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 SUMARY
- Collectability risk has moved to the forefront of litigation finance as a result of the Covid-19 induced financial crisis
- Asset recovery and enforcement is a niche area within litigation finance that requires a unique skill set to be successful
INVESTOR INSIGHTS
- Asset recovery and enforcement is a component of any piece of litigation, but certainly more prominent in certain case types and during times of financial stress
- There are many risks associated with asset recovery and enforcement actions which give rise to different investor return characteristics – higher volatility, higher potential returns, and longer durations, to name a few.
Expanding on a recent article I wrote about defendant collectability risk in the context of the current Covid-19 induced financial crisis, I have reached out to AVVISO, a firm specialising in enforcement and collection, to discuss some of the challenges litigation finance managers may face in the current environment.
The Covid-19 pandemic is forcing many industries to adapt to new realities. The litigation finance industry is no different. As new realities emerge, so do new opportunities, and as the dust settles, we anticipate the following developments:
- Collectability risk will be assessed as rigorously as legal risk before any commitments are made against sovereigns and commercial counterparties affected by the crisis.
- A growth in demand for asset recovery and enforcement funding.
This article explores how to effectively assess collectability and maximise returns on asset recovery investments. Key to both is a multidisciplinary approach to supplement the traditional legal one.
COLLECTABILITY RISK
Let us take a closer look at what it means to assess collectability in the context of the broader litigation finance underwriting process. Woodsford Litigation Funding provides an overview of the assessment process it employs, which is broadly representative of the wider industry. “The funder will focus on six fundamental criteria when evaluating a claimant-side litigation funding opportunity”:[1]
- Merits of the claim
- Claimant (e.g. motivations for seeking funding and prior litigation history)
- Strength of claimant’s legal representation
- Litigation budget
- Expected damages
- Respondents and recovery
Litigation funds are well-equipped to address the first five criteria. Between the formidable in-house legal knowledge of most funds, input from external law firms which are retained to provide opinions on the merits, and input from claimant’s counsel and other experts, funders have this covered.
However, fund managers without internal expertise may be on comparatively shakier ground when it comes to that final sixth point, which is concerning at a time when the importance of effectively assessing collectability risk has perhaps never been greater. So why is this?
Assets…but not only
A sophisticated methodology to properly assess collectability is not just about assets. It is also about humanising problems which are predominantly viewed through a legal lens. Whether the opposition is a state, corporation or individual, we would explore:
Key stakeholders
- Profile and motivations of the main decision-makers
- What is their level of resource and resolve?
- How entrenched is their position: are they likely to settle or fight a protracted legal battle?
- If the former, what do they perceive to be an acceptable settlement range?
- How politicised is the dispute and how would a change of government impact a state’s attitude towards it?
Modus operandi: disputes
- Are they currently or have they in the past been involved in other major disputes?
- If so, what lessons can be gleaned from the experiences of others who have faced them?
- Do they have a history of avoiding payment of judgment/award debts?
- Could we face a scenario where we are competing with other creditors over a limited pool of assets?
Assets
- What assets does the defendant/respondent hold directly in jurisdictions amenable to enforcement?
- How leveraged are these assets? How has the current financial crisis impaired asset values?
- What is their asset profile more broadly and how is their ownership of these assets structured (if not held directly)?
- Would these structures impede our ability to attach key assets if we needed to?
- Are there any indications that the defendant is actively dissipating assets or otherwise making themselves ‘award proof’?
- Has the defendant been forced to sell off assets previously thought available for collection as a result of liquidity needs stemming from the financial crisis?
Commercial activities
- What is the nature and extent of their ongoing commercial operations?
- How viable are these operations long-term and how concerned should we be about any commercial vulnerabilities (e.g. high customer concentration)?
- Are there any commercial vulnerabilities which could be exploited as part of a legal or enforcement strategy (e.g. unreported allegations of bribery)?
Enforcement plan
- What is the proposed enforcement plan if no voluntary payments are made at the conclusion of the litigation/arbitration?
- Is the proposed enforcement budget realistic?
And so on. These kinds of questions are answered by means of specialised open source research, human intelligence gathering and other investigative means. In short, collectability is at its heart an intelligence problem – not a legal one. This explains why funds are comparatively weaker at addressing this problem – because the underwriting process they employ is mainly underpinned by legal analysis.
There are of course powerful legal tools (e.g. discovery to identify bank accounts internationally) which can and should feed into the process of assessing collectability. As long as someone then takes the time to understand the data generated by legal means, and answers the ‘so what?’ question by placing it in the context of the broader intelligence picture.
One final point on collectability: it is fluid. Once litigation finance commitments are made, funds would be well-advised to thoroughly monitor how the answers to the above questions evolve over the duration (often years) of major legal disputes. In the same way that investment banks, private equity firms, and major corporations routinely use intelligence to inform their investments and operations, so too will the litigation finance industry, as it becomes more competitive and established.
