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Gordon Legal Exploring Funded Class Action Against Magnis Energy Technologies

Class actions representing investors who lost money due to the failings or fraudulent behaviour of corporate directors are a top target for litigation funders, with Australia being a prime jurisdiction for these claims. The appetite for these class actions has been highlighted once again as an Australian law firm has stated that it is exploring a claim, supported by litigation funding, against a battery manufacturing company. Reporting by The Australian reveals that Gordon Legal is investigating a potential class action against Magnis Energy Technologies, which would represent both current and former Magnis investors who suffered financial losses. The claim would primarily focus on Magnis’ actions from 2021 onwards, with the law firm exploring potential wrongdoing around the company’s directors ‘providing market sensitive information to shareholders, while the market remained uninformed.’ Speaking with The Australian, Andrew Grech, partner at Gordon Legal, emphasised that the law firm was “at the beginning, not the end, of our investigations,” but explained that the scope of the claim could include “the conduct of the directors, officers, and (Magnis’) auditors Hall Chadwick.” He also revealed that the firm had already made progress towards securing third-party funding for any potential claim, saying, “The discussions with funders are proceeding as we would hope and like us they want to get to all the facts and circumstances before any decision is made.”

Litigation Funders See ‘Incredible Opportunity’ in Impact Investing

Whilst there is much debate about what constitutes ESG investing and to what extent it is driven by a desire to achieve positive outcomes rather than increase financial returns, there can be no doubt that the litigation funding industry is increasingly focused on impact investments. An article in Bloomberg Law looks at the ongoing trend of litigation funders focusing their investments on cases with a positive social impact, with ESG issues at the forefront of many funders’ investment strategies. The article highlights several examples of new funders launching their businesses with an explicitly stated focus on impact investing, including the likes of Aristata Capital, Vallecito Capital, and Flashlight Capital. For Aristata Capital’s chief executive, Rob Ryan, the interest from funders in social impact cases is a clear result of the “recognition from investors that this is an incredible opportunity to generate impact and some significant returns.” Will Zerhouni, managing director at Flashlight Capital, argues that it speaks to the reason why legal professionals take on their vocation in the first place: “it wasn’t because this was the fastest way to money, but this was the fastest way to justice.” Looking at the trend from an outside perspective, Richard Wiles, president of the Center for Climate Integrity, acknowledges that whilst “hedge funds are going to bring a profit motive and will have a narrower set of cases that they’ll want to get involved in,” they can still offer a helping hand to plaintiffs who lack the financial resources to bring a claim.  Michael Gerrard, founder and faculty director at the Sabin Center for Climate Change Law, argues that the true test for the longevity of funders’ interest in social impact “is which of these cases will yield money.” Gerrard points out that, to date, “there hasn’t been a single court decision anywhere in the world awarding money damages against fossil fuel companies because of climate change.”  

