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Legal finance for asset managers

October 11, 2019
Michael Sternhell

Legal finance can be a particularly valuable resource for asset management firms investing in the global capital markets. When a portfolio security loses value because of an issuer’s misconduct, mutual funds, ETFs and other pooled investment vehicles may find themselves in possession of a legal claim worth tens if not hundreds of millions of dollars. Yet these contingent assets have no recognizable value on a fund’s balance sheet. Even if a fund pursues a claim, it can take years of litigation and the expenditure of millions of dollars in legal fees to monetize the claim through settlement. And because a fund’s shareholder base is constantly changing, the benefits of a successful lawsuit may not go to the shareholders injured by the issuer’s behavior.

Furthermore, fund portfolio managers are in the business of assessing market and credit risk, not legal risk. While expert in evaluating a company’s financial prospects, they typically lack the expertise needed to determine whether an investment loss caused by issuer misconduct has given rise to a meritorious legal claim, let alone conduct a cost-benefit analysis to pursue the claim. Even the asset management firm’s in-house counsel may be ill-equipped to assess all potential claims, particularly claims against foreign issuers that would need to be pursued in unfamiliar jurisdictions. Affirmative litigation by mutual funds is typically too episodic to justify an asset manager maintaining a large in-house litigation function, particularly given the budgetary constraints many legal departments currently face.

Because legal expenses are unpredictable and directly impact a fund’s expense ratio, asset managers and independent trustees are understandably reluctant to pursue uncertain litigation recoveries using fund assets. Law firms willing to take cases on contingency can mitigate this problem. But the best choice of counsel may be a firm that does not operate on a contingency model.

Litigation finance can provide a better solution. Burford can help asset managers identify, evaluate and finance meritorious legal claims, and as a result, fund managers can not only avoid the unhappy choice between forgoing a potentially lucrative recovery or forcing shareholders to bear the unpredictable costs of litigation, but also monetize their legal assets in the short term. In a typical financing arrangement, Burford covers the counterparty’s legal fees on a non-recourse basis, meaning we only get repaid if the litigation is successful. If the litigation is successful, Burford receives a multiple of its invested capital, a percentage of the plaintiff’s recovery or both, depending on the financing terms.

By using outside capital to finance all fees and expenses associated with prosecuting a claim, Burford can afford asset managers and their funds a wider selection of counsel and the ability to retain the best law firm for each case they wish to pursue. Instead of relying on a limited pool of plaintiffs’ law firms willing to take cases on full contingency, Burford can leverage its experience working with the majority of the AmLaw 100 and the most elite litigation boutiques in the world to help the asset managers assemble a panel of law firms to choose from when pursuing affirmative recoveries.

Funds with multiple claims they wish to pursue simultaneously can benefit from portfolio financing. Because the risk of loss is diversified, the cost of capital is typically lower in a portfolio financing arrangement. Portfolio financing may also allow funds to finance defense costs. For example, a mutual fund that holds a distressed debt security may have a claim against the issuer or underwriter if the security’s offering statement included material misrepresentations. The fund may also be involved in an unrelated inter-creditor dispute in which it is a defendant. The fund can enter into a financing arrangement with Burford whereby the anticipated recovery in the fund’s affirmative lawsuit finances defense costs in the inter-creditor dispute.

In addition to offering better—and potentially more cost effective—choices of counsel, Burford can monetize claims by advancing a portion of the estimated recovery years in advance of actual case resolution. Monetization can allow funds to unlock the value of claims for the immediate benefit of the fund shareholders, while transferring some of the fund’s litigation risk to Burford. Additionally, funds can use claim monetization to manage unanticipated fund expenses. Finally, Burford can monetize a claim by a fund in liquidation, so shareholders receive some of the claim’s monetary value when the fund’s assets are distributed.

Asset managers can also benefit from the extensive diligence we devote to evaluating all potential litigation finance investments. A fund’s portfolio manager may wish to initiate a lawsuit against an issuer, but the fund manager may lack the expertise necessary to conduct a full cost-benefit analysis of bringing a case. In evaluating any financing opportunity, Burford exhaustively evaluates the merits of the claim, the anticipated costs of litigating and any collectability risk plaintiffs may face against the defendants. A fund’s board of trustees that is contemplating whether to authorize a lawsuit can benefit from Burford’s experience in funding and overseeing litigation globally, as well as our objective assessment of the costs and benefits of proceeding.

Although Burford is a passive capital provider, an asset manager can also leverage the ongoing case management we perform on funded matters to extend the capacity and capabilities of the manager’s in-house legal staff. We speak at least monthly about progress in the case with the law firms handling funded matters and share our recommendations to position the lawsuit for a successful resolution. We regularly provide substantive comments on pleadings and draft briefs and help counsel prepare for oral argument through moot courts. We work with clients and firms to monitor budgets and making sure cases are litigated efficiently as well as effectively. The client is at all times “driving the bus,” but Burford works to make certain everything under the hood is functioning smoothly.

Legal claims are fund assets and asset managers should treat them as such, maximizing their value for the benefit of fund shareholders. In partnership with Burford, a fund manager can do so in a manner that balances achieving the best possible return to shareholders with minimizing litigation risk and fund expenses. Burford can offer a variety of financing solutions that allow a fund manager to fulfill its fiduciary obligations and select the structure that best serves shareholders’ interests.