See you in court: Litigation finance special report
Litigation finance is a growing industry, but is it an appropriate opportunity for retail investors? Michael Lloyd investigates…
“Litigation Finance is a little like a John Grisham novel, there’s an interesting narrative to cases, a good guy and a bad guy, and human interest,” says Cormac Leech, founder and chief executive of online litigation crowdfunding platform AxiaFunder.
The litigation finance market is an intriguing, growing area with many advantages, from high returns to a social benefit of enabling claimants to take their cases, such as house repairs against landlords, to court.
There are currently limited options for restricted retail investors wishing to access the sector. Litigation funders either tend to be balance sheet lenders or they are looking for institutional, sophisticated and high-net-worth lenders. However, there could be more avenues for everyday investors as the sector increases in size.
“What’s interesting with litigation is that investors can make a nice return because it’s an area of finance that has not had as much capital access,” says Leech. “There’s also a social positive, as you can provide capital for meritorious claims, such as protecting property rights, making society function better so you can feel good about the investment from a moral point of view.
“Furthermore, the cases are intellectually stimulating.”
The area is certainly on a high growth trajectory, with figures from law firm RPC showing that the value of court cases and cash directly held by UK litigation funders reached a record high of £1.9bn in the 2018/2019 year.
Read more: AxiaFunder set to switch to ‘tax efficient’ partnership model
This represented a 46 per cent rise from £1.3bn the previous year and is a huge jump from £378m in 2014/15.
“The market is growing rapidly,” says Kenny Henderson, a litigation partner at law firm CMS.
“We haven’t yet seen the swathe of Covid-related litigation that many have predicted, but it remains early days and Covid likely will lead to significant claims in the coming years.”
UK retail investors can invest in litigation funding through P2P business lending platform Money&Co, while EU investors can access the sector through European lending marketplace Mintos.
Money&Co was attracted to this area due to having several lawyers within its team. It lends to a legal firm which decides on which cases to pursue.
Within litigation finance, the platform focuses on financial mis-selling and housing disrepair claims with the average funding per claim being around £3,000.
“It has taken us a long time to fully learn about the market and establish a position,” says chief executive Nicola Horlick.
“It isn’t for everyone, and it is difficult to break into without knowledge of how lawyers work.
“It is a good opportunity for retail investors. It is particularly attractive to hold in an Innovative Finance ISA as the average yields after fees are seven per cent.”
Mintos added UK litigation funder Fenchurch Legal to its marketplace in July, as another option for its retail, high-net-worth, sophisticated and institutional investors based in the bloc.
Each separate claim is listed individually as a business loan on Mintos and the majority are small ticket claims which take between nine and 12 months, and are for house repairs.
If the case is won in court, the claim is repaid by the defendant. If unsuccessful, each claim on Mintos comes with an attached insurance policy that covers the repayment upon the case resolution.
Read more: The letter of the law: Exclusive interview with AxiaFunder’s Cormac Leech
Lukas Alijošius, partnerships executive at Mintos, says adding Fenchurch Legal loans was one of the platform’s most successful launches in over 18 months.
“The first batch of loans was wiped out in the first day,” he says.
“There’s a lot of demand in the market especially post Covid. Litigation finance in the UK is gaining traction and is a growing area for investment due to the UK’s favourable legislation environment.”
However, investors need to do their due diligence and only invest if they believe it is right for their risk profile.
Cases are complicated and illiquid, money can be tied up for years and investors face the possibility of losing all their funds.
In the UK, litigation claimants can be responsible for paying the defendants’ legal fees if they lose, so many funders take out After the Event Insurance (ATE).
This is where an insurance company agrees to pay costs to the defendant if the claimant loses the case, in exchange for getting paid a premium – either the full amount upfront or contingent on the claimant winning the case.
“It’s quite high risk but in strong cases with reasonable prospects of recovery, reasonable returns can be made,” says Luke Harrison, partner at law firm Keidan Harrison.
AxiaFunder has been exclusively catering to high-net-worth and sophisticated investors for the past two years. It offers a whopping 55 per cent average annualised return on cases won to date.
“This is a very high number, in the long run we expect our average returns to come down to 20 to 30 per cent per annum, and we expect to have some losses,” Leech explains.
AxiaFunder checks potential cases across 10 different criteria, including the defendant’s ability to repay. The platform also has ATE insurance and is soon launching a secondary market to bring investors more liquidity.
Read more: First secondary market trade of litigation funding assets completes
Leech says the majority of AxiaFunder cases settle and avoid the courtroom. He says they expect to win 70 to 75 per cent of cases that settle and factor in a 50:50 outcome for those that go to trial.
“If we go to trial, maybe we miscalculated the situation because the defendant would settle unless they think they have an ace up their sleeve or a strong position,” he says.
“There can be an adverse selection in those going to trial, it depends on the day how the witnesses perform and what mood the judge is in. There are more wild card factors going to trial, so we want to settle beforehand to avoid any surprises.”
Before onboarding Fenchurch Legal, Mintos says that it completed its comprehensive due diligence process, then decided on its risk score for the litigation funder.
