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Category: Advancement of Fees

Article: 5 Reasons Lawyers Often Fail to Secure Litigation Funding

August 24, 2021

A recent Law 360 article by Charles Agee, “5 Reasons Lawyers Often Fail To Secure Litigation Funding,” reports on litigation funding.  This article was posted with permission.  The article reads:

It's no secret that parties seeking litigation funding face steep odds in securing a deal.  How steep?  According to my firm's research, more than 95% of commercial litigation funding deals presented to any particular funder never advance to closing.  Experience tells me one of the overarching reasons the litigation finance deal closure rate is so low is that lawyers and their clients drastically underestimate the challenges and nuances of obtaining this specialized form of financing.

For many, the downside of trying and failing to secure funding is simply that — not obtaining the funding.  So why not approach a few funders and see if one bites?  On the surface, this approach has appeal; in reality, it is fraught with hidden costs.  The litigation fundraising process can be extremely laborious, and the time sunk into an unsuccessful deal typically is not billable.  Each year, leading law firms squander millions of dollars in time alone seeking funding for deals that do not bear fruit.

Even more concerning, lawyers who are unsuccessful in obtaining funding for their clients almost always damage their credibility with the client.  The good news is that these challenges can be anticipated and, in many instances, overcome.  To overcome those challenges, however, it is important to also examine why so many parties fail to obtain litigation funding. Here are the top five reasons why.

1. Misunderstanding the Funders' Acceptance Standards

Funders reject the lion's share of deals that they are shown because most of them should never have been brought to the market in the first place.  My colleagues and I have seen that far too many lawyers and clients present litigation opportunities that make no sense to pursue, regardless of who is funding the case.  Nothing can be done to change the substance of the underlying matter, and short of committing fraud, you are not going to sneak into a funder's vault with a meritless deal.

The best — and only — advice for these weak opportunities is to avoid the litigation fundraising process altogether.  But we also see that funders also reject a significant number of matters that are meritorious and economically viable enough for experienced litigation counsel to be willing to risk their own legal fees on a successful outcome.

Why are these opportunities declined?  The reason — and it may not be a satisfactory one — is that a litigation funder's diligence process and investment criteria are generally more rigorous than that of most law firms.  Unless a lawyer has a great deal of experience with funding, this disparity can be jarring and more than a little ego-bruising, especially when clients or colleagues are watching.

To appreciate why the litigation funders' bar is set so high, it is helpful to consider the investment proposition from their perspective.  The funder must develop a high degree of confidence in a financially successful outcome of a legal dispute — usually involving complex subject matter — because it will only receive an investment return if the underlying matter resolves favorably.

As a purely passive investor, the funder also must structure the deal in a way that achieves alignment with both counsel and client, and often the economics of even the strongest of cases are insufficient to do so.  Further, unlike a venture capital fund that can accept high levels of losses because of their upside in successful investments, litigation funders' more modest returns are too low to subsidize VC-level loss rates.

Because most litigation funders are relatively new and have not yet established substantial track records, this dynamic fosters a stronger bias toward risk aversion within the industry.  A litigation funder's diligence process is designed to find reasons not to invest in an opportunity. It also tends to follow a leave-no-stone-unturned approach, which can be exhausting for the party seeking funding.  However, even the most discriminating funders' processes can be successfully navigated with proper preparation and analysis before approaching the funder.

What are the main challenges counsel will face in the litigation, and how will these be overcome? What is counsel's track record in similar matters? What level of financial risk is counsel prepared to assume?  These are just a few of the questions that parties should consider before approaching funders. Lawyers and their clients are well-served to anticipate these and other questions that a skeptical investor might ask, and be prepared with clear and thoughtful responses.

2. Failing to Approach the Most Suitable Funders for the Opportunity

Parties seeking funding often fail to approach the funders most likely to invest in their claim.  There are currently 46 active commercial litigation funders in the U.S., each with different funding criteria, risk appetites, structuring preferences and return profiles.  Most parties seeking funding only present their opportunity to a few of these funders. This is a mistake, because even the largest funders in the world are not configured to accommodate every potential type of deal.

