Litigation is expensive and, honestly, not without risk. Hence, many who would otherwise pursue enforcement of their rights fold, feeling the whole hassle “isn’t worth it.”
Enter litigation finance, bringing together investors and those who have a legitimate claim.
Litigation finance in a nutshell
Litigation finance, or litigation funding, is the practice where an unrelated third party provides capital to a plaintiff to help them cover lawsuit expenses.
Imagine Alice (the plaintiff) suing Bob (the defendant) for damages of up to 300,000,000 USD. However, Alice might not be able to afford the top-notch legal representation that could (nearly) ensure her case is successful at the Court of Law.
Hence, Alice may look for some external support. Suppose she manages to find an investor who happens to like the prospects of her winning the case. The investor weighs the risks, shells out 3,000,000 USD, and helps Alice retain highly skilled lawyers.
The investor, of course, puts the price of their capital on the table as well. Should Alice’s highly trained lawyers win the case, she will have to reward the investor with, say, 10% of the recovered damages.
So, now, if we assume that Alice’s lawyers pursue the case until the very end, the investor could 10x their initial investment. However, even if Alice opts for a settlement for 100,000,000 USD, the investor would have an ROI of over 300%.
You might find the above to be just a figment of imagination, but some funds have been pursuing this investment strategy for years. Take LexShares, one of the leading litigation funds, as an example. They have invested in 103 cases since 2014. Forty-three have been resolved with a 70% win rate and median annualized returns (post fees and expenses) of 52%. Overall, they have beat out many hedge funds and far exceeded the 8.7% annualized return of the S&P 500 over the same period.
So what is the catch?
Yes, if it were only that easy. In practice, litigation finance is not without its issues (even though this practice took place well over the previous decade, if not earlier).
According to Kevin Sekniqi, the Chief Protocol Architect of Avalanche (an open-source platform for launching DeFi applications), litigation funders have been scoring sky-high returns, averaging over 40% per annum. However, as Kevin suggests, there are still at least two problems that prevent litigation funding from being more widely used.
For starters, litigation usually takes years to unravel. Not all investors are willing to commit their capital and liquidity over such horizons. Quick hits exist but are not all that frequent.
Secondly, funding opportunities in this area were so far reserved for institutions and high net-worth individuals. Retail investors still cannot finance such ventures.
The good thing is – those problems are both solvable.
Retail access via claim tokenizations
Tokenization of claims would, in essence, provide for both retail investment opportunities and solve the capital lock-up issue. But how would that practically work?
Simply put, tokenization is a process of issuing tokens on a blockchain network supporting such features (Ethereum is a notorious example of such a network; however, there are others as well).
In the context of litigation funding, the Initial Litigation Offering would be fundraising and a tokenization process, whereby litigants would raise the capital on an open market. The funding opportunity would be available to all interested parties (retail included).
Each issued token would represent a pro-rata claim over the results of the litigation. Investors could buy and hold such tokens until the case is resolved or settled. Upon any of the two events, token holders could claim their portion of the reward against their tokens. Hence, retail could take part in such investment vehicles without any specific capital requirements.
How about liquidity bottleneck issues?
I’ve mentioned that not all investors have the same risk appetite nor the same investment timeline. Some prefer shorter spans; others might be ready to “hold the stock forever.”
Initial Litigation Offering (ILO) solves this problem as well. Tokens are, by their very nature, tradeable via both Centralized and Decentralized crypto exchanges (CEX and DEX, for brevity). Therefore, token holders could scale in and out of their initial investment and post returns even in shorter periods. The very prospect of available liquidity would likely make this market even more appealing to the broader range of investors and speculators.
ILO benefits and a macro watchdog
It is clear how ILO enhances access to justice to claimants who otherwise wouldn’t bear costs to seek remedy via courts. Essentially, the blockchain infrastructure makes this sort of crowdfunding possible.
However, as with any opportunity, likely, we could also see a new form of “ambulance chasers” – i.e., a predatory behavior from ROI-seeking firms and individuals.
Although “predatory behavior” might sound negative, having more activist funds and individuals in this space could benefit society.
This form of activism, paired with more accessible capital to fund disputes, would likely lead to market players’ more cautious behavior. Knowing that the bar to litigate is significantly lower could increase self-moderation by companies, authorities, and individuals.
The ILO initiators
The so-called ‘Initial Litigation Offering’ is a concept coined by Ava Labs (the Avalanche protocol creator), Roche Cyrulnik Freedman LLP (US law firm), and Republic Advisory Services (a consultancy firm).
And while litigation financing has already been made available to retail investors via crowdfunding platforms, blockchain brings a new dimension to the market.
Kyle Roche of Roche Cyrulnik Freedman LLP states: ”The reason from a practical perspective why I think blockchain-based markets enable and bring a disruptive force to litigation finance is the power it gives to making a market both liquid and truly transferrable around the world.”
Additionally, blockchain technology provides a convenient way to distribute funds for successful cases.