Historically confined to David vs Goliath claims, a new band of dispute funders are pushing the model into new frontiers. How far can they go?
Hedge fund methodology – the process of using hard numbers to make statistical predictions – is not part of a dispute lawyer’s traditional armoury. Yet the same kind of financial calculation used by banks and asset managers is not just creeping into the disputes market, but threatening to have a significant impact on it.
In January, Burford Capital, the AIM-listed litigation and arbitration funder, announced that it was providing $45m in ‘litigation financing’ to a FTSE 20 company, which subsequently turned out to be BT.
The deal is part of a litigation portfolio financing strategy that Burford has been honing in recent years and is targeted at BT’s pending collection of disputes. In a statement, Burford said: ‘Previously, the company paid for the significant legal fees and expenses associated with litigation out of its own revenues, thus reducing operating profits. With the Burford arrangement, it has transformed how it manages litigation expense.’
The key to this product is that it gives BT an alternative to paying legal fees by the hour. It takes some legal expense off the balance sheet and does not affect operating profits. BT has a fighting fund to take on cases and Burford receives ‘a portion of the proceeds from the litigation matters in the portfolio on a cross-collateralised basis’.
Michael Madden, head of Winston & Strawn’s litigation practice in London, believes this model is going to look attractive to big litigants: ‘It’s likely that in the next few years large corporates and financial institutions with a big litigation spend will look at this sort of deal and seek arrangements where they can share the risk and reduce some of the cost of litigation generally.’
‘Large corporates with a big spend will seek arrangements where they can share the risk and reduce some of the cost of litigation.’
Michael Madden,
Winston & Strawn
Burford’s deal with BT also shows that funders are now prepared to work on the defendant side, having previously focused on supporting claimants seeking significant damages.
Nick Rowles-Davies, who leads Burford’s business in the UK, says: ‘We look at litigation as asset and give finance for that asset. One-off cases are only about 30% of what we do now. We have large amounts of capital to deploy and it’s an inefficient use of resources to do lots and lots of one-off cases.’
The theory with portfolio financing is that with a group of homogeneous disputes, the funder does not need to perform exhaustive due diligence on each individual case. It can analyse the strength and worthiness of the portfolio overall and take a view on whether wins will outweigh the losses. For funders, it can be a better way of spreading their exposure to risk.
As part of this increasing enthusiasm for portfolio funding, Therium Capital Management is in talks with several law firms, including Harcus Sinclair, to create an alternative business structure (ABS). By financing its own ABS, it is expected both the funder and ABS will be able to make decisions and bring claims more quickly. It’s a model that is clearly gaining credence among litigation funders: in January, Burford was granted its own ABS licence, meaning funders are no longer simply patiently waiting for law firms to approach them with potential funding opportunities.
New models
Burford’s BT venture is one of a series of novel moves. In October 2015, it also announced a €30m agreement with Hausfeld, the claimant law firm focused principally on antitrust litigation and class actions, to enable the firm to launch claims in Germany and to open a branch in Berlin. It is thought to be the largest facility provided to fund litigation in Germany, where lawyers are prevented from using contingency fee arrangements.
Rowles-Davies says that Burford is essentially providing the client with a synthetic alternative fee arrangement that doesn’t breach German conduct rules.
In December, Burford and Hausfeld announced that Hausfeld was intending to bring a case against Volkswagen (VW), following the controversy surrounding its emissions testing. Burford said it would be providing ‘additional and substantial’ financing for Hausfeld to take the case on.
A sorry Chevron tale
Litigation funding is not without controversy and one notable example is three funders that have pulled out or been forced to pull out of a long-running environmental case against Chevron in Ecuador.
In 2011, an Ecuadorean court awarded $19bn in damages following allegations that Texaco, now owned by Chevron, had dumped toxic waste and spilt oil over an 18-year stretch. The decision was upheld by the higher courts, although the damages were reduced to $9.5bn. However, in 2014, the US courts ruled that the award had been ‘obtained by corrupt means’ and found that the plaintiffs’ attorney, US-based Steven Donziger, had submitted ‘fraudulent evidence’.
Woodsford Litigation Funding is the most recent funder to finance the case. Woodsford invested $2.5m in 2013 but was faced with a law suit from Chevron in 2014 for its part in the allegedly fraudulent claim.
