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Covid-19 and Defendant Collectability Risk

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

  • Covid-19 will likely lead to the biggest financial crisis since the Great Depression
  • The crisis has affected the solvency and viability of corporations and sovereigns
  • Litigation managers need to re-assess collectability risk, immediately and regularly, of each defendant in their portfolio

INVESTOR INSIGHTS

  • Diligencing litigation managers should involve a deep understanding of how they assess defendant collectability risk
  • Defendant collectability risk is an ongoing risk that changes over time, therefore managers need a continuous risk assessment methodology
  • Investors looking to invest in litigation finance secondaries to take advantage of the current dislocation should avoid single case risk and look to portfolio acquisitions, but must assess collectability risk across the portfolio being acquired

As Covid-19 has taken the planet and the legal community by surprise, I think there are some lessons learned from private equity that can be applied to litigation finance.  In short, focus on cash – its collection, generation, distribution and availability.

So, how does this relate to Litigation Finance?

This novel Coronavirus-driven healthcare crisis which has spiralled into a broad-based economic crisis, the likes of which the modern global economy hasn’t seen since the Great Depression, has had the effect of taking otherwise viable, profitable and cashflow positive businesses and stopping them in their tracks.  Overnight, certain businesses and industries have performed a complete one-eighty, whereby they went from solvent to being on the precipice of insolvency.  For many litigation finance firms, their immediate reaction has and should be to undertake an immediate and urgent review of the defendants involved in each and every case in which their portfolios have an investment, in order to re-assess collectability risk, one of the key areas of litigation finance underwriting.

When an economy, especially a consumer driven economy like the US, effectively shuts down overnight, there are few industries and companies that will be spared from a diminution in their value and blockage from access to capital.  Former “recession-resistant” and “necessity” businesses have just experienced a new reality, which is that necessity is determined by context.  The current context states that the only necessity is feeding, hand washing, shelter and healthcare, and this has had a massive impact on the economy. While this too shall pass, the economic impacts will likely linger for a number of months and years.  The hope for a “V” shaped recovery has been dashed, as the crisis has extended beyond initial duration estimates.  My personal opinion is that it will at best look like a “U” shaped recovery with the possibility of a double “W”, meaning there will likely be some ups and downs along the way, should the dreaded “C-19” rear its ugly head again going into the next flu season, or should it fail to be contained due to premature ‘return to daily activity’ policy.  My hope is that the massive amounts of stimulus that are being pumped into the global economy actually make their way to the most hard-hit regions of the economy, namely ‘Mainstreet’, and thereby mitigate the damage that would otherwise be experienced for many small and medium-sized businesses on which most economies rely.

While we tend to focus on home first, litigation funders should also be mindful that the economy is global.  As bad as developed countries think they may have it, fund managers who participate in the international arbitration market, which by definition, involve developing countries and corporations therein, need to be mindful that those defendants in developing countries will likely be even more greatly affected. Yes, even sovereigns.

Those managers that are focused on patent litigation involving start-up technology companies should also ensure the plaintiff is solvent through the end of the litigation, not to mention the collectability risk of the defendant, which may have been negatively impacted.

All of this is to say, that it is in the best interests of litigation finance managers to undertake a re-assessment of collectability risk of each and every defendant in their portfolio, and to do so on a regular basis for the foreseeable future.  Managers will need to assess (i) the degree to which the defendant’s industry has been impacted, (ii) the strength of each defendant’s business and balance sheet, (iii) the ability for the defendant (business or sovereign) to access sufficient capital to maintain solvency, (iv) the degree to which the value of such business has declined, (v) a study of the defendants’ behaviour during the last economic crisis, as it relates to litigation ongoing at that time, if any, (vi) determine the extent to which other parties have security and seniority ahead of the plaintiff’s claims and (vii) assess the defendants’ ability to raise capital outside of financing (i.e. asset sales, equity raises, etc.).

Once a determination has been made as to the relative collectability risk, managers will then need to determine next steps with respect to protecting themselves from those cases where the defendant collectability risk has materially changed.  This may involve the withdrawal of any further financing provisions (to the extent the financing was milestone-based), partnering with other parties to share the increased risk of the case, or selling all or a portion of a case or a portfolio (although the manager would be selling into a weak secondary market with relatively few participants, which will be reflected in the valuation, if they can secure bids).  While the options may not be great, they may be better than investing ‘good money after bad’.

Investor Insights

For investors that are invested in the sector or considering making an investment in the litigation finance market, now is a good time to diligence how and the extent to which managers were on top of their portfolio in assessing collectability risk.  For those investors interested in secondary market opportunities, caveat emptor.  The risk profile for a single case secondary is much higher given the high level of uncertainty in today’s market so a portfolio of secondaries may be a better risk-adjusted avenue to pursue but the portfolio’s diversification benefits would not negate the need to reassess the collectability risk of each defendant in the portfolio.

