Final Funding Provisions

Posted on by | 8 Comments | View Comments

Today and Friday we’re introducing the last of our provisions tied to the funding process. Today we have two: one is the essentially boilerplate provision from venture capital contracts that disclaims any promise by the funder(s) to provide or assist with financing in any way other than per the contract, and one that deals with bringing new funders in, not as replacements but as co-investors. Friday we will introduce our language in response to Mr. Reilly’s suggestion that accelerated investments were not fair if the litigation counsel was the reason funding fell short.

First the provision limiting the funder to its commitments in this contract:

5.8 No Commitment for Additional Financing: The Plaintiff acknowledges and agrees that [no Funder has/the Funder has not] made any representation, undertaking, commitment or agreement to provide or assist the Plaintiff in obtaining any financing, investment or other assistance, other than the investments as set forth herein and subject to the conditions set forth herein. In addition, the Plaintiff acknowledges and agrees that (i) no statements, whether written or oral, made by [any/the] Funder or its representatives on or after the date of this Agreement shall create an obligation, commitment or agreement to provide or assist the Plaintiff in obtaining any financing or investment, (ii) the Plaintiff shall not rely on any such statement by [any/the] Funder or its representatives and (iii) an obligation, commitment or agreement to provide or assist the Plaintiff in obtaining any financing or investment may only be created by a written agreement, signed by such Funder and the Plaintiff, setting forth the terms and conditions of such financing or investment and stating that the parties intend for such writing to be a binding obligation or agreement.

Next the limitation on new funders:

5.9 New Funder Participation: Plaintiff can invite other potential funders to participate in any Closing at its sole discretion, provided that existing Funders are allowed to continue participating according to the capital commitment each had already made. Funders can invite additional potential funders to participate in Closings, but the Plaintiff, in its sole discretion, must approve both the new funder’s participation and the size of its investment before the potential funder can participate. For the avoidance of doubt, no Litigation Proceed Rights shall be sold to any person unless such person joins this Agreement.

In one way the provision makes an obvious point; of course Plaintiff need not sell to anyone it does not wish to. These are arms’-length, private transactions. However the provision adds value by making clear the Plaintiff cannot disadvantage existing funders and that existing funders’ consent is not necessary for the Plaintiff to bring in new participants.

 

8 thoughts on “Final Funding Provisions

  1. Abigail,

    Your observations on the preemptive rights issue are fair. There is no reason that a funder needs a preemptive right to preserve the percentage interest in the recovery represented by the purchased units. It is also fair to say the the claimant has little incentive to commit to give the incumbent funder a first refusal on future issuance. Such a preemptive right might discourage another funder from doing its due diligence to bid into the next round of funding.

    The funder may, however, want to bargain for this right because 1) having made a significant iinvestment in due diligencing the case, the funder may want the first option to put additional money to work as the case progresses and 2) since funders often endeavor to influence the claimant’s strategic decisions along the way, the funder may prefer to preempt another funder with a different strategic perspective from getting involved with the case.

    The preemptive right provision might be one to footnote into the model agreement as an alternative for the parties to consider.

    Ed

  2. Ed & Abigail: I agree with both of you. And, if each investor is buying “shares” in a non recourse transaction, my reasoning would not apply. In my experience in the industry, investors have invested “X” for a specified return of “Y” and have not purchased not a fixed percentage share of the subject litigation; thus, the introduction of subsequent investors without an opportunity to cash out could dilute the original investor’s profit potential in a disappointing recovery scenario. I was contemplating a different model.

    Having said that, in my experience, you always want to have a hungry litigant and the sale of too large a percentage of the litigation will reduce the litigant’s incentive to resolve the case reasonably, while Champerty prevents investor control of the litigation. Ed’s 33% suggestion is a sound method of preventing that problem from occurring.

    • Hi Ed & Mark,

      Thanks for your thoughtful comments, they are helping highlight how VC investing, while conceptually very similar, is actually more complex than the approach we’re modeling.

      In the VC context priority makes a lot of sense, and so does concern about preserving a pro-rata share because the pie is not fixed, and control and other rights can be packaged with the stock. We’ve already settled priority, but I want to touch on the pro-rata issue. I’m not sure why preserving a pro-rata share is important in this context.

      If an initial funder commits capital to purchase, cumulatively, 10% of a claim and another initial funder commits capital to purchase, cumulatively, 10% of a claim, why do they care if a later funder comes in and buys 10% too? The new funder’s 10% does not in any way diminish the value of the other funders’ rights.

      What am I missing?

      There can be a pricing fairness issue if the new funder does not do any due diligence/otherwise sinks no costs in making the investment decision, but that can be contractually negotiated in a straightforward way, and in any case, initial funders are likely to have gotten the most favorable pricing to reflect their taking the initial risk that later funders are unlikely to get.

