HOW TO MEET THE FINANCIAL CHALLENGES OF THE 21st … · Services Study Sept 2013)… 69% use both a smartphone and a PC for research. (Google Legal Services Study Sept 2013) 31% of

HOW TO MEET THE FINANCIAL CHALLENGES OF THE 21st CENTURY

(It's not just a law firm—it's also a business)

Presented by

Joseph DiNardo, Esq.

6400 Main Street, Suite 120

Williamsville, NY 14221

P: 716.568.0070

E: [email protected]

6 KEY WAYS TO FINANCE YOUR LAW FIRM Page 2

© Counsel Financial 2018

Why do plaintiffs’ firms need financing?

1. To balance cash flow peaks and valleys

The very nature of contingent fee litigation can result in unpredictable revenues for a law

firm—both in terms of timing and the amount of fees that will be received. As a result, plaintiffs’

firms can suffer from intermittent cash flow problems while they await payment from their cases. In

the meantime, however, these firms need cash readily available so that they can cover operating

expenses, advance litigation costs, pay bills and market to clients. Financing presents a solution to

the peaks and valleys inherent to a contingent fee practice.

2. To advertise for clients

In 2015, the National Law Review published an article concerning marketing trends in the

legal field.1 The article, in pertinent part, states:

“96% of people seeking legal advice use a search engine. (Google Consumer

Survey, Nov 2013)

38% of people use the Internet to find an attorney. (FindLaw U.S. Consumer

Legal Needs Survey 2014)

62% of legal searches are non-branded (i.e., generic: “Phoenix divorce

attorney,” etc.). (FindLaw U.S. Consumer Legal Needs Survey 2014)

74% of consumers visit a law firm’s website to take action. (Google Legal

Services Study Sept 2013)…

69% use both a smartphone and a PC for research. (Google Legal Services

Study Sept 2013)

31% of all law firm related website traffic comes through mobile

search (FindLaw Aggregated Hosted Site Data 2014)….”2



While marketing trends in the legal community continues to evolve, the foregoing statistics

depict how it has become increasingly necessary for plaintiffs’ attorneys to put more money

towards its marketing budget to obtain clients. With financing, firms can handle the burden of

paying for marketing campaigns, which are often expensive.

3. To advance litigation expenses

The ABA Model Rules of Professional Conduct provide that a lawyer may “advance court

costs and expenses of litigation, the repayment of which may be contingent on the outcome of the

matter.”3 The standard practice of a traditional plaintiffs’ practice is to advance the costs associated

with lawsuit itself; however, such costs can escalate quickly, especially in complex actions involving

catastrophic injuries, mass torts or a class of individuals.

In addition, litigation expenses are not deductible for federal income tax purposes unless

the case is lost.4 In the event the case is won, the expenses are also not tax deductible because the

client repays the costs of the litigation out of their portion of the award.5

With certain types of financing, a firm can deduct any interest charged as a business

expense, as well as be able to fund litigations without worrying about whether the practice has

enough capital available to pay for the best expert witnesses, for depositions, document review, or

to try the case.

4. Expansion



Launching a new firm, delving into different practice areas, expanding the firm’s

geographical presence and/or hiring extra attorneys or support staff all require additional capital,

which is another essential reason firms seek financing.

What are the financing options available for law firms?

Traditional Options

1. Self-financing

In the past, many managing partners used their personal assets and income generated from

the practice to fund their firm. The advantage of self-financing is that the firm does not incur any

debt. The disadvantage is that this type of financing can limit the firm’s growth potential because

its growth is dependent upon after-tax profits. Further, self-financing drains the personal net worth

of the firm’s owners or principal members.6

2. Co-counsel agreements

Another way that firms have historically financed their practices is by entering into co-

counsel arrangements. By engaging co-counsel, a firm can shift the financial burden of litigating a

case to a law firm that is more equipped to advance the expenses.

