Investing in David’s Lawyers, Defeating Goliath – and Taking a Profit along the Way

June 18, 2020

Dafna Maor, TheMarker
Translated from Hebrew

Ralph Sutton founded Validity Finance in order to finance legal proceedings in the commercial sector and then discovered that the U.S. corporate lobby had an interest in stopping his fund. Upon the founding of an Israel branch, he discusses how the financial crisis is benefitting his business and how the U.S. legal system is biased against the weak.

They were lawyers who felt that they were fighting for justice. “But it was a challenging way to spend life.” When they turned to a complementary sector, an innovative approach to investment and finance – financing lawsuits in the commercial sector – the investors welcomed them eagerly. But then they encountered objections from an organization whose very name makes the hearts of all who stand in its way quiver – the U.S. Chamber of Commerce – the strongest business lobby in the world.

“The business sector has a lobby that is totally dedicated to what it calls ‘legal reform’ but in practice protects the rights of large corporations to do whatever they want in a legal way. They need to see that when we make society fairer, this strengthens society and the economy, and the rule of law,” says Ralph Sutton, CEO of Validity Finance, which is engaged in litigation finance despite the Chamber of Commerce

In an interview with Sutton, a veteran lawyer who is Jewish, speaks Hebrew, and interned with the late Israeli Supreme Court Justice Menachem Elon, he discusses the opening of an Israel branch of Validity Finance, led by Adv. Eli Schulman, who also takes part in the interview. Schulman, a Boston native, moved to Israel in 2004 and worked in the international department of the State Attorney’s Office. Subsequently, he founded a law firm that specialized in representing Israeli businesspeople and companies in U.S. commercial litigation.

In the two years of its existence, Validity has raised more than $300 million. Its investors include the British private-equity fund TowerBrook. So far, the fund has invested more than $100 million in 20 lawsuits and “portfolio” deals with law firms. About 20 percent of the capital has been invested in international-arbitration cases around the world.

The activity in Israel involves investing in financing lawsuits that are being conducted abroad. According to Sutton and Schulman, this is the only U.S. fund in this field that has official representation in Israel. It focuses on commercial disputes, such as protecting intellectual property. The fund rejects 95 out of every 100 cases that it examines for investment, based on the chances of winning.

How did you get into legal financing?

“This is a small and relatively new area,” Sutton says. Fourteen years ago, he approached Credit Suisse and proposed that the Swiss bank set up a legal financing fund. In his words, the field was not yet ripe: “The legal profession is conservative and stuck in the past. It deals with precedents rather than innovations. We wanted to offer clients access to legal justice. We founded Validity in order to focus on clients – not on financial returns. We wanted to set up a company that was unlike any other in the U.S., which was built on trust between clients and lawyers, and to ensure that deals were fair, sustainable, and still profitable for the investors.”

And how did you raise financing?

“It wasn’t at all difficult to raise capital for this strategy because it is attractive. Investors are looking for alternative assets,” Sutton says. “We raised from TowerBrook, who are former investors from George Soros’s fund. They had a vision – to build the value of the company, to grant ownership to its employees, with a financing structure that has never been seen before.”

Schulman adds that in the financial crisis there are many opportunities, and the company is receiving more inquiries. “Liquidity is very important now, and there is a lot of money looking for returns. In April, the number of our investment opportunities grew [significantly].”

“A huge engine for growth”

The size of the global market for legal financing in 2018 was estimated at $10.9 billion, according to data from the Absolute Market Insights research company, which predicts it will grow to $22.4 billion in 2027. U.S. funds in 2019 held assets worth $9.5 billion. In this field there are publicly traded companies, like Burford Capital, which has a market cap of $1.1 billion. Another company, Vannin Capital, was acquired by a subsidiary of SoftBank.

Why Israel?

Sutton: “Israel is a huge engine for growth. My family invested in Israeli companies like Mobileye. But the prominent difference between Israel and Silicon Valley is that in Israel the people pushing innovation are aged 30-plus, people with a Ph.D., a family, and children. In Silicon Valley you are mainly talking about young college dropouts. The Israelis have experience in the army, leadership, and an understanding of what is important for the country. Tech companies in the U.S. are not prepared to think in an innovative way about their legal activities.”

In what cases do you invest?

