Making Money From Litigation

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Like them or loathe them many of you will have heard of 'ambulance chasing lawyers', keen to act for the injured party to obtain compensation, and profit by taking a share of that compensation. 

More recently there was the case of Michelle Young using the courts to find out more about the loss of her estranged husband's fortune, valued at £400 million three years ago. In the commercial arena, settlements and fines are racking up from the air cargo price-fixing litigation resulting from raids on airlines by US and European antitrust authorities in 2006.

The commercial cases have downside and an upside; the high costs of lawyers and barristers, and the potentially high returns from compensation. This is where third-party litigation funding comes in handy. They provide some of the funding and get some of the compensation. 

The good news is that there are now litigation funds quoted on the junior market, AIM, and I reckon the returns are good enough for them to be considered as an alternative investments.

Reducing the cost and risk for the plaintiff

Companies are always engaging in litigation. This may be because a competitor has infringed a patent, is participating in a cartel or engaged in some other damaging activity. The current allegations and subsequent legal case brought by Nokia (Xetra: 870737 - news) against Apple (NASDAQ: AAPL - news) illustrate the importance and complexity of such cases.

This means that the fees from industry researchers, legal advisers solicitors and barristers soon rack up. Not only that, but time scales can be lengthy as well due to the legal system and appeals process. To reduce the risk and cost of bringing legal action, companies and their legal advisers often seek third-party funding for the case.

The third party, or parties, (which may be a fund, individuals or a partnership) commit to paying all or part of the legal fees in return for a share of the damages or compensation awarded. For the third party, the transaction is like any other investment or acquisition. They conduct due diligence, take their own legal advice and reach a decision based on the risks and rewards. Not dissimilar to private equity, when you think about it. And almost as rewarding.

A small but growing asset class

There are currently two litigation funds quoted on AIM. Both are relatively new so involve a bit of risk. However results to date indicate that both funds may be worth tucking away, as returns do not depend on the direction of shares or the state of the economy. There has been no reduction in companies suing each other over the last two years.

The first company to list on AIM, in December 2007, was Juridica (LSE: JIL) which raised £74 million in its initial listing, and a further £33 million in April. In its first full year to December 2008, its Net Asset Value (NAV) grew by over 30% and it paid a dividend equivalent to 4.6% for its initial investors. OK, its share price 'only' rose 10%, but that's pretty good in a year when most share indexes plummeted by more than 30% and most hedge funds and absolute return funds returned less than cash.

Juridica produced interim results last month and sounded generally positive, announcing that the three cases that had reached 'finality' all delivered profit and the best one netted $4.3 million on an investment of $3.1 million (most of its investments are in the US).

The second quoted company is Burford Capital (LSE: BUR). This is a much more recent entrant, in fact its shares only started trading a week or so ago. It sold 80 million shares at 100p, raising £80 million. Does that sound like small fry? Well yes, maybe, but it is the second largest IPO this year. It's so young you can only really judge it on its board quality and its initial investors -- I'm impressed by both.

The Burford principal is Christopher Bogart, ex GC at Time Warner (NYSE: TWX - news) , his co-principal is Selvyn Seidel, retired from Latham and Watkins where he chaired the international litigation and arbitration group. The board also has other eminent experts in this field. Fairly important as they'll be making the investment decisions.

The Burford shares were snapped up by some pretty influential and respected investors. Neil Woodford of Invesco Perpetual gobbled up no less than 45% of the initial offering with Sanjeev Shah of Fidelity Special Situations going for 10%. Woodford also maintains a holding in Juridica.

Both companies' shares are thinly traded, and the share prices have quite wide bid/offer spreads (3% to 5%), so bide your time when buying. But it's not every day you get to buy into a new asset class.