By Elliot Wilson | December 14, 2020
This article was first published on the Euromoney website
Nick Rowles-Davies has been called a few things in his career, but the one that comes directly to mind involves a throwaway line by a member of the Fourth Estate.
“I was once described by a journalist as being a ‘pinstriped ambulance chaser’,” he says. “I took exception to that. I have never owned a pinstriped suit.”
The choice of insult makes sense once you know what he does. Rowles-Davies, a cheery Englishman, is the executive vice-chairman of Sydney-based LCM Finance, one of the world’s oldest litigation finance companies.
Also known as litigation funding, it is an uncorrelated asset class that’s been around for a few decades, growing at a steady pace without ever quite catching fire. But given what it offers – outsized returns at a time of super-low yields on judiciously placed investments – is this its moment in the sun?
At its heart, litigation finance is the process of investing in or buying up – both terms work just as well – outstanding legal claims, then working to profit from them through settlement out of court or adjudication in it. Hence the ‘ambulance chaser’ jibe.
LCM Finance describes the asset class as a process of a funder paying the legal fees of one party (often but not always the plaintiff), including court and solicitors’ fees and the cost of independent experts, then taking a share of any proceeds.
At first glance, it looks no different to any other investment product.
Litigation itself, says Christopher Bogart, chief executive and co-founder of Burford Capital, which employs 125 legal and finance experts in four continents, is “just a process of moving money from one person to another. Just like any receivable, it has value.”
Yet it is an industry that has taken time to find its feet. It didn’t really exist until a group of pioneering Australian firms (including LCM Finance, founded 1998) spotted its potential in the 1990s.
It took root in the UK and Europe in the wake of the global financial crisis, before expanding over the last five years.
At first, the original pioneers mostly worked on one-off cases, helping corporates to get the risk and cost associated with a specific lawsuit off their books. Others focused their attention on class-action lawsuits.
It is intellectually rewarding work. Many love it.
Timothy Mayer, senior investment officer at London based Therium Capital, has been a lawyer since 1997 and a part of the industry since 2012.
“I still come at it from a single-case approach,” he says, adding: “That means I’m old-school.”
Single-case litigation funding can be hugely profitable.
“If I look at my own portfolio of cases, most of the big returns come from individual cases,” Mayer adds.
But it has its risks. It is, notes Rowles-Davies at LCM Finance, “the most expensive of its kind, as it is a lot of work and cases are binary win/loss scenarios”.
The industry took a big step forward in 2005, thanks to a case called Arkin v Borchard Lines. The UK Court of Appeal ruled against the claimant, Arkin, but capped its costs at the point where its backer, a now-defunct firm called Managers & Processors of Claims, had first financed the case.
The ‘Arkin cap’, as it is known, gave litigation funders the legal cover and financial security they needed. If a case was settled in their favour, they would profit, perhaps handsomely. If they lost, the loss – a key and volatile source of risk – was capped.
And so the industry grew. New names such as Omni Bridgeway, listed on the Australian Stock Exchange, and Burford, whose shares trade in London and New York, sprang up.
It is hard to put a precise figure on the industry’s value. Omni Bridgeway, which merged with IMF Bentham in November 2019, puts its global worth at $85 billion.
Boston-based litigation funder LexShares puts the value of the US market at $9.5 billion, against $5 billion a decade ago.
Marc Syz, founder of Syz Capital, a Switzerland-based boutique investor that works with high net-worth families across private equity, private debt and real estate, puts its value, including hidden capital allocations in hedge funds, at $10 billion to $20 billion. He tips it to be worth up to $35 billion within five years.
The sector is growing fastest in common law markets, notably the UK and US, but also in Europe.
“We have funded in 14 different jurisdictions,” notes Ellora MacPherson, chief investment officer at Harbour Litigation Funding, which started out in the UK before expanding to Australia, Hong Kong and New Zealand. “In time, we saw increasing opportunities in jurisdictions like Spain and Germany, and Brazil’s commercial arbitration market is also really interesting for us.”
Those enjoying the fruits of the market have the labours of a few driven innovators to thank.
