ESG: Soros-backed Aristata fund aims to turn ESG litigation into profitable investment

ESG-related litigation funds offer “decent” returns and a positive reputational impact from taking part in cases that generate widespread interest, reports David Whitehouse.

Aristata Capital, whose investment clients include the Soros Economic Development Fund (SEDF), aims to show that litigation finance in ESG-related cases can be a profitable investment. In July, the firm had the first close for its Aristata Impact Litigation Fund I, which focuses on social impact litigation. CEO Rob Ryan, previously a director at the ClientEarth environmental charity, says Aristata has an “impact-first mentality”. 

Experience taught him that corporations were much less likely than governments to change their behaviour on climate issues in response to litigation. The not-for-profit sector has not proved itself as an effective player in commercial litigation, he says. “Traditional philanthropic approaches are not enough. Private capital is needed to solve public problems.”

The fund aims to maximise proceeds for claimants and provide a return for investors and generate resources for more litigation. Ryan says the vehicle will work in a similar way to a closed-end private equity fund. The first fundraising, for which law firm Reed Smith acted as adviser, reached an initial close at £40 million (€46 million) at the start of July. The firm aims to increase that to at least £50 million with a hard cap of £100 million. The final close is planned for June 2023, with the fund targeting an internal rate of return of 20%. 

Investors in Aristata include Capricorn Investment’s Sustainable Investors Fund (SIF), The Good Investors co-operative in Paris and several family offices. The SIF helped the fund develop its impact due diligence process for potential cases and helped finance initial cases before the official fund launch. It points to a case in which Aristata invested in litigation supporting indigenous communities in the Pacific. A service provider, SIF says, is accused of having under-reported its use of the communities’ facilities, fees for which are used to provide local public services.

The SEDF, part of the Open Society Foundations (OSF) set up by George Soros in 1997, is also backing the fund. The OSF is the world’s largest private funder of independent groups working for justice, democratic governance and human rights. Traditional litigation funders have a high return threshold meaning there is a “huge untapped pipeline of viable cases”, including many with potential for positive social impact, says Laura Renaud-Studer, senior investment associate at the OSF. The Aristata founders, she says, have put in years of “sweat equity” and could have made more money elsewhere.

Litigation financing
General litigation financing is a model in which investors fund legal costs in return for a share in the proceeds if the claim is successful. The market for litigation finance has expanded since the 2008 financial crisis. By 2020, there were 46 litigation finance fund managers and even a fund of funds, but there is little public data on financial performance. 

The US litigation funding market is about four times that of Europe. But interest is increasing in Europe, where Germany is the largest market. According to RPC, assets held by the top 15 UK litigation funders rose by 46% between 2018 and 2020. Brussels-based litigation funder Deminor has forecast that the global funding market will grow by 8.3% a year. Europe’s share of the global markets is likely to reach nearly 16% of a total of $18 billion (€18.7 billion) by 2025, driven by non-compliance with ESG standards, human rights and consumer rights, Deminor says. That’s underpinned by the European Representative Action Directive, which will make collective actions available in all EU countries by the end of 2022.

“Traditional philanthropic approaches are not enough. private capital is needed to solve public problems.”

Researchers led by Thomas Healey at the Harvard Kennedy School in Cambridge, Massachusetts, have reported litigation finance returns of over 20% annually, with limited correlation to other investments. The excess returns, cautions Healey, may be driven by information asymmetries which could be eroded as more investors enter the sector. The returns are also highly volatile: the research found that 34% of cases in commercial litigation finance portfolios led to negative returns on capital, with a failed case generally meaning losses of more than 85%.

Litigation finance is gaining ground. A survey in the US this year from litigation finance firm Lake Whillans and news site Above the Law found that 69% of legal professional respondents said that litigation finance had become more relevant to their practice in the past year. Still, Healey argues that the marketing strategy of the industry “remains ambiguous”. Positioning litigation finance as a form of alternative lending, similar to payday loans, means that the niche may “struggle to attract greater acceptance”. Greater traction may be achieved, Healey writes, if litigation finance is seen as providing access to capital in an underserved market, similar to online funding portals. 

”This is do-able”
Litigation finance has often been seen as a source of reputational risk, but the growth of ESG investing has opened the possibility of a reverse effect, that of positive reputational impact from taking part in a case that generates widespread interest. Aristata’s move comes as the prominence of ESG concerns and returns from litigation funding drive interest in funding ESG cases. 

Litigation funders such as Therium, Woodsford, North Wall Capital and Litigation Lending Services have prioritised ESG cases, while in Canada, litigation funder Omni Bridgeway has said it is exploring the idea of an ESG litigation fund. North Wall in August announced an investment of $100 million into law firm Pogust Goodhead to pursue ESG cases. In Australia, Litigation Lending Services backed a class action in September 2016 concerning historical underpayment of wages to Aboriginal workers. The settlement of A$190 million (€128 million) reached in December 2019 makes the dispute the largest human rights case in Australia’s history.

Research from the Latham & Watkins law firm argues that the global spread of ESG disclosure requirements will mean more litigation, as disclosures will trigger claims based on public reporting or its absence. Climate change cases will lead the way, but Covid-19 has broadened the ESG lens to include working conditions in supply chains, the law firm says. 

It is possible that Aristata’s biggest impact will be an invisible one as corporates clean up their act to avoid being sued. As Latham & Watkins notes, the mere existence of ESG litigation can affect a company’s ability to retain its stakeholders. 

Aristata can help to “motivate a change in corporate behaviour” while achieving “decent” investment returns, says Renaud-Studer, who manages OSF’s Aristata investment. The first fund can lead to the emergence of a more specialised series of funds, and the potential to make a “catalytic” investment was part of the rationale, she says. 

ESGAristata has “proof of concept, this is doable”. There is widespread interest in climate litigation, but it’s too soon to gauge the investment potential of human rights or gender inequality, she adds.

The management team includes lawyer Michael Hartridge and chief investment officer Jack Naylor, a former partner and head of litigation at PwC. They are supported by an advisory committee, including litigation experts and NGOs, on which the OSF has a seat. Aristata estimates that 70% of cases will come from its global network of law firms and barristers, 15% from civil society and 15% from other sources. The fund, which will run for seven years, plans to make between 18 and 22 investments. There will be a three-year deployment period followed by four years in which returns are realised. 

The firm has already made two investments in the areas of low pay and indigenous rights. Information on the cases is available in a data room open to prospective investors. Aristata is evaluating a pipeline of possible future investments. The fund has a guideline minimum ticket size of £1 million but is willing to talk with anyone who is aligned with its aims. 

About 40% to 50% of the cases in its review pipeline are related to climate and the environment, and it is also considering human rights, racial and gender inequality and modern slavery. The initial aim is to litigate across a broad front to launch more specialised litigation funds in the future, Ryan says. “We want to demonstrate the approach is effective.”

He aims to start fundraising for further funds in two or three years. “The deck is stacked in favour of companies with resources,” Ryan says. “We are trying to level the financial playing field.” 

The fund will back cases in stable and predictable legal jurisdictions and expects the average case duration to be three years. “A paper victory is not what we are looking for,” says Ryan, “the assets need to be recoverable”. 

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