Litigation Funding Opportunity Not Purely Covid-19 Related
During turbulent economic times, the number of cases available for litigation funders – specifically, commercial litigation funders, i.e. business to business litigation - to review increases as more companies find it necessary to assert their rights during times of financial constraint.
Certainly, these are turbulent economic times, and Jay Greenberg, CEO of Boston and New York-based litigation funder LexShares, which manages private funds which invest in litigation assets, says that his firm has seen an influx of new enquiries from businesses who want to collateralize their pending lawsuits and ensure that their meritorious claims are able to be litigated to the fullest extent.
“Companies who might not have previously reached out to us are now doing so,” he said. “There’s definitely been a spike in pandemic-related activity.”
The increased activity by potential plaintiffs in the past six months is mirrored by a corresponding increase in investor interest in the asset class generally. Litigation funding is uncorrelated to equities and bonds because it’s got nothing to do with them. In times like March of this year when both equities and bonds fell simultaneously, uncorrelated asset classes like litigation funding can provide a portfolio hedge; when equities are on the rise, asset classes like litigation funding provide true alpha returns with no beta exposure, because beta exposure isn’t available in this asset class.
For investors wanting a piece of the action, as always, however, the devil is in the detail. Due diligence and manager selection are key, and Greenberg explains that the underwriting function of a litigation funder’s operations need to be scrutinised closely.
“To be a successful litigation funder, your underwriters need to be former litigators with deep experience,” he said. “This way you have the best chance of understanding the particular risks associated with a potential case investment.”
Modelling that success – or not – primarily comes down to three things: the merits of the case, i.e. how well the fact pattern of the case stacks up against the relevant law; the strengths of the plaintiff’s counsel and their track record; and the defendant credit worthiness (the case might be strong, but if the defendant can’t pay the funder, the win is meaningless to the funder as they won’t get paid). When a funder takes on a case, the risk inherent in litigation funding is usually structure upon the binary nature of the outcome of that claim; the funder typically wins or loses, unlike stock investing, where, whilst a share price fall means a loss to the investor, it’s not (necessarily) 100% of their investment.
Alongside evaluating each case on its own merits, taking on a large enough number of deals to diversify away single case risk is a natural piece of the risk management process for litigation funders but the other key is the financial acumen necessary to structure the deals that end up going into the portfolio.
“The pricing and structure that we provide to each plaintiff is case-specific,” Greenberg said. “It depends on a number of factors including our underwriter’s estimated risk profile of the case. It’s not a one size fits all contract that we offer to each plaintiff. Each one is tailored to the risk profile we produce.”
Whilst the Covid-19 pandemic is partly responsible, via the significantly reduced economic activity brought on by the lockdowns, for an increase in potential litigation funding activity, the opportunity set for investors is not reliant on the pandemic. Greenberg says that the penetration rate in the market is low and therefore has growth potential even in times of economic prosperity.
“The Covid-19 crisis has provided a tailwind to litigation funders, absolutely,” he said. “But the opportunity set is there regardless. There isn’t any publicly available data on overall litigation funding activity, but I’d be surprised if more than 250 single commercial cases were funded in the United States last year. In the context of the number of cases, I don’t think that the litigation funding industry is yet to scratch the surface.”
The Litigation funding industry has its detractors, who say that it encourages unjustified lawsuits and wastes taxpayer money. Some larger institutional investors have shied away from allocating to managers in the asset class because of the potential PR risk in supporting lawsuits which might be accused of being frivolous. Greenberg takes the opposing view, naturally, and says there is a bigger picture.
“The entire concept of litigation funding is to help right wrongs,” he said. “We see litigation funding as a mechanism to ensure that deserving cases are able to be decided on their merits rather than which side has the greatest financial resources.”
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