Litigation Finance is a burgeoning industry that is turning legal claims into an asset class. An easy way to understand litigation funding is through an example; if someone or a company wants to sue another party due to patent infringement or another reason, but they lack the funding, they can go to a third party funder who will provide non-recourse financing. If the plaintiff wins, the third-party funder gets a pre-determined portion of the proceeds. Litigation funding has appeal to both parties; the plaintiff takes less risk and has potential upside while the funder receives attractive IRRs that is also non-market correlated. If litigation funding is so appealing why don’t law firms all do this in-house? Some are certainly being more aggressive than others with contingency fees however the vast majority don’t because each case is unique with significant differences in potential awards and lengths of time it will take for cases to resolve. Only with tremendous scale can a firm be reasonably sure of a consistent revenue stream. Law firms are also generally structured as partnerships where the most senior lawyers are entitled to draw on the firm's cash profits. A steady paycheck is hard to break away from. Litigation finance helps both plaintiffs and law firms, expanding the TAM for both parties.
The largest player in this space far and away is Burford, followed by several private players and other public ones such as Litigation Capital Management, Omni Bridgeway, and Manolete Partners. For the rest of this article, we will focus on Burford Capital and Manolete Partners as we believe they represent the best plays in litigation funding.
Burford Capital
Burford Capital (NYSE:BUR) is the incumbent in the space starting back in 2009 with about a 100mm dollar portfolio size. Fast forward 12 years later and BUR has a 5 Billion dollar portfolio with 3 billion coming from its own assets and another 2 Billion from its AUM arm. As it grew, BUR started to go after larger high dollar cases to be able to scale as the work required to find out if a case was a good investment was roughly the same for a one-million-dollar case vs a ten-million dollar one. These high-dollar cases typically meant international arbitration coupled with enforcement. Enforcement means recouping the settlement awards. Winning a case is just the first step, getting the money is the second. To do this one needs an enforcement team that can track assets through various countries to be able to take possession and liquidate. Burford is unique in that it is the only litigation funder with a top-tier enforcement team that has the means to chase the money down. Its enforcement arm is far and away the best in the business giving it the ability to pursue cases that its competitors cannot.
BUR was a compounding machine returning greater than 30% CAGR until a short report from Muddy Waters in 2019 claimed that Burford was the next Allied Capital. BUR share price collapsed 50% from both large institutional selling (Woodford) and fear that BURs legal claims were at best overvalued, and at worst dross. MW claimed that BUR was juicing earnings by being quick to increase the fair value of its investments and slow to realize losses. BURs accounting murkiness stems from how it classifies its litigation assets, IFRS level 3. These are financial assets and liabilities that are extremely illiquid and hard to value, other examples of these assets are MBS and complex derivatives. BUR increases the fair value of its investments once certain checkpoints are hit during litigation; the problem is some of these cases last for several years. Although Muddy Waters raised several good points- and Burford could certainly be more transparent- we do not think BUR is as shady as MW makes them appear to be. However, this overhang is unlikely to clear as many of BUR’s cases are still open from seven years ago and investors are uneasy about how BUR can properly value these cases. We delve into the mechanics of BUR’s litigation funding below.
Initially before investing in a legal claim BUR has some lump sum of cash that it needs to deploy. The pipeline of potential claims comes from companies or law firms that have worked with or have heard of Burford. A case has to make its way past several filters before arriving at a 9-person committee who will have the final say as to whether to accept it or not. BUR has a high rejection rate which is around 96%. Once Burford makes an investment (either with a law firm or company), it considers that capital to be “deployed” and waits for one of three possibilities: a settlement, a win, or a loss. The likelihood of each scenario The likelihood of each scenario is shown below from BURs historical track record. Approximately 60% of BURs cases settle, 30% go to adjudication and win, and 10% of them lose. Although settling is the desired outcome as it is the quickest to resolve, if a case goes to adjudication and BUR wins, the ROIC is 5x higher.
As a third-party funder, BUR does not have a decision-making role in the case and has to accept how the claim lawyers want to proceed. Once the case is settled or if won, BUR contractually has multiple ways of splitting the proceeds, it could be a flat 50/50 split or if BUR expects the case to take longer, a certain IRR (generally around the 20-30% mark) hurdle attached to the initial sum. The average duration of these cases is typically around the two year mark. However in total, from the time it takes to deploy the capital, to the duration of each case, and to finally receiving the payment ( via enforcement or other methods), takes roughly 4-6 years. We have graphed the percent of their cases completed by year below.
From above, one can see that BUR has resolved less than half their cases from …