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‘Secondary’ Investing in Litigation Finance: Why, why now, and how to approach investing in Lit Fin Secondaries

By John Freund |

The following article is part of an ongoing column titled ‘Investor Insights.’ 

Brought to you by Ed Truant, founder and content manager of Slingshot Capital, ‘Investor Insights’ will provide thoughtful and engaging perspectives on all aspects of investing in litigation finance. 

Executive Summary

  • Evolution of Litigation Finance necessitates the need for a secondary market
  • Investing in Litigation Finance secondaries is much more difficult than other forms of private equity due to the inherent difficulty in valuing the ‘tail’
  • Experts should be utilized to assess case merits and valuation
  • Life cycle of litigation finance suggests timing is right for secondaries

Slingshot Insights:

  • Investing in the ‘tail’ of a portfolio, where most secondary transactions will take place, can be more difficult than primary investing
  • Dynamics of the ‘tail’ of a portfolio are inherently riskier than a whole portfolio, which is partially offset by enhanced information related to the underlying cases
  • Secondary portfolios are best reviewed by experts in the field and each significant investment should be reviewed extensively
  • Derive little comfort from portfolios that have been marked-to-market by the underlying manager
  • Investing in secondaries requires a discount to market value to offset the implied volatility associated with the tail

In my discussions with litigation finance institutional investors, the topic of secondary investments has been raised a number of times by those who understand the economics of the asset class and are seeking to take advantage of some of the longer duration cases and portfolios in existence.  In this article, I explore why there is interest in the secondary market, why now, and how best to approach investing in secondary investments, as well as some watch-outs.

The concept of secondaries has been well established in the private equity world, specifically leveraged buy-out private equity, and, having been in existence for a couple of decades now, represents a mature strategy not only within leveraged buy-out, but also infrastructure, real estate, venture capital, growth equity, etc.  So, it is not surprising to see the concept applied to litigation finance. As David Ross, Managing Director & Head of Private Credit at Northleaf Capital Partners, notes

“Having been active in private equity secondaries for close to twenty years, Northleaf has extended its secondaries expertise over the past few years to include investments in litigation finance, which is an area that provides attractive and uncorrelated returns for our investors. Executing investments in litigation finance requires dedicated expertise but can provide attractive transaction dynamics for both existing investors seeking liquidity and prospective investors capable of underwriting and structuring an attractive secondary.”

To begin with, let’s first define what constitutes a “secondary” transaction.  Essentially, a secondary is any transaction where one party is acquiring the interests from the original investor (the ‘primary’ investor) in an investment opportunity.  In the case of litigation finance, this could take the form of a single case investment, portfolios or LP interests in funds, among other opportunities.  In this sense, they are the ‘second’ investor to own the investment, as they have acquired their interest from the first investor through the acquisition transaction.

Types of Secondaries

In order for a secondary market to make sense, at least for institutional investors, there needs to be a sufficient number of opportunities that are adequately aged to allow for one party to sell at typically, but not always, a discount to either their original cost or their current fair market value of the investment.  These opportunities can arise for a number of reasons, as outlined below.

For fund managers, they may be looking to raise a new, larger fund, and in order to do so they will have to demonstrate that they are good stewards of capital and that they can produce attractive returns to investors relative to the risk they assume.  If these managers do not have a sufficient number of realizations in their predecessor portfolios, they will have to create a track record by selling off interests in single cases or entire portfolios.  In this way, they will receive arm’s length validation that their portfolio has intrinsic value, with the idea that other potential investors should take comfort in the fact that a third party has assessed the attractiveness of opportunities and decided to invest at a value that is, hopefully, in excess of their original cost, or matches their internal assessment of fair market value.  Of course, this assumes that the purchaser is a knowledgeable purchaser of litigation finance assets and an expert at valuing litigation finance investments, of which few exist in the world, as valuation is perhaps more art than science.

A relatively recent public example of this is Burford’s multiple secondary sales of interests in their Petersen case, which was sold in several tranches at increasing valuations as Burford continued to de-risk their investment through positive case developments during its hold period.  According to the Petersen article hyperlinked above, Burford generated $236 million in cash from selling off interests in the claim, which significantly benefited its reported profitability and cashflow, and evidently, fueled its stock price at the time.  All in all, a smart move by Burford to hedge its bets and de-risk its investment by selling down to other investors.  However, it remains to be seen whether those who acquired the secondary interests in Peterson were as astute as the sellers, time will tell.

