This article originally appeared in Goldberg Segalla’s Professional Liability Matters. Read the issue here.
The world of litigation financing has exploded in recent years, moving from small lawsuit loans funding personal-injury cases to multimillion-dollar investments in major commercial disputes. Litigation funders therefore have increasingly found themselves in the spotlight, with some of them subsequently targeted by an unwanted beast in the world of publicly traded companies: the short attacker.
A short attacker essentially places a bet that a company is overvalued and then publicizes its analysis to convince the market the short attacker is correct. The first such short attack on litigation financiers affected U.K.-based Burford Capital (Burford).
This summer, according to Reuters, short-seller Muddy Waters sparked a 2 billion pound slump in shares of Burford Capital (BURF.L), a London-listed fund that finances lawsuits in return for a cut of any payouts, after criticizing its accounts and saying it had bet on its shares falling.
Muddy Waters, known in financial markets for regularly declaring short equity positions on the basis of its in-house research, claimed, concluding that its “operating expenses, financing costs, debt, and funding commitments … put it at a high risk of a liquidity crunch.”
Muddy Waters went so far as to compare Burford’s method of valuing its assets to that used by Enron because lawsuit litigation is “an illiquid and esoteric asset class.” It further claimed that Burford fails to take into account uncollectible judgments, delays reporting trial losses under the guise of an impossible appeal, and fails to properly account for non-cash settlements. Finally, Muddy Waters notes that just four cases accounted for 66 percent of Burford’s net realized gains from 2012 through 2019, despite published figures that suggest a more balanced portfolio of returns.
One of the most revealing aspects of these allegations is that, to most plaintiff-side law firms, they are nothing particularly noteworthy. Lawsuits are obviously illiquid, valuations are subject to constantly changing circumstances, and predicting when—or if —recovery will be obtained can be quite volatile. Although the figures certainly vary from firm to firm, and year to year, it also is quite normal for the majority of profits to come from a few big winners while the remaining cases tread water or lose. These are just some of Muddy Waters’ criticisms of Burford, but their disclosure as damning evidence of overstated balance sheets shows that the marriage between hedge funds and litigation may not be such a match made in heaven.
Nevertheless, Burford has raised a staggering $2 billion in capital over the past two years, and more middle-market financiers are opening every day. As capital raises increase, along with general litigation costs that push settlement, an increase in all types of litigation seems inevitable. Simply put, Burford and its brethren must employ the capital they receive. That means finding new suits to file or continue that would have otherwise been deemed too financially risky. At least according to Muddy Waters, this also means using massaged reporting numbers to perpetuate abnormally high investment returns, which yields even more capital raises, and the completion of a vicious litigation circle.
The outcome of the Muddy Waters Burford short attack, and a recently filed lawsuit based on the analysis, will therefore be a harbinger of litigation finance’s future. If most of the claims are shrugged off as a reality of plaintiff-side litigation, we can be sure that new players and funding find their way into the market and flood every corner of the litigation world. If the investment world instead views these issues as incompatible with investment evaluation, perhaps a slowdown in litigation finance may be in the future. The stock price of Burford suggests the investment world is watching, and litigators should too as the dispute will certainly rage for years to come.
Professional Liability Magazine, a collaborative effort of Goldberg Segalla’s Management and Professional Liability Practice Group, examines the latest best practices, emerging developments, and influential court decisions impacting the defense of professional-service providers. Read our latest issue here.