With cash pouring into third-party funding, law firms are well-placed to enter the market and provide capital at lower rates. But they need to take heed of the risks, reports Rachel Rothwell.
THE LOW DOWN
As litigation becomes a popular asset for investors struggling to make much of a return elsewhere, third-party funders find themselves awash with funds – and in need of cases to invest in. This is likely to lead to more price competition between funders, with obvious benefits for clients.
The breadth of disputes now attracting funding is considerable, with many high-profile class actions currently being backed by funders. These range from the frenzy of truck cartel claims, to the VW emissions scandal, or more recently a precedent-setting collective action against Google for alleged misuse of data, being contested by the tech giant. More high-net-worth individuals are now using funding in relation to their trust disputes, while on the corporate side funders are finally catching the attention of general counsel. GCs are beginning to sign deals directly with funders – something that has always been a long-term goal of the funding industry.
The river of cash flowing into the litigation funding sector shows no signs of slowing.
In February, funder Therium completed a first close of a new £300m fund, on top of the £250m it raised in 2015.
A month later, rival funder Harbour launched its fourth fund, adding £350m of extra capital, bringing its total quantum of funds raised to £760m since its 2007 inception.
Also in March, the world’s biggest funder Burford Capital announced record results. The listed funder’s share price soared as it unveiled a 130% hike in net profits, to $264.8m for 2016/17. Burford now has a bulging investment war chest of $3.3bn.
Meanwhile two other funders, Vannin Capital and specialist insolvency funder Manolete Partners, are reportedly planning to follow in Burford’s footsteps with an AIM listing; and law firm Rosenblatt, which pulled off a £43m AIM listing last month, has set out bold plans to muscle its way into the funding market.
It seems 2018 is proving to be an eventful year for the sector.
In a climate in which it can be difficult for investors to wring much of a return from traditional investments, litigation – which is not aligned to mainstream economic trends – is becoming a very popular asset class.
For clients looking for financial backing to bring their case, the more funds available the better. But for existing players in the funding market, this is starting to cause a problem.
As Lianne Craig, partner at claimant law firm Hausfeld, explains: ‘As a firm, we were quite early adopters of funding, so we have always seen a high demand for it, even among our blue-chip clients. There is certainly a growing understanding of the funding market among clients and law firms; although there are still a significant number of lawyers who aren’t au fait with it.
‘But at the moment, there is actually too much money in the market.’
She explains: ‘There has been a real influx of funds into the market in the last few years. That is partly due to the perception that there are good returns to be made. We use funding a lot, so there would always be eager funders looking to work with us. Now, there is certainly more money available.
‘That is not a problem from the litigators’ perspective, as it means there is more choice in the market and pricing is more competitive. But I suspect that what it means for the less well-established funders, who do not have the relationships [with law firms], is that it can be difficult for them to place their funds.’
If the problem these days is not so much raising the capital as finding the plum cases to pump it into, then the recent announcement by City firm Rosenblatt that it intends to enter the funding market would seem a logical step. Lawyers, after all, have direct access to clients and their disputes, potentially giving them ‘first dibs’ on the best cases when it comes to offering funding.
SEARCHING FOR A RETURN
While litigation funders are active across the full range of commercial litigation and arbitration, some areas are proving particularly popular. Most of the major funders, for example, are involved in the litigation bonanza that followed a July 2016 finding by the European Commission that a cartel existed between several major truck manufacturers. Businesses affected by the cartel are now lining up to sue the companies involved, backed by funders.
The VW emissions scandal has also provided meat for funders, with Therium backing what is now the biggest consumer
legal action to have been brought in the UK, led jointly by Slater & Gordon and Leigh Day. Some 60,000 diesel vehicle owners have already signed up to the action, and with as many as 1.2m cars affected, that number could rise significantly. VW denies that its emissions software broke any UK or EU laws, and it has offered ‘technical fixes’ to more than 840,000 cars in the UK.