Twenty years ago, Burford Capital’s Bogart was working in New York as general counsel of Time Warner, then the world’s largest media company.
His employer had “lots of money but wanted to spend it not on lawyers, but on making movies and music”.
He adds: “It was always very difficult to allocate capital to fund the cases we needed to defend or pursue.”
Too often, firms struggled to grasp the financial ramifications of litigation.
If, say, Company A spends $10 million on a case, wins and earns $100 million, it is good news. But as it is nonrecurring income, there’s no lasting impact on its market value.
Bogart describes this as “a self-destroying value proposition”.
A lack of visible upside wedded to a fear of losing a case, leads in-house legal teams to “avoid litigation even when they could and should be actively pursuing it”.
For years, he helped friends to fund legal cases on a hobby basis, watching as the asset class took shape.
In 2009, he put his money on the table and set up Burford, which describes itself as “the largest direct balance sheet investor and the largest investment manager in litigation funding”.
There are plenty of these stories to go around. The industry is rife with specialists who want the best for it, and proclaim to all concerned the financial benefits of outsourcing litigation to experts who can fund it properly.
Each litigation funder is unique in its own way, says Harbour’s MacPherson.
“You have different types of structures: funds, multi-asset managers, credit funds, all doing something slightly different. We began with single-case funding.”
Some work on a case-by-case basis, pursuing lawsuits they believe they can win. Others, including Harbour, LCM and Burford, invest in a portfolio of cases.
There are two benefits to this approach.
First, it lets a funder move capital between better or bigger cases, to focus on those it deems more timely or likely to succeed. Second, it limits the downside.
“Besides the importance of having a diversified portfolio, people are realising there is much lower risk to this industry than other asset classes,” says Syz Capital’s Syz.
It is a hugely entrepreneurial asset class – which might explain why it attracts some rather interesting characters. As it grows, leading players are finding novel ways to drum up new business.
Again, there’s no right way to go about it.
Some litigation funders co-invest in cases with law firms they know well, from smaller specialists to the biggest in London, New York and Frankfurt.
“Ten years ago, when we talked to law firms as generators of cases, most were very sceptical,” notes Harbour’s MacPherson.
While there is “much work still to be done” in educating the legal professions about the benefits of outsourcing, she adds, most law firms are willing to ask “for facilities to support clients and their demands”.
Another option is to buy into or to join forces with a law firm keen to explore and expand the market.
In August 2020, LCM Finance unveiled Aldersgate Funding, a new £150 million ($200 million) fund it owns with international law firm DLA Piper. It will focus on large-scale litigation and arbitration brought by DLA’s big corporate and financial clients.
A month after that, Therium Capital and a Liverpool-based boutique called Provenio Litigation launched a £50 million fund focused on business-to-business claims, including financial and economic delinquencies caused by the pandemic.
This kind of investment is growing in popularity and for good reason. It gives the litigation funder access to a far larger pool of active cases it can view first-hand, giving it a jump on its competition.
Some like to buy clusters of cases direct from large corporates keen to get them off their books.
“We have a multinational aviation firm with a 42-case portfolio spanning the US, Europe and the Middle East,” says LCM Finance’s Rowles-Davies. “We also have a 25-case, $40 million investment with a multinational construction firm, and another seven-case portfolio that covers Europe and the Gulf.”
He says some industries are more likely to embrace the asset class, such as construction, aviation and oil and gas.
“They are high-volume, low-margin businesses, so taking out the legal stuff makes a big difference to” their earnings.
“Over time you become like a consigliere to companies,” he adds. “They come to you to ask whether to put a case into a portfolio or not.”
What else do litigation funders look for in legal cases, and what do investors want? Beyond the obvious answer – returns – lies plenty of complexity.
For the funder, there’s clearly no need to invest in a case you don’t want or believe in.
To Syz Capital, which invests in consort with its ultra-high net-worth clients, the “return on a single case needs to be [a multiple of] at least three times on our invested cost,” says Syz.
But there are no guarantees of success.
