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Are you tired of guessing between small- and large-cap equities, or short- and long-duration bond funds? Have you decided your clients need nontraditional investments to expand their efficient frontiers? Are real estate and oil and gas investments no longer providing a reliable alternative to the unpredictable equity and fixed income markets?
Maybe it's time to give your clients' money to your friendly attorney. But before you write this off as another hair-brained scheme akin to windmill farms and the liberation of fabled Nigerian riches, consider what Tom Ross is doing. An engineer by education, and owner of Palm Beach Capital Advisors LLC, located in the town it's named after, Ross offers qualified clients specialized venture capital and hedge fund investments, along with something called "litigation funding."
What is it? Litigation funding isn't a new concept, just a new investment opportunity for advisors. Although perhaps not obvious, it's understandable that many lawsuits-due to clogged court dockets, time-consuming appeals processes and other systemic delays-take financial detours. Sometimes cases are settled for less than their potential simply because a plaintiff lacks the income he needs for day-to-day support, or his attorney incurs expenses in trying his case without compensating cash flow. Even when cases are concluded and settlements are known, if an insurance company is the defendant's payor, the ultimate payoff date is likely uncertain, and probably later rather than sooner.
Ross offers an example of how a litigation funding investment works in these cases: "Let's say a bricklayer gets hit by a car and can't work. The defendant's insurance company says 'here's $5,000, now go away.' The plaintiff's attorney knows his client has a legitimate case, but the client has no income and must meet his living costs. Litigation funding allows this financially weakened plaintiff to level the playing field against his stronger defendant. The average investment in that type of case might be $2,500. If the case is lost, there's no return...it's essentially like a venture capital investment."
The need for interim financing is therefore obvious and, traditionally, banks have played a major role. Explains Robert Hockett, president of Cambridge Southern Financial Advisors in Stockbridge, Ga. and a former financial advisor with Wachovia's Private Banking Group, "We represented the 'conventional side' of litigation lending."
Working with the 60 largest law firms in Atlanta, Hockett's group lent money in two different scenarios. First, the litigation department of a large law firm doing corporate work would typically have high front-end costs, such as expert witness fees, which would require funding. Second, smaller but financially sound law firms representing plaintiffs in personal injury or wrongful death cases, sometimes class-action suits, would need funding because they would get nothing from their plaintiff or any other source until the case was settled. Only then could they look forward to their contingency fee, the first income they would realize from the case.
With both types of suits, Hockett's group would set up lines of credit for the law firms. He says, "Some of these cases might be very long term-ten years or more. A firm working a case with an expected settlement of, say, $2 million to $5 million, might receive a $3 million line of credit." To counteract the long time frames, the borrower would make interest-only payments against the line. To secure the line, the bank would often get the limited guarantee of the law firm's partners and/or a lien against its office equipment. "These working capital loans could go as high as $20 million for larger firms," Hockett says.
This gives you the background on the need for litigation funding and how it's traditionally been done. What Ross is doing differently is providing private lending by making his clients investors in the lawsuits he and his team deem to have the right characteristics. Says Ross, "The plaintiff's attorney, the capability of the defendant and/or the defendant's insurance company to pay, and the expert witnesses to be called in the case are all important factors in determining the amount of investment, risk and potential reward [to be realized from the investment]."
The likely period of settlement is also critical, as it determines a deal's return on investment. "On average, our cases have settled in just under 300 days," says Ross. Of course, Ross' ability to track down eligible cases in the first place is critical, too. To find the cases, he has established a network of more than 700 attorneys in 20 states who are aware of the funding options Ross' firm can offer.
Most of the time, Ross packages cases of varying risk into a fund or pool-like structure. This is particularly advisable when he includes more speculative cases along with those of more certain outcome. While the funding of plaintiff and attorney expenses in cases with sure settlements represent a known risk-i.e., the waiting game before the plaintiff receives his award and the attorney his contingency fee-getting involved in cases at an earlier stage adds the additional risk of speculating on an unknown result. By blending both types of cases into a fund, Ross provides his clients with a monthly cash flow and a return on investment that's not market related-all while exerting a high level of control over the fund's blended risk profile.