The Nuanced Reality of Litigation Finance

The Nuanced Reality of Litigation Finance

“Litigation Finance” is a broad term for various types of investments that fund participants in the civil justice system. While these investments can theoretically take the form of any security, they are typically fairly vanilla in nature, most often taking the form of a credit or credit-like structure.  The investment thesis supporting modern litigation funders represents a  paradigm shift that recognizes legal claims as assets with value that can support capital investment. Given annual revenue in the legal services industry exceeds $430 billion, there has never been a better time to explore the space either as an investor or consumer of capital

However, some industry commentators (and particularly opponents) tend to overlook the nuances within Litigation Finance and as such, fail to recognize the distinctions between industry sub-sectors. There are three main unique investment strategies within the litigation finance market: Consumer Funding, Plaintiff’s Firm Lending, and Commercial Investing.

Consumer Legal Funding

Consumer litigation finance in the United States primarily serves litigants with non-recourse cash advances against anticipated settlements or judgments. The average size of these transactions is around $5,000. Presumably, many consumers who accept this type of funding do not have the option to borrow from more traditional consumer lenders. Advances typically serve to help borrowers meet pressing financial obligations. Being non-recourse, they can also be an attractive means to guarantee at least some recovery from a civil case. 

There are scores of small firms or solo practitioners funding consumer loans in small geographic regions via local or regional networks of plaintiff’s attorneys. There are fewer larger-scale players that tend to operate nationally; it is estimated that the total annual market volume is $600 million. 

Plaintiff’s Firm Lending

In this industry segment, loans and lines of credit are provided to plaintiffs’ law firms. In contrast to consumer legal funding, these contracts are secured by all of the assets of borrowing firms, including future fees from cases. Plaintiff’s Firms value this funding because it can meaningfully increase the probability of a successful case outcome, which can be subject to lengthy appeals and other delays. According to the Legal Finance Journal, the average time to reach a personal injury settlement is approximately two years, and that timeframe can be significantly longer if a case goes to trial. 

There are well over a dozen companies providing this type of financing, and, according to their websites, they focus on helping firms maintain solvency or manage irregular and unpredictable cash flows. 

Commercial Claim Investing

In the commercial litigation sector, funders provide litigants or plaintiffs with capital that effectively converts intangible/contingent assets into cash. That is, contingent outcomes are priced; and the risk (or part of the risk) transferred in exchange for part or all of the contingent outcome (in this case, the lawsuit outcome). This allows plaintiffs or plaintiff’s counsel to manage their own litigation risk. The cases most commonly financed in this segment are antitrust, intellectual property, international arbitration, and contract disputes. Typically, structures involve financing of up to several million dollars.

Total market penetration is still fairly low at 32% but continues to increase with top participants having broad market coverage. The large publicly-listed funders are based in the U.K and Australian markets, while U.S. funders typically draw from privately funded investment funds. Smaller funders sometimes operate as independent sponsors on a deal-by-deal basis.

As the industry expands we expect new market participants to drive further market specialization and development of new niche strategies. Overall, we view this as a net positive for the industry. Funding groups will differentiate themselves by developing best of breed specialties and overall liquidity will improve to support both funders and borrowers. Economic rents will undoubtedly compress as Litigation Finance becomes a more mainstream product. But until then, expect some wild competition - and may the best group win!