A comprehensive guide to litigation funding as an alternative investment

Litigation financing – also known as commercial litigation funding, third-party funding or legal finance – is the funding of legal cases by third parties in return for a share of the proceeds. It’s a fast-growing and compelling alternative asset class, with the market predicted to be worth $25.8 billion by 2030.

Are you a litigation finance newbie? Want to know more about how it works, the rewards and risks it delivers, and the role it plays in diversifying a portfolio? Our comprehensive guide reveals all.

What is litigation funding?

Relatively new as an alternative asset class, litigation funding is growing in popularity amongst individual and institutional investors. At its heart, the concept is simple. Third parties provide financial backing to law firms to pursue legal cases. In return, they receive a share of the proceeds or settlement.

Litigation finance can be used to fund a wide range of legal cases – commercial litigation, class actions, arbitration, intellectual property disputes and personal injury claims, for example. It gives investors the opportunity to benefit from the lucrative legal system and supports access to justice for those who don’t have the money or expertise to pursue it.

Unlike many other alternative investments, litigation funding hasn’t been around for centuries. Historically, litigation costs had to be covered by the client or the solicitor – if neither could pay, the case couldn’t proceed. However, during the 1990s in Australia, insolvency legislation permitted practitioners to enter into contracts to fund legal cases for the first time. And in the 2000s, litigation funding took off, becoming a mainstream feature of the legal industry.

Today, it’s increasingly popular – not just because of the potential it offers for high returns, but because of its lack of correlation with global markets and traditional strategies. It also appeals to investors keen to level the playing field and give access to justice to those who might not otherwise afford it. What’s more, it’s increasingly accessible to individual investors as well as institutions, family offices, private equity firms and hedge funds.

Understanding litigation funding

So, what’s the process of litigation financing? Of course, it varies wildly from case to case – and we’ll get into the mechanics below. However, it can feel overwhelmingly technical for a first timer! Broadly speaking – from an investor perspective – it looks like this:

• You invest in a legal case or (more commonly) a portfolio of cases via a funder
• The case reaches its outcome
• In the case of a win or a settlement, you receive a percentage of the proceeds

Of course, it’s crucial to choose a reputable funder – one that conducts extensive research to ensure that the case or cases in which you invest have a strong chance of winning. Traditional litigation funders – the companies that we partner with, for example – have accumulated vast experience and are committed to conducting extensive due diligence on cases. They’re also experts on structuring agreements (which can be complex) to mitigate risk – more on that below. Plus, they’ll provide ongoing management throughout the claim.

Other key players in the litigation funding market include multi-strategy hedge funds, many of whom have a dedicated litigation finance desk. They’re also experts in law and tend to be able to execute deals faster than traditional funders, though the minimum investment tends to be higher.

Unlike traditional investments – by which we mean stocks, bonds and cash – litigation finance isn’t correlated to the stock market. When weighing up the pros and cons of traditional vs. alternative investments, it’s also worth considering that many litigation finance investments have predefined coupon payments (so you know in advance what your returns will be) over set timeframes. Many – those we source, for example – offer accessible entry points and incorporate strong protection mechanisms. However, it’s crucial to remember that no investment is free from risk and that due diligence is critical.

However, as part of a diversified portfolio, litigation funding provides a hedge against economic volatility as well as the scope for consistent returns. Its appeal to those in the know is therefore unsurprising.

Mechanics of litigation funding

Litigation finance is a broad term. However, there are some elements that are common to the overarching model, as follows:

• The funder invests an agreed amount, which covers all or some of the legal costs of the case (or portfolio of cases)
• Agreements are non-recourse, which means returns depend on the case being successful
• Typically, returns are based on a percentage of the damages or settlement, though they can involve fixed fees or a multiple of the initial investment
• Whatever the payment terms, the funder has no direct interest in the proceedings
• All decisions are made by the law firm acting for the claimant, who is also free to discontinue their claim, should they wish

Funders can choose to finance either a single case or a portfolio of cases. With the former, the funder pays for a single dispute and receives repayments if the case is won. Under a portfolio model, the funder pays for multiple cases. This spreads the risk, and the funder is repaid from the cases that are successful.

Whatever the model, it’s essential for litigation financiers to conduct thorough investigations into cases and claimants before deciding to fund them. Due diligence is crucial to success and an important factor when it comes to mitigating risk.

Of course, as with any court case, the case could be unsuccessful; funders take on that risk too. However, by financing a portfolio of cases with high success potential – a winning probability of at least 65%, for example – that risk is mitigated.

