What is Litigation Finance and how long has it been around?
The concept of Litigation Finance has become increasingly popular in recent years and there has been much discussion of this area in the financial media and forums focused on investment opportunities with uncorrelated market returns. Although sometimes presented as an untried and untested offering, it is not in fact, a new phenomenon at all.
This burgeoning industry has been masked under different names for years. Third-party funding of public interest lawsuits, contingency fee arrangements between lawyers and their clients, factoring, and bankruptcy claims have been in existence for as long as we can remember. The Litigation Finance that is most prominent in the press refers to various private investment vehicles that aim to profit from a cut of the winning legal fees, using a strategy where they provide those pursuing claims with necessary funds to move forward with litigation and associated costs. While it appears to be a lending strategy, it’s actually closer to an asset purchase or venture capital type of investment with upside potential based upon a the prospect of a positive outcome on the settlement.
The litigation financier is more often than not backing a plaintiff they feel can win a case on merit, but cannot secure the funds necessary to pursue the case professionally and aggressively through its entirety. The screening process for these litigation financiers includes rummaging through promising cases they’ve learned about through relationships with multiple law-firms, public advertisement responses, and monitoring trends in mass tort/class action and other areas of legal practice. These all can turn out to be costly cases that need support and are high risk for all parties, yet for an investor, if they are well-chosen they have the great potential for a successful return on their stake . While contingency fee agreements and traditional litigation financing deals by finance-parties are rather similar, the primary difference is the control of the litigation strategy by the lawyer representing the plaintiff. While it isn't as common, the defense is sometimes being backed by funding. As the defendant is often sued because they have significant resources or liability insurance coverage policy in the first place, it makes them a target and is certainly a growing area for the industry – particularly where the lawsuit claims are of a magnitude that will threaten the solvency of the targeted defendant (eg, big pharma, tobacco or asbestos claims). For further clarity on the defense side of things, if the defendant submits their claim to the litigation finance firm, they assign an expected loss or damages amount to the case. Then any amount below the expected damages is the value generated by the litigation finance firm, which gets a portion of that value. It should be mentioned that this growing industry of litigation finance has not come without controversy, as some fear it fuels frivolous lawsuits and encourages claimants to press for unreasonable settlements. Yet, many believe the financing offers a slew of benefits by helping to level the playing field and prevent an increasing number of 'David vs. Goliath' scenarios from occurring in the courtroom. In summary, this kind of financing provides resources to undercapitalized plaintiffswho otherwise could not pursue meritorious legal claims or provide additional capital to in-progress cases where plaintiffs face funding shortages.
How do financiers decide which cases to back?
The analysis of litigation scenarios and prospective outcomes is a critical process for the litigation financiers. If an investor is allocating funds to one of these fund vehicles, they'll want to make sure they're backing a team with reputable experience and credibility in the industry - more often than not this involves having Big-Law seasonality at Am Law 100 firms. Track-records may be tough to put weight on, given the relatively nascent period of time these funding vehicles have been around. Funders focus on different segments of the market and deals of varying sizes. Areas of specialization can range from smaller personal injury and liability cases to very large complex commercial litigation on IP matters and mass tort class actions. The volume of cases funded and the diverse mix of cases are additional and important considerations for someone allocating to these fund vehicles. At this point, there are currently only 2 publicly traded litigation finance firms – Burford Capital on the London Stock Exchange and Bentham IMF on the Australian Stock Exchange. But it's the latest sharp stock decline of Burford Capital that is garnering attention from the financial press. This decline is based on allegations of Burford egregiously misrepresenting its returns and the state of its overall business. However, this isn’t representative of the state of the industry and the success other players in the field (a growing list of private firms) have demonstrated. Such disruptive attention on an otherwise niche segment often provides an unique investment opportunity for those savvy enough to see through the fog that these side discussions create.
Are there research methods to gain an edge for the Litigation Finance teams and how profitable can these vehicles be for investors?
Just as the traditional investment funds are finding different ways of looking at the public markets such as leveraging various alternative data sets, and gathering specialized knowledge via expert networks from GLG, Third Bridge, and AlphaSights, so they can quickly get up to speed on their target – the Litigation Finance world will inevitably begin to use differentiated tools and methodologies to better assess the outcome and select cases to fund.
Investigations and Business Intelligence firms such as Gryphon Strategies will serve as important resources to attain this incrementally valuable insight.
Sourcing a consortium of witnesses, informed actors, and industry specialists that aren’t directly involved in the case being funded may prove to arm the litigation financiers with the critical intelligence needed to hedge the risk on these investments. This type of intelligence will unequivocally equip the financiers with an information edge and fill any gaps that remain unclear as they determine which cases to fund. As the industry stands now, there are roughly 30-50 independent
litigation finance firms across the globe. This number will inevitably grow after the bluster regarding the Buford scandal dies down, as will the business units
within banks, hedge funds, and other investment firms that are looking to add additional strategies to their portfolio suite. Our Enhanced Diligence & Intelligence team at Gryphon stands to take advantage as we understand the potential and the role we can play. In addition to the source-work where discreet interviews are at the center of the value proposition, Gryphon has a team of external advisors with forensic accounting research and litigation analysis backgrounds. One of our external advisors, Mitch Sockett, has vast experience analyzing litigation scenarios and outcomes from his years spent at a well-known hedge fund, coupled with strong multi-faceted-litigation experience at Skadden Arps, Meageher & Flom for over a decade. His skill-set will undoubtedly add a substantial amount of value to an investor’s commitment to such a fast-growing field. The Gryphon team is excited to watch this industry take off, as profitability can be tremendous with many of the leaders showing double-digit returns. But appropriate due diligence is important.
Please get in touch with Rich Finley, Head of Business Development at Gryphon Strategies to learn more about our ability to help investors assess the potential for high returns in this space as well as the litigation finance firms themselves as they employ expert strategies to mitigate risks and identify the best cases to fund.