“In patent-infringement cases, for example. Such as where a person creates an invention and shows it to a large company, and they sign a non-disclosure agreement (NDA) – and then the big company steals the patent. The small inventor needs capital in order to fight the big company. This can cost $6-10 million in legal fees and expenses. This is bad exploitation of the system.”

“There are also cases of minority shareholders being harmed by large shareholders who defraud them, and the dispute must be settled. To win you need excellent lawyers who make magic.”

What is the financing model?

Sutton: “We participate 50-50. Say there is a budget of $5 million for the lawsuit. $4 million goes to fees and $1 million to routine costs like expert witnesses and travel. We will pay $2 million, and the law firm conducting the suit will pay $2 million. The additional million is for expert witnesses and travel – we will cover most of it and the client will pay a small part, say $100,000. This way, the client gets a partner that can also help as an advisor in the lawsuit. Our participation in the financing can reach $20 million.” He explains that the fund carefully screens the clients and invests only in promising lawsuits with a strong basis.

The fund also provides clients with operating capital for the period of the lawsuit in order to allow them to continue their activities. “The lawsuit is an asset,” says Sutton. “Corporations have an intangible asset in the form of lawsuits that can yield money. If we lose, they don't give back the money.”

Have you had cases that the heart wants but the head rejects?

“We fall in love all the time,” Sutton says. “Sometimes it’s the case, sometimes the people, or the concept of fighting against bad companies. I tend to fall in love with people, and I don’t want to disappoint them. So, I need my colleagues to tell me: Have you gone crazy, this won’t succeed.”

“The business lobby has an agenda and a lot of money”

It's a bit difficult to understand the objections of the Chamber of Commerce. If you only invest in strong lawsuits, then you are again creating a situation in which the strong get financing and the weak lose out from the start.

“The Chamber of Commerce has claimed for years that financing lawsuits causes frivolous lawsuits. That is really stupid. We disqualify from the start frivolous lawsuits – we would lose money on weak lawsuits. They also claim that it interferes with attorney-client privilege, and that’s also not logical. Insurance companies have more control over lawsuits than we do,” Sutton says.

“The business lobby has an agenda and a lot of money. They will always object to us. In Australia, Britain and Canada, financing is perceived as a way of expanding access to the courts. Only in the U.S. is it polarized and political. Sometimes we represent large companies – we don’t always take the side of David, sometimes we represent Goliath against Goliath.”

Schulman adds, “The Chamber of Commerce ignores the fact that most of the businesses in the U.S. are small and mid-size. Our product is important for these companies.”

Activists claim, and there are jurists who agree with them, that the U.S. legal system works for the rich, that there is one type of justice for the strong and another type of justice for the weak. Do you agree with that?

Sutton: “In the index of world justice that measures equality of the legal system, the U.S. is perhaps free from corruption, but is ranked 100th out of 120 in the world in access to civil law. We are ranked below small and corrupt countries.”

“The coronavirus crisis has shown that U.S. society is flawed in terms of inequality – in education, in technology, and in health. People without resources cannot cope with the loss of insurance, work, and the difficulties in receiving medical treatment. In our field, the inequality in the law harms small and mid-sized companies.”

Schulman: “Most of the business dynamics in Israel belong to small companies. Some years ago, I represented a small Israeli company that did business with a large U.S. company that stole their technology, registered patents in its own name, and when the Israeli company confronted them, the American company told them, ‘Sue us – you will never succeed.’ How do you cope with this? At this point I discovered third-party funding. This experience lit a fire within me. It promises access to justice, though it does not solve everything.”

Do you expect substantial political change following the coronavirus?

Sutton: “The only political dynamic that I can talk about is as a citizen who sees civil protest that is asking for a fundamental reevaluation of the relationship between the police and minorities. In our society there is a terrible heritage of slavery and racism that has not disappeared. There is no melting pot here.”

"As a society, we want to explore what can be done so that society and its institutions will be fairer. If Donald Trump wins again, it will take a lot more time to make this change. If Joe Biden wins, it will be easier to change."

Schulman: “It is a difficult question and a difficult subject. Civil society is based on equal rights before the law. It is difficult to apply this. In 2011, there were protests in Israel and there was energy, but there were not significant results. I hope that it will be different this time.”

Sutton: “If Barack Obama had not been in the White House after the 2008 recession, people would have taken to the streets and burned tires. There was protest but there wasn’t violence after 2008-09. Obama was a stable person, not controversial, and not unpredictable.”

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