Litigation finance: a new form of venture capital

Financial agreement

Xavier Fornt
Professor of the Master in International Business
Expert in International Banking
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It is common knowledge that our world is constantly and rapidly evolving. In the field of international banking, this evolution can also be seen, and financial institutions (traditional banking or the new fintechs) are constantly offering new products and new financing formulas adapted to the changing needs of their customers. 

Litigation finance is one of those new forms of venture capital that are becoming common in more mature financial markets, such as the United States or the United Kingdom, or even in Australia and South East Asia.

By 2022, litigation funding has moved up to $17 billion

In fact, in 2022, litigation finance was worth as much as $17 billion, which is a significant figure and shows that his is a product that is doing well in the English-speaking markets. It is very likely to spread to the rest of the developed world's financial markets, so we should be prepared. 

A new market niche

Although the name itself is very indicative, let's take a brief look at how litigation finance works. First of all, let's say that it is not a typical financing for which interest is paid according to the capital and duration, but rather it is venture capital operation in which the financing entity bears all the costs of the litigation (legal, expert evidence, appeals, etc.) in exchange for a percentage of the compensation that will be received in the event of winning the case. 

The fact that no interest is charged by the financier in this type of transaction makes litigation finance compatible with the principles of Islamic banking and would therefore be a perfectly acceptable product in this market as well. 

It is not an ordinary financing, as the financing institution bears all the costs of the litigation in exchange for a percentage of the compensation to be received if the case is won

Moreover, the return is not related to the amount invested, as the amount of legal expense is not always proportional to the value of the dispute. They are therefore high-risk investments, as they do not depend on the capital markets and do not have a defined maturity. 

We are therefore facing a new market niche that undoubtedly offers very good opportunities for specialists who must be aware that in this type of financing, it is not the classic factors such as yield, interest rates or the viability of the product that are analysed, but the legal factors such as facts, causality, the law and legislation applicable to each case, as well as the regulations applicable to the contract, if any.

Factors to consider

Analysts must therefore determine some essential factors in this risk analysis, such as: 

  • Whether this is an entirely new procedure or whether there has been any previous arbitration or mediation on it. 
  • If it is a procedure with previous judgement and therefore a judicial remedy at national level or if it has already passed the last step and starts a process to go to international tribunals. 

Some factors to be evaluated and weighed would be the country risk –basically referring to the litigation takes place –or the solvency of the defendant, to ensure the feasibility of the possible favourable enforcement of the judgment, as well as a forecast of the possible expert evidence required –not always easy and affordable to obtain. 

The possible ethical incompatibility of litigation funding would arise if plaintiff and defendant were clients of the same funder

Finally, the analyst must know the origin of the disputes. If there are prior contracts, whether commercial or service contracts, or if, on the contrary, they are disputes that originate without a contract, such as cases and lawsuits related to copyright

It remains for us to analyse the possible ethical incompatibilities of litigation funding. This possible incompatibility would arise if plaintiff and defendant were clients of the same funding institution. Would it be ethical to fund the litigation of one client against another client? 

Litigation finance is a venture capital field that offers a wealth of opportunities, but, as in almost everything else, it requires well-trained specialists who are familiar with the international environment.