Welcome to Deep Dives, where we explore interesting companies in the alt investment space.
Last Sunday we looked at the complex world of Litigation Finance. The sponsor of that issue was a firm called Fenchurch Legal, and today we’re going to analyze their unique offering & strategy.
What I find interesting about Fenchurch is how they’re two steps ahead of the market. Most investors — even alternative ones — are just starting to wrap their heads around the idea of financing court cases.
But the founders of Fenchurch, Louisa and Matt, understand this world to such a degree that they’ve carved a unique niche out of thin air.
In this issue we’ll show you why Fenchuch stands apart from the rest. (TL;DR: They discovered a way to get paid the exact same amount on each case — win or lose.)
The legal world can be dry, but what Fenchurch has done is fascinating. And don’t worry — we’ll make everything easy to understand.
Note: This issue is sponsored by Fenchurch Legal. Join our fireside chat this Friday to chat with Louisa and Matt live.
Let’s go 👇
Table of Contents
Join our fireside chat this Friday 🔥
This Friday, Nov 3, we’re hosting a webinar fireside chat with Louisa Klouda and Matt Haycox, founders of the subject of today’s deep dive: Fenchurch Legal.
This isn’t a long, boring presentation. It’s an interactive AMA chat with two litigation finance experts. Ask questions, and learn about the smarter way to invest in this space.
You’ll learn:
- The pros & cons of “normal” litigation finance
- How to mitigate risk in litigation finance
- A smarter way to invest in this space (that nobody is talking about)
- How to get simple, fixed-income returns
What is litigation finance?
Quick recap:
- Litigation finance is when an investor pays for the legal expenses of a plaintiff in exchange for a cut of the winnings. (This is a genuine problem as many plaintiffs cannot afford legal fees.)
- It’s not all high-profile cases. Many of these are boring, procedural cases, where due diligence is less of a barrier. (This is key to Fenchurch’s strategy)
- As an investor, you can bankroll plaintiffs directly, but you can also bankroll the law firm taking the case to court.
- This asset class has high returns and essentially no correlation to any other markets.
- Over the past 10 years, regulations have loosened, and the industry has exploded (it’s now a $39 billion industry)
This all sounds great in theory, but in practice the industry is full of complex, nuanced problems.
Lucrative, expensive, and risky
It’s all or nothing
When you’re investing in stocks, it’s pretty rare to lose all your money.
Sure, some stocks can be extremely volatile. But unless you’re investing in a company that’s near-death (ahem, Bed Bath & Beyond), you probably won’t see its share price fall to near zero.
Investing in a lawsuit, though, is pretty much all or nothing. If the lawsuit is successful, you can win big. If not, you can lose everything, period.
That’s partly due to the binary nature of lawsuits, which have a winner and a loser. But it’s also because litigation finance investments are most often non-recourse. That means the investor can’t pursue the funded party for repayment from other assets.
This has strong parallels to unsecured lending in debt markets. Secured lending means there’s some sort of collateral backing up your loan in the event that the initial repayment plan doesn’t work out. Unsecured lending, in contrast, offers no backup plan.
This makes litigation finance investments very risky.
Lawsuits can drag on for ages
Evaluating between two bonds is straightforward. You have the interest rate and the maturity date for each bond upfront. Simple math.
But evaluating between two competing lawsuits is far more complicated. Yes, you can look at historical cases (precedent) and estimate the potential winnings. But there are no guarantees! It’s basically a form of sophisticated betting.
Oh, and don’t forget that lawsuits don’t have a set end date. If a case goes in an unexpected direction (or if the other side uses delaying tactics) the case can drag out far longer than anticipated.
Yep, defendant lawyers can file unnecessary motions and make excessive discovery requests in an attempt to delay the case.
(Note: Forcing a case to go on longer than necessary in order to increase the burden of the opposing party is known as “prolonging litigation” or “litigation abuse.” Courts may impose sanctions or penalties on the party responsible for the abuse.)
But that’s for a judge to decide. And in the meantime, if you’re financing the case, every second that passes is costing you money.
Expensive cases make diversification nearly impossible
In most asset classes, risks such as these would be minimized by diversifying funding across a bunch of different investments. But in litigation finance, that’s not common.
Why not? Because it’s very expensive!
To fund the average commercial case, you need $3 million dollars.
Funding even a single commercial lawsuit is out of reach for all but the wealthiest investors. Sure, investors could pool their money together to achieve sufficient diversification. But litigation finance funds are mostly all private — typically risk-taking hedge funds that are tough to get access to.
Okay, what about small-ticket cases?
Yep, that’s an option. Average funding amounts for small-ticket consumer claims are in the thousands of dollars, rather than millions.