“Everyone wants an easy win – there just aren’t many out there,” says Rowles-Davies. “There will always be risk – litigation is not straightforward and you can win bad cases and lose good ones.
Harbour’s MacPherson adds: “I‘d love to say we only fund dead-certs, but that’s not how it works. There are often a lot of dynamics.”
Funders rely on the fact that most litigation is resolved out of court.
“You see a lot of people suing each other but not many cases going to trial,” says Burford Capital’s Bogart. “That’s key as it removes the risk from the underlying sentiment.”
There’s a trade-off here. Go to court, triumph, and you can win big. Lose and you walk away with nothing but a fistful of legal bills. Again, it is binary.
Settlements in the claimant’s favour typically generate lower returns. It is an asset class built on settlement, not adjudication.
But you can’t always guarantee a desired outcome. Life, particularly the legal life, does not work that way.
It could be that one party in a battle – an airline, for example, suing a financial adviser it accuses of offering bad foreign exchange advice – just doesn’t want to settle.
If that carrier is your client, it is vital to know their desired outcome far in advance.
“You want an incentivised client who is going to take a fair return rather than ploughing ahead in court,” says Rowles-Davies.
There are ‘can’t-win’ cases that swing your way, and dead-certs that don’t.
“The only thing I have control of is the purse strings,” says Therium Capital’s Mayer. “With the best will in the world, you will lose some cases even if they are well-lawyered.”
For all litigation funders, the most valuable work takes place before day one, when it decides if a case is worth pursuing.
“You look straight to the back end, at where damages are going to come from if the claim succeeds,” says Mayer.
A key factor beyond ‘will you win’ is to know your client, starting with the law firm spearheading the case.
“Is it a firm that’s done this kind of work before,” asks Mayer. “Do they have a good reputation, and do the economics of the case work?
“When investing in a claim, you need to be satisfied that the level of damages will make sense for both the claimants and our investors.”
Therium funds a lot of international arbitration with nation states. Some are straightforward; others are strewn with tiger traps.
“You might think: ‘I can win this case against a sovereign, which is a great headline – but will I get anything out of them and over what period? Collection is very important,” he adds. “Or you have a firm engaged in fraud but it has offshore vehicles, so do they contain real assets or are they just shell companies?”
‘Does a case stack up’ is another question litigation funders ask all the time. After all, it is their money – and their shareholders’ – on the line.
Many err on the side of caution.
“I never put up a case to my investment committee where I reckon there’s a good chance we will lose, but that if we do win it will be a big one,” says Mayer.
LCM Finance’s Rowles-Davies approaches each new case with a well-worn tick-list.
Among other questions, he asks: “Does a case add up? How will a person perform in court and will they be believed? We have turned down cases where we took the view that a witness would not come across well in court.
“With some cases, you just get a feeling,” he adds. “I’ve turned down cases on gut feeling and people laugh at that, but if your gut says no, you are going to struggle.”
It is also an asset class that attracts sophisticated investors – a mix of hedge funds, institutional money and sovereign wealth money, with endowments starting to get in on the act.
They like the returns on offer, and many like to know the specifics of a case. They don’t attend court, so they want to know they trust the funders they back, their legal team and the claimant.
Over the last two years, Harvard University has committed capital to two separate $500 million funds raised by IMF Bentham, prior to its merger with Omni Bridgeway.
One focuses on US legal cases; the other to plaintiffs in other developed markets.
“Some very high-profile US universities are funding some of our cases,” says Syz. “[W]e are seeing more of that kind of money coming into the market.”
Investors, says Harbour’s MacPherson, want “a manager who is a safe pair of hands, will look after their money, and make a good return. They want to know we can underwrite, to see how we manage the underwriting, how cases come through, and how we actively manage them.”
That process can be extremely granular, making for long but useful meetings.
Notes Burford’s Bogart: “It is not an asset class where you get people showing up and plonking down a bag of money. They do serious due diligence.”
It is also not for everyone.
Mainstream banks have given litigation funding a wide berth. There are too many potential conflicts of interest with clients, plus the reputational threat of a case winding up in court and getting messy.