Woodsford has refused to comment on the debacle. In a statement last year it said that it had acted in ‘good faith’ but in light of concerns over the ‘ethical standards of attorney Steven Donziger’, it had decided to ‘forego any financial benefit from this matter and to relinquish its entire interest in the proceeds of the litigation to Chevron’.
Woodsford chief investment officer Steven Friel, who joined from Brown Rudnick last year, says that the funder is in good health: ‘I did my due diligence before joining and I would not have joined unless Woodsford was on a positive trajectory.’
It was a bad experience for Woodsford and serves as a reminder that litigation funding is not without risk. However, funders and lawyers point out that this is just one negative story among many successful ones – although the furore around the Excalibur case in 2014, where the funders were found liable for indemnity costs (see ‘Double-edged’) and the Stone & Rolls case, which was the first high-profile defeat for a funded case in 2009 – are two notable exceptions. If a lesson is to be learned from Chevron, funders suggest that it simply confirms the importance of thorough due diligence of not only the case but also the client, the lawyers and indeed, the defendant.
Burford is not the only funder to become involved in the VW scandal. Bentham Europe is another funder that has chosen to openly declare war on large corporates. Traditionally, funders have mostly acted at arm’s length, but rather than waiting for lawyers to approach it with funding opportunities, Bentham seeks out potential disputes and plays a pivotal role in assembling possible claimants. Its bold tactics are aligned with its financial backer, activist hedge fund investor Elliott Management: Bentham Europe is a joint venture between Bentham IMF, an Australian-listed funder, and subsidiary entities of funds managed by Elliott Management. It has teamed up with US law firm Quinn Emanuel Urquhart & Sullivan to seek recompense for losses incurred by VW shareholders as a result of the emissions scandal.
‘We look at litigation as asset and give finance for that asset. One-off cases are only about 30% of what we do now.’
Nick Rowles-Davies,
Burford Capital
Bentham Europe is also working with Stewarts Law to develop a shareholder action against Tesco, after the supermarket overstated its profits in 2014. As far as Bentham is concerned, litigation funding is now out in the open and developing a body of claimants.
‘Tesco is a good example of the important role we have in these cases,’ says chief investment officer Jeremy Marshall, himself the former London head of litigation and dispute resolution at Irwin Mitchell. ‘We brought the case to the market effectively and the market responded. A case like that can’t succeed unless the market buys into it.’
Stewarts Law partner Sean Upson says that the Tesco case demonstrates the appetite from institutional investors to take a case on without it impinging on operating profit: ‘You have claimants that cannot afford to bring claims and then you have a category like Tesco where we are acting for 50 or so institutional investors, most of which could well afford to bring the case themselves, but are looking for an off-balance sheet funding model. What funding allows us to do is say to these clients: “We can tell you that you have suffered a loss and you have a good claim, we have the experience to bring the claim and here is a funder who will cover everything, including after-the-event insurance. So, we can present you with a complete solution and if we win the case, it is all upside for you.”’
Bentham believes it is bringing something new to the market, quite different to the establishment: the group of seven funders that form the Association of Litigation Funders (ALF) – Burford, Calunius Capital, Harbour, Redress Solutions, Therium, Vannin Capital and Woodsford.
Marshall comments: ‘We are more institution-led I suppose. We aren’t predominantly looking at David and Goliath-type cases, which means that we are not being snooty, we are just looking at different markets.’
‘We aren’t predominantly looking at David and Goliath-type cases, which means that we are not being snooty, we are just looking at different markets.’
Jeremy Marshall, Bentham Europe
The David and Goliath model is something that established funders have typically sought: taking a claimant short of money and funding a case against a defendant with deep pockets.
Marshall is content for Bentham Europe to be considered different and not to be part of the ALF: ‘We have been very much an advocate for regulation and transparency and we have not joined the ALF. We don’t feel it provides the necessary degree of transparency. It regulates the investment manager, but you don’t know who is providing the money.’
Leslie Perrin, chair of the ALF and of funder Calunius, says the ALF performs capital adequacy checks on each member on an annual basis. ‘We have a code of conduct and a complaints procedure behind it, which is the mark of a self-regulatory organisation,’ he says.
Evolving market
As litigation funders have gained traction, they have typically sought large one-off cases with prosperous returns and performed detailed due diligence and risk analysis to ensure a higher chance of success. As such, the litigation funding market has stayed relatively small compared with the commercial dispute resolution market as a whole, because bankable David and Goliath cases are rare.
