A media roundtable staged in the London office of law firm Macfarlanes this week drew attention to both the opportunities and challenges associated with litigation finance, a fast-growing corner of the private debt universe.
Typically placed in the speciality finance bracket, litigation finance involves third parties unconnected to the litigation bankrolling the legal fees of a court case. If the case is successful, the funder is paid from the proceeds; if unsuccessful, the funder will not obtain any return on its investment.
There are two main reasons why litigation finance has become highly popular. One is the possibility of private equity-like returns of 20 percent or more – not to be sniffed at in today’s environment. Two is that it is a highly distinctive area of investment that fits well with portfolio diversification objectives.
As a result, strong growth is being experienced. In its early days, funders would typically only back single cases. These days, more and more funders are taking a portfolio approach – backing multiple cases and putting a larger quantum of capital to work as a result. Other ways are also being found to deploy capital, including lending directly to law firms to enable them to fund cases and build their books, as well as financing spinouts from law firms where start-up capital is required to establish litigation finance boutiques.
According to Macfarlanes’ litigation finance specialists, there is very significant appetite from investors with deep pockets including large asset managers, high-net-worth individuals and sovereign wealth funds. They noted that, three or four years ago, single cases proceeding through London’s High Court would involve financing of up to £5 million ($6.0 million; €5.9 million); today, that figure has risen to around £40 million. While the published worth of the UK litigation finance market overall is £2 billion-£2.5 billion, Macfarlanes believes this is only the tip of the iceberg in reality.
The legal cases being financed range through the likes of competition cases, fraud and insolvency, divorces, intellectual property claims and professional negligence. An interesting area that is also seeing growth is the secondary market, where a case needs more capital than that provided by the original funder to proceed further – where that original funder declines further involvement, a different financier may then step in.
While this growth speaks to a market in rude health, there are a couple of reasons for caution. One is the prospect of greater regulatory scrutiny. It was back in 2009 that light-touch regulation was first introduced to the UK’s litigation finance market. Part of this was the formation of an industry association with a voluntary code of conduct. But there is a question mark over whether simply asking financiers to adhere to a code of conduct provides investors with sufficient comfort. No one is expecting a heavy hand anytime soon – but nor can the status quo be taken for granted.
The other aspect worth considering is the degree of risk an investor is prepared to tolerate. As mentioned earlier, a failed case means no return – but, in addition to that, could also mean paying at least some of the costs of the other party. While litigation financiers are keen to stress that they will only take on the most winnable cases, the Macfarlanes lawyers pointed out that there’s no such thing as a slam dunk. And you also have the “judge variable” to take into account – the possibility that a given judge will come to an unexpected verdict.
A betting person would probably predict further strong growth for the litigation finance market. But it’s worth bearing in mind that a bet is precisely what predicting legal outcomes boils down to.
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