Potential returns from litigation funding

Litigation funding is a lucrative alternative asset class offering the potential for attractive and consistent returns that are typically higher than those delivered by traditional asset classes. There are various options for investors – dependent on your attitude to risk and investment timeline:

• Fixed-income bonds – these tend to be short term (up to 18 months) and generate returns of between 15% and 20% per annum, uncorrelated to the timing of case
• Loans – also uncorrelated to case timing, funders can offer short, medium or longer-term options that deliver higher returns
• Equity – directly correlated to case timings and outcomes, these also offer the scope for multiple ROI

So, what factors influence returns? The first obvious answer is the merits of the case, which makes rigorous due diligence a prerequisite. Successful funders determine whether a case is suitable by considering its economics, its merits and the solvency of the defendant. With this approach, they are able to focus on cases with a strong likelihood of a favorable ruling.

Another effective strategy is the inclusion of a broad mix of cases to mitigate the impact of unforeseen events. For example, leading funders incorporate low-value, high-volume case portfolios – so if one or two cases are impacted by an external factor, the portfolio as a whole remains on track to achieves its targets.

Further efficiency is achieved via the aggregation of portfolios spanning different sectors and geographic locations at different stages of the litigation cycle. This layered diversification strengthens risk mitigation and enhances the overall resilience

Risks associated with litigation funding

As with all investments, there are potential risks and uncertainties associated with litigation finance.

The first and most obvious relates to the inherent uncertainty of legal cases themselves. There is always a chance that a legal case will be dismissed, won’t settle or will lose at trial – or the possibility that any settlement isn’t sufficient to pay back investors. Alternatively, a lawsuit might take a lengthy time to reach trial. Other legal risks include the law firm withdrawing or being sued on a separate matter, which could impact the case.

There are also regulatory considerations to bear in mind. Unexpected events – such as the UK Supreme Court’s 2023 ruling that litigation funding agreements are damage-based agreements – have the potential to negatively impact the outcome of cases. Alternatively, the appointment of a new judge also has the potential to disrupt expected case outcomes – as does a downturn in a particular sector or industry.

So, as an investor, what strategies can you adopt to mitigate these risks? First, it’s crucial to ensure that you partner with a reputable funder – one able to demonstrate robust due diligence when it comes to selecting cases. Our litigation finance partners, leading companies with global reach, will never focus all cases in a portfolio on a single jurisdiction, for example.

Next, you should look for investment products that incorporate security structures to ensure an additional layer of protection. Measures such as first-charge debentures, security trustees and insurance policies manage risk, though it’s important to note that it can’t be mitigated altogether.

And finally, always opt for an investment structure that’s in keeping with your risk profile and time horizon. One major benefit of fixed-income bonds in litigation finance is that they offer the scope for regular coupon payments – a draw for those seeking stable and consistent income.

Litigation funding in a diversified investment portfolio

Litigation finance not only offers the potential for attractive returns. It’s a sound strategy if you’re looking for ways to bring diversity to an investment portfolio.

As discussed above, there’s low correlation between legal funding and traditional asset classes of stocks and cash. So, when you allocate a proportion of your portfolio to a litigation finance investment, you’re diversifying and mitigating overall risk.

Moreover, there are also diversification benefits within the asset class itself, provided you choose a funder that’s committed to including a variety of cases in its portfolios – spanning jurisdictions, sectors and case stages, for example. Further mitigating risk, this strategy ensures that your investment isn’t dependent on a single case type.

Another advantage of this alternative asset class is its ability to provide consistent returns. If you’re looking for a reliable income stream – to supplement your income or to enjoy your retirement, for example – a fixed-income bond is a solid choice. And with a relatively varied offer in terms of entry point, dividend schedule and maturity profile, legal funding is accessible to a growing range of investors.

While it’s growing fast, litigation finance is still relatively unknown. It’s evolving as a market, and there’s a trend towards multi-claim portfolios rather than single-use cases emerging. Ultimately, it’s one of the most attractive alternative asset classes and is generally considered to be recession proof.

How to invest in litigation funding

Thinking of diversifying your portfolio with a litigation finance investment? Selecting the right funder is paramount to success. Look for a provider with:

• A successful track record on case selection
• A thorough due diligence process
• Products that incorporate robust security structures
• A commitment to transparency

And if that seems overwhelming, we can help. We’ve partnered with leading litigation funders with global reach to give you access to unique investment opportunities in the litigation funding space. Our partners specialize in exclusive litigation funding opportunities that have passed a strict vetting process. Leveraging their international reach, they seek out cases with multiple-ROI potential – and share our commitment to exceptional service and communication.