Litigation finance: Unlocking the value of disputes

An offshore oil platform and wells are silhouetted by the setting sun in the Gulf of Mexico off the coast of Louisiana, U.S., on Thursday, July 15, 2010. Photographer: Derick E. Hingle
An offshore oil platform and wells are silhouetted by the setting sun in the Gulf of Mexico off the coast of Louisiana, U.S., on Thursday, July 15, 2010. Photographer: Derick E. Hingle
Opinion by Nick Rowles-Davies (Executive Vice-ChairmanLitigation Capital Management)

The energy sector has long been familiar with disputes, especially lengthy, high-value and high-profile claims. Some of the highest-value arbitral awards in history have arisen from energy-related arbitration.

The volume of disputes is also growing in the sector and 2018 saw a 20% increase in the number of cases. Energy companies are currently operating within an increasingly contentious and regulated environment, presenting numerous challenges for those businesses and individuals responsible for the accompanying growing legal spend.

Third-party funding finances a company’s litigation or arbitration costs, allowing the company to remove the entire financial risk of the dispute from its balance sheet.

If the dispute being financed is successful (i.e. a court or tribunal rules in the company’s favour, or a favourable settlement is reached), the funder receives its investment and a return with the balance distributed to the business.

Third-party funding has a further benefit of providing an additional layer of due diligence on claims from highly experienced litigation and arbitration specialists.

Despite these reasons, to date the energy sector has not fully realised the benefits of dispute finance.

Dispute funding within the energy sector has for too long favoured the traditional, single-case approach (which sees cases being funded on an individual basis); however, this does not benefit the business from a pricing perspective.

The single-case model is not designed to support businesses on an ongoing basis and is typically focused on the strongest claims a company has.

All too often, the single-case approach is used out of necessity in distressed situations, which fails to solve the ultimate challenge facing businesses in the energy sector – namely, managing the cost of multiple legal cases, both in bringing claims but also defending them.

There is, however, a growing understanding, such as with oil and gas companies operating in the Middle East, about how dispute finance can be used as an effective and profitable financial solution.

A shift in the thought process about litigation and arbitration costs can help a company manage the cost of its legal claims, turn the legal department into a profit centre and even offer the potential for monetisation straight into the P&L.

Most companies within the energy sector will have numerous disputes, which can be viewed as a portfolio by grouping together some or all cases.

By funding a portfolio of cases, financing is secured against the book as a whole, not just the strongest case(s), which allows the funding of claims which may not be funded on an individual basis.

This portfolio approach considerably lowers the cost for the business as the risk is spread across multiple cases and has the additional benefit of potentially creating a financial provision for any defence cases.

When dispute finance is used in this manner, more commonly known as corporate portfolio financing, it results in a company being able to (i) move the financial risk of disputes, (ii) remove the costs associated with disputes from the company’s balance sheet and (iii) release the financial upside of multiple claims where returns are generated at zero cost.

Litigation and arbitration are converted from an expense to a source of revenue, allowing the company to reallocate capital to core business activities. It can also present a solution to the problem of significant costs defending claims or investigations.

Awareness and interest in corporate portfolio financing continues to grow and there is arguably an increasing need for energy companies to look for ways to mitigate and manage their legal spend on disputes.

Energy is one of several sectors, alongside aviation, construction and insurance, that is poised to benefit from this new and developing corporate portfolio approach to third-party funding.

Ultimately, it is contingent asset finance and should be viewed an alternative asset class that provides an additional source of corporate finance to a business.

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