 Edward Truant is the founder of Slingshot Capital Inc., and an investor in the consumer and commercial litigation finance industry.

Commercial

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Case Developments Commercial

CAT Finds in Favour of Professor Andreas Stephan in Amazon Claims

By Harry Moran |

Whilst last week saw a flurry of activity in the Competition Appeal Tribunal (CAT) as trials began in multiple collective proceedings, this week has seen the Tribunal hand down a ruling in a carriage dispute between two claims both targeting Amazon for allegations of anticompetitive behaviour.

A press release from Geradin Partners highlights the judgment from the CAT in a carriage dispute, which saw the Tribunal find in favour of Professor Andreas Stephan in collective proceedings being brought against Amazon. The carriage dispute related to the parallel claims brought by Professor Stephan and by the British Independent Retailers Association (BIRA), over allegations that Amazon engaged in anticompetitive practices that harmed third-party sellers on the online marketplace. Professor Stephan’s proceedings had instructed Geradin Partners and secured litigation funding from Innsworth, whilst BIRA had instructed Willkie Farr & Gallagher and agreed to funding from Litigation Capital Management (LCM).

In its ruling, the CAT found that whilst BIRA had an advantage in its suitability to act as the class representative, “this was clearly outweighed by the factors which favour Prof Stephan”, which it identified as “the scope of the claims and the expert methodology.” Although the CAT highlighted that the breadth of Professor Stephan’s claims “would no doubt enlarge the scope of a trial and therefore make it more complicated”, the ruling cited case law in emphasising that his claims “more consistent with the goals of access to justice by capturing more viable claims”.

The published judgment also shed light on the details of the funding arrangements in the claims. Professor Stephan’s litigation funding agreement (LFA) with Innsworth committed a maximum of £32.9 million to cover costs and expenses, with an additional commitment “to pay adverse costs of £5 million until the grant or refusal of a CPO and of £20 million thereafter.” As to the returns outlined in the funding agreement, Professor Stephan’s LFA with Innsworth “provides for a total multiple rising from 4 up to 10 (if the recovery is after the commencement of the substantive trial).” The CAT noted that the returns from Professor Stephan’s LFA were higher than for the funder in the BIRA claim, in the conclusion of its examination the Tribunal noted that “the funding arrangements of the two applications are a neutral factor in choosing between them.”

The CAT’s full judgment in the carriage dispute can be read here.

Additional analysis of the CAT’s ruling and its implications for future carriage disputes for funded proceedings can be found in a LinkedIn post from Matthew Lo, director at Exton Advisors.

Commercial People Moves

Ayse Yazir Appointed Managing Director at Bench Walk Advisors

By Harry Moran |

Ayse Yazir has started a new position as Managing Director at Bench Walk Advisors. This latest promotion comes in the seventh year of Yazir’s tenure at the market-leading litigation funder, having joined the firm in 2018 as a Vice President and most recently having served as Global Head of Origination.

In a post on LinkedIn, Yazir reveals that her work at Bench Walk Advisors incorporates a wide range of matters across the litigation funding industry including international and commercial arbitration, insolvency, class actions and global litigation matters as well as law firm and corporate portfolio arrangements and defense funding.

Yazir also expressed her delight at starting the new role and thanked her fellow Bench Walk Advisors’ managing directors Stuart Grant and Adrian Chopin for the opportunity.

Case Developments Commercial

Judge Preska Orders Argentina to Comply with Burford Discovery Request

By Harry Moran |

As we enter yet another year in the story of the $16.1 billion award in the case funded by Burford Capital against the YPF oil and gas company, a US judge has ordered the Argentine government to provide additional information about the country’s financial assets to the funder as part of its efforts to collect on the award.

An article in the Buenos Aires Herald provides an update on the ongoing fight to recover the $16.1 billion award in the YPF lawsuit, as a New York judge ordered Argentina to comply with a discovery request for information around the Argentine Central Bank’s gold reserves. The order handed down by Judge Loretta Preska followed the request made by Burford Capital in October of last year, with the litigation funder citing media reports that Argentina’s Central Bank had moved a portion of its gold reserves overseas.

Lawyers for Argentina’s government had submitted a letter last week arguing against the discovery request on the grounds that the Argentine Republic and Central Bank are legally separate entities, and that any such gold reserves have “special protection from execution under [United States’ Foreign Sovereign Immunities Act] and UK law.” Responding to these arguments in her order, Judge Preska stated plainly that “regardless of whether the gold reserves are held by [the Central Bank], the Republic shall produce its own documents concerning the reserves.”

Judge Preska also ordered the Argentine government to provide additional information concerning its SWIFT data on its overseas accounts and for documents from another lawsuit brought against the Republic, saying that all this information could “lead to other executable assets.”