A New Era Of Innovation – In The Legal Department

Ask a dozen chief executives what parts of their business they consider the greatest value drivers, and I doubt a single one would list the legal department. But that may be changing.

In the past decade a cadre of innovative executives have set about transforming their law departments from cost centers to value centers, not only by introducing new efficiencies to the delivery of legal services, but also by using new financial tools to unlock latent value in legal claims. And while their methods are highly sophisticated, they can be described quite simply: those CEOs are pushing their General Counsel to make better business decisions.

Historically, law departments have been shielded from the productivity demands imposed on other business functions. Because, while every CEO needs lawyers – to negotiate contracts, manage risks, navigate disputes and, occasionally, guide them through bet-the-company litigation – their very necessity, along with their relationship to the cumbersome legal system, insulated them from pressure to manage costs.

That started to change after 2009’s withering economic downturn. Back then, beset by plummeting revenue, many CEOs gave their general counsel new mandates: curb the limitless hourly billing from expensive law firms, stop paying top-dollar for commodity legal work and do whatever it takes to rein in costs.

That austerity push continued into the recovery. Headcounts in corporate law departments soared as companies hired waves of in-house attorneys to perform routine work. Last year businesses with $10 billion or more in revenue carried nearly 300 full-time employees in their legal departments, according to a survey by the Corporate Legal Operations Consortium. The movement also fueled growth in legal operations. That business function originated in the 1990s at a few financial giants, including General Electric and Bank of America and has grown so fast that last year companies reported an average of 12 legal-ops professionals on staff. Those professionals manage electronic billing, negotiate pricing with outside firms and implement technology solutions for things like managing contracts and evaluating law firms.

“While litigation finance is still in its infancy in the U.S., it is growing explosively: its use has grown five-fold since 2013.”

To be sure, companies still need law firms for important things like cross-border transactions and high-stakes litigation – and they’re willing to pay for that work. On average 62 percent of law-department budgets still flow to outside legal costs. But this territory is shrinking and companies are being ever more assertive about extracting value.

While all this was happening, a few GCs also came to believe that their departments should not only be containing costs, but pursuing revenue. In a widely circulated 2010 report, Dupont General Counsel Thomas Sager declared that generating revenue to be “our job as lawyers within the company.”

The primary way Sager and like-minded GCs do that is by pursuing legal claims. But that creates a whole other set of challenges. Litigation has always presented a conundrum for business leaders. Under Generally Accepted Accounting Principles, litigation expenses are normally recorded as operating expenses, both reducing a company’s cash balance and lowering its net income – and often, as a consequence, its valuation. But when litigation is successful, the proceeds are typically treated as other income, which has no impact on operating income or EBITDA, the most important drivers of valuation. That makes filing a lawsuit – even on a strong claim – look like a lose-lose proposition for many CEOs.

But now we’re seeing innovative executives avoid this problem by using litigation finance. When a litigation finance firm agrees to finance a legal claim, it provides the funds to cover all the legal costs. If the claim is successful it takes an agreed-upon portion of the proceeds. The company incurs no cash charges related to the litigation and it shifts the risk to the financier, allowing the company to allocate its capital resources to other corporate priorities.

While litigation finance is still in its infancy in the U.S., it is growing explosively: its use has grown five-fold since 2013. There are many reasons for that of course. But underlying all of them is a simple reality: business leaders are treating their legal departments like they treat the rest of the organization, demanding better business decisions – and getting better results.

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Timothy Farrell :Timothy Farrell is managing director at Longford Capital.