June 7, 2019

Litigation finance crowd talks underwriting hurdles, case budgets, conflict management

As it appeared on debtwire.com

by Andrew Ragsly

Litigation finance is poised for growth, according to nearly every one of the industry leaders and upstarts in the standing room only crowd at this week’s IMN 2nd Annual Financing, Structuring & Investing in Litigation Finance conference in New York. But while big picture expansion is clearly on the horizon, gray areas around best practices for underwriting, deal shopping and the sector’s mainstream presence garnered most of the attendees’ and speakers’ attention.

Keynote speaker Eric Blinderman, CEO of Therium Capital opened the 3 June event by ticking off recent high profile fundraises that underscore the industry’s ascension. Therium’s USD 430m fundraise in March was “oversubscribed”; Bentham IMF raised USD 500m in 4Q18; Validity Finance started with USD 250m last summer, and Curiam Capital started with USD 100m last year before subsequently getting its committed capital for investments up to more than USD 400m.

This influx of capital will inevitably bring with it more diversified financial products such as securitization in order to unlock secondary opportunities, Blinderman said. However, in light of all the new money that needs allocating, funders at the event maintained they are staying scrupulous. Arrowhead Capital President Mark Jacobs, for instance, speaking on the “Underwriting Best Practices” panel, said his firm “still funds less than 10% of what we see,” as the painstakingly long due diligence process remains necessary.

On that front, the concept of funders locking potential clients into NDAs – often for up to 30 days – while negotiating contract terms and assessing the validity of a litigant’s case sets a dynamic that can leave both sides disenchanted. As Andrew Langhoff, director of litigation funding brokerage Red Bridges Advisors, depicted during the “Deal Issues and the Challenges of Obtaining Financing for Litigation” panel, the origination process can be “insidious” in the sense that clients can go from “belle of the ball” status with multiple funders interested to then getting perceived as damaged goods should the client have to go back on the market after NDA talks don’t result in a deal. “Funders know this,” Langhoff said, and offered that the exclusive negotiating period could be improved with the introduction of a simple breakup fee to rebalance the scales of power during negotiations.

Boris Ziser, co-head of Schulte Roth’s structured Finance & Derivatives Group, countered that funders also assume vulnerability during exclusive negotiating periods since there is risk the funder puts in due diligence for a term sheet, only to have the prospective client then go out and shop for better pricing behind virtually the same term sheet.

But related to that, Charles Agee, CEO of lit funding brokerage firm Westfleet Advisors, said during the “Underwriting Best Practices,” discussion that he doesn’t just recommend clients take the lowest-priced bidder since the cases can be fraught with pitfalls – so clients need to ensure compatibility beyond award economics.

For instance, the topic of attorneys budgeting out their cases for the purpose of funding agreements was cited by several panelists as an area with room to improve. ”If you want to see some light financial analysis, look at law firms,” joked Collin Cox, partner at Yetter Coleman. “All of us have gotten better at business when we have to work with budgets, because when we are out of budget [on a lit funding deal] that’s it. It’s on us. We have never gone back and ask to re-trade a deal. That’s our deal.”

Cox added that while his own sense of timing out a case is strong, the advent of lit funding has forced him to become shrewder at handicapping expert costs. Arrowhead’s Jacobs advised firms not to “lowball” on the budgets “because you will live with that budget.”

Other contract variables that both funders and litigants have been wrestling with include MAC clause and bad boy guarantees guarding against wild case disruptions or fraud type behavior. J. Ross Wallin, managing principal at Curiam, speaking on the “Deal Issues …” panel, cautioned funders from taking such a hard line on enforcement. “If you have a reputation of firing that bullet too aggressively, opportunities will dry up,” he said.

Speaking on the same panel, Joshua Meltzer, a managing director at Woodsford, agreed that those provisions are only for extreme cases. “What funders don’t want is for a client who has very little engagement, who might look at it as a free shot on goal with a lottery ticket mentality,” he said. “It’s prudent to put [the MAC and bad boy clauses] in the contract but triggering them is not.”

Schulte Roth’s Ziser made the connection to how typical loan covenants are utilized. “In reality, do you enforce it? As someone who represents lenders, a lot of lenders use covenants to bring everyone to the table [to say] ‘what went wrong? How do we fix it?’ “

Drawing another parallel to the levfin world was Westfleet’s Agee on the topic of funder protections when financing a corporate litigant. “Funders want to be secured, and often you’ll see a blanket lien on all assets, including litigation,” from the bank lender, Agree said, noting that it’s better to deal with issues of subordination or carve-out requests early on in deal talks.

On the commercial and corporate front, Burford Capital Senior Managing Director Aviva Will, speaking on the panel “Developments in International Commercial Litigation and Investment Treaty Arbitration Case Funding,” claimed that fewer litigations are going forward without some sort of third-party backing. “To use [corporate] balance sheet capital for litigation instead of growing your business doesn’t make sense from an accounting point of view,” Will said.

Relatedly, several panelists and attendees on the sidelines predicted that at this time next year the industry will have made strides figuring out how defense-side funding can be more of an option for funders and corporates. “Unless a defendant is getting sued over and over again, it’s difficult to get enough deal flow,” said Steven Tountas, litigation partner at Kasowitz, a panelist on the “State of the Market” panel.

But conflicts of interest do hang over the sector, even as it becomes more mainstream. From the “Risk/Reward: Institutional Capital Perspectives” panel, Drew Kelly, general counsel at Delta Capital Partners, shared a past anecdote of negotiating with a university endowment over a potential LP deal. The talks advanced to a final stage when one university board member killed the proposal over concerns that the school, through Delta, could end up indirectly suing one of its many large donors.

On the same panel, Evan Wein, partner at Mercury Capital, shared a similar story about being in talks to facilitate a deal with a prospective LP who asked to see a list of cases for the given portfolio, only to conclude that 12 of the 14 cases involved parties that were the institutional investor’s clients.

Curiam Capital