Typically, the price of such an arrangement is that a firm must give up a percentage of its

contingent fees. Thus, every time the firm enters into a co-counsel agreement, it is essentially

sacrificing a future revenue source for the practice.



3. Traditional bank loans

Loans from traditional banking institutions are typically recourse, which means that the law

firm is obligated to repay the lender the principal amount of the loan irrespective of the success or

failure of a case. Banks generally require that the loan be secured by all assets of the law firm (or

the principal members of the firm), including any attorneys’ fees received from the firm’s cases.

For the most part, traditional banking institutions offer loans at lower interest rates than

other law firm financing providers. The downside of a bank loan is that the law firm cannot usually

obtain the full amount of working capital it needs. This is because most banks refuse to give any

value to a law firm’s contingent legal fee assets in determining the total amount of capital to give

to the law firm. Consequently, the firm’s loan is limited to a percentage of the law firm’s or its

owner’s hard assets, such as cash, securities and real estate. Moreover, bank regulations require the

lender to take actions, such as an annual pay-off of the loan, which usually does not coincide with

firm’s cash flow.

Specialty Options

Third party litigation financing first emerged as an industry in the United States in the early

1990s, when a handful of small lenders began providing cash advances to plaintiffs involved in

contingency fee litigation.7 Within a decade, as many as one hundred third party litigation financing

companies were offering financing to lawyers, to plaintiffs, or both.8 This industry continues to

grow as cases continue to become more expensive to litigate and the need for expansive

marketing tactics more pervasive.

4. Non-recourse advances



Non-recourse litigation financing usually involves a third party investing in a law firm’s fees

arising from a lawsuit. The funder advances cash to the law firm and in exchange the law firm

assigns or sells a portion of its future interest in its fees.

These arrangements are non-recourse—meaning that the funder has no claim for repayment

if the lawsuit does not eventually produce attorneys’ fees. The benefit for a law firm is that by

receiving the advance, it eliminates some of the risk that it will not receive payment from the case.9

The drawback for a law firm is that if the case is won, then the funder receives an often-significant

premium on the amount it advanced—many funders obtaining a more than 3% return on their

investment each month the debt remains outstanding.

The rates charged for non-recourse funding tend to be high because of the substantial risk

that the funder will not be repaid, as well as because this type of arrangement is generally not

subject to state usury laws since it is not customarily characterized as a loan.

5. Specialty lender loans

Loans from specialty finance companies to law firms are usually a recourse transaction much

like a traditional bank loan. The law firm has an absolute obligation to repay the lender the

principal amount advanced, plus all interest and fees. Upon an event of default, the lender can

collect from the firm and all of its assets, as opposed to limiting the recovery to the proceeds of

one particular case or a group of cases like a non-recourse funder. In particular, with a specialty

lender loan, the lender takes a security interest in all assets of the law firm, inclusive of current and

future fee receivables, as collateral under the Uniform Commercial Code.10 The proceeds of the



financing can be used for any law firm purpose, including the firm’s actual out-of-pocket expenses

and case disbursements, operating expenses, marketing campaigns, etc.

The interest charged under a specialty lender loan is generally higher than what is charged

under a traditional bank loan because of the increased risk to the lender in valuing contingent fees

as assets. Nevertheless, most specialty law firm lenders are owned and managed by attorneys who

have a better understanding of the nature and timing of contingent fees and the actual value of a

law firm’s cases. Consequently, these lenders can usually be more flexible than banks concerning

the terms and conditions of the loan—providing for repayment based upon when a fee is received

and having the maturity date of the loan associated with the natural cycle of a lawsuit.

Moreover, the interest rate charged by specialty lender is usually less than rates of return

offered by non-recourse funders, and can be less than a co-counsel arrangement as set forth in the

graphic below, which compares Counsel Financial’s loans to a co-counsel agreement:



6. Structured settlements

A structured settlement is a special type of financing that arises from the payment of an

award or settlement. Instead of an attorney or law firm receiving their fee as a lump sum, they have

the option to defer the payment of their fees over a set period of time.

