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Litigation Finance 101

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How Litigation Finance is Helping David Beat Goliath

Kazakhstan Kagazy is one of the Central Asian country's only paper recycling and cardboard production companies. When Tomas Mateos Werner became its majority shareholder in 2009, the firm was in severe distress: it owed $110M to creditors, and according to Werner was “hollowed out by frauds." But thanks to Litigation Finance firm Harbour Litigation Funding, Werner has been able to bring a case against the firm's former CEO that would otherwise have proven too costly to pursue. The lengthy, expensive trial could lead to a payout of close to $260M; a real boon for Kazakhstan Kagazy, whose assets total $40M. Litigation Finance is leveling the playing field for the Kazakhstan Kagazy's of the world, via unparalleled capital infusion. In 2017, Litigation Finance investors raised £10B worldwide. Buford Capital - one of only two publicly traded litigation funders - led the charge with a record $1.3B invested during the calendar year. According to Burford’s CEO Christopher Bogart, we are witnessing the modernization of the legal industry, as it shifts from a cash-only business model towards more complex financing deals. “We’re leading the economic transformation of the legal industry,” Bogart says. The brash CEO is quick to point out instances where his Litigation Finance firm has upended the traditional legal paradigm. Take airline owner and Spanish investment group Teinver SA's claim against Argentina, alleging the country illegally expropriated its airlines. Seeking justice in international courts is fraught with challenges, especially when dealing with countries like Argentina which is rife with corruption, yet Teinver's case - backed by Burford - managed to secure a payout of $324m plus interest (disputes over the final awards are still ongoing). Indeed, the industry is making justice more accessible the world over. It is providing David a bevy of slingshots in battle after battle with Goliath. Yet that hasn't stopped regulators the world over from sounding alarm bells. Former UK Justice Minister and Tory Peer Lord Faulks QC, contends that litigation funding is “parasitic." According to Faulks: “The trouble is there’s a risk that the whole thing becomes about a commercial transaction rather than a dispute … it could become the corporate equivalent of [ambulance chasing].” Bogart bristles at the comparison. “The vernacular of ambulance chasing is quite literally ambulance chasing," says Bogart. "It’s about lawyers who deal in the world of small claims. That is not the business that we’re in at all." For the most part, lawmakers have been welcoming of Litigation Finance as a means to enable parties access to the justice system. After all, you can't win cases with money - you can only contest them. And Litigation Finance allows individual and businesses to contest cases that they otherwise would not have the resources to pursue. Which brings us back to Kazakhstan Kagazy. Harbour Litigation Funding, the company's litigation financier, currently maintains a $1B AUM, and has doubled its capital deployment over the past year alone. “One of the cases we’re funding at the moment is a class action of seaweed fishermen in Indonesia claiming compensation for alleged damages caused by an oil spill by PTTEP Australasia Ashmore Cartier PTY Ltd,” says Martin Tonnby, Harbour's Founder and CEO. A Kazakhstan paper company looking to recoup losses from corruption? Indonesian fishermen fighting a global oil & gas producer? Goliath beware: the Davids of the world are coming... and they're carrying shiny new slingshots.
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The Importance of Diversification in Commercial Litigation Finance

Presented by Balmoral Wood | Litigation Finance Why is diversification so important in commercial litigation finance? In a word, RISK. Lack of diversification in a commercial litigation finance portfolio increases the portfolio’s risk substantially. Now, the same can be said for many asset classes, but in this asset class the risk is more acute because of the quasi-binary risk (see explanation below) nature of litigation.  The quasi-binary risk stems from a series of underlying risks related to a single piece of litigation.  The more significant risks (setting aside legal representation risk) of a single piece of litigation can be summarized as follows: (i) legal risk, (ii) counterparty risk, (iii) judiciary risk, and (iv) plaintiff risk. In part 1 of this article, we’ll look at the legal and counterparty risks to commercial litigation finance. In part 2, we’ll examine the judiciary and plaintiff risks, as well as the potential discrepancy in deployed vs. committed capital that is so unique to this asset class. We’ll then wrap things up with an explanation of the reward for successfully investing in commercial litigation finance (spoiler alert: the returns are huge!). Legal Risk Legal risk is a catch-all for a variety of legal considerations inherent in a piece of litigation.  These could include the risks associated with the legal counsel’s and litigation finance manager’s interpretation and assessment of the legal merits of the plaintiff’s case.  This risk is more significant when investing in the earlier stages of a case due to fewer facts/disclosures being available when a financing decision is necessary. However, such risk can also be mitigated through milestone financing, pursuant to the funding contract such that the funder does not risk too much capital when limited information is available. There could also be risk associated with litigation reform, or adverse jurisprudence related to the specific case type being financed.  As an example, patent reform has had a significant impact on the ‘patent trolling’ industry, hence very few litigation finance firms will consider those opportunities.  