Plaintiff’s lawyers have been funding litigation since decades through contingency cases. Joining the glamorous niche is a backwater of the legal world, Litigation Financing.
The contingency fee or conditional fee is a fee charged for a lawyer’s services only if the lawsuit is successful or is favorably settled out of court. Contingency fees are typically between 20% and 50% of the award and are often paid in addition to a discounted hourly rate and out-of-pocket legal expensed which the client has to pay regardless of the case resolution. As such, contingency arrangements are often used for plaintiffs where the client stands to win large amounts with a good probability.
The difference between contingency and litigation funding is that a plaintiff’s lawyers are de-facto investing their time and money in the case whereas litigation funding is provided by 3rd party financial institutions who have no direct affiliation with the defendant, plaintiff or the lawyers. Often hedge funds, the 3rd party financial institutions are merely seeking a return on their investment, and they are looking at the arrangements as a pure financial product. Where contingency is prevalent in class action or personal injury cases, litigation financing is better suited for commercial litigation in asymmetric cases where the plaintiff has a good chance of winning but does not have the means to pursue a much larger institution for years in court.
The litigation financing investor is meant for funding the litigation expenses. In case of success, the funder shares a percentage of the returns awarded either through a trial or negotiated via a settlement. If the plaintiff loses, the funder will have to write off their investment as the plaintiff will not owe the funder anything. Therefore, a litigation claim is treated as a binary financial asset with a value comparable to accounts receivable, IP or real estate. It is important to appreciate that litigation funding is not a loan; it’s a form of non-recourse financing. Different types of investors deal with different categories of cases according to their area of specialization and knowledge. Cases that require between $2m-$10m in investments are expected to typically provide a return between 3x to 5x over a 3 to 5 year period. The return profile is similar to a VC or PE fund. Return on investment also depends on the percentage of recovery shared by different participants of the case. The investments can be structured as multiple tranches of investments depending on achieved milestones as well. The returns can also be structured: a return can be set to 2x if a return is obtained within 2 years and 5x if it is after 4 years.
Litigation funding is currently unregulated on a Federal level and compliance is on a state level basis. This increases the regulatory costs for litigation investors and they tend to focus their investments on California, Delaware and New York, as these states have the most sophisticated approach towards litigation funding, a fair share of the corporate litigations market and principally allow the funding process. Lawyers and/or clients approach funders and discuss the case, parameters, merits and risk/reward to figure out potential funding structures. Generally investors do not like to fund anything less than $5mil; the sweet spot for the industry seems to be 2-10 million$. After signing an LOI or agreement of confidentiality, funders conduct thorough due diligence to assess the case. Depending on complexity of the case, lawyers of funders take 7 to 30 days to dig through, evaluate merits and understand recovery options. A vital element for evaluation for funders is enforceability of judgment. Winning the case, but failing to enforce would obviously not translate into a good investment.
There are a lot of questions on ethics of having an outside party invest in lawsuits. U.S. Chamber of Commerce is lobbying to enact regulations that would require funders to post a bond worth 25% of a lawsuits damage claim, to pay the defendant’s attorney fees and to give FTC rule making power on the nascent industry. If such rules were to be enacted, they would certainly sound a death knell for the industry. There is also an issue of attorney client privilege. The funder requires information about the case to decide whether the case is a good investment. But defendants have argued that whatever information is shared with a funder, should also be shared with them. Attorneys have found a way around by sharing only the “work product” and not any privileged information with the funder. “Work Product” is a legal document which has been created by the attorney for the purpose of the litigation. This is shared with the funder and courts have generally favored the notion that information provided in the work product is protected and need not be shared with defendants.
Industry players and numbers
The litigation funding industry has around 12 major dedicated players in the US. The market size is estimated to be around 1 Billion$ a year currently. The big kahuna of the industry is Burford Capital. It has funded deals in the range of 25-50 million$ and has reported an 89% increase in profits for 2014 versus the previous year. The company is quintupling its investment outlay to 62 million dollars towards new investments. Not far behind is Juridica Investments Ltd, a six year old fund which has generated proceeds in excess of 241 million$ during its lifetime, out of which net profits amount to 178 million$. Burford and Juridica are both listed in London, underlining the acceptability of the new asset class. Others are crashing into their party, with Gerchen Keller Capital & Longford Capital raising more than 300 million$ and 55 million$ respectively.
Example of cases
Supporters of litigation finance highlight the case of Miller vs. Caterpillar, a small corporation pitted against a much larger corporation with deeper pockets, the typical David vs Goliath story. As Miller did not have millions of dollars to fight, it opted for litigation funding. A massive 73.6 million$ judgment was awarded in favor of Miller, which would not have been possible without litigation financing. But there are other cases, which depict all is not rosy in this industry. Case in point: Deep Nines, the company received an 8 million$ investment from a funder and agreed to a 25 million$ settlement. After settling the dues of investor (10.1 million$), attorneys, courts costs and miscellaneous, Deep Nines got to keep a paltry 800,000$. Some of these arrangements have literally gone to the dogs. Juridica is actually suing one of its former investee- Valerian Simirica, in a deal gone sour.
Keeping aside the positives and the negatives, the industry is poised to expand. Litigation has become a major cost of doing business and many companies would like to remove the uncertainty of a long drawn litigation and the associated attorney costs from their balance sheets. There is also a genuine need and market for people who have claims but are unable to enforce or make an appeal. Litigation Financing provides a good opportunity for monetization and is a very important tool through which meritorious claims can be brought into. Though it might lead to frivolous litigation, it has to be accepted that the David versus Goliath situation is true for many cases which have been funded. As of now, this segment in concentrated only in the hands of highly sophisticated and niche players, but with the infusion of more capital, litigation financing will become a more common way of doing business in America.
Author: George Popescu and Heena Dhir