Capital Management Photo 3 of 3

Michael Blum, CEO of Law Finance Group gives a background and history into the company. This is Part 3 of a 3 part segment. 

Capital Management Help - Part 2

Michael Blum, CEO of Law Finance Group gives a background and history into the company. This is Part 2 of a 3 part segment. 

Capital Management Help - Part 1

CEO of Law Finance Group Michael Blum discusses Capital Management. This is part 1 of a 3 part series on Capital Management. 

History of Law Finance Group

Michael Blum, CEO of Law Finance Group gives a background and history into the company.

False Imprisonment, taxable or tax free recovery?

Are recoveries excludable? It depends on the facts, but also on who you ask. Claims for false imprisonment or wrongful conviction can invoke the common law torts of false imprisonment, malicious prosecution, or abuse of process. Section 1983 allows suits for violation of constitutional rights.  Plus, twenty-two states, the District of Columbia, and the federal government now have compensation statutes for false imprisonment. Although the tax authorities are not clear about false imprisonment, being unlawfully confined behind bars seems by its very nature physical.  

Interestingly, payments to the following victims were all excluded from income: (1) survivors of Nazi persecution; (2) U.S. prisoners of war during World War II and the Korean War; and (3) Japanese-Americans placed in internment camps.  Unfortunately, though, the IRS has now declared that tax authority "obsolete."  


It is difficult to think of a decent argument for taxing these recoveries.  By declaring its prior rulings on related subjects obsolete, the IRS has suggested these recoveries are taxable, adding one more gotcha to the odyssey of exonerated prisoners.                

This podcast with Scott Drake, Mark Wahlstrom, Chairman of the Legal Broadcast Network, and Rob Wood, host of the Tax Law Channel, explores what lawyers and settlement professionals can do to help in this growing field.

Listen Now

The Article from April 2008

Michael Blum on Economic Turmoil

The current economic turmoil makes things uncertain for everyone. Law firms are no different...especially plaintiff firms. Michael Blum, CEO of the Law Finance Group and host of the Law Finance and Management Channel talks with Scott Drake about financially managing a contingency fee practice during this economic downturn.

See page 2 for "Financing your legal practice in uncertain times"

Michael Blum interviewed by Jan Schlichtmann, Part 1

Low-cost lines of credit for case expenses

At any given moment, trial lawyers have thousands of after-tax dollars tied up in litigation costs. To make matters worse, the IRS has ruled a lawyer is not allowed to deduct case-related expenses in the year incurred because they are considered non-deductible loans to clients. The result: A cash-flow nightmare.

Even if these lawyers are eventually repaid, they take a loss, having forfeited the opportunity to put that money to other, more productive uses in the interim.

Contingency-fee attorneys have been neglected by the finance industry and forced to fund litigation expenses internally or borrow against personal assets.

A partial solution
All firms, big or small, float these expenses which can be a considerable burden. But a solution is emerging. Over the past decade a growing number of states have permitted an attorney passing the costs of borrowing litigation expenses to the client. States explicitly allowing this arrangement include Utah, Florida, Georgia, Illinois, Kentucky, Missouri, New Jersey, New York, Arizona, Ohio, Tennessee and Texas. Permission is implied in many more states, like California, but no formal ruling has been issued- Local rules should be checked. The ABA Contingence Fee Engagement Letter has been modified for pass-through of interest expense. It states, in part, as follows: “You acknowledge and agree that we may borrow funds from time to time to pay certain of the costs referred to above and agree that, in additional to reimbursing us for the amount of such costs, you also will reimburse us for any interest charges and related expenses we incur in connection with such borrowings?’

IRS and non-deductibility of case expenses
The IRS considers case expenses as non-deductible, interest-free loans to the client. This “locked up” capital is not available for growing the practice. Consequently it is the firm’s after-tax dollars used for funding case costs. A profitable law firm may easily have its revenues taxed near 50 percent (federal, state and local combined). Therefore, the firm must earn $2 pretax to be able to spend $1 for case expenses. In Figure A, the law firm must generate at least $2 million to fund $1 million in litigation expenses. No money is left to invest in firm growth or to distribute to partners.