Yet now there has been a shift towards the smaller-value, higher-volume model. In February, Welsh law firm Capital Law announced the launch of a £50m litigation fund, in a move that is intended to finance smaller disputes (see box below). The firm intends to recover up to 25% of any damages or up to two times the amount of capital it invests. This is significantly less than the established funders, who typically seek to recover three to four times their investment (although this tends to be time-incremental; the earlier cases settle, the lower the multiple). Funders may also seek a higher multiple from higher-risk disputes. However, this model is not sustainable in smaller cases, because it leaves little room for the claimant to recoup their losses once the funder has taken its cut.
Law firm funders: Capital Law’s £50m war chest
Chris Nott, the founder and senior partner of Capital Law, says that traditional litigation funding products are expensively priced and are aimed at the high-risk market. ‘They price themselves out of the bulk of the cases that we deal with in courts every day,’ he remarks.
He believes that the process of convincing financiers to back a case is too clunky and that lawyers themselves are best equipped to assess the merits of a case: ‘What litigation lawyers do every day is underwrite, think about cases and evaluate the prospect of success.’
Nott had first-hand experience of litigation funding during the long-running Roadchef dispute – in which the firm succeeded on behalf of hundreds of employees who had spent 17 years in a dispute with the company’s former chief executive regarding its employee share option scheme, in a case that was bankrolled by Harbour Litigation Funding. Nott says that he had to think hard about how the funding model would apply to smaller cases. ‘The financiers on that case were best of breed. There is no criticism of them whatsoever; I am genuinely saying that. If it was not for the fact that they were first out of the gate and backed thousands of ordinarily employees, the claim would have been left stranded and as a consequence, we would not have got this result. Everybody knew what their terms were, but I kept thinking about whether there could be a way of doing things more cheaply.’
Capital Law has spent two years developing its own litigation funding model, which is broadly priced at half the three or four times the investment return that traditional funders seek, but it may be some time before Capital Law’s investors see positive returns. Says Nott: ‘A profit on the fund would be great, but that is not the reason why we have done it. It is about delivering a better service and generating more work for the law firm.’
The first case to be financed is a £1m claim for an SME against a government department. The second is a substantial professional negligence claim by the insolvency department of a Big Four accountancy firm against the former auditors. The fund is expected to last five years. Nott says he has had several lunch invitations from established funders who want to better understand his model.
Capital Law’s move could be something that other law firms adopt but it is unlikely to start a full-scale transformation. Says Norton Rose Fulbright’s head of dispute Resolution and litigation for Europe, Middle East and Asia, Deirdre Walker: ‘If law firms do look to put in place litigation funding arrangements, in many ways they will be competing with the likes of Burford and Harbour. I don’t see that happening any time soon as lawyers are naturally risk averse.’
Capital Law is not alone in identifying a strategy based on multiple smaller cases rather than the usual solitary dispute with a big payout. Augusta Ventures markets itself as ‘the UK’s largest provider of litigation funding for the SME market’. Since launching in January 2014, it has provided a total of £15.6m of financing to 68 cases. Co-founders Louis Young and Robert Hanna are ‘finance guys’ according to Hanna, who has spent over 20 years in the hedge fund industry, with Young also having an investment banking and fund management background.
Young was previously chief executive of Argentum Capital, which exited the ALF in 2014 after Hong Kong’s Securities and Futures Commission raised concerns over its main investor Centaur Litigation – although the ALF received no complaints about Argentum itself. This does, however, provide a reminder that litigation funding still has many detractors and the emerging industry has faced a number of high-profile reverses in recent years (see box, ‘A sorry Chevron tale’, above).
Burford is not the only funder associated with the VW emissions scandal. Bentham has chosen to declare war on large corporates.
Augusta’s focus on the SME market means it has even funded matters with damages of less than £100,000. ‘We offer a different fee structure to the traditional funders,’ Hanna says. ‘We know that over 90% of cases settle before they go to court and if they do go to court then more than 50% will resolve in favour of the claimant.’
Of the 68 cases that it has financed to date, 22 have settled so far and Hanna expects over 90% of the total caseload to settle.
Under Augusta’s approach, the funder, lawyer and client will usually all have some skin in the game; Augusta normally puts up 58% of the litigation cost. If a case is won, everyone gets their money back, and the claimant receives at least 50% of the net proceeds. Augusta typically takes about 20% of the net proceeds from a successful case.
