In a March 9, 2015 article entitled “Hedge Fund Manager’s Next Frontier: Lawsuits” (here), the Wall Street Journal described how the “next act” for EJF Capital LLC, a hedge fund run by Friedman, Billings, Ramsay Group’s former co-founder Emmanuel Friedman, will be to deploy a new litigation finance arm that has already, according to the Journal, “raised hundreds of millions of dollars” to “lend to law firms pursuing class-action injury lawsuits.”
The hedge fund’s foray into litigation financing is pretty far afield from the firm’s prior investments. According to the Journal, the fund’s last big investment successes involved purchasing troubled mortgage securities during the financial crisis and buying the federal government’s investments in smaller banks.
Why would a hedge fund focused on financial securities get involved in something like litigation financing? For a very simple reason – litigation financing is profitable.
How profitable? Well, because a number of litigation funding firms are publicly traded, we don’t have to guess. For example, on March 18, 2015, Burford Capital Limited, the largest player in the growing U.S. litigation funding business and a publicly traded firm whose shares trade on the London Stock Exchange AIM Market, released its results for 2014, showing that the company’s revenue during the year rose by 35 percent to $82 million, with a 43 percent rise in operating profit, to $61 million. The company, which has assets of over $500 million under management, reports that since its inception it has produced” a 60% return on invested capital.” My prior post about Burford Capital can be found here.
Similarly, Bentham IMF, the U.S. arm of IMF Bentham Limited, whose shares trade on the Australian Stock Exchange, reported in December 2014 (here) that it had funded ten deals during the year, with client recoveries of nearly $100 million resulting from jury verdicts and settlements. The firm itself had gross returns of more than $31 million for the year, with a net profit of $17 million.
These kinds of results attract attention. The increasing involvement of financial firms in litigation-funding also attracts criticism. In a March 26, 2014 guest post on this blog entitled “The Real and Ugly Facts of Litigation Funding” (here), Lisa Rickard, the President of the U.S. Chamber of Commerce’s Institute for Legal Reform, said “Litigation funding is a sophisticated scheme for gambling on litigation.” She said further that the growth of litigation funding will lead to “more lawsuits, more litigation uncertainty, higher settlement payoffs to satisfy cash-hungry funders, and in some instances, even corruption” (the latter comment referring to the Chevron case in Ecuador, noted below)
There is no doubt that the litigation funding industry has been involved in controversy. In a March 18, 2015 Bloomberg article entitled “Hedge Fund Betting on Lawsuits is Spreading” (here), Paul M. Barrett, discussing the rise of the litigation-funding in the U.S., notes that while Burford Capital has “helped move litigation funding into the corporate-litigation mainstream,” its funding ventures include its “most notorious – and least successful investment” relating to a class action oil pollution lawsuit against Chevron in Ecuador.
Barrett, the author of the Bloomberg article, and who is also the author of the 2014 book Law of the Jungle: The $19 Billion Legal Battle Over Oil in the Rain Forest and the Lawyer Who’d Stop at Nothing to Win (here), notes in the article that Burford invested $4 million in the Ecuador case in 2010. The plaintiffs, a group of Ecuadorians, won a $19 billion judgment in Ecuador against Chevron, but the oil company then “turned the tables” and persuaded a U.S. judge that the Ecuadorian suit involved coercion, bribery and fabricated evidence. By then, Burford had sold off its interest in the lawsuit and accused the plaintiffs’ attorney of deceit. As Barrett puts it in his article, the Ecuadorian episode “constituted a black eye for Burford” that continues to provide “ammunition for critics of litigation finance.”
Despite the criticism and controversy, litigation funding continues to attract new entrants and investors, as the recent entry of EJF Capital discussed above shows. Litigation funding is well-established in several other countries. As I have noted in prior posts on this blog, most recently here, litigation funding is an important part of the class action litigation landscape in Australia. As discussed here, litigation financing continues to play an important role in class action litigation in Canada. Litigation financing may play an increasingly important role in the U.K.; as I discussed in a recent post (here), the U.K. litigation involving Tesco is being supported by a litigation funding firm.
There are important differences between the legal system in the U.S. and the legal systems in the other countries where litigation funding is now well-established. Canada, Australia and the U.K. all have a “loser pays” litigation model, where an unsuccessful claimant must pay their adversary’s legal fees. In the U.S. by contrast, we follow the American rule, under which each party bears its own cost. In addition, most states in the U.S. allow contingency fees, by contrast to many other countries where contingency fees are not permitted. Because of loser pays model and the prohibition of contingency fees, there may be reasons why litigation funding is better established in other countries.
