Heirloom on the rise of U.S. litigation financing

Heirloom Investing is an alternative investments advisor that specializes in “niche investments that are difficult for most investors or advisors to either access or effectively diligence.” One of its strategies involves loans to U.S. law firms, settlement trusts and related entities, financing litigation in a manner secured by the assets of the borrowers. Heirloom offers both funds and co-investment pools. One of its funds, the Heirloom Alternative Yield Fund, is an uncorrelated portfolio of asset backed or income-earning investments. The other, and our chief focus here, is the Heirloom Legal Lending Fund, which follows what amounts to a niche private credit strategy. Its loans to law firms allow it to offer investors the same return profile they might get from unsecured or mezzanine loans, with the security of asset backing at loan-to-value ratios of above 20%. Legal lending and its close cousin, litigation finance, are an important trend both within the U.S. legal system and in finance. The barriers to third-party funding have fallen in the United States, and in other common law countries as well. In the years since the turn of the millennium, the frequency of the practice has exploded. In a recent discussion, Geoff Dover, the chief investment officer of Heirloom, answered Alternative Watch’s questions on how investors can profit in lending to law firms. Dover joined Heirloom in Toronto in 2015, which began as a single family office. Prior to that Dover was at the family office Kestrel Capital Global Investors. Alternatives Watch: Can you give us a brief explanation of what litigation finance is, and how legal lending is different? Dover: The biggest difference is that in traditional litigation finance you are equity funding individual cases, while in legal lending you are lending to law firms, settlement trusts and other related entities, generally secured by assets. Litigation finance is akin to venture capital, providing highly variable outcomes that often take many years to reach a conclusion. Legal lending is akin to secured and/or lower-risk cash flow lending, providing a predictable return, better cash utilization and faster repayments. Alternatives Watch: Does it matter to your approach to legal lending that some law firms charge their clients on a contingency basis, while others charge by the hour or use a hybrid of those two approaches? Dover: We provide flexible financing solutions for both hourly or contingency-based law firms. Both litigation finance and legal lending enable plaintiffs to pursue contingency-based lawsuits, providing access to justice for those that may otherwise not be able to afford it. We believe that legal lending is a better alignment of interests for counsel, their clients and the financier, by providing counsel with the resources to pursue the best economic outcome for their client, while leaving the economic incentive alignment between them intact. Alternatives Watch: Isn’t the alignment of incentives different? Some law firms might be willing to take a flier on a wildly speculative case if they are charging by contingency fee and the potential payout, even if unlikely, is huge. This is the usual complaint against such a system, is it not? Dover: That is absolutely a possibility with either contingency-based or hourly-based structures. Unlike some other lenders, we offer only recourse loans, and where the collateral is dependent upon case outcomes, this must be secured by a diverse case pool, and often personal guarantees of the equity partners of the firm. This strongly discourages such speculation as the borrowers bear the majority of the risk. Alternatives Watch: Is it safe to say your collateral is not overly concentrated in any one circuit, and that this offers you protection from the exceptions? Dover: Where our loans depend upon case outcomes, they are secured by a pool of collateral that is highly diversified, including by defendant, defending counsel, case type, circuit, judge, and point of law. This helps to ensure that even if an exception occurs, it will not harm the value of our loan. Alternatives Watch: Does geographical diversification include the investment in law firms outside of the United States? Dover: Our legal lending fund lends exclusively in the U.S. at this point. Separately, we do provide traditional litigation finance in certain Asian common-law jurisdictions, but we prefer the legal lending structure generally. Alternatives Watch: Let’s look at a couple of classes of litigation. In California, Heirloom has lent money supporting litigants against Pacific Gas & Electric, with reference to its role in sparking major and disastrous wildfires. Could PG&E have available to it effective defenses against such lawsuits, under existing law or in the legislative pipeline? Dover: Where we do have pre-settlement collateral, these are always to borrowers with diverse collateral bases. No one case or defendant has a material impact on our financing. Various cases against PG&E comprise an important part of the collateral of one of our borrowers, but the vast majority of that is post-settlement, as in the case has already been decided, with assets in the form of cash and stock placed in escrow and our borrower is merely awaiting the disbursement of the damages from the settlement trust. Dover expects that between two and two and a half years from now this trust will have been fully paid out. Alternatives Watch: Let me ask you finally about the litigation arising out of the ‘big freeze’ in Texas early this year. Can you say something about the stage of proceedings there, and where they are headed from the point of view of investors? Dover: It is likely that there will be multiple lead counsels, with the case treated as a multi-district litigation even though it remains within Texas. One of our borrowers is likely to be one of those lead counsel, and they expect to receive a substantial contingency-based fee for their efforts, but we would not ascribe much value to these cases today in our collateral evaluation due to how early in the process the cases are.

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Heirloom on the rise of U.S. litigation financing

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Christopher Faille

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