The changing world of dispute finance, part 1 – where it all began
IMF Bentham Executive Director and pioneer of the dispute finance industry, Hugh McLernon, shares insights into the origins of modern-day dispute finance and its global expansion.
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Welcome to In Conversation with IMF Bentham. My name is Nathan Landis, and I'm your host for today's podcast called ‘The changing world of dispute finance’. I'm an investment manager at dispute funder, IMF Bentham, and responsible for conducting due diligence on cases, and managing funded claims.
In part one of this episode, I'll be joined Executive Director of IMF, Hugh McLernon. Hugh is one of the pioneers of the industry, and he's going to talk about where it all began, the origins of modern-day dispute finance in Australia, and its global expansion.
In part two, I'll be joined by two of my colleagues, Chief Investment Officer for Asia, Tom Glasgow, and Managing Director and CEO of IMF Bentham's global operations, Andrew Saker. Tom and Andrew will be chatting more about the expansion of the industry, both globally and the types of funding products being offered; and also, how the funding process works, including the funder's investment criteria.
I hope you take away from this podcast a better understanding of the dispute finance industry and how this innovative funding product is developing and assisting parties around the globe. My first guest today is Hugh McLernon. Welcome Hugh.
Hugh, you're one of the pioneers of the dispute finance industry. Can you tell us how you got started, and the types of cases that you were funding at the beginning?
Pre-1987, I was working doing commercial cases with a firm that's now known as Clayton Utz and when the 1987 crash occurred, there were a very large number of clients around Perth who had gone very quickly from being in a position where they had say a $10 million house with a $7million mortgage. All of a sudden, they had a $7million mortgage with a $5 million house, and a bank which was very keen to get repaid quickly.
So, many of those people found themselves in a position where they couldn't defend themselves because they didn't have the ready money to do that, and it struck me as slightly ridiculous really that they could not seek assistance in part by using whatever causes of action they had to help pay for their legal fees. So, I thought there was a reasonable opportunity there.
I researched for a month or so the law and the rules relating to champerty and maintenance, thought they were wrong and that the courts would eventually say they were wrong, and left legal practice, gave up my certificate, and started funding. The rest is history.
Thanks for the background Hugh. Can you tell us a bit about the transition from being an unlisted company to the first listed litigation funder in the world?
Yes. We were in a position in mid-2001 where we essentially had two businesses. One I was running, which was a small number of very large claims, and the other, Clive Bowman and John Walker were running in Sydney which was a large number of smaller claims. We weren't sure which was the most appropriate business model, so we decided we would put the two together and list, not so much the cases, but the idea of litigation funding onto the Stock Exchange.
So, we did that, and the market got the prospectus about the 10th of September, and of course the world paused on the 11th of September when the attacks on the Twin Towers in New York occurred, and elsewhere in the US, and our thought was that our little listing would not occur, but somehow the market recovered reasonably quickly and we were actually listed about the 14th or 15th of September 2001.
We did it really for three reasons, I think. First of all, the obvious one which was capital. Much easier to attract capital if you're listed. Secondly, it gave us the greatest opportunity to attack the audience, to interest the audience, to attract the audience through the publicity that goes with a listed company. The ability to launch statements with the ASX which then went around the world was an amazingly effective, cheap way of getting the story worldwide. And the third one was responsibility. Because of the rules relating to listed companies, we had to be absolutely on our game from day one, and we made sure that we were, and that sort of stood us in very good stead.
The courts would inevitably in those early days start with the opening line, "IMF is a company listed on the Australian Stock Exchange", and that in one sentence said it all. We were the only listed company in the world that was carrying out the business of litigation funding, and that took a lot with it, both to the courts, the public, investors, clients, you name it. Everyone started with the proposition, "These guys are the only listed game in town. I can see their accounts by pressing a button. I can see everything they've said about their business" and so on.
Did that access to the capital that you were able to get through the listing process lead to a change in the type of matters that IMF funded?
Not really, I don't think. It's often said that IMF started business as a provider of finance to insolvency practitioners. That's not actually right. That was a reasonable part of our business, but we funded across the board from day one.
What it did enable us to do, that is the access to capital, was to take on bigger cases, and in particular, three or four years after we listed, to start taking on a very large number when you look back, a very large number of class actions. We essentially grew the whole class action process in Australia because we were able to provide for five years or so all by ourselves the necessary funds, averaging probably six to seven million dollars a class action for 30 odd class actions.
How do you think the decision in the Fostif case in the [Australian] High Court affected the business?
