We have previously written about how Claim Based Funding can make it more advantageous for portfolio companies of Venture Capital and Private Equity Funds to pursue meritorious litigation. This is particularly relevant to cases that may not otherwise been pursued because of the sponsor’s liquidity objectives and aversion to impairing EBITDA at the portfolio company. This article will address situations in which litigation finance may serve as a financing tool in various other commercial situations.
Consider the example of a company that has pledged substantially all of its assets to finance expansion of its business capacity to support a large new customer. Unfortunately after the company has expended the financing to expand its capacity to support the customer, the large customer turns the tables and steals the supplier’s trade secrets, shares them with an alternative off-shore supplier and then moves its supply chain to the lower cost captive producer overseas. Although the jilted supplier may have been able to find a capable law firm willing to work for a contingent fee to pursue its claim against its former customer for theft of trade secrets, it also desperately needs working capital to fund its operations while pursuing its case to settlement or judgment. With its conventional assets already pledged to conventional creditors, how can the company finance its operations until it can recover its damages?
Claim Based Funding can be the solution for the Company. A funder such as Themis has the competence to evaluate the evidence required to establish liability against the former customer, determine the range of likely recovery, research the creditworthiness of the former customer to pay a recovery, estimate the likely duration of the case and consider a host of other anecdotal factors that are applicable to the case in order to assign a range of value to the claim. Having determined a reasonable valuation for the case, Themis can structure a transaction to provide a working capital facility to the company which will allow it to get back on its feet pending the resolution of the case. In exchange, Themis will acquire a right to participate in the ultimate recovery along with the contingent fee law firm and the company.
Another situation in which litigation finance can be used to solve a complex legal problem arises when two companies are working toward a merger or acquisition. Assume that the target company is the plaintiff in the early stages of a significant legal case arising from the breach of a contract by a former joint venture partner and the target is expecting a very large recovery down the road. Naturally the target’s shareholders expect that the purchase price will include a component reflecting the discounted present value of the anticipated recovery from the case. The acquirer, on the other hand, may see things much differently. Because it is much less familiar with the facts of the case and the likelihood of success, it will be much less likely to ascribe the same value to the claim as the target. To further complicate matters, the acquirer may have other business relationships with the defendant in the case. In that situation the acquirer may be unwilling to assume the litigation at all or the target may doubt the acquirer’s commitment to prosecute the case aggressively even if it were offered an earn-out to bridge the valuation gap.
Again a Claim Based Funder like Themis can solve the problem. By applying its case evaluation tools to the case and assigning a range of values to the potential outcomes, Themis can offer a transaction to take the valuation issue off the negotiating table for the M&A transaction. By providing Claim Based Funding, Themis can enable the target to spin out the litigation into a special purpose vehicle for the benefit of the target’s shareholders. Financed by Themis, the shareholders can see the case through to conclusion for their exclusive benefit. Upon closing the shareholders have the benefit of the full proceeds of the sale of the core business and a future interest in the proceeds of the case while avoiding the need to risk sale proceeds to pursue the ongoing litigation. Meanwhile the acquirer takes the target business free from the risks and expense of the litigation and the business conflict that it may have involved.
Finally, consider the example of a leveraged company that is attempting to raise money to make an important strategic acquisition. The prospective purchaser may not have free collateral and cash flow to support the incremental additional funding to pay the purchase price required to win a contested auction for the target. The acquirer may, however, be the plaintiff in one or more meritorious litigations. In that case a litigation funder may be able to value to litigation claims and offer funding secured by those cases. The funding can both provide the additional required financing for the acquisition and improve the company’s cash flow by assuming the on-going cost of the litigation.
The lesson is that litigation claims are significant off-balance sheet assets. Litigation funders like Themis are uniquely capable of determining the range of values of those assets and helping companies to monetize those assets to facilitate a range of corporate objectives.