Law, the Investment
A new class of lawyer-entrepreneurs in U.S. legal services is attracting hundreds of millions of dollars from global investors, even while traditional law firms are forced to cut back.
These risk-takers speak a language investors understand. Rather than profits per partner, they talk about market share and return on invested capital. They converse as easily about finance, technology and management as finer points of law. And their enterprises produce steady returns even when unemployment soars and stock markets tank.
Some drive down costs by automating routine legal tasks. Others assemble dedicated teams of lawyers for in-house legal departments to draft simple contracts, review documents and conduct research. Still others use proprietary models to predict probable outcomes in complex commercial litigation, then contract to finance the most promising cases, freeing up corporate litigants’ capital for other uses.
Backed by institutions, private investors and hedge funds, these entrepreneurs and financiers employ a growing legion of lawyers in the United States and offshore. Even though their enterprises don’t counsel clients—they are prohibited from doing so by the ABA Model Rules of Professional Conduct—they are changing expectations about how legal services are priced and delivered.
They are part of a global legal services transformation that is expected to accelerate if Britain’s new coalition government allows investors to begin buying British firms, as permitted under the British Legal Services Act of 2007.
“The money is going to go where it can work fastest, to businesses that can take market share away from the traditional law firm model,” such as fixed-fee boutiques, says Ottawa, Canada-based legal consultant Jordan Furlong, partner in Edge International Inc. and publisher of the Law21 blog. “The biggest thing that does is change client expectations. All it takes is a few of these corporate-minded, equity-funded firms to come into the market and there’s a tipping point when a client’s question changes from ‘Why is this new firm charging less for this?’ to ‘Why is my old firm charging so much?’ “
The impact would be felt broadly across the U.S. market, especially in light of the wave of cross-border mergers like that of SNR Denton, a top-25 global player created by the merger this month of U.S.-based Sonnenschein Nath & Rosenthal and Britain’s Denton Wilde Sapte.
AGAINST THE RULE
Rule 5.4 of the ABA’s model rules strictly limits instances in which a U.S. lawyer or law firm can share legal fees or form partnerships with nonlawyers, effectively barring U.S. lawyers from taking outside equity, private or public. The rule is aimed at avoiding potential conflicts of interest between investors and clients.
“As practice changes, financing changes, governance in other countries changes, we’ve got to consider the impact on those practicing law in the U.S.,” says immediate-past ABA President Carolyn B. Lamm, a partner at White & Case in Washington, D.C. “It’s simply not something we can ignore. If you’ve got a fair amount of money from capital markets funding law firms from other countries, and you are in fact competing with them or opposing them in other cases, it would very likely have an impact on what you can do for clients. U.S. lawyers should consider it; what they decide to do I cannot predict.”
The ABA Commission on Ethics 20/20, formed by Lamm in August 2009 to consider these and other issues, is to begin offering recommendations to the House of Delegates at the 2011 midyear meeting.
Some say the market already has moved beyond the bar’s restrictions. “The question used to be: ‘Will the ABA change Rule 5.4?’ ” says lawyer and professor Larry Ribstein, associate dean for research at the University of Illinois College of Law. “The question now is, ‘Who cares?’ If the ABA wants to continue to regulate a tiny fraction of the legal market, they can keep their rule.”
“If the law firms themselves can’t have outside investors, the market will continue to chip away at every part of a law firm that is not the pure provision of legal advice,” says Nick Baughan, a managing member of investment banking firm Marks Baughan & Co., with offices in Conshohocken, Pa., and London. “Anything that can be provided legally by a third party will be.”
Outsourced legal services make up only a fraction of the total legal market. As one measure, America’s 100 biggest law firms grossed a total of $64.8 billion last year, while e-discovery services—a fast-growing segment of the outsourced market—are expected to generate $4.4 billion in sales this year, according to Socha Consulting of St. Paul, Minn.
Yet the pace of investment is picking up. An estimated $2.5 billion in capital flowed into e-discovery and legal process outsourcing firms since 2006. That’s approximately triple the amount invested during the previous five years, according to an analysis by Marks Baughan and Integreon’s Grail Research.
Los Angeles-based Integreon has raised about $100 million since 2001 to buy legal services companies. In February, Actis, a private equity firm that specializes in emerging markets, invested $50 million in Integreon. Integreon’s majority owner is Ayala Corp., a Phillipine-based conglomerate, which invested through LiveIt Investments, a business process outsource holding company.
“Ten years ago when we started down this path, people were skeptical this was a business,” says Integreon’s president and CEO, Liam Brown. “We have seen real scale, and it’s accelerating.”
In May the firm announced a 10-year service contract valued at about $855 million with British law firm CMS Cameron McKenna. Integreon will assume many nonbillable services, such as accounting and information services.
“We are not in competition [with law firms],” Brown says. “It’s just the tectonic shift from the old law firm pyramid [staffing model] to putting the right people doing the right thing in the right place at the right time.”
But those “right people” are not in the law firms earning BigLaw salaries, and that “right thing” is collecting payments that formerly were part of law firm billables.
