Litigation Finance Demystified: A Real Estate-to-Litigation Funding Conversion (Part 4)
In this post, we’ll compare and contrast litigation finance to real estate lending.
I find that the easiest way to explain investments in litigation finance is to compare them to other similar investments.
If you have experience in real estate, whether through equity ownership or debt financing, you’re already familiar with many concepts needed to understand litigation funding.
Allow me to draw some simple analogies between our Litigation Portfolio and our Income Funds’s real estate-backed loan portfolio to illuminate the similarities and help you see how easily these ideas translate.
Understanding the Basics
Imagine you are providing a loan to a law firm instead of a real estate property. The law firms we work with are much like seasoned real estate investors – they have extensive experience, strong financial resources, and a solid track record.
Returns and Borrowers
In real estate debt investments, you receive returns from principal and interest payments without upside. In litigation funding, you get equity-like returns with preferred distributions and then a waterfall split of the profit derived from the plaintiffs’ settlement or award.
Use of Funds
In real estate, loan proceeds might be used to acquire or improve properties. Similarly, in litigation funding, proceeds are used to acquire new claimants and fund ongoing litigation costs.
Collateral and Security
Your investment in real estate is secured by the property itself. You typically secure a first lien position by filing a lien. In litigation funding, the collateral comes from the law firm’s contingency fee agreements with their claimants. We secure a first position by filing a UCC-1 lien on the law firm’s assets.
Criteria and Valuation
In real estate, we choose stabilized, performing properties in favorable markets for real estate. In litigation funding, we focus on late-stage mass tort and individual cases backed by strong evidence and expert testimony.
In real estate, an appraiser evaluates the property’s value. In litigation funding, a law firm collateral valuation specialist assesses the value of the legal claims to ensure their potential for significant returns.
Conservative Loan-to-Value (LTV) Ratios
In real estate, moderate to high LTV ratios (50-65%) provide a cushion against valuation fluctuations. In litigation funding, low LTV ratios (20-40%) offer substantial protection and ensure we have a solid buffer.
Skin in the Game
To earn our trust, both real estate investors and law firms need to show a commitment to sucessful outcomes. In real estate, this is often through down payments. In litigation funding, law firms demonstrate their commitment by the law firms previous and continued co-investing of their finances, time, and resources into the cases.
By comparing these two asset classes, you can see that both require due diligence, strong collateral, and a clear understanding of the risks and returns.
| PIM Diversified Litigation Portfolio | PIM Income Fund, A Real-Estate Debt Portfolio | |
|---|---|---|
| Investment | Litigation funding is an investment, or loan, to a law firm | Real estate lending is an investment, or a loan, to a real estate investor |
| Returns | Equity-like payback terms with preferred returns and waterfall distributions of the profits. | Debt-like returns with principal and interest payments and no upside. |
| Desired Borrower | Nation’s leading plaintiff law firms with extensive experience, strong track record, well-capitalized financial resources, and substantial litigation capacity to facilitate proceedings | Nation’s leading real estate investors with extensive experience and a strong track record, significant assets, and the ability to manage and improve properties. |
| Use of proceeds | Loan proceeds are used to acquire claimants and/or fund ongoing litigation costs. | Loan proceeds are used to acquire or improve real estate. |
| Loan Collateral | Law firm’s contingency fee agreements for claimants they represent. | Real estate |
| Collateral Criteria | Late-stage mass tort and individual cases with strong scientific data and expert testimony proving liability & causality. High-value claimants with proof of exposure and harm with supporting medical records likely to result in significant awards. | Stabilized commercial multifamily, retail, and industrial performing assets in favorable markets. Strong tenant base with long-term leases and verifiable financials. |
| Collateral Valuation | Law firm collateral valuation specialist | Real estate appraiser |
| Security | Senior position UCC-1 filing on the law firm | Senior position lien filed on the property |
| Loan-To-Value (LTV) | Low 20-40% LTV ratios provide substantial cushions against potential valuation fluctuations | Moderate to high 50-65% LTV ratios provide significant cushions against potential valuation fluctuations |
| Borrower Skin In The Game | Required previous and ongoing law firm co-investment shows confidence and commitment, and aligns financial interests. | Required down payments show confidence and commitment and align financial interests. |
I hope this helps demystify litigation finance for you.
Have questions?
Want The Litigation Investing Mastery Series delivered each week to your inbox? Subscribe here
Or click here to jump ahead and read next week’s blog.