      • Abigail: While I agree, conceptually, that when investments are divided into percentage shares, additional investments make no difference. Litigant and investors split their appropriate shares in accordance with the various contracts. I also realize that your model deals with more sophisticated sellers (corporate and business clientele) than my small funding practice deals with. However, my concern centers around the litigant and the subsequent resolution of the case. Investments and investors are ‘yesterdays news’ in the mind of the litigant. The litigant received that money months and/or years ago and it is not relevant to today’s quest for litigation satisfaction. Because of the Champerty doctrine, the litigant retains complete control over the litigation. Assuming that the litigation is highly successful, the sale of multiple shares presents no problem; everybody is happy. However, let’s assume the case takes a turn for the worse. Discovery uncovers evidence unfavorable to the expected result and the case is now worth half (or less) than the amount anticipated by the litigant and/or the investors. The litigant, who controls whether the case is settled or tried, says “I don’t care how much I have received from investors, if I don’t net ‘X’, I won’t settle the case”. His ultimate settlement expectations are substantially diluted by overselling the litigation investment, months or years ago. The lawyers know, because of the unfavorable turn, that trial is very dangerous and more expensive. Do they spend more money for a trial that they consider unwise and may result in an even lower outcome? So now, you have investors and handling attorneys at the mercy of a litigant who will not resolve a case that must be resolved unless he gets a bigger slice of the pie. The investors are forced into an unfavorable compromise. If investments are limited to Ed’s 33% number, that helps prevent this scenario. When I underwrite a case for funding/investment, I am always concerned with what I call “over funding”, the concept of allowing investors to purchase that amount which would reduce the incentive of the litigant to settle for that which his/her/its lawyer deems reasonable and appropriate under the circumstances. Or, to quote Abigail: What am I missing?

        • Thanks Mark.

          Indeed, buyer’s remorse is a big concern. The model deals with it to some extent by setting a plaintiff minimum recovery, which is itself a percentage of the ultimate proceeds. The plaintiff’s minimum is designed to help with both buyer’s remorse and unconscionability. Even so, the model does not eliminate the risk because it tries to preserve the funder’s “expected value” of its “shares” via a type of anti-dilution provision that kicks in if the actual claim value proves much less than originally anticipated. As a result a funder can ultimately capture a much higher percentage of the proceeds than it purchased, limited only by the plaintiff’s minimum recovery.

          The issue is more acute (I imagine) in the funding you do both because the plaintiffs are much less sophisticated/less able to assess risk and cost, are more likely to be emotionally vested because injury is involved, and may be more desperate for a certain recovery amount.

          Thanks again for the thoughtful contributions.

  3. Maya,

    Typically in a VC deal the incumbent investors are given preemptive rights – which is the right to purchase their pro-rata share of subsequent investment rounds. The thinking is that the investors have made the investment in the due diligence and in collaborating with the plaintiff through the case (or in the VC situation, prior stages of the company’s development) and expect to be able to maintain their share of the recovery as long as they are willing to continue to fund.

    In the VC context, therefore, new investors only come in when the incumbent investors won’t or can’t fund their pro-rata share or where the investors and company conclude that there are strategic advantages in expanding the investor base.

    Mark raises an interesting question of priority. In the VC context the investors typically have a preference over the founder’s common stock and receive all of their money back (often with a return) prior to the founders receiving anything. Also later rounds almost always have priority over prior rounds.

    Priority should not be an issue in the litigation funding context, however, since I believe your premise is that the investment is on a non-recourse basis and the units sold in each round represent a right to receive a percentage of the recovery. Accordingly, the aggregate of the units sold will never exceed 100% (and I think you would target more like 33%) of the full recovery and so the priority issue seems moot.

  4. Maya: In my experience, it is a good idea to have subsequent investors purchase, for profit, the interest of any current investors. Subsequent investment capital is difficult to procure if these “new” investors will have a subordinate interest in the litigation to that of the initial investor. If the case results are disappointing and proceeds are limited, investors will be paid in order of priority and there will be some very unhappy, subordinate, investors.

    • Hi.

      I’m not sure I understand your concern. Each investor is buying a “share” in the proceeds reflecting a percentage of the proceeds. Senior/subordinate concepts aren’t relevant; all investors stand side by side just as common stock holders do. That is, if original investors bought 10% of the claim, and a new funder bought 3%, and the claim was ultimately worth $1000, the original investors get $100 the new funder $30. A funder v. funder issue could arise in repricing/the anti-dilution provision, because the pie is fixed and the more funders that participate, the fewer new litigation rights can be issued to any one funder to “true up” its expected value.

      Certainly in any deal initial funders can try to negotiate special rights attached to their “shares”, making them a type of “preferred” rather than “common” share, but at this point the model is not attempting to detail every term. With the funding terms we’re introducing a particular deal structure and trying to highlight its advantages and implications.

Leave a Reply

Your email address will not be published. Required fields are marked *


× one = 9

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

  • © 2014 Maya Steinitz All Rights Reserved
  • Designed By: MWD Affordable Web Designs