It was super important obviously because it could have gone the other way which would have been the end of the business. So it's obviously a very important decision, but I think the small decisions on the way to the High Court in other cases virtually made it, let's say, a high likelihood that when the High Court finally got the question before it, it wouldn't knock over the business and it didn't. I don't think it came as a huge surprise to anyone that that was the result. Although when you look back, there were two dissentients, and they were quite, how shall I put it, strong in the wording of their judgments against litigation funding. But I think if you go back and read those judgments, they are of historical interest only because all of the problems that were thought to arise from litigation funding which were set out in those judgments hasn't occurred.
Thanks Hugh. Perhaps we could talk through what third party dispute finance is. Can you tell us in brief what third party dispute finance or litigation funding actually involves?
Yes. At the root of whole process is the question of risk, so that if you have a $100 claim and you don't want to spend the $5 to pursue it, then you can get a litigation funder to put up the $5 and to risk having to pay the other side's costs, and give up say $30 of the $100. In doing that, you have no risk. You don't have to pay for your own side, and you don't have to pay the other side if you lose. So if you lose the case, you don't actually lose anything. You don't lose any more than the chance you had of winning the case.
On the other hand, if you win, you end up with about 65% say of whatever the other side pays. So it becomes this question, should you take all the risk all the time, and try and manage a piece of litigation where you've never done it before in your life, or not very often, and get 100% if you win, or give it to someone else without risk who knows what they're doing, and get $65 out of the $100? Most people, when they sit down and put it into those simple terms, can't see any point otherwise than taking the no-risk route, and that's why litigation funding is so popular around the world, and increasingly popular.
On that point, Hugh, around the early to mid-2000s, dispute finance started to spread around the globe. Can you tell us about the expansion of dispute finance around this time, including the types of cases that have started to be funded since then?
Yes. I think it's reasonable to say that our off-shoot in the US was the catalyst in that country, the real catalyst. There were some smaller operations, but it was the first major step into the sort of litigation funding that had taken off in Australia in 2001, or actually earlier than that because, as I mentioned earlier, 1987 was when we started funding in Australia. That's what - 13, 14 years before IMF was listed.
So America and the U.K. were the next two places that we went. We went to South Africa and New Zealand, and we did a couple of cases in Hong Kong, but I think it was a happy combination of factors that really lit the fire under litigation funding. One was the GFC which did two things. It produced an enormous number of good cases, and secondly, it led to a situation where interest rates were zero or negative. It made a search for yield rabid around the world, and investors began to put a small percentage of their total investments into litigation funding, and all of a sudden it went from a fairly small situation to a phenomenon really around the world as a new business.
What IMF did was not to create a business, it created an industry. It's still growing, and it's still to be tested, that is, the industry. But it's now, what? 16 years, 17 years moving up towards two decades and getting stronger every day.
What the business is now doing, or what litigation funding, what's happening to it, is that it's branching out, looking for other opportunities. Lots of people around the world are thinking about it, things like the funding of legal firms based upon non-recourse. In other words, you maybe put $50 or 60 million into a good firm for a return on a bundle of maybe 10 or 15 cases. That suits the law firm because it gets the cash upfront. It suits the funder because the risk is ameliorated by having it stretched across a number of cases rather than just one.
So, it's changing all the time. In fact, new areas are being funded, new types of cases in new places, and the business has basically doubled, or the opportunities have doubled by virtue of the fact that we are now funding arbitration, not just litigation. In theory, it's a hundreds of billions, trillions [dollar] business because that's the money that's spent on litigation around the world every year.
And Hugh, where do you see the business going?
Well, it's hard to say because there is a very large increase in competition. I personally think competition is a good thing. When we were by ourselves, everyone wondered whether, because we were marching in one direction and everyone else was marching in the other, that we were slightly crazy off by ourselves. We're over that hurdle, but it's hard to see, or you know, in the same as any business really, regulation, all the risks are there, but the big ones I think are competition, regulation, lack of capital.
Those are the three big things that could impact the business. But I think because it's got off to such a hot start, the immediate fear is that funders will overstep the mark, be driven down towards the lower end of the totem pole, picking cases that have only just got a reasonable chance rather than a very good one, and you'll see some failure of funders, and that will put a cloud over the industry, which will then have to prove itself again. But that sort of fits and starts aspect of business is common. It's what I fully expect in due course. We've just got to make sure we're not one of those funders.
Thanks very much Hugh. That concludes part one of this episode.
Please join me for part two of ‘The changing world of dispute finance’ via the blog page of our website at www.imf.com.au/newsroom/blog. You can also access a transcript of this podcast and subscribe to future podcasts, blogs and e-bulletins on dispute finance.
Thank you for joining us. Goodbye.