Litigation funding is taking off. Endowment and hedge funds, private equity and other savvy investors are pouring billions of dollars to funds that invest in litigation, enticed by ostensibly attractive returns. It’s also an area that is evolving quickly, and the market is experimenting with a variety of different types of funding arrangements. Litigation funding is no longer solely intended for funding class actions or personal injury suits. Corporate and insolvency litigation, international arbitration, and whistleblower suits are growing areas for litigation funding.
Accepting money from third parties to fund cases in exchange for up to 40 per cent of awards has been a staple in Australia and the United Kingdom for the past decade, with the U.S. not far behind. But for Canadian lawyers and law firms looking at litigation funding as an option to mitigate risk and manage cash flows and costs, it is still early days. But “there’s more interest today than there was two years ago and more interest two years ago than there was five years ago so it is definitely picking up momentum,” notes Edward Truant, one of three principals behind Toronto-based Balmoral Wood Litigation Finance, a firm that invests investor’s capital alongside or in partnership with litigation funders.
Litigation financing, still a contentious issue that raises concerns over the effect of outside money on the litigation process, is gaining traction following a series of court rulings that have relaxed and whittled away the statutory restrictions behind champerty and maintenance, an ancient doctrine that prohibited third-party funding. These decisions in turn have caught the attention of litigation funders and have led to a proliferation of financing options. So long as the funder does not stir up litigation, is not being overly controlling in the litigation or demands unreasonable rates of return, chances are the courts will approve funding agreements.
Consumer litigation funding and commercial litigation financing may appear to be similar on the surface but are very different beasts. To begin with, they serve two distinct kinds of litigants, one aimed at individual consumers while the other targets business interests. The size, scope, and terms of the deals are therefore necessarily different. Consumer-oriented funding usually involve matters with lower overall damages such as personal injury, malpractice or discrimination cases. “The consumer side has proven to be a very good asset class, both in Canada and the U.S.,” observes Truant.
Interest in commercial litigation funding is rising. A growing number of Canadian companies and law firms alike are interested in pursuing litigation funding to finance legal claims, raise capital and eliminate risk from the balance sheet. The widely-held assumption that plaintiffs turn to funding because they can ill-afford litigation is somewhat misleading, at least in this market.
“The view has always been that funding is for the financially distressed but the reality (is) we see more corporate clients approach us to take funding off their balance sheet,” said Katie Armstrong, director of international development at litigation funder and insurance broker TheJudge, at a conference this spring on third party financing. Tanya Sulan is more nuanced. “We are going to move into a phase where it’s not necessarily a product that is used when needed,” forecasts the chief investment officer at Australian-based Bentham IMF Capital Limited, one of the largest publicly traded litigation fund heavyweights. “We are starting to see applications from clients who can afford to litigate.”
Commercial financing, though, comes at a price and conditions have to be met. At its most basic, funders advance legal fees, expert reports, other disbursement costs and covers adverse cost orders if the case was unsuccessfully argued. The funder may also provide working capital to the client. In exchange, funders are entitled to a financial return, usually a multiple of the investment or a percentage of the settlement, if the case has been settled or the party received a judgment in its favour. All litigation funders provide funding on a non-recourse basis: if the case is unsuccessful, the funder loses its money and nothing is owed by the litigant. “We are not lending,” points out Sulan. “We are providing a non-recourse investment and that makes what we provide a fundamentally different product to bank finance or some other loan instrument.”
But to pique the interest of commercial litigation funders, millions of dollars usually have to be at stake. Funders have different minimum claims thresholds but at Bentham the funding requested by a party must be at least $500,000 and the likely recoverable damages — excluding punitive damages — must be at least $5 million. Clients are also expected to have some “skin in the game” even if they have limited financial resources. In other words, they are expected to contribute financially and it could be as little as $10,000 or $20,000. The point is, says Sulan, “this thing” doesn’t come for free. There are exceptions, says Ezra Siller, co-founder of Nomos Capital, a Canadian litigation funder. With a “truly” insolvent entity who “really has nothing” you have to take them as they are, says Siller. “Most clients or potential clients come having already spent of their own money on the case and they’ve kind of hit the limit of their budget, or they actually approach us wanting to do a risk sharing arrangement where they’ll pay 50 per cent and we pay 50 per cent,” explained Siller at the same third-party litigation funding conference. “So there’s a variety of ways in which the plaintiff is not getting a complete free ride.”
