Is the litigation funding industry under existential threat?
That’s certainly what some are suggesting following recent events in Australia, which culminated in the enactment of legislation headlined, “Litigation funders to be regulated”. While that may seem an overreaction to what is regulation only for Australia class actions (and who can blame them given the recent boom of this market?), the inquiry into litigation funding by the Australian Parliamentary Joint Committee on Corporations and Financial Service laid bare a deeper objection to the industry. And the transcripts seem to add weight to claims that there are global commercial interests wanting to limit the influence of (or in the words of one funder, “destroy”) litigation funding.
For now though, this risk is very low. For a start, the regulation debate needs to be kept in perspective. ASIC has captured litigation funding under its framework of managed investment schemes, which is based on the principles of consumer protection. Translating that to non-consumer markets is structurally very difficult to justify, when substantially deeper professional, commercial markets are largely unregulated. Think private equity or commercial real estate. If litigation funding were to be regulated, how could these markets justifiably not be?
And at a time when judiciaries are running on tighter budgets, could governments actually justify a regulatory budget for a young, evolving and complex market which is relatively tiny in size and influence? Regulation is expensive for the regulated, but multiple times more expensive for those creating and overseeing it, and the funding industry is not nearly as grand as it likes to think it is yet.
But even if regulation of litigation funders became uniformly obligatory, this may be an existential threat for some of the funders because of the associated costs of being regulated, but others will make the business model work by mitigating greater overheads with operational efficiency.
In fact, what the existential question really strikes at is not one of existence itself but of regulation and credibility. Does the industry need to be regulated, or does self-regulation suffice? What are best practices in the industry and how could they be implemented? Is the industry actually doing all it can to address these issues, or is it actually allowing anti-litigation funding interests to build a credible case because the industry is not on the front foot?
In a previous post, I argued that the premise of the Association of Litigation Funders was good. The premise of its code of conduct was good. But in 2011. In today’s vastly bigger and rapidly globalising market, a body with only a handful of members and a strictly England and Wales focus that urges “ … claimants and their lawyers… to work only with those funders who are approved members of the ALF…” lacks authority and credibility.
And what might one infer from the recently launched International Legal Finance Association last week, a trade association consisting largely of the same members with a few additional international players, that seems to be geared towards avoiding regulation? All things considered, an outsider might reasonably conclude that this disjointed approach with a whiff of self-serving interests does not add much credibility to the industry and that this is precisely why there is a need for a regulatory framework.
So what’s the solution, because as the industry continues to grow, the pressure for regulation will inevitably increase further. Much like ALF, the premise of ILFA looks good for now. But if we see the current pressures on the industry not as existential threats but as compliments to its success and an opportunity to be progressive and re-shape what to date has been more akin to a private members club, then ILFA’s vision looks misplaced and short-sighted. Instead, funders should focus less on words and more on actions to continue establishing the credibility of the industry, and improve their own standards so that natural market competition filters out the weak, and those that remain stand up to scrutiny.
Stop overplaying success
A common criticism of funders is the seemingly vast and unjustifiable profits funders seem to make at the expense of those seeking justice. But when funders don’t talk much about their performance and only of the successes to the extent they create the impression that every case is like a “Petersen”, how can that be avoided? What rationalises profits/returns is the recognition that litigation funding is not risk-free and investing in litigation puts significant capital at risk. It certainly isn’t for the faint-hearted.
Perhaps for an industry ultimately populated by litigators who gauge status by the winners on one’s CV, it should come as no surprise that talking losses does not come naturally. Maybe it’s because the industry hasn’t quite evolved out of that teenage phase of insecurity where a few blemishes seems to undermine the value of the whole. Whatever the reason though, without talking losses, it inadvertently relays an impression of commercial arrogance that will no doubt have motivated to some degree Muddy Water’s attack on Burford last year and ShareProphet’s more recent attack on Manolete. When one considers that Burford’s loss rate seems to be at around 32.5% (based on their own publicly available data), some would actually consider Burford’s performance to be even more impressive.
