You Can’t Handle the Suit
LexShares and the Rise of Third-Party Financing
When we hear about crowdfunding, most of us envision a company like Kickstarter. With a few clicks, a user can solicit donations for anything under the sun, from film financing and passion projects to cab rides (1) and potato salad (2). But in the legal world, similar opportunities are few and far between. Many plaintiffs walk into the courtroom ill-equipped to handle the full cost of litigation: attorney’s fees, court costs, consultant charges, you name it.
And contingency fee arrangements offer little reprieve. Most contingency lawyers self-finance, “having only small bank lines of credit or no bank credit at all.” (3) On top of that, contingency fees can inflate the cost of legal services or encourage a minimum effort for maximum reward. As a result, plaintiffs sometimes forfeit their opportunity to pursue their case.
But then along came LexShares (4) Since its November 19, 2014 launch, the New York-based start-up connects accredited investors with cash-strapped plaintiffs. Investors provide upfront financing in exchange for future proceeds from the litigation. If the plaintiff wins, the investor pockets a portion of the winnings, but if the plaintiff loses, the investor gets nothing. For the plaintiffs, the investments can reduce the risk of accepting a premature and depressed settlement and increase the chances of nabbing top notch legal talent that might not normally work on a contingency.
Co-founders Jay Greenberg and Max Volsky, both well-versed in third-party funding (“TPF”), wanted to create a reasonable and promising approach to save cases from being swept off the docket. Before LexShares, Greenberg was a technology investment banker at Deutsche Bank, and Volsky, who has reviewed more than 10,000 investments in legal claims for fifteen years, (5) is the founder of litigation finance fund LexStone Capital and author of Investing in Justice.(6)
Litigation Finance: A Growing Industry
Litigation finance, or the use of third parties to cover the costs of lawsuits, is far from a newfangled invention.(7) The industry kicked off around 1997 when a few companies provided opportunities for personal injury plaintiffs.(8) But while companies like Peachtree and Law case help fund personal injury or slip-and-fall cases, LexShares is available for plaintiffs in commercial cases, typically between businesses, with $10 to $40 million in claim value.(9)
On the investors’ end, TPF opens a whole new asset class, one that is independent of the capital markets. Because the cases exist in a vacuum, investors have an opportunity for substantial returns “uncorrelated to traditional assets like equities, fixed income, foreign exchange, and commodities.” (10) In fact, LexShares’s team boasts “an annual rate of return in excess of 50% over the past 10 years.” (11)
So why, then, the lack of opportunities for litigants? Greenberg, from his experience, believes that an “education gap” is the culprit. In short, no one knows how these systems work or that they are even available.(12) At any rate, even with that knowledge, estimating a case at the very beginning is notoriously difficult. But just like Kickstarter, LexShares can serve as a bridge between opportunity and capital. And as this service becomes more popular, it may have a huge impact on insurers.
The LexShares Approach
Unlike Kickstarter, however, LexShares is not open to everyone; only accredited investors (13) can participate. To qualify, a prospective investor must meet the wealth criteria of the U.S. Securities and Exchange Commission. For instance, he must make $200,000 for two years or have a net worth of over $1 million. Only then can he invest in a stake to the tune of $2,500 or more. By evaluating the investors, the vetting process plucks out anyone with a motive to take down deep-pocket corporations, including possibly their competitors.
And the vetting process extends to the cases, too. All cases are pre-vetted by a team of legal and securities professionals. Every case requires, in part, a plaintiff’s attorney with a strong track record, a claim with a sound basis, and a defendant with an ability to pay. Anything else meets the chopping block.
After a case has been approved, LexShares posts a preview on its website. The case descriptions provide the key players and the funding needed. Take, for starters, a products liability case where the use of a popular consumer good allegedly created catastrophic results. Or consider a breach of contract action where an oil & gas developer failed to cough up several million dollars after a successful deal. The offering size for the first example was $250,000 and the second $110,000.
In calculating these offering sizes, LexShares follows standard industry practices and funds no more than 10% of the projected value of the case. Moreover, the lawsuits must reach the full funding target before the plaintiffs or their attorneys receive a dime. Afterward, investors can follow the courtroom action and receive gavel-to-gavel updates.
The Pursuit of Profit and Other Perils
But as this industry grows, so does its critics. (14) The U.S. Chamber Institute for Legal Reform has expressed a mounting concern over the lack of federal oversight. As it stands, no federal law regulates the litigation finance industry. Instead, the industry operates on a state level “by a diverse patchwork of case precedent, common law doctrines, state bar ethics opinions, state statutes, and agreements with regulatory bodies.” (15) Without an agency to make rules and regulations, lawyers and investors are left with little guidance.