The question for a financier is whether the case type which they are financing could be the subject of reform, or adverse jurisprudence before the settlement or court process is finalized, which could have a material impact on the outcome of the case. The other aspect of legal risk is jurisdictional in nature, in terms of the legal jurisdiction or the forum (i.e. court or arbitration panel).  Different courts and judges can maintain distinct biases and interpretations which effect the outcomes of cases. With respect to arbitration, if it is binding in nature, the plaintiff and the financier lose the ability to appeal the panel’s decision, which makes that venue more restrictive on one hand, yet more definitive on the other. The variety of legal risks inherent in litigation – some objective, some subjective – makes it that much more difficult to underwrite in a systemic way that results in a series of reliable and recurring outcomes. Counterparty Risk  With respect to counterparty risk, this too can take many forms.  The core component being that even if the plaintiff were to win its case, the plaintiff may not be able to collect the award or settlement.  In some cases, the defendant has the financial resources to pay the award, but due to the jurisdiction of the case, the plaintiff may not be able to enforce and collect its award (because, for example, the legal jurisdiction may not match the jurisdiction in which the defendant owns most of its assets). This can also be referred to as “collection risk”, but ultimately has to do with the characteristics of the counterparty (or defendant). Typically, litigation funders are very focused on this risk early in their underwriting process, and if there is no clear path to collection, the litigation funder will typically pass on the opportunity. The other counterparty risk is behavioural/cultural in nature and may be assessed through the past performance of the defendant in a similar set of circumstances. A plaintiff may be in dispute with a corporation that has a predisposition to fight each dispute ‘to the bitter end’ even though that may not be an economically rational decision.  This behavior is often rooted in a corporate culture that encourages strength in litigation, in order to prevent future potential plaintiffs from engaging in similar litigation, and maintain a pristine reputation.  In this way, the corporation believes that ‘a strong defense is the best offense,’ which ultimately results in long-term savings, as it serves to deter future costly litigation. Other corporations take a more practical approach and treat litigation as a cost of doing business, thus making economically rational decisions to minimize the costs of litigation (legal costs, discovery costs, settlement costs, etc.).  These organizations are generally more likely to enter into a settlement agreement. Ultimately, the counterparty and their philosophical approach to litigation will have a significant impact on the outcome of a case, so whatever can be accomplished upfront to assess their likely approach will benefit the party’s outcome. Having said that, each case is unique, and each successive executive team may harbor different beliefs, so it becomes inherently difficult to consistently assess and anticipate counterparty behaviour given these ever-changing variables. Judiciary Risk Judiciary risk is simply the risk that despite a meritorious claim with ample supporting evidence, the judiciary will make an unpredictable or incorrect decision that results in a loss to the plaintiff.  This risk will differ depending on the nature of the forum (court or arbitration) and the nature of the judiciary (judge, jury or panel), not to mention the individual making the decision. The only remedy in this situation is success through an appeal, but that option may not be available, and typically the chances of a successful appeal are less than 50%. Judiciary risk encourages many to believe that litigation risk is “binary”, which is to say that a plaintiff will either win or lose its case, but rarely is there a judicial outcome somewhere in the middle.  I would argue that the asset class, when viewed through the lens of a large diversified portfolio, possesses “quasi-binary” risk, as described below. During the earlier stages of a case, there is uncertainty on either side of the dispute because a lack of disclosure has taken place, and so the counter-parties’ confidence in their respective cases relies solely on what they know about the case (both sides, of course, appreciate that there may be much they do not know). When you look at two parties in a dispute that have equivalent economic resources, the parties quickly turn their attention to focus on the merits of the case and the probability weighted potential outcomes of the case if it were to proceed to a judicial process. This uncertainty, married with the concept promoted by litigation finance of ‘level the playing field,’ creates a breeding ground for settlement. When you consider the large variety of potential outcomes in the context of a negotiated settlement, the possibilities are infinite. It is this series of potential outcomes that make a piece of litigation much less binary during the pre-trial period. The reality of litigation is that the lion’s share of resolutions is derived through settlement (90-98%, depending on the data source). Hence, a commercial litigation finance portfolio is not as binary as one might think.  However, in the context of a single piece of litigation, there is the possibility that it gets resolved through a judicial decision and hence there is an element of binary risk inherent in any single piece of litigation. Since most commercial litigation is settled, and since there is binary risk associated with a single piece of litigation that reaches the judiciary, the application of portfolio theory decreases the binary risk inherent in a portfolio of cases. Plaintiff Risk Most jurisdictions prevent a third party from influencing the plaintiff with respect to their case.  “Officious intermeddling” is a reference to a third party interfering with the plaintiff’s decision, and is a component of the definition of the legal doctrine of ‘champerty’, which is still relevant in many jurisdictions.  Accordingly, when a litigation funder takes on a case, they must ensure that the plaintiff will be an economically reasonable decision-maker, which is difficult to assess, as the injured party typically wants to exact revenge for the damage done to them. There are ways in which a litigation funder can construct its funding contract to make the plaintiff act economically rational, but the provisions are more ‘guard rails’ than a ‘podium’.  Good litigation funders will spend time with the plaintiff to assess their economic rationality, but ultimately the funder is adopting an element of plaintiff risk when funding a new case. Commitment vs. Deployment  In addition to the risks outlined above, the other characteristic of the commercial litigation finance asset class that merits comment relates to deployment rates. In this asset class, there is a distinction between the amount the litigation funder ‘commits’ to a case, and the amount they ‘deploy’.  The former is the amount that the financier is willing to commit to fund based on a set of assumptions, milestones and limitations. The latter is the amount that is actually funded. Since litigation funders cannot possibly know (particularly in early stage cases) how much of their commitment they will ultimately deploy, it becomes that much more difficult for fund managers to design diversified portfolios.  As an example, if I manage a fund with a 15% concentration limit based on aggregate committed capital, and my entire fund deploys 75% of its aggregate committed capital throughout its term, then my concentration limit is effectively 20% (15%/75%) of deployed capital.  If that same fund has 2 investments that have hit the fund concentration limit, then the returns of the fund will mainly be dictated by 2 cases representing 40% of the deployed capital.  When you layer on single case binary risk, you quickly come to understand how inappropriate the concentration limit is for the fund, and how difficult it can be for a fund to overcome a loss related to 1 large case investment and still produce strong absolute returns. The Reward Given that many of these risks exist in a single piece of litigation, the economic return must be significant to justify assuming these risks, which is why the industry has the perception of being an expensive source of capital. In addition, the industry does have the potential to achieve outsized returns depending on the funding contract and timelines, but these are typically driven by single cases and are extremely difficult to underwrite and predict. While the industry risks are numerous, many of them are manageable and diluted in the context of a diversified portfolio, and many investors believe the rewards are well worth the risk. So, when an investor looks at the risks and rewards of a single piece of litigation in the context of a large diversified portfolio, it is easy to conclude that the application of portfolio theory (i.e. diversification) is necessary to achieve appropriate risk adjusted returns. Diversification can take many forms (fund managers, geography, case size, case type, counterparty, industry and legal representation) and it is important to have a mix of each within the portfolio to reduce risk, while obtaining the overall benefits of the absolute returns inherent in the asset class.   About the Author: Edward Truant is a principal of Balmoral Wood Litigation Finance, a litigation finance fund manager based in Toronto, Canada.  The author can be reached at edwardt@balmoralwood.com.
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Is Consumer Legal Funding a Loan? Why Does it Matter?

Opponents of Consumer Legal Funding have been working overtime to classify the product as a loan within the confines of State Legislators. So why does this matter? The classification of Consumer Legal Funding as a loan is more than mere semantics. Consumer Legal Funding is the purchase of an asset; that being a portion of the proceeds of the consumer’s legal claim. This form of investment allows the consumer to access much needed support in order to obtain the financial assistance they need while their claim is making its way through the system. In her publication “Harmonizing Third-Party Litigation Funding Regulations,” Professor Victoria Shannon Sahani clarified why Consumer Legal Funding is not a loan:
  • First, there is no absolute obligation for the funded client to repay the litigation funder. If the client is the claimant, the client must only repay the funder if the client wins the case. If the client is the defendant, the premium payments end as soon as the case settles, and if the defendant loses, the funder will not receive a success fee or bonus.
  • Second, litigation funding is non-recourse, meaning that if the client loses the case, the funder cannot pursue the client’s other assets unrelated to the litigation to gain satisfaction.
  • Third, the funder is taking on more risk than a traditional collateral-based lender; therefore, the funder is seeking a much higher rate of return than a traditional lender. This is not a unique concept. For example, an unsecured credit card typically carries more risk than a secured loan, so regulations tolerate much higher interest rates on unsecured credit cards than allowed even on subprime mortgages, which are backed by collateral. Similarly, as mentioned above, funders structure their agreements to avoid classification as loans in order to avoid the caps that usury laws place on interest rates for mortgages and credit cards.
