The GPs that want to see you in court

One of the best-kept secrets of the private debt universe may not be under the radar for much longer, with one source telling us that “new litigation funders are popping up every week”.

Rather like infrastructure investing, litigation funding has its birthplace in Australia, but migrated quickly to the US. It is now becoming popular in Europe and other parts of the world.

In a nutshell, litigation funders lend to law firms or claimants to cover the costs of legal actions and receive a share of any future award. In the case of a £100 million ($132 million; €117 million) claim, the funder might pay legal fees of, say, £10 million and be entitled to around 30 to 40 percent of any eventual pay-out.

It seems like a pretty good way to make a living. Research by Goldman Sachs and Bloomberg, referred to in a Bloomberg article towards the end of last year, found these specialist financiers achieving a multiple on invested capital of more than two times – a return that Emma Bewley of wealth investor Connection Capital described as “similar to private equity but expected to be generated within a shorter timeframe”.

No wonder litigation funding is such a fast-growing industry. According to its annual report, Burford Capital, which claims to be the “world’s largest publicly traded provider of litigation finance”, had assets under management of $2.5 billion in 2018 in its investment unit, compared with $1.7 billion the year before. Last year, the firm’s income rose by 23 percent while its profits after tax increased by 24 percent.

But even as these specialist lenders grow, some claims are simply too big for them to swallow. It’s at this larger end of the market that distressed investors are increasingly taking an interest. Given that the credit cycle appears to have been “almost” on the turn for about the past five years, they can be forgiven for thinking it might never happen. Therefore, sources say, established distressed investors – Davidson Kempner is among those mentioned in dispatches – are increasingly turning their hands to the litigation market.

What’s attracting the distressed players is not just the size but also the nature of the opportunities. Although a mainstream litigation funder will typically buy into a claim, a distressed investor is more likely to buy into a court judgement or arbitration award with appeal risk that may require enforcement. This plays to some of the strengths in the distressed investor’s skillset, including assessing creditworthiness and the likelihood of getting their money back in much the same way that they would with a troubled corporate.

The broader context for all this is the tough environment for distressed investors amid low interest rates and record-low defaults, which has forced them to adapt or die. Under the “special situations” banner, distressed investors have been able to gain better access to dealflow while using many of their traditional skills. Litigation funding is one example of this, and it’s gaining increasing prominence.