Legal Risk Can Now Be Shared

By Louis Young, MD, Augusta

Insurance for a huge variety of commercial risks has been commonplace for centuries. However, legal risks such as the costs of litigation were not legitimately transferrable in England & Wales until less than a decade ago. The historic principles of Champerty and Maintenance barred a third-party from funding legal cases. But in 2013, Lord Neuberger, the president of the UK Supreme Court, adapted the rules in the name of enabling access to justice, and the litigation funding industry was born. Today, such funding is increasingly in demand from claimants and their lawyers, and by investors alike.

On the ‘demand side’, claimants with legitimate commercial disputes can readily access third-party litigation funding. Such arrangements differ to traditional insurance policies in that rather than requiring premiums to be paid in advance of the risk being taken on, no payment is required until a case is won or settled in favour of the claimant. Costs are in fact taken from winnings from the defendants. And should a case be lost, the funder takes the loss, without recourse to the claimant, who has no costs to pay. The process is a reverse image of standard insurance.

Louis Young

Such a risk transfer mechanism can be appealing to claimants in a variety of situations. Many legal disputes are unexpected. So those without legal budgets set aside for litigation can often find third-party funding attractive. So too can those businesses without the significant free cash flow required for funding of often hefty legal fees. But funding is increasingly attractive also to cash-rich organisations, who wish to manage their working capital and to transfer risks of litigation, turning a potential sizable liability into an asset.

Well managed funders have effective case management processes in place. Often combining analytical and legal skill, they assess cases on a variety of bases including not only the legal merits, but also the financial dynamics of the claim, the defendant’s ability to pay and the lawyer’s calibre. Such processes act as a filter, often leading to only 2-3% of cases offered to funders being taken on. This results in the funders enjoying a high success rate of 70% plus, as is the case with Augusta. The result is strong returns on capital that have not gone unnoticed on the ‘supply-side’ amongst institutional investors.

In today’s low yield highly volatile markets, many sophisticated investors are seeking innovative asset classes in order to diversify their portfolios. Money has flowed in increasing quantum into the litigation funding industry over the past several years, as savvy pension and credit funds seek to access this emerging asset class. Augusta, for example, raised £150m in 2018 and a further £195m in 2019 from significant institutions. Offers of additional capital are a regular event and seem set to increase given continuing macroeconomic uncertainty, in part accentuated by the worrying advent of the coronavirus.

The challenge for funders is to manage risk in their portfolios. It is all too easy for ambitious individuals with an understanding of litigation to seek to pile into the industry. From experience, it takes time to build effective risk management processes and to identify optimal segments of the market. The key is to select case types, jurisdictions and law firms who offer rational, predictable behaviours and outcomes. In much the same way as a commercial insurer, data on past cases and legal track records need to be modelled to understand potential risks and returns.

With hype around the industry growing, both investors seeking to place capital in litigation funders, and claimants looking for funding for their cases, should carefully consider the appropriate funder to work with. Those participating in the self-regulatory body ALF – the Association of Litigation Funders, promise to act transparently, fairly and to ensure appropriate returns for claimants. ALF membership demonstrates a commitment to good governance and fair businesses practices akin to established insurers. Given the low barriers to entry in the industry, it is feasible that poorly managed and undercapitalised litigation funders may be setup. ALF exists to assure both investors and claimants that its members are trustworthy counterparties.

In a little under a decade, litigation funding in England and Wales has gone from a novel phenomenon to a must-have for sophisticated litigation lawyers and their clients. Our recent survey with The Lawyer shows that 69% of solicitors expect the industry to grow apace in 2020. This trend on the demand side will only cement appetite on the supply side amongst investors. This offers such institutions strong returns, uncorrelated to traditional asset classes. Investors, however, should choose their investment carefully, looking at the quality of process and management of potential investees. Those litigation funds set up with the proper processes offer both claimants and investors insurance like returns and risk transfer. These are attractive in today’s uncertain environment and promise to widen access to justice, which is undoubtedly a social good.