Cormac Leech on Litigation Funding as an Investment

One of the day two panels at the 7th Annual LF Dealmakers event was titled "Structuring Win-Win Deals". Michael Kelley, Partner at Parker Poe moderated a discussion between Joseph Dunn, Managing Director at Fortress Investment Group, Adam Hudes, Partner at Vinson & Elkins, Sarah Johnson, Head of Litigation Investing team at D.E. Shaw & Co., and Ryan Stephen, Co-Founder of Pine Valley Capital Partners.

The conversation began around structuring deals for alignment and success. Sarah Johnson noted that it's difficult to achieve perfect alignment, but pricing deals with 'good scenarios' in mind can ensure that all parties are satisfied. Of course, deals are bespoke, so this is very difficult. Which is why D.E. Shaw models out scenarios and walks through them with the client - what is a good settlement, what is a satisfactory damages amount? Ensuring that all parties are all on the same page, which goes into the documentation so all parties can agree to the terms upfront.

Ryan Stephen noted that at Pine Valley they are more law firm focused. They operate like a credit shop, in that they protect downside vs. focus on upside. They look at their capital as a de-risking tool, which means there can be a misalignment if the law firm thinks that value must be proven right away so capital can get out the door. They look to ensure alignment with both the plaintiff and the law firm, such that we're on a similar page in terms of what's a good outcome and what's an outcome that we would not accept. Also understanding of what the law firm needs from an operational perspective. The lender wants to continuously be de-risked, but there is a blind spot there, if the lender de-risks too quickly and the law firm doesn't have the resources need to effectively try their cases. So we need to get on the same page regarding operational budgets.

Michael Kelley then brought up the extrinsic factor of time, to which Ryan Stephen agreed that time is the risk that everyone is dealing with in the space. It is difficult to know what defendants are thinking, how plaintiffs will respond and behave. Getting on the same page regarding a variety of outcomes is key. Lawyers, by necessity, are eternal optimists. Everything is high value and coming very soon. Most capital providers know that is just not how it plays out, because you need to make sure that in those edge scenarios the law firms need to be safe, and the capital providers need to be safe as well.

Adam Hudes then spoke to red flags around non-alignment. He pointed to less-than clear exit terms, referencing the Burford / Sysco dispute as a scenario they want to stay away from. When dealing with a funder that can't clarify exit terms at the outset, that is something that his firm walks away from. From a law firm perspective, cases seem to be never-ending, so law firms are increasingly calculate how can we best manage the duration of these cases, and they want funders to understand that and work with them. If a funder is too pushy, that is another red flag. If they're not willing to truly partner with the law firm, then they should probably part ways early.

Michael Kelley asked about the risk of migration of terms, from the time that the term sheet is proposed. Joseph Dunn answered that it depends on the counter party. In this asset class there isn't a one-size-fits-all process for doing deals. There's less of a market, there's less data, there's fewer intermediaries who have seen that exact deal happen 20 times and here's how it's done. So that lends itself to parties re-cutting terms more frequently than in other asset classes. The likelihood of that happening is driven as much by personalities than it is the economics of a deal.

Dunn added: "I've probably never done a transaction where we agreed with the counter party on the value of the financing. So I think it's more about calling the counter party's BS vs. simply structuring the assets. When we structure deals, we ask the counter party what their view of success is. Usually we disagree with that, and we explain that's more of a homerun, and then propose a more downside scenario. If both sides blindly accept the upside case, then you're not keeping people aligned on the downside."