In addition to nonbillable work, some outsourcers also take on legal tasks that previously went to first- or second-year associates or contract attorneys. Public and private investors finance a growing array of these ventures involving critical thinking and judgment.
Counsel Press, a national firm that helps lawyers file appeals, recently launched the CP Legal Research Group, targeting midsize-to-small law firms. Counsel Press is owned by the Dolan Media Co., formerly Dolan Media, a NYSE publicly traded company.
“Clients that come to us want some strategy. They want advice on how to proceed, the best way to move forward,” says the group’s director, lawyer Cameron Gilbert.
“We play a strong decision-making role within the case for our customers in the appellate world,” says Counsel Press’ president, Brian Robinson. “It’s not the kind of thing we’ve seen done really well [when] outsourced.”
Lawyer-entrepreneur Daniel Reed, chief executive officer of the Overland Park, Kan.-based legal process outsourcer UnitedLex Corp., says law firms are ill-equipped to deal with pressure from boards and procurement experts to work more efficiently.
“It’s a catalyst for what we do,” he says. “It’s a unique opportunity for investors to participate very directly in the revolution in legal services.”
Reed recalls a lightbulb moment in early 2006 while in Hyderabad, India, for a conference featuring a presentation on outsourcing giant Accenture’s model for implementing large software projects. He had recently wrapped up the $165 million sale of Adjoined Consulting—a technology venture where he was general counsel and chief financial officer—to India-based outsourcer Kanbay International Inc.
Excited by the idea of applying Accenture’s consulting model to legal services, he telephoned a former colleague in Texas who was general counsel of an operating division of a Fortune 20 company. Her chief complaint (one they had discussed often) was how much of her time she spent on tasks not commensurate with her skills.
“Why reinvent the wheel?” Reed asked. “Think Accenture, but for law.”
She became his first client at UnitedLex, whose annual sales approach $40 million. Investors include Canaan Partners, a multibillion-dollar venture capital firm with offices in the U.S., India and Israel; and Helion Venture Partners, an India-focused venture fund.
UnitedLex offers advice on strategy and technology and, like Accenture, identifies operations that can be performed at lower cost in other areas—whether in the U.S. or overseas. “Over 50 percent of our revenue derives from the U.S.,” Reed says. “There are many cases where going offshore does not make sense.”
In contrast, Ganesh Natarajan, president and chief executive officer of Chicago-based Mindcrest Inc., is a pioneer in legal outsourcing to India. As a partner in Chicago at the former Gardner, Carton & Douglas (now Drinker Biddle & Reath) and McGuireWoods during the 1990s technology boom, he advised U.S. corporations that were investing in India as well as companies in India hiring engineers for U.S. businesses.
He and three other attorneys founded Mindcrest in 2001. The company employs 700 lawyers in the U.S. and India.
“We looked at big law firms, which was my background, and said, ‘These firms operate in an inefficient manner,’ ” Natarajan recalls. He and his partners saw legal research as finite, project-based work that could be easily supervised. “We started with the idea of doing legal research and grew from there,” he says.
Chicago-based Talon Asset Management bought a minority stake in the company for $4 million in 2007 when Mindcrest needed to expand its operations to accommodate a large project—adding legal data to Bloomberg’s financial information systems for the product called Bloomberg Law.
“We saw this as a unique opportunity to participate in the next big wave of offshore work that we thought was logical,” says Talon’s chief operating officer, William Wolf, a Mindcrest director. “If you can offshore tax work and accounting, there’s no reason you can’t offshore legal work. The revenue potential is in the billions. We’re still at the very early stages of this cultural and market shift.”
Growth areas include legal process work such as reviewing garnishment orders for big employers, Natarajan says. “If you look at the processes companies get involved in which have a legal component, there are numerous processes which have not even been touched. We have barely scratched the surface.
“The legal work we do still requires an element of judgment,” he adds. “How people are trained, managed, the culture we have is all geared toward helping them exercise that judgment. Law firms typically prefer that. They like to hire a vendor who mirrors themselves.”
Mike Guthrie was scouting opportunities to invest in legal process outsourcing two years ago when he met over breakfast with a friend, a career litigator of 20-plus years. His friend suggested that legal process outsourcing firms are only one symptom of a much bigger disruption in legal services—an evolution of sorts that can offer investment opportunities. Their conversation stuck in his head.
Guthrie’s friend and two other senior litigators are now planning to join him in launching a litigation finance firm, Corax Capital Partners, before the end of the year. The San Francisco-based group will provide money and intelligence for companies to pursue complex commercial claims.
“Litigation is a multibillion-dollar industry for which there is almost no private capital,” says Guthrie, a private equity investor and former investment banker. “That’s unique and odd. Most major industries in the U.S., from manufacturing to high-end services, have a lot of private and/or public investment dollars in them.”
Investing in commercial litigation is a small but growing business in the United States supported by hedge funds and other investors. They rely on lawyers to analyze and identify promising cases to finance in return for a multiple of their investment when the case settles. Unlike a loan, there is no payout if the litigant loses.
Only a handful of larger players focus on the U.S. commercial market: a unit of Credit Suisse Group, Juridica Capital Management Ltd. and Burford Capital Ltd. The latter two manage multimillion-dollar funds that trade publicly in London. In addition, some large hedge funds employ lawyers to invest directly for them.
