Investment

Litigation Funding – a Sharia-Compliant Investment?

Many of us are familiar with the term litigation and for most of us it is something that we desperately try to avoid as it conjures up visions of paying huge legal fees, spending years being embroiled in the legal system or reading tedious legal jargon.

However over the past few years, there has been a boom in the number of litigation funders operating in the UK.  Litigation Funders are companies that essentially seek to make money off commercial litigation or arbitration.

What is litigation funding?

Litigation funders fund the costs of pursuing legal claims in exchange for a share of any damages awarded.  RPC, a city law firm which analysed the total assets held on the balance sheets of the top 15 UK litigation funders found that the value of assets (active litigation and cash) has been increasing by £300m year-on-year since 2014/15 and that they currently hold £1.9bn in assets.[1]

It is a high risk, high reward investment class with litigation funders promising investors double-digit returns and also the opportunity to diversify their portfolio away from the traditional equity and debt.

Litigation is generally unconnected to general market conditions and the macroeconomic situation.  It is generally difficult for the everyday investor to obtain direct exposure to litigation funding.  However, there is a rise of crowdfunding platforms in this space which offer the everyday investor the opportunity to invest in particular cases.

AxiaFunder allows investors to fund vetted litigation claims.  It says that to date, “9 litigation cases have been fully funded via [its] platform, of which two have been successfully resolved, generating a 43% and 94% return to investors in 8 months and 15 months, respectively, while the other 7 cases are still ongoing”.[2]

That is an impressive IRR figure although in this space more so than others past performance is not a guarantee of future results given the particularity of each individual case and the multiple variable involved in any litigation.

Additionally, it doesn’t appear they have been active recently, so perhaps one to keep a tab on to see how they develop.

So how does litigation funding work?

Litigation Funders essentially enable companies and individual access justice by funding their legal costs.  A claimant could pay legal fees of £150,000 to recover damages of £1,000,000.  If unsuccessful, £150,000 in legal costs would have been spent and the claimant is likely have to pay the other side’s legal costs of about £100,000.  Bringing total losses to £250,000.

Litigation funders, if they decide to take on the claim after having conducted their due diligence, would pay for the claimant’s legal fees in exchange for a success fee (usually a percentage of the estimated damages, say 40%).

If successful, the claimant would be allowed to retain £600,000 of the £1,000,000 in damages but would not have had to pay any legal costs.

If unsuccessful, the after the event (“ATE”) insurance cover arranged by the litigation funder would cover any adverse cost order and the claimant will not have to pay the funder.  The Claimant’s potential loss would be £0.

What cases do Litigation Funders fund?

Litigation Funders generally fund commercial cases with good prospects of success, although some have ventured into more unconventional areas funding high value divorce cases.  They also carry out due diligence on the cases to ensure that amongst other things, the cases have good legal merit, the ratio of legal costs to damages is viable; the defendant has the financial resources to pay any judgment and the claimant has viable ATE insurance in place.

Although Litigation Funders will monitor the cases that the fund on a periodic basis they will not generally manage the cases in any way.  That is left to the claimant and their legal team.

What are risks of investing in a Litigation Funder?

As with any investment, litigation funding carries with it, its own risks.  Litigation is risky and even the most legally or factually meritorious claims may be unsuccessful resulting in a loss of the entire investment.

More importantly, just as there could high returns with litigation funding the losses could be high.  Investors may stand to lose double their investment or potentially more if the claim fails and adverse costs orders are made; in such a situation the investor may have to pay further moneys to cover the adverse cost orders.  Litigation Funders manage this risk by amongst other things structuring the investment through SPVs and ensuring the Claimant takes out ATE insurance with a reputable provider.

So is Litigation Funding Shariah Compliant?

This is a new area of investment and there is no decisive consensus of the scholars yet on this.

Here is an argument for litigation funding being halal

In principle, the concept of Litigation Funding itself is not adverse to Shariah principles.  Put basically, the investor (the capitalist) provides capital to the claimant (the entrepreneur) to pursue their claim in exchange for a share in any damages (profits).

If the claimant succeeds both the claimant and the investor would share in the damages according to pre-agreed percentages.  If the claimant loses, the investor loses all of their capital and the claimant would have not gained anything from pursuing the claim and both the claimant and the investor would be liable for any adverse costs order on a primary and secondary basis respectively.

The litigation as a whole is a mini-business in itself. It requires investment, strategy, understanding of the market etc.

This is similar to a classic Mudaraba agreement.  This is of course provided that the subject of the dispute does not contradict or is any way adverse to Shariah principles, i.e. it does not concern claims for interest, alcohol, etc.

However, where Litigation Funding may fall foul of Shariah principles is how the funding is structured.  As a rule of thumb, Litigation Funders require ATE insurance to be in place as a hedge to limit the investor’s exposure in the event that the claim fails.

The ATE insurance will pay any adverse cost orders, thereby limiting the investor’s loss to 100% of their capital and nothing more.  Whether ATE insurance is halal or haram is beyond the scope of this article but this is one issue on which investors into Litigation Funds may want to obtain clarity before investing.

Here is an argument against litigation funding being halal

Litigation funding is not structured in a classic mudaraba structure as the claimant is not really the one providing the sweat labour, and the litigation is not really a standard business. This is a court process to settle a dispute – it is a reactive process and not a proactive entrepreneurial venture.

Alternative ways of structuring a sharia-compliant litigation funding however could include a constructed shariah structure where funders give a qardhe hassana, with a unilateral promise by the claimant that should they win the case, then they will gift X amount to funders.

Of course, this does leave the knotty problem of ATE insurance – which is fundamental to the viability of litigation funding. The majority of scholars do not allow insurance however there are some compelling minority views out there.

Alternative ways to gain exposure to Litigation Funders

Rather than directly investing in litigation funding by funding a particular case through AxiaFunder, one can also gain indirect exposure to litigation funders by purchasing shares in publicly listed litigation funders such as Burford Capital Limited, Litigation Capital Management Limited or Manolete Partners, the latter two being AIM listed.

Investing in shares obviously brings with it additional market risks which may not necessarily be present when one chooses to fund cases directly albeit the investor’s exposure would be more spread out with the former.  The shares of all three companies have had a rather tumultuous run over the last three years. As with all equity investments Muslims should conduct a sharia-compliance review of these stocks. To find out more on how to do that, check out this article.

Conclusions

Litigation funding is an interesting emerging asset class and one Muslims should pay attention to. Right now it is likely a little more scholarly work is needed to establish whether litigation funding in its current guise is fully Islamic or if it needs tweaks. For a wider list of halal investments that are signed off as Islamic check out the IFG Investment Comparison Tool.

[1] https://www.rpc.co.uk/press-and-media/uk-litigation-funder-war-chests-hit-record-high-of-2bn-up-46-percent-in-a-year/#:~:text=RPC%20says%20litigation%20funding%20has,share%20of%20any%20damages%20awarded.

[2] https://www.axiafunder.com/news/case-performance-statistics

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