May 14, 2020
Litigation Finance Set to Grow in Current Economic Downturn
Max Egan
The economic crisis related to COVID-19 is poised to trigger an increased interest in using commercial litigation finance, against the backdrop of an overall rise in disputes.
Corporations and law firms are primed to turn to litigation finance as a valuable tool that can help them weather challenging economic conditions. Litigation finance is the transformation of cash flows where the ultimate payouts will result from a legal outcome. Litigation finance enables companies to reduce expenses and law firms to increase revenue.
Increased interest in litigation finance (demand-side)
Corporations are looking to preserve cash to stay afloat. In the last economic recession, trailing-12-month earnings per share for the S&P 500 fell almost to zero (by -92%) from June 2007 to March 20091. Companies can employ litigation finance to improve cash flow generation in two broad ways:
1. Monetize contingent assets - legal claims are assets with future potential payoffs that can be brought forward in time
2. Reduce current legal expenses - companies can retain quality law firms without draining cash reserves
Law firms are also looking to steady their ships. While the mix of activity among legal specialties will likely change during the crisis (think more bankruptcy work and less transaction work), law firms will cut costs broadly if the previous pattern holds. In the Great Recession, headcount for employees in legal services changed by -6% from 2007 to 20112. Here, litigation finance can help law firms on the revenue side of the equation:
1. Gain new clients - law firms can offer alternative fee arrangements while maintaining the billable hour compensation structure
2. Preserve revenue from existing clients - if clients are unwilling or unable to pay, litigation finance can fill the gap
3. Monetize work-in-progress - law firms can bring forward fees from cases that are nearing resolution
Finally, demand for litigation finance is likely to grow based on extrapolation of the existing trend towards increased usage. Litigation finance is becoming more acceptable. The amount of capital raised by dedicated commercial litigation funders has grown at a +31% annualized rate from 2012 to 20193. One survey found that familiarity with litigation finance has ticked up steadily within the legal community4, and now increased usage is likely to follow.
Increased volume of lawsuits (supply-side)
“You only find out who is swimming naked when the tide goes out5,” was the way Warren Buffett characterized how a challenging economic environment can affect fragile businesses. One study found that there were nine times as many Ponzi schemes revealed in 2009 than the average during the pre-crisis years6. It was only once Bernie Madoff’s funds were hit with a wave of redemption notices that his scam unraveled. Two early allegations of accounting frauds uncovered recently include the Chinese retailer Luckin Coffee and the Singaporean energy trader Hin Leong. The stresses on the system indicate that more frauds will be revealed.
Losses lead to disputes. Tenants and landlords everywhere are currently sorting out how to share the burden of disused commercial real estate spaces. Companies could strategically break contracts that are no longer beneficial, especially if a counterparty is financially unable to hire counsel to enforce its rights. Businesses facing cash constraints will start accelerating the payment of receivables. Companies would be wise to use proactive legal measures in order to line up for payment before the counterparty becomes insolvent.
Lastly, there will be many lawsuits directly attributable to COVID-19. Business interruption insurance claims and force majeure clauses will certainly be in focus. Through May 2nd, Lex Machina showed that there have been 287 cases filed in federal district court where plaintiffs mentioned the current pandemic as a reason for filing the complaint7; many more are likely to follow.
Max Egan is the Founder and CEO of Permentum Capital, a litigation-finance firm that launched in January 2020.
1 S&P Global
2 US Bureau of Economic Analysis
3 Proprietary collection of publicly available data gathered from regulatory agencies and press releases
4 Burford Capital’s 2019 Legal Finance Report: A Survey of In-House and Law Firm Lawyers
5 Berkshire Hathaway Inc.'s 2001 Annual Report
6 Marquet International’s The Marquet Report on Ponzi Schemes
7 Lex Machina’s Ongoing Impacts of the Coronavirus Pandemic on Litigation Activity in Federal District Court