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Valuing Indemnity Protection Investment Returns in Litigation Finance

February 12, 2020

Valuing Indemnity Protection Investment Returns in Litigation Finance

The following article is part of an ongoing column titled ‘Investor Insights.’  Brought to you by Ed Truant, founder and content manager of Slingshot Capital, ‘Investor Insights’ will provide thoughtful and engaging perspectives on all aspects of investing in litigation finance.  Executive Summary
  • Indemnities are not costless instruments; they are akin to securities options, but without a stated option value
  • Approaches to determining cost of indemnity include: Probability weighted outcome approach, Opportunity Cost Approach and Approach based on empirical evidence
  • Implications for Portfolio Returns are that improper assessment of indemnity returns may materially skew return results of a portfolio
Investor Insights
o   Indemnities have a cost and their cost should be used to determine investor returnso   Depending on how indemnity performance is measured, it has the ability to skew portfolio performance
Some litigation finance providers offer a product called indemnity protection (please don’t call it insurance), which is a product designed to protect plaintiffs against adverse costs in certain jurisdictions (Canada, Australia and the UK, for example) where the plaintiff may be found liable for defense costs should the defendant win the case.  Indemnity protection is prevalent in product class action and securities class action cases. What makes indemnity protection challenging is the process of estimating the returns inherent to providing the protection.  Indemnities differ from traditional litigation finance, in that the latter requires the funder to finance hard costs (legal counsel, court costs, expert witness costs, etc.), while the former only pays out once a case is lost by the plaintiff, and subject to the court’s determination regarding the application of adverse costs.  In the event the plaintiff is successful, the indemnity provider shares in the contingent proceeds and is not liable for any payout. However, in the event the defendant is successful, the indemnity provider must pay the indemnity amount and forego any prospective proceeds.  In a normal rate of return calculation, the numerator (i.e. gains or proceeds) and denominator (dollars deployed to finance costs) help determine a Return on Invested Capital (“ROIC”) or Multiple of Invested Capital (“MOIC”). However, with indemnities there is no denominator; in the event the plaintiff wins the case and hence there is no “cost”. Or is there? I think most people in finance would argue strongly, and rightly so, that there is indeed a cost.  I liken the analysis to that of a securities option.  In the context of a securities option (a put or call option, for example) one pays an upfront amount (i.e. the option price) to attain the right to benefit in either the reduction or increase in the underlying stock price.  The value of the option is based on the market’s view of the weighted average probability of the event taking place (i.e. achieving the strike price in a given period of time). In the case of an indemnity, there is no cost to providing the indemnity (other than out of-pocket contracting costs) even though the opportunity has value to the indemnity provider.  The value of the indemnity for the investor is inherent in the pay-out they expect to receive on success, which is offset by the likelihood of having to pay out under the indemnity.  Essentially, it is a costless option.  The upside produces infinite returns, while the downside produces a total loss. Approaches to Valuing the Indemnity Protection As we all know, nothing is “costless”. Instead, I would suggest that an investor in an indemnity needs to determine a theoretical cost for that investment. One approach is to look at the litigation funder’s underwriting report and economic analysis to determine the probabilities associated with various negative outcomes pertaining to the case, and probability-weight the negative outcomes to determine a theoretical cost of capital. Of course, these need to be looked at in the context of the risks of the various case types in the relevant jurisdiction, in addition to the risks of the case through the various stages of the case, as adverse costs can have multiple pay-out points throughout the case.  As an example, securities class actions in Australia and Canada, when certified by a court, have an extremely high success rate (meaning that they typically settle quickly after the certification). Another approach might be to look at the alternative to utilizing that same capital in an investment with a similar risk profile, where the potential outcome could be the same and the risk of loss is similar.  As an example, if the opportunity cost of providing an indemnity was to buy a securities option with a similar risk profile, then you could use the market cost of the option as a proxy for the cost of the indemnity. Yet another alternative would be to study the outcomes of a large sample of identical indemnities to try and determine the probability of a negative outcome and apply it to the indemnity amount to determine a notional cost.  Unfortunately, much of this information remains in the private domain, as most cases which use indemnity protection tend to settle.  In time, it may be that there is sufficient data to make this approach realistic, but as it stands, there is insufficient data to make this a viable alternative. While approaches will differ by fund manager and investor, the important point is to eschew the concept that an indemnity is a costless financial instrument, as to do so would skew the results inherent in a fund manager’s track record where indemnities are an important part of their strategy.  This same result can also occur in more traditional litigation finance cases where there is a settlement shortly after the funding contract has been entered into, and which did not necessitate the drawing of capital.  In this case, the returns are also infinite, but perhaps there should have been a theoretical cost of capital based on the probability of the funding contract being drawn upon. Investor Insights: When assessing the rates of return on an indemnity, my approach is to determine a weighted average probability of loss outcomes and apply them to the Indemnity amount in order to determine a notional cost for the indemnity.  This analysis becomes extremely important when assessing portfolio performance because most often fund managers do not assign a notional cost to their indemnities when providing their investment track records, and hence positive indemnity outcomes make their overall portfolio performance seem more impressive than one might otherwise assess.  A simplified example of the potential for an indemnity to skew portfolio performance based on approach is as follows: Assumptions: Case Type:                             Security Class Action Indemnity Amount:             $1,000,000 Damage Claim:                      $10,000,000 Contingent Interest:              10% Contingent Interest Award:  $1,000,000 Probability of Loss                $ Loss* Loss at Summary Judgement:                  10%                     $100,000 Loss at Certification:                                   5%                       $50,000 Loss at Trial:                                                 25%                     $250,000 Notional Cost of Indemnity:                                                  $400,000 * calculated as probability of loss multiplied by Indemnity Amount.
  1. Return Calculation applying a theoretical cost to the Indemnity in a win scenario:
ROIC: =       $600,000 ($1,000,0000-$400,000) = 150% $400,000 MOIC:                  $1,000,000 = 2.5 $400,000
  1. Return Calculation applying no cost to the indemnity in a win scenario:
MOIC & ROIC:          $1,000,000 = Infinite $0 Edward Truant is the founder of Slingshot Capital Inc. and an investor in the consumer and commercial litigation finance industry. Slingshot’s blog posts can be accessed at www.slingshotcap.com.

