Fortunately for law firms, legal funding is different than financing from traditional lending institutions. Funding companies acquire assets—in this case, an interest in the firm’s anticipated legal fee on a settled case. The firm acts as the funder’s escrow agent and fiduciary and transfers the portion of the firm’s fee that the funder purchased when the firm’s fee is finally received. This transaction is non-recourse. Therefore, if the underlying payer (insurance company, private company or government agency, for example) fails to ultimately pay or becomes insolvent, the law firm no longer has an obligation.
For funding companies who do a proper investigation, there is minimal risk while for law firms there are added benefits to this arrangement. Funders only fund cases where a signed settlement has occurred so they know the firm is owed fees. In addition, a funding company should do extensive due diligence before agreeing to the transaction in order to identify any potential risks in getting paid. This due diligence, which is at no cost to law firms, determines whether the settlement is even going to be valid. A reputable funder should make sure that the underlying obligor is sufficiently capitalized to pay the obligation. For instance, as funders we have run into situations where municipalities have “C” bond ratings. Since that is not investment grade, we will not take that deal and will let our client know why. For insurers, we run their rating through insurance credit agencies like AM Best to confirm their licensure and that they are capitalized properly and not in dissolution or in danger of being seized by the commissioner of insurance.
There is some risk to the funder in the case of a class action where the settlement was not approved. It is extremely rare, but in any event, the funder is responsible, not the law firm. In cases, where the obligor defaults, a reputable funder should assist the lawyer in trying to recover all of the assets owed, which again is a benefit to the law firm.
In more than 3,600 cases we have handled, we have a minimal amount of defaults. If you are considering legal funding for your cases, contact us for a consultation.