Why is diversification so important in commercial litigation finance?

In a word, risk. A lack of diversification in a commercial litigation finance portfolio increases the portfolio’s risk substantially. The more significant risks (setting aside legal representation risk) of a single piece of litigation can be summarized as follows: (i) legal risk, (ii) counterparty risk, (iii) judiciary risk, and (iv) plaintiff risk.

• Legal Risk

Legal risk is a catch-all for a variety of legal considerations inherent in a piece of litigation.  These could include the risks associated with the legal counsel’s and litigation finance manager’s interpretation and assessment of the legal merits of the plaintiff’s case.  This risk is more significant when investing in the earlier stages of a case due to fewer facts/disclosures being available when a financing decision is necessary.

• Counterparty Risk

The core component being that even if the plaintiff were to win its case, the plaintiff may not be able to collect the award or settlement.  In some cases, the defendant has the financial resources to pay the award, but due to the jurisdiction of the case, the plaintiff may not be able to enforce and collect its award. This can also be referred to as collection risk.

• Judiciary Risk

Judiciary risk is simply the risk that despite a meritorious claim with ample supporting evidence, the judiciary will make an unpredictable or incorrect decision that results in a loss to the plaintiff.  This risk will differ depending on the nature of the forum and the nature of the judiciary and not to mention the individual making the decision.

• Plaintiff Risk

Most jurisdictions prevent a third party from influencing the plaintiff with respect to their case. Officious intermeddling is a reference to a third-party interfering with the plaintiff’s decision and is a component of the definition of the legal doctrine of ‘champerty’, which is still relevant in many jurisdictions. Accordingly, when a litigation funder takes on a case, they must ensure that the plaintiff will be an economically reasonable decision-maker, which is difficult to assess, as the injured party typically wants to exact revenge for the damage done to them. The good litigation funders will spend time with the plaintiff to assess their economic rationality, but ultimately the funder is adopting an element of plaintiff risk when funding a new case.

Topics: Diversification | Commercial Litigation | Risk

Work cited: Ed Truant | Slingshot Capital | June 10, 2020