The field of law is notorious for its jargon. Rife with Latin words and phrases, legalese can aggravate even the most sophisticated of your clients.
Frustrating, industry-specific terminology, however, isn’t limited to the legal profession. It infiltrates other fields, including litigation financing.
When words are lost in translation it can have unintended (and sometimes harmful) consequences to your firm, especially when it pertains to your finances. You may accidentally expose yourself to significant personal liability, pledge more assets than anticipated or incur substantial indebtedness as a result of hidden fees, complex interest rate provisions or prepayment penalties.
Below is a short list of common terms used by litigation financing companies translated.
- Case Collateral or Fee Collateral
Collateral is a term that describes property or assets pledged to a lender to secure repayment under a financing agreement. Generally, the funder bases the amount that they’ll advance to you on a multiple of the assessed value of your collateral, so that they can be assured they’ll recover all amounts owed.
But what do law firm financing companies mean when they say “case collateral” or “fee collateral”?
“Case collateral” and “fee collateral” are phrases that refer to your firm’s greatest assets—current and future rights to payment from cases (not the cases themselves!). This includes all of your legal fees that you’ve earned but haven’t yet received, as well as your unearned fees. Often the definition will also include your reimbursable expenses.
Because a number of law firm financing companies are able to value your potential fees as collateral—whether arising from resolved or pending litigations, or those in the pre-litigation stage—you can obtain significantly more financing than that traditionally offered by a bank. Find out more about the differences between bank and litigation financing here.
- Loan-to-Value Ratio (LTV)
Some litigation financing companies have provisions that require your collateral to be a certain value above the amount they’ve advanced to you. This provision is known as LTV or the Loan-to-Value ratio.
LTV is used to measure the lender’s risk. The finance company divides the principal amount advanced to you by the value of the collateral you pledged. If the resulting percentage is high, then the perceived risk to the lender of a default is high, and if low, then the perceived risk is low. Generally, the level of risk is proportionate to the cost of financing you’ll be charged. Due to the unpredictable nature of contingent fee practice, litigation finance companies often require as much as $5-8 dollars of collateral for every $1 borrowed.
- Non-Recourse / Recourse or Unsecured?
Many confuse the terms “non-recourse” and “unsecured,” but there are meaningful differences—not the least important of which is that non-recourse financing arrangements are almost always secured by collateral.
In litigation financing, your fee collateral usually secures non-recourse debt. This means the funder won’t receive payment even if the case produces fewer fees to your firm than what was advanced, and that the company can’t sue you personally for any deficiency. It also means that because the debt is secured, the company has the right to collect any earned, but unpaid fee collateral in the event of a default.
With unsecured debt (e.g. credit card debt), in contrast, no collateral is required. If you don’t pay, then the lender must sue you for the amount owed, but can’t seize any of your assets (until a judgment is entered against you).
Of course, recourse financing means that one or more partners personally guaranty the debt and this is often combined with a security interest in all assets of the firm (more about guarantees below).
Be aware that both non-recourse and unsecured financing transactions pose heightened risks to funders, and consequently the rates charged frequently far exceed that of a conventional loan or line of credit. Don’t know which is best for your firm? Read how to choose here.
- Loan or Line of Credit
Loans and line of credits are two more financing terms often confused with one another, but which are different. If you’ve obtained a loan, you receive the full amount at closing and interest accrues immediately. Under a line of credit, you get financing up to a maximum level and then have the flexibility to make draws, repay and re-draw when you need. Interest only accrues on the amount outstanding. Learn more about the differences here.
- Limited, Unlimited and Joint & Several Guarantees
Personal guarantees, like collateral, provide financing companies an alternative source for repayment in the event you can’t meet your obligations under the funding agreement—i.e. you personally. However, there are varying types, such as unlimited, limited, joint, several and joint & several.
An unlimited personal guarantee is, as it sounds, unlimited. The finance company can collect from you 100% of all amounts owed by your firm, including interest and fees, even after death.
A limited guarantee arises when the lender agrees to only hold you liable up to a fixed amount that is less than the total amount owed—perhaps due to some additional collateral you may pledge, such as real estate.
A several guarantee usually involves more than one guarantor and caps each individual’s potential liability at a percentage (usually their respective percentage interest in the firm) of the total amount owed.
A joint and several guarantee means each guarantor has total responsibility for repayment of the full amount of the debt and the lender can proceed against any or all of the guarantors for all or any portion of the total amount, at the lender’s discretion. A paying guarantor may then have a right to sue the other guarantors for contribution if unequal collection occurs among the guarantors.
While giving an unlimited and/or joint and several guarantee may sound onerous, it usually means that you can get considerably more funding and, at a better rate. Uncover more about the requirement for guarantees here.
When seeking financing, you’re likely to stumble upon other industry-specific terms you don’t necessarily understand. Rather than gloss over the text, it’s important to find the meaning of those terms to ensure you get the financing you believe your bargaining for.