Burford Capital, a New York-based company, provides litigation finance. This is a subject of endless debate, especially among members of the plaintiffs’ bar. The old-style plaintiffs’ lawyer simply says “no, thank you” to any potential client without the financial wherewithal to bear the costs of an action, especially if the action has the potential to be protracted and expensive before any settlement or judgment that could make for a payday. But the new style plaintiffs’ lawyer is very sophisticated about looking for financing.
Legal finance companies offer a nonrecourse cash advance. It isn’t considered a loan at law but, rather, a form of venture capital; in effect an equity interest in the litigation.
Burford is big in this business. It has principal offices in Guernsey, London, New York, and Chicago, and it has been trading on the London AIM Stock Exchange (BUR:LN) for 10 years.
This year, the renowned short seller Muddy Waters and Burford went to war. Their war began on Aug. 7, when Muddy Waters indicated it was short Burford, and gave its reasons why. Essentially, it is short because Burford “manipulates its metrics to create what we believe is an egregiously misleading picture of its investment returns.”
A few days later, Burford struck back, saying that its shares have been trading in a way consistent with “illegal market manipulation.” In effect, it was accusing Muddy Waters of that manipulation, with only a minimum of indirectness.
The lawsuit financing business model raises in a dramatic way the issue of “fair value” accounting. If a position in a lawsuit is an “intangible asset,” the owner of the asset should carry that asset at cost, likely until a settlement. But if its position in a lawsuit is a “financial asset,” it gets to treat them on a mark-to-market basis, revising balance sheet values according to what it reasonably believes it could get by selling the position, under IFRS 9. That makes a considerable difference in how much the asset, and the financing company, are each worth. And, assuming that the market believes in the numbers Burford puts out, the characterization of these assets makes a difference to what one might expect of its stock price.
Bringing HIV Into the Picture
As the back-and-forth continued, the Burford/Muddy Waters dispute focused on the Napo arbitration. Once upon a time two pharmaceutical companies, Napo and Glenmark, had a collaborative agreement for the development and marketing of HIV-related drugs. Napo pulled out of that agreement for reasons we need not discuss here, and Glenmark sought a declaration from an arbitration panel that the withdrawal was unfounded. Napo defended itself from Glenmark’s charges, saying that its action had been justified, and asserting counterclaims along with its defense.
Muddy Waters claims that in its 2013 annual report, Burford said that it was justified in increasing its valuation of its position on this dispute. It had backed Napo and Napo had won.
Burford now says it never said that. It also says that Napo was a legitimate source of gains to Burmark aside from this arbitration case, and the disputed 2013 report was referencing those other gains.
Muddy Waters is sticking to its guns on this, saying that it was clear well before the end of 2013 that the dispute was going to be a disaster for Burford. Accordingly, any mark-to-market changes—if such changes were appropriate—should have been downward, not upward.
Only one of three concluded cases…
However, the specifics of the Napo/Burford situation may be sorted out, one intriguing point here is that Burford’s own analysis indicates that only 26 of the 76 “concluded” cases in which it had an interest ever showed a fair value change. Does this mean that two out of every three times, Burford estimates the value of a case exactly right the first time, and eventually receives a payout of just that amount?
It does seem probable that Muddy Waters has a point here: that Burford cherry picked those 26 cases in order to mark outsized “fair value” gains on that sample while using historical pricing of the bulk of the cases as a hedge.
A Final Thought
Some of the difficulties suggested by the ongoing Muddy Waters/Burford clash seem to be difficulties inherent in the whole lawsuit financing business model. For example, Muddy Waters complains that Burford is hiding behind attorney-client privilege in order to make its own financial documents opaque. But isn’t that a problem with the whole model? Of course Napo is represented by counsel. If the presence of a third-party investor compromises the confidentiality of that relationship it is arguably at serious variance with an important public policy consideration. But if the traditional confidentiality is to be respected despite the presence of this third party: that by implication will mean some lack of transparency.