By: Padraic Lau and Waleed Khalid
Even with the rise of different alternative asset classes, litigation financing as an investment vehicle has been minimally covered. This little-known asset class has outperformed the likes of private equity, real estate, credit and hedge funds on a multiple of invested capital basis. Before we analyze returns, it’s a good idea to understand what litigation financing is and how the asset class works. Litigation financing is an investment vehicle where a pool of capital is raised to provide upfront funds to plaintiffs and for defendants that generally cannot afford the cost of legal disputes or settling for a share of damages. Cheque sizes vary with the size of the fund and the number of cases underwritten; however, most funders look for major cases with costs in the millions.
Cheques are written on a non-recourse basis (aka one-time upfront cash) to pay for the legal costs during the life of the case. If the case is successfully won, the funder would be entitled to the initial capital plus a share of the proceeds from the case (usually from damages and settlement claims/awards). If the case is lost, however, then the invested capital is often seen as a 100% loss and written off assuming no cash can be recouped from a smaller settlement. These terms are usually governed by a Litigation Funding Agreement (LFA) contract. The cash is often used at the discretion of the litigants for: lawyer fees, appeal costs, and court and documentation fees.
For litigation funds, the challenge lies in case selection. Cases with low risk, quick settlements and discrete outcomes are the most promising investments. Although purely anecdotal, class action lawsuits have seen the lion’s share of cheques written. Simply put, a class-action lawsuit groups multiple plaintiffs together who all have the agenda against the defendant. Class action suits are often subject to larger payouts and a higher likelihood of settlement compared to single-plaintiff cases.
Similar to risks, returns in litigation finance are spread across a spectrum of investment sub-sectors including commercial, personal injury and tort law. Similar to risks, returns in litigation finance are spread across a spectrum of investment sub-sectors including commercial, personal injury and tort law. Similar to risks, returns in litigation finance are spread across a spectrum of investment sub-sectors including commercial, personal injury and tort law.
Litigation finance is a growing alternative asset class that provides unique exposure to opportunities - completely uncorrelated to markets. Since 2008, litigation finance has grown while yielding promising returns with an increasing number of private funds deploying capital. As the asset class becomes more sophisticated and developed, it is possible that returns diminish from current levels as competition for investment opportunities increases in addition to more data points and information becoming streamlined or readily available. Overall, litigation finance can provide exposure to a niche area of investing while also supporting access to justice - serving the needs of both investors, and plaintiffs.