Should You Be Allowed to Invest in a Lawsuit?
In recent years, investors have started buying shares in other people’s litigation proceedings. Are they warping the legal system in the process?
By MATTATHIAS SCHWARTZ
OCT. 22, 2015
The New York Time Magazine- The Miller quick coupler comes in a few different sizes. The one I tried out has the proportions of a laundry bin and weighs nearly 700 pounds. It allows the operators of hydraulic digging machines to switch buckets without ever leaving the cab. Two flanges rise from its sides, supplying it with the Volkswagen-like curves that inspired its nickname, the Bug. The flanges are drilled clean through with four holes set inside four bosses; beneath the front pair of holes are two upturned latches, like the open ends of two wrenches. Other than its poppy-red color, the device appears to be an ordinary specimen from the menagerie of heavy-duty construction equipment.
But in a Chicago courtroom on Oct. 26, the Bug will star in a multimillion- dollar dispute that represents a new frontier in the march of global capitalism. The nominal occasion is a paternity feud between two of the Bug’s corporate parents, Miller UK, the equipment manufacturer based in Cramlington, England, and Caterpillar, the American construction-equipment giant that was once Miller’s biggest customer. The themes of Miller UK v. Caterpillar are classics of the intellectual-property genre: greed, betrayal, bloodlines. But Miller’s method of funding its side of the production is something new. Rather than paying its lawyers out of pocket, Miller has turned to a private firm to front the money for its legal costs: the Illinois-based Arena Consulting, which is headed by two brothers, Herbert and Douglas Lichtman. If Miller loses, Arena gets nothing. If it wins, Arena will get a share of the proceeds, which could run well into the tens of millions of dollars.
This new form of lawsuit funding is called litigation finance. It lies at the crossroads of two Anglo-American tendencies. The first is our litigious side, in which we celebrate our equality before the law by dragging those who have wronged us before a judge. The second is our ingenious mercantilism, as demonstrated by our penchant for turning everything from church raffles to mortgages into marketable securities to be chopped up, bundled and resold. Like the celebrity bonds backed by royalties and popularized by David Bowie during the 1990s, litigation finance represents the expansion of securitization into hitherto virgin territory. Those involved in the practice argue that it allows smaller companies like Miller to afford a day in court. Detractors worry that it could give rise to a litigation arms race, with speculative money aggravating the already high costs of the American legal system.
While the amount of litigation funded by outside financiers is still relatively small, the industry — which barely existed outside personal-injury cases until the mid-2000s — is growing rapidly, driven by increasingly permissive laws, the promise of high returns and hourly billing rates that run $500 or more for the largest and most sophisticated law firms. Between 2013 and 2014, Burford Capital, a public company traded in Britain, increased its lawsuit investments from $150 million to $500 million. During the same period, its profits rose by 89 percent, with a 61 percent net profit margin. The two-year-old Gerchen Keller, one of the industry’s youngest funds, has now raised $475 million in private capital. With investor-backed war chests, plaintiffs are crossing borders to find the most favorable jurisdictions, and sometimes enlisting the help of foreign governments. Like equities and mortgages, lawsuits are making a transition from a private arrangement to a fully monetized asset class. The ‘‘portfolio’’ held by IMF Bentham, an Australia-based funder, consists of 39 cases, which the firm values at just over $2 billion. United States lawmakers are beginning to ask questions. In August, two senators from the Judiciary Committee sent letters to major funders asking them for the names of the cases they had invested in and many details of their business dealings. The letter called litigation finance a ‘‘burgeoning industry’’ that was ‘‘largely unregulated and operates with no licensing or oversight.’’
Larger companies, even those with their own in-house counsel, are selling off pieces of lawsuits to smooth out cash flow and offload risk. Juridica Investments, a Miami-based fund with $650 million under management, specializes in working with Fortune 500 companies, which make up 80 to 85 percent of its investments, according to Richard Fields, its chief executive, who says that outside funding helps align the interests of plaintiffs’ lawyers with those of their clients. ‘‘You want the largest recovery, in the shortest time, with the least uncertainty,’’ he says. Smaller companies can use litigation financing to finance growth, by using their future award as a credit line.
Over the last century, many have come to see lawsuits as a means of expression, a political weapon and a powerful deterrent against those who might do wrong. And yet creating lawsuits is not the same as creating something like the Bug. Litigation is a zero-sum industry — every dollar in damages taken home by the winner, minus fees, must be wrung out of the loser. Litigation also helps shape legal precedent, defining the terms under which civil justice may be sought. It’s hard to imagine how billions in outside capital won’t wind up changing the justice system. The only question is how.