By JENNIFER SMITH
April 7, 2013, 7:46 pm EST
Law would seem to be the furthest thing from a growth industry these days. But a certain class of investors sees one aspect—big commercial lawsuits—as an increasingly good bet.
A new generation of investors is plunging into “litigation finance,” putting up millions of dollars to fund lawsuits in hopes of collecting when verdicts come down. Established financiers are expanding into new areas, including loans to law firms, and finding clients among the biggest American companies.
Law firms themselves are starting to jump on the bandwagon, too. They are seeking funding arrangements for clients who need help going after opponents with deeper pockets, or simply want to keep litigation costs off their balance sheets.
“I think you would find a notable percentage of the Fortune 100 have engaged in some kind of funded litigation,” says Kent Gardiner, chairman of Washington, D.C., law firm Crowell Moring LLP, which has represented more than a dozen large companies in such cases. “Overwhelmingly, the impetus has been very, very tight legal budgets.”
Critics complain that the trend will enable frivolous lawsuits and have argued—including at a congressional hearing last month—that the government should step in to regulate funders of litigation.
But as corporate legal budgets shrink, litigation-finance options are proliferating.
One of the latest entrants is Gerchen Keller Capital LLC, a Chicago-based team that includes former lawyers from Gibson Dunn & Crutcher LLP and Bartlit Beck Herman Palenchar & Scott LLP. The group has raised more than $100 million and says there is plenty of room for newcomers given the size of the U.S. litigation market, which they put at more than $200 billion, measuring the money spent by plaintiffs and defendants on litigation.
Chief Executive Adam Gerchen, a former portfolio manager at Chicago-based hedge fund Alyeska Investment Group, says demand for alternative financing continues to grow. He points to the success of older funds, such as Burford Capital Ltd. BUR.LN +0.30% and Juridica Investments Ltd., JIL.LN +6.63% which have investment pools of more than $300 million and $200 million, respectively, and are traded on the London Stock Exchange.
But he says Gerchen Keller will offer new approaches, too. “One of the thing we’re doing differently is investing in financing on both sides of litigation—both defendants and plaintiffs,” Mr. Gerchen says.
On the defense side, the fund plans to advance money to companies fighting lawsuits to cover legal fees. The fund gets repaid, plus a bonus if the outcome is successful.
The new outfits are drawn by the prospect of netting millions off investments that range from $2 million to $15 million a lawsuit.
Litigation funders say they help level the playing field by allowing litigants—mostly corporations—to pursue lawsuits against better-financed opponents. The investors assume the risk, and their money helps pay for high-price lawyers or to keep a fight going instead of settling because the money has run out.
Plaintiffs’ lawyers have long taken cases on a contingency basis, offering their services free on the front end in exchange for a portion of the reward if they win the case. But some companies—even those that are short on cash—don’t want to use plaintiffs’ firms, whose lawyers they may have faced in previous lawsuits.
It is difficult to know how widespread the practice is. Third-party funding arrangements aren’t typically disclosed unless a dispute between the parties comes to light in court filings.
In one of the more prominent examples, a Burford Capital subsidiary provided $4 million for legal work on behalf of a plaintiff in a large and contentious environmental case against Chevron Corp. CVX -0.54% concerning an oil spill in Ecuador. Burford says it has since sold the interest to a third party, though it retains a residual interest in the outcome.
Burford also stepped in to provide financing for Gray Development Group in a 2010 suit against a Chicago developer in which Gray ultimately prevailed.
Juridica has backed patent lawsuits brought by companies, universities and investors, and provided a line of credit for the plaintiff in a contractual dispute between two hedge-fund managers, according to Richard W. Fields, chairman of the fund’s board.
A $3 million investment in an Illinois oil-equipment manufacturer’s international arbitration against Romania soured, and Juridica is now suing the company for breach of representation, Mr. Fields says.
Critics worry that third-party investors will exert undue control over legal decisions, and they fear that the practice will drive up the overall cost of litigation.
“This turns the courts into a stock market of sorts,” says John Beisner, a partner at Skadden Arps Slate Meagher & Flom LLP whose practice focuses on mass torts and insurance litigation and who has spoken out against the practice on behalf of the U.S. Chamber of Commerce’s Institute for Legal Reform.
“If investors are getting that sort of return,” Mr. Beisner says, “either defendants are paying a lot more or claimants are receiving a lot less.”
Those objections are brushed off by the lawyer-financiers behind the funds.
“We don’t want to have a seat at the table, second-guessing strategy,” says Mr. Gerchen of Gerchen Keller Capital.
Christopher Bogart, a co-founder and CEO of Burford Capital, and a former general counsel for Time Warner Inc., TWX -0.01% says he is no fan of frivolous litigation. Funding it, he says, would be “the fastest way for me to go out of business.”
In recent months Burford has branched out in new areas, such as providing financing for law firms, and Mr. Bogart says the market for such services continues to grow.
“The world of litigation—which is a very large world economically—has historically been very badly underserved by capital,” he says. “What we are seeing now is that business wants solutions.”
Write to Jennifer Smith at firstname.lastname@example.org