Without adequate knowledge of the market, it is difficult to know which funders are most suitable for a particular deal. It is critical to know what a funder's investment criteria are, including preferred deal size, type of litigation, jurisdictions and stage of litigation, among others.  Too often, parties meet resistance from funders that were never a good fit for the opportunity and elect to abandon the fundraising process altogether.  If they had only identified the right audience, they might have been able to secure funding.

3. Inadequately Packaging the Presentation of the Opportunity

First impressions matter, especially in litigation finance.  Our conversations with funders inform that the largest litigation funding firms see more than 1,000 opportunities a year and don't have the bandwidth to wade through poorly packaged opportunities.  Still, parties often fail to spend the time necessary to appropriately present an opportunity. The failure to properly present an opportunity often is the difference between a yes and a no.

What are the most common deficiencies in litigation fundraising presentations?  Most lawyers are more than capable of presenting the legal merits of an opportunity; however, we have observed time and again that they tend to fall short in demonstrating a thorough approach to the economics, i.e., the damages model and the budget.  Lawyers and clients may also downplay or omit entirely a case's potential challenges, whereas a funder expects these downsides to be soberly acknowledged and addressed.

Another similar mistake is to leave too many analytical black boxes in the presentation, such as factual questions that could be investigated now but are proposed to be left for discovery, or assumptions underlying the damages model that have not been rigorously researched.  The negative impression left by these and many other deficiencies is difficult to overcome.  Parties seeking funding should prepare a thoughtful and complete presentation of their financing opportunities.

4. Lacking Awareness of Norms That Guide Negotiations With Funders

A common misconception is that litigation funding deals are easy to negotiate and that funding agreements are relatively uniform.  In reality, these deals have several peculiarities and are governed by particular legal and ethical parameters.  Even parties with experience in other types of financing or business dealings struggle to extend their acumen to litigation financing deals.

Indeed, the process is guided by certain industry norms that outsiders may not necessarily appreciate or even be aware of. Parties that neglect to understand these nuances run a considerable risk of derailing the litigation fundraising process, sometimes after many months have been spent.  Each funder approaches the investment diligence and documentation processes differently.

For instance, some will provide parties a term sheet and, after the term sheet is executed, proceed to deeper diligence and final deal documents.  Other funders might have a three-phase negotiation process where the party is expected to execute a term sheet, a letter of intent and then a litigation funding agreement. Parties should be prepared to negotiate with the funder at each phase of the process.

Prior to closing, the last document to be negotiated is the definitive litigation funding agreement, or similarly named instrument.  While no two funding agreements are identical, most agreements have certain types of provisions that are essential to the funder, given the contingent-repayment, no-control nature of the investment.  Parties seeking funding should understand that these types of provisions are nonnegotiable and that pressing too hard can sour an otherwise fruitful closing process.

5. Prematurely Agreeing to Exclusivity With a Funder

Perhaps the most critical decision in the litigation fundraising process involves granting exclusivity to a funder.  Once a term sheet has been negotiated, a funder will nearly always require a period of exclusivity — sometimes more than 60 days — to complete its diligence and documentation of the transaction. After granting exclusivity, you are largely at the funder's mercy.

Parties seeking funding almost universally misread the significance of obtaining a term sheet from a funder, mistakenly believing that the probability of closing is far higher than it actually is.  Depending on the funder and the extent of its preliminary due diligence, the term sheet can merely be a hope certificate describing what a transaction might look like. Terms may be retraded or, as is often the case, the funder declines to proceed with the deal following a deeper dive into the opportunity.

Selecting the wrong funder for exclusivity may also hamper a party's future prospects of securing a deal with another funder, if negotiations with the original funder stall.  Funders will often assume that the deal with the original funder stalled because of a fatal flaw in the deal.

In an industry that is already risk-averse by nature, this kind of red flag in the middle of a fundraising process is extraordinarily difficult to overcome.  The key to avoiding this mistake — aside from refusing to grant exclusivity — is to understand the approach, process and track record of any funder requesting exclusivity.

