Litigation financing for small law firms

The first step to establishing a line of credit is to have a business plan for the firm

2014 September

Over the years, plaintiffs’ contingency-fee practice has undergone significant changes. One such change has been the increase in the amount of capital needed to operate a law firm whose primary revenues are derived from contingent fees. In the past, in order to maintain a prosperous law practice, litigators did not need much more than their knowledge of the law and skill in the courtroom to attract clients. Today’s attorneys, however, must rely on much more than their legal expertise to stay competitive in an ever-increasing technological world. Today, both pre-trial procedures and the courtroom are consumed by electronics, professionally created demonstrative evidence and as many experts as can be afforded — all of which come at great cost to the attorney and their firm.

Another growing expense for law firms has been the cost of advertising. The public has begun associating advertising with a law firm’s success and the skill level of its attorneys. Mass advertising has become so prevalent that even the most experienced and accomplished attorneys may not necessarily be the most well-known or sought-after litigators in their field. Thus, in order to promote the knowledge and experience of a law firm’s attorneys, law firms need to promote themselves extensively in all forms of media — an extremely costly exercise.

The expenses associated with pre-trial preparation and the trial itself have become astronomical. As a result of the heightened popularity of legal dramas on television, jurors have developed somewhat unrealistic expectations as to how and what attorneys should be presenting at trial. These expectations have led attorneys to invest more money into physical evidence and expert testimony than ever before in order to bolster their clients’ cases. What may have been construed as an unnecessary trial expense fifty years ago has now become standard operating procedure.

In addition, due to significant increases in defense spending, procuring supplementary evidence, obtaining additional expert witnesses and utilizing courtroom technology have all become elements essential to success. In particular, the use of courtroom technology — fueled by the ease of display through computers, tablets, and smartphones —has become the expected means by which jurors will interpret the evidence.

The escalating cost of operating a law firm, including advertising and additional trial expenses, has turned the traditional law firm into a commercial entity. As such, the law firm can no longer continue to operate as a mere extension of an individual attorney. Rather, the law firm needs to create, and abide by, a solid business plan, incorporating future projections as well as the costs associated with achieving those goals. Detailing the costs needed to build the law firm will help determine the amount of capital the law firm needs in order to grow and be successful.

A solid business plan should include a complete inventory of all the law firm’s current cases, with assessments of liability, value and timing of case resolution. Truly understanding the value of the law firm’s case inventory and projected resolution dates can help the attorney determine cash-flow needs. The business plan should also incorporate miscellaneous expenses such as advertising, labor, overhead, benefit packages for employees, equipment, experts and other case costs. By assessing future revenue and expenses, the attorney can more accurately determine what type of financing is needed to support the firm.

Once the attorney establishes a business plan projecting the amount of capital required to run the firm, the attorney must then determine how to obtain that capital. Traditionally, law practices have been either self-funded or operated with the assistance of a small bank line. This type of traditional financing was limited to the attorneys’ personal assets and net worth. Today, specialized commercial lenders also exist that can analyze the firm’s contingent fee receivables and add this asset to the collateral “pot,” allowing the law firm to borrow substantially more than conventional banks can provide.

Acquiring a line of credit for the law firm also gives an attorney the financial flexibility needed to maximize the value of its portfolio of cases. Often large corporate defendants and insurance companies try to delay lawsuits in an attempt to make the case more expensive for the plaintiff and to, in turn, force the plaintiff into accepting an earlier, smaller settlement. A credit line for an established attorney gives the law firm the financial stability throughout the litigation to be able to thwart defendant delay tactics and prepare the case in the most advantageous way.

Furthermore, interest paid by the law firm for a loan is considered a business expense that is tax-deductible, whereas out-of-pocket funding is not. Most states even allow attorneys to charge back a reasonable portion of the interest expense to their clients when this issue has been previously addressed in the retainer agreement and the line is utilized for a case-specific expense. This translates into an effective rate of interest that is significantly less than the stated rate.