The case for funding litigation with Alison Trusty

Hear from Alison Trusty, Associate Partner at Aon, on the need-to-know facts about litigation finance. Learn about the challenges of investing in litigation finance, tap into the potential for diversification within a broader private markets portfolio, and understand the key drivers of returns from this strategy.

We also caught up with Alison at SuperReturn Private Credit Europe 2022. Enjoy this short conversation on medium-term opportunities in the European private credit industry.

The 'case' for funding litigation

A law firm typically incurs significant costs over the lifecycle of a case but with the expectation of recovering these costs through the settlement of damages pending successful litigation. However, law firms do not generally have access to traditional forms of financing, as banks are often reluctant to lend given the uncertainty surrounding litigation. Furthermore, law firms are typically unable to raise capital from public markets through issuance of equity or bonds, due to the constraints of their legal structure as a partnership.

Litigation financing has evolved as a means for investors, not affiliated with a lawsuit, to receive a portion of the proceeds from a case judgment in exchange for funding of those legal proceedings. As such, institutional investors are now able to fill the gap by providing finance to law firms and in return benefit from uncorrelated and potentially attractive levels of return. That said it remains a relatively small market; it is estimated that in the US, UK and Australia, potentially fundable litigation amounts to around $20-25 billion per annum, of which only $2.1bn - $2.7bn is currently funded.

Soliciting good returns

Although there are several ways to invest in litigation finance, we believe the most attractive from a risk and return perspective is to invest through loans directly to a law firm.

One of the key challenges to investing in litigation finance can be the binary risk associated with the outcome of a case since the return will be contingent on its success.

Providing a loan directly to a law firm secured against the case inventory, can mitigate this risk. The law firm is agreeing to repay the principal amount of the loan with interest through cashflows from the settlement of cases. As the investor has recourse to all the law firm’s ongoing and future cases, the return is less dependent on the success of a single case.

Manager selection here is key as it requires specialist knowledge of legislation and legal proceedings. A key part of the success in this opportunity is sourcing the right cases to fund, with the manager’s due diligence seeking to determine the probability of success of the case and the size of the likely settlement or award. Managers are further able to add value in portfolio construction by diversifying across law firms and cases. As the market has evolved, we have identified several institutional managers offering access to this strategy.

Role in a portfolio

Litigation finance can offer diversification within a broader private markets portfolio since the return is solely dependent on case settlement and not broader financial markets. Even during the Covid-19 pandemic, while some court proceedings slowed down because of nationwide lockdowns, there was little impact on the value of case settlement inventory for law firms.

As with any investment, there are risks. The biggest risk is that the case is ruled in favour of the defendant and there is no ability to recoup the cost of the legal proceedings. However, even in a successful case, the payouts are subject to the ability of the defendant to pay and there is often no set schedule.

Whilst it is possible to see some return through monetisation in the secondary market, quite often the timing of settlement will be a key driver in the ultimate return of the strategy.

For this reason, we believe success in the strategy will favour investment managers that fund cases where there is already strong legal precedent, in addition to the defendant having both the ability to pay and an incentive to settle.

Is it impactful?

In our opinion, litigation finance can be considered a strategy aligned with driving societal change as it seeks to assign financial accountability to corporations for acts of wrongdoing. Furthermore, it provides access for plaintiffs that may not have otherwise been able to afford legal proceedings.

Some notable high-profile litigation funded cases have included car manufacturers embroiled in the diesel emissions scandal, healthcare companies liable for medical device failure and pharmaceutical companies misrepresenting the benefits and side effects of their drugs. In theory, the threat of the financial burden of litigation should incentivise companies to improve their governance and practices going forward.

Uncorrelated opportunity

We believe there is a compelling opportunity in litigation finance as it offers the potential for an attractive level of return while being truly uncorrelated to other investment strategies.

The market for litigation finance is still fairly young as legislation globally has only in recent years allowed investors to participate. However, there is a strong fundamental case for why there is a structural gap in financing for law firms that can be filled by institutional investors.

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Under the spotlight: Alison Trusty

Alison Trusty is an Associate Partner within the global investment management team, with 15 years investment experience. At Aon, Alison’s research focus is on alternative credit, with expertise across both liquid and private debt markets. She has led the firm’s research efforts in strategies such as distressed debt, regulatory capital relief and litigation finance. Alison is also a member of Aon’s global private credit group.

Aon plc (NYSE: AON) exists to shape decisions for the better — to protect and enrich the lives of people around the world. They provide their clients in over 120 countries with advice and solutions that give them the clarity and confidence to make better decisions to protect and grow their business.

For more exclusive insights from Alison Trusty and other industry leaders, be sure to join us at SuperReturn Private Credit Europe >>