An LFJ Conversation with Tanya Lansky, Managing Director of LionFish

Tanya Lansky is Managing Director of LionFish and has been working in the disputes finance and insurance industries for close to a decade. After reading law in London Tanya sought to abstain from treading the traditional legal pathways, and instead began her career at TheJudge Global, the then independent specialist broker of litigation insurance and funding. Tanya then joined boutique advisory firm Emissary Partners to leverage her relationships in the market and her economic understanding of disputes as an asset. LionFish is a London-based litigation funder offering financing solutions for litigation and arbitration risks. Founded in 2020 as a subsidiary of listed RBG Holdings Plc, the firm was acquired by funds managed by Foresight Group – the private equity firm with over £12bn AUM – in July 2023. With a core focus on efficient delivery, the firm’s transparent approach is a reflection of its corporate structure as principal investor which in turn also enables it to ensure alignment with its clients and their interests. Below is our LFJ Conversation with Ms. Lansky: Litigation finance has grown exponentially over the past decade, yet the industry is still nascent, with room for innovation and growth. What role does LionFish play in the funding industry's future growth? To-date, our market has often been compared to trends and growth of the legal industry. The reality is, we are a financial services industry which we believe should be our reference point as a market. This is why we encourage, share and apply standards that are commonplace in financial markets, which we believe will help drive further growth as well as a more robust framework with established credibility and transparency from which innovation can flourish. In this context, we frequently vocalise the drivers we believe would help further industry growth. Standardisation or documentation frameworks, as we recently wrote about in Bloomberg Law, is one such example. Another is encouraging market standard processes around the mechanics of how litigation funding agreements work, which naturally delivers greater transparency. Although the list can go on, a third is more coordination with the contingent and dispute risks insurance markets who play a central role in our market and beyond. We appreciate that we are just one of many players in the market and that this will have to be an industry-wide effort, but it must start somewhere. So, our contribution to the industry’s future growth is a starting point that encourages greater engagement and highlights the issues that we see prohibiting growth, all whilst practising the things we preach. Your website states that you are not a traditional litigation funder - how does LionFish differentiate from the competition? We are often asked by funders, insurers and lawyers to talk about “your fund” because many assume that all litigation funders are investment managers using third party capital raised from external investors. LionFish’s core business does not involve managing investor monies; we do not run a fund based on management and performance fees, but instead invest straight off our balance sheet such that if we lose, we are not losing investor monies but our own. Conversely, if we win, we keep those returns instead of paying them to investors. Greater reward but also greater risk, but critically, and in terms of how this translates to our client, this means that the decision-making sits with us and not our investors. This benefits our clients in several other ways. Firstly, we do not waste time looking at cases that may be remotely fundable but unsuitable for our portfolio. We are therefore candid, sincere and swift in our responses. Secondly, given that the decision-making sits solely within LionFish, we deal with opportunities and live investments efficiently and quickly. Thirdly, we are not investing in a defined pool of capital for fees but simply building and sustaining a profitable business. We therefore think in terms of long-term solutions that help forge long-term relationships. Perhaps most importantly though, our model allows us to invest in the £500k to £2m range that most often funders cannot do viably because of their business models. So, while we do compete for and have funded investment tickets considerably larger than £2m, our greater range of investment appetite means that we are more relevant to a wider range of lawyers than most others. How has the Foresight acquisition changed LionFish's strategy and operations? When our previous parent company, RBG Holdings Plc, announced that they were going to sell LionFish, we received significant interest in the business from multiple, differing parties. However, because of the different perspective they had on us as a business Foresight was such a natural fit. From very early on, it was very clear that Foresight recognised the strengths of our model and acknowledged that the issue was that the business was housed in the wrong structure (RBG being listed). Foresight therefore had no want to make changes to our business model but instead sought to enhance it. For example, our previously robust infrastructure became even more resilient and slick. We have also been able to assemble a new Board and panel of advisors, all of whom bring very relevant, heavy-hitting gravitas both in terms of breadth and depth of expertise and experience. So, although our strategy and USP has not changed, the operational tweaks have strengthened the business and improved the ‘user experience’ for our customers, providing them with greater confidence in working with and choosing LionFish as long-term partner. Much is being made about the recent PACCAR ruling in the UK, where the Supreme Court found that litigation funding agreements can be classified as 'DBAs', and may therefore be unenforceable under the 2013 DBA Regulations. What are your thoughts on the implications of this ruling? How impactful will this be on the funding industry in the UK going forward? Six months on from the judgment, we are pleased to see that the recognition of its damaging implications have been widespread and that there is movement and an explicit desire from the government to address it. The Post Office scandal in the UK has highlighted the value of litigation funding; at the height of its widespread media coverage, the lead claimant Alan Bates (after whom a BBC mini-series on the scandal was named) wrote a piece in the Financial Times regarding his views on reversing the PACCAR judgment given that justice would not have been served following one of the greatest domestic injustices of the 21st century to-date. This brought the consequences of the PACCAR judgment to the fore. Against this backdrop, Justice Secretary Alex Chalk MP told the Financial Times that litigation funders should be protected from the PACCAR judgment and that the Government would remedy the issue across the board at the earliest possible opportunity. The Digital Markets, Competition and Consumer bill is working its way through parliament and if it is passed into law, LFAs in opt-out competition claims (where DBAs are not permissible) will not be deemed to be DBAs (which would of course apply retrospectively). The latest Parliamentary debate surrounding the bill has been quite telling and reflective of the Lord Chancellor’s statement regards the intention to remedy what some Lords described as the “mistaken decision” and for this to be achieved across the justice system. Although the latest Parliamentary debate suggests that the bill will not go further than the CAT, Lord Offord of Garvel emphasised government’s policy to return to the pre-PACCAR position at the earliest opportunity. It is worth noting the long-term support of this point, in that as early as 2015, the Ministry of Justice has stated that LFAs should not be considered DBAs and the DBA Regulations should be clarified to reflect this. If nothing changes, the impact will continue to be damaging to the detriment of some claimants and more generally to access to justice – despite the fact that the industry would (as it has already done) adapt. That said, at the time of writing, we are encouraged by the drive and determination at the legislative and parliamentary levels to address the consequences of the PACCAR judgment. What are the key trends to watch out for as the litigation finance industry continues to evolve over the coming years? Consolidation and sophistication are probably the two key trends to watch out for. That said, the elements that drive these trends are what we think are the most interesting to watch. The first is that the institutional capital involved in the market is more experienced than ever and is sharpening in terms of appetites and investment profiles. This will inevitably continue to propel the industry forward and see it evolve in a Darwinistic way, with institutional capital focusing on the stronger players. Another, and a sign that the market is maturing, is the recognition of the various subsets of the litigation funding asset class – in the same way that real estate investing has long been recognised as a combination of many subsets of investing (e.g., residential, commercial, etc.). This is because funders are developing more targeted investment strategies. For example, the rise of law firm portfolio lending, which is very different from single case investing, appears to have driven funders to hire former bankers rather than lawyers. While some focus on group actions and mega-value claims, others focus on specialist claim types such as intellectual property or high-volume mass tort consumer claims. And, within single case investing, some are even redefining their strategies around philosophies such as ESG, or size (as we are). Fundamentally, with greater focus and specialisations, the feel of the litigation funding market will become more comparable to other established financial markets. The biggest trend-setting-element though is the increasing financial sophistication of the industry. To date, the industry has been dominated by ex-litigators but with the interplay of litigation insurance and funding, it is clear that beyond the underlying investment is a need to understand the structure it sits in. With funders increasingly hiring beyond the litigation sphere, we can only see this as a beneficial element which will allow for the market to continue evolving and maturing.
Community Spotlights
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Member Spotlight: Steven Weisbrot

Steven Weisbrot is an internationally recognised class action expert who is known for innovative data-based media and bookbuilding plans as well as class and collective action claims administration and distributions. He regularly writes and lectures on class action notice and is a widely sought out speaker to address industry conferences across the globe, as well as bar associations and private law firms, on the best methodologies to communicate with large audiences and driving them to act.