Structured settlements are generally funded with an annuity policy that can be tailored to

meet the law firm’s specific needs, i.e. payments can be scheduled for any length of time, vary in

amount, begin immediately or be deferred.

Firms that choose to structure their fees can better manage income and cash flow because

it provides the firm control over the exact instance when it will receive income. In addition, with a



structured settlement, a firm is able to defer the taxes on its fees until actual receipt of the settled

fee payment—allowing for improved tax planning. Lastly, firms can take advantage of tax-free

growth of the settlement funds that they choose to structure. This is because the structured

settlement funds are transferred to an annuity pre-tax, which results in a more significant rate of

return than if the firm were to receive an upfront lump sum and invested the funds after such

funds were taxed.

The shortcoming of a structured settlement is that it does not provide a firm readily

available cash. This type of financing is best suited for firms that want to manage their future

income.

Falsehoods about third party financing

1. Financing arrangements constitute fee sharing

The ABA Model Rules of Professional Conduct state: “[a] lawyer or law firm shall not share

legal fees with a non-lawyer, except that:

An agreement by a lawyer with the lawyer’s firm, partner, or associate may

provide for the payment of money, over a reasonable period of time after the

lawyer’s death, to the lawyer’s estate or to one or more specified persons;

A lawyer who purchases the practice of a deceased, disabled, or disappeared

lawyer may, pursuant to the provisions of Rule 1.17, pay to the estate or other

representative of that lawyer the agreed-upon purchase price;



A lawyer or law firm may include non-lawyer employees in a compensation or

retirement plan, even though the plan is based in whole or in part on a

profit-sharing arrangement; and

A lawyer may share court-awarded legal fees with a nonprofit organization

that employed, retained or recommended employment of the lawyer in the

matter.”11

Most financing agreements are not considered fee sharing under the ethical as traditional

and third party litigation financing companies are only assigned an interest or take a lien in the

firm’s receivables. Thus, when the financing company advances money to a lawyer or law firm

based on the firm’s interest in a specific case or cases it does not ascertain the same right that a

lawyer has pursuant to a retainer agreement. Rather, the financing company’s interest only arises

upon the firm’s receipt of its fee.

Under the Uniform Commercial Code, current and future fees can be collateral for a loan, as

collateral is defined to include: (A) proceeds to which a security interest attaches; (B) accounts

(such as a law firm’s bank accounts), chattel paper, payment intangibles, and promissory notes that

have been sold; and (C) goods that are subject of a consignment.”12 The characterization of

“collateral” not only includes accounts and chattel paper, but also was expanded to incorporate

proceeds subject to a security interest, payment intangibles, and promissory notes that have been

sold.13 Furthermore, some courts have specifically held “unmatured contingency fee agreements

are a form of ‘contract right’ and thus are ‘accounts’ . . . fall[ing] squarely [within] Article 9.”14

For instance, in In re Holstein, the Seventh Circuit upheld the District Court’s decision that a

creditor’s security interest, which expressly included accounts, attached to a law firm’s rights to



receive fees under its contingency fee contracts and would remain attached to that collateral or its

proceeds even if the contracts were assigned or otherwise transferred to another firm.15

2. Taking financing from a third party will effect a lawyer’s independent judgment

Under the ABA Model Rules of Professional Conduct:

“A lawyer shall not permit a person who recommends, employs, or pays the

lawyer to render legal services for another to direct or regulate the lawyers

professional judgment in rendering such legal services.”16

A concern about third party financing is that the attorney’s loyalty will be

transferred from a client to the funding entity.17 However, there is no evidence that

when a firm enters into funding agreement that it will represent its clients less effectively

as a result.18 In fact, it is more likely that the opposite would be true since the funding

companies benefit the most from a successful resolution of a case. Moreover, interfering

with a lawyer’s professional judgment enhances the risk that the lawyer could be subject

to disciplinary action, which would also diminish a funding company’s chance of

achieving a return on its investment.

