The proceeds payment of the securities financing contemplated by the draft model is fundamentally different than the standard non-recourse loan. In the traditional approach, the lender (funder) is repaid the loan principal, which represents the costs of the litigation (or its share of the costs of the litigation, if Litigation Counsel is also contributing some), before getting its return. That return is generally paid in “waterfall” fashion among the funder, plaintiff and possibly Litigation Counsel, with the amount received by the funder ultimately capped. In the draft model, the costs are paid with the proceeds of selling Litigation Proceed Rights. Nothing need be paid back when the Proceeds come in from the litigation. The funder simply gets the percentage of proceeds represented by its Litigation Proceed Rights.
As drafted, the model allows for unlimited upside; if the Litigation Proceed Rights are badly priced (from the plaintiff’s perspective), the funder can reap a windfall that would be deemed usurious or unconscionable in a loan context. Indeed, given the unique nature of litigation as a quasi-public good, the profit on Litigation Proceed Rights could be deemed unconscionable as a moral if not legal matter. One option would be to cap the potential payout to the funder, by structuring the securities to pay out 1% per right up to a fixed amount of dollars. We have not proposed a cap for several reasons, not least of which is that any numerical cap could only make sense in a specific context.
Here is how the draft model defines the “Costs” of the litigation:
Costs: the Costs are the expenses incurred by or on behalf of the Plaintiff for conducting the Claim and complying with the terms of this Agreement, and include: professional fees, whether for attorneys, advisors, experts or witnesses; and procedural fees relating to court or arbitration or other process, including filing and arbitrator fees; provided that the amounts in each case are approved by Litigation Counsel.
This definition may require customization depending on the Claim.
The model presumes the costs will be paid by an Escrow Agent from the Litigation Account, which will be governed by an Escrow Agreement separately entered into. The Litigation Account is funded by the purchasers of Litigation Proceed Rights, who pay for their rights by depositing the purchase price in the Litigation Account. While we have not included a model escrow agreement, the parties to it should be the funder(s), plaintiff, and the escrow institution/agent. The draft model contract requires the Litigation Counsel’s prior approval of cost invoices before the Escrow Agent can pay them, however, the Escrow Agreement and/or the funding agreement could also give the funder the right to review the invoices so that the funder can play a monitoring role. An important issue to consider when giving the funder the right to review such invoices is the effect, if any, on privilege.