Litigation Funding: Private Equity Investment Opportunity and Portfolio Risk Management Tool

Litigation funding, the third-party financing of legal costs in disputes, is increasingly common in the UK. As litigants have become comfortable with sophisticated litigation funders, these funders are responding to business needs, and finding new disputes markets. The UK litigation funding landscape has begun to resemble the US, where external parties commonly finance a wide range of claims in return for a share of any ultimate litigation win. In our view, PE firms should consider litigation funding as a growth sector — and as a valuable tool for de-risking portfolio company claims.

Litigation Funding: Drivers of a Growing Market

Litigation funding is finding new markets. Increased use of group redress and group litigation orders is creating demand for funding. Following trends visible in American class action litigation, European legal systems are developing new group redress claims procedures. Germany and the Netherlands have well-established systems, and other jurisdictions (including the UK) are heading in the same direction. In fact, 60% of shareholder group actions are now outside the US. Group litigation includes related claims, e.g., mass torts affecting a large number of defendants, or similar-fact claims such as device malfunctions, or the VW emissions scandal. Group litigation can also facilitate unified actions where individual claims are financially unviable, such as shareholder actions.

Funders have targeted corporate insolvencies, when financing would not otherwise be available for entirely meritorious claims — an area that could prove increasingly lucrative in a downturn. Litigation funding is no longer just for those lacking the means to pursue claims. Entirely solvent companies are seeking funding to de-risk litigation downsides (cost of litigation, adverse costs, etc.), at the price of a proportion of the claim, or giving away upper or lower tranches of recovery.

While the mainstream litigation funding market is focused on high value cases (in which estimated cost/damages ratios are at least 1:10), funders have recently broadened their scope to fund litigation in high volume but low value claims, such as personal injury claims, in which a portfolio can be built on the basis that most will settle and generate funds.

As their influence grows, funders are also targeting the later stages of litigation by buying arbitration awards or court judgments, and taking on the enforcement and recovery risk. There is also a burgeoning industry for brokers linking litigants with funders.

Funding opportunities are also increasingly global. Hong Kong and Singapore recently relaxed prohibitions on litigation funding in international arbitration. Elsewhere, South Africa relaxed its rules in 2014 and large claims are now beginning to be funded. The Dubai International Financial Centre is also seeing cases that are third-party funded. Others will no doubt follow.

Litigation Funding as a Tool for Unlocking Deal Value

For deal teams considering an acquisition with potential claims, litigation funding can limit downside risk to the portfolio company and maintain some upside, albeit at the cost of giving away part of any ultimate recovery. Litigation funding could also monetise an unpaid judgment, saving time and cost towards the end of a case. In long-running cases that exceed the PE firm’s period of ownership, funding can also unlock value on exit by isolating litigation risk and providing comfort to future buyers.

Private Equity Investment in Litigation Funding

Funders are often seeking capital. PE firms should assess the life cycle of a funder’s cases against the buyout firm’s investment horizon and consider how long the case portfolio will take to see returns. Firms should also review the underlying risk profile of a funder’s cases, as these can vary widely. Funders have typically sought out other forms of investment, but as they seek to respond to increasing demand, opportunities for private equity may arise.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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