But funding consumer cases comes with its own set of problems. Finding them, vetting them, etc. To make any real money in this world, you need to play the volume game.
You need to partner with an entity that sees these types of cases all the time. You need to partner with a law firm.
This is exactly what Fenchurch Legal does — they don’t lend to consumers, they lend to law firms.
How Fenchurch got started
Louisa Klouda has deep experience in the lending market. She was running brokering and dealing desk at a London wealth management firm, when she identified a significant gap in the litigation finance market.
What Louisa realized is that law firms needed operational capital to handle all their small consumer cases, but no one was lending to them.
See, most litigation finance firms take the same classic approach; funding flashy, big-ticket claims and passing all the risk along to investors. But Fenchurch discovered a unique way to get exposure to this market without the risk. They did this through something called law firm disbursements.
Why Fenchurch lends directly to law firms
Disbursements are a very specific type of financing arrangement, where Fenchurch lends law firms money to pay for third-party, pre-litigation expenses. This stuff like expert witness testimony and court fees.
To keep things simple, Fenchurch only funds disbursements associated with small-ticket consumer cases. These are mostly boring, procedural cases. By avoiding the high-ticket market, they can achieve a much greater level of diversification, meaning performance isn’t dependent on the success of any one case.
Law firms often take consumer cases on a “contingency basis.” That means they don’t charge upfront, and only get paid if they win the case.
But before and during the trial, expenses still need to be paid. Deep-pocketed law firms have no problem paying for these expenses directly, but this is a burden for smaller players. Without special financing, these firms would have to wait for existing cases to conclude so they could recoup their initial outlay, before starting any new ones.
Why don’t these small firms turn to banks?
I suppose they could? But this area isn’t exactly to traditional bank lending. The amount of funding needed for any one case can be limited, and law firms turn over these consumer cases quite frequently. The flexibility smaller law firms need is more than banks can offer.
This is the opportunity for Fenchurch. They lend directly to smaller law firms that have the expertise and staff needed to take on consumer cases, but just need the funding to cover expenses.
Another thing Fenchurch does differently is that they only fund pre-litigation expenses. (This is different than almost every other form of litigation finance.)
Why? Because repayment from law firms is far less dependent on trial outcome! The vast majority of cases that Fenchurch funds are quickly settled anyways. But it doesn’t actually matter if a case drags on — those expenses aren’t Fenchurch’s responsibility.
But what really sets Fenchurch apart from the rest of the industry, is that their returns are wholly independent of how each case is decided!
This is worth repeating, since it solves one of the fundamental problems with litigation finance. When Fenchurch funds a case, they get paid the exact same amount — win or lose.
They achieve this through something called ATE Insurance.
Insuring every single case
When you undertake a lawsuit, there’s always a chance that the court won’t rule in your favor (or that the recovery won’t be sufficient to recoup your expenses.)
But did you know you can buy insurance against this possibility?
That’s what an ATE insurance policy gives you.
ATE stands for “after the event,” and like all insurance, you’ll have to pay a premium for this.
- If the case turns out well, then the premium is just a cost of doing business.
- But if the case goes against you (or the winnings aren’t as high as you anticipated) then the insurance policy kicks in. The insurance company pays you back for the costs of litigation (or the difference between the costs and the winnings.)
Pretty neat, right?
Fenchurch secures an ATE insurance policy on every case they back. If the law firm wins the case, then Fenchurch’s loan gets repaid from the winnings. But if the law firm loses the case, Fenchurch still gets paid back — only this time by the insurance company.
It’s basically a giant hedge against the possibility of losing cases – they pay a bit extra upfront to completely eliminate litigation finance’s all-or-nothing nature.
What a cool idea 👏
How Fenchurch works
As you can see, Fenchurch’s business model is distinct from other litigation funders. ATE insurance effectively transforms their loans into secured litigation financing.
Their process can have a lot of moving parts. To understand Fenchurch’s approach more deeply, let’s look at the mechanics, from the perspective of both investors and law firms.
For investors
To fund their revolving portfolio of law firm loans, Fenchurch raises money from outside investors. They pool this with some of their own retained earnings, direct from Fenchurch’s balance sheet, to ensure they have some “skin in the game.”
Most investments in litigation finance come with terms that mirror the underlying lawsuits — an uncertain return over an unknown length of time. Fenchurch has opted instead for a fixed-income structure.
They can do this because of the high volume of small-ticket claims they’re funding. Since the loans get repaid on an ongoing basis, Fenchurch itself can continually distribute interest to investors, rather than needing to wait for a big lawsuit to settle.
