The Chicago-based firm, Gerchen Keller Capital LLC, officially opens Monday. The firm's four principals, which includes former hedge funders, firm attorneys and a onetime general counsel, closed an initial round of fundraising on April 1, and have already committed to backing their first case.
While that initial investment was a plaintiffs case, the firm said its strategy is to distance itself from plaintiff-focused competitors by working with corporate clients "on both sides of the 'v.'"
"In this marketplace, where companies are really grasping for ways to reduce costs ... and manage their legal spends, the message from us is that we want to be an active part of that discussion on the defense side as well as the plaintiffs' side," said Travis Lenkner, Gerchen Keller's chief underwriting officer and former Gibson Dunn & Crutcher LLP attorney.
CEO Adam Gerchen said the fund has already found a ready market, both among sophisticated investors and companies looking for help spreading the financial risks of pursuing complex litigations, and reducing their own legal liabilities. The $100 million was raised quickly, he said, from a "low teens" number of institutional or otherwise sophisticated investors.
He likened the binary outcomes of many litigations to the arbitrage and so-called "event-driven" investment strategies he pursued previously as a hedge fund portfolio manager.
"There is this Holy Grail of noncorrelated, positive risk adjusted returns," Gerchen said.
The firm joins a small but growing number of investment funds created specifically to finance commercial litigation, at a time when in-house counsel and firms are under pressure to find cheaper routes to case closures and turn unresolved legal issues like patent infringements into moneymakers.
"It's an emerging industry, it's controversial, but it's certainly gaining acceptance," said Maya Steinitz, an associate law professor at the University of Iowa College of Law and an expert on litigation finance.
The industry, she said, is still little understood in the legal and investment communities. It also has vocal critics who argue third-party investment in litigations encourages a "justice jackpot" mentality, and potentially gives investors leverage in matters of law and justice in which their own interests are strictly financial.
The American Bar Association has also noted numerous risks to fee agreements, attorney-client privilege and conflicts of interest. The U.S. Chamber of Commerce has called litigation finance a "clear and present danger" to the justice system, and ripe for abuse.
"This industry has exploded in the U.S. over the last five years, and it's growing globally as well, with more and more people thinking about it, including whether and how to regulate," Steinitz said.
Those concerns don't appear to be cutting into returns. Burford Capital Ltd., the biggest and best known of a small group of U.S. corporate litigation investors, reported a 61 percent net return in 2012, and has committed $373 million in investments since it was founded in 2009.
Last year, it was reportedly set to make a 91 percent return on more than $30 million in investments in nine cases from 2011. Others, including Juridica Capital Management Ltd., have also posted impressive returns.
A Burford-backed survey last year found that nearly two-thirds of 462 litigation partners, general counsel and chief financial officers expected litigation finance to increase in the near future; more than half said they have previously had a case that would have benefited from outside financing.
A corporate litigation finance deal typically starts with a funder making a detailed analysis of the case — nearly always on the plaintiffs side, where the funding need is greater and the risks clearer — along with calculations of the potential value of a favorable outcome and percentage chance of it being won.
In exchange for putting up the money to pay for the litigation, claimants agree to split potential awards or settlements with the firm, with the funders typically shooting for a 3-1 or higher return. If the case is lost, the funder loses the entire investment.
The blueprint of Gerchen Keller's defense-side strategy looks something like this: The firm commits to pay a company's law firm fees on a matter in exchange for a premium cut of whatever savings are secured between the settlement or judgment amount and a pre-agreed-upon figure — the theoretical total liability the client faced.
In this scenario, Gerchen said, the law firm would also give a fee discount, and be in line for a smaller cut of that difference if they secure a favorable outcome. If the case is lost outright or fails to meet contract benchmarks, the client is still liable to plaintiffs, but investors swallow the legal fees.
Steinitz said defense-side financing has been discussed for several years, but has found few if any takers. Among several tough scenarios: A defendant client with a litigation going south could see the shrinking space between a settlement figure and the funder's premium payment as a disincentive to purse the case aggressively, she said.
"I can see a business case for it, but I note that the idea has been floated around for a few years unsuccessfully," she said. "It all hinges on the ability of the client ... and the funder to agree on the estimated liability, and that's a very speculative number."
The firm said its market positioning also includes a completely hands-off role in legal issues, once a pre-review of the case is complete and a deal signed.
"We have a thorough due diligence process on the front end ... but once that process is complete, we're committed to respecting the sanctity of the attorney-client relationship and never interfering in that," Lenkner said.
In addition to Gerchen and Lenkner, the firm principals include Terry Carlson, a former general counsel and head of government affairs at Medtronic Inc., who will serve as chairman of the investment committee.
Ashley Keller, the firm's chief investment officer, was formerly an analyst at Alyeska Investment Group LP, where Gerchen also worked, and a partner at Bartlit Beck Herman Palenchar & Scott LLP. He and Lenkner both clerked for U.S. Supreme Court Justice Anthony M. Kennedy.
--Editing by Jocelyn Allison and Katherine Rautenberg.