- Funding could safeguard solicitor revenues
- Interests not guaranteed to align
Litigation funders do not fear recessions. The state of the economy has little bearing on the trajectory of court cases, and more insolvencies usually mean more disputes, which mean more investment opportunities. As an alternative asset class, lawsuits should shine in times of trouble.
And yet - investors are jittery. Shares in Litigation Capital Management (LIT) have fallen by 10 per cent since the company announced delays in its portfolio earlier this month (and almost a fifth year-to-date) and refused to provide further market guidance. In March, Burford Capital (BUR) attributed its first pre-tax loss to similar “timing" issues, and insolvency specialist Manolete (MANO) is still awaiting its post-Covid business boom, although Burford has shown resilience in the current market, its shares climbing a quarter in the past month.
The inherent lumpiness of litigation funding revenue – together with the industry’s lack of transparency – has still not resolved itself, it seems. But there might be an alternative for investors.
A growing body of solicitors’ firms are setting up third-party funding arms. Last September, Gateley (GTLY) teamed up with a US company to create a £50mn funding facility. A couple of weeks earlier, Mishcon de Reya – which has been poised to float for over a year – announced a £150mn funding venture. In the non-listed world, a variety of City titans are also getting involved.
Markets like these developments: Gateley’s share price rose by 11 per cent following its September announcement. At first glance, however, it's a strange trend. Solicitors are famous for their aversion to risk, and one of the reasons investors like law firms is their reliability. Operations are heavily regulated and revenue streams tend to be stable.
Litigation funding sits at the opposite end of the spectrum. The industry is largely unregulated, revenue is subject to the “vagaries of the litigation process” and even if a case is successful cash can prove elusive. These two business models are not likely bedfellows, therefore. How can investors evaluate risk and make accurate predictions given the different forces in play?
It might not be as high-risk as it seems, however. In the case of Gateley and Mishcon, third-party finance is used to fund cases run by their own solicitors – thus securing their own fees.
“Some firms got into litigation funding worrying less about the outcomes, and more about ensuring there’s a way of funding the cases they want to do,” said Tony Williams, principal of legal consultancy Jomati and former managing partner at Clifford Chance. “To that extent, it actually safeguards that income stream.”
When law firms and funders get too chummy, however, three words often spring to mind: conflicts of interest. RBG Holdings (RBGP) has always been vocal about this. The Aim-traded company owns Rosenblatt, a London-based law firm, and provides litigation funding via a subsidiary called LionFish. However, the two businesses are independent. LionFish does not fund cases run by Rosenblatt, and Rosenblatt only engages with third-party funders other than LionFish.
“Each business has to stand on its own two feet,” said Tets Ishikawa, managing director of LionFish. “A litigation funding business set up to help boost the revenue stream of a law firm is not a good proposition for any litigation funder. And a litigation funder cannot build a credible business by funding one firm.”
The interests of law firms and funders are often very different, according to Ishikawa. In most scenarios, solicitors get paid whether or not they win their case. If you are bankrolling a dispute, however, you want to be sure that it’s water tight. Motives will not always align, therefore, and firms risk alienating clients if their in-house funder refuses to cough up.
Beyond commercial concerns are potential regulatory risks. Law firms must ensure clients have the chance to consider different financing routes, for example, rather than pushing them towards their in-house team. And what if a case is wrapped up quickly, and the claimant suspects interference from their funder?
“Just to protect your own reputation you’d want to make sure you’ve got procedures in place to make sure a client can’t legitimately claim that,” Williams said.
Given the way litigation funding has developed in recent years, many clients are now sophisticated businesses with their own legal departments, reducing the risk of such clashes. However, class actions – in which large numbers of people are represented collectively – could come under scrutiny. In Australia, where the industry first rose to prominence, the former government tried to impose more regulatory burdens on funders dealing with such cases. These attempts have since been reversed by the new Labor government, but they highlight a lingering sense of unease.
For now, therefore, there’s no easy solution to the challenges faced by the industry. Business models are still being trialled, and regulation is still in its infancy. As the market matures, however, investors should be alert to the risks that underpin such generous rewards.