Misuse of consumer data looks set to be another goldmine for funders. Therium has agreed to provide £15.5m in funding for a precedent-setting blockbuster action being brought against Google. The collective action alleges that between June 2011 and February 2012, Google’s algorithms allowed it to trick people’s iPhones into releasing personal data from the phone’s default internet browser, Safari. Google has said the case has no merit and will be contested.
Vannin’s Rosemary Ioannou points to the variety of disputes that are now attracting funding. She says: ‘We are funding a huge breadth of cases – both litigation and arbitration – across the globe, in a single case, portfolio and group action basis.
‘There has recently been an increase in funding demand for high-net-worth trust and other offshore claims, as well as claims involving the real estate, construction and energy sectors.’
Much of Rosenblatt’s headline £43m flotation figure will not actually be going into its new war chest, as around £18m is being spent on repayment of loans and another £2m on tax. But the firm says it plans to use around £5m-£7m of the cash acquired through its AIM listing for the in-house funding of litigation and working capital. It has earmarked another £5m-£7m to buy up other litigation boutiques, and for investing in IT and artificial intelligence systems.
The firm’s CEO Nicola Foulston asserts that the AIM float will enable the firm to capitalise on changes in the legal market driven by regulatory reform and new technology. ‘We want to use the funds to take advantage of what is a highly fragmented market to engage in consolidation, as well as fund more litigation in-house’, she says.
Rosenblatt believes it will be able to offer funding at a lower cost compared with external funders; they will tend to want a return of at least three times their investment, or 30% of damages. But although law firms would appear to be perfectly positioned to enter the funding arena, many in the market are sceptical that Rosenblatt’s move is the start of a major trend.
Nick Rowles-Davies, founder and CEO of Chancery Capital, acknowledges that there is scope for the price of funding to start coming down. He says: ‘The funding market continues to evolve rapidly. We are seeing more competitive and innovative terms, portfolios for law firms and end clients, litigation being viewed as an asset class, more entrants into the sector and generally greater innovation.
‘Challenging traditional models and greater competition can only be a good thing. The market has been too expensive for non-distressed clients for a while now, and anything that makes it more commercially attractive and viable for clients generally should be viewed in a positive light.’
So is there a law firm-shaped gap in the market that lawyers could neatly squeeze into and provide funding at lower rates?
‘There is of course scope for law firms to offer their own form of funding,’ he says. ‘They can do so via their own “fund” or war chest to cover their damages-based agreements – after all, this is common (and accepted) practice in the US.
‘But there is a question as to whether law firms will pay disbursements such as counsel’s fees, e-disclosure and experts’ fees from their fund; so there is still a role for funders to play alongside those firms willing to take risk.’
Rowles-Davies adds: ‘But just because a firm is willing to do a case under a DBA, that won’t necessarily make it cheaper than competitive external litigation financing – especially if the client has a number of matters they want to run, and the external funder can offer terms on a portfolio or cross-collateralised basis. I’ve seen law firm DBA terms on a single case that are more expensive than external financing.’
For Neil Purslow, founder and chief investment officer of funder Therium, the problem for law firms that want to move into funding is that it will be harder for them to achieve the necessary spread of risk. And that risk could be substantial. ‘If a law firm gets the budget wrong, it could suddenly find that its investment is twice the size it had expected,’ warns Purslow. ‘Plus, in litigation, the timings are uncertain and the outcome is uncertain. A big funder can ride that out more easily; but law firms will tend to have more concentrated investments rather than a broader portfolio.’
Obtaining funding from their law firm could prove attractive to clients, however. ‘Clients are actively seeking more risk alignment with law firms,’ Purslow concedes.
Craig adds that litigators based in multi-disciplinary law firms may find it tricky to persuade their transactional colleagues that the firm should take on funding risk. She adds that despite the obvious synergies, the skills needed to be a funder as opposed to a lawyer are actually quite different.
She says: ‘Law firms are generally run by lawyers and staffed by lawyers. It is a different skill set to run a funding operation, where you need someone who can go out and raise the fund, and look at cases in a different way.
