Non-recourse financing—a transaction where you receive funding in exchange for a portion of your interest in the proceeds of a lawsuit—is a prevalent construct in the litigation finance industry.
The reason is simple. If you win, you repay the funder the amount advanced, plus a return. If you lose, you pay nothing. The funder’s recovery is limited to your interest in specific cases, which means your potential liability to the funder is finite.
At least that’s the concept advertised. However, these financing arrangements can be more complex than marketed.
Here are 3 surprising facts about non-recourse funding transactions you should know before considering this type of financing for your firm.
- It may not actually be non-recourse
Generally, a non-recourse obligation is only be satisfied out of the collateral securing the obligation. As it relates to litigation finance, this means that if you’re unable to repay your funder, then the funding company’s exclusive source of repayment are the litigation proceeds you’ve pledged in consideration for the funding.
Due to the risk involved with such a transaction, non-recourse companies often include provisions that’ll trigger recourse liability or specified damages, such as so-called “bad boy” guaranty. Under a bad boy guaranty, you’re penalized for engaging in certain enumerated “bad acts.” Examples of bad acts include failure to perform under the funding agreement, fraud, misappropriation, intentional misrepresentation, bankruptcy, insolvency or fraudulent transfer.
Beyond bad boy guarantees, there may be other recourse carve-outs contained in your non-recourse funding agreement. Therefore, before signing, it’s important to check if something in the contract will trigger fully recourse liabilities.
- Repayment isn’t always limited to one case
Over the years, many non-recourse litigation funders have started moving away from single-case financing and towards portfolio financing (the financing of several cases).
With portfolio financing, the funder reduces its risk—if you lose one case, the funder still has the opportunity to collect from proceeds of your other cases.
The advantage to portfolio financing is you’ll probably receive a larger amount of financing than you would if you only pledge a portion of your fees from one case. The disadvantage is that you’re still going to be charged a significant rate of return due to the non-recourse nature of the advance, yet the likelihood that you’ll have to repay the funder increases exponentially.
If you’re thinking of obtaining non-recourse funding against multiple cases, you should consider a line of credit or loan as an alternative financing option. The cost of financing is much less, you can get considerably more funding and the proceeds can be used for any law firm purpose, such as payroll, litigation expenses, taxes, inventory, advertising, travel or your firm’s expansion.
- Non-recourse agreements are subject to more rules and regulations
While the fundamental character of a non-recourse transaction doesn’t vary too much among funders, the funding agreements do—by their terms, as well as structure.
Unlike recourse transactions, where the agreement is relatively straightforward, non-recourse contracts can be structured as a sale or assignment of claims, purchase agreement, loan or some variation thereof. A single non-recourse funding provider can have differing types of arrangements depending on the state where you’re located and the laws or ethical rules governing that jurisdiction.
The foregoing is in large part due to: (1) state statutes regulating the rate of interest that may be charged; (2) archaic doctrines of champerty and maintenance aimed at precluding frivolous litigation; and (3) rules of professional conduct governing you and your firm. For instance, the New York City Bar recently issued a formal ethics opinion wherein it concluded an arrangement that is contingent on a lawyer’s receipt of legal fees or the amount of legal fees in one or more specific matters violates the prohibition on fee sharing with non-lawyers, whereas a traditional recourse loan or line of credit would not.
This isn’t to say that you should avoid non-recourse funding agreements entirely; it’s merely highlighting that non-recourse transactions are subject to more rules and regulations than their recourse counterparts. As such, proceed with caution—verify compliance under statutes and your state bar before taking non-recourse funding.
As with many things in life, non-recourse funding has its pros and cons. Ultimately, it’s your decision what type of financing is best suited for your firm, but such a decision is better made when your fully informed. Find out more about different types of financing options here.