Apractice that used to be illegal has now been accepted by the legal establishment – and is forming the basis of a new asset class for adventurous investors. Third-party litigation funding, in which a wealthy investor helps cover the cost of someone else’s expensive legal action in return for a share of any successful claim, once known as champerty, is expected to become more widespread.
For the investor, it’s a lot more exciting than stocks and shares. One trailblazer in this area is Toby Duthie, a Brit now living in the US. A former investment banker, Duthie is founder-director of Forensic Risk Alliance, a forensic accounting and investigations business.
“I got interested in litigation funding six years ago through my work at FRA in the UK,” he says. “I became familiar with the US litigation system while assisting European companies responding to US-based litigation. I learnt about the differences between the US and the various EU legal systems. For example, unlike in the UK, the application of contingency fees to plaintiff actions is permissible in the US (ie law firms are remunerated according to a percentage of the proceeds of litigation). Another important difference is that in the UK the losing party has to pay the entire cost of the litigation while, in the US, each party bears its own costs. At the same time, I also discovered that new forms of litigation funding were being developed in Germany and Australia.”
Duthie realised that, particularly in the insolvency area, there was a need for funding in order to allow insolvency practitioners to meet the costs of pursuing claims on behalf of their creditors (e.g. banks, shareholders, tax authorities). “Once I had made sure that there were no legal barriers to such funding being extended by a third party, it was clear that this could be the basis for developing a very interesting asset class.”
To this end, in 2002 he set up IM Litigation Funding with a group of lawyers experienced in insolvency work. So far they have funded some 50 cases, mostly insolvency-related and in the UK, but they are now dealing with non-insolvency matters as well and have twice funded claims in other countries.
“When deciding whether to invest in a case, we look at its legal merits, the cost of pursuit (including the risks associated with losing) and the defendant’s ability to pay. We require a 70 per cent chance of success based on those factors and only pursue strong claims.”
Duthie and his fellow IM shareholders have won more than three-quarters of their cases. He says nothing has yet gone disastrously wrong but admits that, at times. they have been poorly advised – they currently have a claim against a firm of solicitors they believe were negligent. “The key is to learn from experience – the most painful, but most effective, way to learn.”
They invest anything from £50,000 upwards, often co-funding with others (primarily hedge funds) to spread risk as well as increase access to capital. The amount of the investment is proportionate to the expected legal costs.
“If we win, we ask for reimbursement of our costs, plus 25 per cent to 50 per cent of the litigation proceeds after the costs have been met. We tend to see hefty returns. Our most successful case so far was a claim that lasted 10 months and from which we realised a return of more than 1,300 per cent. Other cases have a less profitable outcome. It’s important to look at returns overall rather than on a case-specific basis.”
Duthie’s personal investment in litigation funding – via IM – over the past four years has been £350,000. “I reckon the value of my investment has increased at least fivefold and I expect this to continue.”
He believes litigation funding has huge potential, both as an investment opportunity and to facilitate access to justice and that there is a growing number of good opportunities for it.
While its use so far has been limited mainly to large commercial cases, the Civil Justice Council (which advises the government on litigation funding) is expected to recommend shortly that it be recognised as an option in mainstream litigation. An individual does not need to invest through a “corporate vehicle” such as IM but can do so independently and directly.
Duthie says: “The legal establishment has come to realise the value of litigation funding in helping legitimate claims to be pursued and it understands that investors like us apply a crucial self-vetting process. After all, the pursuit of spurious or vexatious claims would be a very poor kind of investment.”