In legal circles, it has always been thought that crises breed litigation. And while that appears to be the case in the current crisis, it may not have been the case in the global financial crisis of 2008/9, as pointed out in a recent article by Eric Blinderman, the chief executive officer for the U.S. at Therium Capital Management. The reason for the ultimate lack of litigation during that time, he argued, was fear.
However, in the current environment it appears as though people are less fearful (of litigation, that is) as the number of coronavirus-specific legal cases is clearly on the rise. These cases include those where the terms COVID-19, coronavirus or pandemic are specifically identified and that, if not for the existence of one of these descriptors as a cause, the claim would not have been filed or where the claim has been exacerbated as a result of the descriptors. During the week of April 26 to May 2, 2020 alone there were 123 new cases filed that met this criteria, bringing the total to 395 cases in the U.S. Federal District court.
As an example, some of these cases would include cases for those seeking refunds for services not provided as a result of the pandemic. Further, a few interesting cases have been filed seeking declarations regarding the availability of contract avoidance based on the doctrine of impossibility of performance or force majeure clauses. I suspect the growth of new cases will continue for the foreseeable future as the crisis’ impact on businesses increases and forces business owners and executives to react in ways previously thought unthinkable.
Lex Machina Inc., a division of LexisNexis, has been tracking coronavirus-derived cases since the beginning of the pandemic. When the data is analyzed with respect to case type, it is evident that the volume of cases is focused on contract (43 per cent) and insurance (26 per cent) claims, accounting for 69 per cent of all coronavirus-related cases, which should come as no surprise. Issues of force majeure and breaches of contract are likely the majority of the volume of contract claims.
Business owners have been placed in an unprecedented position in that they are likely being forced to breach contracts to save their businesses. While business owners and executives may regret their actions and would not have acted in a similar way under normal circumstances, they are no doubt, in their opinion, acting in the best interests of the business to avoid insolvency and will deal with the repercussions (litigation) once they have righted the ship.
The insurance sector has also been particularly negatively impacted and much of this likely stems from denial of payouts under existing policies, with business interruption insurance being particularly active. When litigation funding is used to pursue these cases, litigation financiers will be beneficiaries of this activity.
The results of a recent survey I conducted along with the Litigation Finance Journal show there has been a direct link between the impacts of the novel coronavirus and the uptick in origination activity at litigation finance firms. About 50 per cent of respondents have seen increases in origination activity above 25 per cent. Of course, quality is more important than quantity and so it remains to be seen whether the origination activity is out of desperation or rooted in strong meritorious claims against solvent entities.
In speaking with litigation finance fund managers, it appears the first wave of origination activity came from law firms themselves, specifically plaintiff bar firms that work on a contingent fee basis. In the current environment, liquidity is at a premium and legal work, especially commercial work, has been under significant pressure. The combination of illiquidity and reduced demand have forced some law firms with a portfolio of contingency fee cases to turn to litigation finance to provide working capital in exchange for a portion of their (typically) significant contingent fees. Accordingly, law firm portfolio financing has seen the largest increase in terms of new activity in both number of cases and by dollar volume (portfolios tend to be large dollar investments for litigation finance firms).
Of course, any demand increases will ultimately create opportunities for institutional investors looking to access the asset class. Accordingly, approximately 50 per cent of the survey respondents stated that the current crisis has accelerated their fundraising plans. So, for those investors looking to make a new investment in the commercial litigation finance asset class or expand existing exposures, the next 12 to 18 months will likely see a number of new investment opportunities coming to market to raise capital commitments for blind pool funds. While the market is still in its infancy with respect to more exotic structures like syndications and secondaries, I do expect to see more of those opportunities coming to market as well.
As always, I believe a prudent approach to investing in the commercial litigation finance asset class is deeply rooted in a well-diversified portfolio managed by best-in-class managers to mitigate quasi-binary litigation risk and idiosyncratic case-specific risk. Concentration limits are an important aspect of fund investing as deployment rates can vary by underlying strategy and will ultimately impact the degree to which your portfolio is diversified on a dollars-deployed basis (as contrasted with a dollars-committed basis). Investors should also be aware that different case types and sizes produce different return profiles in terms of duration, return volatility and overall win/loss ratios.
Edward Truant is a founder of Slingshot Capital Inc. These views are those of the author and not necessarily those of the Canadian Investment Review.