For investors, they may be in a situation where they are in a liquidity squeeze, and could be frustrated with the duration of the litigation finance portfolio and therefore wish to exit the remainder of their investment to redeploy capital into a new fund or a new strategy. They could also have had a change in management which created a shift in strategy, or any number of other causes.  For investors in individual cases or funds, they currently face a difficult task in finding a secondary investor to acquire their interests, which can be made more difficult by the fact that the manager may not be motivated to find them a purchaser, as there is no economic incentive to do so. The fate of these investors remains in the hands of the manager.  However, if there are enough investors clamoring for liquidity, then the manager may be forced to hire an investment bank or another intermediary expert to solicit the markets’ appetite and obtain bids for the portfolio; but this will come at a cost which is typically assumed by the selling investor.

But is a secondary a “realization”?

The short answer is NO!

While a secondary can be an indication of perceived value in the market, it is simply a point-in-time estimate of value by the new, prospective owner that makes a series of assumptions to underlie their valuation. As such, it has no bearing on whether the case is more or less likely to settle or win, whether the defendant has the resources to pay, and whether it could take two years or ten years to collect.

Litigation is well known to have a binary outcome.  In the context of large cases where there are significant dollars at risk, it may be in the best interests of the defendant to take the trial risk and deal with the consequences by ultimately settling for a fraction of the damages after the court decision is handed down.  In the Petersen case referenced above, it has been felt by some in the market that an award could still be years away (in the absence of collection frustration tactics that the Argentinian government may pursue); and even then, there is some concern that the decision may allow for damages denominated in Argentine pesos, which have been significantly devalued since the case began.  In addition, the Argentine government has defaulted on its sovereign debt a few times over the last numbers of years and is currently in default on its International Monetary Fund loans, so it is difficult to assess the risk of collectability.

Just because you win a case, doesn’t mean you get to collect the spoils. Collection is a whole other issue and perhaps a topic for another article.  Suffice it to say, that a case is not completely de-risked until the ‘cash is in the bank’ (your bank account, not the lawyer’s trust account). So, I personally would take very little comfort in the fact that another party has looked at a case and made a decision that it has value – you would have to have a deep understanding of that buyer’s motivations (are they merely incentivized to get money invested? Are they motivated by Litigation Finance FOMO?) and that buyer’s ability to value litigation, which is difficult to do with accuracy because of the number of variables & uncertainties involved.

Why are litigation finance secondaries interesting?

Perhaps the better question is, “Are litigation finance secondaries interesting?” And the answer is, “It depends”.

When you look at a portfolio of litigation finance single cases, there are a number of individual investments that typically resolve early in the fund’s life, and this usually gives rise to attractive internal rates of return (“IRR”), but low multiples of  invested capital (“MOIC”); then, there are those that resolve in and around the 30 month mark, which is a fairly typical duration, which should result in stronger MOICs and perhaps somewhat lower IRRs; and then, there is the ‘tail’ of the portfolio (see chart below).  The ‘tail’ of a portfolio refers to those cases that are outside of the normalized expectation for case realizations in terms of duration that reside in the portfolio near the end of, or perhaps even outside of, the investment vehicle’s life.  These cases could be outside the normal time distribution because the cases are highly complex, the defendant has tried to procedurally frustrate & delay the litigation, the case is going through a long drawn out trial or arbitral process, or the nature of the case simply takes longer (intellectual property, international arbitration, etc.) among other explanations. Often, when an investor is provided with a secondary opportunity, they are quite likely looking at investing in the ‘tail’ of the portfolio because the early part of the portfolio has already been resolved, and the proceeds have either been paid out or used to fund the cases remaining in the tail.  Investing in the tail has many implications for expected outcomes. The potential tail outcomes, as depicted with red arrows in the chart below, indicate the uncertainty in both quantum and duration of the tail.

In part 2 of this article, I will explore some of the intricacies of ‘investing in the tail’ and explore considerations for investing in secondary transactions in litigation finance investments.

