As has been widely reported, hedge funds are increasingly looking to invest in litigation funding as a strategy to provide returns that are not correlated to stock market performance. For instance, MKM Longboat (a Jersey-based, London-run hedge fund) has hired a former litigator to run a portfolio investing in European legal disputes, to which it has reportedly dedicated an initial fund of US$100 million.

The emergence of alternative ways to fund commercial litigation is a relatively new development. Traditionally, litigation has been funded primarily by the client paying agreed hourly rates to its solicitors. Over the past few years, however, new methods of funding, previously unavailable or unavailable at the financial levels required, have emerged on the scene. There is some debate as to just how much these new methods of funding will change the litigation landscape, but it is important for both parties and prospective funders to be aware of the issues that arise.

Of the three principal methods set out below, the first two are most relevant to hedge funds:

  • Most common is professional funding, where an independent third party funds some or all of the claimant's costs in return for a percentage of any damages awarded.
  • More novel is litigation risk hedging, where a claimant sells a percentage of its claim in return for a fixed sum, which can be used in part to fund the case. This allows the claimant to offset not only the costs risk but also some of the outcome risk if the case is lost. It is also available to defendants who can in effect cap their losses in return for a premium.
  • There is also after the event (ATE) insurance, which covers a party's risk of paying the opponent's costs and its own disbursements if the claim is unsuccessful, in return for a premium. Cover for a percentage of own party costs may also be available.

The availability of funding may encourage parties to bring or continue claims or defences which might otherwise have been considered too costly or too risky. It could lead to actions which would never previously have been pursued getting off the ground. An obvious example is class actions in jurisdictions where these are available.

There are a number of issues for those considering investing in litigation funding. Firstly, funders will be looking to maximise the chances of making a good return on their investment. They are therefore likely to want to support cases which have a good prospect of succeeding – though for a large enough share of the proceeds, some funders may be prepared to make riskier investments in weaker claims. Secondly, funders should be aware that they may be liable for a proportion of the opponent's costs if a claim fails. On the current state of the case law, this is likely to be limited to the amount the funder has contributed to the claimant's costs, but it could in some circumstances be higher. Thirdly, funders need to be careful not to offend against the ancient rules against "trafficking" in litigation known as the principles of maintenance and champerty. In particular, there is a risk that a funding arrangement may be held to be unenforceable where the funder controls the running of the litigation.

These are early days and it remains to be seen to what extent these new methods of funding will form a major part of hedge fund investment strategy. In our view, however, the costs and risks involved in litigation mean that alternative methods of funding are likely to grow. The regular reports in the legal press of new entrants to the funding market suggest others agree.