Steven is often hired for his expertise where local norms require cultural nuance or where comprehensive messaging is at the heart of case communication requirements. He is the only class action notice expert currently running notice programmes in five different European countries, in addition to the thousands of integrated notice plans that he has successfully implemented in the United States.

Steven received his J.D. degree from Rutgers University School of Law and holds a bachelor’s in Professional Writing from Rowan University.

Company Name and Description:  Angeion Group provides comprehensive settlement management services for class and collective actions, including notice, distribution and claims administration.

Company Website: www.AngeionGroup.com

Year Founded:  2014

Headquarters:  Philadelphia, PA

Areas of Focus: Class and Collective Actions including Bookbuilds, Claim Rate Estimates, Notice Programs and Distribution of Proceeds.

Member Quote: I see our role as notice and claims administrator as an essential element of providing access to justice in the truest sense of the phrase, which in large part, is what the funding mechanism is designed to do.  By notifying and then verifying claimants, we make sure that the monies are distributed to as many legitimate claimants as possible.  We also assure the justice or judge that all reasonable steps are being taken to reach claimants, which is of heightened importance in an opt-out situation since claimants will be bound by the judgment whether they see the notice of settlement or not.  We work with funders to help estimate the take up rates and redemption rate as part of their due diligence.

Using Litigation Funding for Shareholder Disputes and Claims Against Directors

As litigation funders continue to try and grow their offering for corporate entities, they are looking to engage in a wide variety of cases, such as shareholder disputes. A new blog post from a UK law firm looks at the different ways third-party funding can support both companies and shareholders to pursue meritorious claims, helping them offset costs and reduce risk. An insights post from Damian Carter and Jessica Kraja at Weightmans highlights the different use cases for litigation funding in company and shareholder disputes, examining how third-party financing can achieve successful outcomes whilst reducing risk levels. Analysing shareholder disputes, Carter and Kraja acknowledge that shareholders looking to pursue a case against the company may find it ‘difficult to find the funds personally to pay for legal costs to bring such a claim’, especially when faced with the prospect of having to pay adverse costs if the claim is unsuccessful.  Similarly, the authors highlight an example where majority shareholders may face a claim from a group of disgruntled minority shareholders, and are unable to use company funds to finance their defence. In both situations, third-party funding may provide an avenue for shareholders to cover the costs of litigation without adding to their own risk portfolio. Carter and Kraja also raise the possibility of companies wanting to bring claims against directors who breach their fiduciary duties, thereby creating a dispute that the company’s legal department may not have accounted for in their budget and planning. Once again, litigation funding can enable the company to pursue such a claim against a director, without further straining internal legal costs. The article also highlights Weightmans’ own all-in-one litigation funding solution: Enable. The firm’s litigation funding service provides clients with a streamlined process for securing outside financing for their disputes, with Weightmans bringing together the funder, insurer, and broker, to craft a bespoke funding solution. The Enable service aims to complete the funding and insurance process within 18-21 days, and includes a review of the funding terms by a specialist broker to ensure the client receives a competitive offer.

Judgement Preservation Insurance in the Spotlight in Health Insurers’ Dispute with Quinn Emanuel

Alongside the growth of the litigation finance market, the proliferation of litigation insurance services has also experienced its own boom through the provision of a variety of policies, including after the event and judgement preservation insurance. A new court order in a dispute between a law firm and its clients over fees may now shed some light on the world of litigation insurance, which has as similar a reputation for limited transparency as litigation funding. An article in Bloomberg Law covers a new development in the dispute between Quinn Emanuel Urquhart & Sullivan and the health insurers which it represented in a case brought against the federal government over unfulfilled payments under Obamacare. The law firm has been ordered to disclose its judgement preservation insurance (JPI) policy documents, which it obtained on its $185 million fee to represent the insurers. Last year, an appeals court overturned the nine-figure fee and then ordered a federal court to recalculate the fee. US District Judge Kathryn Davis ordered Quinn Emanuel to hand over the details of the JPI policy, after the insurers argued that it was necessary to ensure they would receive an equitable payment if the recalculation of the fee resulted in a reduced amount.  Explaining her reasoning for ordering Quinn Emanuel to hand over the policy documents, Judge Davis said that “the JPI’s terms may be relevant to the court’s task on remand if the policy provisions are inconsistent with the court’s objective ‘to ensure an overall fee that is fair for counsel and equitable within the class.’”