Slingshot Insights 

For those investors interested in the litigation finance secondary market, I think it is important to approach the investment with caution and a high level of expert diligence to offset the implied volatility that the ‘tail’ of the portfolio offers.  It is also important to understand the motivations of the seller – a manager looking to create a track record will have different motivations than an investor who needs liquidity.  The seller’s motivations may also offer insight into the extent price can be negotiated. It is important not to lose sight of the typical loss rate of the industry and the fact that the tail should exhibit enhanced volatility (more losses) as compared to a whole portfolio, and so an investor should model their returns, and hence their entry price, accordingly. Should you choose to make a secondary investment, consider a variety of options to de-risk the investment by sharing risks and rewards with others (i.e. insurance providers or the vendor of the asset). Above all else, make sure your secondaries are diversified or part of a larger diversified pool of assets.

As always, I welcome your comments and counter-points to those raised in this article.

Edward Truant is the founder of Slingshot Capital Inc. and an investor in the consumer and commercial litigation finance industry.  Slingshot Capital inc. is involved in the origination and design of unique opportunities in legal finance markets, globally, investing with and alongside institutional investors

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Commercial Special Features

Key Highlights from the Inaugural LF Dealmakers European Edition

By John Freund |

Last week, the LFJ team attended the inaugural LF Dealmakers European Edition, held across two days at the Royal Lancaster in London. Building on the longstanding success of Dealmakers’ New York event, the first edition of the European conference brought together an impressive selection of leaders from across the industry.

Spread across two days, LF Dealmakers featured an agenda packed with insightful conversations between some of the most prominent thought leaders in the European litigation finance market. An array of panel discussions covered everything from the looming potential of regulation to the increasing corporate adoption of third-party funding, with these sessions bolstered by a keynote interview between two of the key figures in the Post Office Horizon litigation.

A long road to justice for the postmasters

In a conference that managed to fill every single panel discussion with speakers engaged in some of the largest and most influential funded disputes taking place in Europe, the standout session of the two days provided unparalleled insight into one of the most famous cases of recent years. The keynote interview on ‘The Future of Litigation Funding in the Wake of the Post Office Horizon Scandal’ saw James Hartley, Partner and National Head of Dispute Resolution Freeths, and Neil Purslow, Founder & CIO, Therium, offer up a behind-the-scenes tale of the sub-postmasters campaign for justice.

Going back to their first involvement with the case, James Hartley reminded attendees that whilst those looking at the case post-judgement “might think it was a slam dunk”, this was not the viewpoint of the lawyers and funders who first agreed to lead the fight against the Post Office. As Hartley described it, this was a situation where you had “a government owned entity who would fight to the end”, with a multitude of potential issues facing the claimants, including the existence of criminal convictions, the limited amounts of documented evidence, and the fact that the Post Office was the party that had ninety percent of the data, documents, and evidence.

Hartley also offered his own perspective on the legal strategy adopted by the Post Office and its lawyers, noting that at every stage of the litigation, “every single issue was fought hard.” He went on to explain that whilst he was “not critical” of the defendant’s strategy in principle, there remains the underlying issue that “the arguments they made were not consistent with the evidence we were seeing.” Hartley used this particular point to illuminate the issues around defendant strategies in the face of meritorious litigation that is being funded. He summarised the core issue by saying: “There is nothing wrong with fighting hard, but it’s got to be within the rules, and in a way that helps the court get to a just outcome.”

Offering praise for the support provided by Purslow and the team at Therium to finance the case, Hartley stated plainly that “without Therium’s funding it would not have gone anywhere, it would not have even got off the ground.” Both Purslow and Hartley also used the case to highlight problems around the lack of recoverability for funding costs and how that incentivises defendants such as the Post Office to prolong litigation and inflate legal costs. Hartley said that he would welcome a change to rules that would allow such recoverability, arguing that in this case “it would have neutralised the Post Office’s strategy to just keep driving up costs on the claimants side.”

What problem is regulation solving?

It was unsurprising to find that questions around the future of regulation for the litigation funding industry were a regular occurrence at LF Dealmakers, with the event taking place only a few days on from the House of Lords’ debate on the Litigation Funding Agreements (Enforceability) bill. From the opening panel to conversations held in networking breaks between sessions, speakers and attendees alike discussed the mounting pressure from government and corporate opponents of third-party funding.

