Portfolio Financing: A Way to Reduce Risk in Litigation Funding
Within the growing litigation funding industry, new models are emerging which allow investors to minimise their risk. One of these is portfolio financing. It allows investors to spread their capital over a wide number of cases, thus reducing both the costs and risks of their investment.
Evidence suggests the demand for litigation funding is no longer just motivated by financial necessity but increasingly as a hedge against risk. Financial risks in a business such as interest rates and foreign exchange are routinely managed by hedging. Now CFOs know that dispute risk is no different and so are turning to litigation funding even though they might be financially able to pursue a case.
For this reason, the sector is seeing massive growth and portfolio financing is a rising star in the maturing litigation financing industry. The majority of litigation funding providers report that more than half of their committed capital is now invested in portfolio cases.
As an asset class, this emerging funding industry represents a real opportunity for yield-hungry investors and by deploying portfolio diversification investors can minimise their risk exposure.
How may portfolio financing be used?
Legal firms can use portfolio financing to pay for all or partial fees and expenses, or for expenses only. The advantage of portfolio finance is that it allows firms to deploy capital quickly to where it is needed most. Clients and their lawyers benefit from accelerated financing and a lower cost of capital reflecting the lower risk profile of investments made across a portfolio of cases.
Another advantage is portfolio financing is it can reduce contingency risk, which enables firms to onboard more contingency matters without increasing total exposure. For clients, portfolio financing is particularly advantageous for managing the impact of litigation on their balance sheets and risk profiles; this can be hugely compelling for publicly traded companies concerned with the negative accounting impact of litigation on EBITDA.
The Ideal Portfolio:
A portfolio may range from as few as two cases to an entire firm’s casebook where it is taking contingency or alternative fee risk. The diversity of unrelated cases and their time frames is the key to a balanced portfolio. The ideal portfolio will include uncorrelated cases involving different parties, different subject matter and different courts. As in any investment scenario, spreading risk across a range of matters reduces over-exposure in any one area and the risk of total loss of the investment, thus resulting in opportunities to provide more funding and/or lower pricing. However, as in traditional case financing, a portfolio investment is almost always non-recourse and so if the case is unsuccessful any investment is lost.
Ideally, a combination of high, medium and lower risk matters provide a more diverse portfolio. Some matters are more suited to portfolio financing such as high-risk cases including patents and international arbitration and sometimes preferred terms can be offered using a portfolio structure rather than single case financing.
How are portfolio investment terms determined?
Terms for both single-case or portfolio finance are ultimately based on our clients’ needs and can, therefore, vary widely, depending on the number of matters included in the portfolio and the length and strength of each case.
If a client values certainty, we may structure returns as a multiple of the investment or an interest rate based return as opposed to a percentage of proceeds, which cannot be known until resolution of the matter. With portfolios, returns are often staggered as cases resolve at different times, so an interest rate or IRR-based return may be preferable.