In November 2015, the funder revealed that its cases were largely breach of contract and professional negligence claims, often against solicitors. It had invested between £7,000 and £570,000 per case and claimed an overall win-rate of 93%. Like most funders, Hanna is opaque on financial results, saying the fund and its investors are ‘comfortable with the returns’.
Investor appetite
While most funders do not reveal the identity of their main investors, the funding base has clearly expanded in recent years. In May last year, Therium announced that it had completed a £200m fundraising to invest in ‘large-scale commercial litigation, group litigation and arbitration globally’. In a statement, it claimed that the fundraising, provided by one ‘large financial services company’, was the single largest investment in litigation funding to date.
Therium co-founder Neil Purslow says: ‘It’s illustrative of the institutional investor appetite and the confidence there is in this market. When we started, we just didn’t have the track record to attract that kind of money, particularly from one investor. If we hadn’t been so successful, we wouldn’t have been able to raise this money.’
Certainly, with a welcoming investment climate, there is more capital being raised. Calunius raised £40m in 2011; its second fund achieved £50m in 2014; and Perrin says the third, which is likely to complete this year, will be bigger.
Burford has also taken advantage of the increasing investor appetite. In 2014, it completed a $150m retail bond fundraising on the London Stock Exchange.
‘Third-party funding has a long way to go. However, there is definitely a place for it and the more creative they can be, the better.’
Simon Bushell, Latham & Watkins
Much of this hunger is driven by the acknowledgement that litigation funding is expanding into new areas. While traditionally it has made an impression on the common law world, litigation funding is now being employed in civil law jurisdictions and notably in a number of international arbitration cases. Investor-state arbitration has captured the attention of the funders, because states are cash rich and can afford to pay any damages awarded. Perrin says many within the funding community are behind a number of Energy Charter Treaty cases against Spain.
Dan Craddock, chair of Vannin Capital, says that arbitration funding was relatively unknown in 2012, but now accounts for around half of the business and is ‘the fastest growing area for our industry’.
He says that this trend has further enabled the sector to move on from largely funding cash-poor entities. ‘We’re now seeing, at least for Vannin, typical clients being multinational corporates and sovereign states,’ he remarks.
With more of a global perspective, funders are targeting new markets. Harbour and Burford have launched offices in Hong Kong in the hope that Asian jurisdictions will become more amenable to litigation funding. So far they are much-less developed than the UK, US and Australia.
Bentham IMF reported a 60% surge in ‘viable investment opportunities’ in 2015. It announced that six funded matters had successfully or partially concluded, which included three portfolio deals with law firms. It had provided new funding to 15 disputes out of some 300 cases presented to it. In addition, it is launching an office in Toronto to add to its nine other offices around the world.
‘We’re now seeing typical clients being multinational corporates and sovereign states.’
Dan Craddock, Vannin Capital
This year, Therium will establish an office in New York. It is currently in negotiations with local lawyers to join the new branch and Purslow believes that, while the US market is reasonably developed, Therium can bring something new. ‘It’s not a saturated market at all. We have been doing this for a number of years, and we have been active for longer than many of the US funders. There are techniques, investment methodologies and experience that we can bring to the market.’
Value chain
While funders’ principal role is to provide the capital to get claims off the ground, they are gradually becoming more valued by the legal community. Deirdre Walker, Norton Rose Fulbright’s head of litigation and dispute resolution for Europe, Middle East and Asia, recognises that funders can provide additional expertise and discipline to a case: ‘One of the key contributions that the third-party funders bring to litigation is their rigour over budgeting. They are very good at that and they will continue to challenge law firms to project manage more efficiently.’
Craddock elaborates: ‘No one is more adept at assessing, calculating and then managing the risk of dispute resolution than a third-party funder. This is our specialism.’
Ben Knowles, co-chair of the global arbitration group at Clyde & Co, says that he appreciates the ability to ‘bounce ideas off’ other senior dispute resolution professionals. He also believes that the funding element forces a lawyer to be more commercial because of the need to persuade the funder’s investment committee a case is a good investment.
Simon Bushell, London head of litigation at Latham & Watkins, concludes: ‘The evolution of third-party funding still has a long way to go. However, there is definitely a place for it and the more creative they can be, the better.’ LB