The view from the majority of executives at the event seemed to revolve around one question, which was succinctly put by Ben Moss from Orchard Global: “What are the specific issues that require regulation, and what is the evidence to support those issues?”

This question became somewhat of a rallying cry throughout the conference, with suggestions of increased scrutiny and oversight being turned back on the industry’s critics who make claims of impropriety without citing evidence to back up these claims. Whilst several speakers referenced the recent LFJ poll that found a broad majority are open to the potential for new regulation, Ben Knowles from Clyde & Co described a lot of the discourse around the issue as “a fairly partisan debate.”

Among the few speakers in attendance who offered a contrasting view on regulation, Linklaters’ Harriet Ellis argued that “regulation done right would be good for the industry.” However, even Ellis acknowledged that any rules would have to be carefully crafted to provide a framework that would work across the wide variety of funded disputes, saying that a “one size fits all approach does raise issues.”

Regarding the government’s own approach to the issue through the draft legislation making its way through parliament, all of the executives in attendance praised lawmakers’ attempts to find a solution quickly. Alongside these government-led efforts, there was also a feeling among legal industry leaders that funders and law firms have to be part of the solution by promoting more education and understanding about how litigation finance works in practice. Richard Healey from Gately emphasised the need for firms to engage in “hearts and minds work” to change wider perceptions, whilst Harbour’s Maurice MacSweeney emphasised the need to “create the environment where law firms and funders can flourish.”

Innovation through collaboration

Outside of the narrow debate around legislation and regulation, much of the conference was focused on the speed at which litigation finance continues to evolve and create new solutions to meet complex demands from the legal industry. This was perhaps best represented in the way speakers from a variety of organisations discussed the need for a collaborative approach, with executives from funders, insurers, law firms, investors and brokers, all discussing how the industry can foster best working practices.

The interplay between the insurance and funding industry was one area that offered plenty of opportunity for insightful discussions around innovation. Andrew Mutter from CAC Speciality noted that even though “insurers are not known for being the fastest and moving the most nimbly,” within the world of litigation risk “the insurance markets are surprisingly innovative.” This idea of an agile and responsive insurance market was backed up by the variety of off the shelf and bespoke products that were discussed during the conference, from the staples of After-The-Event and Judgement Preservation Insurance to niche solutions like Arbitration Default Insurance.

Delving into the increasingly bespoke and tailored approach that insurers can take when working with funders and law firms, Jamie Molloy from Ignite Speciality Risk, described how there are now “very few limits on what can be done by litigation insurers to de-risk.” Whilst there is sometimes a perception that insurers are competing with funders and lawyers for client business, Tamar Katamade at Mosaic Insurance offered the view that it is “more like collaboration and synergy” where all these parties can work together “to help the claimant and improve their cost of capital and reduce duration risk.”

Class action fervour across Europe

Throughout both days of the LF Dealmakers conference, the volume and variety of class actions taking place across the European continent was another hot topic. However, in contrast to an event focused on the American litigation finance market, the common theme at last week’s forum was the wideranging differences between large group claims across individual European jurisdictions. In one of the most insightful panels, the audience were treated to an array of perspectives from thought leaders practicing across the UK, Spain, and the Netherlands.

The example of Spanish class actions provided an incredibly useful view into the nuances of European claims, as a country that is still in the process of implementing legislation to comply with the EU’s collective actions directive, but has already evolved routes for these types of actions over the last decade. Paul Hitchings of Hitchings & Co. described how the initiative to innovate has come “more from the private sector than the legislature”, with domestic law firms having become “experienced with running massive numbers of parallel claims” as an inefficient, yet workable solution. Hitchings contrasted Spain’s situation with its neighbouring jurisdiction of Portugal, which he argued has been comparatively forward thinking due to the country’s popular action law.

Speaking to the Dutch class actions environment, Quirijn Bongaerts from Birkway, argued that the “biggest game changer” in the country was the introduction of a real class actions regime in 2020. Bongaerts explained that the introduction of this system allowed for “one procedure that fits all types of claims”, which allows not only claims for damages, “but also works for more idealistic cases such as environmental cases and ESG cases.”

