Litigation Finance Is Like Venture Capital—Burford’s Wild Week

Hello, and welcome back to the Big Law Business column on law firm strategy amid a changing legal marketplace, written by me, Roy Strom. Reach me with your thoughts here.

It was a wild week for Burford Capital. It’s not every day that a publicly traded company has to defend itself from accusations of being “arguably insolvent” due to “Enron-esque” accounting. (Burford says neither of those things are true.)

Then again, Burford has never been like most publicly traded companies. There are only a few other litigation funders whose shares are listed on a public exchange. And one of its publicly traded competitors, IMF Bentham, was quick to point out another defining characteristic of Burford: It attempts to value the lawsuits it invests in as they progress.

This strategy is worth a brief explanation. It helps to crystallize the point I think Burford’s problems drive home for law firm leaders, especially those who have been considering an increased role in plaintiff-side contingency fee cases. That point is investing in lawsuits can be very risky— venture capital risky.

Just ask Burford CEO Christopher Bogart. He compared his business last week to a venture capital firm. He said Burford will hit some big winners; some cases will lose; and others will fall somewhere in the middle.

“It’s not all that dissimilar from a venture capital model,” Bogart said in a call trying to soothe the nerves of jittery investors. “That is the real nature of the business.”

VC funds and their “win-big-or-go-home” investors are about as far away from law firm partners as possible on the “I’m-OK-with-risk” spectrum.

Risk shy law firm partners, like the market itself, might get pretty spooked by the conclusions that short seller Muddy Waters drew this week about Burford’s record in valuing cases mid-litigation.

When one of Burford’s cases has a positive development, Burford will typically book “fair value gains” on its balance sheet. The cash doesn’t come until a case and any appeals conclude. They’re paper profits, but they’re important to investors. In the first half of the year, Burford said nearly 50% of its income came from those unrealized gains. That’s actually lower than the company’s 54% average over the past three years.

Burford has been upfront about this element of its business, even posing this question in its latest financial report: “Should I be concerned about the presence of unrealized gains in Burford’s financial reporting?” “No,” it went on to say, in so many words.

But Muddy Waters says, emphatically, yes. The short seller’s report released on Aug. 7 pointed to a number of instances where it said Burford did not mark down the value of its cases after adverse rulings. Perhaps the most intriguing involved an oligarch’s yacht and a messy divorce. The report said other times Burford took years to mark down its losses, and that it all that adds up to significantly lower historical returns than the funder has reported.

Muddy Waters also says Burford’s four most profitable cases account for 66% of the company’s realized gains since 2012. In the venture capital analogy, Muddy Waters is in effect saying Burford invested in four good companies and it has largely struggled to pick other winners. Burford, in its first-half report, said viewing its business this way would be akin to valuing venture capital firm Sequoia Capital without its investment in Google.

One analyst on Thursday’s conference call asked Bogart how many home run-hitting cases the company had in its pipeline. Bogart’s answer could be taken as a warning to law firms hoping to do get into plaintiff-side contingency fee work.

“It is often difficult to tell at the beginning of a piece of litigation what is going to happen, and whether it is going to be particularly profitable for us or not,” he said.

He used one of the firm’s most profitable cases as an example, saying the company initially believed it would be a run-of-the-mill case. The facts were strongly in the plaintiff’s favor, Burford thought, and that would likely lead to a quick settlement. Instead it was a drawn out litigation that resulted in a 722% return on invested capital.

“So, will there be another big case in our future that produces big, interesting returns?” Bogart asked on the investor call. “We certainly hope so. And part of what we do is talk with law firms to [find those].”

I’ll keep following the fallout from Burford’s very bad week. The lawsuit valuation issue is sure to spur more debate not far down the road.

And per our usual disclosure: Burford Capital Managing Partner David Perla is a former president of Bloomberg Law.

Worth Your Time

On Failed Law Firms: LeClairRyan voted to dissolve last week after months of partner departures. The wind down may be orderly, or it may lead to a bankruptcy, which was most recently seen in the law firm context at Sedgwick in October last year.

On Regulatory Change (Or Not): California lawyers are coming out in droves to say they don’t want the State Bar of California to adopt new rules that would allow nonlawyers to share in law firm profits. Some 90% of the 420 comments to the bar on the proposals have been negative so far.

On China: Herbert Smith Freehills struck a deal with Chinese law firm Kewei to become the sixth global firm to gain approval from Chinese regulators to integrate with a domestic law practice there, the Financial Times reports. Other firms that have engaged local firms to make a play in the restricted China market include Baker McKenzie, Linklaters and Hogan Lovells.

That’s all I’ve got until next time! Reach me here to share your views on law firms, litigation funders, and whatever else is happening in the world of Big Law Business.