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Litigation Finance Faces Regulatory, MSO, and Insurance Crossroads in 2026

By John Freund |

The litigation finance industry, now estimated at roughly $16.1 billion, is heading into 2026 amid growing uncertainty over regulation, capital structures, and its relationship with adjacent industries. After several years of rapid growth and heightened scrutiny, market participants are increasingly focused on how these pressures may reshape the sector.

Bloomberg Law identifies four central questions likely to define the industry’s near-term future. One of the most closely watched issues is whether federal regulation will finally materialize in a meaningful way. Legislative proposals have ranged from restricting foreign sovereign capital in U.S. litigation to taxing litigation finance returns. While several initiatives surfaced in 2025, political gridlock and election year dynamics raise doubts about whether comprehensive federal action will advance in the near term, leaving the industry operating within a patchwork of existing rules.

Another major development is the expansion of alternative investment structures, particularly the growing use of management services organizations. MSOs allow third party investors to own or finance non legal aspects of law firm operations, offering a potential pathway for deeper capital integration without directly violating attorney ownership rules. Interest in these models has increased among both litigation funders and large law firms, signaling a broader shift in how legal services may be financed and managed.

The industry is also watching the outcome of several high profile disputes that could have outsized implications for funders. Long running, multibillion dollar cases involving sovereign defendants continue to test assumptions about risk, duration, and appellate exposure in funded matters.

