Litigation Funding: Is Financing Justice An Attractive Investment Opportunity?
Used to fund everything from high-value divorce settlements to corporate software theft, litigation funding can be a win-win scenario for investors, plaintiffs, and law firms. Paying someone else’s legal fees in return for a cut of the damages is a fast-growing new investment opportunity that promises high returns as well as the satisfaction of helping less-affluent plaintiffs to pursue justice.
What Is Litigation Funding?
In simple terms, litigation funding is the practice of financing third-party legal cases. The funds are used to cover the high costs of litigation. In return investors get a predetermined cut of any damages that are awarded, which can either be a fixed fee, a percentage of the award or settlement, or a combination of the two.
It’s also a way for plaintiffs who wouldn’t otherwise be able to afford to bring a case to court to get access to justice. “Many now see a claim as a potentially valuable asset, rather than viewing litigation as an evil to be avoided,” Justice Natalie Hudson wrote last year when the Minnesota Supreme Court abolished the state’s ban on litigation funding. “It is also possible that litigation financing, like the contingency fee, may increase access to justice for both individuals and organizations.”1
Since investors only usually receive a return when damages are awarded, litigation funders select only the most promising claims which have a high chance of success. The vast majority of litigation finance firms don’t get involved with the prosecution, they just manage the funding and due diligence of selecting high potential claims. They’re often staffed by former litigators who know the legal system inside out and can handle the complexities of structuring the deal with the attorney and plaintiff.
Why Now?
Before 2008 litigation funding was mostly restricted to specialized firms providing loans for small commercial or personal injury cases. Litigation funding has exploded over the last decade or so, largely due to the reduced liquidity options after the 2008 global financial crisis. More recently, the emergence of litigation platforms like LexShares has helped broaden the market beyond just specialized funders and institutional investors to include retail investors.
According to Jay Greenberg, the founder of the LexShares litigation funding platform, there are now more than 30 commercial litigation funding companies, up from just 6 before 2008. This reflects the growth in cases requiring alternative funding solutions and the desire for plaintiffs to try to spread and reduce their risk with regards to litigation costs. Just like during the 2008 crisis, the COVID-19 also seems to have accelerated growth for litigation funding, with 59% of litigation funders reporting having more business in 2021 than before the pandemic began.2
Key Players
Due to the risks involved, litigation funding is restricted to accredited investors. To qualify, investors need to have either an annual income of $200,000 and up, a net worth of over $1 million, or specific financial professional credentials. Most choose to work with dedicated firms rather than go it alone due to the high level of legal expertise and extensive legwork required.
LexShares enables accredited investors to invest in individual commercial cases through their platform, with a minimum investment threshold of $50,000. The company claims to scour more than 1,000 cases per day using their Diamond Mine software to select promising opportunities. Another option is the LexShares Marketplace Fund II which was launched in June last year and has a minimum threshold of $250,000. In total they claim to have funded over 130 cases, over 50 of which have been resolved.
AxiaFunder is a similar platform based in the UK. So far they claim to have raised £2.2 million to fully fund 14 cases. Six of these have been successfully resolved, with the remaining eight still progressing.
LitiCapital is a pioneering Swiss private equity company which has merged litigation funding with blockchain technology.
There’s also the option to invest indirectly by buying stock in publicly-listed companies like Burford Capital which specializes in corporate litigation funding.
What To Know Before You Invest
Let’s run through the main pros and cons of litigation funding for the individual investor:
A Growing Market: The litigation funding market is still relatively young, which means there’s still potential for high returns and rapid growth. The total US litigation market is estimated to be worth around $200 billion, but litigation funding accounts for just 2-3% of the total.3 A recent report by Research Nester has forecast that the global litigation funding market will hit $24 billion by 2028, up from $11 billion in 2019.4 Evidence suggests law firms are warming up to this alternative funding method, with the Bloomberg Law Litigation Finance Survey 2021 finding that 69% of lawyers are more likely to seek funding now than they were five years ago.5
Uncorrelated To Capital Markets: Litigation funding can be a way to diversify your portfolio since it has very low correlation with traditional assets like equities and bonds. Given current concerns around inflation and the ongoing pandemic, litigation funding could be used as part of a hedging strategy.
Promising returns: Returns can be high compared with other alternative assets. For example, the UK-based AxiaFunder claims a current IRR of 48% across their successfully-resolved cases while in 2020 LexShares reported a median IRR of 52%.
Short Investment Cycles: Compared with other alternative investments, litigation funding tends to offer shorter cycles. In the case of LexShares, the median duration of their resolved investments is 15 months.
Greater Certainty: Ultimately, litigation financing has just two possible outcomes. Either damages are awarded and the investor earns their return, or the legal claim is unsuccessful. Rather than having to wait around for an IPO or sale of a private company, investors have greater certainty on how the investment will be realised.
No win, no fee: On the flip side, investors need to be aware in most cases they’ll only receive a return in the event of a successful outcome. These types of transactions are usually structured as non-recourse equity investments rather than loans. Consider that new information might emerge that could result in the case being dropped. In this case no damages would be awarded, and investors would typically lose most if not all of their investment. There’s also the possibility that the defendants would be unable to pay up in the case of a sudden drop in their net worth. It’s a good idea to diversify across multiple cases and other asset classes as well to spread risk and increase your chances of success.
No regulation: Litigation funding is not currently regulated at federal level in the US, with individual states instead choosing to prevent the practice or require plaintiffs to disclose their use of third-party funding. Generally speaking, most states permit litigation funding without significant limitations.
Final Thoughts
High returns and growing demand for alternative sources of funding make litigation funding an attractive option both for the big institutional players as well as smaller individual investors. But it’s important to remember that success is not guaranteed, and investors need to spread their risk to cushion the blow of a significant loss should a case fall through.
Disclosure: All opinions expressed herein constitute the author’s judgement as of the date of this article and are subject to change without notice. Statements made are not facts, including statements regarding trends, market conditions and the experience or expertise of the author are based on current expectations, estimates, opinions and/or beliefs. Such statements are not facts and involve known and unknown risks, uncertainties and other factors. Past events and trends do not predict or guarantee or indicate future events or results.
https://news.bloomberglaw.com/business-and-practice/minnesota-supreme-court-abolishes-champerty-prohibition
https://news.bloomberglaw.com/bloomberg-law-analysis/analysis-lit-finance-complexities-opportunities-on-the-rise
https://www.marketwatch.com/press-release/global-litigation-funding-investment-market-size-value-competitive-landscape-industry-outlook-and-forecast-till-2028-2021-09-23?tesla=y