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Capital Access to Law Markets

Business claim holders – whether major corporations with antitrust claims or individuals in slip-and-fall cases – have questioned the fairness of the defendants’ ability to transfer risk to an insurance company before the event, while plaintiffs are left to absorb all the risk of returns on their claims until the eventual outcome. Alongside the legal profession’s exclusive access to contingent fee joint ventures, one can question the economic efficiency and moral justification for promoting claim transfers to insurance companies before the event, while discouraging the transfer of a claim by a claim holder after the event.

Why should an insurance company be able to take direct control of a claim through the contract right of subrogation, while a financial institution is restricted from purchasing an interest in a legitimate business claim held by a business?

In the end, the prohibitions on claim transfer are more mythical or perceptional than real. In most U.S. states, champerty has been relegated to the bin of legal curios occupied by statutes permitting paramour killings or spitting on a public sidewalk. And, while fee-splitting is still prohibited in every U.S. state, no court has ever effectively challenged the ability of a law firm to transfer to a lender a security interest in its fee income in return for a commercial loan.

After all, if the fee-splitting rules were applied to an illogical extreme, a lawyer would be prohibited from paying a nonlawyer for goods or services if the source of the payment were, originally, a legal fee. In other words, there are a variety of ways to legitimately purchase claim interests and to finance a law firm’s operations and cases even under the most unfavorable interpretations of current legal and ethical doctrines. A number of businesses are doing just that.

Capital movements into the law market industry have surged in recent years. The capital in-flow is perhaps most evident in the intellectual property claims field. There, a variety of hedge funds and venture capital businesses have entered the marketplace armed with an estimated $4 billion of capital available to invest. The market is growing, fueled by the demands of law firms and claim holders for financial choices and risk mitigation products.

Recognizing this, and the exciting implications for capital markets, The London Times heralded the creation of a “new asset class” at the announcement of the listing of shares of Juridica Capital Management, which provides strategic capital for law markets, on the AIM market of the London Stock Exchange in December 2007. [The author is the general counsel of Juridica.]

What comprises this new asset class, and what does it mean for law firms and other businesses seeking access to capital markets for claim valuation and finance? The possibilities are numerous, and will increase as businesses and law firms realize the scope of the opportunities. They will also increase if and as laws allowing claim transfer and investments in law firms are implemented and absorbed into the world economy. The following are examples of “financial products” that are available to law firms and business claim holders:

• Portfolio loans to law firms secured by interests in firm income, including case recoveries;

• Direct purchases of claim interests from claim holders;

• Nonrecourse loans to claim holders, secured only by an interest in the claim;

• Insurance products that cover downside risks of litigation and adverse costs awards;

• Insurance-like products, where outside capital sources guarantee a core recovery to the law firm or claim holder even if the trial or appeal is unsuccessful;

• Claim portfolio transactions, where baskets of claims can be monetized to finance claim defenses, to mitigate overall claim portfolio risks, or to provide “off-balance-sheet” financing to supplement law department operating budgets; and

• Purchases of risk of loss in defended claims (allowing valuation of claims in merger and acquisition transactions, for insurance purposes, or other internal financial reasons).

Leading law and economics scholars generally welcome capital access to law markets: It can level the playing field between parties to a dispute; afford additional risk-mitigation options to businesses; afford monetization options to claim holders; and help free up lawyers to operate professional services firms rather than financial institutions.

The forces shaping the legal marketplace are legion: hesitant access to traditional capital markets; increasing global competition among major firms; pressures to expand law firms in a crucible of internal competition and archaic profit distribution models; demands from corporate clients for innovative ways to finance claims and legal services; and expanding needs of businesses to unlock claim values and mitigate risk of loss in claims.

Like the barrister’s pouch, and soon even the barrister’s wig, the disassociation of law markets from capital markets is bound to become an anachronism. But the transformation must happen carefully and thoughtfully – with leadership – rather than haphazardly. The challenge will be to realistically reassess the goals to be achieved through the legal system, and to meet those goals in a modern, reasonable manner.

About the author: Timothy D. Scrantom is an American lawyer and an English barrister-at-law (currently non-practicing) at Fields Scrantom Sullivan in Washington, D.C, and the general counsel of Juridica. A significant portion of his practice is focused on disputes, audits and investigations in international finance, and he has consuluted on complex multi-jurisdiction litigation and business migrations.

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