As previously discussed, the nature of legal claims as assets is such that plaintiffs can be deeply destabilized if funding runs out between milestones. In addition, litigation costs can be very uncertain, and it is hard to accurately estimate in advance how much funding would be needed to reach a milestone. That is, when a plaintiff is selling Litigation Proceed Rights at the outset, need it sell a million dollars’ worth to finance the claim’s conduct through to the completion of discovery, or two million? If a plaintiff sells much more than it needs to finance the claim, the plaintiff is giving up too much. If the plaintiff sells too little, the plaintiff runs out at a dangerous time.
The concepts of Accelerated and Supplemental Investments, coupled with the Funder’s ability to exit without cause, address this issue.
At the outset of the litigation financing the funder indicates how much capital it is willing to commit to financing the claim, and how much of that amount it is willing to make available at the initial investment and how much is contingent on the successful completion of future milestones. That much is analogous to staged funding in the VC context. However, under the model contract, if the money invested initially drops below a certain, negotiated level, and the litigation counsel reasonably believes that remaining balance is insufficient to reach the next milestone, the litigation counsel can so certify and the funder will be required to accelerate the investment of some of the capital committed for investment at the next milestone. This infusion of pre-committed cash is called an accelerated investment.
A supplemental investment occurs if all the capital committed has been invested, the claim is not yet concluded/the next milestone not reached, and the litigation counsel certifies that the balance in the litigation account has fallen below a negotiated level and that it reasonably believes the remaining funds will be insufficient to conclude the claim/reach the next milestone. A supplemental investment is a more drastic commitment than an accelerated one because it changes the amount the funder had intended at the outset to invest. However, the funder is receiving value for its additional investment in the form of additional litigation proceed rights.
The funder is given three additional ways to compensate for the increased exposure. First, the funder can exit at any time without penalty, as long as the funder lines up acceptable qualified replacement funders who commit at least as much capital as the exiting funder is withdrawing by exiting. Second, the funder can exit at any milestone without lining up replacement funding. However in that scenario, the funder “pays” for exiting by losing the right to have the value of its Litigation Proceed Rights adjusted upward if the claim proves substantially less valuable than initially estimated. The repricing provisions will be discussed in a later post. Last, the funder can exit at anytime by simply surrendering its Litigation Proceed Rights. While the third option mean the funder takes a total loss, it would enable the funder to avoid accelerated or supplemental investments without having to line up replacement funding. The total loss is appropriate because the destabilization of the claim from exit other than at milestones is extreme, more so than in venture capital. Of course, the parties could negotiate some other price for thus destabilizing the claim, such as the surrender of 90% of the funder’s litigation proceed rights.
The relevant contract terms and definitions have been added to the Contract and Defined Terms at left.
Update: A point the original post failed to highlight is simply that the contract anticipates funders will want a premium if forced to make a Supplemental Investment, and suggests that one way the premium could be paid is by discounting the purchase price.