Here’s How Hedge Funds Are Speculating on Justice

1. How does litigation funding work?

A law firm will often shoulder the costs of a case on behalf of its client, then a specialized hedge fund will reduce its financial exposure by making periodic payments to cover expenses. If the case succeeds, the backer typically receives a multiple of the funds invested, or a percentage of the damages, whichever is higher. If the suit fails, the funder loses the money and the litigant doesn’t need to pay them back. Funders most often support commercial cases but can get involved in a range of actions, from environmental suits to personal injury and banking fraud cases and even the divorces of Russian oligarchs. Proponents say the practice allows individuals or firms with fewer resources to pursue valuable claims that might otherwise be abandoned, and means claimants can hire their preferred counsel without being left out of pocket. 

2. How much money is in it?

Swiss Re research found there was around $17 billion invested in litigation finance globally in 2020, with more than half of that deployed in the US. In the UK, $2.7 billion was on the balance sheet of the country’s top 15 funding firms last year, almost double the figure three years earlier, according to data from law firm RPC. Some of the biggest specialist funders are Burford Capital LLC and Omni Bridgeway Ltd. Big investment firms including D.E. Shaw & Co., Elliott Management Corp. and TowerBrook Capital Partners have also got involved. The industry has tended to back plaintiffs but is now pushing to fund defendants too.

3. What are the potential returns?

Funders generally receive around 30-40% of damages and costs recovered, said James Popperwell, a lawyer at London-based Macfarlanes. Litigation funders in Australia have been making internal rates of return approaching 400% in some cases, according to figures cited by the US-based Institute for Legal Reform. The industry’s prospects look bright as opportunities for litigation tend to grow during economic downturns, when disputes and insolvency proceedings multiply. 

4. What makes a successful investment? 

A fund manager will spend a lot of time researching the plaintiff and the legal landscape before getting involved. They will also consider how good the lawyers are and whether the other party has the means to pay out. A good case usually has damage multiples much larger than the case budget. 

5. What are the risks for investors?

Investments are difficult to sell out of and cases can take years to resolve. Investors often get nothing back if the case isn’t successful and can end up on the hook for heavy legal costs, sometimes also for the opposing side. Even if a case is won, the amount the court awards can fall below expectations. So funders usually build a portfolio of diversified cases to spread their risk. 

As funding agreements are private, judges are often in the dark about how much money the injured party has committed to pay investors if their claim is successful. Sometimes a fund will end up with a bigger slice of the damages than the claimant.  

Critics say the vast sums now invested in litigation are distorting the purpose of the judicial system: Rather than being about resolving disputes, cases are now about declaring winners and losers. Ever more marginal, riskier cases are coming to court, sucking commercial defendants into litigation when they should be focused on running their businesses, and leading to frivolous or abusive cases that have only a slim chance of success. In 2015, a long-running litigation campaign against oil giant Chevron Corp., backed by several different funders, was found by a New York court to have devolved into a racketeering conspiracy involving bribery, coercion, and fabricated evidence. Those accusations saw funders pull out of the case. 

8. What do regulators say? 

Following a run of speculative class-action suits in Australia, the government there is starting to act. Proposed legislation would restrict fees for class-action lawyers and funders to a maximum 30% of any total payout and give courts the power to approve and adjust funding agreements. European lawmakers recently voted in favor of tabling legislation that will introduce new regulatory curbs to the industry. The US are also looking to tighten rules around disclosure of third-party litigation funding. 

(Updates with EU detail in section eight. An earlier version of this story first published on Aug. 27 corrected the Australian figures in section three to reflect maximum returns, not averages)

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