Thus, an attorney can accept financing from a company without violating their

ethical obligations as long as:



“The lawyer reasonably believes that the lawyer will be able to provide

competent and diligent representation to each affected client; The

representation is not prohibited by law; The representation does not involve

the assertion of a claim by one client against another client represented by

the lawyer in the same litigation or other proceeding before a tribunal; and

Each affected client gives informed consent, confirmed in writing.”19

6400 Main Street, Suite 120

Williamsville, NY 14221

P: 716.568.0070

E: [email protected]

Presented by

mailto:[email protected]



Joseph DiNardo, Esq.

Counsel Financial has created this publication to provide you with accurate and authoritative information concerning the subject

matter covered. However, this publication was not necessarily prepared by persons licensed to practice law in a particular

jurisdiction. Counsel Financial Services is not engaged in rendering legal or other professional advice, and this publication is not a

substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent

attorney or other professional.

COPYRIGHT © 2017 Counsel Financial

1 Stephen Fairley, Legal Marketing Stats Lawyers Need to Know, The National Law Review (Oct. 1, 2015); available at:

http://www.natlawreview.com/article/legal-marketing-stats-lawyers-need-to-know.

2 Id.

3 ABA Model Rules of Prof’l Conduct, R. 1.8(e)(1).

4 IRS Field Service Memo, 1997 FSA LEXIS 442 (I.R.S. 1997).

5 Id.

6 Christopher Matthews, When Is It a Good Idea For a Company to Take on Debt?, Time (Apr. 11, 2013); available at:

http://business.time.com/2013/04/11/when-is-it-a-good-idea-for-a-company-to-take-out-debt/.

7 NYC Eth. Op. 2011-2, 2011 WL 6958790 (N.Y.C. Ass’n. B. Comm. Prof’l. Jud. Eth.).

8 Id. citing Terry Carter, Cash Up Front: New Funding Sources Ease Strains on Plaintiffs Lawyers, ABA Journal 34-36 (Oct. 8, 2004);

available at: http:// abajournal.com/magazine/article/cash_up_front/.

9 Marco de Morpurgo, A Comparative Legal and Economic Approach to Third-Party Litigation Funding, 19 Cardozo J. Int’l & Comp. L.

343 (2011).

10 UCC § 9-102(a)(12).

11 ABA Model Rules of Prof’l Conduct, R. 5.4 (a).

12 UCC § 9-102.



13 Id.; see also UCC § 9-102, comm. 3(a).

14 U.S. Claims, Inc. v. Flomenhaft & Cannata, LLC, 519 F. Supp. 2d 515, 522 (E.D. Pa. 2006). See also American Nat’l Bank & Trust Co. v.

Holstein (In re Holstein), 2000 Bankr. LEXIS 293 (Bankr. N.D. Ill. 2000) (holding that contingency fee contracts are “accounts”).

15 In re Holstein, supra, 2000 Bankr. LEXIS 293. The creditor in In re Holstein, had a priority security interest in the debtor law firms

accounts, contract rights, general intangibles and other receivables, “and for the most part the receivables consisted of the law firm’s

right to be paid for services rendered in personal injury and class action litigation that the firm was handling before it closed its doors.”

16 ABA Model Rules of Prof’l Conduct, R. 5.4 (c).

17 Douglas R. Richmond, Other People’s Money: The Ethics of Litigation Funding, 56 Mercer L. Rev. 649, 676 (2005).

18 Id.

19 ABA Model Rules of Prof’l Conduct, R. 1.7.

Documents

HOW TO MEET THE FINANCIAL CHALLENGES OF THE 21st … · Services Study Sept 2013)… 69% use both a smartphone and a PC for research. (Google Legal Services Study Sept 2013) 31% of