The past 6 months has been an unusual time in the litigation finance market. Whereas in years gone by there was a fairly constant fanfare of new litigation funding companies entering the market, the past six months has shown a worrying trend for those law firms who frequently engage with litigation finance. Nowhere more so than in the finance market dedicated to patent infringement cases.

Several high-profile departures have occurred as of late, some very public and some less so. For example, both Validity Finance and Woodsford Litigation have exited this market for cases in the US. Their reasons for doing so will doubtless vary, but it has understandably generated some concern amongst those litigators whose business models rely, to a degree at least, on securing external funding for their cases.
So, is there turmoil in the market or are these isolated incidents?

It’s a difficult one to gauge as things stand. The funding market has shown it’s not immune from macro-economic events. Rising interest rates and therefore cost of capital impacts the funding market as it does many other industries.

In periods of low interest rates, the returns from the exotic market of litigation finance were a temptation for those seeking above market returns. However, in a world where investors can now secure much higher returns in traditional bond investments than has been the case in over a decade, suddenly the motivation for investing in this unusual market has become less apparent.
Furthermore, as the market matures, it has become clear that investing in litigation finance doesn’t necessarily yield the optimistic returns advertised. Cases can often take longer to resolve than expected, costs budgets will frequently overrun and therefore require a capital upsize (also known as ‘top-up funding requests’). Cases will often resolve for a lower quantum sum than originally envisaged or modelled. And all of this is before you factor in loss ratios arising from the litigation risk itself.

Many early funders’ investor prospectuses would reference 80-90% settlement rates in given sectors. However, those prospectuses often failed to take into account that the market will always suffer from a degree of adverse selection, and so those stats don’t necessarily hold. What’s more, rising budgets and retracting quantum values can create a challenging dynamic: depending on how the funder’s return is calculated, a plaintiff’s approach to settlement could be altered given the hurdle it needs to pass in order to pay its various stakeholders returns (e.g., funder and counsel), who will often enjoy a higher priority in the waterfall. The result of the latter can mean a higher volume of cases ultimately proceed to trial, which then increases the litigation risk of an adverse result.

Many funders in the market, ourselves included, are international in nature and thus need to address the individual quirks of each jurisdiction in which we operate. In the UK, for example, a recent Supreme Court case decision has sent shockwaves across the funding market. The decision has potentially rendered any litigation funding agreement in England & Wales invalid where the agreement allows for a percentage-of-damages-style return. This has been particularly difficult for many of the early market players, as the judgment has an immediate and retrospective impact on all live agreements that include a percentage-based success fee. This has led to a huge number of LFAs needing to be hastily re-negotiated for cases that could be at any stage in their litigation lifecycle. Needless to say, the parties won’t necessarily be aligned in their approach to any such request to re-negotiate.

At Erso we are, to an extent, in an enviable position. We are coming to the end of our first fund and shortly about to start our second commitment cycle. This means that the majority of our investments are at an earlier stage in their lifecycle and so the impact of the Supreme Court’s decision has been negligible. We readily admit, this is just good fortune. So, whether it’s macro-economic issues, curveballs in particular jurisdictions, or just the difficulty of running a profitable business in an industry that is only now starting to show the performance reality of a full portfolio lifecycle (anywhere from 5-12yrs lifecycle), the litigation finance market is an increasingly challenging space. Whether we’re seeing a market retraction, correction, or an inevitable evolution, what’s clear is that law firms need to be light on their feet and keep an active eye on developments. And so, that brings us back to Erso. We don’t criticise the decision of various funder peers who have had to abruptly change course. We can only speculate as to their motivations for doing so, but we can well understand why it can be a particularly challenging time depending on where you sit in the market.

Erso is somewhat fortunate -given the timing of our funds- to be able to navigate recent events. We have significant available capital to invest in patent assertion disputes and, far from withdrawing from patent enforcement, we’re actively seeking to accelerate our deployments. So, whether you have immediate cases in need of commitment upsizing, are seeking funding for new matters or perhaps wish to start a discussion regarding a longer-term capital commitment (e.g., a sizeable law firm capital facility) in order to provide greater certainty and mitigate market turbulence, our global team is open for business.