Emerging Trends In Litigation Risk Insurance

Litigation risk insurance refers to a relatively new set of insurance offerings that allow businesses to better manage the legal risks stemming from known litigation.

There is a growing market for such products, which gives companies a new set of tools for dealing with the uncertainty of high-stakes litigation. While these policies are all highly bespoke and cover a number of different risks, one form of litigation risk insurance, known as adverse judgment insurance, offers coverage for final judgments in litigation, but typically not for defense or settlement. This kind of insurance can be especially helpful in the mergers and acquisitions (M&A) context, where an otherwise attractive target company is involved in material litigation.

An adverse judgment policy can give a prospective buyer or merger partner the certainty to move forward with the transaction, even while the underlying case remains pending. Another form of litigation risk insurance, known as judgment preservation insurance, allows successful litigants who have won money damages to “lock in” some or all of that award, pending appeal. Given the expense and disruption of high-stakes litigation, in many cases such insurance would add great value by setting a “floor” for recovery and achieving considerable certainty well in advance of the appellate outcome. Decision-makers involved in M&A activity and big-ticket litigation may consider litigation risk insurance as a potential solution when facing material litigation uncertainty.

Adverse Judgment Insurance

As introduced above, and as its name suggests, adverse judgment insurance is designed to protect a defendant (or other intended beneficiary) in the event of an adverse judgment. This kind of insurance can be a valuable tool for businesses engaged in M&A activity.

Litigation risk can be one of the biggest problems in the context of deal diligence. In addition to the substantive risk of loss, in many cases prospective buyers will find litigation risk much harder to evaluate than the ordinary course aspects of the business. As such, open litigation can be a significant problem for otherwise attractive target companies, especially where target companies are defendants. In some cases, open litigation will make an otherwise attractive target too risky to acquire.

To address this issue, a target company may attempt to achieve a settlement pre-transaction, but this gives significant leverage to the other side and may fail in any event.

Indemnification agreements are another alternative in some situations, but these can raise their own risks of future litigation.

Adverse judgment insurance is an option that can help to cabin the risk of pending litigation — and give comfort to a potential buyer — without having to deal with an adverse party or the potential complexity of an indemnification situation.

Adverse judgment insurance may also eliminate the need for large escrows, and the resulting loss in liquidity, for potentially lengthy and uncertain periods of time. The coverage may also offer value where a litigant wishes to offer additional assurance to investors, commercial partners or the market as a whole as to its financial and commercial stability. This approach may also provide some level of certainty on a balance sheet by making a contingent liability a quantifiable insurance cost, which can be a considerable advantage for some companies.

Adverse judgment insurance can potentially add value outside the M&A context, as well. Litigation financing is here to stay, and many commentators predict a rapid rise in such activity in the coming years as capital providers look to turn lawsuits into investment portfolios. Adverse judgment insurance potentially provides a way to counterbalance the strategic asymmetry that can occur when a financed plaintiff sues an uninsured defendant. In this dynamic, plaintiff side risk is distributed across multiple entities (a strategic advantage), but the uninsured defendant is burdened with all downside risk, which may prompt it to consider less attractive settlement possibilities.

Whether or not a plaintiff has outside funding, there are many circumstances where the underlying litigation dynamics tend to favor the plaintiff obtaining an early settlement that is “too large” compared to the underlying merits of the case. For example, many forms of litigation that can generate large damages awards — including patent, antitrust, securities and products liability class actions — require extensive fact and expert discovery, which tends to drive the high cost of litigation. These costs, plus the inherent uncertainty of litigation and the risk of loss down the road, mean that many defendants will be willing to settle at significant amounts even where they think that plaintiffs’ claims are weak. Even a remote chance of a bad outcome can push a defendant to make expensive settlement decisions, especially if it would exceed other insurance coverage or otherwise be particularly disruptive.

However, in cases where there is sufficient information for an insurer to underwrite litigation risk, adverse judgment insurance can help level the playing field by allowing a defendant to negotiate a more reasonable early settlement with the understanding that the risk of not settling has been controlled.

Judgment Preservation Insurance

Judgment preservation insurance, also as its name implies, is designed to underwrite the risk associated with a judgment being overturned or significantly decreased on appeal. In this case, a plaintiff who has prevailed at trial can be confident that a win is insured at a certain level slightly below the total award, even in the unlikely, yet possible, event of reversal on appeal.

This is particularly applicable in the intellectual property (IP) litigation context. Take the example of patent litigation or contractual licensing dispute involving underlying confidential or otherwise protected and extremely valuable IP. The winning IP owner may have spent significant amounts of money, not to mention significant time, to secure a litigation victory at the trial court level. But that successful plaintiff now faces an even longer appeal horizon and continued uncertainty as to whether the trial court result will be upheld, reduced after more time on remand to the lower court, or overturned entirely on appeal.

