Litigation Funding: An Increasingly Popular Investment Vehicle

As US equity markets enter their 10th consecutive year of growth, countercyclical assets and those whose performance is not correlated to other market cycles are increasingly in demand. The over-the-counter area of ​​third-party litigation funding seems to fall into the latter category.

An emerging investment sector, worth billions

Most forms of litigation funding were historically prohibited in common law jurisdictions, under the torts of “maintenance” and “champerty”. These torts are now more strictly enforced in many jurisdictions, creating an opportunity for carefully crafted litigation funding arrangements. As a result, the litigation funding industry has grown tremendously, especially over the past two decades, where it has grown into a global industry worth billions.

The need for third-party funding is rooted in the growing size and complexity of litigation. As contingency fee agreements become less viable for law firms and proceedings take longer to resolve, clients with legitimate claims are often faced with an immediate need for resources to support their lawsuits. An influx of capital from a litigation funding provider can make a difference and enable a party to pursue its case.

Global leaders in this space, such as Bentham MFI and Burford Capital, have promoted their value to the companies and businesses they fund in a variety of ways, including promoting their funding as a way to de-risk their balance sheets or accelerating growth by freeing up capital tied up in ongoing business.

Law firms are also becoming increasingly familiar with this resource. Last year, more than a third of U.S. law firms used litigation funding — more than triple the percentage from four years ago, according to the 2017 Litigation Funding Survey led by Burford. Funding is usually provided on the plaintiff’s side, although defendants sometimes use funding to cover their legal costs as well.

Why invest in litigation funding?

From an economic perspective, litigation funding is attractive to investors for two reasons:

  1. It is not correlated to market cycles. This means that it provides protection against a potential economic downturn, as litigation does not follow changes in monetary policy or financial markets. It could even be inversely correlated to the state of the financial markets, if litigation increases during a recession, in particular due to a higher number of insolvencies.
  2. It offers high return, at potentially lower risk. Litigation funding often offers double-digit returns, a relatively high return for an investment class that typically carries less risk due to the high number of settlements.

In the early days of litigation funding, investors were primarily global banks, but have since been overtaken by alternative asset managers such as hedge funds and special situation investors. Asset managers typically fund commercial litigation, but are increasingly providing funds to litigate so-called “mass crimes”. These are consumer class actions involving large numbers of plaintiffs who have suffered personal injury from consumer products, drugs or medical devices.

Recently, commercial funders have made larger investments in broad business portfolios, as opposed to individual lawsuits. Among litigants who received third-party funding in 2017, nearly 40% used the capital received to finance portfolios containing several files. Some providers, like Burford, dedicate the majority of their capital commitments to portfolios. Another key sign of the commodification of litigation funding is its burgeoning secondary market: Because litigation can take years to resolve, funders sometimes exit their positions by selling their stake in ongoing litigation.

State of play: strong investor demand despite new regulatory review

The growth of the litigation funding industry and increased focus on consumer litigation has led to greater scrutiny from state and federal regulators, as well as the legal ethics community. The New York Bar Ethics Committee issued a opinion which cautioned against funding agreements directly between a lawyer and funder tied to specific future legal fees, as such agreements could violate long-standing prohibitions on sharing fees with non-lawyers. Meanwhile, at least 12 states have passed laws regulating some aspect of litigation funding. For example, Wisconsin requires all litigation funding agreements must be disclosed.

Despite increasing regulatory scrutiny, the litigation funding industry is estimated to be around $10 billion in the United States alone. Alternative asset managers are increasingly invading this area, as around 30 funds have been created in the past two years to invest in litigation. These new funds have raised more than $2 billion.

This growing sector has the potential to level the playing field in the courts by allowing complainants easier access to the court system. More competition and more regulation in this area will likely provide more choice and better protection for litigants in the years to come, while investors will have a range of options to diversify their portfolios.

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