Finally, tensions with the insurance industry remain unresolved. Insurers have intensified efforts to link litigation funding to rising claim costs and are exploring policy mechanisms that would require disclosure of third party funding arrangements.

Taken together, these dynamics suggest that 2026 could be a defining year for litigation finance, as evolving regulation, new capital models, and external pushback shape the industry’s next phase of development.

Commercial Regulatory Issues

Liability Insurers Push Disclosure Requirements Targeting Litigation Funding

By John Freund |

Commercial liability insurers are escalating their long-running dispute with the litigation funding industry by introducing policy language that could require insured companies to disclose third-party funding arrangements. The move reflects mounting concern among insurers that litigation finance is contributing to rising claim costs and reshaping litigation dynamics in ways carriers struggle to underwrite or control.

An article in Bloomberg Law reports that the Insurance Services Office, a Verisk Analytics unit that develops standard insurance policy language, has drafted an optional provision that would compel policyholders to reveal whether litigation funders or law firms with a financial stake are backing claims against insured defendants. While adoption of the provision would be voluntary, insurers could begin incorporating it into commercial liability policies as early as 2026.

The proposed disclosure requirement is part of a broader push by insurers to gain greater visibility into litigation funding arrangements, which they argue can encourage more aggressive claims strategies and higher settlement demands, particularly in mass tort and complex commercial litigation. Insurers have increasingly linked these trends to what they describe as social inflation, a term used to capture rising jury awards and litigation costs that outpace economic inflation.

For policyholders, the new language could introduce additional compliance obligations and strategic considerations. Companies that rely on litigation funding, whether directly or through counterparties, may be forced to weigh the benefits of financing against potential coverage implications.

Litigation funders and law firms are watching developments closely. Funding agreements are typically treated as confidential, and mandatory disclosure to insurers could raise concerns about privilege, work product protections, and competitive sensitivity. At the same time, insurers have been criticized for opposing litigation finance while also exploring their own litigation-related investment products, highlighting tensions within the market.

If widely adopted, insurer-driven disclosure requirements could represent a meaningful shift in how litigation funding intersects with insurance. The development underscores the growing influence of insurers in shaping transparency expectations and suggests that litigation funders may increasingly find themselves drawn into coverage debates that extend well beyond the courtroom.

Case Developments Commercial

Diamond McCarthy Backs Lansdowne Oil Treaty Claim Against Ireland

By John Freund |

US-based litigation funder Diamond McCarthy has agreed to back a high-stakes investment treaty claim brought by Lansdowne Oil and Gas against the Irish state, with the claim reportedly valued at up to $100 million. The dispute arises from Ireland’s policy shift away from offshore oil and gas development, which Lansdowne argues has effectively wiped out the value of its investment in the Barryroe offshore oil field.

According to NewsFile, Lansdowne Oil and Gas, a small exploration company listed in London and Dublin, is pursuing arbitration against Ireland under the Energy Charter Treaty. The company alleges that Ireland’s 2021 decision to halt new licences for offshore oil and gas exploration, followed by regulatory actions affecting existing projects, breached treaty protections afforded to foreign investors. Lansdowne contends that these measures frustrated legitimate expectations and amounted to unfair and inequitable treatment under international law.

Diamond McCarthy’s involvement brings significant financial firepower to a claim that would otherwise be difficult for a junior energy company to pursue. The funder will cover legal and arbitration costs in exchange for a share of any recovery, allowing Lansdowne to advance the case without bearing the full financial risk. The arbitration is expected to be conducted under international investment dispute mechanisms, with proceedings likely to take several years.

Ireland has previously defended its policy changes as part of a broader climate strategy aimed at reducing fossil fuel dependence and meeting emissions targets. Government representatives have indicated that the state will robustly contest the claim, arguing that the measures were lawful, proportionate, and applied in the public interest. Ireland is also in the process of withdrawing from the Energy Charter Treaty, although existing investments may remain protected for a period under sunset provisions.