LFJ would like to extend our thanks to the entire Dealmakers team for hosting such an engaging and insightful event, which not only offered attendees a view into the latest developments in litigation finance, but also created a plethora of networking opportunities throughout both days. LFJ has no doubt that after the success of the inaugural LF Dealmakers European edition, a return to London in 2025 will cement the conference as a must-attend feature in the litigation funding events calendar.

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Commercial Regulatory Issues

The Dangers of Retrospective Legislation in Litigation Funding

By John Freund |

The debate around whether the Litigation Funding Agreements (Enforceability) Bill should be retrospective is a complex one, with valid arguments on both sides. A recent op-ed makes the case that retrospectivity poses significant dangers and unfairness.

Writing in LegalFutures, Jeremy Marshall, Chief Investment Officer of Winward UK, argues that the core issue is whether it is unfair to allow litigation funders to rely on contractual agreements that were freely entered into by both parties, even if those agreements were based on a mistake of law.

Marshall claims that the common law right to recover money paid under a mistake only applies when the mistake led to one party receiving an unintended benefit. In the case of litigation funding, the only benefit that has accrued is the one that was explicitly drafted into the contract. Allowing retrospectivity would open the door to satellite litigation and unreal counterfactuals, according to Marshall.

Claimants who have already received funding and won their cases are now arguing for the "right" to renegotiate and keep all the proceeds for themselves. But what about the funders' arguments that cases may have gone on longer or become more expensive than intended? Fairness demands that both sides' positions be considered.

Marshall insists that the true drawback in retrospectivity is the inherent danger of prejudicing one party to the exclusion of the other, or conferring an unexpected benefit to one party at the expense of the other. Ironically, this is precisely what those challenging the bill are attempting to do. So while the debate is a complex one, one can make a compelling case that retrospectivity in litigation funding poses significant dangers and unfairness.

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Commercial Regulatory Issues

The CJC’s Review of Litigation Funding Will Have Far-Reaching Effects

By John Freund |

The following is a contributed piece by Tom Webster, Chief Commercial Officer at Sentry Funding.

Reform is on its way for the UK’s litigation funding sector, with the Civil Justice Council firing the starting gun on its review of litigation funding on 23 April.

The advisory body set out the terms of reference for its review, commissioned by lord chancellor Alex Chalk, and revealed the members of its core working group.

The review is working to an ambitious timetable with the aim of publishing an interim report by this summer, and a full report by summer 2025. It will be based on the CJC’s function of making civil justice ‘more accessible, fair and efficient’.

The CJC said it will set out ‘clear recommendations’ for reform in some areas. This includes consideration of a number of issues that could prove very significant for funders and clients. These include:

  • Whether the sector should be regulated, and if so, how and by whom;
  • Whether funders’ returns should be subject to a cap; and if so, to what extent;
  • The relationship between third party funding and litigation costs;
  • The court’s role in controlling the conduct of funded litigation, including the protection of claimants and ‘the interaction between pre-action and post-commencement funding of disputes’;
  • Duties relating to the provision of funding, including potential conflicts of interest between funders, lawyers and clients;
  • Whether funding encourages ‘specific litigation behaviour’ such as collective action.

The review’s core working group will be co-chaired by CJC members Mr Justice Simon Picken, a Commercial Court judge, and barrister Dr John Sorabji. The four other members are:

  • High Court judge Mrs Justice Sara Cockerill, who was judge in charge of the commercial court 2020 – 2022, and who is currently involved in a project on third party funding for the European Law Institute;
  • Academic and former City lawyer Prof Chris Hodges, chair of independent body the Regulatory Horizons Council which was set up to ensure that UK regulation keeps pace with innovation;
  • Lucy Castledine, Director of Consumer Investments at the Financial Conduct Authority; and
  • Nick Bacon KC, a prominent barrister and funding expert who acts for both claimants and defendants

The CJC had said that it may also bring in a consumer representative, as well as a solicitor experienced in group litigation.

In a sign that the review seeks to be informed by a wide range of views, the CJC has also extended an invitation for experts to join a broader consultation group, which will directly inform the work of the review and provide a larger forum for expert discussion. Meanwhile the advisory body has said there will also be further chance ‘for all to engage formally with this review’ later this year.

Given the broad remit of the review and significant impact that its recommendations may have on the litigation funding industry, litigation funders, lawyers and clients would be well advised to make the most of these opportunities to contribute to the review.

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