‘I’d be surprised if many law firms were actively looking at [entering the funding market] at the moment. But that might change in the next five to 10 years.’
The rise and rise of third-party funding is a trend that reaches far beyond UK shores.
Purslow says: ‘The US is interesting. I was at a conference in New York the other week and it was standing room only. It was like the kind of event you saw here [in the UK] in 2009/10, where everyone is trying to work out what funding is and how it works. You wouldn’t get that here now. It just shows where the US market is in relation to the UK.’
While the US has its share of litigation funders – including the world’s biggest, Burford – the funding industry has currently permeated only a fraction of the overall US litigation market, with plenty of room for growth.
Further south, as arbitration gains a greater foothold in south American jurisdictions such as Brazil – regarded as the second most litigious country in the world, with one lawyer for every 326 people, compared with one for every 300 in the US and one for every 401 in the UK – so too does funding.
Meanwhile in Asia, rival arbitration centres Hong Kong and Singapore have both amended their laws to facilitate third-party funding in arbitration, seen as essential in maintaining their allure to arbitrating parties.
Craig Arnott, managing director at Burford responsible for the UK, continental Europe and Australasia, says this new focus on litigation finance in Asia has been ‘the most significant development in the [litigation funding] sector in the last 12 months’. He adds: ‘Both Hong Kong and Singapore had previously prohibited litigation finance, but following significant education and lobbying – including by Burford - both jurisdictions passed legislation in 2017 opening the door to finance for arbitration. The amendment to the legislation reflects a growing demand for litigation and arbitration finance in Asia.’
Arnott says Burford will be keeping a close eye on what happens in Hong Kong, which is still to release its guidelines on the use of funding there.
Elsewhere, however, moves are afoot that could be seen as a gradual glide towards statutory regulation of the funding sector. Earlier this month, for example, Australian attorney general Christian Porter backed moves to license litigation funders as part of an overhaul of Australia’s class actions regime. Meanwhile in the UK, in his 2009 report, Lord Justice Jackson recommended that the third-party funding industry should be allowed to self-regulate; but he said the time would come when statutory regulation would be needed. The argument for statutory regulation becomes more powerful the more successful the industry is, the bigger it gets and the more it moves away from purely corporate clients to also embrace everyday consumers and high-net-worth individuals.
The Burford UK chief predicts that as well as the Asian expansion of funding, the other big development on the cards will come from general counsel.
He says: ‘We expect there to be a growth in corporate interest in funding, as GCs continue to proactively embrace litigation finance as a go-to tool to manage risk and cost, as well as to reduce the uncertainty around litigation budgets. We expect a number of corporates to look to the use of portfolio-based litigation finance, to not only provide an assurance about the reliability of capital sources, but also to be offered better terms.’
Signing up corporate clients directly has been a prize that funders have long hankered for. But aside from the occasional deal – such as Burford’s 2016 agreement to provide $45m of funding to a FTSE 20 firm, widely reported to be BT – this is something that has always been ‘talked up’ by the industry but has happened little in practice.
Now, however, the stars have begun to align to turn this dream into reality. Funders with bulging pockets are anxious to report back to investors that they have found new opportunities to place their cash – and rival funders are more likely to jostle with one another over price in order to secure the deal. Meanwhile, as the price of funding comes down, its reputation as a mainstream part of the litigation landscape has gone up. Third-party funding is now reaching the point where GCs and finance directors are not only aware of it, but are also comfortable with the notion of actually using it – if the price is right.
‘The funding of corporates is infrequent, but it is happening,’ confirms Purslow.
Rosemary Ioannou, managing director at Vannin Capital, says: ‘Beyond law firms, inevitably in-house lawyers and an increasing number of chief financial officers and financial directors within businesses are discussing funding directly with us. This is only going to increase, and the number of funding opportunities coming directly from businesses to funders is likely to rise exponentially.’
For funders, that would truly be a dream come true.
Rachel Rothwell is editor of Gazette sister magazine Litigation Funding (see lawgazette.co.uk/law/litigation-funding for details of how to subscribe)