Alijošius says Fenchurch Legal only accepts claims that have an insurance policy, but investors should still do their own due diligence.
“We invite each investor to do their own due diligence and evaluate the investment opportunity according to their own investment strategy, considering the related risks,” says Alijošius.
“I personally think it is a very interesting investment opportunity with tremendous potential.”
Neil Faulkner, managing director at P2P research firm 4thWay, says that litigation finance is suitable for any investors willing to make a lot of effort to understand what they are doing and who want to take more risks for more potential profit. However, he adds that most investors should limit the amount they allocate to the sector to a relatively small proportion of their investing pot.
He says without deep, historical datasets on the risk-reward balance of litigation finance, assessing these opportunities is based on qualitative factors, but case assessors with lots of experience can predict the result correctly about 90 per cent of the time.
“So broadly speaking it’s possible to take a view on the risk-reward balance, which I expect will prove to be more than generous over time,” he says.
“You can only invest wisely and avoid selling into unnecessary losses if you are confident in what you are doing. That applies to any investment.”
Robert Hanna, co-founder of litigation funder Augusta Ventures, says litigation finance can be an appealing option for investors.
“I believe that a diversified pool of litigation financing is a very attractive proposition for investors and as such should be available for retail investors if they fully understand the risks and processes involved,” he says.
“Saying that, it is practically very difficult for retail investors to gain access to litigation funds apart from through the listed shares of some of our competitors.”
Leech goes one step further, claiming that litigation finance is not suitable for mass marketing to retail investors, but reveals that AxiaFunder may work on a product better suited to this type of lender.
“We think it’s more suitable for high-net-worth investors and sophisticated investors, as it’s a relatively complex, risky product,” he says.
“I think over time we will work to create a solution that gives investors the opportunity to invest into a larger number of cases via a single fund which will create a much higher level of diversification. It would be less risky and more suitable for mass-market retail investors.”
Read more: AxiaFunder launches first international case
Litigation funders and lawyers predict continued growth in the space, but some warn that returns may come down as competition rises.
“I think it’s a fascinating space, evolving for the last 10 years or so and is now really taking off,” says Hanna. “That evolution will continue.”
It’s not John Grisham’s ‘A Time to Kill’ or ‘A Time for Mercy’, but it may be a time to consider investing. e for those that go to trial.
“If we go to trial, maybe we miscalculated the situation because the defendant would settle unless they think they have an ace up their sleeve or a strong position,” he says.
“There can be an adverse selection in those going to trial, it depends on the day how the witnesses perform and what mood the judge is in. There are more wild card factors going to trial, so we want to settle beforehand to avoid any surprises.”
Before onboarding Fenchurch Legal, Mintos says that it completed its comprehensive due diligence process, then decided on its risk score for the litigation funder.
Alijošius says Fenchurch Legal only accepts claims that have an insurance policy, but investors should still do their own due diligence.
“We invite each investor to do their own due diligence and evaluate the investment opportunity according to their own investment strategy, considering the related risks,” says Alijošius.
“I personally think it is a very interesting investment opportunity with tremendous potential.”
Neil Faulkner, managing director at P2P research firm 4thWay, says that litigation finance is suitable for any investors willing to make a lot of effort to understand what they are doing and who want to take more risks for more potential profit. However, he adds that most investors should limit the amount they allocate to the sector to a relatively small proportion of their investing pot.
He says without deep, historical datasets on the risk-reward balance of litigation finance, assessing these opportunities is based on qualitative factors, but case assessors with lots of experience can predict the result correctly about 90 per cent of the time.
“So broadly speaking it’s possible to take a view on the risk-reward balance, which I expect will prove to be more than generous over time,” he says.
“You can only invest wisely and avoid selling into unnecessary losses if you are confident in what you are doing. That applies to any investment.”
Robert Hanna, co-founder of litigation funder Augusta Ventures, says litigation finance can be an appealing option for investors.
“I believe that a diversified pool of litigation financing is a very attractive proposition for investors and as such should be available for retail investors if they fully understand the risks and processes involved,” he says.
“Saying that, it is practically very difficult for retail investors to gain access to litigation funds apart from through the listed shares of some of our competitors.”
Leech goes one step further, claiming that litigation finance is not suitable for mass marketing to retail investors, but reveals that AxiaFunder may work on a product better suited to this type of lender.
“We think it’s more suitable for high-net-worth investors and sophisticated investors, as it’s a relatively complex, risky product,” he says.
“I think over time we will work to create a solution that gives investors the opportunity to invest into a larger number of cases via a single fund which will create a much higher level of diversification. It would be less risky and more suitable for mass-market retail investors.”
Litigation funders and lawyers predict continued growth in the space, but some warn that returns may come down as competition rises.
“I think it’s a fascinating space, evolving for the last 10 years or so and is now really taking off,” says Hanna. “That evolution will continue.”
It’s not John Grisham’s ‘A Time to Kill’ or ‘A Time for Mercy’, but it may be a time to consider investing.