Factoring Legal Receivables — How This Growing Area of Specialty Lending Helps Attorneys & Their Clients
The author shares why a growing number of legal professionals would want to take advantage of a relatively new branch of factoring, known as legal funding — or the factoring of legal receivables — to ensure faster payment of services, access to client benefits and the ability to invest in and grow their business operations.
Like the legal industry, the financial practice of factoring has existed for centuries. Factoring is the process by which a finance company (factor) purchases the amount owed to a separate entity (receivables) at a discounted price in exchange for immediate capital. Factoring can be non-recourse, meaning that any losses assumed from the receivables will become the responsibility of the factor; it can also be recourse, meaning that the factor is reimbursed for any losses incurred from the purchased receivables. Factoring is a very common practice, and is employed amongst many different types of industries. Businesses of all kinds are at least familiar with factoring, and have been using it more often in light of the recent economic climate.
In the past few decades, factoring has been applied to legal fees and other legal costs. Legal fees can vary in payout amount; one case may settle for $5,000, while another settles for $5 million. A variety of aspects influence the legal fee amount and payout date, such as what type of case is being tried, who the defendant is, and the length and complexity of litigation. While many attorneys are paid at scheduled intervals and would not need to use legal factoring, others might experience large payment delays that could cause financial difficulties. In these instances, attorneys may want to turn to factoring.
Contingency Fee Attorneys
During trial, an attorney’s expenses can accumulate quickly. Litigation expenses, such as payroll, expert witnesses, travel and office costs, can add up to hundreds of thousands of dollars. This is a large risk for contingency fee attorneys who only receive payment after a case decision has been made. In some instances, payment may not be distributed for months or years after a case has been decided. For these reasons, contingency fee attorneys must be very mindful of case expenses.
Contingency fee attorneys are especially susceptible to financial discrepancies because of the uncertainty of their practice. Attorneys who are paid contingently typically invest their own capital to try a case, but when legal fees are backed up, allocating funds to new opportunities can be challenging. In some cases, attorneys have had to pass up litigation opportunities because delayed payments prevented the attorneys from making new investments.
Fortunately for contingency fee attorneys, factoring has recently become an accepted practice in the legal realm, and can now provide attorneys with the financial boost that they may need.
“Legal funding” is the general name for the factoring of legal receivables. The legal funding industry was born when a group of entrepreneurial litigators and financiers recognized the monetary troubles faced by some contingency fee attorneys. These new companies offered to purchase legal receivables in exchange for an inflow of capital that could be applied to solve cash-flow issues.
Factoring legal receivables has become such a popular option for attorneys because of its relative convenience when compared to receiving bank loans or lines of credit. Banks and credit unions will often refuse to advance funds to attorneys and law firms because attorneys frequently have very little physical collateral; legal funding is a viable alternative that exists specifically to advance capital to attorneys. Legal lenders will have comparatively higher interest rates than banks or credit unions, but this expense is usually offset by the application, which is fined-tuned specifically for attorneys, and a faster distribution rate. Legal funding has developed into a viable industry that advances capital to attorneys and law firms who would be denied by traditional lenders.
Perhaps one of the best aspects of legal factoring is its versatility. There are various types of legal funding practices in order to accommodate the needs of different attorneys and their clients. Legal funding companies might offer pre-settlement funding (funding during or before a case), post-settlement funding (funding after a case has been decided), appeals funding (funding specifically for appeals cases) or judgment / verdict funding. Furthermore, the industry offers services to the clients of attorneys. In the same way that legal funding can benefit attorneys, plaintiffs can receive advances on their settlement awards to help pay for daily expenses or cover legal and medical fees.
American Legal Finance Association
Insurance companies are among the most common defendants against which contingency fee attorneys litigate. The growth of the legal funding industry has spurred a backlash against plaintiff’s attorneys and legal funding itself, because although litigation funding technically evens out the playing field in the courtroom, defendants see legal funding as providing an unfair advantage to the plaintiff’s side. This is untrue, as defense firms are often very well-financed and can afford expensive litigation without funding, while plaintiff’s firms are typically much smaller without access to much capital.
The aforementioned defendants and their allies have pushed to increase regulation of the legal funding industry, and some more extreme spokespeople have launched campaigns to ban or curtail the practice of legal funding. In order to self-monitor, and in order to curb protests, some members of the legal funding industry follow a common set of rules, ethics and practices that have been set forth by the American Legal Finance Association (ALFA). ALFA was first established to respond to and anticipate issues that might arise in the legal funding industry. Today it functions as a monitor on excessive, unjustified advances and ensures that frivolous lawsuits will not occur as a result of legal funding.
Evolving Legal Billing
Typically, legal funding is an offer that is only extended to contingency fee attorneys, who have a great need for immediate capital as they await payments. Defense firms that bill hourly have been excluded from legal funding agreements because of their billing practices, which permit attorneys to access their payments almost immediately. However, in light of recent economic downturns and a constantly evolving legal industry, defense firms are contemplating adopting new billing methods. Instead of the hourly billing rate that has thus far dominated the legal sphere, some such firms are considering moving towards a contingency fee structure in order to cater to more clients.
The change from hourly billing to a contingency fee structure could radically alter the legal world. Presently, many big law firms are self-funded entities and have lucrative relationships with traditional financial institutions to help manage cash-flow. However, in the wake of the 2007 recession, many traditional lenders have become more hesitant to part with large capital sums. Stuck in a credit crunch, big law firms have been forced to reconsider their options. Furthermore, clients have pushed for greater billing transparency. Law firms are seeking to a compromise between their rates and their clients’ demands, and as such, many are considering switching to a contingency fee structure. This would not only make legal procedures significantly less expensive for the average client, but would also make firms that currently bill hourly eligible to factor their legal receivables.
As the legal industry has been facing more financial difficulties due to the credit crunch, using legal funding to factor legal receivables may become a more and more pertinent option. Defense attorneys, who are typically paid prior to litigation, may start seeing payment delays. State attorneys, who are supposed to be paid by their state employers within a few weeks of litigation, may see their wait periods increasing. Larger firms, who see the competition around them increasing, may choose to factor legal receivables to invest in their own operations and promote growth. Legal funding could provide benefits to these firms that were previously difficult to obtain.
For centuries, factoring has benefited business across a broad spectrum of industry. In recent years, an individually regulated legal factoring industry has emerged, offering specific services to certain attorneys with cash-flow issues. As the success of this industry has become more apparent, more legal institutions are considering how the benefits of factoring legal receivables could impact business. Like all businesses, law firms require a constant flow of capital in order to thrive. Factoring ensures that firms will have access to useable capital. Moreover, factoring allows firms to compete on an even playing field. As the legal industry continues to evolve, so will legal funding companies continue to enable superior legal practice.
Joseph Genovesi is president of RD Legal Funding.