How to Invest in Litigation Finance as an Alternative Investment

In the ever-evolving world of alternative investments, savvy investors are increasingly seeking ways to diversify beyond traditional assets like stocks, bonds, and real estate. One of the more intriguing—and potentially lucrative—options is litigation finance. This unique asset class allows investors to fund legal cases in exchange for a portion of the financial settlement or judgment.

But how does one navigate the complexities of investing in lawsuits, and what are the risks and rewards involved? In this blog, we’ll explore the fundamentals of litigation finance, break down its potential as an alternative investment, and guide you on how to get started in this emerging field. Whether you're a seasoned investor or looking to explore new avenues, litigation finance offers a promising opportunity to diversify your portfolio with an asset uncorrelated to the broader market.

What is Litigation Financing?

Litigation financing is an alternative investment where a party not involved in the litigation provides capital to the litigant in exchange for a share of any settlement awarded. Also known as third-party litigation finance, legal funding and alternative litigation financing, this niche investment provides billions of dollars to law firms and their clients. 

Funds provided through litigation funding pay for attorney fees, personal expenses, hiring expert witnesses, court-related fees and other costs to build a stronger case. 

How Does Litigation Investing Work?

Litigation finance is a type of investment in which investors provide capital to individuals or businesses to help them pay for the costs of pursuing legal action. The investment is typically in the form of a loan, and the investor is repaid only if the case is successful. 

The borrower typically pays the investor a percentage of the proceeds from the case, such as a settlement or judgment, as payment for the loan. This type of financing can help plaintiffs and defendants who may not have the financial resources to pursue legal action on their own. It can also help level the playing field by allowing smaller parties to take on larger, better-funded opponents in court.

Who is Involved in Litigation Finance?

A litigation financing arrangement includes three parties: 

• Attorneys: Attorneys serve as fund custodians for stakeholders — the plaintiff, outside investors and the law firm — and they are in charge of distributing the funds. 
• Plaintiffs: Plaintiffs refer to a person or organization who files a lawsuit against another party in a court of law. Plaintiffs require help from outside investors to front costs related to the lawsuit and improve their chances of winning the case. 
• Investors: Investors purchase a portion of the future settlement from a lawsuit by providing funds to help the plaintiff win a meritorious case. 

Pros and Cons of Investing in Litigation Finance

Litigation financing is becoming more attractive as an investment, but potential investors must understand the benefits and risks.  

Pros

• Above-average returns: Compared to traditional investments, litigation finance generates higher returns. The industry average is 51% per annum, but investment returns can be higher depending on the fund manager. High returns attract institutional investors, including hedge fund managers, investment banks and financial institutions. 
• Performance independent of economic cycles: Unlike other asset classes, the performance of litigation investments does not correlate with the economic conditions. Investors looking to diversify their portfolios can invest part of their funds in litigation funding to hedge against risks. Because insolvencies increase during a downturn, litigation activity is often higher, which creates more potential opportunities to make profitable investments in litigation funding. Gains from lawsuit financing are uncorrelated to stock markets, allowing investors to diversify their portfolios even during periods of economic turbulence.
• Reasonable liquidity: On average, it takes 26 months to receive a judgment, which can be a shorter exit timeline compared with other alternative investments. Because there is a secondary market for litigation investments, investors can also liquidate early by selling their stakes in the case. 
• Increases access to the judicial system: A Bloomberg L.P. survey found that 88% of lawyers believe litigation funding provides greater access to the justice system. Pursuing a case with a high winning rate may be impossible for some individuals and companies because they lack funds. Allowing outside investors to finance litigation creates an even playing field for plaintiffs who lack resources. 

Cons

• State restrictions: Public policy involving litigation funding varies by state. There can be restrictions on who can provide outside funding because some state laws consider it illegal for individuals who are not lawyers to receive a share of the settlement.  
• Unnecessary delays in litigation: Attorneys who involve outside investors may forgo their share of the settlement money. When this happens, law firms may lose the incentive to seek the quickest settlement because they earn more profit as litigation drags on. If this happens, it can take years to receive final judgment for the lawsuit.
• Total loss of investment: Most litigation investments involve a nonrecourse, no-win, no-fee contract. An unsuccessful judgment may result in a total loss for the investor because law firms and plaintiffs don't have to repay the funds used for litigation. Sometimes, the settlement money may be insufficient to cover the investment and result in a partial loss. 

How to Invest in Litigation Finance

Investors can fund pending litigation by working with law firms directly or using a broker or litigation finance company. Some hedge funds also include litigation funding in their portfolios. For passive investors, the best route is to invest through a company that understands the risks involved and the best practices for finding winnable lawsuits. 

Because of market volatility, fund managers are looking for uncorrelated assets with strong returns, and litigation funding fits this category well.

Consider Litigation Funding to Diversify

Litigation investing allows investors to connect with attorneys and their clients who lack the capital to pursue a legal claim. With possible turbulent economic times ahead, lawsuits are likely to increase, creating an opportunity to profit by financing a case. 

Frequently Asked Questions