The Institute for Legal Reform, moreover, raises concerns about the increase in litigation. In essence, TPF invites a stranger to a lawsuit, one that may only focus on protecting his investments and maximizing his returns. LexShares, for its part, avoids a low barrier to entry with a $2,500 threshold. But without government oversight, a company’s moral compass is the only means to prevent the increase of questionable claims. Public policy often bars the assignment of certain claims, which crowdfunding, in a roundabout way, effectively does.
On top of that, TPF may even prolong litigation. A plaintiff may trade a fair settlement offer for the chance of something bigger down the road. As one case noted, the amount a plaintiff owes to an investor can be an “absolute disincentive” to settle for an otherwise reasonable amount. (16) This may force more cases to trial and clog the country’s already overburdened dockets.
Another case provides an even greater cautionary tale.(17) Deep Nines partnered up with an investor for an $8 million investment plus interest. Together they took on anti-virus software juggernaut McAfee and eventually settled for $25 million. But after squaring away the investment, attorney’s fees, and court costs, Deep Nines only walked away with a measly $800,000. But that was until the investor, still not satisfied, sued Deep Nines in New York state court. The parties later settled, but the terms were never disclosed. (18) No doubt, crowdfunding litigation provides the possibility for even more litigation.
Yet another case ignited controversy in the world of TPF—Chevron Corporation v. Donziger.(19) The case pitted Steven Donziger, the lead plaintiff’s lawyer in the mass-tort Lago Agrio suit, against Chevron, one of the world’s leading energy companies. Donziger had filed suit against Texaco Petroleum—later acquired by Chevron—after its oil operations in Lago Agrio, Ecuador harmed the local population. Burford Capital, a financing firm, tossed in $4 million to fund some of Donziger’s case in exchange for a percentage of any award to the plaintiffs. Ultimately, an Ecuadorian court awarded a multibillion-dollar judgment against Chevron, who then sued Donziger for obtaining the judgment through fraudulent means. In March 4, 2014, the U.S. District Court for the Southern District of New York agreed with Chevron, finding the judgment unenforceable.(20) The court blasted the plaintiffs’ lawyers for the “romancing of Burford” to maximize the plaintiffs’ ability to collect a judgment. According to the court, the plaintiffs’ lawyers adopted a litigation strategy to harass the company and rack up its defense costs—a concern for any TPF case.
And regulation abroad has sounded the alarms, too.(21) PF has gained traction in the United Kingdom and Australia, widely considered the birthplace of litigation finance. But a study by NERA Economic Consulting has concluded that the increase in TPF alchemized into an increase in class action litigation.(22)
Despite some well-placed criticism, TPF looks like it is here to stay. True enough, the New York City Bar Association has recognized that litigation finance is a “valuable means for paying the costs of pursuing a legal claim, or even sustaining basic living expenses until a settlement or judgment is obtained.” (23)
And TPF is not exclusive to plaintiffs, as defense-side funding has started to take shape. Gerchen Keller Capital LLC (“GKC”), for example, specializes in financing business litigation for both plaintiffs and defendants.(24) Most of the investments turn on how the parties classify “success” at various stages (e.g., settlement before summary judgment). Meanwhile, GKC foots all of the bills and only nets a return if one of the “successful” outcomes is attained. (25)
With change in the air, insurers should expect TPF to continue to expand. In fact, Burford Capital released a survey indicating that 72% of outside lawyers and 69% of general counsel consider TPF to be a “useful tool.” (26) And since its 2013 launch, GKC raised over $700 million to meet consumer demand.(27)
The bottom line: TPF is quickly making economic hurdles a distant memory. This way, litigants have a better opportunity to achieve results despite the size of their pocketbook. Insurers and general counsel should be aware of this new litigation tool, as it may increase litigation risks and the costs of defending cases that both have and lack merit.
1. Caroline Moss, 26-Year-Old Successfully Crowd Funds To Pay For Her $362 Halloween Uber Ride, BUSINESS INSIDER (Nov. 2, 2014, 10:39 AM), http://www.businessinsider.com/women-raises-362-to-pay-for-uber-ride-2014-11.
2. KICKSTARTER, https://www.kickstarter.com/projects/324283889/potato-salad (last visited June 3, 2015) (demonstrating that a first-time attempt at potato salad raised $55,492).
3. Max Volsky, A Brief Introduction to Litigation Finance (2014), at 10, available at https://www.lexshares.com/Legal_Finance_Summary_Volsky.pdf.
4. LEXSHARES, https://www.lexshares.com (last visited June 3, 2015).
5. Jonathan Shieber, Crowdfund Your Next Lawsuit with LexShares, TECH CRUNCH (Nov. 19, 2014), http://techcrunch.com/2014/11/19/crowdfund-your-next-lawsuit-with-lexshares/.
