Legal disputes can be expensive and risky. They can also hold a great deal of value, which is why a growing number of investors reckon they can insulate themselves against market swings by funding litigation in return for a generous share of the proceeds.
The industry is also growing in sophistication. A practice that started by catering to plaintiffs unable to finance expensive lawsuits against deep-pocketed companies is quickly evolving into an industry that will also bet on big-ticket commercial litigation: Contract disputes, patent and trademark litigation, insolvency litigation, international arbitration. All are growing areas for litigation funding. And institutional investors — from endowment and hedge funds to private equity funds — are taking notice by ramping up their efforts to pour billions of dollars to funds that invest in what they consider is a promising asset class. As Christopher Bogart, the chief executive at publicy-traded Burford Capital, recently told the Financial Times, litigation funding is “a regular part of legal economics.”
Legal disputes can be expensive and risky. They can also hold a great deal of value.
That may still be an overstatement in Canada where the practice is a little slower to hit the mainstream. Accepting money from third parties to fund cases in exchange for a share of the returns has been common in Australia and the United Kingdom, and to a lesser extent in the U.S, for the past decade.
Even so, there is far more interest in litigation funding in Canada than there was only two years ago, according to Edward Truant, one of three principals behind Toronto-based Balmoral Wood Litigation Finance, a “fund of funders” that invests capital alongside or in partnership with other litigation funders. “It is definitely picking up momentum,” he says.
If it has been slow to catch up here, it is because it took longer for the courts here to accept that providing financial support to a lawsuit does not necessarily violate rules against champerty and maintenance, when access to justice considerations apply. Then in 2015, the courts in Canada began opening the door for litigation funders to involve themselves in commercial litigation. So long as the funder does not stir up litigation, avoids meddling in the litigation or demands unreasonable rates of return, the courts can approve funding agreements.
These decisions caught the attention of litigation funders, who are now moving into the market offering different financing options. This openness has caught the attention of litigation funders, who are now moving into the market offering different financing options. As Truant observes, “the consumer side has proven to be a very good asset class, both in Canada and the U.S.”
Now, lawyers and law firms are starting to consider how litigation funding can help them mitigate risk and manage cash flows for their clients. “We are starting to see applications from clients who can afford to litigate,” says Tania Sulan, the chief investment officer at Australian-based Bentham IMF Capital Limited, one of the largest publicly traded litigation fund heavyweights.
Typically, funders will advance legal fees, expert reports, other disbursement costs and covers adverse cost orders when the case is unsuccessfully argued. The funder may also provide working capital to the client. In exchange, funders are entitled to a financial return — usually a multiple of the investment or a percentage of the settlement — if the case gets settled or the funded party receives a judgment in its favour. If the case is unsuccessful, the funder loses its investment and the litigant owes nothing to the funder.
“We are not lending,” says Sulan. “We are providing a non-recourse investment and that makes what we provide a fundamentally different product than bank finance or some other loan instrument.”
But for commercial litigation funders to get involved, the potential returns have to be worth the time, effort and risk. Funders have different minimum claims thresholds. At Bentham the funding requested by a party must be at least $500,000 and the likely recoverable damages — excluding punitive damages —must be at least $5 million. Clients are also expected to have some “skin in the game” even if it is as little $10,000 or $20,000 if they have limited financial resources. “This thing” doesn’t come for free, says Sulan.
In most cases, that is. A truly insolvent entity might curry favour with a funder, says Ezra Siller, co-founder of Nomos Capital, a Canadian litigation funder. “Most clients or potential clients come having already spent of their own money on the case and they’ve kind of hit the limit of their budget,” he says. “Or they approach us wanting to do a risk sharing arrangement where they’ll pay 50 per cent and we pay 50 per cent,” he told attendees at the Toronto Commercial Arbitration Society Conference in April. “So there’s a variety of ways in which the plaintiff is not getting a complete free ride.”
There is a process to applying for funding, as funders obviously want to screen applicants and perform extensive due diligence on the file to gauge the financial viability of the case. That process will vary from one funder to the next, but the broad strokes are similar. It begins with a non-disclosure agreement with the client to protect confidentiality and privilege. The funder then conducts assessment of the merits of the case to determine cost exposures, the likelihood of recovering the settlement or judgment award, time to completion, and whether the likely recovery is adequate for the likely amount of funding that would be required. If all goes smoothly, the parties draw up a term sheet and, working with the lawyers, set out the broad parameters of the funding arrangement. Due diligence is then performed, and often times the funders will seek a second legal opinion, ideally using local counsel. That is followed by the negotiation and execution of the funding agreement. The monitoring of the case thereafter is where it gets sticky. “We play a role that’s akin to contributing to the brain trust,” says Siller. “The lawyer has certain expertise and experience and we strive to supplement that but we’re not controlling the case. The client’s in charge of strategy and settlement decisions.”
That has been the experience of Ira Nishisato, national leader of Borden Ladner Gervais' cybersecurity and cyber-risk management practice. Nishisato, who has worked with litigation funders on several cases, says that overall, then are mostly non-interventionist. “They have played a beneficial role in terms of project management and monitoring the conduct of the litigation,” adds Nishisato.
As with any emerging market, new developments are in the offing. Litigation funders such as Bentham are hoping to entice Canadian law firms with portfolio funding, something they have done with more than a dozen law firms in the U.S. Under this model, a law firm obtains funding to advance a basket of cases, all of which are handled on a contingency or partial contingency basis. Such cases could involve a client who may have a number of cases or it could be a number of cases that arise in a particular sector. The end game is the same, says Sulan who believes that portfolio funding will take off in Canada only when law firms and corporate clients “get comfortable with funding as a concept.”
Much of it also hinges on a law firm’s culture, says Nishisato. “It will depend to a great extent on the nature of the firm’s practice, the types of cases they take on, and whether they regard the risks of portfolio funding as risks they are prepared to take,” says Nishisato.
There is another market that could help litigation funding gain further traction in Canada – sub-million dollar financing support, says Truant. There are relatively few cases in Canada, outside of international arbitration, where millions of dollars are at stake, says Truant. There are however “quite a number” of cases that require funding between $100,000 to $500,000, a market exploited by at least one player in the U.K. and in the U.S. “We are going to need either one of those groups to come to the Canadian market or a fresh group to look at the sub-million financing opportunity to really expand the market.”
In the meantime, Truant is betting views on a Canadian market that he views has a lot to offer in terms of low-hanging fruit, blessed with exceptional returns, just as private equity was in the 1970s. Balmoral Wood recently raised $30 million from high-net worth Canadians and family offices. Those investors, he says, are attracted to returns largely uncorrelated to the stock market, or to other asset classes. What’s more, there are more cases that are looking for financing than there is financing available for those cases. “There is an element of inefficiency in the marketplace that we felt was reminiscent to the early days of private equity,” says Truant.