Litigation Finance

Litigation Finance: Truly An Uncorrelated Asset?

As previously dependable ways to diversify a portfolio are becoming less reliable, interest in asset classes that aren't correlated to the market is increasing.

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Could litigation finance be the key to a properly diversified investment portfolio? That was the question animating a lively discussion Tuesday afternoon as people came from around the world to Harvard Law School for the first-ever Harvard Litigation Finance Symposium.

Sponsored by the Harvard Law and Technology Society, the conference drew an even number of practitioners and curious students for programming on a wide range of topics inside the litigation finance world. The cavernous, 137-year-old, wood-paneled Ames Courtroom provided a decidedly traditional setting for a field that is newly shaking up the legal market.

By the end of the end of the panel “Litigation Finance: Truly an Uncorrelated Asset?”, with Harvard Business School professor Chris Malloy serving as an able Socratic interrogator, the panel had thoroughly explored but not definitively answered the question. Overall, panelists Lee Drucker, co-founder of Lake Whillans Litigation Finance, and Andrew Woltman, co-founder and principal at Statera Capital, expressed optimism that litigation finance can continue to be largely uncorrelated with the wider economy, providing a hedge against the risk of loss.

Why? In theory, whether an individual lawsuit succeeds or fails should have nothing to do with the overall economy or the stock market. And the hunt for asset classes that aren’t correlated to the market is growing, as previously dependable ways to diversify a portfolio are becoming less reliable. Asset classes like bonds, real estate, and foreign stocks are more likely to move up and down with the U.S. stock market than they had been in the past.

But with most cases settling before reaching a judge, the economy would certainly be on the minds of the parties to a lawsuit — affecting, for example, the ability of a successful plaintiff to collect a judgment from the defendant. Lee Drucker of Lake Whillans said that his firm focuses on cases where they know that the likely value of the case could be easily paid by the defendant, minimizing the economy as a factor.

Chris Malloy noted that the structure of funds can affect whether litigation finance represents an uncorrelated asset as well. If a funder has a portfolio with a wide range of assets that lose in a down market, they may be forced to sell otherwise well-performing litigation finance instruments at a loss.

Litigation finance is a relatively new space in the United States, at least compared to jurisdictions like the United Kingdom and Australia, where it has been around for two decades or so. As a result, as Lee Drucker observed, his firm and most of the other litigation funders in the U.S. have yet to go through a recession. That will be the real test of non-correlation.

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Much of the discussion explored the way that litigation finance is disrupting the existing business model of law firms. In the past, in the world of Biglaw (as opposed to smaller plaintiff-side shops), contingency-fee cases were more common in just a few kinds of specialized firms. It can be hard, for example, for a traditional firm to figure out fair compensation for an associate who will not achieve a payday for five years while another associate is racking up billable hours.

But today, litigation finance is expanding the number of claims that can be litigated. With financing, corporations without the cash to float a lawsuit that could last for years and law firms that wouldn’t traditionally take on a contingency fee case can work together, providing access to a much wider range of legal options. Larger and well-funded corporations may be attracted to litigation finance as a way to reduce risk and keep litigation expenses off their balance sheets.

It’s not clear yet if this model can help consumers with smaller cases that fall outside the world of large-scale, commercial cases that are the focus of most litigation funders. As Lee Drucker pointed out, it takes a lot of time and legal expertise to evaluate the strength of a complex case, making it hard to come up with a compensation model that works for the funder and the litigant. Both Statera and Lake Whillans emphasized that they want to make sure that both the claimants and counsel in a funded litigation will receive a fair payout if the case is settled at the expected value, which limits the universe of fundable cases to ones with the right amount of room to compensate everyone.

Although in theory litigation finance could expand access to justice, for now, most major litigation finance firms are only likely to take cases where the estimated value is at least one million dollars. Andrew Woltman, from newer entry Statera, said that his firm is trying to be responsive to needs at the lower end of the spectrum: they’ll finance a case worth $500,000.

It may be too early to tell if litigation finance is truly an uncorrelated asset class. But that isn’t stopping the growing interest and appetite for it. With high returns and attractive options for both law firms and corporations, it appears that there is plenty of room for growth in the litigation finance space.

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Quinten Steenhuis is an attorney and software developer and founder of Lemma Legal consulting. In addition to serving on state and city committees in his hometown of Cambridge, Massachusetts relating to public policy and access to justice, he has worked as a housing litigator at Greater Boston Legal Services for the past 11 years. He is the author of MADE, a free and open source web application that helps pro se tenants facing eviction. You can connect with Quinten on Twitter (@QSteenhuis) and LinkedIn.

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