Litigation Funding can Generate High Returns For Investors but What are the Risks?

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You have probably heard of a lawsuit in which one of the parties was clearly right but had to resign because it could not keep up with the financial strength of its opponent. Too often, cases are won by those who can afford to fight for a claim.

Legal financing (also known as “litigation funding”, “litigation financing” and “lawsuit loans”) levels the playing field for plaintiffs and defendants. Litigation funding also unlocks the value of legal claims by advancing funds to plaintiffs or defendants before their cases are settled.

Critical points for interested investors

  • This investment strategy generally involves providing cash to litigants or attorneys to fund their litigation in exchange for a portion of the award of damages if the case is won. 
  • However, if the case does not work in your favour, that is, the plaintiff loses the case, you may have to say goodbye to all of your investment. 
  • According to the experts, funds held by many of these funding arrangements have lower overall risk.

Some investors can get a part of the lawsuit settlement without being involved in it.

It comes from investing in what is known as litigation funding, a strategy that generally provides cash to litigants or lawyers to fund their litigation in exchange for some of the damages awarded if litigation is won. 

Daniel Digiaimo, CEO of Baker Street Funding commented: “it’s a growth-focused market. As investors look for returns that don’t correlate with traditional markets, this small and largely unknown part of the investment world can provide consistent non-correlated returns.”

“Additionally, demand from plaintiffs or law firms seeking funding could increase as the economic impact related to the coronavirus leads to more lawsuits, which is common in recessions, and more demand for capital by individual plaintiffs whose cases have been extended due to court shutdowns.”

However, not everyone has access to funding for litigation or similar options; in general, you must be an “accredited investor”. That is, you must have an annual income of at least $ 200,000, a net worth of more than $ 1 million (excluding home equity), or a joint annual income with a spouse of more than $ 300,000. 

And the risk is significant, including potential eye-catching returns that end up being a fantasy. 

To invest or not depends on your overall knowledge of the market and your strategy. According to many experts, an understanding of the basics is a must. Here are the things one should consider and know of before investing.

Generally speaking, corporations that offer legal proceeding funding have a team composed of attorneys — who will assess the merits of a case and its probability of success. They also have investment professionals who handle the finance side of things (i.e., structuring every deal). 

Currently, commercial cases make up the lion’s share of lawsuits, which may involve providing cash to a company suing another company for patent or contract infringement. In these cases, litigation funding goes to the plaintiff, who pays the litigation costs for experts and their lawyers.

Or the money could go straight to law firms, who often split the funding across multiple cases. Sometimes these companies are working on a partial contingency basis; they charge the client a reduced fee and then take a percentage of the economic damage awarded.

Westfleet Litigation Funding research shows, in the United States, there are approximately 40 organizations that manage US$9.5 billion in assets involved in litigation funding. There are some public companies as well that deal with such transactions, but most are private companies dealing in such business. According to funders, before the 2008-2009 financial crisis, only six companies dedicated to litigation funding launched seven years ago.

Experts also emphasized that those who are interested in such investments should be aware that the minimum investment that can be made could be relatively small: $ 5,000 or $ 10,000, but you pay some percentage of the profits to the funders in the form of so-called carried-over interest. And if the case you chose to invest in, lost, then there is no reimbursement. You lose all your investments!

It is truly a hit-or-miss kind of investment.

A lot of companies dealing with such transactions also enable the investors to fund a portfolio- a group of cases- which helps diversify their investments, though the minimums are steep. Also, such a sort of investment is quite expensive with more interest and annual management fees. Aside from this, there are many other areas of lawsuit fundings that investors invest in, such as:

  • Pre-settlement funding
  • Law firm financing
  • Financing for leveraged buyouts of law firms 
  • Strategic capital for legal advertising
  • Post-settlement funding

Aside from investing in litigation, legal funding has a high risk; your money will often get immobilized for at least several years simply because of the time it can take for a case to get through the legal system. The longer the case, the higher your payment. 

Also, as with all investment decisions, experts recommend ensuring that they are made in the context of your overall portfolio and your goals for that money. Going in blind will be a financial drawback at your end. 

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