  • Fourth, distancing funding even further from a loan, funders are taking on even more risk than unsecured credit cards because the credit card agreement is a bilateral transaction, while funding is a multilateral transaction.
Shahani is explaining that Consumer Legal Funding does not contain any of the characteristics of a loan, as illustrated in the chart below:
CharacteristicsLoanConsumer Legal Funding
Personal repayment obligationYESNO
Monthly or periodic paymentsYESNO
Risk of collection, garnishment, bankruptcy.YESNO
What is interesting to note is that no state where the legislature has carefully examined the product has classified it as a loan. In fact, states has gone so far as to declare that Consumer Legal Funding is unequivocally not a loan. Take Indiana for example: Recently, a statute was passed regulating the industry which specifically states: “Notwithstanding section 202(i) of this chapter and section 502(6) of this chapter, a CPAP[1] transaction is not a consumer loan.”  The statute further articulates: “This article may not be construed to cause any CPAP transaction that complies with this article to be considered a loan or to be otherwise subject to any other provisions of Indiana law governing loans.” The Nebraska state legislature has declared: “Nonrecourse civil litigation funding means a transaction in which a civil litigation funding company purchases and a consumer assigns the contingent right to receive an amount of the potential proceeds of the consumer’s legal claim to the civil litigation funding company out of the proceeds of any realized settlement, judgement, award, or verdict the consumer may receive in the legal claim.” In Vermont: “Consumer litigation funding means a nonrecourse transaction in which a company purchases and a consumer assigns to the company a contingent right to receive an amount of the potential net proceeds of a settlement or judgement obtained from the consumer’s legal claim. “ In other words, Consumer Legal Funding is specifically classified as a purchase, not a loan. And it’s not just the state legislatures that have weighed in on this, the courts have as well. On June 27th 2017, the Georgia Court of Appeals stated: “Unlike loans, the funding agreements do not always require repayment. Any repayment, under the funding agreement is contingent upon the direction and time frame of the Plaintiffs’ personal injury litigation, which may be resolved through a myriad of possible outcomes, such as settlement, dismissal, summary judgment, or trial.” Even dating back to 2005, when the New York Attorney General’s office came to an agreement with the industry, it stated in its press release: “The cash advances provided by these firms are not considered “loans” under New York State law because there is no absolute obligation by a consumer to repay them.” So this leads me back to my opening question: Why does it matter? Classification matters because once you mischaracterize the product by calling it a loan, you limit consumers’ availability to access it by subjecting Consumer Legal Funding to state laws that regulate loans. According to CNBC, 78% of Americans are living paycheck to paycheck. When their income stream is interrupted (typically due to an accident), they desperately need some economic assistance to help them through the lengthy and extensive process of filing their legal claim. So we ask State Legislators, when you are deciding how best to regulate this important financial product, to do what is best for your constituents by providing them access to economic assistance during their time of need, and ensuring that they are fully informed as to the terms and conditions of the transaction by having their attorney review it with them in order to confirm that it is properly classified as a purchase. Blanket statements labelling Consumer Legal Funding as loans only serve to hurt those in need of its assistance. Eric Schuller President Alliance for Responsible Consumer Legal Funding [1] CPAP Civil Proceeding Advance Payment
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Past Events

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Key Takeaways from LFJ’s Special Digital Event: Innovations in Litigation Funding

On Wednesday, November 10th, Litigation Finance Journal hosted a special digital conference titled Innovations in Litigation Funding. The event featured a panel discussion on disruptive technologies within Litigation Finance, including blockchain, AI and crowdfunding platforms. Panelists included Curtis Smolar (CS), General Counsel of Legalist, David Kay (DK), Executive Chairman and Chief Investment Officer of Liti Capital, Cormac Leech (CL), CEO of AxiaFunder, and Noah Axler (NA) Co-founder and CEO of LawCoin. The panel was moderated by Stephen Embry (SE), founder of Legal Tech blog TechLaw Crossroads Below are some key takeaways from the panel discussion: SE: All of you seem to have an interest in taking litigation funding out of the back rooms and making it more mainstream so that anyone can invest. I want to ask each of you to briefly explain your specific approaches in trying to accomplish this goal. CS: Basically, what Legalist does, is we use artificial intelligence and machine learning to reduce the potential for adverse selection and hazards that may exist in the Litigation Finance field. By reaching out to those who have valuable claims, we’re able to select the cases we want, versus simply having cases presented to us and sold to us. This has been extremely valuable to us, as we get to really pick the best cases based on criteria that we are selecting. DK: I think we’re getting