Litigation finance is increasing in popularity, so it’s no surprise that peer-to-peer lenders are getting in on the act. Emily Perryman reports
ONCE THE PRESERVE OF hedge funds and private equity houses, peer-to-peer lenders are opening up the litigation finance sector to individual investors – and the returns are not to be sniffed at.
AxiaFunder launched in January 2019 specifically focusing on litigation funding, while P2P business lender Money&Co is now expanding into the space. There is also the Just ISA, managed by Northern Provident Investments. Advertised returns are highly attractive, ranging from eight per cent to a whopping 30 per cent. Litigation finance is a very risky investment, but the platforms claim they are offering investors a potentially lucrative opportunity that is uncorrelated with other asset classes.
What is litigation finance?
Litigation finance providers offer funding to claimants who can’t afford their legal fees. If the claimant settles or wins their case the provider takes a share of the costs and damages, but if they lose the claimant doesn’t owe the funder anything.
Litigation funding became accepted into UK law around 15 years ago, and over the past five years it has developed into a mainstream funding option for people involved in litigation. There are a whole host of litigation funders in the market and, as the sector picks up speed, this has caught the eye of P2P and crowdfunding platforms.
“Litigation finance is increasingly in demand on both the supply and the demand side, i.e. from both investors and from claimants and their lawyers,” says Louis Young, managing director of litigation funder Augusta.
“For investors, we represent a strongly yielding asset class, uncorrelated to traditional securities, which is important in a highly volatile, low yield environment. For claimants and their lawyers, litigation funding offers a risk management tool, providing the opportunity to seek redress without taking on the financial burden should the claim fail.”
Neil Faulkner, managing director of P2P comparison site 4th Way, suggests P2P platforms are attracted to the sector because the risk-reward profile of litigation finance is easy to understand. “If you focus on one very specific niche you will more quickly build a portfolio of those kinds of loans and improve your underwriting more swiftly,” he says.
Individual investors who are interested in dipping their toe in the litigation finance sector currently have three propositions to choose from. AxiaFunder enables sophisticated investors to back individual litigation cases. Cases are structured as Innovative Finance ISA (IFISA)-eligible bonds or equity-based investments. There was one case open for investment at the time of writing – a professional negligence case offering a return of 61 per cent.
AxiaFunder recommends investors build a portfolio of 10 cases and says potential returns on a portfolio basis are 20 to 30 per cent. Just, an ISA managed by Northern Provident Investments, offers an eight per cent return, but unlike AxiaFunder, investors don’t pick individual cases. Investors put their money into a five-year bond and the company’s directors decide which cases it will back. Money&Co has just launched into the space and, as of the time of writing, hasn’t yet listed a litigation finance loan on its platform.
Money&Co says investors will receive a return of eight per cent per annum. Aside from the high returns on offer, litigation finance could be attractive to investors seeking diversification in their investment portfolio. Cormac Leech, chief executive of AxiaFunder, says litigation finance is uncorrelated with stocks, property and credit and unaffected by macroeconomic risks.
“In addition, each case is almost entirely non-correlated with every other case, so when investors add new cases into their portfolio they get a rapid reduction in the volatility of their portfolio,” he states. “Investors probably need at least 10 cases to get a decent level of diversification.”
Risk vs reward
Litigation finance is a high-risk investment because there is a strong chance the claimant will not win their case. Leech says around a quarter of cases won’t be successful and the impact on investors depends on how the case is structured. In some instances the majority of the principal is protected so investors will only lose 20 per cent of their capital. In other “cases – typically the ones with the highest return – investors will lose all of their money.
“Statistically about 80 per cent or more of cases will settle before trial,” says Leech. “If the case goes to trial, the claimant typically wins 50 to 55 per cent of the time. Essentially, 80 per cent of the time you’re getting a good return, however 10 to 20 per cent of the time cases go to trial and the risk of losing is higher.
“Often we will structure our funding agreement so that the rate of return increases if the case goes to trial in order to compensate for that extra risk.” Litigation funders put a lot of work into analysing cases to try to minimise the risk of cases failing.
They look at the legal merits of the case, the quality of the legal team, the attitude of the claimant, the risk versus the return, and whether the claim is of a high enough value relative to its costs. Cases also need to have after-the-event insurance in place, which covers instances where the claimant loses and is required to pay the defendant’s fees.
The insurance policy ensures investors won’t lose more money than they put in.
“Investors should expect, as always, that the people behind the platform have plenty of experience,” says Faulkner. “Here, they need solicitors with a great deal of experience in litigation. Preferably, the P2P lending platform also has experience in the credit-risk space.”
On average, funders take on one in 10 cases put before them, however despite going through a stringent due diligence process the risk of failure is still high. Augusta’s long-term success rate is around 70 per cent on more than 220 individual cases.
“Professional funders with a track record of success over a number of years are able to offer strong returns over a portfolio of cases,” says Young.
“The model is however non-recourse, so any individual case can fail, leading to a total loss for funders.” Alex Jakubowski, a partner in Clarke Willmott’s commercial litigation team, says that even the strongest claim with the best lawyers and the most bullish advice can still lose.
“Any solicitor worth their salt will tell you that if the witnesses don’t perform on the day they can look unreliable or dishonest and the judge just won’t believe them,” he warns. “A case can be lost simply because the witness has a bad day in court.”
Issues can also arise when trying to recover damages from the defendant. Jakubowski points out that even if the defendant appears to have sufficient money on paper, published accounts can be misleading.
Moreover, some litigation can take years to conclude, during which time an unscrupulous defendant could move their money offshore or spend it.
“For the right claimant, litigation finance is an excellent resource to have available to them,” Jakubowski adds. “It can provide access to justice for claimants who can’t otherwise afford it and can be a potentially lucrative investment for those who are willing to back the claim.
The underlying principles are the same as for any investment: do your due diligence and understand your investment.”
Most experts think the litigation finance sector will continue to grow, thereby attracting more P2P platforms to the space. Nicola Horlick, founder of Money&Co, says she expects litigation finance to be a major source of finance for legal firms in the future.
And unlike other commentators, she doesn’t think it is particularly high risk for investors. “In fact, it is significantly lower risk than making a working capital loan unsecured to a small business as many other P2P platforms do,” she argues.
Tony Lewis, dispute resolution partner at law firm Fieldfisher, suggests there is more scope for P2P platforms to enter the sector because platforms are leaner than traditional funders and are able to take a smaller cut from claimants. This means they can consider funding the smaller claims that traditional funders are not interested in.
“I think the sector will continue to expand because there will always be people who are willing to trade risk – who can afford legal fees but who would rather share the risk with someone who is prepared to fund their claim,” he says. AxiaFunder’s Leech adds that there are lots of meritorious cases around that cannot progress to trial because of lack of funding, or which go to trial but with excessive stress and risk being carried by the claimant themselves.
“Anecdotally, almost every adult knows someone or some SME that has suffered clear wrongdoing by a large company or wealthy individual with deep pockets,” he says. “For the sector AxiaFunder is focused on, we believe the addressable market is £2bn to £5bn annually.
In the very long run, arguably, ready access to litigation funding capital will make the market start to shrink as would-be defendants reconsider their positions – a positive externality for society.”