Alts Academy: Litigation finance Part 1 — Overview

Hey everyone,

Today we’re kicking off an Alts Academy series on Litigation Finance — a niche form of alternative investing that is completely uncorrelated to other markets.

On the heels of our first ​film finance deal​ going live (the most in-demand deal we’ve ever done!), we’re now preparing to bring our first litigation finance deal to ​Altea​ in the near future.

But this alternative asset class is rife with complexity and confusion. There is a huge gap between the number of people who want to invest in litigation funding deals, and those who actually understand how it all works.

So in this series, we aim to close this gap.

We’ll break down this fascinating but complex world, together with help from our friends at Homefront Group.

• Today we’ll start with a brief overview
• Next week, in part 2, we’ll explore different deal structures
• In part 3, we’ll look at the risks
• Finally, we’ll end with a deal memo on an actual deal we’re putting together which you can invest in

If you’ve ever wanted to get into this asset class but thought it was too complex, start here.

Let’s go 👇

What is litigation finance?

In many countries, the legal system is heavily weighted towards wealthy people who can afford the best lawyers.

Consider the average prices in the US for taking someone to court:

• Legal fees: ​$250 – $600/hour​ for a lawyer, depending on the state
• Court fees: $350 to file a suit, and $.50 ​per sheet of paper filed​
• Expert witness fees: Median initial retainer is ​$2,000​

The average cost of a “simple” lawsuit in the US is roughly ​$20,000​. But this can be much higher depending on the number of witnesses, the complexity of the case, etc. Complex cases which drag on can easily cost upwards of ​$50,000​.

So it can be a struggle for average citizens to even afford to bring a case to court.

This is where litigation financiers come in.

Litigation financiers cover the upfront costs in exchange for a portion of settlement winnings.

It’s a method of funding legal disputes which involves a third party providing capital to a plaintiff in exchange for a portion of the financial recovery from a lawsuit.

This arrangement allows parties to pursue legal claims they might otherwise be unable to afford, potentially leveling the playing field in David vs. Goliath scenarios.

Litigation finance is almost always used to fund plaintiffs, not defendants. The potential payouts are larger, and there is a smaller cost to losing.

Because of this, some industry groups oppose it, and feel it is unethical – akin to “ambulance chasing. However, in recent years ​defendant funding​ has risen up to the surface.

How does litigation finance work?

It’s usually easy to tell whether a financial asset is equity or debt. Investing in, say, ​​tequila​​ is owning an asset, whereas investing in something like ​​private credit​​ is holding debt.

You can think of litigation financing as a loan, but it’s actually more similar to an investable asset:

1. No collateral is involved
2. Getting litigation finance doesn’t affect the plaintiff’s credit score
3. If the lawsuit fails, the plaintiff (the one suing) typically doesn’t have to repay the investor. (“Thanks for paying my legal fees! Sorry we lost. Tough break.”)

The fact is, legal investments tend to combine features of both equity and debt.

Litigation funding agreements are often styled as “loans,” because investors are providing capital upfront that needs to be repaid. But unlike normal loans, litigation loans have no fixed interest rate or maturity date.

The process typically unfolds as follows:

1. Case evaluation: Funders assess a case’s merits, potential value, and likelihood of success.
2. Due diligence: A thorough review of all relevant documents and information related to the case.
3. Funding agreement: If the case is deemed worthy, the funder and plaintiff (or law firm) negotiate terms.
4. Funding: The agreed-upon capital is provided to cover legal expenses.
5. Case progression: The litigation proceeds, with the funder typically having no control over the case strategy.
6. Resolution: If successful, the funder receives their agreed-upon share of the proceeds.

Remember, most loans are often non-recourse, meaning the lender (investor) can’t pursue the borrower (plaintiff) for repayment if the lawsuit fails (which it often does).

This dynamic creates an incentive for investors to only fund claims that have a good chance of winning.

