Using Legal Funding to Assess the Time Value of Money

From a financial point of view, personal injury lawyers who prosecute claims are managing a portfolio of assets. To be successful asset managers, lawyers must optimize the returns for their clients while also making a profit for themselves.

To optimize returns, attorneys must consider not only their ongoing cost of pursuing a claim. They must also calculate the time value of money – the value of recovering money today compared to receiving that money in the future.

This article discusses how lawyers can use Cartiga’s legal funding to calculate the time value of money in their cases, and better optimize returns on their claims.

Optimizing Returns on Claims for Clients

Lawyers know that it takes time and expense to prosecute a personal injury claim effectively. But what is the optimal time to settle once they have completed pre-trial discovery and obtained the necessary damage and other expert reports?

Lawyers should weigh the value of a recovery that could be received today compared to the “net present value” of a recovery in the future. The “time value of money” principle tells us that a dollar recovered today will be worth more than a dollar recovered in the future. That’s because clients can use money recovered today to earn interest at a certain rate or to pay off expenses that would otherwise grow unless they have money to pay them.

Thus, to optimize the return for a client on a claim, an attorney must evaluate:

• whether the claim will settle in the future for a higher amount than the claim will settle for today;
• if so, what are the best estimates of that higher amount and how long will it take to obtain that higher amount; and
• how does the “net present value” of the estimated higher dollar amount in the future compare to the actual dollar amount that could be received in settlement today.

If the expected net present value of a future recovery does not exceed the actual value of a recovery received today, then (from a financial point of view) the client should take the money today and avoid the deteriorating value of money based on the time value of money principle.

Calculating The Value of Recovery Now Compared to The Future

So, how does an attorney calculate the “net present value” of a recovery at some point in the future? That calculation requires the attorney to apply an annual “discount rate” to that estimated future recovery amount (that is, the rate at which the value of a dollar erodes for the client), which is compounded over the expected time to a settlement.

The discount rate is derived from the client’s “cost of capital.” For clients who need money to pay bills while their case is pending, attorneys can use Cartiga’s rate on its funding as a “cost of capital” proxy for calculating whether the value of an estimated future recovery will exceed the value of a recovery today. This funding “cost of capital” rate is probably lower than alternative sources of capital available to many unbanked or underbanked consumers who need money to pay their bills. ¹

This “time value of money” calculation underscores how consumer funding can very much be in clients’ best interests. It makes sense for clients to have the use of at least part of a future recovery as soon as possible, since clients are effectively paying some portion of that cost of capital anyway by not otherwise having access to funds (that can earn interest or be used to reduce expenses that would otherwise grow) until their cases resolve.

Managing Claims Profitably for Lawyers

Using similar calculations, lawyers can determine whether, from their own financial standpoint, it is more profitable to settle a claim today or to wait for a higher recovery tomorrow.

To calculate whether it makes financial sense to pursue a legal claim and invest additional time and money, attorneys should compare the actual amount of fees that they would receive on a settlement today with the net present value of estimated fees on a settlement in the future. That estimated net present value of future fees should exceed the actual fees that would be received today for lawyers to profitably continue the pursuit of a claim.

Cartiga’s working capital funding can inform these calculations of net present value that reveal the time value of money. An attorney’s “discount rate” (that is, the rate at which the value of a dollar erodes) will be somewhere near his or her cost of capital, and Cartiga’s commercial working capital funding rate for lawyers is a good proxy for that cost of capital.

This calculation is particularly important for lawyers because their contingent fees are more than just compensation for legal services rendered. Contingent fees essentially compensate lawyers for the “loan” of their time and resources on a case for an extended period, as well as for the risk of non-payment in a losing case. The percentage rate of return in contingency fees is high because the risk is “considerably higher than with ordinary loans.” ² To maximize this return, attorneys must be attuned to the time value of the money that they will receive in fees, and how that value erodes over time if they settle cases too slowly.

Conclusion

There is considerable evidence that Cartiga’s legal funding delivers higher recoveries for plaintiffs in personal injury cases, as well as other compelling benefits that outweigh the costs.³ To maximize those recoveries for plaintiffs, and to ensure healthy profits for themselves, lawyers should be calculating the optimal time to settle cases based on the time value of money.

This article is for marketing purposes only, does not constitute legal advice, and should not be relied upon as legal advice.

1. Id.
2. Michael A. Dover, Contingent Percentage Fees: An Economic Analysis, 51 Journal of Sir Law and Commerce, 531, 538-539, 550- (1986); R. Posner, Economic Analysis of the Law 448 (2d ed. 1977).
3. Heuristics, Biases, and Consumer Litigation Funding at the Bargaining Table, Vanderbilt Law Review, Vol. 68:1:261, 266 (2015); Ronen Avraham and Anthony Sebok, An Empirical Investigation of Third-Party Consumer Litigant Funding, 104 Cornell L. Rev. 1133 (2019); Paige Marta Skiba and Jean Xiao, Consumer Litigation Funding: Just Another Form of PayDay Lending? Law and Contemporary Problems, Vol. 80:117, 119, 121-123, 126, 137-138, No. 3 (2017); Andrew F. Daughety and Jennifer F. Reinganum, The Effect of Third-Party Funding of Plaintiffs on Settlement, American Economic Review, Vol. 104, No. 8, pp. 5-6 (August 2014); Susan Lorde Martin, Litigation Financing: Another Subprime Industry That Has A Place In The United States Market, 53 Vill. L. Rev. 83, 84-85, 100, 101-102 (2008); GAO Report on Third-Party Litigation Funding: Market Characteristics, Data, and Trends, pp.12-14, 18-19 (December 2022).