Litigation Finance

Litigation finance, also known as legal financing or third-party litigation funding, is an alternative investment where a third party (the funder) provides capital to a plaintiff involved in litigation in exchange for a portion of the potential financial settlement or judgment. It has grown in popularity as an investment strategy due to its uncorrelated nature with traditional markets, meaning it can provide returns independent of stock or bond market performance.

Key Features of Litigation Finance

1. Third-Party Funding:
   • The investor or funder provides the capital to cover the legal costs of a lawsuit, such as attorney fees, expert witness fees, court costs, and other litigation-related expenses.
   • In exchange, the funder receives an agreed-upon portion of the financial recovery if the lawsuit is successful, either through a settlement or court judgment.
2. Non-Recourse Investment:
   • Litigation finance is generally non-recourse, meaning the funder only receives a return if the plaintiff wins the case or receives a settlement. If the case is lost, the funder loses the investment and does not recoup the capital or receive any payment.
   • This structure limits the financial risk to the plaintiff, as they are not required to repay the funder out of their own pocket if the case is unsuccessful.
3. Types of Litigation Financed:
   • Commercial Litigation: This includes lawsuits between companies or involving breach of contract, intellectual property disputes, antitrust cases, and other large-scale commercial disputes.
   • Class Action Lawsuits: Funders may invest in large-scale class action lawsuits where plaintiffs sue corporations for harm caused to a group of people, such as product liability or securities fraud cases.
   • Personal Injury Cases: Plaintiffs in personal injury cases, such as medical malpractice or wrongful death suits, may also receive litigation financing.
   • International Arbitration: Increasingly, funders are participating in international arbitration cases, often involving disputes between corporations or governments.
4. Returns for Investors:
   • Returns in litigation finance are typically high due to the risk involved, often ranging from 20% to 50% of the settlement or judgment. However, these returns are contingent on the case’s success.
   • The timeframe for investment returns can vary greatly depending on the duration of the litigation, which can last from several months to many years.

Benefits of Litigation Finance

1. Uncorrelated Asset Class:
   • Litigation finance is largely uncorrelated with traditional asset classes like stocks and bonds, providing diversification to an investor’s portfolio. Returns depend on the outcome of legal cases rather than market conditions, which can provide stability during economic downturns.
2. Access to Justice:
   • For plaintiffs, litigation financing provides access to justice by enabling them to pursue meritorious claims that they might not otherwise be able to afford. It levels the playing field, especially when taking on large corporations with significant resources.
3. High Potential Returns:
   • Given the high-risk nature of litigation finance, the potential returns are substantial. Investors can earn significant profits if the cases they fund succeed.
4. Risk Management through Diversification:
   • Litigation finance firms often invest in a diversified portfolio of cases across various sectors, types of litigation, and jurisdictions to mitigate the risk of losing in any one case. This diversification can make litigation finance attractive despite its high-risk nature.

Risks of Litigation Finance

1. Binary Outcomes:
   • Litigation finance is inherently risky because it has binary outcomes—either the case is won, and the funder receives a portion of the award, or the case is lost, and the funder gets nothing. This all-or-nothing risk requires careful case selection and due diligence.
2. Legal and Reputational Risks:
   • If a case is lost or dismissed, the funder loses its investment. Additionally, there may be legal or reputational risks if the funder is involved in cases that are highly publicized or controversial.
3. Long Time Horizons:
   • Litigation can take years to resolve, which means that the capital tied up in litigation finance is not liquid. Investors may need to wait several years before seeing any returns, and the outcome of the litigation is uncertain throughout the process.
4. Complexity and Costs:
   • Legal cases are complex and require deep expertise to assess the likelihood of success. Due diligence is critical, and it is necessary to evaluate the strength of the case, the capabilities of the legal team, and the merits of the claim. Additionally, litigation costs can escalate, potentially reducing returns.
5. Regulatory and Ethical Considerations:
   • Litigation finance operates in a legal gray area in some jurisdictions. Some countries may have restrictions or bans on third-party funding due to concerns about the ethical implications, conflicts of interest, or the potential for funders to exert undue influence over litigation strategies.

How Investors Participate in Litigation Finance

1. Direct Investment:
   • Some wealthy individuals, family offices, or institutional investors invest directly in specific cases or portfolios of cases through litigation finance firms or as part of a private arrangement with plaintiffs.
2. Litigation Finance Funds:
   • Investors can participate through specialized litigation finance funds managed by professional firms. These funds pool investor capital and invest in multiple cases, diversifying the risk and offering access to a broad portfolio of litigation opportunities.
3. Publicly Traded Litigation Finance Firms:
   • Some litigation finance companies are publicly traded, allowing investors to buy shares and gain exposure to litigation finance indirectly. Examples include Burford Capital and Omni Bridgeway, which are leaders in the space.

Notable Players in Litigation Finance

1. Burford Capital:
   • One of the largest litigation finance firms in the world, Burford Capital provides capital to plaintiffs, law firms, and corporations involved in commercial litigation and arbitration. They also offer portfolio financing, where they fund a group of cases for a single client.
2. Omni Bridgeway:
   • Omni Bridgeway specializes in funding disputes across the globe, including class actions, insolvencies, and international arbitration. They have offices in multiple countries and provide tailored financial solutions for litigation.
3. Bentham IMF:
   • This firm focuses on commercial litigation and arbitration, providing funding for high-value claims. Bentham IMF has been involved in many high-profile cases and offers clients financial backing as well as strategic support throughout the litigation process.

Conclusion

Litigation finance is an intriguing alternative investment for those seeking uncorrelated returns and the potential for high yields. It allows investors to gain exposure to legal cases, providing capital to plaintiffs who otherwise couldn’t afford to pursue claims. While it offers significant rewards, the risks are high, making due diligence, diversification, and a strong understanding of legal processes critical to success.