The Pandora's Box of Litigation Financing

September 18, 2017

"For Zeus had packed the box full of all the terrible evils he could think of. Out of the box poured disease and poverty. Out came misery, out came death, out came sadness - all shaped like tiny buzzing moths. The creatures stung Pandora over and over again and she slammed the lid shut."
-Pandora's Box, Hesiod
. . . . .
Ten years ago, San Diego-based class-action attorney William S. Lerach was found guilty of using kickbacks to recruit plaintiffs in more than 150 class-action lawsuits against U.S. companies.
Lerach did not invent the securities class-action lawsuit. But he helped it to evolve into the tool it has become. More often than not, Lerach was successful in his pursuit of alleged corporate wrongdoing. A factor of his efficacious targeting of corporate malfeasance, and the fact that companies would usually settle instead of litigate. Why? Because insurance would cover a settlement. But would not cover fraud if a trial went south.
Eventually, legislation was passed making it more difficult to sue big companies. Because while plaintiffs claimed to be doing the Lord's work in protecting shareholders and consumers from corporate wolves, many of the suits were blatantly frivolous. Brought for quick financial rewards.
Upon sentencing, Lerach was disbarred and sent to prison. From whence he cautioned that without the threat of securities class-action suits, boardroom buccaneers would have no real check on their corporate schemes. Even as the SEC might disagree.
Today, I'm not sure whether Mr. Lerach would be pleased or appalled. Though he would not likely be surprised. As his methods have evolved into something entirely new. An asset class born from the western world's litigious habits and love of high finance.
Born and developed in the UK, third-party litigation funding is the legal world's equivalent of private equity. A practice by which outside financiers fund large-scale plaintiff's litigation against companies perceived to have wronged shareholders, consumers or any one of a variety of constituents. Even as they reap the financial benefits of successful cases, litigation funders claim to be promoting corporate justice. A claim that often appears disingenuous.
Western society has become increasingly litigious. Though the opportunities to bring a lawsuit against a corporate defendant for any wrongdoing may seem infinite, plaintiffs often lack the funds required to successfully press such large and costly cases. And lack the resources to simultaneously identify and organize against the next corporate target.
Enter the litigation financier. Capable of providing historically successful plaintiff's attorneys a war chest with which to press their cases. While simultaneously organizing for the future battles. Regardless of current outcomes. In return, these funders claim a cut of any damages rendered or settlements incurred during the lawsuits they finance.
In other words, third-party, for-profit litigation financing. Like private equity. But instead of taking an ownership interest in a growing business, you find businesses believed to have committed some malfeasance, and sue them. And then identify another. And sue them. Ad infinitum.
Increasingly, major law firms perceiving an abundance of opportunity seek partners to invest in their litigation efforts. Making litigation finance teams in high demand.
Of course, when law firms share a profit motive with non-legal professionals interested not in righting perceived injustices so much as turning a profit from so doing? Problems ensue.
According to Lisa Rickard, the President of the U.S. Chamber Institute for Legal Reform, litigation financing arrangements increase litigation frequency, as well as the costs associated with such litigation. More troubling, however, is the fact that the litigation finance industry is unregulated and largely unseen. Seeking to turn a profit at the expense of the parties involved in litigation, attorney-client relationships and the integrity of the U.S. judicial system.
Even to the layperson, integrating a for profit function into the nation's esteemed judicial system would seem fraught with peril.
Nor do many entrepreneurs, creators, producers and C-suite executives realize the insidious trend threatening their efforts. Until, that is, they find themselves the target of such an action.
And with litigation funders awash in cash, we're now seeing the creation of litigation financing funds. Whereby litigation funders form investment partnerships, and then seek investment capital from accredited third-party investors looking to participate in the fruits of such litigation. Simultaneously enabling litigation financiers to mitigate the risk of bringing such suits on their own.
Following a successful capital raise, litigation funders use proprietary algorithms capable of mining for opportunities within the 1,000 newly filed federal and state cases per day. With the software flagging cases based upon such factors as the plaintiff filing the case, the type of claim, and the creditworthiness of the defendant.
Having watched the spread of litigation financing sense it entered the U.S. a decade ago, the U.S. Chamber of Commerce says the influx of capital is driving unnecessary lawsuits, and that funders have undue influence over litigation outcomes.
Not that the trend appears to be slowing.
Longford Capital Management LP recently announced a $500 million fund to be used as backing for corporate lawsuits in exchange for a piece of any eventual settlement or judgement. Rather like a private equity fund that doesn't create, add or build any commercial endeavor, so much as it seeks to win a legal ruling against the endeavor.
Nor have such opportunities just appeared. As competing litigation financing firms have raised and deployed hundreds of millions of dollars in recent months, reports The Wall Street Journal. With the industry accelerating as pension funds, family offices and wealthy investors are increasingly drawn to an asset class that is not tied to the broader markets.
Since its founding, Longford has allocated $137 million into 102 lawsuits. 43 of which have settled or been resolved, thus far, in a favorable way for investors. And the firm hopes to begin backing litigation pursued by universities and government agencies, in addition to the corporate litigation already being funded.
"The amount of growth to take place is extraordinary," said Longfords Mr. Strong, who previously worked at Morgan Stanley. "It reminds me of what private equity felt like in the late 1970s."
Well, minus the creation of jobs, economies of scale, productivity and GDP growth.
Burford Capital, a publicly traded firm and the industry's eight-hundred-pound gorilla, placed $488 million in new investments in the first half of 2017. Six-month profits-after-taxes were up 170 percent, The Wall Street Journal reported.
Will litigation funding become just another common asset class? No different than private equity, real estate or absolute return strategies? Only time will tell. But unlike other alternative investment options, litigation funding will likely have a detrimental impact on much of what it touches. Driving up the cost of doing business. Impeding the progress of ambitious entrepreneurs. While creating the need for businesses to defend themselves from aggressive, profit seeking pools of litigation capital.
Unfortunately for America's private sector, Pandora's Box has been opened. And the demons that lived therein will not be easily returned

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