Portfolio Funding for Law Firms in the Energy Sector

Whilst single case funding remains the bedrock of the litigation finance market, portfolio funding for law firms has continued to grow in popularity, thanks to its ability to offer a source of capital that can be deployed in a variety of ways. A new article suggests that the energy sector may be a prime candidate for the expansion of portfolio funding. In a guest editorial for the February issue of Inside Energy, Peter Petyt, CEO of 4 Rivers Services, examines the opportunities for third-party dispute funding in the energy sector. In particular, Petyt focuses on the opportunities for law firms who specialise in energy litigation, and how portfolio funding can be used to enhance their offerings to clients across the sector. Petyt provides a detailed overview of the different aspects of portfolio funding, explaining how law firms can use the capital in different ways: ‘to pay the (often significant) disbursements of a case (including court and arbitration fees, experts, e-disclosure etc); and potentially to fund other initiatives such as acquisitions, recruitment, marketing and IT.’ Petyt goes on to highlight that the portfolio funding model ‘allows for the law firm to draw capital more flexibly than in a single case funding scenario’, and has the benefit of avoiding ‘much of the often complex and torturous nature of single-case funding.’ Petyt points out that for law firms assessing energy sector claims with a variety of strength and viability, portfolio funding can enable the law firm to pursue some of these less sure claims as ‘the funder’s return is collateralised by all cases within the funder’s portfolio.’ He also draws specific focus to the current state of the energy sector, noting that ‘increased globalisation of the energy sector has made dispute avoidance and resolution strategies increasingly important for mitigating risk’. In this environment, third-party portfolio funding can allow law firms to offer their energy clients bespoke fee solutions that maximise positive litigation opportunities whilst downsizing their risk profile.

CFLF Announces Relaunch of Campaign to Reform Consumer Lawsuit Lending 

Consumers for Fair Legal Funding (CFLF) — a coalition of community groups, social justice organizations, and business interests across New York — today announced the relaunch of its push for commonsense reform of the unregulated and predatory lawsuit lending industry.  The coalition’s founding members have been joined by two of the best-known ride-hailing companies — Uber and Lyft. Uber is the nation’s largest insurance consumer and is committed to ensuring both affordable coverage and safety for drivers and riders alike.  “Uber drivers operate in every corner of the state and are critical to helping New Yorkers get around, while also playing an important role in supporting the local economy,” said Hayley Prim, Senior Policy Manager at Uber. “The unchecked lawsuit lending industry is driving insurance costs up, consuming an ever-larger share of fares, and making it harder for drivers to earn a living. Lawmakers need to establish some simple rules to reign in lenders and protect hardworking individuals statewide.”  “Steadily rising insurance costs are the biggest hurdle to keeping rides affordable and paying drivers more,” said Megan Sirjane-Samples, Director of Public Policy at Lyft. “If we can curb — or better yet, reduce — these costs, the savings are going to go directly back into drivers’ pockets and help lower fares. Without putting in place some commonsense regulations, the lawsuit lending industry will continue to boom, and consumers and hardworking New Yorkers will pay the price.”  Over the past decade, lawsuit lending — also known as third-party litigation funding, litigation financing, or car accident loans — has grown into a multibillion-dollar global industry, with lenders funded by deep-pocketed hedge funds and foreign interests. A 2022 study found that increased litigation, fueled by unchecked and unregulated lawsuit lending, contributes to rising insurance costs. That’s something New York, with the nation’s second-highest average insurance premiums, can’t afford.  CFLF was launched in 2022 to push for lawsuit lending reform that would preserve an important funding stream for vulnerable individuals in need of funds — often to cover medical bills or living expenses as they await the outcome of legal action — while protecting them from unscrupulous lenders. CFLF supports both an interest rate cap on lawsuit loans and transparency in the lawsuit lending process to expose conflicts of interest and create a level playing field for all.  Unbanked and underbanked individuals — frequently members of communities of color — are often targeted by lenders who promise them fast cash by borrowing against expected legal settlements. With no limit on interest rate caps, lenders can charge up to 100 percent — or more — and borrowers can end up owing most or all of their eventual settlement or jury award to a lender, ending up with very little of their settlement or even in debt.  “If the governor and lawmakers are truly committed to a robust and equitable consumer protection agenda this session, they will pass lawsuit lending reform,” said the Rev. Kirsten John Foy, faith leader and founder of CFLF member Arc of Justice, who is himself a lawsuit lending victim. “At a time when New Yorkers are struggling and the state faces a budget deficit, this issue is an easy way to protect vulnerable individuals — at no additional cost to the taxpayers.”  Lawsuit lending firms are expanding in New York — one of the four most attractive states for those looking to invest in the industry. Unprincipled lenders have been known to pursue anyone without a financial safety net, even taking advantage of unhoused and wrongly convicted New Yorkers.  To learn more about CFLF and efforts to enact commonsense reforms on lawsuit lending, visit https://fairlegalfunding.org/.

