If you thought you had explored it all, from entertainment projects with guaranteed returns to revenue-based financing with a 3x return multiple, it’s time to meet the new kid on the block: Litigation Finance. While it may be a fresh alternative investment niche, it’s worth taking a look at its stunning return on capital potential and the light 3 year investment timeline. 

During our latest DiffuseTap session, we had the opportunity to dig into the details of this new asset class with two lawyers who are leading the charge in bringing legal claims in impact cases made by Public Sector Entities to the forefront of litigation finance: Michael P. Kelley, corporate partner at Parker Poe Adams & Bernstein, and W. Grant Farrar, founder and managing director of Arran Capital. 

What is litigation financing?

Litigation financing turns a legal claim into an asset. Cases come in all shapes and sizes, from commercial, to consumer and public sector entities financings. Which case type a legal funder chooses to fund depends entirely on whether the prosecuting law firm and client are able to demonstrate merits and damages for the claim and probabilistically predict the odds of a favorable outcome. 

The mechanics of a case are a bit more complex than a standard financing deal. According to Michael, there are generally three parties to a litigation finance transaction: the funder, which is a third party that funds the litigation in hopes of a return; the law firm, which benefits from the funding directly or indirectly by having its fees and costs paid; and the claimant, or the aggrieved party.  

Traditionally, financing litigation comes from scenarios wherein an aggrieved party is not able to finance certain claims so they reach out to a third party for financial help. However, over the years financing litigation has proven to become an effective investment model. Michael explains: 

“The nature of litigation funding relates to parties who have had a history of not being able to finance their claims, so they’re seeking out third party funding to help them. Increasingly, however, we’re seeing more strategic use by large corporate entities, and even by law firms who are financially very solvent.” 

Litigation funding can have a meaningful impact on the funded entity’s bottom line by providing the working capital that helps companies and law firms manage their balance sheets, optimize cash flow, and re-invest in growth. 

Legal funding in the public sector

As niche as litigation finance may be, according to Grant, there is already an estimated $8 to 10 billion AUM worldwide deployed in the space. Leveraging his deep domain expertise in public sector litigation, Grant’s firm, Arran Capital, focuses its practice to only service litigation cases in public sector entities. 

“If you think of cities, states, counties, or villages in the United States, they’re very active in litigation, usually as plaintiffs. They may be suing, for example, an opioid manufacturer in court, and they may need funding. But there is no litigation fund dedicated specifically to public sector entities. So that’s where we’re coming in.”

Grant calls Arran Capital’s model a “niche within a niche,” with an impact investing component. It allows citizens to get behind and fund their local government or any cause they care deeply for.

The profitability of these cases can be impressive. Citing ‘Dark Waters,’ a recent blockbuster film about a famous case against a big chemical manufacturing corporation, Grant says public sector litigation funding has proven to produce very attractive returns.

“On our end, usually it’s a public sector entity suing somebody to stop their conduct and recover money. Therefore, you’re talking about potentially billions of dollars nationwide that states, cities, and counties are going after. Factor in the civil penalties, the triple damages (under some statutes), and you can bet the risk-return profile on that is pretty attractive.”

The positive social impact of litigation funding

While funders are generally for-profit, litigation funding tends to scratch a ‘moral and social itch’, addressing an underlying imbalance in the system. Grant says that in cases particularly related to patent claims, he’s seen litigation financing help smaller companies prevail against big corporations:

“Particularly in the patent realm, in the private sector litigation finance world, the way the discussion has been evolving is about these ‘David versus Goliath’ cases, wherein a small company gets big-footed by a big company on a patent issue. From what I’ve seen, litigation financing has really helped those smaller companies survive, and eventually prevail in court.”  

Michael echoed Grant’s statements, saying more often than not, he’s heard great stories of how litigation funding has turned small companies around, and how financing market capital is becoming a trend:

“I think there is an increasing tendency for funders to finance working capital for a lot of these companies. In some of these David and Goliath stories, the claimants are coming to the funder on their last legs. They’re having to lay people off, and their business has been destroyed because of the events.

“In such cases, the funder provides working capital for the company to keep people in place and keep the company operating, to see it through the litigation. I’ve heard these remarkable turnaround stories where not only do these companies survive, but they’ve actually thrived because of the legal finance that was provided.”

Litigation financing in the public sector also seems to generally yield positive outcomes because of the very nature of the claims. Grant explains that the cases that funders want to get behind for profit also tend to be for ‘the greater good’ by their intrinsic merit. 

“We only want to fund meritorious claims that have the prospect of an attractive return. Therefore, for funders who have an impact investing focus, this is an excellent way to get involved. Public sector entities, they sue to make water clean, to keep air good, to have access to financial instruments that help citizens. And we’re all part of that process, so it’s very rewarding.”

Litigation financing is an attractive alternative investment model not only because of the great potential for returns, but also because at the end of the day, it’s a win-win situation for communities at large. 

If you want to learn more about spinning up and investing in alternative asset classes, ping us at contact@diffuse.vc to have a chat.

Meet the Speakers

Grant Farrar is the founder and managing director of Arran Capital Incorporated, a Chicago-based law firm that provides capital legal financing for public sector entities. Arran Capital‘s unique value proposition recognizes that public sector entities benefit from investment capital to ensure citizen access to the courts, and a level playing field in the litigation environment. 

Michael Kelley is a corporate partner at Parker Poe Adams & Bernstein LLP, a Charlotte-based law firm that has represented many of Southeast’s largest companies and local governments for over a century. With over 25 years of experience in finance and law, Michael represents both inbound and outbound investors on the structuring, documentation, issuance, and management of investment funds, including providing counsel on regulatory compliance and best practices. He has been recognized by Lawdragon as a top 10 global adviser and service provider to the litigation finance industry.

If you want to make new friends from the Diffuse Fund Ecosystem, email contact@diffusefunds.com.

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