As more traditional investment sources dry up, litigation funders are seeking to tap the private credit market. But the industry will have to adapt if such capital flows are to endure
The evolving nature of funds flowing in and out of the litigation finance sector came under the spotlight at Brown Rudnick’s packed European litigation funding conference last week.
Many traditional investors, such as pension and endowment funds, are pulling back from investing in litigation because macroeconomic factors, particularly higher interest rates, enable them to make quicker, less risky returns elsewhere. Instead, funders have begun targeting a new source of investment: private credit. The private credit market comprises professional lenders that are not banks, whose usual bread and butter comes from lending money directly to corporates.
As Brian Roth, CEO of private credit firm Rocade LLC, said: ‘The private credit market has exploded since the financial crisis [of 2007/8]. The reason you’re seeing interest from private credit [in litigation funding] is that we’re looking for assets that are complex or hard to source, that require a high degree of expertise to manage… [this] creates what we term the “complexity premium”, which allows you to source higher risk-adjusted returns.’
Roth added: ‘Private credit might fund funders, it might fund portfolios, it might look at insurance-wrapped portfolios. If you can segment the yield and the risk in the space, you’ll see private credit attach to the lower end of the risk spectrum. It’s already here and it’s growing.’
'I see the private credit beast playing a huge role. That’s partly a function of the weight of money that’s sitting there; so much has flowed into these funds'
Neil Purslow, Therium Capital Advisors
In a sign of the times, Therium’s Neil Purslow launched independent advisory business Therium Capital Advisors earlier this month, aimed at addressing the ‘relative paucity’ of traditional funding capital. Therium Capital Management, set up by Purslow in 2009 and best known for funding sub-postmasters’ claims against the Post Office, is now in runoff, having made its 30 staff redundant earlier this year.
Purslow said: ‘I see the private credit beast playing a huge role. That’s partly a function of the weight of money that’s sitting there; so much has flowed into these funds. There’s absolutely the money available in the space, but it’s very bespoke. This pool of investors is very diverse; they think very specifically about their strategy and approaches, how they want to underwrite it and so on. So tapping into that capital requires a much more sophisticated approach.’
Michael Gulliford, co-founder of Soryn IP Capital Management, struck a more cautious note. He said: ‘There’s a lot more money available in private credit, and there are only so many direct lending opportunities available – so that lends itself to niche, alternative, uncorrelated areas of private credit; and clearly [litigation funding] fits in that.
‘But at the same time, a true private credit investor is allergic to lack of solid collateral packages, allergic to deals that take too long, and allergic to deals that don’t generate return during the life of the investment at a minimum. Right now, it’s an attractive place for that capital to flow to, but whether it continues to do so will depend on whether the industry can put together structures that ultimately deliver on these hallmarks of private credit.’
In a separate panel session, several well-established litigation funders voiced concerns over some market activity. Robert Rothkopf, managing partner of Balance Legal Capital, said: ‘On recent fundraising trips, I found the seat was always warm from some outfit that had been pushing a structure I frankly didn’t understand. They were offering investors a percentage yield on their commitment; so they put their commitment in, and see this interest rate ticking up nicely over time, and they could even give a year’s notice and have their money back. And my question was, from what liquidity? The cases underlying it are not going to be generating that yield, so that’s a totally artificial IOU. It seems there’s this financial engineering – or rather dressing up – going on… which doesn’t match the actual underlying asset. That could cause problems.’
Susan Dunn, founder of Harbour Litigation Funding, said she was worried about some propositions ‘floating around the market’. She added: ‘I’m seeing a lot of people getting attention from funds with less experience, to invest in things where people like us would say, “hell, no!”. And I wonder if it is a numbers game, that they will eventually find someone who doesn’t know what questions to ask and so will invest… Things that really shouldn’t get off the ground, are getting off the ground. And if and when they go wrong, that reflects badly on us.’
2 Readers' comments