Global litigation finance: a bright spot in the gloomy marketplace lending picture

By Gary Chodes on Friday 29 July 2016

OpinionAlternative Lending

eDiscovery and litigation finance are now disrupting the legal sector, similarly to fintech.

In the US, recent slowdowns in loan originations at large consumer marketplace lenders (e.g. Lending Club, Prosper, Avant) and a noticeable uptick in credit defaults have been covered extensively in the media.   In May, the sudden departure of Lending Club’s founder and CEO Renaud Laplanche came on the heels of an internal probe that revealed previously undisclosed improprieties.  This scandal broadly impacted investor confidence in the sector and has led to significant capital outflows. 

In the UK, media focus has been on Brexit and its ramifications:  a slowdown in UK economic growth which in turn would hurt small business lending, the primary activity of UK marketplace lending leaders such as Funding Circle. 

One could blame scandal and economic instability for the current slowdown in marketplace lending activity after several consecutive years of hyper-growth, but this slowdown is no surprise.  In fact, it was predicted by many experts as a natural period of “boom and bust” that all traditional financial services sectors experience, with periods of capital flight.

The alternative finance community should be looking for indicator trends that portend growth and seeking investments in areas not currently experiencing the downturn we see from the likes of Lending Club. 

A key area of growth?   Litigation Finance.  

US Legal Services Market and Legal Tech

US spending on legal services exceeds $250bn.  In the same vein as the fintech revolution that has disrupted financial services, “legal-tech” is disrupting the US legal sector. And like marketplace lending, litigation financing is positioned at the intersection of technology and finance in the legal services world. 

Overall US spending on ‘eDiscovery’ - the ‘litigation component of legal-tech- exceeded $6bn in 2014, and is expected to nearly double to $11bn or more next year.  According to Scott Stuart, chief executive of Esquify, a leading eDiscovery platform,

"Growth investments in legal-tech at all stages have surged in the last two years, including by private equity giants like Stone Point Capital.  Global Players in eDiscovery now include Thompson Reuters, FTI Consulting, HP and Epiq Systems amongst others. kCura, the most dominant eDiscovery software platform in the space, based in Chicago, has attained ‘unicorn’ status after having closed a $125m venture round in 2015 led by Iconiq Capital in 2015."

US Litigation Finance Market

Overall, the US market for litigation finance has grown steadily for the last decade.  In the US, it breaks down broadly into four sectors; consumer, commercial litigation (non-intellectual property), intellectual property litigation and law firm lending. Virtually all of the financial backing for each of these sectors is from institutional investors.

Litigation financing of consumer claims, which started about a decade ago, now exceeds $500m on annually and is growing at more than 25 per cent annually.  According to the American Legal Finance Association (ALFA), its 37 members account for about 80 per cent of consumer litigation funding activity.  Consumer litigation finance players include established leaders such as Oasis, Lawcash and Golden Pear, as well as emerging players such as Signal Funding and DRB Capital.   Commercial litigation and IP litigation finance each likely exceed $1bn annually, but origination volume is harder to track than in the consumer litigation finance sector due to confidentiality agreements and the lack of industry standardized reporting mechanisms. Lending to law firms involved in litigation is exceeds $500 million annually. 

There has been a surge in US capital-raising in the last 24 months supporting commercial litigation finance.  Gerchen Keller alone raised $410m in its newest fund and now manages $1.4bn in assets dedicated to financing litigation. Longford Capital Management has already deployed the bulk of its initial $60m fund and is currently raising a substantially larger amount in its second fund.

In the commercial sector, examples of financed claims can vary widely, such as claims involving the BP Oil Spill, litigation stemming from corporate or investor fraud such as with Enron and “Madoff” and major product safety violations and recalls such as GM ignition Switch.  On the IP side, funding tends to back major IP disputes covering mobile technology and e-commerce, many involving patents; fewer investments have gravitated to bio-science or investments involving trademarks or copyrights.

UK/Europe Litigation Funding Market

The UK currently leads the world in publicly traded funds - such as Burford, Juridica, and Bentham Europe -- dedicated to financing parties in litigation.  London in particular has seen a surge in private fund raising activity in recent years   Participants include large players such as Harbour Litigation Funding - now with roughly $500m of assets under management and smaller funds such as Vannin Capital, Calunius Capital, ILF Advisors and Therium. 

These firms tend to focus on high-stakes commercial disputes involving larger businesses, often multi-nationals, including anti-trust, compliance and regulatory event-driven litigation.   It’s not unusual for major corporate scandals and executive malfeasance to attract well-heeled litigation funders.  

For example, Bentham Europe has announced its intention to finance shareholder litigation stemming from recent events at Volkswagen; the financing would help support litigation to allow shareholders to recover a portion of the roughly $25bn of market capitalisation lost at Volkswagen in the wake of its recent auto emission scandal.   At present, there is no active consumer litigation finance market in the UK or Europe.

Litigation Finance as Socially Responsible Investing

Much has been said about the inherent benefit of marketplace or peer-to-peer lending as a form of democratization of finance, a way for the little guy to invest in credit asset previously available only to banks or other large institutional investors.   This model is most prevalent in the UK, where consumer marketplace lending leaders such as Ratesetter and Zopa rely almost exclusively on retail investors making small investments. 

In the US, the property finance end of marketplace lending such as. Patch of Land, RealtyShare, Fundrise and Realty Mogul tend to focus on bringing real estate investments to the small individual investor.  The merits of this approach have been widely hailed by many as a positive evolution in financial services, particularly in the aftermath of the credit crunch. 

Recent disclosures of corporate wrongdoing (as at Lending Club) and increasing credit defaults may burst this bubble somewhat, as the retail investor may not have completely understood the risks associated with these credit related investments.  Litigation finance also promotes a higher mission. 

In the US consumer legal finance market, funding typically goes to consumers that are at odds with large insurance company defendants; in these scenarios legal funding will often serve to level the playing field and allow the consumer to hold-out for a better settlement against a better-funded corporate defendant, and limits the likelihood of the desperate consumer being forced to accept a quick or low-ball settlement. 

In the case of commercial litigation finance, investments are often targeted toward situations involving corporate malfeasance, fraud, product safety and environmental harm.   Thus the presence of litigation financing itself serves to put additional pressure on corporations to compensate victims fairly in cases of clear wrong-doing or liability.

 As for the presence of individual investors in the litigation funding market, it remains to be seen if this approach will ever gain traction.  Given the inherent risk in litigation, and the substantial possibility of an outcome where the legal claim has no value, the market may be best suited to the institutional investor.

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