Remaining issue
All litigation expenses must be identified from the moment they’re advanced and interest calculated separately for each litigation expense by case — a highly impractical and time-consuming proposition for the typical trial firm.

When a Louisiana trial lawyer tried to avoid that Herculean number-crunching by simply using a cost-averaged estimate, the state’s Supreme Court slapped him down, holding the loan itself alright, but disallowing any accounting shortcuts. See Chittenden v. State Farm, No.2000-C-0414, 2001 WL. 508342, at *6 (La. May 15, 2001).

Figure A
Firm’s pre-tax profits
$2,000,000
Taxes payable on profits@50%
($1,000,000)
Cash flow after taxes
$1,000,000
Litigation expenses
($1,000,000)
Net for partners or firm expansion; Zero.

Banks don’t help
Banks don’t understand a contingency fee practice. They understand bricks and mortar as collateral. So, unless a lawyer can offer the security of significant physical property— real estate, automobiles — litigation-cost loans may be beyond his or her reach. Plus, banks do not provide required accounting services.

Complete business solution
Specialty finance companies provide innovative financial solutions for contingency fee law firms and their clients that banks won’t provide and the necessary accounting services. They understand the cash needs of contingency fee attorneys as a result of the up and down nature of a trial practice, providing firms with the ability to get litigation costs interest free, and removing cash-flow stress.

It works like this: The specialty finance company advances litigation expenses as simply a source for capital. The principal is due at the resolution of each case and interest is due monthly. If structured properly, the interest is passed on to the case, costing the firm nothing. The rate is based on the current prime rate and there is no interference with the attorney-client relationship.

A Word of Caution.

Do your homework. Choose a company wisely. The terms of a cost financing transaction vary greatly from company to company, so it may be in the seller’s best interest not to base their decision on price alone. Consider the experience and reputation of the company with whom you intend to do business. Get references from reputable sources and talk to attorneys with whom the company has conducted business.

Michael Blum is a partner in Litigation Resource Counsel, LLP, a member of the Consumer Attorneys of California Board of Governors, a member of the Board of Directors of the Consumer Attorneys of Marin, and CEO of LawFinance Group, Inc., a specialty finance company serving contingency fee attorney’s and their clients. He may be contacted at 800-572-1986.

The information in this article is provide for informational purposes only and with the understanding that the author is not engaged in rendering legal, accounting, tax or other professional advice or services.

© 2007 LawFinance Group, Inc. all rights reserved.

Financial management in a contingent fee practice

Financing is the bane of most contingency fee practices. An active plaintiff firm will have hundreds of thousands – even millions – of dollars locked up in case costs at any given time. The outlays for litigation expenses do not even qualify for tax deduction1because the IRS considers them as non-deductible loans to the client. This “locked up” capital is not available for growing the practice or distributing to the partners.

Many plaintiffs’ firms must ration capital. They must turn away good cases, because they need all of their existing capital to adequately fund existing cases, let alone finance new cases, mass tort or class action cases.

Fortunately, contingency fee law firms now have financing techniques to bring new funding to the firm. Partner equity need no longer be the sole or even the major source of cash for funding litigation costs, practice expansion or smoothing out cash flow cycles.

This article illustrates how borrowing funds and converting non-deductible litigation expenses (zero interest loans to clients) into tax deductible expenses has the cumulative dual benefits of creating a larger pool of funds for law firm investment in litigation costs, growth and partner distributions, and reducing the firm’s net cost of using borrowed funds.

