Savvy private investors have found in recent years a very promising opportunity in distressed asset recovery, which is shedding some of its shady reputation by successfully using courtrooms — rather than conducting sneaky repossessions or bounty hunting.
Known as litigation funding, this investment opportunity stems from what began as contingency contracting by law firms in the US. Taking on several of such cases and packaging them as security to obtain financing for the law firm’s operational expansion, this created a new asset class.
Because banks will not typically accept such security for loans, this asset class attracted funds from private individuals and institutions drawn by the high-risk, high-reward lure, Burford Capital EMEA Co-Head Daniel Hall told IFN Investor.
Based in Dubai, Daniel said the underlying asset recovery activity has been gaining rapid traction in the Middle East — especially among Islamic banks seeking to maintain Shariah compliance while legally pursuing settlements for bad debts across multiple jurisdictions.
These deals are structured so that the investment firm and bank clients act as partners on a risk-sharing basis. Daniel emphasized these deals should not be viewed as loans or factoring, despite the parallels, because the risks involved can be tremendous and returns are priced accordingly.
Daniel said this industry is relatively new, dating back around two decades, with Burford Capital being among such investment pioneers with its 2009 founding — ahead of its listings on both the New York and London stock exchanges.
Explaining how a group of legally trained investors realized this opportunity was an asset class in waiting, the solution was in response to their question: “How can we get money from people to fund meritorious claims, which are not really catered for in the traditional financial world?”
This basis of helping people who do not have the money to fight their legal battles soon evolved as it became clear how such external financing can help corporates — despite them having cash in hand. Examples include vehicle fleet purchases or funding a factory expansion.
Another example is often cited by Burford Capital Founder and CEO Christopher Bogart, who was previously general legal counsel at Time Warner. He would regularly face cash flow tension as available funds are meant to produce movies, TV shows, music and entertainment content.
Christopher also had a lot of copyright infringements that were not being pursued, despite potential high returns, because those lawsuits are expensive. He saw the possibility of selling those cases to law firms at a discount and unlocking the cash prospects.
This led to further sharing-out of the risk by securitizing such cases to a group of investors, who pump in the cash — though there is no guarantee that such cases can be won, due to various legal technicalities and hurdles. But wins can outweigh losses on aggregate — with investors often gaining far more than they put into the litigation funding pot.
Despite this outlook, Daniel cautioned: “We are not in the business of vexatious litigation because that is a losing strategy. That would be a very bad choice for us as investors.”
The litigation funding industry really took off in the aftermath of the COVID-19 pandemic as corporates realized how it was possible to maintain their business focus and not be mired in legalities of soured deals.
“Cases in courts took far longer to resolve and all that risk was parked with the investors. While their returns came later than expected, it was still a win–win situation for everyone,” Daniel noted.
Why litigation funding should be Shariah compliant
Litigation funding is an investment made by third parties to finance the legal costs of litigation or arbitration in return for remuneration. It is a non-recourse investment; if the funded party loses, the funder does not receive any return, and consequently loses all their investment.
It is a growing trend in litigation and arbitration proceedings, as the last decade has seen a proliferation of litigation-funded cases across the globe. Indeed, the funding mechanism has become so ubiquitous that it has spread to Muslim countries.
An example is the UAE, where the Dubai International Financial Centre (DIFC) published Practice Direction No 2 on litigation funding in the DIFC courts in 2017. But it must be noted that DIFC courts are not subject to Shariah law. It is a financial free zone within the UAE and common law is applied in the DIFC.
As such, the status quo is similar to civil law jurisdictions as there are no specific rules in Shariah law impeding third-party litigation funding arrangements. Arguably, it should be allowed in Islamic finance, where profit- and loss-sharing is as fundamental as it is in third-party litigation funding, since the funder assumes the risk of legal proceedings.
Thus, litigation funding might be expected to fit very well into the framework in Islamic law. Litigation funding addresses massive inefficiencies in the legal process market and it is a multibillion market around the world.
Source: Dr Can Eken, an assistant professor in commercial law at Durham Law School