Indeed, the larger the damages award at trial, the greater defendant’s motivation to pursue a vigorous appellate challenge to that outcome. On top of an already lengthy trial process, appellate timelines are often measured in years, significantly reducing the practical value of a hard-fought judgment. Another concern is that the uncertainty involved in preserving the value of the judgment may be material to a corporate earnings report or other important communications with investors, commercial partners or the market. All things considered, even after a victory at trial, uncertainty still looms.

In each case, judgment preservation insurance can be used to provide further certainty and potentially accelerate recording a significant amount in earn-ings or other income, serve as collateral for more competitively priced financing than might otherwise be offered by a judgment monetization lender, or otherwise improve the successful litigant’s position.

How It Works: The Numbers

So, how does litigation insurance work in terms of the numbers? Much like other insurance products, potential insureds pay a premium for the coverage subject to a retention and certain defined limits. In return, insureds receive bespoke coverage, and peace of mind, for many of the litigation risks discussed above. These are highly tailored and bespoke policies and subject to detailed diligence, given the sophisticated and high-stakes nature of the underlying litigation, so the specific terms will vary.

For illustrative purposes only, for example, a carrier providing coverage for an adverse judgment after underwriting may determine that damages claimed are in the range of $60 million to $100 million. The carrier may assess the claimed amount and determine that a more likely damages award is closer to about $8 million to $10 million. In such a situation, assuming the insured and carrier can come to agreement on premiums, retentions and limits, a carrier may provide coverage that exceeds $10 million in likely damages, up to the full damages claimed of $100 million. Thus, if a final non-appealable adverse judgment is entered against the defendant for $100 million, under this illustrative example, an insured would be exposed only to a $10 million retention, and the carrier would bear the risk of damages in excess of $10 million up to $100 million (or $90 million of covered loss). If the final decision was $25 million, then the insured would be subject to satisfying a $10 million retention, and the carrier would cover the additional $15 million, subject to other terms in the policy (such as bespoke exclusions).

For judgment preservation (and drawing on our earlier example of the hypothetical IP dispute), assume an IP plaintiff wins a $100 million judgment at trial. The plaintiff could insure the appellate risk in preserving the $100 million damages judgment less a retainer (usually tied to the amount thought likely to be reduced), for example $10 million, such that coverage extends up to $90 million. In the event the final award is reduced by the expected $10 million, to $90 million, there would be no payout due to the retention.

But, if after all appeals have been exhausted, the award is reduced to $60 million, the insurance policy would pay out $30 million (the $90 million coverage less the $60 million final award, subject to a $10 million retention). In the event of complete defense victory on appeal and the damages award is zeroed out, then the policy would pay out the $90 million.

Again, the above figures are purely hypothetical; premium, coverage limits and retentions will vary greatly depending on the facts of the underlying litigation (potential exposure, procedural posture, previous settlement interactions, etc.).

Other Material Considerations

Much like the bespoke provisions of the policy, litigation risk insurance has its own unique facets. First, coverage will typically be excluded for losses resulting from material misrepresentations or omissions made during the underwriting process.

Second, coverage under litigation risk insurance is almost uniformly triggered on the ultimate and non-appealable final judgment or disposition of a litigation. Thus, while flexible in the sense that each coverage plan is customized and can provide other more immediate benefits, the insurance payout comes only if there is a judgment and after any applicable appeals are exhausted, such that the triggering adverse judgment or order is truly final and can no longer be challenged. For certain coverage, this could mean that if a case settles, the litigation insurance policy would be inapplicable since there would not be a final judgment on the merits, and therefore those seeking to include coverage for defense costs including settlement would need to be clear as to that goal for the coverage.

Additionally, the coverage applies to the final judgment and would not protect against the risk of a judgment-proof defendant, where the plaintiff receives only a portion of the full award because the judgment debtor cannot pay or be collected against.

Third, due diligence and underwriting of these policies are fact-intensive and detailed. A prospective insured should be ready to provide feedback on the opposing party’s litigation tactics and tone, potential damages, and, in the context of adverse judgment insurance, an assessment of the procedural path forward (timeline, dispositive motions, trial and appellate issues). While this process is unavoidably involved, the insured not only benefits from the coverage that may be afforded by the policy, but also the value of an objective review and assessment of litigation risks by a carrier that has aggregated hard data on litigation trends and risks.

Conclusion

In summary, litigation insurance is not a solution for any and all litigation risk, but in the case of the winnable or defensible legal position, it can provide an important tool for safeguarding against the vagaries of civil litigation. And at the stage where there is sufficient information for an insurer to conduct its diligence review, a litigant would do well to consider the benefits of a stronger negotiating position and the peace of mind that custom litigation risk insurance can provide.

Topics Lawsuits Trends