The party seeking funding should also assess the extent of the funder's preliminary diligence and the degree to which the funder grasps the key issues.  Of course, ensuring that all material facts have been disclosed to the funder prior to exclusivity also helps avoid surprises. But candor may not be enough to avoid this pitfall.  Exclusivity is a necessary evil in the litigation finance industry — for now — and parties seeking funding should be extremely judicious in granting it.

Conclusion

While securing litigation funding may seem daunting, there are ways to beat those odds and maximize the chances of securing funding.  Parties that approach the market in a thoughtful and informed manner have a much higher likelihood of success and of avoiding wasteful dead ends.  As the market continues to mature, funders should innovate and improve their processes to make the experience more predictable and user-friendly.  Until then, experience in the market and knowledge of the funders and their approaches will remain the key to improving the odds of obtaining litigation financing.

Charles Agee is managing partner at Westfleet Advisors.

Article: The Right Retainer: Classic, Security or Advance-Payment?

February 7, 2021

A recent New York Law Journal article by Milton Williams and Christopher Dioguardi, “Retaining the ‘Right’ Retainer: Classic, Security or Advance-Payment?,” reports on different retainer types in New York.  This article was posted with permission.  The article reads:

This article evaluates which type of retainer agreement gives attorneys the best chance to preemptively shield their retainer fees before a client ends up in bankruptcy or the Department of Justice seizes and forfeits the client’s assets.

The scenario is this: A struggling business on the precipice of bankruptcy, or a criminal defendant whose property is subject to forfeiture, would like to hire you.  The prospective client has funds available to pay its legal fees, but what if you and/or the client expect that bankruptcy trustees or the Department of Justice will soon claim those funds for themselves?

At the outset of an engagement, an attorney can structure his or her retainer agreement to protect the retainer to the greatest extent possible in the event the client’s creditor comes knocking.  New York law recognizes three types of retainers: “classic,” “security,” and “advance payment.”  And under New York law, a retainer fee is shielded from attachment so long as the client does not retain an interest in the funds. See Gala Enterprises v. Hewlett Packard Co., 970 F. Supp. 212, 219 (S.D.N.Y. 1997).  For this reason, described in more detail below, it is the “advance payment” retainer agreement that will likely provide the most protection.

The ‘Classic’ Retainer

This type of retainer is typically a single, up-front payment to the lawyer simply for being available to the client—the attorney commits to future legal work for a specific period of time, regardless of inconvenience or workload constraints.  The classic retainer is not for legal services, and is therefore earned upon receipt, whether or not the attorney performs any services for the client (i.e., it is nonrefundable). See Agusta & Ross v. Trancamp Contr., 193 Misc.2d 781, 785-86 (N.Y. Civ. Ct. 2002) (general retainer compensates a lawyer for “agree[ing] implicitly to turn down other work opportunities that might interfere with his ability to perform the retainer-client’s needs” and “giv[ing] up the right to be retained by a host of clients whose interests might conflict with those of the retainer-client”).

Because the classic retainer is earned upon receipt and is nonrefundable, it without a doubt provides the most protection against would-be creditors.  However, the classic retainer is really only “classic” in the sense that it relates to antiquity.  Indeed, it is difficult to imagine a situation in the modern practice of law where a client would want to pay a classic retainer.  And attorneys would be remiss to draw up a nonrefundable classic retainer agreement unless certain specific conditions are met.

In general, under New York Rule of Professional Conduct 1.5(d)(4), “[a] lawyer shall not enter into an arrangement for, charge or collect … a nonrefundable retainer fee.” Further, under Rule 1.16(e), fees paid to a lawyer in advance for legal services are nonrefundable only to the extent they have been earned by the lawyer: “upon termination of representation, a lawyer shall promptly refund any part of a fee paid in advance that has not been earned.” See also Matter of Cooperman, 83 N.Y.2d 465, 471 (1994) (holding that nonrefundable retainer fee agreements clash with public policy and transgress the rules of professional conduct; affirming lower court decision that the use of nonrefundable fee arrangements warranted two-year suspension.); Gala Enterprises, 970 F. Supp. at 219 (narrowly construing the holding in Cooperman, and holding that only retainers with express non-refundability language are invalid per se).

