Private equity funds deploy new investment strategy: financing lawsuits

By: L.M. Sixel

Private equity and hedge funds have found a new way to get richer: Financing lawsuits in exchange for a cut of the winnings.

The investment funds, which have raised billions of dollars to funnel into promising cases, have become a rich source of cash for lawyers to acquire cases, buy advertising, recruit clients and underwrite litigation expenses. If the lawyers win, private equity backers can pocket up to six times their initial investments, amounting to as much as 50 percent of a settlement or trial verdict.

This large and growing pool of money has opened the door for lawyers to gamble on big cases against big companies involving thousands of victims and millions of dollars in damages, but it also raises questions of whether lawyers will act in the best interest of clients or their financiers, who might prefer a quick settlement over a lengthy trial. In addition, the cuts taken by private equity and hedge funds can be so high that clients who win big awards on paper may end up with as little as 10 cents on dollar, legal experts say.

“It’s like the white collar version of pay-day loans,” said Houston lawyer John Zavitsanos.

Litigation finance has been around for more than a decade, but only in recent years has it taken off as private equity and hedge funds seek better returns beyond stock, bond and commodity markets, according to legal and finance specialists. By some estimates, more than one-third of U.S. law firms used litigation financing in 2017, up from 7 percent four years earlier, while private equity and hedge fund investments in lawsuits have surged to about $30 billion from $1 billion in 2011.

Burford Capital, a publicly traded litigation funder listed on the London Stock Exchange, provides a window into this mostly private world. Burford, like most litigation financiers, raises the money it plows into lawsuits from institutional investors such as pension funds and university endowments. In a recent presentation to investors, Burford estimated that it earned a 37 percent return in 2017 — compared about 22 percent for the S&P 500 stock index — and more than tripled its investments in lawsuits to $1.3 billion from $378 million.

Another publicly traded litigation finance firm, Bentham IMF of Australia, opened an office in Houston last year, just days after the firm announced it raised $200 million to fund lawsuits, with most of the money coming from a large, but unidentified hedge fund. At the time, Bentham reported its investments in U.S. lawsuits returned an average of 83 percent.

Bentham’s terms vary from case to case, but lawyers who win typically pay up to three times the original investment to Bentham, plus a percentage of the award or settlement. “We share in the recovery” of damages, said Eric Chenoweth, investment manager for Bentham in Houston.

Bentham does not require lawyers who lose cases to repay the money, so the firm is choosy about which cases it funds, said Chenoweth, a long-time Houston lawyer who uses his knowledge of judges, courts and lawyers to evaluate lawsuit risk. Ninety-five percent of the firms seeking funding from Bentham are rejected, he said.

Legalist, a San Francisco litigation finance firm uses a computer algorithm to predict the likelihood of winning by weighing the type of claim, outcome of similar cases, previous rulings by the judge and the financial strength of the defendant. The company, which more than $10 million in seed capital last year, is backing a Boston-area ice cream sandwich maker suing one of its suppliers over allegations of inferior ice cream.

Software engineers make up half the staff at Legalist, said CEO Eva Shang, who started her company after receiving a $100,000 fellowship from the foundation started by Peter Thiel, the co-founder of PayPal who footed the bill for Hulk Hogan’s sex tape lawsuit against Gawker Media.

Investment funds solve cash flow problems for trial lawyers, who often need lots of money upfront to pursue cases. Some lawyers use private equity and hedge fund money to cover the cost of bringing complex cases such as intellectual property or anti-trust disputes that can require high-priced experts, deep research and extensive travel.

Lawyers who represent consumers hurt by car wrecks and prescription drugs often use private equity money to buy television ads to recruit potential clients, operating call centers to handle the inquiries. One of the nation’s biggest legal advertisers is the Pulaski Law Firm of Houston —owner of the toll free number 1-800-BAD-DRUG —which spent $25 million in 2016 running 98,000 television ads, according to X Ante, a firm that forecasts litigation risk.

Pulaski declined to comment.

A 2015 lawsuit brought by Amir Shenaq, the former chief business development officer of the Houston law firm AkinMears, sheds some light on the workings of litigation financing. Shenaq, a former Wells Fargo banker hired to raise the capital the firm needed to increase its revenues, sued when he didn’t get the commissions he said he was promised.

AkinMears built its business through television ads that alerted viewers to health problems related to medical devices, prescription drugs and occupational diseases, such as asbestos-related cancer, and the possibility they could collect from the companies responsible. The firm acted as a kind of legal broker, operating a phone bank to sign up clients, bundling the claims and sending them to other lawyers to handle, according to the lawsuit.

AkinMears signed up tens of thousands of clients, charging each a 40 percent contingency fee — meaning it was only collected if the clients won verdicts or settlements. The fee was divided with the lawyers contracted to handle the cases.

But AkinMears wanted to grow faster and came up with a plan to acquire easy-to-settle medical device cases from other lawyers, according to Shenaq’s lawsuit. Gerchen Keller Capital, a Chicago litigation finance firm since acquired by Burford Capital — agreed to provide nearly $100 million to AkinMears.

About $46 million went to buy 14,000 transvaginal mesh cases and another 900 non-mesh cases from a group of four law firms — a deal that AkinMears estimated could earn as much as $200 million in legal fees, according to court documents.

Thousands of women received mesh implants to treat pelvic conditions including urinary incontinence, and sued the manufacturers after suffering from infections, bleeding and organ damage. Several won multi-million dollar verdicts, which drove mesh makers to settle thousands of additional claims for millions of dollars. AkinMears, according to court documents, estimated that each settlement of a transvaginal mesh case would bring $14,000 to $16,000 in legal fees.

Shenaq’s lawsuit was settled two years ago, but terms were not disclosed. AkinMears’s lawyer, Allan Huddleston Neighbors IV, declined to comment. Shenaq also declined to comment.

Litigation finance first came into the public eye about three years ago in a case against Chevron Corp. which was sued in federal court in California after a natural gas rig exploded off the coast of Nigeria. Chevron discovered the financial backer of the case brought by Nigerians hurt in the blast was Therium Capital Management, a litigation investment firm based in the Channel Islands off the coast of France.

Therium invested $1.5 million into the case, under the terms that it would be paid $9 million, or six times what it initially invested, plus 2 percent of the total recovery if the lawsuit succeeded, according to court records. Therium’s contract with the Nigerians’ lawyers also prohibited them from spending money on additional lawyers, forensic accountants or other experts without the written permission of the investment firm, raising questions of whether the lawyers were representing the interests of their clients or their financial backer.

Therium did not respond to a request for comment.

In Texas, lawyers have to get clients’ consent before they can share contingency fees with other lawyers. But lawyers don’t have to tell clients if they bring outside investors aboard to fund their case, a fine line that leaves some lawyers squeamish.

Mike Doyle, a Houston personal injury lawyer, said he considered doing a deal with a private equity fund, but the financing would have cost him 20 to 25 percent a year. In the end, he didn’t do it, worried that the financial pressures would influence the decisions he needed to make in the best interest of his clients.

“I didn’t think the juice was worth the squeeze,” he said.