6. AMAZON, http://www.amazon.com/Investing-Justice-Introduction-Advances-Litigation/dp/0988510502 (last visited June 3, 2015).
7. See, e.g., Volsky, supra note 3; Kevin LaCroix, What’s Happening Now? Litigation Funding, Apparently, D&O DIARY (Apr. 9, 2013), http://www.dandodiary.com/2013/04/articles/securities-litigation/whats-happening-now-litigation-funding-apparently/; Maya Steinitz, Whose Claim Is This Anyway? Third-Party Litigation Funding, 95 MINN. L. REV. 1268 (2011); Terry Carter, Cash Up Front: New Funding Sources Ease Strains on Plaintiffs’ Lawyers, 90 A.B.A.J. 34 (Oct. 8, 2004).
8. AM. LEGAL FIN. ASS’N, http://www.americanlegalfin.com/FactsAboutALFA.asp (last visited June 3, 2015).
9. Erin Hobey, LexShares Launches New Legal Crowdfunding Platform: Investors Buy Stakes in Lawsuits, CROWDFUND INSIDER (Nov. 19, 2014, 3:18 PM), http://www.crowdfundinsider.com/2014/11/56522-lexshares/.
10. See Volsky, supra note 3, at 22.
11. LEXSHARES, https://www.lexshares.com (last visited June 3, 2015).
12. Jack Newsham, Boston Native Unveils Crowdfunding Site for Lawsuits, TECH CRUNCH (Nov. 19, 2014), http://www.bostonglobe.com/business/2014/11/19/boston-native-unveils-crowdfunding-site-for-lawsuits/Ksm9pcGVgRCMEfD8O0DApN/story.html.
13. Investor Bulletin: Accredited Investors, SEC Pub. No. 158 (Sept. 2013), available at http://www.investor.gov/sites/default/files/ib_accreditedinvestors.pdf.
14. See, e.g., Stopping the Sale on Lawsuits: A Proposal to Regulate Third-Party Investments in Litigation, U.S. CHAMBER INST. FOR LEGAL REFORM (Oct. 14, 2012), available at http://www.instituteforlegalreform.com/uploads/sites/1/TPLF_Solutions.pdf (finding that TPF “compromise[s] the attorney-client relationship and diminishe[s] the professional independence of attorneys by injecting a third party into disputes”); Am. Bar Ass’n Comm. on Ethics 20/20, White Paper on Alternative Litigation Finance (Oct. 19, 2011).
15. Volsky, supra note 3, at 18.
16. See Rancman v. Interim Settlement Funding Corp., 789 N.E.2d 217, 220–21 (Ohio 2003).
17. See Joe Mullin, Patent Litigation Weekly: How to win $25 million in a patent suit – and end up with a whole lot less, THE PRIOR ART (Nov. 2, 2009), http://thepriorart.typepad.com/the_prior_art/2009/11/altitude-capital-partners-altitude-nines-v-deep-nines.html.
18. See Altitude Nines v. Deep Nines, No. 603268/2008 (N.Y. Sup. Ct. 2008).
19. Kevin LaCroix, Guest Post: The Real and Ugly Facts of Litigation Funding, D&O DIARY (Mar. 26, 2014), http://www.dandodiary.com/2014/03/articles/litigation-financing-2/guest-post-the-real-and-ugly-facts-of-litigation-funding/.
20. See Chevron Corp. v. Donziger, Case No. 11-cv-0691 (S.D.N.Y. Mar. 4, 2014).
21. Ripe for Reform: Improving the Australian Class Action Regime, U.S. CHAMBER INST. FOR LEGAL REFORM (Mar. 2014), available at http://www.instituteforlegalreform.com/uploads/sites/1/RipeForReformUS_web1.pdf.
22. U.S. CHAMBER INST. FOR LEGAL REFORM, http://www.instituteforlegalreform.com/global/australia (last visited June 3, 2015).
23. N.Y.C. BAR ASS’N, http://www.nycbar.org/ethics/ethics-opinions-local/2011-opinions/1159-formal-opinion-2011-02 (last visited June 3, 2015).
24. GERCHEN KELLER CAPITAL, http://www.gerchenkeller.com/ (last visited June 3, 2015).
25. Kevin LaCroix, Guest Post: Inside Litigation Finance, D&O DIARY (Feb. 26, 2014), http://www.dandodiary.com/2014/02/articles/litigation-financing-2/guest-post-inside-litigation-funding/.
26. BURFORD CAPITAL, http://www.burfordcapital.com/ (last visited June 3, 2015).
27. Sheri Qualters, Third-Party Litigation Funding Hitting Its Stride, THE NAT. L. J. (Dec. 8, 2014), http://www.nationallawjournal.com/id=1202678199135?slreturn=20141122124331.