Using Legal Funding for Law Firm Financial Management
When a law firm has a contingency fee practice, it often has a problem with effectively using its capital. The partners of the firm have to commit their retained earnings and other capital assets to covering the litigation costs associated with the contingent fee cases. Not only does the firm have to wait for its fees, but it must also expend its resources for discovery and other litigation expenses. This means that the firm’s capital resources are not available to grow the practice or to take on new cases.
One of the biggest problems with using capital this way is that there are no tax deductions for self-financing. After federal, state, and local taxes are combined, a profitable law firm may be subject to a tax rate of at least 50% on its marginal revenues. Thus, the firm must earn $2 for every $1 that it advances in litigation costs from its own reserves.
Of course, other businesses face the same economic realities. But law firms have had a particular problem because conventional lenders are usually reluctant to provide financing to a contingency fee case because the plaintiff’s claim does not seem like an ordinary collateral asset that can effectively secure the loan. From the bank’s perspective, financing a contingent fee claim seems like making an unsecured loan, and most hesitate to do that.
Third-party legal funders don’t share that conservative view of contingent fee claims. They recognize that a strong claim has real economic value and can be effectively used to secure a loan. This is the foundation of their non-recourse lending to litigants. And more and more legal funding companies are willing to make similar kinds of non-recourse lending to law firms, as well.
The increasing availability of third-party funding means that law firms have new opportunities to grown. When financing is available to cover litigation costs or pending contingent fee cases, the firm can use its retained earnings or similar assets to grow the firm or make distributions to the partners. Moreover, because the interest costs on third-party financing can be deducted, the firm’s real cost for using capital is much lower.
Topics: litigation finance, legal reform, third-party funding, litigation costs, non-recourse financing, alternative litigation funding, financial management, leveraged investment, law firm financing
Works Cited:
Financial Management in a Contingent Fee Practice, Findlaw, available at http://practice.findlaw.com/financing-a-law-firm/financial-management-in-a-contingent-fee-practice.html
