Litigation Funders Planning a New Role: Law Firm Ownership

Finance has a long history of creative expansion. Financing lawsuits is proving to be no exception. Since litigation finance hit the scene just a couple decades ago, the business has evolved from investing in single lawsuits to groups of claims to purchasing judgments at bankruptcy auctions, as Chicago-based Gerchen Keller Capital did earlier this year. See, “Litigation Funder Wins Stake in $213M Renco Judgment,” The Am Law Daily (Sept. 8, 2016) (http://bit.ly/2euJgPJ). Now, some litigation finance firms are preparing for an even bigger change to their business model: Injecting cash directly into law firms in the form of an equity stake that isn’t tied to any specific case. Litigation funders Burford Capital and Woodsford Litigation Funding told Law.com they intend to invest in UK-based firms that are allowed to have nonlawyer owners, something that remains against professional ethics in the United States. “We’re open to that and excited about that,” Burford’s chief investment officer, Jonathan Molot, said regarding investing in firms known in the UK as “alternative business structures.” Not everyone agrees. There is a segment of the lawsuit finance industry that believes taking ownership in law firms could put litigation funders at odds with the lawyers with whom they seek to work. Others argue that better-capitalized law firms may cannibalize the need for more traditional funding of individual or groups of lawsuits before the industry matures. And equity investments in law firms would require a change from the “underwriting” method litigation funders currently use to analyze the likely results of potential cases. “I don’t think you’ll have nonlawyers just handing money to law firm management and saying, ‘We trust you,’” said a litigation funding executive who declined to be named. The discussion comes on the heels of Burford’s announcement last month that it had formed its own law firm under the UK’s alternative business structures (ABS) law. The firm, Molot said, is limited to a lawyer who will track down funds from litigants who try to dodge judgments that Burford’s investments have helped to win. Burford hired Akin Gump Strauss Hauer & Feld counsel Tom Evans for the role, which it says represents “in-sourcing” an aspect of legal work in which neither Burford nor the firms it funds typically specialize. Burford does not plan to hire lawyers to conduct its own case work, Molot said. The funder is wary to be seen as competing for legal work that it currently pays large law firms to handle, for fear of upsetting its relationships with those firms. Litigation funders typically rely on law firms to find many of the cases in which they ultimately invest. “That would never be our plan,” Molot said of creating a full-fledged ABS law firm. For now, these concerns don’t affect law firms in the United States, where the American Bar Association still restricts nonlawyer ownership. The ABA asked for comments on potential rule changes in April, and Burford’s CEO, Christopher Bogart, responded in favor of expanding law firm ownership to nonlawyers (see, http://bit.ly/2eETxaS). A change is not widely anticipated, and the ABA declined to expand ownership rules the last time it reviewed the subject, in 2011. But there are plenty of U.S.-based litigation funders that do business in the UK, and those financiers may see the opening of the country’s financial markets as an opportunity. At least one firm across the pond sees potential financial benefits for a litigation funder to build its own law firm. Steven Friel of UK-based Woodsford Capital said his firm is actively considering whether to make a move into the ABS space, largely because of two advantages he sees. Owning a law firm could eliminate a unique risk litigation funders face in England: They can be held liable for the defendant’s costs in losing cases they fund, Friel said. Contingency-fee attorneys don’t share that risk. And owning a law firm would allow the funders to exert more direct control over the course of litigation, something champerty rules still disallow for funders. Friel said his firm is still weighing whether to make its own move into the ABS space. But he is confident that he will invest in an external ABS firm. The Challenge: Valuing Investments In Law Firms One difficulty facing litigation funders who take equity shares in ABS firms will be to figure out a new model for projecting their returns. The industry has in the past been based on investing in cases or portfolios of cases that the funder knows already exist and are expected to generate a successful outcome. A shift to equity investing would require something closer to a private-equity firm’s due-diligence model, where the investor is placing trust in a group of executives to create value; or, in the law’s case, skillful lawyers to select and win cases. “That’s a much different type of law underwriting than we do,” said an executive at a U.S.-based litigation funding firm. Both Burford and Woodsford stressed that, in situations where they took equity stakes in law firms, it would require strong relationships and trust between the funder and management of the firm. Another concern voiced by executives in the area was that investing directly in law firms would reduce the need for more traditional litigation finance, cutting into a more mature line of business for these financiers. But Burford’s Molot said firms that have taken on outside investors will still have room for “specialty finance” if they see a lawsuit that presents a bigger investment or risk than normal. That is much the same way that publicly traded companies view finance. But it is a new concept for law firms. “There is not another industry where there is this much money and this much productivity that does not have access to the financial markets,” Molot said. “And in the UK, the ABS offers yet a further step in giving lawyers access to the financial markets that any other industry anywhere near that size has long had access to.”