Gross v. Net Return Dispersion in Commercial Litigation Finance

The following is an article contributed by Ed Truant, founder of Slingshot Capital, Executive Summary
  • Gross v. Net return dispersion needs to be considered by investors & fund managers
  • While present in many private equity classes, managers that can limit dispersion can attract more capital for a given return profile
  • Wide dispersion prevents many institutional investors from considering investing in the asset class
Slingshot Insights:
  • Fund performance reporting can help address the appearance of wide dispersion in gross to net returns
  • The valuation of litigation assets is very difficult due to a combination of idiosyncratic case risk and binary outcome risk
  • Fund managers need to ensure that they are obtaining returns on their undrawn capital to reflect the opportunity cost of undrawn capital
In my recent set of articles, I discussed the concept of managing duration risk as this is often a topic that comes up in conversation with institutional investors.  The other topic that invariably comes up in discussions is the common case of wide dispersion between gross and net returns in commercial litigation finance (this is not typically an issue within consumer litigation finance).  It’s a problem that is somewhat unavoidable and somewhat explainable! I have been privy to fund manager returns that start off with cases that have gross internal rates of return in the hundreds to thousands of percent range that ultimately turn into negative IRRs at the fund level (albeit in the first few years of the fund) – hence the gross v. net return dispersion dilemma.  The problem with this dynamic for fund managers is that it undermines the entire investment thesis because it leaves the investor wondering how such a high performing strategy at the case level ultimately yields low net returns at the fund level as the same does not necessarily hold true for many other alternative asset classes.  In turn, this dissuades investors from investing in the asset class because the return profile does not match the risk profile or, in other words, they can either get better returns for the same risk profile or commensurate returns with a lower risk profile, so why invest in commercial litigation finance? Let’s start with the basics. The term ‘gross’ typically refers to the raw return of a given investment or portfolio of investments.  Simply, this is the rate of return that was produced on the realization of the investment (i.e. money received) for a given dollar of investment (i.e. money invested or drawn), whether expressed as a Multiple of Invested Capital (“MOIC”) or as an Internal Rate of Return (“IRR”) before considering any of the costs of the manager (management fees, expenses or carried interest) or the investment vehicle (administrative costs for legal, audit and reporting) (collectively, the “Costs”).  It is very common for commercial litigation finance managers to refer to the gross returns of their realized cases and these, sometimes sexy, returns have been used to generate interest in the asset class and the manager, but it may not all be as it seems. Conversely, most other private equity asset classes (Leveraged Buy Out (“LBO”), Venture Capital (“VC”), Private Credit, Real Estate, etc.) refer to the valuation of their entire portfolio when they refer to gross returns.  The problem with referring to returns that stem from only the realized portion of the portfolio in commercial litigation finance is that it is often the case that the early cases produce strong IRRs and few losses which means that they represent an overly optimistic view relative to the reality of the entire portfolio. Investors can expect that a typical commercial litigation finance fund will ultimately have a few losses (20-40%) and a few cases with longer durations, depending on the nature of its strategy, both of which have a significant negative impact on the portfolio’s overall return profile. The challenge that litigation finance has when valuing its entire portfolio is that it is extreme difficulty to establish credible valuations (so called ‘fair value’ or ‘mark-to-market’ valuations) for the unrealized portion of their portfolio.  Other private equity asset classes have the benefit of being able to point to well defined and accepted valuation methodologies and metrics (Enterprise Value (EV) / Earnings Before Interest Taxes & Amortization (EBITA) in the case of LBO and multiples of Annual Recurring Revenue (ARR) in the cases of ‘Software-as-a-Service” VC investments).  These well-defined and accepted metrics allow managers to publish credible fair value estimates on a quarterly basis and, while not perfect, the investor can then adjust the valuations based on their perspective on market valuations as the industry metrics are fairly transparent and available.  The same cannot be said for litigation finance investments as each case has its own idiosyncratic characteristics and risks and each dispute has its own unique resolution, which are two variables that I would argue are virtually impossible to value with any accuracy.  I will agree though that it may be possible to come up with a reasonable estimate of the value of a portfolio of investments but to estimate a single case with reasonable accuracy is nearly impossible.  Further, any portfolio estimate would only be possible if the portfolio was relatively diversified and had a number of equal weighted investments which is also nearly impossible to create due to single case deployment risk. Portfolios of cross-collateralized law firm portfolios or corporate portfolios would be good candidates for this approach. The term ‘net’ typically refers to the returns that the investors in the fund will receive after taking into consideration all of the Costs involved in producing those returns which applies equally to MOIC and IRR.  While some investors like to focus on MOIC as it gives them a sense of the multiplier effect of the investment, I think a better measure in this asset class is to focus on IRR as duration risk is real in this asset class and this is a metric on which most investors get measured and compensated. The other critically important concept to understand is what has been termed the “J-Curve” effect as this can have a significant impact in commercial litigation finance, especially in the early years of a fund.  The J-Curve effect is a description of the tendency of net returns to first decline in the early years of an investment fund’s life when costs are high and valuation are relatively stagnant and then strongly produce returns (or so investors hope) as the fund matures and when value creation within the portfolio is at its peak.  When you plot time and returns on a chart, the curve resembles a “J”, hence the term.  The reason this happens is that in the early days of a fund’s life, there is money being spent to originate opportunities and make investments, including ‘broken deal’ costs associated with the failure to secure investments after investing some diligence capital to pursue the opportunity.  