Scenario 1: Traditional self-funding: Use earnings to fund the practice.
Most contingency fee firms fund their case costs directly out of firm revenues. This traditional strategy resulted from the irregular, uncertain and long term patterns of a contingency firm’s cash flow. Given the highly specialized industry knowledge and expertise needed to assess the value of a plaintiffs’ firm’s “case inventory,” most banks are unwilling to make a loan against a contingency fee practice. If made at all, bank loans are generally made to a firm’s partners, individually, with established loan limits and limited to the personal assets of the partners. Self-funding is not an optimal financial strategy.

Self-funding ties up a large portion of a firm’s revenues and partners’ capital in litigation costs. It leaves the firm exposed to a financial “squeeze” in the event that cases-in-process do not conclude favorably and on-schedule. Furthermore, litigation costs paid directly out of firm earnings result in nondeductible, interest free loans to clients made with the firm’s after-tax dollars.

It is the firm’s marginal revenues that are used for the funding case costs. A profitable law firm may easily have its marginal revenues taxed near 50 percent (federal, state and local taxes combined). Therefore, the firm must earn $2 pre-tax to be able to spend $1 after tax for case costs.

In our example, the law firm must have cash flow after all operating expenses of at least $2 million (two times the amount needed to fund litigation costs) to provide the firm with after-tax dollars to fund $1 million in litigation costs. No money is available for the firm to invest in growth or distribute to partners (See Figure A).

Using borrowed money to fund case costs.
Leverage is the concept of using borrowed money to generate a return. Borrowing to invest in your firm adds to the profitability and value of your firm, provided you can use the borrowed funds for activities to generate new business or finance litigation costs of a larger caseload, or for investments in technology, training and human resources necessary to be a more efficient, effective and profitable law firm.

If a firm were to borrow funds to pay case costs, the interest paid to the lender can be deducted as ordinary business expenses in the year paid.2 With a 50 percent marginal tax rate, the deduction for interest paid reduces in half the after-tax cost of debt financing. Using debt effectively can dramatically enhance the returns on partners’ capital and can assist the partners to build both their practices and personal wealth. Funding case costs with borrowed money can put more capital in the hands of the firm or its partners (see Figure B).

Scenario 2: Debt funding (leverage) to fund the practice.
The firm borrows an incremental $1 million to be used for ordinary business expenses to grow the firm. The interest is deductible as an ordinary business expense (see Figure B). Using leverage (borrowing $1 million for a two-year period) frees up a net increase of $860,000 in capital for the firm to use to grow its business. If the new capital generates enough to repay the principal and interest, or achieves a reasonable return of fees to litigation costs, then this strategy will grow the value of the firm and/or enable partners to increase their annual draws.

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Scenario 3: Debt funding the law practice and passing through costs to the client.
A number of jurisdictions permit an attorney to borrow money to fund case costs and then to pass on a reasonable portion of the interest expense to the client as an additional cost.3 If the lawyer’s fee agreement contains appropriate language,4 if the interest charged is not usurious and if the client gives their informed consent, then such allocation of interest expense may be permissible.5

If the firm were to pass through to the client all or a portion of the expense of borrowed funds used for litigation costs, as it does with other reimbursable expenses of litigation such as filing fees, experts, or discovery expenses, then the net law firm benefits of borrowing are increased further. Many law firms already charge their clients interest on advanced litigation costs.

Pass-through of the cost of funds – eliminating the practice of granting clients a zero interest loan – further reduces the firm’s cost of external debt financing: The first step in reducing the cost of external debt was provided through the value of the tax shield (Scenario #2); a second step may then be available with the recoupment from the client of all or a part of the cost of capital to support their litigation (see Figure C).

In this example, the law firm takes a $1 million loan to grow its business, use for case costs, marketing expenses or to distribute to partners. The per annum after-tax cost to the firm for this financing is only $40,000 versus the $280,000 nominal cost of interest. The clients pay for a share of the interest incurred for borrowing the funds necessary to finance their cases, and the interest expense becomes a deductible expense to the firm. Assuming the case is resolved successfully, passing part of the interest expense for client costs on to clients generates an additional $100,000 for the law firm.

