Litigation Finance — The What, the Why and What Next!
An exploration of litigation finance, the implications for the various stakeholders, challenges and the future outlook, especially in India…
Currently, we are witnessing a low interest rate environment for traditional investment options. Investors seeking higher returns are thronging stock markets and exploring alternative investments. One interesting asset class I recently came across is litigation financing. Popular in the UK, US and Singapore, a litigation financier is an entity that offers to fund parties engaged in a legal dispute. Typically, claimants avail this third party funding. Financing could cover various costs involved including traditional court litigation, arbitration and mediation. Following the completion of the litigation process, the third party entity gains a certain percentage of the monetary reward recovered through the proceedings, which becomes its return on investment. In case the verdict isn’t in favour of the claimant, there are no returns for the funder.
An analysis of litigation financing can be done by looking at the various stakeholders involved: financiers, investors, claimants and the country’s judicial system as a whole.
Financiers
Financiers generally raise capital in a fund format, similar to a PE fund, and deploy that capital to claimants or law firms. Law firms, in turn, spread the capital over various cases and the fund secures returns from the combination of cases. Funders focus on certain aspects when deciding where to invest and the quantum of investment. These include the party’s involvement in the suit, the mettle of the legal team representing the party, the expected legal budget, ‘winnability’ of the suit, the size of the monetary reward and expected time to resolution. Long-drawn proceedings aren’t desirable as it increases uncertainty and risk and, unless the funder is confident of making returns commensurate with the risk involved, an investment wouldn’t be expected. Big-ticket commercial cases, class action lawsuits are some priority targets on the radar. With the implementation of the Insolvency and Bankruptcy Code and the overhaul of the Companies Act a few years back, the Indian litigation market seems to offer a lucrative proposition for financiers.
Investors
Investors stand to gain immensely as such an investment has the potential to provide very lucrative returns which is unrivalled among other investment options when comparisons are made across similar timeframes. The median annualized return for resolved investments after deducting fees and expenses is 52%, according to LexShares, a firm that has invested in 103 cases since its 2014 inception (70% of cases funded have won, the rest are ongoing). Adding this investment to a portfolio also helps in diversification since this is uncorrelated from traditional markets. It is, in a way, even counter-cyclical to the economy. As a relatively unexplored area, opportunities abound. However, there is risk associated with case failure, an event where all the capital deployed would be lost. There’s also uncertainty around the duration required to resolve the case, which depends on a multitude of external factors, not under the control of the fund or the investor. Thus, investors do need to exercise caution.
Companies and Claimants
Litigation and legal proceedings can prove to be a costly affair. Companies and entities may choose to not seek legal recourse to various situations simply because of the capital intensity involved. And, of course, there are also numerous inefficiencies riddling the system which results in long-drawn tedious proceedings. With litigation financing, however, entities get access to no-recourse capital and can source the aid of legal expertise to recover claims. In the event of success, they get access to the reward after providing the funder with the agreed-upon cut. In case of failure, while the claimant doesn’t get any monetary reward, there is no loss either. Without the weight of legal fees on the balance sheet, funds can be focused on core operations of the business and this contributes towards better financial health. And, with an experienced litigation funder backing a claimant, chances of success would be higher since there’s an alignment of goals and provision of good guidance to the party.
Judicial System
When it comes to the judicial system as a whole, litigation financing has immense potential to drive efficiency, improve legal access in the country, and create a level playing field. While big-ticket cases are what funders may look at, smaller-scale legal financiers may take up the small and medium-size cases. Legalist, for example, funds small business claimants seeking justice but who find it difficult to do so, being pitted against deep-pocketed corporations. Social justice can be facilitated through this as well when financiers fund claimants seeking justice but who don’t have the monetary power or legal awareness. Burford Capital has allocated funds to finance commercial litigation cases led by women. IMF Bentham, Johnson Winter and Slattery Lawyers have funded a class action lawsuit against Facebook for privacy breaches.
Challenges for Adoption
However, while this model is actively in play in various countries like the US and Singapore, it is to be noted that these are developed regions with stringent rules and lower incidences of corruption. There is a high potential for gaming of the system unless strong rules and regulations are in place. And, while the high litigation cost is indeed a barrier, one can argue that it is a necessary evil. It prevents overflooding of the system with cases that may or may not merit such levels of resolution. But, again, financiers might not take up such cases in the first place. There’s also the other side to the coin where medium to large players may leverage this to file suits against smaller players. Their existing financial advantage combined with funding support can serve death blows to the opposite party who, due to sheer financial overburden, could settle the case in the claimants’ favour, which is very dangerous to the society. Overplay of money power may lead to anarchy. Conflicts of interest, interested party dealings, confidentiality breaches and public policy considerations cannot be overlooked either.
Litigation financing in India is not illegal. While the Civil Code of Procedure explicitly allows such funding in some states, there is nothing in any book that bans such activity in the country. The Supreme Court, in Bar Council of India v. AK Balaji, acknowledged how advocate funding of cases is impermissible, but it didn’t mention any restrictions on third-party financing. Thus, if this asset class kicks off in the country, additional rules and regulations may have to be brought in, including transparent disclosure requirements of third-party funding.
While class-action lawsuits and cases which offer blockbuster rewards to claimants are lucrative prospects for financiers, such cases, specifically class action lawsuits, aren’t as common in India as in other developed countries. The average duration of proceedings is long as well. Databases that can provide historical data throwing data points required by fund managers to take a call on investment opportunities is still a work in progress. Risk-sharing with lawyers by requiring them to work on a contingency fee basis is not permitted in India.
Future Outlook
Despite a few wrinkles, the sector is ripe for exploration in India. Companies like Patel Engineering and Hindustan Construction Company have already taken this route. With the pandemic upending numerous businesses, suits to recover receivables could be on many cash-strapped firms’ agenda. Firms like Australia’s Omni Bridgeway and Abu Dhabi’s Phoenix Advisors have already expressed interest in establishing their India presence soon. These foreign litigation financing firms also plan to join hands with consultants and law firms to set up an Indian Association for Litigation Finance, as they venture into this nascent space. A factor to note here would be how the regulatory response might be towards third-party funding from foreign promoter entities.
The prodigious growth of ML, AI, data analytics, provides great incentive to deeply incorporate technology into the process. Investor interest in high-return assets is a natural factor favouring this investment vehicle. With the ongoing ESG investment focus, incorporating such a flavour to litigation financing could add to investor interest. Some other products merging financial instruments with litigation that can be looked at include insurance and risk transfer arrangements for claimants and defendants. Indeed, opportunities for innovation are plenty and the shaping of this new area would be an interesting one to observe.
