Litigation Finance

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A common tactic of university administrations is to unlawfully fire a tenured professor, knowing that he would win if he sued them in court for breach of contract, but then to settle out of court by paying him a lump sum of money. Looking at it this way, a lot of apparently senseless university behavior makes sense. Why do they fire the professor when they know they'd lose in court? ---because they've done the calculation, and they've decided it's worth paying $100,000 to get rid of him.

The question for a university president is thus how much firing the professor will cost, not whether it is legal or not. A big part of how much it costs is the university's use of three sub-tactics: 1. Professors' impracticality, 2. The conflict of interest of the professor's lawyers, and 3. Starving him out.

Professors' Impracticality

Professors are not practical people. That is why they become professors. They are mild-mannered, timid even, and lack practical business skills. As a result, the university can expect them to settle for too little. Suppose a professor earns $80,000/year plus $20,000 in fringe benefits (health insurance, pension, etc.) and is 50 years old. If the university fires him, and as a result of the firing he will not be able to get a comparable job, he has lost about $2 million. Let us suppose, too, that he has an 80% chance of winning in court. The value of his claim is .8*2 million = $1.6 million (ignoring time discounting). He will have to pay 1/3 to his lawyers, about $500,000, but the university will have to pay about the same to its lawyers, another $500,000. If professor and university are equally good at bargaining, we'd expect the university to pay the professor $1.6 million to settle the case. In reality, though, the university will offer the professor $300,000 and the typical professor will accept it. The sum of $300,000 looks really big to him, and he doesn't realize how badly the university wants to settle. Also, he is highly averse to risk, and incapable of living quietly and calmly the four years the lawsuit will take.

The conflict of interest of the professor's lawyers

The professor's lawyers are probably doing the suit for a contingency fee, one third of the winnings. The longer the suit proceeds however, the more the cost to the lawyers in time and energy rises, and the cost rises at a faster and faster rate. If the suit settles before it is even filed, the cost to the lawyers is very low, so they have a strong incentive to urge their client to accept even a low offer if it is made early. Filing does cost the lawyers a considerable amount of time and energy, because they have to file the Complaint and other papers. Their costs then decline to a fairly low level until after the Motion to Dismiss is defeated. At that stage, costs rise much much higher during the Discovery process. [to be continued]

Starving him out

Most people live hand to mouth. They do not have a large amount of savings. They own a house by middle age, but they still are making mortgage payments. Thus, when the professor is fired, he has little income and large yearly expenses. He could borrow against his home equity, but he is reluctant to do that for purely psychological reasons. He does not think of such a loan as a business venture, as investing $200,000 to gain an 80% chance of earning 2/3 (after he pays the lawyers) of $2 million. If he does think of that, he is very risk averse, and doesn't want to risk losing the $200,000, even though when he was younger he was quite happy despite not having any equity in a house. So the professor simply can't afford to wait four years for the lawsuit to end, and couldn't wait even if he had a 100% chance of winning instead of 80%. The university knows this, so it offers him $300,000, and he accepts it.

Selling Shares in the Professor's Lawsuit

The professor has already, in effect, sold a 1/3 interest in his lawsuit if his lawyers are working on contingency. Why not sell more, but for cash rather than labor?

Under the common law, and under state laws of 1970, I think this might have been illegal (and, indeed, maybe contingency fees were illegal under the common law). In 2021, some states definitely permit this. I don't know if all do.

Here's how it would work. It would operate as a simple contract. Investor agrees to immediately pay Plaintiff $50,000. Plaintiff agrees that if his lawsuit or lawsuits on the subject of Complaint X results in his winning damages, he will pay 1/5 of the net proceeds (after subtracting lawyer fees, expert witness fees, filing fees, etc.) to the Investor. Investor and Plaintiff agree that Plaintiff retains complete control over the suit, including control over hiring the lawyers, legal strategy, choice of court and counts, and the decision of whether to settle out of court, and the Plaintiff may make similar contracts with other investors but may not cede control in any way to any of them.

If the Plaintiff won and refused to pay Investor, Investor would then file suit for breach of contract. A more complicated way to ensure compliance would be maybe to do something like lawyers do for their contingency fees. I think it's that the Defendant pays the entire damages amount into an account controlled by the lawyer, who then deducts his fees and reimbursement for miscellaneous costs and writes a check to the client Plaintiff. This goes beyond what is necessary for a particular Defendant who is unlikely to flee to Brazil with the money or spend it all before the breach-of-contract suit is concluded. Lawyers do have to worry about such clients though, because they do exist.

Thus, if the Plaintiff has a 90%-sure-thing lawsuit for $400,000 after lawyer's fees, he could not be starved out. He could sell a 50% share, worth .9*200,000 = $180,000 if we ignore the risk, to an investor for $100,000, a price so low it would be very easy to find an investor. He could then tell the Defendant that he'd sold the share and could no longer be starved out, and the Defendant, having learned that, would immediately agree to settle for $180,000--- there would be no point in going to trial.

Selling Shares So You Can Pay Your Lawyers' Hourly Fees

It gets even better. For some kinds of suits, the lawyers do not want to be paid a contingency fee; they want an hourly fee. Or, you may wish to pay them an hourly fee, for one reason or another (it is sometimes much much cheaper than paying by contingency fee). In car accident suits, contingency fees are standard. I am under the impression that they are not standard in some other kinds of civil suits. Also, a lawyer who has just launched his own practice, either because he is fresh from law school or because he has split off from the big law firm where he was a successful partner but didn't want to share his fees with the others so much, or because he has left a nonprofit or government employer to set up as a private lawyer, will himself need the cash flow of hourly fees.

Selling shares allows the Plaintiff to pay the hourly fees of his lawyers. Suppose the case has a 80% chance of success in obtaining $600,000 in damages net after expert fees, etc. but not deducting legal fees. The Plaintiff could sell a 50% share, worth .5*.8*$600,000 = $240,000 to an Investor for $180,000 in cash, and gradually pay out the $180,000 to the lawyer in hourly billings. Note that 1/3 of the expected value of the net winning would be (1/3)(.8)*$600,000 = $160,000, so $180,000 would be more than enough to cover the likely cost of the lawyer's time.

It does need to be kept in mind that a lawyer paid hourly does not have so much "skin in the game". I was told by a lawyer once that he *really* didn't want to do hourly billing for me because he wanted to throw his whole life into the case and it was harder mentally to do that if it wasn't on contingency. I think I would suggest now to a lawyer who *wanted* to bill hourly that we do that at a slightly lower rate than his usual, but with a sizeable bonus for winning--- maybe $30,000 in a case of the size described above. That would make for a more exuberant victory party too.

The Indiana Litigation Trust

See the article, The Indiana Litigation Trust.

Application to Writers, Musicians, Artists, and Consultants

Much of this applies to copyright as much as it does to litigation. Suppose you are writing a novel, and you have an 80% chance of the novel being a hit and earning $2 million in royalties when it is finished in four years.

It also applies to start-ups generally; indeed, this is the idea of venture capital, but it can be applied to individuals. I have a friend who would make a very good consultant for small businesses. I've suggested to him that perhaps I could pay him for his time while he tries it out, in return for a share in the proceeds if his clients actually think his advice is valuable and pays him for it (our idea was to in turn not bill clients hourly, but to let them pay the consultant whatever they thought he was worth and rely on their honesty, a risky but potentially highly profitable strategy).