Litigation funding & due diligence: A best‑in‑class approach

In 2023, the Supreme Court sent the litigation funding market into turmoil by ruling that litigation funding agreements – which entitle litigation funders to a payment based on the level of damages recovered – are damage-based agreements.

Why is this significant?

Essentially, the ruling rendered many existing litigation-funding agreements unenforceable unless they complied with the restrictive regulations that govern damage-based agreements. For litigation funders focused solely on UK cases, this ruling had the potential to impact every single portfolio case – leaving many facing losses, as well as an urgent need to review the way they drafted agreements.

The ruling caused widespread upheaval in the industry, with hundreds of funded civil lawsuits in the English courts thought to be affected. However, the litigation funders that we work with didn’t panic. This is why.

An overarching focus on due diligence

At DFC, we expect our provider partners to share our rigorous approach to due diligence – and those operating within the litigation finance sector are no exception.

Accordingly, we work with partners who are committed to implementing robust risk mitigation measures at every stage of the investment process. Having a portfolio that encompasses a variety of cases is a key element of this success: our partners will never focus all cases in a portfolio on a single jurisdiction, for example.

Leveraging a three-pillar approach when selecting cases

In general, our providers focus on three basic pillars – which apply regardless of jurisdiction – to determine whether a case is suitable for investment. They ask:

1. Do the economics of the investment work?
2. Is the case strong on merits?
3. Is the defendant solvent and will any award be enforceable?

In simple terms, our partners use these pillars to seek out strong cases where there’s a high chance of a favorable ruling.

Looking outside (as well as within) the UK for the best cases

Commercially, the UK is a highly developed market and is currently oversupplied with funders. As a result, investors are more likely to find a high quantity – rather than quality – of cases to fund. What’s more, many strong UK cases now offer reduced commercial appeal when compared with opportunities in other jurisdictions. That’s why we look for providers with a genuinely global approach when it comes to sourcing cases.

Ultimately, when considering the merits of an investment, jurisdiction should never outweigh the three pillars. Leveraging their extensive network of international contacts, our partners are committed to sourcing cases that offer the strongest potential returns for investors.

Ensuring variety to mitigate the impact of unexpected events

These are by no means the only measures taken to protect investor capital. Our partners also prioritize low-value high-volume case portfolios, which statistically increases the likelihood of achieving favorable outcomes.

Because of this breadth of exposure, there is a lower likelihood that unforeseen events – an industry downturn or the appointment of a defendant-friendly judge in a district, for example – will cause large waves across the portfolio. Instead, the portfolio’s performance is designed to be insulated. While one or two cases might be negatively impacted, the portfolio as a whole is designed to remain resilient.

In addition, by grouping cases into portfolios, returns are no longer dependent on the outcome of a single case. And by designing each portfolio to encompass logistically and sector diverse cases – all at different stages of the litigation cycle – risk is further mitigated.

Fixed-income products with robust security structures

Finally, this commitment to rigorous due diligence is reflected in the security structures underpinning fixed-income opportunities – insurance policies and performance guarantees, for example – offered by our partners.

The Supreme Court ruling disrupted the litigation funding market, with smaller operators likely to exit the sector. While leading funders have, understandably, reassessed the structure of their agreements in response to the ruling, a select group – those distinguished by a deep commitment to due diligence – continue to source high-quality cases for investors. And we remain focused on building and strengthening partnerships with these funders.

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