As Fenchurch is repaid on the maturing loans in its portfolio, interest payments flow through to investors on a quarterly basis. At maturity, investors have their principal balance repaid in full.
In fact, the best way to understand Fenchurch isn’t necessarily through the lens of litigation finance. Instead, Fenchurch’s model looks very similar to factoring (also known as invoice discounting.)
Viewed this way, Fenchurch is buying the rights to a company’s future receivables. By operating in the underserved market of litigation finance, however, Fenchurch can still generate an attractive return for investors.
For law firms
For law firms, borrowing from Fenchurch follows a step-by-step process for each case.
Step 1: Law firm takes on consumer case
- The process starts when a plaintiff lodges a consumer claim with a law firm.
- The law firm evaluates the case
- if it’s viable, agrees to take it on a “no win no fee” basis (i.e., contingency)
Step 2: Fenchurch evaluates the law firm
Fenchurch performs extensive due diligence on the law firms they choose to partner with and lend to. They analyze financial statements, understand their operating history and economic strengths.
They also evaluate the law firm’s legal performance to date, to ensure they have a history of winning the cases they take on.
Step 3: Fenchurch evaluates the case for funding
Fenchurch only backs specific case types. In particular, they target consumer cases with strong precedents backing them.
Currently, the biggest part of Fenchurch’s claim book are financial mis-selling (where consumers were harmed by deceptive or fraudulent practices when entering a financial agreement) and housing disrepair (where plaintiffs sue landlords for not addressing inadequate living conditions).
Firms take these cases all the time, and have a particularly high success rate with them.
Moreover, Fenchurch only backs small-ticket cases, ensuring they don’t risk too much capital on one suit. The average claim value for approved cases is in the range of £10k – £25k.
Step 4: Fenchurch buys the ATE insurance policy
Once Fenchurch has decided to fund the case, they secure an ATE insurance policy.
Again, this insurance policy requires an upfront premium paid directly to the insurer, but means Fenchurch will get repaid even if things don’t go according to plan.
Step 5: Fenchurch makes the loan and retains the interest
With the ATE insurance policy is in place, Fenchurch extends the loan to the law firm. Interest on the loan is deducted upfront, in what’s known as a “discount loan” structure.
As the law firm incurs expenses associated with litigating the case, they can draw down the loan facility to pay for them. Fenchurch’s average loan is small compared to other litigation financiers, with the average range between £3 – £6k, a reflection of the specific market they’re targeting.
While the case is ongoing, Fenchurch performs ongoing due diligence to make sure things are going according to plan. The loan agreements contain stipulations that the law firm must provide regular updates, and software makes it simple for Fenchurch to track the loan’s financial position.
Step 6: The case concludes and Fenchurch is repaid (no matter what)
Once the case concludes, the balance of the loan comes due. Usually these cases end with a settlement, but some do go to trial.
If the case has settled or been successful in court, winnings from the case are used to repay the loan. If the case has been unsuccessful, then the insurance policy pays out instead.
How to invest in Fenchurch
Right now, Fenchurch is offering investors the opportunity to participate in their unique approach to litigation funding.
Here’s a brief summary of the terms:
- Note options: 2-year note at 11% annual interest, 3-year note at 12% annual interest
- Distribution schedule: Quarterly interest
- Minimum investment: $25k
- International Investors: Accepted
To date, Fenchurch has already lent more than £31.3 million to law firms, with £8.5 million in principal already repaid and £10.3 million in interest already earned.
Want to learn more?
Louisa and Matt have carved out a fascinating niche in an under-served market. And you can chat with them live.
If you’re interested in hearing more, you can get it directly from them!
We’re going live on Friday, Nov 3 at 2pm EST.
You’ll hear more about how Fenchurch’s approach to litigation finance is making waves, resulting in simple, stable, and high-yielding opportunities. Ask questions directly and learn the right way to invest in litigation finance.
Register here to reserve your spot.
Can’t make the webinar?
No problem. Register anyways and I’ll send you the recording.
If you have questions for Louisa and Matt, just reply to this email and I’ll introduce you.
Disclosures
- This issue was sponsored by Fenchuch Legal
- Neither the author nor our ALTS 1 Fund holds any interest in any companies mentioned in this issue
- This issue contains no affiliate links
This issue is a sponsored deep dive, meaning Alts has been paid to write an independent analysis of Fenchurch Legal. Fenchurch Legal has agreed to offer an unconstrained look at its business, offerings, and operations. Fenchurch Legal is also a sponsor of Alts, but our research is neutral and unbiased. This should not be considered financial, legal, tax, or investment advice, but rather an independent analysis to help readers make their own investment decisions. All opinions expressed here are ours, and ours alone. We hope you find it informative and fair.
