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Money Fix: Enabling 'David to fight against Goliath' could result in big returns, or losses

"The potential returns in litigation finance are higher

"The potential returns in litigation finance are higher than what investors can earn elsewhere," says Chip Hodgkins, co-founder of a Chicago investment fund focused on commercial litigation claims. Credit: Getty Images/iStockphoto/gerenme

When you think of investing your first thought is likely the stock market. But there are all sorts of alternative investments. You probably haven’t even heard of litigation investing. Believe it or not, you can invest in the outcome of lawsuits.

For sure, the idea is intriguing. Here’s more to feed your curiosity.

In a nutshell, “It enables David to fight against Goliath in pursuit of justice,” says Steven Mandel, founder of the Mandel Law Firm in Manhattan.

Oliver Bravo, founder and CEO of Best Lawsuit Funding, which provides lawsuit funding in Beverly Hills breaks it down like this. “Someone has a lawsuit which is expected to result in the recovery of money. It could be any lawsuit, like a car accident or patent infringement. The plaintiff needs money and can't wait for the lawsuit to settle to get his money. It could be two-10 years before you see a penny, and that's assuming you’re successful.”

Most litigation finance investments are non-recourse, meaning the plaintiff does not have to repay the third-party investor if a lawsuit resolves unfavorably. 

How does it work?  

Investors commonly invest through dedicated litigation finance funds — like venture capital funds, except the investments are in legal matters, not startups. Some funding companies are publicly traded. Others use crowdfunding to source capital for individual cases. Two popular companies are LexShares in Boston and YieldStreet in Manhattan.

There are two types of litigation funders, those that specialize in commercial litigation and those that specialize in personal injury lawsuits and other civil claims. Commercial litigation funders typically invest in civil disputes between businesses, such as breach of contract, theft of trade secrets, and patent infringement claims, wherein the plaintiff often seeks several millions of dollars in estimated damages. 

For a full list of fees and expenses, investors should refer to the offering documents associated with each investment offering on the LexShares and YieldStreet platforms.

What is litigation investing?

“LexShares invests in commercial lawsuits with funding requirements of at least $200,000, although currently we typically make investments of $1 million or greater. In contrast, consumer litigation funders might only invest thousands of dollars in a single case,” says Jay Greenberg, CEO of LexShares.

LexShares and other funders employ former litigators, who assess the risk and potential value of every case investment they evaluate. “Once an investment agreement is finalized, most litigation funders maintain a purely passive role in the litigation, with the plaintiff and the attorney managing the matter as they see fit,” Greenberg says.

By investing in litigation finance, you are purchasing a stake in the outcome of a legal claim. Transactions are often priced as a multiple of the principal investment or percentage of the gross recovery of the case. Litigation funders usually invest no more than 10-15% of the plaintiff’s conservative estimate of total damages owed. (For example, if the plaintiff was seeking base damages of at least $2 million, LexShares might invest a maximum of $200,000-$300,000 in the case.), Greenberg explains.

The minimum investment required for those participating in individual marketplace offerings may vary based on the size of the opportunity; however, it can be as little as $2,500. Once LexShares and the funding recipient have consummated the litigation funding agreement, investors receive an email alert 24-48 hours before the new case is added to the marketplace, during which time they can review the details of the case before choosing to invest. Investors can follow the proceedings of the case.

The upsides

“The potential returns in litigation finance are higher than what investors can earn elsewhere,” says Chip Hodgkins, co-founder of Statera, a Chicago investment fund focused on commercial litigation claims.

He adds that there is greater opportunity for litigation investments in the current down economy. “Lawsuits often increase in recessions, and traditional financing sources, including contingency representations from law firms, are less accessible. If nothing else, outcomes in legal matters have limited correlation with the broader markets, making litigation finance an important hedge and diversifying investment,” Hodgkins says.

One woman who used LexShares to raise money during her whistleblower case won a $28.5 million settlement.

The risks

Understand the tax implications of your investment, capital gains vs. ordinary income. “The IRS offers limited and conflicting guidance on litigation finance. Ask your financial adviser or investment fund how they structure their investments and the resulting tax treatment,” Hodgkins says.

Don’t kid yourself. Says Stuart Grant, co-founder of Bench Walk Advisors in Manhattan, “This is not an investment for the faint of heart. It’s high risk. You win big or lose big. This should be a small slice of your portfolio.”

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