Article: The Impact of Commercial Litigation on a Business Balance Sheet
When considering the risks of commercial litigation, one of the main concerns many businesses have are in relation to the impact it will have on their balance sheet. Fortunately, certain funding models and products, such as ATE insurance can help businesses transfer the costs and risks of litigation away from the balance sheet.
The cost of litigation and the impact on business balance sheets
Engaging in commercial litigation involves legal fees and expenses, which can include solicitor fees, court fees, expert witness fees, and other related costs.
Regardless of whether a company is pursuing or defending a commercial litigation claim, the litigation is likely to have a negative impact on the balance sheet if appropriate funding or insurance is not secured.
Legal expenses can accrue rapidly, particularly in complex cases, and can put a strain on a business's cash flow.
When a company incurs legal expenses related to pursuing a litigation claim, these are typically not treated as investments in long-term assets, as the outcome of the case is uncertain.
When a company pays legal expenses for pursuing a case, they are recorded as an expense on the balance sheet, thus reducing the company's net profit for the specific period. In other words, these expenses are treated as operating costs and directly impact the company's profitability during that period.
Similarly, if a business is defending against a claim, they will also be required to incur expenses throughout the process of litigation, with the same impact on the balance sheet.
The risks associated with losing your case
Even if you believe you have a solid case, there is always the risk of unsuccessful litigation.
Businesses, both pursuing and defending a case, need to assess the likelihood of losing and adjust their accounts accordingly.
Contingent liabilities will need to be disclosed when defending or pursuing a commercial litigation case. These liabilities are disclosed when there is a possible obligation for future spending arising if certain conditions are met i.e., if they lose the case.
Funding models to reduce the impact of litigation on the balance sheet
Funding models, such as damages based agreements, conditional fee agreements and third party funding can be used to reduce the impact of litigation on the balance sheet in a number of ways:
Conditional Fee Agreements (CFAs) and Damages Based Agreements (DBAs):
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- No win, no fee: With a CFA or DBA, the law firm representing the business will only receive payment if the case is successful. If the case is lost, the law firm typically waives its fees, which reduces the immediate financial burden on the business.
- Reduced legal costs: In a CFA or DBA, the law firm may agree to a success fee if the case is won. This structure can potentially reduce the overall legal costs for the business.
- Cost management: CFAs and DBAs often require careful cost management by law firms, as they have a vested interest in the case's success. This can lead to more efficient and cost-effective litigation strategies.
- Cash flow preservation: Since the business does not have to pay legal fees upfront, its cash flow is preserved during the litigation process, allowing it to allocate funds to other areas of the business.
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- External financing: TPF involves a third-party funder providing the necessary capital to pursue a legal claim. The funder takes on the financial risk, including legal fees and expenses, in exchange for a portion of the damages if the case is successful.
- Risk mitigation: TPF allows the business to transfer a significant portion of the financial risk associated with litigation to the third-party funder. If the case is unsuccessful, the business is not responsible for repaying the funding.
- Improved balance sheet: Since the costs of litigation are offloaded onto the third-party funder, the business's balance sheet is not burdened by the legal expenses, and its financial position may appear stronger.
ATE insurance to mitigate the impact of commercial litigation on a business balance sheet
Legal expenses insurance, such as after the event (ATE) insurance, is often used alongside funding options, such as CFAs, DBAs and TPF. It can help mitigate the financial impact of commercial litigation on a business's balance sheet in several ways:
- Risk reduction: Commercial litigation can be unpredictable, and the potential costs can escalate quickly. ATE insurance provides a safety net by shifting the financial risk of losing a case from the business to the insurance provider. This risk reduction helps protect the business's financial stability and prevents the potential depletion of its assets due to an adverse legal outcome.
- Enhanced negotiating position: With ATE insurance in place, a business might have a stronger negotiating position in settlement discussions. The insurance coverage demonstrates that the business is financially prepared to see the litigation through, which can encourage the opposing party to consider reasonable settlement offers. This can lead to quicker resolutions and reduced legal costs.
- ATE insurance can also be used to cost-effectively satisfy a Security for Costs requirement, avoiding the need for cash to be lodged with court. This can keep litigation on track and avoid a case being stifled as a result of such an application.
How can Annecto Legal assist?
Annecto Legal help clients realise the value of their commercial litigation claims, whilst transferring the costs and risks of litigation away from the balance sheet.
The application, quotation stage, costs and premium structures of commercial ATE insurance can be particularly complex. Therefore, we recommend that you contact our team as soon as possible so that we can provide the guidance you require.
We provide our services to a range of clients, including businesses, solicitors, commercial insurance brokers, individuals, insolvency practitioners and liquidators.
Get in touch with us today to find out more about commercial ATE insurance and which commercial litigation cover is the right litigation funding choice for you.
Key Contacts:
David Law – 07540 303035 david.law@annectolegal.co.uk
Mark Beaumont – 07730 217643 mark.beaumont@annectolegal.co.uk