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Why Litigation Finance is Suited to Public Markets

August 28, 2019

Why Litigation Finance is Suited to Public Markets

The following was contributed by Nick Rowles-Davies, Executive Vice Chairman of Litigation Capital Management (LCM). The recent and well documented attacks by activist short-seller Muddy Waters on Burford Capital have brought litigation finance into the limelight. Whilst largely focussed on Burford’s accounting methods and corporate governance, the hedge fund’s accusations have raised concerns around the practices and legitimacy of the industry more broadly. One key question raised is around whether funders should even be listed on a public market. More pointedly, why can companies with questionable governance practices, an unpredictable revenue forecast, and operating in an industry with limited access to a secondary market against which claims can be evaluated, be listed? A lot of this is down to varying levels of understanding around Burford’s accounting practices, and indeed those of the wider industry. It is important to recognise that while there are many companies operating in the growing litigation finance space, they do not all do the same thing, or account the same way and shouldn’t all be tarred with the same brush. Fair value accounting – adopted by Burford and others under IFRS 9, is not an evil. But the application of it does matter. There are differing ways of adopting fair value accounting and how it is used is ultimately a management team decision. The accounting treatment for litigation projects varies across the industry and some approaches are more reliant on subjective judgement by management teams than others. For a clear representation, fair value numbers should always be given alongside historical cash accounting figures, so investors and counterparties are able to see the underlying performance of the business. It is vital that funders are fully transparent and have numbers that can be easily verified and valued externally. In practice, this entails the development of a fair value accounting method that can be scrutinised and tested by external parties. This probably results in lower valuations than management may have reached alone. But ultimately, as we’ve seen over the past fortnight, it is prudent to be cautious and conservative. The importance of disclosure to shareholders and clients cannot be underestimated. Subject to the right application of fair value accounting, there are several significant advantages to being listed – relating to transparency, regulation and access to capital – that make it a highly appropriate model for funders. Being listed on any stock exchange ensures a level of regulation and transparency that the private markets do not. We say this with some authority having been listed on both a main market (the Australian Securities Exchange) and the Alternative Investment Market (“AIM”). Our experience has been that there is little difference in standards and accountability between the two. As a constituent of a public market, there is pressure to ensure that standards of corporate governance are upheld. Natural checks exist to hold companies to account in the form of selling investors, analysts publishing negative research, and, at the most extreme level, activists or short sellers publicly targeting companies. What’s difficult is that there is no formal regulation of the litigation finance sector, although its introduction in multiple jurisdictions is inevitable in time. It is hard to predict what form it will take, but I have no doubt that respectable funders will welcome it when it arrives, and we should do. In the meantime, our listed status provides a platform through which we can continue to meet regulatory standards. This is particularly important for firms like LCM looking to fund corporate portfolio transactions. Naturally, sophisticated corporates have stringent KYC protocols, and being listed demonstrates a level of oversight and transparency around where your capital is coming from, often in stark contrast to some. Furthermore, litigation finance is capital-intensive by its very nature and being listed provides funders with access to public sources of capital in the equity and bond markets. Equity raises provide funders with permanent capital to invest from the balance sheet, thereby avoiding any potential liquidity mismatches that might occur with some alternative fund structures. It also means investors of all types (from institutions to individuals) can gain access to the asset class’s attractive, uncorrelated returns. There will be a failure in this industry soon. This will be in large part due to the use of contingent revenues to hide loss positions, as well as funders being over reliant on one part of the market, such as single case investments. This is clearly not a sustainable business model and further illustrates the need for the considered use of fair value accounting. Recent events have been no help to the ongoing education process around the benefits of legal finance generally. It is a rude awakening that the practices of one business in our industry have raised so many questions around the governance and reporting of its peers. It will take time for the jitters to settle. In the meantime, the regulatory oversight that being a listed company provides should be seen as a positive. Nick Rowles-Davies is Executive Vice Chairman of Litigation Capital Management (LCM) and leads the company’s EMEA operations.

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Commercial

Litigation Funding Ethics: What Attorneys Must Weigh Before Saying Yes

By John Freund |

Third party litigation funding has evolved from a niche financing option into a mainstream tool for law firms seeking to manage risk and pursue complex or capital intensive cases. As funding becomes more accessible, attorneys are increasingly evaluating whether outside capital can support growth, extend runway, or enable representation of clients who might otherwise lack resources. However, the expansion of litigation finance has also brought renewed scrutiny to the ethical considerations lawyers must address before entering into funding arrangements.

An article in JD Supra outlines several critical issues attorneys should consider when evaluating third party funding. One of the most significant distinctions is between contingent funding arrangements and traditional non recourse loans. In contingent structures, funders receive a percentage of any recovery, which can raise concerns under long standing prohibitions against fee sharing with non lawyers and doctrines such as champerty. While a handful of jurisdictions have relaxed these rules, most states continue to prohibit arrangements that resemble equity participation in legal fees. Attorneys operating across jurisdictions must be particularly cautious to ensure compliance with applicable professional conduct rules.

Even traditional funding structures can present ethical challenges. Although non recourse loans are generally more widely accepted, conflicts can arise if a funder’s financial interests diverge from those of the client. For example, a lender may prefer an earlier settlement that ensures repayment, while a client may wish to pursue prolonged litigation in hopes of a larger recovery. The article emphasizes that lawyers must retain full independence in decision making and ensure that funding agreements do not give funders control over litigation strategy or settlement decisions.

