Hulk Hogan’s case against Gawker Media made headlines four times — but only twice because of what the jury did.
You’ll recall that a trial in Florida produced a verdict in favor of Mr. Hogan on his claim that Gawker had gone too far with a sex video. Jurors awarded the Hulkster (Terry Gene Bollea) actual damages of $115 million and then — after a second round of deliberations — another $25 million in punitives.
The next round of publicity featured not tawdry sex and vile reporting but news that a vengeful billionaire had provided the Hulk with the means to obtain civil justice. There followed a bankruptcy.
The Chamber of Commerce hyperventilated in print about casino litigation. Oh nos!
Something else caught my eye.
After news of the billionaire’s funding broke, Forbes printed an item about tax treatment of lawsuit funding in contingent-fee cases. That’s where a law firm commits to investing potentially millions of dollars worth of time in return for a share of the upside — usually a percentage of any recovery from a case.
The author of the Forbes piece discloses that he focuses on “taxes and litigation”. He describes a structure in which a third-party funder pays the owner of a civil claim $X up front in return for the claim owner’s promise to convey a share of the claim to the funder at some point in the future. The structure, which he deems a “prepaid forward contract”, allows the funder to invest in an uncertain but potentially valuable claim while providing cash to the owner, who may use the funds to pay counsel on an hourly basis or may stick the money in her bank account.
The author says that the approach may afford big tax advantages. The funder can deduct its expenses and pay tax on any profit at the lower capital-gains rate. The claim owner defers her tax liability until the claim either pays off or goes poof but in the meantime has money at her disposal.
The same, the author says, goes for the lawyers.
Potential tax benefits
In a typical complex commercial case with much at stake, the time from commencement to resolution may run several years, sometimes a decade or longer. The value of the tax deferral can add up.
Take for instance a claim that produces, through settlement or enforcement of a judgment, a lump-sum payment of $50 million after five years. Assuming an up-front payment by the funder to the law firm of $7.5 million for half of its 40 percent contingent fee — fairly standard in commercial cases — the partners in the law firm will pay no tax on the $7.5 million for a five-year period. At the highest marginal tax rate — currently 39.6 percent — the partners will hold onto the $2.97 million ($7.5 million x .396) that they would otherwise pay in income taxes for several years.
If the structure holds up — a big if that I don’t have the expertise to opine on — adopting it could make the interests of claim owners and their contingent-fee lawyers more valuable and could therefore enhance the attractiveness of entering into a lawsuit-funding arrangement.
The time value of having $2.97 million tax-free for four years or so conceivably could make enough difference that people who’d normally shun third-party funding would give it a second look. It might even become mainstream.
Not my area
Let me stress that you’ll have to get your own advice about whether the approach would satisfy tax laws. The lawyer whose article in Fortune prompted this post himself takes a cautious view of the approach, noting several caveats. Proceed at your own risk.