“Hedge funds aren’t there yet,” adds Rowles-Davies, “but they will get it, they are bright guys.”
What everyone wants, given the glaring lack of yield-generating investment ideas in the world, are returns.
In June 2020, LexShares closed its second litigation fund, LexShares Market Place Fund II, raising $100 million, and opened the books on its finances.
It revealed that the average US civil lawsuit takes 27 months from filing to disposition. That correlates to LCM Finance’s data, which reckons it takes on average 25 to 27 months from investment in a single case to completion.
LexShares highlighted a whistleblower lawsuit, Jennifer Perez v Stericycle. The plaintiff accused Stericycle, an Illinois based medical waste company, of overbilling government to the tune of $13.6 million. Stericycle settled for $28.5 million, generating a return on investment of 93% for LexShares.
The company has invested in 103 cases since its creation in 2014, of which 43 are concluded, with the rest pending. It puts the median internal rate of return at 52%.
LCM Finance posted a net profit profit of A$8.05 million ($5.92 million) in the 12 months to the end of June 2020, a year-on-year fall of 12.8%.
Burford Capital posted a pre-tax profit of $197.9 million in the first six months of 2020, down 15% year on year, due in part to the Covid-enforced closure of law courts early in the year.
That kind of financial uncertainty will always be there – some cases take longer than others but are worth the wait. Besides litigation funding marches to its own tune. It is unconnected to events in the outside world, which can work to its benefit.
“This asset class is truly uncorrelated from financial markets, so we really like it,” says Syz Capital’s Syz.
Burford’s Bogart says: “Investment returns stemming from litigation outcomes are not related to market or economic conditions.”
It is clear that litigation funding is here to stay. Many corporates see it as a valid and valuable way to get costly litigation off their books. Law firms like its double-headed benefits, as more funders invest in cases and the legal industry.
More lawyers, notes Bogart, are becoming “experts at financing transactions”.
The global financial crisis gave the industry a boost; so too should Covid.
“The last five deals we scrutinised were with financial institutions looking at how to deal with delinquencies,” says LCM Finance’s Rowles-Davies. “NPLs will be a growth area for us in 2021. Banks need to know what to do. We have found a way to track down delinquent debtors in bulk, which enables us to cut costs and take less risk.”
Growth offers opportunities and challenges. Syz tips the market to continue to generate outsized returns.
“But if 10 years from now, it is a bidding market for claims, then like with private equity, the numbers will come down,” he says. “I can see that happening, where returns will fall from three-times to two-times invested capital – but that is just a function of a healthy and much larger market.”
It is also becoming a data-driven industry, as funders search for new ways to identify the best and tastiest cases.
LexShares has built its own software called Diamond Mine, which scours court dockets and flags up likely cases.
Much of this innovation is US-led, with firms able to “work out strategies down to each judge – how many cases of its nature a judge has seen, and how they have ruled,” notes Therium Capital’s Mayer.
It is an approach that bears serious financial benefits.
“I would love there to be real statistics [on] what kinds of settlements work,” says Harbour’s MacPherson. “That’s something you’d really want to overlay on a portfolio. That kind of data will be really invaluable in how you construct your portfolio. Over time, I think it will happen.”
Litigation finance will always be a risky proposition. Funders will continue to lose good cases but win bad ones. A case might be wrapped up in weeks or drag on for years. It is tough, non-repeatable work: when a case is done, you start all over again.
But the industry is evolving, getting more global and sophisticated. Each year it grows in size, unearthing cases in new markets, be it Burford leading asset recovery and enforcement against a former Soviet state, or Harbour funding a case brought by Indonesian seaweed fishermen against an Australian oil firm.
LCM’s Rowles-Davies says he and his peers are “only scratching the surface” of the asset class’s potential. “I’d like for corporates to get to the point where they go to an IT finance house for their IT leasing, to a vehicle finance house for their vehicle leasing and to us for finance when they have a legal dispute.”
By Elliot Wilson | December 14, 2020
This article was first published on the Euromoney website