What is litigation finance?
Litigation finance (or Litigation Funding) was created to provide litigants in a lawsuit with capital from unrelated third parties to fund a litigation (or lawsuit). In exchange, the third parties receive a return of a portion of any financial recovery from the lawsuit.
Why was litigation financing created?
Lawsuits, especially class action lawsuits, are incredibly expensive and can take years to resolve. To that end, litigants and their attorneys conduct a cost-benefit analysis to determine if the litigation is worth the time, effort, and money - even if the case has merit. Keep in mind, many of these cases are against some of the largest corporations in the world who may have a “war chest” and can litigate your average law firm into the ground. Cue litigation financiers.
Litigation financing helps litigants, usually plaintiffs (the party suing) and law firms offset the cost of litigation by injecting capital to assist with litigation costs. Ultimately, litigation financing arms plaintiffs and their attorneys with the necessary capital to go “all the way” and see their day in court.
In return for the capital infusion, in the event there is an award or settlement, Litigation Finance companies receive a multiple on their investment due to the high-risk, and unpredictable nature of litigation. Companies that engage in litigation financing typically diversify and reduce risk by investing in a bundle of litigations, rather than a single case.
Litigation Finance and Regulation Crowdfunding
Historically, litigation financing was once reserved for high-net-worth individuals and institutions. For example, traditional funders are often structured akin to hedge funds, family offices, or very well-off individuals. Now, Republic has made it accessible enabling retail investors to participate in the potential upside historically reserved for the elite.
Litigation financing products can be offered under Regulation Crowdfunding (Reg CF) and Regulation A+. As such, opportunities in the litigation finance space can be open to all investors regardless of accreditation status—one of the main differentiators when compared to typical litigation funding. Unlike a traditional litigation fund, however, litigation financing on Republic is an investment in a single litigation, not a portfolio of multiple litigations.
Now, everyday retail investors can invest in litigation financing opportunities - specifically, in lawsuits - just like hedge funds have done for decades. Specifically, retail investors invest in a specific lawsuit with the expectation that the plaintiff will prevail and, as a result, get paid. The infusion of capital is commonly used by the law firm representing the law firm to cover expenses and costs associated with the litigation.
Investors should consider the high-risk nature of these investments given the unpredictable nature of litigation. Likewise, investors should be aware that the law firm representing the plaintiff typically do so on a contingency basis and typically: (1) receive 25-33% of the proceeds, and (2) are paid before investors. Further, there is no guarantee that investors will receive an upside on their investment and, statistically, they are more likely to lose than win.
Litigation Financing Offering Terms
Terms of the offering vary by deal, so it is important to research the offering documents before investing in any litigation financing. Some material terms include:
Downside Protection
Some offerings may contain “downside protection” characteristics where a portion of investors’ funds are held in escrow until a milestone is reached. If the milestone is not reached, a portion of the funds may be distributed back to investors on a pro-rata basis. There is no guarantee, however, that every deal has downside protection.
Potential Returns
Distribution to investors typically depends on three factors:
The length of time it takes to litigate the case;
The outcome of the litigation; and
The terms of the security issued
Notably, potential returns are dependent on the multiple types of outcomes that arise from a litigation. They also vary in duration, so investors need to review the terms of each deal individually. Typically, litigations with longer durations or those deemed to be higher-risk may yield higher returns (multipliers).
Risks*
Litigation financing is very risky and may result in a total loss of investment. Further:
There is a risk the lawsuit is dismissed, does not settle, or loses at trial or on appeal resulting in a total loss for investors.
There is a risk the lawsuit results in a nominal recovery insufficient to pay back investors and resulting in partial or total loss.
Litigation is risky and there is no set time frame in which a lawsuit must be settled or go to trial. To that end, there is a risk the lawsuit takes years to conclude resulting in an uncertain and highly variable time horizon.
There is a risk the lawsuit is dismissed at the motion to dismiss stage resulting in a total loss for investors.
There is a risk the lawsuit is dismissed on summary judgment resulting in a total loss for investors.
There is a risk the plaintiff prevails at trial but loses on appeal resulting in a total loss for investors.
In the event that the claim survives a motion to dismiss, but there is no successful recovery in the litigation thereafter, the associated investments will no longer have value and will become non-transferable.
Investing in a single litigation offering may be more risky than investing in multiple matters. Since these arrangements are secured only against the outcome of one litigation, the funders bear the risk in the event the claims are unsuccessful.
There is a risk there are more senior creditors who will make a claim to the litigation proceeds.
There is a risk the law firm litigating the matter withdraws as counsel.
There is a risk the law firm litigating the matter is sued for reasons separate and apart from the litigation which may adversely affect the litigation.
*This is not an exhaustive list of risk factors. Investors should conduct their own diligence on each investment opportunity. In the case of litigation financing, investors should read all pleadings and make their own determination as to whether the case will be successful. Litigation financing is risky and can result in partial or total loss of principal. Investing in a single case presents more of a risk than traditional litigation financing because risk is not diversified across multiple litigations and, instead, concentrated into an individual litigation. Do your own research. Invest at your own risk.
Invest in Litigation Finance