ASSET RECOVERY
We are frequently asked why asset recovery problems are so common. One reason is the ease with which judgment and award debtors can avoid paying what they owe – if they so choose – which must represent one of the most profound shortcomings of the legal process.
And it is easy. If a sophisticated fraudster, sovereign state, or hostile corporate makes a commercial or political decision not to pay a debt, then it is fairly straightforward for them to structure their affairs in such a way that makes it difficult, time consuming and costly for creditors to pursue them. The Covid-19 pandemic will only increase the propensity of debtors to follow this path.
Another reason is the failed enforcement approach adopted by many creditors. Typically, the legal team which secured an award or judgment goes on to inherit the enforcement problem if the other side refuses to pay. Often, this team is ill-suited to tackle what is a very different problem than winning the legal argument. Indeed, it is not uncommon for legal teams to inadvertently trigger this problem by adopting a process-driven ‘get the judgment’ approach, while failing to engage sufficiently throughout the lifetime of the dispute with the question their clients care about most: how will we get paid?
This creates enormous investment potential in the asset recovery space, especially now, yet it remains on the frontier of the litigation finance industry. We anticipate an increase in opportunities to invest in asset recovery and enforcement matters, and for more funds to develop the knowhow to maximise their returns on these investments. For example:
- Monetising awards and judgments against sovereign states and/or state-owned enterprises
- Funding and coordinating enforcement efforts against fraudsters and other recalcitrant commercial debtors
- Providing capital and expertise to governments to assist with their efforts to repatriate proceeds of corruption (e.g. post regime change)
- Investing in the non-performing loan (NPL) portfolios of financial institutions in emerging markets
- Funding cross-border insolvencies and restructurings
So, how will we get paid?
Major asset recovery situations are complex problems requiring a flexible, coordinated and multi-disciplinary approach. If funds want to play this game well and maximise their returns on investments, then they need to retire the tired lawyer-investigator trope. Below is a sample of the methods in a multidisciplinary asset recovery playbook:
Legal
- Relevant civil legal work in appropriate jurisdictions (e.g. for the purpose of discovery and to attach assets)
- Criminal remedies (e.g. private criminal prosecutions and confiscation orders)
- Insolvency tools
Intelligence
- Open source intelligence (e.g. to map complex offshore structures and identify revenue streams or personal assets)
- Human intelligence (identifying and developing relationships with individuals who have access to information of potentially critical importance to the recovery)
- Surveillance (e.g. to establish a debtor’s pattern of life, identify key associates, or to serve documents)
- Financial intelligence and forensic accounting
- Software and other tools (e.g. eDiscovery and proprietary asset tracing software)
Stakeholder engagement
- Diplomatic approaches (e.g. working with ambassadors to facilitate negotiations with governments)
- Backchannel negotiations with opposition decision makers
- Well-timed media and PR strategies (e.g. prior to elections in a sovereign enforcement case)
Secondary market solutions
- Post-settlement monetisation
- Identifying non-traditional buyers of awards and judgments. Examples include: hedge funds with existing country exposure seeking to strengthen their hand during sovereign debt restructurings; or global commodities companies which can use a sovereign award to offset their tax liabilities in-country.
This list is not exhaustive and every bullet point merits its own separate discussion. The point is that as with collectability, asset recovery is not just about identifying (and in this case pursuing) assets. It is also about creative problem solving and recognising that there are people on the other side of the equation whose commercial or political calculus needs to change.
Asset recovery situations should be overseen by asset recovery specialists – professionals who have an awareness and understanding of the uses and limitations of all the tools in the box and are able to deploy the right ones at the right time. Their individual specialisation matters less than their ability to coordinate international teams and provide overall strategic oversight.
If funds embrace the complexities of asset recovery and the need for a multidisciplinary approach, then the new frontier will be bountiful. If they follow too narrow a path, then it may prove unforgiving.
Investor Insights
For investors in the litigation finance asset class, there should be an appreciation that enforcement and asset recovery represents a niche within a niche. Accordingly, these types of investment exposures have a different risk-reward profile than traditional litigation finance as they are much more about collection risk than litigation risk. Consequently, proficiency in this area requires a different skill set from a fund manager perspective, and that capability can either be internalized or outsourced depending on the frequency of these opportunities. Concerns in this segment of the market are around ultimate collectability and the timelines involved with collection, both of which may be difficult to assess at the outset.
Edward Truant is the founder of Slingshot Capital Inc., and an investor in the consumer and commercial litigation finance industry. Ed is currently designing a product for institutional investors to provide unique access to the asset class.
[1] See https://woodsfordlitigationfunding.com/wp-content/uploads/2019/01/A-Practical-Guide-to-Litigation-Funding_ROW.pdf
