Litigation financing is a relatively new field that has recently attracted a host of hedge funds, including Juridica Investments, Burford Capital, Harbour Litigation Funding, Calunius Capital, Argentum Capital and Giltspur Capital. That the last of these is being wound up attests to the challenges players face.
To find out more about litigation financing—who provides it, what type of litigation best lends itself to it and why it's more prevalent in the U.K. than the U.S., FINalternatives Senior Reporter Mary Campbell spoke to Jeremy Walton, a litigation and insolvency partner with the international law firm Appleby.
Who provides litigation funding?
The insurance companies were one of the first waves to provide what's called "after the event" insurance, effectively a form of litigation funding. Then the second group is privately-held companies that get together, pool their assets and then use their expertise to advise on and then pursue litigation claims or invest in other litigation claims. Also, there are companies that have cropped up on both sides of the Atlantic that are in the litigation funding field, funds such as Harbor Litigation Funding, for example. The most recent group is the hedge funds whose business is investing in litigation, and we've helped form a few funds like these. One such fund is the Giltspur Capital.
You're seeing two types of hedge funds and investment vehicles getting involved in this space. One is, obviously, litigation funds per se; that is, the funds that raise money from investors in order to provide funding for other litigation.
Hedge funds are also getting involved as existing investors in defunct enterprises or with other hedge funds which have either got into trouble or have gone into some form of bankruptcy protection and have various compensation claims they want to bring, but lack the means to do so because the hedge fund has become insolvent.
Are there many hedge funds focused on this area?
I've seen relatively few, certainly, crossing my desk, in part because of two things. One is that the nature of litigation is such that it is not very easy to offer liquidity. Effectively, you're looking at a private-equity-type investment, which is one of the reasons why Giltspur, for example, is incorporated in Guernsey, a leading private-equity domicile.
The final reason why you won't see huge amounts in the offshore world is because of the difficulties that exist due to maintenance and champerty, a medieval legal doctrine which effectively bars people from buying stakes in other people's litigation. That's been abolished by statute in places like the U.K. and the U.S. and elsewhere, but it hasn't been abolished by statute in the Cayman Islands and some similar jurisdictions, which severely restricts the ability of people to get involved or invest in other people's litigation in return for a share of the spoils.
Why is much of the litigation funding coming out of the U.K.?
A lot of these initiatives arose in jurisdictions where they didn't have what you already have very well-established in the States, a contingency-fee bar which really diminishes the need for investors in litigation to get involved. Obviously, if you have a claim and you can persuade a contingency-fee lawyer to do it, you don't have to concern yourself with getting any kind of external funding because effectively the law firm itself is funding your case in return for a healthy chunk of the proceeds.
What factors would a hedge fund weigh when considering funding litigation? Obviously, chances of winning would be one.
There are really three things they look at. Firstly, as you say, the prospects of success. As well as getting the claimant's attorney's own estimate of the prospects of success, they will need to retain their own counsel to run the rule over the case and to come to their own view on prospects which will play a significant part in the pricing of the funding proposal.
The second thing they look at, obviously, is the likely costs to be incurred on behalf of the claimant in running the case through to trial and through appeals and so on and, in different jurisdictions of course, those costs can be effectively doubled by reason of the loser pays, a practice that applies in English and English common law-following courts, where the loser tends to pay the costs of the winning party.
The third thing that all sensible litigation funders look at is the risk in any particular jurisdiction of an adverse-costs order being made against the fund itself or the funder itself. In some jurisdictions there is some risk of the court looking through the claimant and saying, "Well actually, I'm not going to make the claimant who lost pay the costs of the successful defendant, I'm going to make the funder pay because it was the funder who enabled the claimant and caused the defendant to incur these costs. Without the funder there wouldn't have been any litigation at all."
Can the threat of litigation backed by a funder with deep pockets lead to an out-of-court settlement?
Absolutely. It's often a strategic point to make in early course for a claimant to say, "We are backed by X and therefore we have a large war chest and so we're not going to go away until you pay us a significant sum of money," and that can often result in an early settlement.
It's a strategic question, because it can cut both ways; in some jurisdiction it can be potentially harmful that you are subject to litigation funding because, as I say, of the risks of adverse costs and so on. But in other cases it's very helpful to let the other side know that you've got a large pot of money behind you. It's quite often inferred. If you see the liquidators or bankruptcy trustees of an insolvent company bringing these enormous claims. It's pretty apparent that the reason why they've been able to do that is they've been put in funds by a funder.
What types of cases lend themselves to litigation funding?
Class actions and securities litigation is already pretty well mined by the contingency law firms. It's really more for private claims and, in the offshore jurisdiction specifically, it's for the insolvency practitioners, the professional liquidators or bankruptcy trustees who need access to funding in order to recoup the lost assets, which is the very reason why they were appointed.
When you're in a bankruptcy scenario, where ex hypothesi you're looking at fewer than 100 cents on the dollar—where it's been caused by fraud, for example, and usually the nature of the fraud is that the company's been bilked and there's nothing left. But the very reason why you're looking at that level of bankruptcy, is against other people who may have allowed the fraudster to perpetrate the fraud—the service providers and auditors who failed to spot the fraud, other directors who stood to one side and let the fraudster steal the money or whatever it is. The fraudster may be in prison, may already have had his assets confiscated, or he may be on the run or hid his money. But there are usually professional third parties, deep-pocketed, insured third parties, whether they are audit firms or bankers or custodians or professional directors, who in some way allowed the fraud to happen or failed to prevent it from happening and may be pursued for claims. If those claims can be made good, that will restore money to the bankrupt estate and in turn increase the dividend to the unfortunate investors.
What sort or returns do litigation funders target?
I would say in general they are looking for private-equity-type returns, reflecting the risk and illiquidity involved. Often they're looking for real multiples of their investments, and that's one reason why you will find that amongst the professional litigation funding outfits, the number of cases they fund is a tiny proportion of the number of cases that they look at.
What sort of impact could litigation funding, and particularly the participation of hedge funds in litigation funding, have on the justice system?
Litigation funding certainly changes the litigation landscape enormously and it's been the subject of intense navel-gazing, certainly in the U.K., where the whole subject was subject to a review by an eminently respected senior judge, Lord Jackson, who produced a series of reports all about litigation funding which are now with the government for reform to the law.
But to answer your specific question, I would say not significantly more than the general impact of litigation funders, because the terms that hedge funds are offering to plaintiffs, or potential plaintiffs, they have to be competitive. As far as the plaintiffs are concerned, they're just another source of funding which they will weigh up against all other sources of litigation funding, whether they're conventional sources or otherwise. So I don't think hedge funds getting involved will really change things that much.