David Desser, managing director, Juris Capital Corp.
David Desser, a former merger and acquisition lawyer at Katten Muchen Rosenman, is managing director of Juris Capital Corp. in Chicago, which invests for hedge funds and other private investors.
“Litigation is extremely expensive, outcomes are very difficult to predict, and you’ve got to pay the expenses up front,” Desser says. “General counsel want certainty on their budgets, and one way you can offer them certainty is some kind of fixed-fee arrangement.
“There’s now a small group of sophisticated investors who are willing to provide capital. You’re dealing with public and private companies, and the notion of raising capital so they can focus on their core business and reduce their exposure to the litigation” is appealing.
For law firms engaged in fixed or contingent-fee arrangements, “our capital smooths out the cash flows” while transferring some of the risk inherent in that type of engagement, Desser says.
Litigation is attractive to investors because returns don’t vary with economic trends. “Hedge funds that are looking for noncorrelated returns love this asset,” Desser says. “Litigation has nothing to do with whether employment or interest rates go up or down.”
The practice, already well-established in Europe and Australia, has critics. The U.S. Chamber of Commerce last year proposed banning third-party litigation funding. The chamber’s objections center on introducing a “stranger”—whose only interest is financial—into the attorney-client relationship. The group said the practice encourages frivolous actions, which commercial financiers dispute, saying they reject many more cases than they fund.
Richard Fields, chairman and CEO, Juridica Capital Management
“We’ve seen major law firms bring cases we wouldn’t touch with a 10-foot pole,” says Richard W. Fields, Juridica Capital Management’s chairman and chief executive.
The firm manages Juridica Investments Ltd., on London’s AIM stock exchange since December 2007. Shareholders are large British institutional investors. As of March 31, Juridica had invested $122.8 million in 22 cases, half of them patent matters. Five antitrust cases represented $77.5 million of the total.
Fields practiced as a corporate plaintiffs lawyer at large firms for nearly a decade before starting—and later selling—an Internet company that focused on using risk assessment software to resolve insurance claims. Fields also founded a company in London to create a market for trading insurance claims.
“I began to see claims simply as a business asset that needed to be monetized,” he says. “Litigating for three or four years is not necessarily the most efficient way to get to a business solution.”
His team at Juridica uses proprietary software and a 100-page underwriting model in deciding which litigation to fund. Over the last two years they reviewed more than 400 cases, rejecting 94 percent of them, Fields says.
“Every time we reject something we hope we’re teaching lawyers something about how capital sees the process,” he says. “We are bringing the discipline of the capital market to the legal markets.”
Desser says most litigation financing is done under contract with the claimant because professional conduct rules prohibit lawyers from sharing fees with nonlawyers. “When we contract with a company, we purchase some portion of the litigation proceeds,” he says. As an example, “for every $1 we invest, we might be entitled to an additional $2 if the outcome is successful” within a specified time.
Juris typically invests between $500,000 and $5 million per claim, Desser says. He declined to say how much his partnership expects to invest this year.
“We look for creditworthy, rational parties, not someone who says, ‘I’m suing based on principle,’ ” Desser says. “It has to fit our ability to model the outcome with our analytical models. We look at jurisdiction, venue, parties, facts of the case, relevant law, other precedent, the litigation background,” he says, ticking off still other variables. “It’s exceedingly cautious.
“We are cherry-picking the absolute best cases with a fact pattern that we can deconstruct. We’re not interested in winning one out of 10 like in the venture capital world, where you look for that home run. … We want to win 7 out of 10, with doubles or triples on our money.”
Once they invest, they remain passive to comply with the ABA ethics code, Desser and Fields say. “Our interests are all aligned,” Desser says. “If we don’t see that good relationship, we wouldn’t invest.”
University of Illinois prof Ribstein says the growth of these financiers underscores the legal industry’s transition.
“Bringing in capital allows businesses to scale up and provides efficient specialization,” he says. “Once a business model calls for capital, there’s no particular reason why lawyers themselves are the best people to provide it.”
Daniel E. Reed
Chief executive officer
Overland Park, Kan.
Investors: Venture capital firms
Former firm: Greenberg Traurig
President and chief executive officer
Mindcrest Inc., Chicago
Investors: Private equity firm
Former firms: Gardner Carton & Douglas, McGuireWoods
Richard W. Fields
Chairman and chief executive officer
Juridica Capital Management Ltd.
Guernsey, U.K. and New York City
Investors: Large institutional investors
Former firms: Howrey & Simon; Swidler & Berlin; Dickstein Shapiro
Juris Capital Corp., Chicago
Investors: Hedge funds
Former firm: Katten Muchin Rosenman
CorrectionIn print and initial online versions of “Law, the Investment,” September, the relationship between outsourcing firm Integreon and private equity firm Actis was stated incorrectly. Actis invested $50 million in Integreon.
The ABA Journal regrets the error.
Barbara Rose is a freelance journalist in Chicago.
Barbara Rose is a freelance journalist in Chicago.