If the new capital can generate a return of at least $40,000 in additional cash flow, then this strategy will grow the value of the firm and enable partners to earn more. Note: If the case is lost, however, the plaintiff is not liable to pay the pass through interest. Therefore, a firm considering a leverage strategy will need to adjust its use of leverage to incorporate its historical rate in recovering money for its clients.

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Specialized lending expertise. Most banks lack the skills and experience to understand the contingency fee law firm. Without the expertise to evaluate and monitor their case collateral and the ability of the firm to originate and settle cases, banks are often unwilling to extend sufficient credit to a contingency fee law firm. A specialty finance company focused exclusively on this form of legal practice will be capable of lending greater sums of capital and on terms that are flexible enough to meet the needs of an individual practice.

A word of caution, here. Banks are regulated. Some specialty finance companies are licensed but some are not. Do your homework. Choose a company wisely. The terms of various lenders vary greatly so it may be in your firm’s best interest not to base your decision on price alone. The profit from using leverage in a successful practice may cover your cost of funds many times over. Select a reputable, experienced specialty finance firm with whom to develop a long-term relationship and to conduct business.

Conclusion. With all the alternatives available, a contingency fee law firm should carefully weigh the advantages and disadvantages of self-funding against the potential bottom- line gains achievable by adding borrowed funds to increase a firm’s resources. Using leverage may enable the contingency fee law firm to achieve greater financial rewards for its partners.

Endnotes:
1 IRS Rev Procedure 97-27
2 IRC 162
3 See ethics rules in local state
4 See ABA Contingence Fee Engagement Letter as modified for pass through of interest expense that states in part: “You acknowledge and agree that we may borrow funds from time to time to pay certain of the costs referred to above and agree that, in addition to reimbursing us for the amount of such costs, you also will reimburse us for any interest charges and related expenses we incur in connection with such borrowings.”
5 See ethics rules in local state

Michael Blum is a partner in Litigation Resource Counsel, LLP, a member of the Consumer Attorneys of California Board of Governors, a member of the Board of Directors of the Consumer Attorneys of Marin, and CEO of LawFinance Group, Inc., a specialty finance company serving contingency fee attorney’s and their clients.

The information in this article is provided for informational purposes only and with the understanding that the author is not engaged in rendering legal, accounting, tax, or other professional advice and services.

© 2007 LawFinance Group, Inc. all rights reserved.

Non-Recourse financing for money judgements on appeal

Attorneys work hard for months or years to achieve a favorable trial outcome. Clients and attorneys invest thousand of dollars in fees and costs. An appeal entails putting more time and money at risk. It subjects the judgment to reversal or remand. At best, it means another year or two until recovery. In the meantime, there are bills to pay, for client and attorney alike.

Leveling the Financial Playing Field for Plaintiffs and Their Attorneys

Non-recourse appeal financing allows judgment creditors to convert part of the money judgment on appeal into immediate cash, before an appeal is decided. By selling a portion of the judgment on appeal, the judgment creditor eliminates all risk of recovery on the portion of the judgment sold. This is because no repayment is required if the appeal is ultimately lost. The seller gets his money in advance of the appellate decision, risk free.

The money may be used by clients to pay trial or appellate attorney fees, personal bills, reimburse costs, or just to have the peace of mind that they can set cash aside, free from the risk of loss, if ultimately there is no recovery. In addition, attorneys can receive an advance on their lien interest in the judgment on appeal, essentially monetizing the lien before the appeal is decided.

The service may be critical for financially burdened judgment creditors with money judgments on appeal. Immediate funds are made available for appellate attorneys fees to vigorously defend a judgment on its merits and to minimize the economic strains which often result during the one or two year appeal period.