In addition, the investments that have been made will take some time to start producing a return that more than compensates for the costs incurred. In short, the fund produces a negative return in its early years which brings the return curve into negative territory before it rebounds into positive territory as the fund matures. However, keep in mind that the J-Curve is and should be a temporary phenomenon the effect of which will dissipate with time as the portfolio produces returns and so it tends to explain large differences between gross and net returns in the early years of the fund. If you don’t have the benefit of fair valuing your portfolio, the J-curve effect will likely last longer which is the case in litigation finance.  If the J-Curve is still having a significant negative impact after three to four years then there are likely larger issues at play and probably some unhappy investors. What is different about Commercial Litigation Finance as regards Gross v. Net? Double Deployment Risk & ‘Effective’ Management Fees In most private equity asset classes, a ‘2/20’ fee model is fairly common, although it is increasingly under pressure. The “2” is a reference to the management fee of two-percent that gets charged on committed capital and the “20” is a reference to the twenty-percent carried interest that accrues to the General Partner, typically once the investors’ principal and hurdle have been achieved.  In most private equity asset classes, there is a lag between when the commitment is made by the investor and when the fund manager invests the committed capital during the investment period (usually two to three years) and this similarly holds true for commercial litigation finance. However, in commercial litigation finance there is a second deployment risk in that the commitments fund managers make to cases or portfolios of cases may not ultimately get drawn which means that if the manager is not able to recycle and redeploy those same committed (but undrawn) dollars, then the effective cost of management fees will be higher than what is found in other private equity funds,  which in turn represents a larger drag on returns and increases the gap between gross and net returns.  Accordingly, fund managers can find themselves in a position where the overall costs of a fund that was designed to deploy say $100 million in fact only deploys say $67 million which then distorts the effective management fee cost. For example, the 2% management fee on $100 million commitment becomes a 3% management fee on a fund that only deployed $67 million, which negatively impact returns and increases the gross to net return differential. For this reason, fund managers need to start obtaining a return on any unused capital commitment in order to help bridge the gap between gross and net, but this can only be achieved by educating their customers that there is an opportunity cost of not utilizing their capital for which they must obtain a de minimis return.  The fact that competing managers are not separately factoring in their cost of undrawn capital makes it difficult to achieve in a competitive environment, but my view is that the industry needs to reflect this cost separately in their funding agreements to drive home the message that their capital, whether drawn or not, comes with a cost.  Similarly, the fund manager would be justified in obtaining a minimum level of overall economics in cases where the resolution happens much quicker than anyone expected and so there should be a floor to the economics a fund manager receives to compensate them for time spent on diligence and approvals. The other fee related phenomenon I have been noticing that also helps to address the gross to net dispersion is having the management fees applied to deployed capital and not committed capital.  Some fund managers are choosing, likely under pressure from their investors, to structure their management fees in part based on committed fund capital and in part based on either deployed capital or capital committed to underlying investments.  This will help reduce the drag that management fees have on net returns, but it goes without saying this means less upfront economics to fund managers to run their funds and may only be relevant for larger fund managers. Litigation Capital Management (“LCM”), has gone one step further and has eliminated management fees entirely in lieu of a larger carried interest.  On the one hand, this illustrates to investors their confidence in their ability to generate returns in excess of their hurdle rate (and they have done so handily) and on the other hand they will get compensated handsomely for foregoing those early management fees.  It is a very good example of strong alignment of interests between the investor and the manager and the investor generally doesn’t mind giving up more on the back-end because they feel that the manager has earned it by assuming risk on the front-end. This has the side benefit of not contributing to the J-Curve effect, although a higher carry will not help with the gross to net dispersion but then investors don’t mind when the dispersion is created through performance.  Of course, having an entity (publicly listed in the case of LCM) with its own balance sheet to fund the operations is necessary to propose this type of economic structure. Portfolio Valuation In a typical LBO fund, the manager will make say 5 investments during a 3-year investment period and then exit those investments around the 5-year hold period for each investment.  Assuming the investing happens evenly over the 3-year investment period, the first 3 years will see a high level of Costs.  Yet, the portfolio will not have had enough time to produce sufficient returns to offset all of the costs despite the fact that LBO fund managers typically revalue their investments on a quarterly basis (with a possible exception of the first year) to reflect their estimations of the fair market value of their investments. However, the same cannot be said for the portfolios of most litigation funders who typically hold their investments at the lesser of realizable value and cost unless they have received proceeds from a realization or recognized a write-off.  The reason they do so is in part due to a lack of accepted valuation methodologies for litigation assets, which is in turn a reflection of the difficulty inherent in valuing a piece of litigation that has idiosyncratic risks and a quasi-binary outcome.  While recent efforts have been made by Burford Capital in conjunction with the Securities and Exchange Commission to create an accepted valuation methodology under Accounting Standards Codification 820 for litigation assets, this is mainly for the purposes of publicly listed companies that utilize a certain set of reporting standards.  