Client consent and transparency are also central considerations. Attorneys should disclose funding arrangements where required, obtain informed client consent before sharing any information with funders, and remain mindful of evolving court disclosure requirements.

Announcements Case Developments Commercial

High Court Refuses BHP Permission to Appeal Landmark Mariana Liability Judgment 

By John Freund |

Pogust Goodhead welcomes the decision of Mrs Justice O’Farrell DBE refusing BHP’s application for permission to appeal the High Court’s judgment on liability in the Mariana disaster litigation. The ruling marks a major step forward in the pursuit of justice for over 620,000 Brazilian claimants affected by the worst environmental disaster in the country’s history. 

The refusal leaves the High Court’s findings undisturbed at first instance: that BHP is liable under Brazilian law for its role in the catastrophic collapse of the Fundão dam in 2015. In a landmark ruling handed down last November, the Court found the collapse was caused by BHP’s negligence, imprudence and/or lack of skill, confirmed that all claimants are in time and stated that municipalities can pursue their claims in England. 

In today’s ruling, following the consequentials hearing held last December, the court concluded that BHP’s proposed grounds of appeal have “no real prospect of success”. 

In her judgment, Mrs Justice O’Farrell stated:  “In summary, despite the clear and careful submissions of Ms Fatima KC, leading counsel for the defendants, the appeal has no real prospect of success. There is no other compelling reason for the appeal to be heard. Although the Judgment may be of interest to other parties in other jurisdictions, it is a decision on issues of Brazilian law established as fact in this jurisdiction, together with factual and expert evidence. For the above reasons, permission to appeal is refused”. 

At the December hearing, the claimants - represented by Pogust Goodhead - argued that BHP’s application was an attempt to overturn detailed findings of fact reached after an extensive five-month trial, by recasting its disagreement with the outcome as alleged procedural flaws. The claimants submitted that appellate courts do not re-try factual findings and that BHP’s approach was, in substance, an attempt to secure a retrial. 

Today’s judgment confirmed that the liability judgment involved findings of Brazilian law as fact, based on extensive expert and factual evidence, and rejected the defendants’ arguments, who now have 28 days to apply to the Court of Appeal.  

Jonathan Wheeler, Partner at Pogust Goodhead and lead of the Mariana litigation, said:  “This is a major step forward. Today’s decision reinforces the strength and robustness of the High Court’s findings and brings hundreds of thousands of claimants a step closer to redress for the immense harm they have suffered.” 

“BHP’s application for permission to appeal shows it continues to treat this as a case to be managed, not a humanitarian and environmental disaster that demands a just outcome. Every further procedural manoeuvre brings more delay, more cost and more harm for people who have already waited more than a decade for proper compensation.” 

Mônica dos Santos, a resident of Bento Rodrigues (a district in Mariana) whose house was buried by the avalanche of tailings, commented:  "This is an important victory. Ten years have passed since the crime, and more than 80 residents of Bento Rodrigues have died without receiving their new homes. Hundreds of us have not received fair compensation for what we have been through. It is unacceptable that, after so much suffering and so many lives interrupted, the company is still trying to delay the process to escape its responsibility." 

Legal costs 

The Court confirmed that the claimants were the successful party and ordered the defendants to pay 90% of the claimants’ Stage 1 Trial costs, subject to detailed assessment, and to make a £43 million payment on account. The Court also made clear that the order relates to Stage 1 Trial costs only; broader case costs will depend on the ultimate outcome of the proceedings. 

The costs award reflects the scale and complexity of the Mariana case and the way PG has conducted this litigation for more than seven years on a no-win, no-fee basis - funding an unprecedented claimant cohort and extensive client-facing infrastructure in Brazil without charging clients. This recovery is separate from any damages award and does not reduce, replace or affect the compensation clients may ultimately receive. 

Case Developments Commercial

Homebuyers Prepare Competition Claims Against Major UK Housebuilders

By John Freund |

A group of UK homebuyers is preparing to bring competition law claims against some of the country’s largest housebuilders, alleging anti competitive conduct that inflated new home prices. The prospective litigation represents another significant test of collective redress mechanisms in the UK and is expected to rely heavily on third party funding to move forward.

An announcement from Hausfeld outlines plans for claims alleging that leading residential developers exchanged commercially sensitive information and coordinated conduct in a way that restricted competition in the housing market. The proposed claims follow an investigation by the UK competition regulator, which raised concerns about how housebuilders may have shared data on pricing, sales rates, and incentives through industry platforms. According to the claimant lawyers, this conduct may have reduced competitive pressure and led to higher prices for consumers.

The claims are being framed as follow on damages actions, allowing homebuyers to rely on regulatory findings as a foundation for civil recovery. The litigation is expected to target multiple large developers and could involve tens of thousands of affected purchasers, given the scale of the UK new build market during the relevant period. While damages per claimant may be relatively modest, the aggregate exposure could be substantial.

From a procedural perspective, the case highlights the continued evolution of collective competition claims in the UK. Bringing complex, multi defendant actions on behalf of large consumer groups requires significant upfront investment, both financially and operationally. Litigation funding is therefore likely to be central, covering legal fees, expert economic analysis, and the administration required to manage large claimant cohorts.