Funding litigation with crypto: look before you leap – Kate Gee and Alasdair Marshall

By Kate Gee & Alasdair Marshall

Counsel Kate Gee and Associate Alasdair Marshall discuss funding litigation with crypto, as blockchain technology is being used to crowdfund a lawsuit in the US through an ‘Initial Litigation Offering’.

In a first-of-its-kind innovation, blockchain technology is being used to crowdfund a lawsuit in the United States through an ‘Initial Litigation Offering’ (“ILO“) – raising c. $350,000.  The ILO represents a new, real-world application for crypto technology: it introduces new fundraising opportunities for claimants to bring otherwise prohibitively expensive legal proceedings, and opens the lucrative litigation funding market to retail investors.  However, for those retail investors, an investment in an ILO could be too good to be true.

The Claim

The claim concerns one of the largest alleged crop destructions by a state official in the history of the US.  Apothio LLC, a California-based hemp producer, is seeking compensation from Kern County Sheriff’s Office for the alleged bulldozing of 450 acres of crops worth up to $1 billion.

Funding the Litigation on the Blockchain

On 26 October 2021, the ILO was launched: investors purchased ‘tokens’ which represented a stake in the claim.  In turn, each token purchase (i.e. each investor’s stake) was recorded on the Avalanche (AVAX) blockchain.  In the event the lawsuit is successful, investors’ tokens will be multiplied in value relative to the amount of damages recovered. If no damages are recovered, the tokens will be worthless.

At the time of writing, the ILO has raised c. $350,000 (updated figures can be found here).  This is $100,000 more than the minimum fundraising required by Apothio to bring its claim.

Are ILOs a market disruptor for litigation funding?

Litigation funding is where third-party investors provide funds to a litigant and earn a return on their investment that is linked to the outcome of the case.  Whilst lucrative (the global market is valued at c. $10 billion and growing), litigation funding is mainly reserved for private institutions who target institutional investors with minimum investments of $1 million or more.  The Apothio ILO, however, is open to the public/retail investors – and requires a minimum investment of only $100.

As the Apothio claim shows, ILOs can be an effective and innovative fundraising tool.  They have the potential to overcome significant barriers faced by potential claimants to bringing good, arguable claims – especially in proceedings against large corporations which might ‘smother’ small claimants with the costs of pursuing a claim to its conclusion.

However, potential limitations may hinder the widespread adoption of ILOs in their current form:

  1. Is the pool of retail investors who are: (i) familiar with cryptocurrencies; and (ii) willing to invest in litigation via blockchain technology sufficiently wide to sustain a market of ILOs?
  2. The crypto-community is famously anti-establishmentarian, perhaps reflected in the strong support for a hemp grower against a government body. Would the same support be shown towards more purely commercial, and less politically charged, claims?
  3. A claimant may have concerns about future funding. Even if enough money is raised to get the claim off the ground, litigation and its associated costs are unpredictable – there is no guarantee the public will fund future, unforeseen costs.

A risky investment on unfavourable terms

More serious, however, is the question of whether the litigation funding investment market should be opened to the general public through ILOs in their current, unregulated state.

Litigation is often unpredictable and risky.  Private litigation funders will only fund a case that has prospects of success of 60% or higher – usually based on a QC’s opinion.  However, the average layperson is ill-equipped to assess the prospects of a claim that is yet to begin.

This problem is exacerbated by the lack of regulatory protection for investors in an ILO.  For example, the only official document regarding the Apothio ILO is the Pitch prepared by Apothio’s lawyers.  There are no rules about what information must be included, and there is an inevitable conflict of interest between: (i) potential investors, who want an independent assessment of the claim (warts and all); and (ii) the intended claimant, who wants to obtain funding and commence proceedings.  It is therefore unsurprising (although alarming) that the Pitch omits certain information that investors might be interested (and ought to be entitled) to know – for example, that a criminal charge has been brought against one of Apothio’s founders on the basis that the destroyed crop, which forms the subject of the civil claim, was illegal marijuana rather than hemp.  There is a real risk that investors will not be provided with sufficient information (including for reasons of legal privilege) to make an informed decision about whether or not to invest in the ILO.

Further, private litigation funders participate in a competitive market, but because the ILO is made to the public at large, the investment is on the intended claimant’s own terms, which are onerous for investors.  For example, if the claim is summarily dismissed, investors will only receive 80% of their funds back – even if the withheld 20% has not been used.

Tread with caution – for now

ILOs may still prove to be a valuable tool for potential claimants and a worthwhile investment for the public.  However, until regulation is introduced ensuring: (i) thorough, independent and publicly available due diligence is conducted on any claim; and (ii) appropriate investment terms are offered, potential investors should tread with caution.  Although headlines of possible 3.5x returns on a $1 billion dollar claim may seem appealing, a contribution to an ILO may be better considered a ‘donation’ akin to crowdfunding, rather than an investment on which one would expect returns.

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