, there are costs. The biggest consideration for most clients when choosing a funder, or funding agreement, will be the cost of the money being borrowed. There are a number of approaches typically taken by funders in determining the cost of the funds they provide:
The first option is a loan with interest payable on repayment. Like any other loan provided by an institution, funders will want to charge a relatively high rate of interest for the funds they provide. However, funders are becoming increasingly wary of ‘non-recourse’ loans, as this pushes them to the end of the queue of parties claiming money from settlement proceeds. Agencies such as Slater and Gordon have their own legal team, can take a large portion of the settlement proceeds, and also court action may be involved.
A second option is no interest payable on repayment, and no risk to you, but with the funding being based on the merits of your case. A funder who agrees with your case’s merits may take it on under an arrangement where they do not charge interest but instead will receive a percentage of the sum recovered from settlement. These arrangements usually range from 25-40% of the settlement proceeds. If a funder agrees to cover the upfront disbursement costs of the case (e.g. court fees, medical reports) then the percentage taken from the proceeds may be reduced. Under these arrangements, you would pay back the money loaned at settlement, without interest, in return for a fixed percentage of the settlement proceeds. Of course the risk is that the fund cannot recover the money but is outlaying potentially large sums into the case upfront without any surety of a return. As a result the merits of your case will be very important to be considered in the application process.
A third option and perhaps one of the most common is a ‘no win, no fee’ agreement. This is the usual funding agreement entered into by clients of law firms/solicitors. Under a ‘no win, no fee’ agreement, the legal firm/lawyer will only be paid if there is a successful outcome to the legal proceedings (for example, settlement or court award). The client will still be liable to pay any disbursement costs, such as court fees or disbursements on expert reports at the conclusion of the case – unless otherwise agreed. In all matters, if a ‘no win, no fee’ agreement is entered into, you retain the right to change law firms/solicitors should you wish. It is also possible to enter into a litigation funding agreement at the same time as a ‘no win, no fee’ agreement, under which the funder agrees to cover the upfront disbursement costs of a matter, in return for a percentage of the settlement sum awarded to you. Again, the risk is the merit of your case that bears the greatest influence.
In addition to understanding the payment terms of any funding arrangement, it is important that you understand whether there is any scope for additional payments if the case is prolonged; what happens if your case is unsuccessful; whether a new solicitor or law firm can be appointed to conduct your case; whether the agreement allows for the assignment of the funding agreement to a different solicitor/law firm should you choose to alternate; who owns the legal costs incurred by your lawyer/law firm; and any other special conditions.
Eligibility Criteria for Direct Legal Funding
Potential borrowers must satisfy a range of criteria in order to be eligible for Direct Legal Funding. In particular, funders will want a borrower to meet the "Merits Test". Under Reg 6.8, the Merits Test requires that funders consider whether the borrower’s case has a "realistic prospect of success": this is the key part of the eligibility criteria.
In addition to the Merits Test, funders will need to determine that it is ‘reasonable’ for a borrower to be funded using Direct Legal Funding, Reg 6.7 states that funders must consider whether, given the nature of the claim/trial, there would be a benefit to all parties if the claimant were to be funded by the scheme. For example, there may be more than one defendant to a claim and any funding may be of apparent benefit to more than one party. These factors will be decided on a case by case basis.
Reg 7(1) sets out the other circumstances where the claimant must also show ‘substantial’ barriers as defined under Reg 7(4). These include if a claimant is:
As will be noted from above, it is important for potential borrowers to be able to show that they have ‘sustained’ an injury or loss rather than simply just having sustained a personal injury, loss, damage or suffering. It is also important that potential borrowers appreciate that even if they have a category of claim that falls into one of the above categories, it does not mean that funders will automatically agree to fund their case.
It should also be noted that under Reg 6.10 funders may consider cases other than those satisfying the Merits Test.
Legal and Moral Ramifications
As the scope and scale of legal funding in the U.S. have continued to grow, critics have called for heightened scrutiny, arguing that disbursement of such funds should be subject to the American Bar Association’s Model Rules of Professional Conduct ("the Model Rules") because the agreements are some form of contract for legal services. However, the Model Rules definition of a legal client as the "person or entity that sends the lawyer to act for it" (Rule 1.13) may foreclose any arguments that funding agreements fall within the Model Rules’ definition of a legal client. This issue was also addressed in a recent state court decision that considered whether the definition of legal client in the state rules of professional conduct extended to litigation funding transactions. (Baker v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 155 A.D. 3d 160, 166 [2017], appeal denied, 31 N.Y.S.3d 36 [N.Y. 2018]) (Both courts held that while the litigation funding transaction may not constitute a permissible loan to the litigation funding company’s litigation client, which would violate the ethical rules, the funder’s allegedly conflicted conduct did not prevent it from being awarded quantum meruit). The legal profession has quietly tip-toed around this issue, silently waiting to see how the litigation funding industry would develop within the regulatory framework. While the Professional Ethics Committee of the New York State Bar Association has not established an express opinion on the permissibility of litigation funding transactions, in March 2010 it opined that a lawyer could ethically enter a loan in which the borrower obtained cash against a lawsuit, even when it encumbered the lawyer’s right to fees. The Loan Agreement also stated that at the end of the case, the lender shall receive its loan and interest out of the recovered funds prior to distribution to the attorney. The Committee cited language from Golden Rule. The only difference we see between the Golden Rule decision and the scenario for which inquiry was made is that here the loan agreement did not condition the advance on the