Getting Your Case Funded

by Alan L. Zimmerman

Back in the days of black-and-white television, a weekly program called The Millionaire opened with a man knocking on someone's door and handing over a check for $1 million, courtesy of an anonymous donor identified to the viewers as "John Beresford Tipton Jr."

The 30-minute drama depicted how a person's life could change suddenly and unexpectedly upon receipt of a massive financial windfall.

If only practicing law worked like that! Not only is there no anonymous benefactor for lawyers, there is scant training in law school about how to finance a law practice.

But funding sources are out there. The good news is that it's never too late to learn about them. Indeed, an entire niche of law firm finance involves financing tied to judgments in specific cases.

I got involved in this esoteric but practical field when I picked up the telephone 18 years ago. A warm spring day found me at my desk, seriously thinking about getting out of the office for a little sunshine. Then a call came in from a San Francisco lawyer whose client had won a $350,000 judgment against her employer for sexual harassment. The verdict followed three years of contested litigation. The defendant had appealed, and the lawyer was determined to defend the verdict in a higher court rather than settle the case for less than it was worth, but the client needed cash.

"Can you think of a way to get her money on the judgment?" the lawyer asked.

I had never thought of advancing money secured only by a trial court judgment due to be attacked on appeal. I knew that if the appellate court reversed the judgment, the client could not repay the money.

But instead of leaving my office for a suntan, I worked into the night doing research to see if it was legally permissible (let alone financially advisable) for me to buy a portion of that sexual harassment judgment. Turns out, nothing prevents such a transaction.

With that realization, my life changed. Three-hundred million dollars in law-related funding later, the company I formed is still going strong. In addition to purchasing portions of judgments, we provide financing to lawyers who need to fund case costs; offer immediate funds secured by long-term payout settlements; factor receivables and supply working capital for other law firm needs. Our philosophy is grounded in sound financial principles and fueled by the belief that the civil justice system works best when both sides have the financial resources required to resolve disputes.

Capital Needs
Unlike other businesses, law practices in the United States can't sell stock to the public--even to friends and family--to raise the capital needed to finance their operations or support a key piece of litigation. They can, of course, turn a case into a "joint venture" with another law firm that has amassed capital from years of successful operations. However, such ventures are rare; because partners tend to draw profits out as soon as they are earned, most law offices don't have significant liquid capital to speak of, much less money to invest in contingent cases.

Unless the rules governing law practice change, then, the only alternative is to borrow money from a third-party lender.

Commercial banks have historically provided funding to law firms, but there is a new reality in the marketplace. In today's world, even law practices that fit the profile of a good customer have discovered that fewer and fewer banks are willing to lend. One reason is that a number of commercial banks are grappling with their own funding problems and don't have money available to lend to law firms--particularly to finance a legal dispute with an uncertain outcome. Another factor is the current contraction in legal services: Lawyering is not a growing business sector. The sad truth is that law firms have become unstable entities--witness the collapse of long-established, well-known firms, their demise hastened as successful partners depart with a "book of business" for greener pastures.

Yet as the capital needs of lawyers have continued to increase, specialty finance companies have entered the market. Many of these new funders have the expertise to evaluate a law firm's caseload and manage loans in a manner that focuses on the special characteristics of law firm collateral.

Unique Collateral
To raise funds, lawyers need to understand how legal fees are different from traditional collateral. When a bank lends to a computer store and the store defaults, the bank can send in the sheriff, haul the inventory away, and sell it; the money generated repays the loan.

With legal fees it's not so easy. The funder generally needs the continued cooperation and assistance of the law firm to complete the work and then collect the fees; it may even be necessary for the firm to generate new business to help pay off the loan. But suppose a key lawyer leaves the firm, taking a significant case along? That is what we call "leakage": The firm's assets spill away, unavailable to help repay the outstanding debt.

Even with these potential difficulties, some nonbank funders--also known as public and private finance companies--nevertheless find attractive the collateral produced by contingent-fee law firms. The same is true for statutory fees in pending probate cases, as well as settled cases that involve payment terms that extend over a span of years. These assets draw interest because a good case or a solid probate will normally continue no matter what happens to the original law firm, and sooner or later the funder will have a source of repayment.

The key inquiry is always: What is the right situation for a law firm to finance its pending caseload? What do lawyers need to show in order to get a loan? And if the case involves a judgment, when is it advisable to invest?

Types of Funding
Most banks provide simple lines of credit. In contrast, the funding offered by law-related specialty funders may include specific funding for case costs; financing secured by a money judgment on appeal; and for a host of contingent matters still being litigated at the trial stage. Some lenders have begun advancing funding in major divorce cases.

Fees and costs in such matters can be financed even though payment will not be received for years, as happens in class actions and mass tort cases; claims involving minors; or matters involving fees due from governmental entities. In those situations, the lawyer (and even the client) can get immediate cash while the lender awaits repayment down the road.

Even if a traditional bank isn't interested, the proverbial "big case" offers another prime funding vehicle. Indeed, a lawyer with a substantial pending matter--say, a case with ongoing costs that requires $4 million to $5 million in financing--has options, including a new breed of publicly traded funders who seek out cases with boxcar numbers attached to them. Such funders generally require a significant multiple on the money advanced, in exchange for the risk they'll take along the way. Many loans on megalitigation cases are "nonrecourse" obligations: The money is advanced, and payback is secured exclusively by the underlying piece of litigation. If the case fails, the money is lost and the lender takes the hit.

In each instance, the key for borrowers is assuring the lender that the practice (or the case in question) is an attractive risk.

Looking Good
Lawyers or firms can follow several specific steps to boost their chances of obtaining financing when the need arises (see sidebar, "What Lenders Look For").

First and foremost, establish a formal system to manage firm finances. Produce timely, monthly financial reports. Nothing turns off a potential funder faster than asking a lawyer for recent financial statements, only to learn that they are not available.

To a lender, an attorney who doesn't keep track of his or her own finances, will seem unlikely to keep track of the loan they are seeking. Financial disarray is a big turnoff.

Lawyers need to show funders that they are sophisticated and capable of controlling their internal financial affairs. In the end, that's what convinces a lender that the borrowed money will be repaid.

Many fine software packages are available to help law firms do this. (Three good ones are Quickbooks (www.intuit.com); Sage Peachtree (www.peachtree.com) and AccountEdge (www.accountedge.com).) If necessary, get an outside bookkeeper or accountant to recommend a qualified person to track details and manage the money in-house. Take time each month to review results, analyze data, and plan for the future.

An experienced funder will insist that you do this, and in some cases will help you get these tasks institutionalized within the firm. In fact, this kind of oversight is a distinct benefit in addition to funding itself; it inevitably makes for a more efficient and productive firm. And don't be afraid to ask for help along these lines, even from a potential lender--it is a sign that you mean business, and that is the most important showing a borrower can make. (Commercial banks probably won't offer such oversight and assistance.)

Create realistic cash-flow forecasts (most lawyers don't), and review them against the actual results. Nonbank funders will make ready use of these projections to analyze where the firm is headed financially, with the aim of accurately forecasting future cash needs.

Being a lawyer, running an office, and serving clients is hard work. Unless a firm's partners are independently wealthy, they owe it to their collective financial health to prioritize the office's goals and locate the capital necessary to achieve them. This involves learning about the crucial and practical importance of financial management and knowing how best to approach a lender.

Alan L. Zimmerman is an attorney and the CEO of LawFinance Group Inc. in San Rafael, which provides financing to lawyers.

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