This article first appeared in Hedgeweek
Third-party funding of litigation is gaining ground in the UK, but its success will depend on the degree to which the concept is embraced by both the legal profession and the investment community, and the appetite for risk and reward among both litigants and investors, according to partner Gavin Foggo (pictured) and associate Molly Ahmed from the litigation department of City law firm Fox Williams.
“For all the talk of litigation funding as an emerging asset class, investors have yet to be convinced that [third-party funding] is going to be a compelling alternative investment”. This is one of the conclusions of The New, New Thing, a study published last month on the emerging market in third-party litigation funding.
The report, commissioned by City law firm Fox Williams and undertaken by legal research company Jures, aims to “further the debate on third-party litigation funding”. It is of particular interest to the hedge fund industry since litigation is seen by some as an exciting new area of investment, particularly in a period that has seen more traditional asset classes fail to produce the required financial rewards.
Third-party funding is the provision of funding for litigation in return for a share of the proceeds. The funder, which could be an individual or corporate entity, is essentially an investor with no interest in or connection with the case other than the funds it has invested in the litigation. The funding is used to cover day-to-day legal costs, so that a case can be taken to a successful conclusion.
Because a funder’s only interest in the litigation is that it makes a profit from its investment, the cases which tend to attract funding are those that have been given a high prospect of success at trial (usually by a leading barrister) and where the litigation is of significant value. A good benchmark is that most funders will not even consider cases where the amount in dispute is less than GBP500,000, and most funders are looking for at least GBP3m.
The share of the proceeds to which the funder becomes entitled if the case is won is calculated either as a fixed percentage of the amount recovered from the losing party, or as a multiple of the funding provided.
The third-party funding market in the UK is still relatively new. This is because in the UK, historically the funding of litigation by third parties that have no interest in the dispute was held to be unlawful. However, in the last five to 10 years, the courts and legislators have had a gradual change of heart and recognised the role third-party funding could play in supporting access to justice for all.
The increasing availability of third-party funding now means a party can pursue a high value commercial claim, albeit that the funder will take a proportion of the ‘winnings’, where previously the fees of lawyers and experts would have rendered even cases with a high prospect of success too costly or risky to pursue.
This is particularly the case for small businesses and individuals. Larger companies that can afford litigation may well nevertheless opt for third-party funding where available to remove the cost of litigation from their balance sheets or to hedge their risk.
A number of funds are already active in the UK market including Harbour Litigation Funding, IM Litigation Funding, Therium, Calunius Capital and US fund Juridica, The principals behind these funds were interviewed for the Fox Williams report.
Neil Purslow of Therium identifies the attraction to investors of third-party funding as “a new area [where] potentially the return is very strong”. He highlights that litigation funding is “a completely uncorrelated asset class [and] the great thing about it is that you can have two cases and the results will not correlate with each other, let alone with the stock market or the property market or anything else in your portfolio”.
Therium itself has proven to be an exciting investment opportunity, with the City of London Group having taken a 50 per cent equity share in Therium in February. The fund is backed by high net worth individuals, who are way ahead of institutional investors in investing in third-party litigation.
Susan Dunn of Harbour considers that the economic downturn has not impeded investors’ enthusiasm for investing in litigation, arguing that due to issues of confidentiality there are more cases (including high-profile litigation) which have been funded than the market appreciates. Perhaps the attention being given to third-party funding by canny investors in the know is illustrated by the fact that Harbour recently raised a GBP60m fund.
Having entered the market as a broker, Calunius Capital now appears sufficiently confident to launch its own private fund. Chief executive Mark Wells describes the process of raising private equity funds as “reasonably protracted”, although unlike Therium, Calunius is pursuing institutional investors.
The institutional investor perspective is encapsulated by Rocco Pirozzolo, a solicitor and senior underwriter at QBE insurance group, who says: “There can’t be many investors willing to shut away millions of pounds for no return for a long stretch of time. It’s a big ask in this economic climate”. This sentiment is echoed by Richard Fields of Juridica: “[Third-party funding] is new and it is complicated, and [investors] are investing in a pretty risky asset”.
The factors that reduce the risk for investors are that funding is generally only available to cases given high prospects of success by barristers, who are conservative when assessing the chances of winning, and to cases where the defendants can meet any award made against them. Typically the ‘ideal’ defendants are insurance companies, government bodies and large publicly listed companies.
According to Dunn, Harbour funds only approximately 8 per cent of cases brought to it; the other 92 per cent do not fulfil Harbour’s criteria. The firm’s investment committee and advisory panel boasts such luminaries as former High Court judge Sir Gavin Lightman and Michael Cook, author of the leading textbook on litigation costs, which should provide investors with comfort that only sure-fire winners are backed.
The rewards can be significant. Typical returns are three or four times the initial investment or a proportion of the winnings, typically 25 to 50 per cent on a sliding scale.
Unfortunately, there are no guarantees in litigation. In the 2009 case of Stone & Rolls Limited (in Liquidation) v. Moore Stephens, the House of Lords found against Stone & Rolls, which was being funded by IM Litigation Funding.
Whilst it is estimated that IM Litigation Funding would have made more than GBP40m if Stone & Rolls had succeeded, it ended up making a loss on that particular case. However, this case was only one of its portfolio of around 10 cases, with an overall success rate of around 80 per cent.
The view of key players speaking to Fox Williams is that the legal world is changing and third-party funding is part of that change. However, its success will depend on the degree to which the concept is embraced by both the legal profession and the investment community, and the appetite for risk and reward among both litigants and investors.