One would think that if the standards are good enough for retail investors, they should be sufficient for investors in private litigation finance funds, but for right now it seems that investors are more comfortable holding investments at lesser of cost and market until there is either a realization that suggests otherwise (i.e. a receipt of proceeds, or a write-off). So, what does this have to do with litigation finance returns?  Well, if you don’t have the ability to mark your investments to fair market value (assuming the portfolio is increasing in value), the impact of all of those Costs that are incurred early in the fund’s life are going to more negatively impact the fund’s early returns unless the fund was lucky enough to have some significant realizations.  Even with early litigation finance fund returns, while they can tend to create very strong IRRs, they typically are not meaningful to the overall fund because they tend not to draw a lot of capital and when your returns are predicated on a return on drawn capital, they end up being not meaningful in terms of their dollar impact on cashflows and hence not meaningful contributors to overall returns. In short, unless the fund had an investment that drew a large commitment and then had a realization shortly after the launch of the fund, the early realizations tend not to contribute strongly to offsetting the J-Curve effect and any early losses exacerbate the J-Curve effect. As an example, if you raised a $100 million litigation finance fund and it had 2 investments that realized in the first year and each of those investments drew $1 million of their $5 million commitment and then doubled in value at the end of the year, you would have created $2 million in gains in the fund in the first year but that would only offset the $2 million in fund management fees you charged your investors and so you would still be in a loss position when you factor in your other operating costs. So, your gross results at the case level would look great at 100% IRR, but the J Curve would cause your net returns to be negative because the dollar value of those gains was not material relative to the costs that have been incurred.  This dynamic is especially true for the early stage part of a commercial litigation finance fund’s life cycle. Loss Profile of Litigation Finance The loss profile of litigation finance also doesn’t help matters.  In LBO investing, a manager would typically target to generate no losses in their portfolio.  Sometimes LBO funds can see up to 20% of their portfolio creating losses but they may not always be complete losses – equity value is not binary (although it can be when too much leverage is applied).  In litigation finance, the average fund manager loses about 30% of their cases and unfortunately with litigation finance the loss is usually complete (although it is possible to have a partial loss). With complete losses, you are now counting on the remaining 70% of the portfolio to not only generate a return for its own capital but it also has to generate a return on the portion of the portfolio that suffered losses.  This is why despite litigation funding contracts having funding terms that might yield 3+ times their investment, the actual math when you factor in the losses results in fund multiples closer to 2 times and then you have situations which either over-perform or underperform the underwritten expectations and so most of the completed funds I have seen (of which there are surprisingly few on a global basis) produce multiples that range anywhere from 1.4 to 2.5 times.  You can then have outliers that result in very large MOICs, but they are few and far between and as an investor you can’t rely on outliers to recur, and so they are dismissed even when the investor benefits from them.  Some people have likened litigation finance to venture capital investing because of the loss profile, but I disagree with that characterization (VC losses are much higher, but they also have the ability to create huge returns to carry the fund which is generally missing in commercial litigation finance), and I think the reality is that it sits somewhere between LBO and VC in terms of its loss profile but significantly different in terms of its overall return profile. As a consequence of the loss profile inherent in litigation finance and the fact that the losses tend to be complete losses, there is a significant negative impact on net returns especially if the losses tend to happen at the end of the life of the portfolio. If the losses happen later in the life of the fund, they can also be larger because more time has elapsed to draw down larger amounts of capital with more invested dollars to lose and thus have a more significant impact on the portfolio. Fixed(ish) Returns In LBO and VC investing your returns aren’t fixed.  If your business grows beyond your wildest dreams your upside is almost unlimited (just ask the early backers of Google).  In litigation finance, your upside tends to be capped or tied to time.  For example, many funding contracts will cap returns at 3 times their investment in 3 years, 4 times in 4 years and 5 times in excess of 4 years.  The reason for capping returns is to ensure there is economic alignment of interests between the funder and the plaintiff (and the lawyer if they are working on a contingent basis) so that all parties remain motivated throughout the case as their involvement may be critical to the outcome of the case. The implication of the somewhat fixed return profile means that you cannot expect that really well performing cases will translate into strong returns for investors and thus the overall return profile of the asset class is somewhat muted (Industry participants may point to Burford’s ‘Petersen’ case as an example of unlimited upside but my experience is that this type of outcome is a statistical outlier in the litigation finance market). Accordingly, with a somewhat fixed return profile time tends to work against commercial litigation finance fund managers in that it reduces their net IRRs thereby increasing the gross v. net return spread. Implications for Measuring Management Performance For investors the question remains, “if all of this noise is in the numbers and there are different ways to present returns with wildly different outcomes how do I know if my fund manager is performing and whether I should keep allocating to the sector?”.  For fund managers, the question is “how do I present my results in a way that balances the reality of my investments without being overly optimistic or overly pessimistic and thereby give investors a reasonable estimate of their expected returns so they can rely on the return estimates?”. First, you can’t manipulate cash-on-cash results.  So, the safest route for an investor is to assess performance based on IRRs that use cash-in and cash-out (this includes the realized investments and the actual Costs incurred) as the measurement mechanism, but this is only really appropriate for fully realized funds.  