borrower’s acknowledging that the loan was necessary in order to pay legal fees. (NY State Ethics Op. 977 [March 15, 2010]) In February 2017, the New York State Court of Appeals expressly declined to agree with the Golden Rule rationale. (Baker v. Merrill Lynch , Pierce, Fenner & Smith, Inc., 155 A.D. 3d 160, 166 [2017], appeal denied, 31 N.Y.S.3d 36 [N.Y. 2018]). We are not persuaded by the reasoning in Golden Rule. We believe a loan made contingent upon the securing of fees for the purpose of entering into a security interest in the loan proceeds and recouping fees from the third-party litigation proceeds is a conflict of interest.. Baker at 165. In Baker, Wallenstein, the action lawyer, entered into a Loan Agreement with the commercial litigation funder, that conditioned its loan (i.e., placed a lien on Baker’s potential award) on the recovery of the attorneys’ fees. The court held that the action lawyer’s interest conflicted with Baker’s, requiring the action lawyer to withdraw, because of the action lawyer’s uncertain interest in future fees. See also Cayman Islands v. Alghanim, CA-005588-2015 (Bermuda) (Oct. 11, 2017) (disbarring an attorney who failed to disclose that he had obtained loans for his fees encumbered by security interests on his clients’ assets and settlements in breach of fiduciary duty). In the second half of 2015, the American Bar Association’s Commission on Ethics 20/20 proposed formal changes to the Model Rules, which would have allowed counsel to enter into contingent fee agreements with third party funders that would have secured loans to cover the attorney’s fees. On June 15, 2015, the ABA House of Delegates rejected the proposal (Resolution 114), citing concerns about the harm that the transactions could cause to third-party funded clients and class actions (see Frank D. Wexler, "Why the Proposals to Allow Litigation Funding Arrangements to Share in Legal Fees Were Rejected," Litigation Finance Journal, August 4, 2015). Thus, while the issue has been addressed and extensively analyzed, the debate over whether funding agreements must be subject to the Model Rules has come to an end. At this time, however, litigation funding companies should continue to work diligently with law firms to craft agreements that align with the ethics and professional conduct requirements. Furthermore, while the ABA has not explicitly adopted a view on the permissibility of funding agreements, the preamble to the Model Rules expressly states that its purpose is to provide "standards for the ethical practice of law." For now, the ABA remains on the sidelines.
Selecting a Legal Funding Company
Before selecting a provider, it’s critical to actually research the company. What have their customers said about their experience? What are the company’s reviews online? How long have they been in business? While even the shoddiest legal funding companies can pretend to be a reputable lender for a time, do they have a record of customer complaints or business practices that would indicate they’re not being fully transparent, trustworthy, and adhering to the law? Go into detail on your research, and don’t stop until you’re confident the provider you’ve selected will take care of your needs.
How quickly can I expect a response to my application? The approval process is simple if you’ve provided all of the necessary information, but in answering this question the provider should look at more than just the applicant’s personal situation. For example, if the company believes your lawsuit might take years to finalize, do they still try to give you money as quickly as possible now, or do they tell you they’ll give you only what you need in the very short-term? Good legal funding providers will always try to break as close to even as they can with their investors, meaning that they shouldn’t be holding up a substantial amount of money for longer than they have to. If you come across a company that promises to get the funds to you ASAP but then takes weeks with no phone calls or explanation until you finally get the money, or if they ask you for a few extra days handling the process to get you a better rate that’s much higher than the competition, then it might be time to go with another option.
Regardless, it won’t hurt to talk to a representative before starting the application process. That way, you can express your expectations, and learn whether or not the provider can meet them. This communication will get you comfortable and familiar with the process of working with this company.
Case Studies
To provide a concrete context for the value of DLA, we consider a scenario involving Maria, a severe exterior decorator whose small business was hit by Covid restrictions and unable to find insurance to cover her lost income. Through YRF, Maria was able to gain access to legal and funding support to pursue a claim for financial compensation.
In another example a multi-store baker who had a solid successful business for over 15 years, purchased a new larger store to expand their business only to discover he had been defrauded of his money and materials. One day later, the company disappeared never to be found. With an agreement, ABV Legal was able to take the earnings lawsuit on contingency helping him reach a successful outcome.
In a similar case, a florist purchased products from a distributor to supply his business only to find that by the time they had arrived, their products had been damaged – all of the perishable items required immediate action to preserve. With no time to wait for an outcome, the florist negotiated a success arbitrage settlement on contingency.
Future of Direct Legal Funding
The landscape of direct legal funding continues to evolve as technology improves and the demand for this form of financing keeps on growing. The number of new entrants into the market that are making their technological offerings available to litigants continues to increase. Consequently, the level of service investors and intermediaries can provide has improved, resulting in better pricing for potential clients. Bids from investors cited on funding platforms can now be received from multiple funders, and competition drives down costs. Clients are becoming more aware of the benefits of legal financing such as defence funding (also known as After The Event insurance , or ATE) and after-the-event and portfolio funding. Many clients are realising that by engaging intermediaries which operate within the regulatory framework of FCA rules, they can access very affordable funding. With the rise in popularity of social media and the internet, we can expect the market for this type of funding to continue to expand. Certainly, operational efficiencies, driven by online activity, will help to lower prices for cash-strapped clients. With the continuing growth of the legal sector, it would not be unreasonable to expect growth in this sector as well. More competition, greater economies of scale and lower costs may well be the key features for this industry going forward.
