How does collateral work in a litigation portfolio?
Legal finance may be an unfamiliar asset class to many. Unlike a concrete piece of real estate or a business with steady profits, the value of a legal case lies in a future settlement or judgment. This uncertainty can lead some people to think that legal cases are especially risky investments. At Yieldstreet, though, we have a strategy to help mitigate the associated risks: cross-collateralized portfolios. For Yieldstreet legal funding, cross-collateralization essentially means that a portfolio is built with a buffer where cases in a portfolio that are more likely to reach a favorable outcome help provide a buffer against those that are less likely. Let’s take a look at exactly how cross-collateralized portfolios work.
Valuing individual lawsuits
The first step in creating a litigation funding portfolio is to value each individual lawsuit. We strive to ensure that every input into the portfolios we offer is a meritorious legal case with a high chance of success. When a legal funding company decides to fund a plaintiff, they conduct detailed due diligence on their case.
Vetting cases involves a twofold inquiry:
- Determining the chance of a judgment for the plaintiff
- Determining the likely value of that judgment
These determinations require a nuanced understanding of the way the legal profession works—for example, the elements that plaintiffs must prove to advance a given claim, and the particular facts that judges or juries look for when deciding whether those elements are met. Therefore, while finance professionals may weigh in on calculations, litigation funders rely heavily on lawyers with decades of experience. These lawyers might draw on cases that they have personally been involved with or use their legal training to research similar cases that others have brought. In essence, lawyers are looking for relevant legal precedent—past cases that are comparable to the case being evaluated. If past cases with similar facts tend to end in the favor of the plaintiffs, lawyers gain confidence that the plaintiff will win the case under evaluation. In fact, if precedent is “controlling,” it may even constrain a court into a certain outcome. Lawyers can also use precedent to estimate how much a court will order a defendant to pay, or in other words, determine the value of the case. If no former case is a perfect fit, lawyers can fine-tune their estimates by adjusting precedential values up or down based on factors unique to the present case. Such factors may include the severity of the injury, the strength of the law firms on each side, and judge assignment.
Creating a cross-collateralized portfolio
Even after legal funding companies have diligently valued the injury and determined the likelihood of recovery, there is a chance that the plaintiff will agree to an undervalued settlement or a judge or jury will resolve the case in favor of the defendant. Because litigation funders are not involved in day-to-day case management, they do not have a way to mitigate these risks in the context of individual cases.
Litigation funders cannot counsel plaintiffs on when to settle or consult with attorneys on case strategy. Yieldstreet, however, has access to a different and, as we see it, effective risk management strategy: cross-collateralized portfolios. By grouping cases into portfolios, investors’ returns are no longer dependent on a single case, and investors do not need all cases within a portfolio to successfully settle in order to recuperate their principal and target interest. It is important to remember that all cases within a Yieldstreet portfolio have been in active litigation for at least a year, and have accrued interest over that period of time.
Yieldstreet does not invest at 100% of the cases’ current accrued value, allowing an equity buffer for unsuccessful cases. If some cases in the portfolio fail (all plaintiff funding is non-recourse, meaning that the plaintiff will not have to repay the plaintiff funding company if there is no settlement), they will be counterbalanced by interest earned from successful cases, and the portfolio as a whole will most likely proceed on course.
The more cross-collateralized a portfolio, the stronger this counterbalancing effect. In a cross-collateralized portfolio, cases vary significantly on a wide range of traits. Dimensions on which cases vary might include: estimated duration; geography; case type (e.g., personal injury versus class action versus mass tort); defendant sector (e.g., healthcare versus automotive versus finance); and stage of the case at investment (e.g., investing shortly after the complaint is filed versus investing during an appeal). Because of this variety, there is a lower likelihood that one or two unforeseen events—for example, an industry downturn or the appointment of a defendant-friendly judge in a district—will cause large waves across the portfolio. Instead, the portfolio’s performance is designed to be insulated from such unforeseen circumstances. Even though one or two cases might be negatively impacted, the portfolio on a whole should remain on track to achieve target returns.
In investing terms, these diversified litigation portfolios can be said to be cross-collateralized. In this instance, legal cases are “cross-collateralized” in a diversified legal finance portfolio because, as discussed above, a single victory can be valuable enough to cover not only that loan but also a loss in another case.
For additional questions regarding Yieldstreet or our legal finance offerings, please email us at [email protected].
This communication and the information contained in this article are provided for general informational purposes only and should neither be construed nor intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, tax, financial, accounting, legal, regulatory or compliance advice. Any link to a third-party website (or article contained therein) is not an endorsement, authorization or representation of our affiliation with that third party (or article). We do not exercise control over third-party websites, and we are not responsible or liable for the accuracy, legality, appropriateness or any other aspect of such website (or article contained therein).
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2 Represents an net annualized return, using an internal rate of return (IRR) methodology, with respect to the matured investments shown in your Portfolio experience, utilizing the effective dates and amounts of subscriptions and distributions to and from the investments, net of management fees and all other expenses charged to the investments.[read more]