Types of litigation finance

The industry has evolved to offer various funding models:

1. Single-case funding: Financing for individual lawsuits. Can be ​consumer​ or ​commercial​ lawsuits.
2. Portfolio funding: Backing multiple cases for a single client or law firm.
3. Law firm funding: Providing capital directly to law firms for operational expenses or case costs. This occurs when lawyers themselves turn to investors to get funding for their own cases — something known as disbursement funding. We covered ​this unique concept​ in detail together with Fenchurch Legal.
4. Appeal funding: Supporting the appeals process post-trial.
5. Judgment enforcement funding: Assisting with the often complex process of collecting on a judgment.

The case for litigation investing

There are two big reasons we’re drawn to this world:

1) It’s big and growing

It’s expected that the investment market in litigation finance is expected to grow 6.7% between 2020–2026, eventually raking in around ​$20 billion​ per annum.

And looking at this map, it’s clear there’s room for expansion:

2) It’s uncorrelated to equities

By their nature, law settlements have essentially no correlation to equity markets.

This makes it a powerful diversification opportunity for venture capitalists, hedge funds, and institutions. (Especially these days).

Recent developments

The litigation finance industry has seen significant growth and evolution in recent years:

1. Market expansion: As of 2023, the litigation finance market was ​valued​ at approximately $18.2 billion, and it is expected to grow at a compound annual growth rate (CAGR) of 13.2%.
2. Technological integration: AI is now used to collect vast amounts of data and analyze patterns and correlations. For example, AI can identify factors that contribute to a case’s success, such as the judge’s historical rulings, the track record of the law firm involved, and specific legal arguments used.
3. Legal tech startups. Startups like ​Litigation Predictor​ offer AI-powered platforms that provide insights into the potential success of legal cases. A risk score is generated for each case, helping investors ​decide whether to invest​.
4. New products: The industry is innovating, with some funders offering litigation ​insurance products​.
5. Regulatory scrutiny: As the industry grows, it’s facing increased attention from regulators. Recently, there has been lots of scrutiny over litigation finance agreements in the UK. They have claimed if the financier is taking a % of the winnings, it could be classed as a DBA (damages-based agreement) and should be regulated by the SRA. And the Australian government conducted a ​parliamentary inquiry​ in 2020, examining the impact of litigation funding on the justice system.

Major players

Several companies have emerged as leaders in the litigation finance space:

1. ​Burford Capital​: One of the largest and most well-known litigation funders, publicly traded on NYSE and LSE.
2. ​Omni Bridgeway​: A global player with a significant presence in Australia and Europe.
3. Institutional Investors: Many hedge funds and private equity firms have entered the market. ​Elliott Management​, a well-known hedge fund, has ​participated in litigation finance​ by investing in high-profile cases, particularly in complex commercial disputes and international arbitrations.
4. Law firms: Some larger firms are starting their own litigation finance arms.

The impact of litigation finance

Proponents argue that litigation finance levels the playing field for small plaintiffs against large, well-funded defendants.

Traditionally, individuals and small businesses faced big challenges when litigating against wealthy corporations due to the significant disparity in financial resources. Litigation finance enables plaintiffs to pursue meritorious claims without the burden of prohibitive legal costs.

It also helps mitigate the risk for plaintiffs. By transferring some or all of the financial risk to the funder, plaintiffs are protected from the potential financial ruin that could result from losing. This empowers plaintiffs to confidently pursue claims, knowing that their personal financial well-being isn’t at stake.

But this asset class can be contentious. Allowing people who are completely unrelated to a legal claim to share in the winnings makes some people deeply uncomfortable. And critics raise concerns about the potential for increased frivolous litigation and conflicts of interest.

And there’s some justification to this argument – the law should be based on the pursuit of justice and truth, rather than profit.

And you know what? That’s exactly why litigation finance needs to exist.

Letting investors bankroll plaintiffs allows cases to be decided based on their virtues in court. The alternative is for such cases to never be brought in the first place! (or to end early thanks to rapidly mounting legal bills)

One thing is for sure: litigation finance is a fundamental shift in how legal disputes are funded and pursued.

That’s it for part 1 of this series.

Next week, in part 2 we’ll dive into the nitty-gritty of deal structures. We’ll explore what these deals look like, how they’re structured, and what types of deals you should expect to encounter in this world.

As ever, if you have any questions, just smash the reply button.

See you next time, Wyatt