Perhaps the industry could learn from its after the event (ATE) insurance cousins. The ATE market is deeper and longer standing, with some major behemoths standing behind them. ATE is also expensive because it reflects the risk they take. Yet, few complain about the profits ATE insurers make despite their expensive premiums because there is an awareness that insurers lose cases and money. Despite very similar risk/reward profiles, insurers seem a more normal and considered business model, rather than the profiteering image that some funders give.
Minimise the use of exclusivity periods
Too many funders have got into the habit of offering indicative terms and demanding an exclusivity period to commence the substantive part of their assessment process as a matter of due process. Perhaps there was a time when these exclusivity periods seemed good practice in the market’s infancy, but this is inherently anti-competitive and places lawyers acting in the best interest of their claimants in an awkward position.
Exclusivity periods should not be about helping funders secure a free option, nor should they be a means for a funder to make up for the operational inefficiencies. Even to cover the risk of being gazumped is not justifiable when one considers that the deeply established residential real estate market has absorbed this as simply another commercial risk with which one should live. Instead, the market needs to embrace the principles of free market competition and allowing the best funder to win (whether that be on price, structure, speed, delivery, execution or any other reason) in a way that other established markets do.
Litigation funding facilities
Naturally, relationships are key in business, but relationships are also the source of risks, such as conflicts of interest, nepotism or accusations of much worse. The recent announcement of DLA Piper’s tie-up with their own litigation funding business, Aldersgate Funding, and LCM, is one fraught with risk for very little upside, with many questioning the risk that DLA are being put under of breaching its client obligations. If, as stated, it is a non-exclusive relationship and they really are seeking best-of-class funding terms for their clients, then what’s the point of entering into it in the first place? All it takes is for one client to identify a funder that is consistently cheaper than LCM and the whole arrangement is fatally undermined.
But it’s not just LCM. Augusta did with HFW, Pinsent Masons and Acuity Law, as did Affiniti with Royds Withy King and Burford with Shepherd & Wedderburn. The real question is why funders would put law firms at this kind of risk. In fact, some might throw the same accusation at my funding business, LionFish, on the basis of being owned by the same listed company that owns the law firm, Rosenblatt. However, there is a key distinction. LionFish exists, not as an internal litigation funding vehicle for Rosenblatt, but an independent funder transacting with other solicitors to offer them best-of-class funding terms. In fact, it does not fund any matters that Rosenblatt is instructed on, so as to protect the integrity of Rosenblatt and LionFish.
Rather than a lobbying or regulatory body, the industry could think more along the lines of a trade body to create a transactional framework. I have previously referred to the ISDA® framework used in the derivatives market, where market-accepted definitions form the basis on which all standard derivative transactions are executed. In fact, there is a current initiative led by a few funders engaging a law firm to create a market standard litigation funding agreement. While this is to be applauded, a more market-wide engagement would lend significant weight to an initiative that has the potential to establish real market credibility.
Perhaps it might be unfair to say that most funders are run by litigation lawyers who have not adapted to the notion of time no longer being a fee-generating asset, but a cost that eats into profit margins. However, it is a well known fact that the single biggest criticism of funders is turnaround times and how long an application for funding can take some funders. (Even DLA Piper’s announcement of its tie-up with LCM referenced the fact that its processes would “significantly reduce approval times”.)
Invariably, litigation cases are complex and some processes are necessarily long, but that is well understood. The criticism is founded in those many applications that do not need to take as long as they do. I do not want to highlight this too much; this is one of LionFish’s USPs and why we win business from those perceived to be funding royalty. However, the fact that the industry struggles to deal with something that could so easily be addressed opens it up to attack for not demanding and striving for the highest standards possible.
Credibility v existentialism
It is a testament to the success of the industry that some believe it is big enough to be considered under existential threat. But as with any industry or any business, credibility is key to ensuring not only its survival, but its future prosperity. Rather than looking at what the potential threats are, the industry could do worse than focusing on improving its own standards, so that if it ever comes under further scrutiny (which it will invariably do as it continues to grow), its strategy is not to avoid it but to pass it with flying colours.