14 November 2013Print This Post

The truth about the new ‘hybrid’ DBAs

Amey: it’s a buyer’s market

Posted by Matthew Amey of Litigation Futures sponsor TheJudge

Traditionally, when we think of third-party funding, it’s usually in the context of financing the claimant. In other words, a litigation funder will enter into a funding agreement with the claimant and agree to pay their legal fees and disbursements. However, as the market evolves, so do the options available for litigation funding.

There has been some recent press and publicity from various funders surrounding funding products specifically designed to finance law firms directly, in order to enable firms to offer damages-based agreements (DBAs). These products have emerged as a response to law firms’ apparent frustrations with the uncertainty around the DBA regulations, particularly the suggestion that these regulations do not allow firms to offer clients partial DBAs.

There are two principle means, highlighted by recent press, through which a firm can use litigation funding to remove some or all of its risk under a DBA and thereby artificially create an outcome not dissimilar to offering a partial DBA directly to the client.

Option one is where a litigation funder agrees to finance a proportion of the firm’s DBA risk. This requires the firm to enter into a full DBA with the client but receive a proportion of their WIP via a separate agreement with the litigation funder. Crudely speaking, this might mean that, if a firm obtains funding for say 50% of its DBA WIP, the funder may seek to charge a fee equivalent to 50% of the firm’s contingency fee.

In reality, many funders may request a larger share which they’d seek to justify on the basis that their money is ‘cash out’.

The example above is, of course, an over-simplification because DBA funding is usually discussed on the basis that it is a funding facility which spreads across a portfolio of cases, rather than a single one-off case. This spreads the risk for the funder but the firm would have to be willing to lock themselves into an arrangement with one funder.

A second route to an outcome similar to a partial DBA from a firm’s perspective has recently been promoted by one funder. The idea is that the firm’s client enters into a traditional third-party funding agreement with the funder. The funder then enters into an additional and separate agreement with the law firm, which allows the firm to put some of their fees at risk in exchange for a share of the funder’s contingency fee in the event the case succeeds. In effect, this would give the firm the ability to act on a partial contingency fee basis.

Under this model, the firm’s retainer is a standard fee-paying one and not a DBA, but crucially the parties collectively agree that the law firm can be paid a share of the litigation funder’s uplift in the event of success.

Some sceptics may say this appears to be a circumvention of the rules or that such an arrangement could result in the firm losing its uplift, if the funder ceases to fund for any reason. Conflicts of interest could potentially arise also, although one would question whether this type of arrangement causes any greater potential for conflicts than a ‘traditional’ third-party funding arrangement (to the extent that one exists).

Whether either of these ‘hybrid’ DBA arrangements’ take off to any real extent remains to be seen. In any event, interest may be short lived, if the DBA regulations are amended to allow firms greater flexibility in terms of the percentage of fees at risk. The possibility of firms being allowed to enter into partial DBAs does still seem quite far off though, with some commentators suggesting it’s at least a year away.

While innovation occurring within the litigation funding market can only be a positive thing, particularly as it keeps competition moving, what neither of these products appear to do currently is overcome the issue of economics, particularly for those cases where the sums in dispute are not in the multi-millions but instead are much more modest.

Whilst there might be some flexibility over pricing where a law firm is promising a portfolio of cases to a funder, unfortunately funders haven’t overnight decided to give their investors a lower internal rate of return. Furthermore, law firms will need to start thinking like a claimant, in terms of the purchasing decision, and ascertaining the competitiveness of the deal on offer. After all, the overall price charged by the funder will affect the returns received by the law firm.

Many of the ideas as to how funders can fund law firms directly come with a new brand or clever product name – but does it really mean anything? Essentially, any litigation funder can offer exactly the same deal.

If the costs-to-damages ratio is sufficiently appealing to attract a traditional third-party funder, then potentially there are a variety of ways – beyond those discussed – which can give the law firm the ability to earn an attractive uplift without having to take on significant risk.

Almost every funder in the market is open to such hybrids so, in the same way as it’s a buyer’s market for claimants, it’s potentially even more so for law firms.

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