The Security Retainer

While the classic retainer might offer the attorney the most security, the security retainer offers little defense against a client’s future creditors.  Typically, payments pursuant to a security retainer are placed in an escrow or trust account to be drawn upon only as the fee is earned.  In other words, the security retainer remains the property of the client until the attorney applies it to charges for services rendered.

So long as the client retains an interest in escrowed funds, the escrow account is attachable.  Under New York law, a security retainer may be attached so long as it is subject to the client’s “present or future control,” or is required to be returned to the client if not used to pay for services rendered. See, e.g., Lang v. State of New York, 258 A.D.2d 165, 171 (1st Dept. 1999); Potter v. MacLean, 75 A.D.3d 686, 687 (3d Dept. 2010) (defendant owed more than $20,000 in arrears on child support obligations and subsequently paid law firm a $15,000 retainer fee; the court found that the retainer fee, which was held in escrow, was subject to restraining order); M.M. v. T.M., 17 N.Y.S.3d 588, 599 (N.Y. Sup. Ct. 2015) (wife’s restraining notice against husband’s attorney’s security retainer was valid and enforceable); see also Pahlavi v. Laidlaw Holdings, 180 A.D.2d 595, 595-96 (1st Dept. 1992) (judgment debtor deposited $50,000 with his attorney after receipt of a restraining order and the court ordered his law firm to return them).

The Advance-Payment Retainer

Similar to the security retainer, the advance-payment retainer is a fee paid in advance for all or some of the services to be performed on a specific matter.  However, unlike a security retainer, ownership of the advance-payment retainer passes to the attorney immediately upon payment in exchange for the attorney’s promise to provide the legal services.  This type of retainer is likely the best way to ensure that the client has sufficient funds to pay for expected legal services.

Under an advance-payment retainer agreement, the law firm places the money into its operating account and may use the money as it chooses, subject only to the requirement that any unearned fee paid in advance be promptly refunded to the client upon termination of the relationship (recall Rule 1.16(e)).

A client’s contingent future interest in an advance-payment retainer, if any, that would be refunded if the firm’s services were prematurely terminated is not a sufficient basis for attachment. See Gala Enterprises, 970 F. Supp. at 219.  Therefore, the most secure option will likely be to require an advance payment for all services to be rendered, commonly referred to as a flat or fixed fee.  In other words, a creditor would not be able to seize such a retainer, even if part of the retainer may yet be refundable.  In Gala Enterprises, the court held that because a $150,000 flat fee as well as a $500,000 flat fee were subject to refund only if the legal services were prematurely terminated, the fees were therefore not attachable.

However, just because a client has paid an advance-payment retainer, does not mean that the retainer is untouchable.  Two specific possibilities come to mind.  First, Gala Enterprises illustrates that law firms might need to defend against fraudulent conveyance claims.  That being said, if the retainer is not excessive or unreasonable, the attorney is in a good position to defend against any such claims.  It goes without saying, when establishing a flat fee—or any fee for that matter—the fee must not be excessive. See Rule 1.5(a) (“[a] lawyer shall not make an agreement for, charge, or collect an excessive [] fee …”).

Second, attorneys of course must not accept funds that may have been obtained by fraud. See, e.g., S.E.C. v. Princeton Economic Intern. Ltd., 84 F. Supp. 2d 443 (S.D.N.Y. 2000) (lawyer who blindly accepts fees from client under circumstances that would cause reasonable lawyer to question client’s intent in paying fees accepts fees at his peril.).

Conclusion

In sum, we offer this advice:

  1. Review the Rules of Professional Conduct and case law cited herein, as well as the relevant New York State Bar Association ethics opinions, specifically: Ethics Opinion 570, June 7, 1985; Ethics Opinion 816, Oct. 25, 2007; Ethics Opinion 983, Oct. 8, 2013; and Ethics Opinion 1202, Dec. 2, 2020.
  1. Be transparent and direct with prospective clients regarding retainer agreements.
  2. A reasonable advance-payment retainer for all services to be rendered will give attorneys the most protection against future unknown creditors.
  3. Make clear in the retainer agreement that the client acknowledges and agrees that the advance-payment will become the law firm’s property upon receipt and will be deposited into the law firm’s operating account, not into an escrow account or a segregated bank account.
  4. Acknowledge in the retainer agreement that the client may be entitled to a refund of all or part of advance payment based on the value of the legal services performed prior to termination.