Through it all applicants are, of course, screened and undergo an extensive due diligence process to gauge the financial viability of the case. Again, while each funder approaches the process differently, the broad strokes are very similar. It begins with a non-disclosure agreement with the client in order to protect confidentiality and privilege. An assessment of the merits of the case is then conducted to determine cost exposures, the likelihood of recovering the settlement or judgment award, time to completion, and whether the likely recovery is adequate for the likely amount of funding that would be required. If all goes smoothly, a term sheet is signed with clients, and often with lawyers, to set out the broad parameters of the funding arrangement. Due diligence is then performed, and often times a second legal opinion is sought, ideally using local counsel, by funders. That is followed by the negotiation and execution of the funding agreement which in turn is succeeded by the monitoring of the case – always a sticky point. “We play a role that’s akin to contributing to the brain trust,” says Siller. “The lawyer has certain expertise and experience and we strive to kind of supplement that but we’re not controlling the case. The client’s in charge of strategy (and settlement) decisions.” That has been the experience of Ira Nishisato, national leader of Borden Ladner Gervais’ cybersecurity and cyber-risk management practice. Nishisato, who has worked with a number of litigation funders on a number of cases, says that overall he found them to be non-interventionist. “They have played a beneficial role in terms of project management and monitoring the conduct of the litigation,” adds Nishisato.
As with any relatively new market, new developments are in the offing. Litigation funders like Bentham are hoping to entice Canadian law firms with portfolio funding, something they have done with more than a dozen law firms in the U.S. Under this model, a law firm obtains funding to advance a basket of cases, all of which are handled on a contingency or partial contingency basis. Such cases could involve a client who may have a number of cases or it could be a number of cases that arise in a particular sector. The end game is the same, says Sulan. Besides being able to monetize some of their work in progress, it can help law firms with their cash flow as well as help mitigate some of their risk. So far, Bentham has had about a dozen inquiries from law firms, with three currently under “active” consideration, says Sulan who believes that portfolio funding will take off in Canada only when law firms and corporate clients “get comfortable with funding as a concept.” Much of it also hinges on a law firm’s culture, adds Nishisato. “It will depend to a great extent on the nature of the firm’s practice, the types of cases they take on, and whether they regard the risks of portfolio funding as risks they are prepared to take,” says Nishisato.
There is another market that could help litigation funding gain further traction in Canada – sub-million dollar financing support, says Truant. There are not that many cases in Canada, other than perhaps in cases dealing with international arbitration, where millions of dollars are at stake, notes Truant. There are however “quite a number” of cases that require funding between $100,000 to $500,000, a market exploited by at least one player in the U.K. and in the U.S. “We are going to need either one of those groups to come to the Canadian market or a fresh group to look at the sub-million financing opportunity to really expand the market.”
In the meantime, Truant is convinced that the litigation funding market will take off in Canada. In fact, he’s betting on it. Balmoral Wood recently raised $30 million from high-net worth Canadians and family offices. He views the market as low-hanging fruit, blessed with exceptional returns, just as private equity was in the 1970s. Litigation investments are attractive to investors because the returns in one case are largely uncorrelated to other cases, to the stock market, or to other asset classes, says Truant. What’s more, there are more cases that are looking for financing than there is financing available for those cases. “There is an element of inefficiency in the marketplace that we felt was reminiscent to the early days of private equity,” says Truant. “That’s one of the reasons why we started this fund.
This story is an adapted version of one published in the National.