Hedge funds investing in big-time divorce

AMONG all the people who lost money in the downturn, one of the most colourful cases was that of Scot Young, businessman friend of Russian oligarch Boris Berezovsky and owner of the Ivy restaurant, Richard Caring. When his wife filed for divorce last year it emerged that Young’s £400m fortune had apparently vanished, with Young pleading that he was £27m in debt, with no money left to pay his wife.

Such stories excite gossip columnists, but the case also has an interesting legal angle. In order to help her find out what happened to her husband’s money, Scot’s wife received third-party legal funding. In fact third-party funding – where a third party funds the cost of litigation in exchange for a cut of any ultimate award from the court – is becoming more common in divorce cases.

Traditionally, in divorce cases parties have funded payment of their ongoing legal costs by using their own resources, though often a divorcing spouse will ask their lawyer if payment of their legal fees can be made once the case is over and the settlement has been received. However, law firms are businesses just like any other, and hence deferring payment of the legal costs will adversely affect the firm’s cash flow. In addition, there has also been a recent trend for private banks to offer a product to help people needing assistance with payment of their legal fees and who are likely to receive a substantial eventual settlement.

The bank provides a sum up-front either to the party or to their lawyer, with interest paid back during the course of the proceedings. The loan will then have to be repaid at the end of the proceedings, regardless of the outcome.

Such arrangements proved very popular before the recession, but banks’ lending criteria have been significantly tightened up since and there has therefore been a reduction in the availability of such lending.

As a result we are now seeing the emergence of a different type of funding being made available in very high net worth divorce cases by a new species of lenders: hedge funds, which have traditionally provided assistance in personal injury or commercial litigation cases. This type of funding is effectively on a “no win-no fee” basis and sees a success fee being paid on a successful outcome to the litigation.

The actual mechanics of arranging litigation funding differ according to the fund involved. The lawyer will typically put the client in contact with a small panel of different organisations so that they can listen to the various propositions. The main advantage of litigation funding is that it can be used in cases where it is difficult to assess what the asset base is at the outset because of a lack of available information, and where a client could potentially receive a very large or small settlement depending on what is uncovered. This opens up a valuable lifeline to clients as banks do not normally lend without this information being available.

On the downside, because of the risk involved, the funder receives a substantial success fee, which makes it a much more expensive option than traditional bank borrowing. For now, though, divorce is the newest alternative investment in town.

Andrew Meehan is a Senior Solicitor at national law firm Mills & Reeve LLP