Monday, May 7, 2012

“Lawyers Investing in Lawsuits – Somehow it Doesn’t Seem Right”

Sydney M. Williams

Thought of the Day
“Lawyers Investing in Lawsuits – Somehow it Doesn’t Seem Right”
May 3, 2012

“The first thing we do, let’s kill all the lawyers.” While the line was spoken by Dick the Butcher, in Shakespeare’s Henry VI, who was anxious to destroy anyone who stood in his friend’s way of becoming king, it has taken on new meaning in our time. The line came to mind while reading an article in Tuesday’s New York Times, “Looking to Make a Profit on Lawsuits, Firms Invest in Them.”

Investing in lawsuits is not a new concept. It is not unlike the purchase of a life insurance policy from someone in need of cash – perfectly legitimate, but somehow unseemly, as the seller knows at least one person is rooting for his speedy demise. The U.S. is a perfect venue for this relatively new investment strategy. On a per capita basis, we have more lawyers than any other country. A year and a half ago, Binyamin Appelbaum, in the Times, suggested that litigation investment firms had $1 billion invested in lawsuits, on behalf of investors like Fidelity, Invesco, and wealthy individuals. In terms of its potential size, Americans in 2006 spent twice as much on litigation as they did on new cars. That same year, lawyers earned $40 billion in lawsuit awards.

Litigation is time-consuming, which means it is also cash consuming. Someone must front the money. In some cases the plaintiff cannot put up the money, and law firms may choose not to ante up the money. Lawyers, for all their pro bono work, tend to charge high hourly rates. Lawyers get paid the most when they take a percent of the settlement, a common practice in class-action suits. In other cases, the plaintiff assumes the risk. In both cases, the costs may be laid off on an investor willing to fund the case in return for a piece of the settlement.

Class-action suits are more typically funded by the law firm; for they have made a decision that the potential award is worth the risk. However, they sometimes lose. The partners at Dewey LeBoeuf know the risk of taking on too much debt. So, it is only natural that some of the risk gets laid off on third party investors. Litigation investment firms are generally comprised of lawyers capable of assessing the likely outcome of each case. These are high risk, high reward investments. The Times cites a case of an Arizonan developer who claimed that a rival had tried to block one of his projects. When the real estate market collapsed the developer was left with a cash shortage, so he approached a litigation investor. A $6 million investment is expected to yield $18 million. On the other hand, the one litigation investment fund I know of that trades in the public market, Juridica Investments (listed on the London Stock Exchange) trades 28 percent below its offering price when it was first listed in December 2007.

Defendants in lawsuits tend to be well-heeled companies or individuals. (After all, why sue a person or business incapable of paying a claim? In 2010, five companies – GE, Goodyear, Bank of America, Wells Fargo and Toyota Motors – were sued for a total of $22.6 billion in U.S. federal courts.) Lawyers love lengthy litigation, as their billing hours expand. And, lengthy litigations provide investment opportunity, as William Alden noted in Tuesday’s Times article.

One of the biggest costs our society bears are frivolous lawsuits. In 2007, the Wall Street Journal, using data from the consulting firm Towers Perrin and the insurance company A.M. Best, estimated the annual cost of frivolous suits at $260.8 billion, or $880 per person. We live in a litigious country, in a litigious era. The numbers will not have gone down. Frivolous medical malpractice suits, in states with no tort reform, cause doctors to cover all their bases, prescribing procedures and medicines that may be unnecessary or redundant. The cost of insurance has caused doctors to give up practice in states with particularly harsh judgments. All of these costs are ultimately borne by us, the consumer and taxpayer.

An unintended consequence of these litigation investment firms might be to increase the number of frivolous suits and, more important, defer tort reform. There is also the potential for conflict of interest. An attorney representing a client with a dubious case may put that client in touch with some investors, thereby assuring that, should the case be lost, he (the lawyer) still collects his $1000 per hour, even if the client walks away empty handed.

Lawyers investing in lawsuits may be perfectly legal, but that doesn’t make it right, and caveat emptor should guide all individuals looking to place money with these folks.

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