Skip to content

This is how hedge funds speculate on justice

Comment

For much of history, it has been illegal to turn other people’s legal claims into investments. This changed in the 1990s when Australia allowed financiers to fund insolvencies. Litigation funding is now a multi-billion dollar global industry that attracts private equity funds and large institutional investors on the promise of double-digit returns. Critics say this secretive and largely unregulated practice tips the scales of justice by pouring money on litigants and turning courtrooms into casinos.

1. How does litigation funding work?

A law firm will often assume the costs of a case on behalf of its client, and then a specialized hedge fund will reduce its financial exposure by making periodic payments to cover the expenses. If the case is successful, the funder usually receives a multiple of the funds invested or a percentage of the damages, whichever is greater. If the lawsuit fails, the funder loses the money and the litigant does not need to repay them. Backers most often back commercial cases, but can be involved in a range of actions, from environmental lawsuits to personal injury and bank fraud cases and even divorces from Russian oligarchs. Proponents say the practice allows people or companies with fewer resources to pursue valuable claims that might otherwise be dropped, and means plaintiffs can engage their preferred attorney without being left behind.

2. How much money is in it?

Research by Swiss Re found that there was approximately $17 billion invested in litigation funding globally in 2020, with more than half deployed in the United States. In the UK, $2.7 billion was on the balance sheets of the country’s top 15 finance companies last year, nearly double the figure three years earlier, according to data from law firm RPC. Some of the biggest specialty funders are Burford Capital LLC and Omni Bridgeway Ltd. Large investment firms such as DE Shaw & Co., Elliott Management Corp. and TowerBrook Capital Partners also got involved. The industry has tended to support plaintiffs, but is now pushing to fund defendants as well.

3. What are the potential returns?

Lenders typically receive around 30-40% of damages and recovered costs, said James Popperwell, a solicitor at London-based Macfarlanes. Litigation funders in Australia have achieved an average annual return on investment of 400%, with a success rate of 96-98%, according to figures cited by the American Institute for Legal Reform in April. The outlook for the industry looks promising, as litigation opportunities tend to increase during economic downturns, when litigation and insolvency proceedings increase.

4. What makes a successful investment?

A fund manager will spend a lot of time researching the applicant and the legal landscape before becoming involved. They will also consider the quality of the lawyers and whether the other party can afford to pay. A good case usually has much larger damage multiples than the case budget.

5. What are the risks for investors?

Investments are hard to sell and cases can take years to resolve. Investors often get nothing in return if the case does not go through and can end up with heavy legal costs, sometimes also for the opposing party. Even if a case is won, the amount awarded by the court may be lower than expected. Thus, funders typically build a portfolio of diversified cases to spread their risk.

Because financing deals are private, judges often don’t know how much money the injured party has agreed to pay investors if their claim is successful. Sometimes a fund will end up with a larger share of the damages than the plaintiff.

Critics say the vast sums now invested in litigation distort the purpose of the justice system: rather than resolving disputes, cases are now about declaring winners and losers. More and more fringe and risky cases are being brought to court, dragging commercial defendants into litigation when they should be concentrating on running their businesses, and leading to frivolous or abusive cases that have little chances of success. In 2015, a long litigation campaign against oil giant Chevron Corp., backed by several different backers, was found by a New York court to have escalated into a racketeering conspiracy involving bribery, coercion and evidence. manufactured. These accusations saw the backers walk away from the case.

8. What are regulators saying?

Following a series of speculative class action lawsuits in Australia, the government is starting to act. The proposed legislation would limit the fees of class action lawyers and funders to a maximum of 30% of any total payout and give courts the power to approve and adjust funding agreements. The United States and the European Union are also seeking to strengthen rules around the disclosure of third-party litigation funding.

More stories like this are available at bloomberg.com