Undoubtedly, the past year has been unprecedented in modern history. As we enter 2021 hoping for an imminent solution to the global pandemic and respite in U.S. political turmoil, the volatility created by these events will continue to affect law firms and corporate clients for several years as they navigate an uncertain economy.
Law firms will run up against liquidity constraints that have influenced other sectors as they try to balance collecting fees from cash-strapped clients with preserving important relationships. This potential liquidity gap is one of the main drivers of continued demand from litigation funding recipients, as it allows law firms to offer more flexible client fee arrangements.
Throughout 2020, the litigation finance industry became even more deeply rooted in the U.S. legal system, as courts and bar associations continued to recognize the potential upside of increased access to third-party funding. With an eye toward the pivotal months to come, we briefly examine how these and other trends may shape litigation finance investments moving forward.
Market Transparency and Standardization
Detractors have frequently singled out the opacity of litigation finance. The necessary confidentiality of most transactions precludes the public from knowing which parties have received funding, and on what terms. The bespoke nature of litigation finance agreements further complicates matters, as deal terms can vary significantly depending on the type of legal claim, the risk associated with the individual case, and the funder’s investment philosophy.
Recent developments, however, have given us a glimpse of how the industry might achieve greater transparency. For example, the NYU School of Law’s Center on Civil Justice now maintains a dispute financing library that aims to be a “neutral repository for documents and media related to third-party litigation funding,” including case law and legislative history.
Another noteworthy example is the emergence of a litigation funding working group in Europe, which aims to simplify and expand industry transactions through the use of model documents. The group fuels hope for U.S. litigation funders relying on more transparent and standardized forms, deal terms, and pricing moving forward. While change will likely come slowly, the assistance of a credible industry association led by its most active participants could one day centralize these efforts. Ultimately, progress in the above areas could lead to better understanding and more efficient usage of litigation finance by attorneys and legal claimants, as well as investors.
The Regulatory Status Quo
U.S. litigation finance is subject to ad hoc regulations that vary from state to state--in some cases greatly. However, court and bar association attitudes toward third-party funding remained largely permissive in 2020, with the industry remaining free from specific federal regulation--despite marked efforts to implement such laws. With state-level decisions continuing to fall in the industry’s favor, we would not expect any dramatic deviation from prevailing regulatory sentiments.
Significantly, legislative attempts to compel court disclosure of litigation funding agreements have stalled, including a bill sponsored by Congressional Republicans as well as the Uniform Law Commission’s yearlong initiative to consider potential litigation funding laws. Defense attorneys seeking to obtain litigation funding documents during discovery have often failed, as well, with courts typically deeming these materials protected by the work-product doctrine in intellectual property-related matters.
Furthermore, two prominent bar associations expressed approval of litigation finance this year. The New York City Bar Association, which previously claimed that certain litigation finance deals violate the state’s rules against attorney fee sharing, determined in February that lawyers and clients benefit from “less restricted access to funding.” The NYCBA’s litigation funding working group also proposed changes to the state’s ethics rules that would more explicitly allow certain types of litigation finance investments. In addition, the California bar recently affirmed many of the best practices already employed by litigation finance firms in a comprehensive ethics opinion.
Growing Number of Participants Leads to Consolidation
Last year, publicly traded Australian litigation finance firm IMF Bentham merged with Amsterdam-based competitor Omni Bridgeway, forming a company with more than $1.5 billion in combined capital. This strategy paralleled that of Burford Capital, another large, public firm that acquired competitor Gerchen Keller Capital in 2016. While both deals are significant, they have been relative outliers in the commercial litigation finance market, even as it expands in the U.S.
Recently, we have witnessed a wave of new players enter the U.S. litigation finance market. Some newcomers have aimed to specialize in certain investment deal sizes or specific types of disputes, such as patent litigation, insolvency proceedings, and cross-border claims. (LexShares remains one of the few firms servicing the commercial case middle market and one of the only platforms giving retail investors access to the asset class.) As the number of active commercial litigation funders grows, however, we believe additional consolidation could occur, with the market’s largest providers seeking to become one-stop funding providers for attorneys and clients.
Arbitrations and Settlements Expected to Increase
The U.S. legal system is not known for its efficiency. Court closures that first occurred last year have exacerbated these issues, extending litigation timelines and the already lengthy waits for trials. Ongoing public health restrictions remain possibilities for various state and federal courts--even as jurisdictions become more acquainted with new procedures for processing cases and hearings.
These difficult realities have pushed more attorneys to rely on arbitration as an efficient and cost-effective path toward dispute resolution. In the pre-pandemic world, arbitration may not have been the most expedient option for resolving complex or high-stakes commercial disputes. Amid COVID-19, however, arbitration has experienced only minor delays, and the entire process can now take place remotely thanks to the widespread adoption of video conferencing technology. Thus, we see arbitration becoming an increasingly popular option for litigants moving forward. The number of claimants seeking capital to cover arbitration fees may grow as a result.
As trial delays force litigants to put courtroom animosity on hiatus, settlement may also become more feasible for certain disputes. Clients, forced to put their lives on pause or perhaps dealing with additional financial uncertainty, could reconsider what constitutes reasonable compensation for their damages. Plaintiffs, defendants, and their attorneys also have the opportunity to more soberly assess their negotiating positions. This forced pause in acrimony may catalyze an increase in settlement discussions and, as a result, might lead to a greater number of amicable resolutions.
The Investor’s Perspective
The first weeks of 2021 provided a stark reminder of the inherent volatility of public capital markets. In recent decades, investors have experienced record highs as well as dramatic lows, including the subprime mortgage crisis of the late aughts and the prolonged recovery that ensued. In light of these remarkable macroeconomic movements, we expect demand for high-quality alternative investment opportunities to increase as investors seek low-beta asset classes that reduce their portfolios’ exposure to systematic risk.
To that end, we at LexShares remain committed to continue sourcing single-case and portfolio investment offerings for our online marketplace. We thank you for investing with us and look forward to partnering with you in the year ahead.
Are you interested in broadening your exposure to litigation finance? LexShares Marketplace Fund II is currently accepting commitments from accredited investors. By participating in our second dedicated fund, LMFII investors can expect:
- Participation in all of LexShares’ marketplace offerings
- Increased portfolio diversification through a wide range of legal claims investments
- Enhanced access to an asset class traditionally reserved for institutional investors
This release may contain “forward looking statements” which are not guaranteed. Investment opportunities posted on LexShares are offered by WealthForge Securities, LLC, a registered broker-dealer and member FINRA / SIPC. LexShares and WealthForge are separate entities. Investment opportunities offered by LexShares are “private placements'' of securities that are not publicly traded, are not able to be voluntarily redeemed or sold, and are intended for investors who do not need a liquid investment. Investments in legal claims are speculative, carry a high degree of risk and may result in loss of entire investment.