Just the same, litigation funding recently has been quickly developing in the U.S., perhaps because there is so much litigation and because litigation in the U.S. can be so expensive – which raises the question of what the rise of litigation funding may mean for civil litigation in the U.S.
The more positive spin may be that the availability of litigation funding will level the playing field for smaller litigants attempting to take on larger adversaries. At the same time, however, litigation funding raises a host of questions. First and foremost are the concerns about the possible conflicts between the litigation investors and the actual litigants. The funders’ investment objectives may diverge from the actual litigant’s litigation objectives – differences that could lead to diverging views about litigation tactics and even case resolution approaches and objectives.
Similarly, there is the question whether litigation funding is appropriate in the class action context. While the litigation funding unquestionably may help facilitate a recovery for the class, the amount to be paid to the litigation funder, in the form of commission or other payment, will reduce the amount of the recovery for the class. (To provide some perspective on this issue, in its report of its 2014 results, Bentham IMF reported that with respect to the recoveries in which it was involved, clients and outside counsel took 69%, with Bentham drawing the remaining 31%.) The absent class members cannot all be consulted in advance about such arrangements, which may or may not look fair after the fact.
A more fundamental question has to do with the possible effect of growing amounts of litigation funding on the litigation system. Will the availability of litigation funding fuel an increase in litigation? Will it encourage adversaries — who might otherwise be able to reach a business resolution of their dispute – to litigate rather than negotiate? And then there are the concerns about a field in which there apparently are huge sums to be made but few barriers to entry — will the outsize profits that are now being reported attract less scrupulous competitors who attempt to extract outsized returns at the expense of litigants? Will competition for the best cases encourage the players that are unable to attract the best cases to finance less meritorious cases?
There are, in short, a host of unanswered questions about the growing presence of litigation funding on the U.S. litigation scene. There is no doubt that the current players’ returns will attract additional participants. Litigation funding seems likely to become an increasingly important part of commercial litigation in the U.S. I fully expect that we will be continue too hear a lot more about this topic. But the point is – litigation funding is here, now. We had better recognize that, get used to it, and try to understand what it means.
SEC Chair Weighs in on Fee-Shifting Bylaws: In a March 19, 2015 speech at the Tulane University Law School (here), SEC Charman Mary Jo White offered a number of observations on a variety of topics, including fee-shifting bylaws. While she made it clear that the SEC is monitoring developments on the topic closely, the agency has not decided to take a position and she declined to comment on the merits of any particular position on the issue, she did say that “I am concerned about any provision in the bylaws of a company that could inappropriately stifle shareholders’ ability to seek redress under the federal securities laws. All shareholders can benefit from these types of actions.” She added that “If the Commission comes to believe that these provisions improperly hinder shareholders’ exercise of their rights, it may need to weigh in more directly in this discussion.”
More About Fee-Shifting Bylaws: In yesterday’s post, I linked to a couple of academic articles discussing litigation reform bylaws, and in particular, fee-shifting bylaws. I wanted to add another link on the topic. In an interesting March 19, 2015 paper entitled “The Intersection of Fee-Shifting Bylaws and Securities Fraud Litigation” (here) Arizona Law School Professor William Sjostrom, examines the possible effect of fee-shifting bylaws would have on securities litigation and then takes a look at whether a bylaw shifting fees for securities litigation would be valid under federal securities laws – Professor Sjostrom concludes that they would not. Professor Sjostrom further concludes that Congress should not validate fee-shifting bylaws. The article includes in an appendix a detailed list of the 43 companies that have adopted fee-shifting by laws since the Delaware Supreme Court issued its May 2014 decision upholding the validity under Delaware law of a fee shifting by law.
The Latest from China: I suspect that many of this blog’s readers, like me, also follow the China Law Blog, which is written by Dan Harris of the Harris & Moure law firm. Harris’s posts are reliably readable and interesting. On March 15, 2015, Dan had a particularly interesting post that I wanted to be sure to note here. The post, entitled “China’s Golden Age for Foreign Companies is Over” (here) details the increasing difficulties foreign companies are having operating in China and notes that many companies are shifting operations to Vietnam. As Harris details in his post, “There is no disputing that China’s golden age for foreign companies doing business in China is over. China today is just not nearly as favorable or easy for foreign companies as it was ten years ago.” While doing business in Vietnam is not without its own set of challenges and may not be the right choice for some companies, a number of companies are relocating operations or their entire business there. Harris’s post is interesting and I recommend reading the full post on his site.
Break in the Action: I will be on the road the week of March 23, 2015, and so there will be a brief hiatus in this blog’s normal publication schedule. Regular publication will resume the following week.