Managing cash flow, mitigating risk & creating value with disputes finance
These are unprecedented times for businesses trying to manage the challenging impact of inflation, labour shortages, supply interruptions, elections, fires, floods, wars and a pandemic. It is more important than ever to manage working capital, mitigate risk and monetise assets.
Disputes finance was pioneered in Australia in the late 90’s, initially with financing of insolvency practitioners. In 2006, the High Court of Australia held that the funding of disputes was not an abuse of process, or contrary to public policy, but valid as a tool which promoted access to justice. Historically, insolvency practitioners have been the most common users of disputes funding. However, the disputes finance industry has evolved to provide a wide range of solutions for companies (both distressed and well capitalised).
Today, disputes finance is utilised by a diverse profile of companies as well as turnaround practitioners as an alternative form of finance, a risk management tool and to create value.
What is disputes finance?
Disputes finance is the provision of non-recourse finance secured against the outcome of a dispute. The facility is drawn upon to meet the costs associated with a dispute or group of disputes. The product may include indemnification for adverse costs risk, the provision of security for costs, and/or an advance of cash for working capital.
If a dispute is successful (meaning that the claimant makes a financial recovery), the funder will be reimbursed the costs it has financed plus an agreed premium. If the dispute is unsuccessful, the funder receives nothing. It will not be repaid the costs it has advanced and will have no recourse to the assets of the funded party.
Additionally, disputes funders can purchase claims held by companies (subject to some exceptions) and external administrators. The claim is assigned to the funder and pursued in the funder’s own name, with no requirement for further involvement (unless agreed), contribution or exposure for the seller.
How does disputes finance benefit working capital?
- Preservation and injection of cash – The company no longer pays the costs associated with a dispute from its working capital so this cash can be preserved for core business needs and growth initiatives. Additionally, if a company has multiple disputes, a portfolio solution can be provided. This can include the funding of defence and investigation costs which would ordinarily be unfortunate liabilities of the company. There is also the ability to immediately inject cash into the company by selling the dispute to a funder.
- Creating certainty – Removing payment obligations from cash flow provides more certainty in relation to working capital.
How does disputes finance manage risk?
- Outcome risk – The disputes funder assumes the risk of an unsuccessful outcome by providing adverse costs cover, which protects the company from paying costs awarded against it.
- Counterparty risk – The disputes funder assumes the counterparty viability risk (eg. if following a successful outcome the counterparty goes into liquidation) as the financier is only repaid from a financial recovery.
How does disputes finance create value?
- Monetisation of assets – Disputes can be monetised as an asset with an upfront advance or sold to a disputes funder.
- Funding un-fundable claims – With a portfolio solution, companies are able to pursue claims which may otherwise have been economically unviable or too risky to fund. When pooled together, these initially irrecoverable claims could provide invaluable cash flow at no cost or risk to the company.
Other benefits of disputes finance
- Promoting settlement – Disputes finance changes the dynamics between the parties to the dispute. A funded party has sufficient resources to efficiently prosecute its claim based on its merits, without financial pressure to compromise. Additionally, where a funded party chooses to disclose the existence of funding, it signals to its counterparty that an independent third party’s assessment of the claim was positive enough to invest its own capital in pursuit.
- Project management – Disputes funders are usually experts at efficiently managing disputes to a successful outcome. Disputes funders can assist with identification of recoverable claims, management of costs and implementation of effective dispute strategies.
Impact of disputes finance in practice – an LCM case study
Background
An ASX listed mining company had a substantial investment in an asset (mining project) overseas. A change in government saw the introduction of legislation that allowed the government to expropriate the asset without payment of any consideration. The company had approximately US$60 million in sunk costs and it was estimated that approximately US$5 million would be required to fund arbitral proceedings against the expropriating government. The announcement of the illegal expropriation and loss of the project caused a drastic drop in the company’s share price. The board was eager to pursue the company’s claim for compensation (estimated to be in excess of US$95 million), but the costs and risks were prohibitive.
Solution
LCM provided the company with a non-recourse financing facility to fund all expected legal and ancillary costs associated with the arbitration process. As the facility was non-recourse, LCM absorbed the risk that: (1) the company’s claim could be unsuccessful; and (2) even if successful, the government may not pay an award in the company’s favour.
Impact
Instead of the costs of the arbitral process being borne by the company’s shareholders, the company was able to utilise its capital to fund its next profit-making project whilst pursuing its claim using LCM’s funds.
The Executive Chairman of the company announced to the market:
‘With litigation funding in place to support all legal costs relating to arbitration, we can proceed to prepare for arbitration knowing that shareholders’ interests have been fully protected and will not incur any further losses in seeking compensation.’
‘LCM is one of the world’s most reputable litigation finance companies and its willingness to support our claim is a tremendous vote of confidence. The agreement with LCM clearly demonstrates that we are sharing risk and reward with a litigation funding partner and that makes solid commercial sense for the Company.’
Where to from here?
In a time when companies are seeking to preserve cash and allocate their funds to their core business, disputes finance is a solution to pass on the costs and risks of disputes and create value for companies.
The growing market of disputes funders will continue to develop bespoke funding solutions with the help of companies and turnaround professionals leveraging their disputes as an alternative form of security for this unique type of asset finance.