Milton Williams is a partner and Christopher Dioguardi is an associate at Walden Macht & Haran LLP in New York.

Chancery Court: Railroad Operator’s Attorney Fees Must Be Covered

November 27, 2020

A recent Law 360 story by Rose Krebs, “Railroad Operator’s Fees Must Be Covered Chancery Says,” reports that a Delaware vice chancellor ruled that American Rail Partners LLC must cover legal expenses incurred by a railroad ownership company that it sued over unjust enrichment claims, saying an agreement in place "unambiguously" provides that expenses be covered.  In a 24-page memorandum opinion, Vice Chancellor Paul A. Fioravanti Jr. said fee advancement provisions of American Rail Partners' limited liability agreement are "quite broad" and unambiguous.

"For purposes of this action, there is no dispute that the plaintiffs are covered persons under the broad advancement and indemnification provisions of the company's limited liability company agreement," the opinion said.  International Rail Partners LLC, its manager Gary O. Marino and Boca Equity Partners LP sued American Rail for the advancement of fees earlier this year, asserting that their LLC agreement entitles them to "mandatory advancement and indemnification" related to a suit filed in the First State's Superior Court in February.

Boca Equity is the sole owner and only member of International Rail, according to court filings. International Rail is one of two members of American Rail, the opinion said.  Despite the "broad scope" of the advancement provisions, American Rail had argued it should not be required to advance legal fees because the LLC agreement "does not provide indemnification for claims between the company and any covered person — what it calls 'first-party claims,'" the suit said.

American Rail argued that "an indemnification or advancement provision may only cover first-party claims if it expressly says so," the opinion said.  The vice chancellor, however, said that argument was "not based upon a plain reading" of the agreement, and there is a "strong public policy in favor of indemnification and advancement" in Delaware.  That policy aims to assure key corporate officers that they will not have to shoulder the risk of paying legal expenses for claims related to the performance of their duties, the opinion said.

In April, Vice Chancellor Fioravanti refused to toss the suit, saying questions remained about fee advancement provisions agreed to by the parties. The vice chancellor said he couldn't conclude as a "matter of law" that American Rail offered the only "reasonable" interpretation of the applicable limited liability agreement.  Although Vice Chancellor Fioravanti identified certain shortcomings with how the complaint was pled, including a failure to invoke certain advancement provisions that were later referenced in briefings, he said there was not enough cause to toss the Chancery Court suit.

Law Firm Seeks Defense Fee ‘Advance’ from Trustee

October 19, 2020

A recent Law 360 story by Andrew Strickler, “Brown Rudnick Seeks Defense Bill ‘Advance’ From Trustee,” reports that facing a $300 million malpractice suit over its work for a bankrupt chemical company, Brown Rudnick LLP told a New York federal judge it is "unmistakably" entitled to having its legal bills covered by the trustee now suing the firm and a trust director.  Rather than pursue "immunity" from the massive potential liability, Brown Rudnick told the court it only seeks an "advance" on its mounting bills under the terms of a trust agreement at issue in the case, which it said provides for the payment of legal costs for any agent sued over work for the trust.

Brown Rudnick also argued that if it ultimately loses the case, it would be required to return the money to the trustee.  Therefore, the payment would not violate ethics rules or case law disfavoring lawyers securing blanket protections from a client's legal malpractice claims.  "[T]here is no public policy concern with advancement of fees where a party commits to returning the fees if ultimately adjudicated to have committed malpractice for which it cannot receive indemnity," the firm said.

Brown's unusual stance in the case stems from work commenced nearly a decade ago for a litigation trust formed in the bankruptcy of Lyondell Chemical Company, of which a Brown Rudnick partner was the original trustee.  After the bankruptcy declaration, trustee Edward Weisfelner of Brown Rudnick filed numerous claims against investor Leonard Blavatnik's company, Access Industries Holdings Inc.  He also lost a trial three years ago in which he tried to recoup some $300 million in credit line repayments made by AIH.