Of course, this approach is the most conservative but it may inadvertently penalize the fund manager as discussed earlier, especially if applied to funds that have many unrealized positions in their portfolios and some upfront losses. In the absence of a fully realized fund, the default then becomes assessing the performance of realized cases and ensuring that the unrealized cases should not otherwise be written off (managers love to hold on to their ‘losers’ to avoid the inevitable write-off so you will have to diligence whether a dated unrealized case continues to have value).  In this scenario, trying to develop a methodology that is reasonably accurate to assess value of the unrealized portion of the portfolio is critical. Fund managers and investors alike may want to interpolate how the remainder of the fund could perform based on the performance of the realized portion of the fund or the manager’s past performance in other funds, although each fund and fund manager is unique and each case has its own idiosyncrasies and binary outcome risk. So, instead of looking at a discrete outcome, I would assess a probability weighted range of outcomes. Although one needs to keep in mind that the tail of any commercial litigation finance fund will certainly perform differently than the front-end of the fund and so adjustment will need to be made accordingly if you are using interim results as a basis to forecast full fund performance. For investors, another valuation methodology would be to approach valuation from a macro perspective.  This might entail accumulating as much data as possible about realized transactions and fund performance in the commercial litigation finance industry, apply the relevant data to the strategy of the manager (for example, data that includes small financings in plain vanilla commercial disputes would be irrelevant for a manager that focuses exclusively on patent disputes), incorporate the data of the manager’s performance to date in predecessor funds (if available) and develop your own model on how you believe this fund should perform in a few different scenarios (involving differing rates of return and durations) to try and triangulate to a series of potential fund returns and then determine whether the series of outcomes fits with the risk/reward profile of the investment.  This approach could also be relevant for fund managers, especially those that are either new to the industry or have yet to establish a sufficient track record although it may be more difficult for fund managers to get data about their competitors’ returns. I would also be cautious about attributing realized results that come from secondary transactions to the manager under consideration. Just because the manager was able to convince a third party of the value doesn’t mean that is how the portfolio will necessarily perform had the manager kept those investments on their books until they realized and ultimately that is what you are trying to underwrite as an investor because you can’t count on secondaries as an exit.  Reliance on secondary transaction values in commercial litigation finance is different than other areas of private equity where it is easier to more accurately determine fair market value using accepted methodologies and metrics. Litigation Finance valuations for secondary transactions will always be theoretical in nature and ultimately dependent on some form of probability weighting to estimate values which may not bear any resemblance to the ultimate reality and could be fraught with bias.  This is not to say that you don’t give any credit to a manager that sells into the secondary market as that may be the best outcome for their fund and they can be viewed as astute capital allocators by deciding that the best outcome for their investors is to de-risk their investors at a decent return rather than continue to assume the risk.  A prime example of an astute secondary sale is the multiple secondary sales that Burford undertook of its ‘Petersen’ case which allowed it to realize hundreds of millions in profits, even though the case had significant litigation risk at the time of the secondaries and it continues to have significant enforcement/collection risk. The promise of a valuation methodology blessed by the SEC is potentially an interesting development, but ‘the devil is in the details’ and I hope to explore those details in an upcoming article concerning valuation in litigation finance. Slingshot Insights Commercial litigation finance is one of the more difficult private equity asset classes in which to perform well, consistently.  The reason for this difficulty lies in a great degree of subjectivity in the issues in dispute, the people that dispute and resolve them, and the judiciary that decides the case, if necessary. The loss ratio coupled with the relatively fixed nature of damages and the need for a fair sharing of proceeds across multiple parties also presents issues in terms of maximizing returns for investors that ultimately places a ceiling on returns (relative to other asset classes). The average single case size is USD$4.3 million according to Westfleet Advisors’ most recent survey, and so this means that it is also a difficult asset class to scale as there are relatively few cases requiring large amounts of financing which in turn means that the manager requires more people to originate and underwrite cases as compared to other private equity asset classes which also means managers need full management fees to fund their operations.  All of this results in an asset class that will inherently have a higher-than-average gross to net return spread, especially in the earlier years of the fund’s life.  Managers would be well advised to not only report their returns based on a conservative cash-on-cash basis, but also look to alternative approaches (including ASC 820) to provide investors with a view as to the likely fund returns if even by illustrating a matrix with several potential return outcomes. After all, investing is nothing if not uncertain. I also firmly believe that the litigation finance industry really needs to start charging appropriately for its capital, specifically the portion of their undrawn capital that has been committed and set aside for potential deployment – there is a cost to having this capital on the sidelines and it should be factored into the terms of the funding agreement.  Similarly, quick realizations require a minimum return on capital that should be factored into the terms of their litigation funding agreements. As always, I welcome your comments and counterpoints to those raised in this article.  Edward Truant is the founder of Slingshot Capital Inc. and an investor in the consumer and commercial litigation finance industry.  Slingshot Capital inc. is involved in the origination and design of unique opportunities in legal finance markets, globally, advising and investing with and alongside institutional investors.