pretty close to it already being in the mainstream. I think adoption has grown a lot over the last ten years. In terms of moving it forward, our view on it at Liti Capital is that we are trying to democratize the availability of Litigation Finance both from the people who finance it and the people who have access to it. CL: What I really see AxiaFunder doing is connecting investors with a new asset class, and at the same time, providing claimants with a new source of flexible funding. AxiaFunder in a nutshell is a funding platform that connects investors with carefully vetted litigation investment opportunities on a case by case basis. The capital is put to work immediately, and then when the case (hopefully) resolves positively, we return the capital with a return. So there’s little or no cash drag. We see it as an obvious win-win. NA: What we’re seeking to do is open Litigation Finance, like some of the other folks on the panel, beyond the institutional space into individual accredited investors and also to retail investors. The additional value add we have, is that we fractionalize the investments as digital assets, or what are sometimes called tokens, using the Ethereum blockchain. We think ultimately that by doing that, we can bring liquidity to the Litigation Finance space and beyond Litigation Finance as well. We’re not the only ones securing this in the private security space. SE: One of the questions we often see with cryptocurrency, whether it’s right or wrong, is that it’s used to hide who is paying what to whom. How does that concept square with the growing concern of many investors (and to some extent, the judiciary) about transparency in terms of funding agreements and the identity of funders? DK: I think the key here is consistency, which is to say ‘who is the funder?’ and I think that’s an important distinction that gets a short shrift from a lot of these discussions. To put it another way, if Liti Capital is the funder, then it’s obviously very important to know who Liti Capital is, and who are any majority or control holders within Liti Capital. And we, like other companies on the blockchain, are still required to do KYC and other rules with our investors to ensure that we’re compliant with domestic and international law. So I think that piece is much ado about nothing. But what I will add, is that I do think litigation funders should be held to the same standard as companies, and whether or not an arbitrator has an investment in our company is important to know, or a decision maker has an investment in our company is important to know. And disclosures in the same way that’s required in US Federal Court makes perfect sense. This is not a new issue. I think where we fall prey to the people that are against litigation funding…we’re falling prey to this argument that somehow everything and everyone must be known—or it’s evil. Access to justice is not evil. Being able to compete with people with large amounts of capital is not evil. NA: I second a lot of the things David said. At LawCoin, we’re selling securities. We’re very upfront about that. That’s a hot button issue in crypto, whether or not a particular token is a security. We have a separate white list that exists off of the blockchain, which might in some cryptocurrency circles lead to criticism that we’re not a decentralized operation in the way that a lot of cryptocurrency evangelists argue that cryptocurrency is most suited for. We embrace the obligations that go with issuing securities, so as a result…there’s no issue with respect to our platform with having anonymous investors that haven’t gone through a KYCAML process. SE: Given the volatility of cryptocurrencies that we’ve all seen…how do you mitigate against a severe price drop or price increase, and what do you tell investors in that regard? DK: How does Blackstone or Apollo mitigate against market crashes or change in the underlying value of their equity? Volatility and movement in price just exist—in terms of value of the corporation. In terms of funding the cases, we’re not funding cases in Bitcoin or Ethereum. We’re not a cryptocurrency, we’re a company that’s listed on the blockchain. Our token trades on the blockchain, but our token represents the underlying equity of the company. The money that we raise, 90% of it is dollars, some small percent is in Ethereum, but…our expenses are paid in dollars, we raise money in dollars, our revenue comes in dollars. There is some currency risk in anything we would keep in Ethereum, but we manage it. … You really just have to be aware and manage the fact that you’re operating in two currencies. SE: Given the way litigation sometimes drags on, especially in the US, given the unexpected twists and turns—what happens when you have to go back to your investor pool and say, ‘we need some more money?’ How do you manage that and how are the terms structured? CL: There are two aspects to it. First of all, before we actually issue a claim, there’s no adverse cost risk for the claimants or our investors. But once you issue the claim, you potentially have adverse costs risk for the claimants. If the claimants can’t pay, our investors could potentially be liable for the adverse costs risk, which we’re obviously not comfortable with. Before we will fund a case where the claim is going to be issued, we basically get a cost budget through trial, and make sure we have enough money to see the case through to the end of trial. Having said that, the cost-budget is always an estimate. So sometimes you need to come back and get more capital from investors.
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