A replacement trustee, Mark E. Holliday, then sued Brown Rudnick, saying the firm committed malpractice by failing to establish at trial that Lyondell had been insolvent, a finding that would have made the money available for clawback as avoidable preference payments.  Brown has denied botching the trial, and insisted that a trust advisory board refused to give Weisfelner authority to settle before it decided to "roll the dice" at trial.

In counterclaims brought in August, Brown pointed the finger at a trust advisory board member, Paul Silverstein, as personally responsible for not settling, and for going after Brown Rudnick in court.  As part of that personal liability claim, the firm accused Silverstein of breaching his duty regarding the "advance fee" portion of the trust agreement, and the board generally of "depleting whatever negligible [trust] funds remained" through their salaries and legal bills.

In the motion, which answers Holliday's own bid for a dismissal, the firm did not put a number on its legal expenses thus far.  But the firm did say that, as of March of last year, the trust had a cash balance of $1.96 million, which it called insufficient to cover its bills.  And at a September hearing, Judge Engelmayer encouraged the parties to reach a settlement, and suggested that a discovery "autopsy" on the bankruptcy court trial would be costly.  He also noted that experts alone could cost the parties $1 million.

Silverstein "committed gross negligence by, among other things, directing the assertion of this malpractice suit against Brown Rudnick despite the fact that the Trust lacked adequate funds to pursue its claims and advance Brown Rudnick's defense costs," the firm said.  The personal liability and counterclaims "clearly arise out of the same transaction/series of transactions, i.e., authorizing suit against Brown Rudnick without advancing funds, or having sufficient funds to advance, to Brown Rudnick for its defense," according to the filing.

Ex-Uber Official Seeks Coverage of Fees Under Corporate By-Laws

October 13, 2020

A recent Law 360 story by Rose Krebs, “Uber’s Ex-Security Chief Seeks Legal Fees For Breach Suit,” reports that Uber's ex-head of security filed suit in Delaware Chancery Court seeking to have the company pay his legal fees in connection with charges he faces for allegedly trying to cover up a cyberattack that exposed the data of 57 million riders and drivers.  Joseph Sullivan, who is also a former cybercrime prosecutor at the U.S. Department of Justice, says Uber Technologies Inc. should cover his legal fees per a "mandatory indemnification and advancement" provision of the ride-hailing company's bylaws.

"Uber granted its 'officers' mandatory advancement rights and yet is resisting those rights for its former chief security officer, Mr. Sullivan, who has been sued by the federal government by reason of the fact of his service to the company as an officer," the suit asserted.  In August, Sullivan was charged in California federal court with obstructing justice and concealing a felony for allegedly misleading the Federal Trade Commission about the 2016 incident, which included a $100,000 payoff he allegedly arranged from Uber to two hackers in exchange for keeping the episode quiet.

Uber initially referred to the payout internally as part of its "bug bounty" program, which incentivizes cybersecurity experts to report security flaws to the company.  But the $100,000 sum was 10 times the program's award cap at the time, and an Uber executive later admitted to Congress that the payoff was akin to extortion.  The payment and cover-up came at the same time as Uber was negotiating a settlement with the FTC over a similar 2014 incident in which hackers pilfered user data from one of Uber's Amazon cloud storage sites, according to another criminal complaint.

Sullivan, who was "visibly shaken" after hearing of the new breach, concealed the episode from both the FTC and Uber's attorneys who were negotiating with federal regulators, the DOJ asserts.  Sullivan told a co-worker at the time "that he could not believe they had let another breach happen and that the team had to make sure word of the breach did not get out," a witness told investigators, according to the California suit.

Sullivan is also accused of misleading Uber's new management team that took over in 2017, editing a summary of the incident prepared by his team to remove key details including that the hackers had stolen user data, court filings said.  The company's CEO, Dara Khosrowshahi, announced the data breach in November 2017, saying that Sullivan had been fired for not disclosing the incident sooner.  Since allegations in the California suit relate to his alleged conduct in connection with the 2016 breach and during his time as an Uber officer, Sullivan contends he is entitled to have the company advance his legal fees.