Litigation finance: where have we reached and where are we going?
March 2018 | EXPERT BRIEFING | LITIGATION & DISPUTE RESOLUTION
To say that litigation finance is experiencing a growth phase would be a bit like saying cryptocurrencies can be a bit up and down. From its roots in the early years of this century in insolvency proceedings and in facilitating access to justice, it has morphed into a multi-billion dollar industry with almost as many angles as dollars. As investment managers chase the types of return that are simply no longer available on traditional markets, the attraction of this relatively new asset class is not hard to work out.
The purpose of this article is not to say whether this is a good or a bad thing, but to reflect upon some of the developments and consider the opportunities and challenges that the industry’s evolution brings. The risks inherent in financing dispute resolution, as well as those attaching to particular jurisdictions or counterparties, are taken as read.
Five years ago, to the extent that they perceived ‘third-party litigation funding’ as relevant to their lives, most major corporations, financial institutions and law firms would have identified that phenomenon with one of a few limited situations: so-called ‘David v Goliath’ access to justice cases, claims brought by insolvency practitioners on behalf of estates or, if this was their territory, competition follow-on damages claims or investment treaty arbitrations. Most substantial market participants saw litigation funding as something that was potentially helpful to others but not relevant to them, except that it slightly increased the prospect of facing claims that they would not otherwise have to deal with.
For the most part, funding arrangements were entered into on a single case basis, with the funder typically paying the claimant’s legal fees and expenses, such as court fees, expert costs and insurance to address adverse costs risk. In exchange, the funder would be entitled to – usually the greater of – a multiple of its investment or a percentage of the claimant’s return upon success, but would have no recourse against the claimant if the claim failed to realise tangible proceeds.
As more and more capital has come into the market – there have been at least two $500m investments into UK litigation finance providers over the last few months, as well as a number of other significant fundraisings – and litigation finance has become increasingly mainstream, the available structures have multiplied.
We see today the financing of disputes portfolios, with funds being made available both to law firms, so that they can more comfortably enter into risk-sharing arrangements with their clients, and direct to corporations. Cross-collateralisation, of course, facilitates softer pricing as the finance provider is taking less risk than in the single case scenario.
We see funds being provided not just for the purpose of paying legal fees and expenses, but also the provision of working capital facilities for the funded entity, repayment sometimes being contingent on the success of an underlying dispute, sometimes not.
We see a greater variety of insurance products, as well as finance being provided through debt, we see equity participations, whether ordinary shares, preference shares, warrants or other structures. We see finance aimed at early-case plays, for example with a view to getting a case over a certification, jurisdiction or summary judgment/motion to dismiss ‘hump’. And we see enforcement plays, sometimes coupled with in-house asset tracing expertise. We see a greater variety of supporting insurance products, from after-the-event cover in respect of adverse costs risk, to disbursements cover for law firms, and award default cover. We see far greater participation in the trading of interests in claims at every stage along the process towards realisation. And we see funds marketing a focus on specific sectors or specific geographies.
At a slight tangent, cause-driven investment in disputes is hardly a new phenomenon. Many a rich individual has backed a case founded on a principle dear to that person’s heart. The difference now is an increasing awareness that it is possible to nuance the philanthropy with commerciality where the donor considers it appropriate, with offerings across the spectrum from pure altruism, through sustainability, to deriving commercial returns to be used for charitable ends.
In many ways, we see in litigation finance simply a maturing arm of the finance market.
Where is all the money going? We still see financing of insolvency-related claims, David v Goliath actions, cartel damages claims and investment arbitrations (although much ink has been spilt on the subject of funding investment arbitrations and there are some points of principle that merit debate, far more heat has been generated than light). Increasingly too, though, we see the financing of ‘ordinary’ commercial disputes – substantial business against substantial business.
Is that because litigation finance is the CFO’s dream? Certainly, it might seem to be, offering not just a solution to realise valuable assets in the form of legal claims – which might otherwise fail to see the light of day due to competing investment priorities or because the legal budget is ring-fenced in case it needs to be used in defence – but also accounting benefits (no drag on profitability due to the off-balance sheet nature of the financing).
Where it is a matter for a potential claimant of joining a group that has suffered loss due to securities or competition law breaches, and it is mainly a question of submitting data to the financiers or law firm and letting the process take its course, the value is not hard to find.
There are wider potential benefits too. For many corporations, litigation is ‘not what we do’. If they find themselves in a dispute, it is usually on the defensive side and there is pressure to throw resource at the issue. The better financiers’ expertise in the ever-disaggregating disputes market can enable them to be true drivers of change, as well as to insist that efficiencies be brought to bear by the providers of dispute-related services. This can benefit the corporate user of finance not just in the immediate case but by educating that user for the longer term. Also, as mentioned earlier, litigation finance can be an enabler for law firms to share risk with their clients. While risk-sharing with their legal advisers is attractive to a growing number of corporations, the financier’s ability to appraise the adviser’s proposed approach and to monitor its performance can be a source of additional value for the user, particularly where it is not a regular buyer of dispute resolution services.
Some pause for reflection is required. Corporations enter into disputes for many reasons, by no means all of them related to the immediate bottom line. Equally, they often resolve disputes for reasons not directly connected, indeed, sometimes entirely unconnected, with the merits of the matter at hand. Furthermore, loss of control and loss of complete flexibility of action are still cited as risks for corporations of engaging in litigation finance. While few finance providers will try to take direct control over a bilateral dispute, the fact that a third party has a direct financial interest in the resolution of a corporation’s dispute brings with it an extra nuance and new challenges for that corporation’s financial and legal advisers.
This means that structuring an appropriate transaction requires serious consideration of the angles and there is inevitably some crystal ball gazing to be done on both sides of the table. It is also arguably an additional pointer towards the mutual attractiveness of multi-case arrangements, as the financier need be less concerned about the outcome of any single case, provided the overall direction of travel is positive.
So what does the future hold? In all probability, we will see continued assimilation of litigation finance into the corporate toolbox, more money into the market, at least for the time being, more multi-case deals and softening but still strong margins for investors. No doubt there will be a few high-profile failures along the way and then the Cassandras will have their moment in the spotlight. But for those who engage in the business with clear and realistic goals and thought-through strategies, there is still likely to be much growth ahead.
Matthew Knowles is a partner at Stewarts. He can be contacted on +44 (0)20 7936 8064 or by email: email@example.com.
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