A brief overview - Litigation Funding
“Litigation funding allows lawsuits to be decided on their merits, and not based on which party has deeper pockets or stronger appetite for protracted litigation”
Bond and stock markets both witnessed bull runs from 1980 to 2021, resulting in higher returns for investors. These strong returns have made equity valuations at historically high levels and bond yields at historically low levels, implying that expected returns are currently lower than their historical averages. As a result, the current situation presents difficulties for conventional portfolios, such as a "balanced" 60 per cent equity/40 per cent bond portfolio.
This has caused numerous investors, both institutional and retail, to
search for a variety of alternative investments, each with
its own set of risks and returns. As a result, they have dramatically increased
their allocations to alternative investments, which have significantly less
exposure to the economic cycle risk of stocks and bonds as well as the
inflation risk built into bonds. A variety of investing methods that operate
outside of conventional asset classes are referred to as alternative
investments. Litigation finance is one such quickly expanding asset class that
has recently attracted a lot of interest from investors.
Litigation Finance
Litigation finance describes transactions in which a third party lends money to one of the parties in a lawsuit (a plaintiff or legal firm) in exchange for a financial interest that is derived from the case's outcome. The success of the underlying claim, whether through a verdict or, more frequently, an out-of-court settlement between the parties, is typically a need for repayment of the financing. Commercial lawsuit finance, mass tort litigation finance, and personal litigation finance are the three segments that make up the litigation finance market.
Litigation finance is one of the classes that has profited from the influx of capital from investors seeking alternative investments due to the high returns attained and the fact that those gains have been uncorrelated to the typical securities market. Due to a lack of liquidity, and a lack of conventional structures, each investment opportunity is connected to a particular case, making it a highly specialised niche.
Structure of Litigation Funds
Typical litigation finance funds have a fixed investment term of three to four years and are organised similarly to private equity funds, with committed capital that is pulled down as it is used. There are also interval funds that offer a certain amount of quarterly liquidity along with allocations for litigation finance. In some private investment funds, in addition to making a bigger fund commitment, co-investing in individual instances is also permitted. Pricing for transactions involving litigation finance may be determined by a multiple of the capital contributed, a portion of the settlement of the underlying claim, or a mix of the two.
Origination
Inbound enquiries, attorney referrals, and outbound marketing initiatives like news releases and paid advertising in legal trade publications are just a few of the ways that cases are generated. Many cases seeking financing don't seem to engage in any kind of bidding procedure with funding companies, instead choosing to accept funding from whoever offers it first and in a decent amount of time. Any prior ties between the attorney and the funder are a significant factor that influences funder selection. As a first step, several organisations analyse databases using artificial intelligence (AI) techniques to look for new cases.
Screening Process
Before a possible case proceeds to full underwriting, the screening process that should be carried out must be carefully considered before deciding to invest in a legal case.
Funders typically search for case characteristics like:
1. Strong legal merits
2. Defendants who are financially capable of paying the claim
3. A case that will result in a legally binding judgment
4. A case in which a successful outcome will result in a substantial financial
benefit
5. A favourable damage-to-investment ratio
6. Timetable for anticipated settlement or case judgment
Underwriting
An extensive investigation of a case, including extrinsic factors like
regulatory changes that could affect a favourable recovery, is required as part
of the underwriting process. Internal underwriting teams made up of seasoned
legal professionals are common in law firms. These teams look at the supporting
material for each case and weigh potential influencing factors including
pricing, return, collectability risk, jurisdictional risk, and procedural
issues. Firms may also outsource this to outside legal experts with specialized
knowledge to review a case in addition to their in-house work.
Case Structuring
A crucial element of this phase is the investment agreement, which explicitly lays out the rights and obligations of all parties involved in litigation finance. In addition to a case budget with significant milestones, this document also provides pricing and payment terms, including the order of payment in the event that a claim is successful. Most investment agreements contain an attorney's undertaking or recognition, which is a set of obligations for the plaintiff's lawyer to follow the provisions of the investment agreement and to take some actions or refrain from taking others.
Litigation financing companies appoint case managers to negotiate the investment management agreement, oversee the case when it is resolved, and control the budget as it develops.
Risk and Rewards
The internal rate of return (IRR) for funding transactions from publicly traded
corporations suggests that they may surpass 20%. The low correlation with other
investment areas and strong returns is another factor. However, the high returns
serve to offset the huge risks involved in these cases, as the investment would
be nearly nothing if the case were to fail.
Summary
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