Experienced trial and appellate counsel are well acquainted with the financial difficulties with which many plaintiffs, ensnared in litigation, must cope. The financial strains on the judgment creditor may compel a settlement for substantially less than the amount awarded at trial. Often unfair settlements are consummated because judgment creditors cannot afford to vigorously defend their judgments on appeal. Appeal financing may provide the resources to sustain plaintiffs and attorneys during the appellate process and bolster the ability to achieve a more just outcome, whether through appellate decision or settlement terms.

What Interest is Charged? What Installments Must be Paid?

None. The funding is not a loan. There is no interest. No points are paid. There are no installment payments. The purchaser is not a lender. Instead, the finance company purchases a portion of the judgment from the plaintiff or attorney, or in some cases, both. The funds received provide a measure of financial security, safe from loss.


What Happens if the Case is Overturned?

By acquiring a portion of the judgment, the purchaser runs the same risk of recovery in the appeal as the plaintiff. However, if the plaintiff ultimately loses and recovers nothing, the plaintiff keeps the funds advanced and the purchaser is owed nothing.

What Benefits Does An Appeal Finance Program Offer Plaintiffs?

With financial strength and qualified representation, a judgment creditor is more likely to receive a fair settlement offer or favorable appellate result. Financial assistance can remove the urgency for a settlement and send the appellant a message that the plaintiff has the financial resources to go forward vigorously. This may prompt the appellant to come forth with a fair settlement proposal, rather than risk the consequences of a defeat in the appeal.

There are no restrictions as to how a judgment creditor uses the money received. If not used to finance the appeal, funds advanced may be used to pay living expenses, legal expenses, or just be set safely aside, free from loss, if there is no recovery.

What Benefits Does An Appeal Finance Program Offer Attorneys?

Attorneys sometimes find themselves in need of cash. An outstanding contingent fee interest in a judgment on appeal with a claim for costs advanced can create tremendous financial pressure on an attorney, a law practice and a family. Appeal financing may convert an attorney’s lien interest in the money judgment into immediate cash, safe from the risks of a court reversal. Like a plaintiff, if the case is ultimately lost and there is no recovery, the attorney keeps the funds advanced and the purchaser is owed nothing.

Do the Client and the Lawyer Lose Control of the Case?

Emphatically, NO! Only financial assistance is provided to plaintiffs and attorneys. The purchaser maintains a strict “hands off” policy. The purchaser does not provide legal advice or legal services to the judgment creditor, and does not require access to, or review of, privileged client information. Control of the case rests solely with the client and attorney.

What Are the Ethical Considerations of a Transaction?

Reputable companies have designed their transactions and business procedures to meet the highest standards of practice and legal ethics. Finance companies do not offer legal advice and do not interfere in the attorney client relationship. Client and counsel maintain control of the appeal and determine all matters of strategy, representations, case management and settlement. Many companies have had their programs reviewed by legal ethics experts, and will provide copies of opinions that the financing transaction fits squarely within the parameters of legal ethics.

A Word of Caution.

Do your homework. Choose a company wisely. The terms of an appeal financing transaction vary greatly from company to company, so it may be in the seller’s best interest not to base their decision on price alone. Weigh the benefits of selling without recourse a portion of the money judgment on appeal. Consider the benefits to the seller of a non-recourse transaction if there is no recovery. Consider the experience and reputation of the company with whom you intend to do business. Get references from reputable sources and talk to attorneys who have sold portions of their interests or advised clients who have sold portions of their judgments on appeal. Appeal finance provides a unique, risk-free opportunity to monetize a case long before the appeal has been resolved.

Michael Blum is a partner in Litigation Resource Counsel, LLP, a member of the Consumer Attorneys of California Board of Governors, a member of the Board of Directors of the Consumer Attorneys of Marin, and CEO of LawFinance Group, Inc., a specialty finance company serving contingency fee attorneys and their clients. He may be contacted at 800-572-1986.

The information in this article is provided for informational purposes only and with the understanding that the author is not engaged in rendering legal, accounting, tax or other professional advice or services.

© 2007 LawFinance Group, Inc. all rights reserved.