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Litigation finance: the new frontier for distressed restructuring in the Middle East

As the financial infrastructure of the Middle East develops, a new force is making its mark on distressed restructuring: litigation finance.

Banks and investors are increasingly using this emerging legal finance tool to optimise asset recovery, offload debt exposure and to fund disputes in the region.

As a result, funders are seizing opportunities in the Middle East. In particular, Burford Capital [NYSE:BUR], a US-headquartered litigation funding firm, recently established its base in Dubai.

“Banks and investors are getting increasingly more comfortable in using legal finance firms to help pursue their claims in situations of financial distress, especially through asset recovery,” said Daniel Hall, managing director at Burford Capital.

As the bankruptcy laws in the United Arab Emirates and Saudi Arabia improve and become more sophisticated, this is helping to increase the adoption of litigation finance in the region, added Hall.

Litigation finance is not necessarily new to the Middle East though.

Omni Bridgeway [ASX:OBL], a global litigation funding firm, opened its Dubai office in 2018, after announcing a partnership with the IFC, a member of the World Bank Group, to establish a USD 100m investment vehicle to help banks solve non-performing loans (NPLs) in the MENA region.

Four years earlier also saw one of the region’s first litigation funding test cases, a lawsuit between the Al Khorafi family and Bank Sarasin, noted Nick Rowles-Davies, CEO of Lexolent, a legal finance firm with operations in the Middle East.

The use of litigation finance is thus not novel. But its increasing adoption in distressed restructurings, and the appetite of these firms to even acquire non-performing loans for themselves, is getting market participants excited.

This foray into the NPL space by litigation funders is being driven by the fact that these firms are sometimes better placed to pursue recoveries than the banks, Marijn Flinterman, senior investment manager at Omni Bridgeway, said.

“Banks throughout the region continue to be confronted with evasive or unwilling debtors defaulting on their loans. This has led to banks having non-performing loans on their balance sheets that are notoriously difficult to solve as the special skills required are often outside of the normal banking tool kit,” Flinterman said.

“In these circumstances, experienced litigation funders are often better equipped to extract value through developing and implementing international recovery strategies,” he added.

There are examples of litigation funders looking to acquire bad debt, such as Burford Capital mulling an acquisition of a portion of Arabtec’s debt on the secondary market last month, as previously reported.

The restructuring of NMC Health has also provided an impetus for litigation funders to get involved in acquiring bad debt, said Dilip Massand, CEO of Phoenix Advisers, an Abu Dhabi-based firm focused on litigation funding and asset recovery.

“Specific situations like NMC made it clear that if one ‘went up the capital stack’ and got a seat at the table as a creditor by buying a portion of the debt at a reasonable price, one would be able to ‘take a few more bites at the apple’ by getting the [right of first refusal] on the ultimate litigation claims that came out of these distressed situations,” Massand added.

During its restructuring, NMC received USD 200m of new secured money, which granted its new creditors a higher claim over its assets.

“And now with new debtor-in-possession (DIP) financing provisions in place – you’d even get a ‘third bite’ at the apple,” Massand continued.

On the restructuring of KBBO Group for example, the company was able to secure some AED 150m (USD 41m) of new DIP financing in January last year from Fidera.

Burford Capital, Omni Bridgeway and Phoenix Advisers are the main litigation firms looking at NPLs, one source familiar with the situation said.

However, outside of the litigation funders, Davidson Kempner Capital Management (DK) and Grant Thornton’s Asset Recovery Fund (ARF) are the two other dominant funds also looking at acquiring NPLs, this source said.

Fidera and SC Lowy are also prominent in the Middle East NPL space, a second source familiar said.

Despite the noise around NPLs, and their exciting potential for the Middle East, the number of transactions taking place is still relatively low, the first source familiar noted.

“There are a lot more people talking about NPLs than actually doing them,” Burford’s Daniel Hall said.

Talk of the evolving NPL scene dominated discussions at this year’s ADGM Financial Restructuring MENA Conference.

Despite the optimism, a panel discussion moderated by Debtwire at the conference cautioned that the actual number of NPL transactions was still relatively low.

A USD 1.1bn NPL portfolio dispatched by Abu Dhabi Commercial Bank to DK was the most prominent and headline-catching transaction, but news since then has dried up, the first source familiar said.

Part of the reason for this comes down to the composition of NPLs that banks are usually looking to sell, which is often at odds with what the large hedge funds and distressed credit funds are looking for, this source added.

Much of what is being offered to the market is uncollateralised loans, which make it difficult for hedge funds to buy and extract value, unless a litigation firm gets involved and provides asset-recovery services, the first source continued.

“When it comes to NPLs, the market still has some way to go. Banks often want to sell uncollateralised loans, whilst traditional distressed credit funds are often looking for high-collateral exposures, where the recovery is through the underlying collateral,” Hall said.

In the case of the famous ADCB NPL portfolio which was sold, there was a suitable level of collateral for traditional hedge funds to get comfortable, the first source familiar said.

Onshore law

Many of the litigation funds interviewed by Debtwire were most interested in pursuing cases that are sufficient in value and that go through common law courts such as ADGM and DIFC.

However, there is still a sizeable opportunity for claims that go through the local courts, and these typically fall below the usual risk appetite of some of the big players, a third source familiar with the situation said.

“Although we do look at larger cases if it makes sense, our sweet spot locally will range in value of between USD 10m-USD 25m. This might typically be below the radar of some of the larger players mentioned,” said Jonathon Davidson, head of Lexolent’s Middle East business.

“Local Civil Court litigation is also becoming more attractive, as opposed to just focusing on common-law courts such as DIFC and ADGM courts. The proceedings tend to be less expensive, there are less adverse cost consequences and local lawyers, like barristers, are accustomed to working on the basis of fixed fees or retainers,” Davidson added.

Local civil court litigations are expected to pick up soon following recent regulatory changes in the Middle East, he continued.

Omni Bridgeway’s Flinterman offered a similar view.

“Governments in the Middle East, led by the Kingdom of Saudi Arabia and by the United Arab Emirates, have been promoting widespread modernisation of their legal and judicial systems. This trend, which shows no signs of slowing down, has certainly had a positive impact on the viability of third-party funding of litigation before the local courts,” he said.

Whether they strike in the DIFC, ADGM or local courts, litigation funders are playing a more prominent role in distressed restructuring in the region. As a result, they are facilitating and engaging in NPL transactions as well as being used more widely by banks and investors to improve recoveries.

As insolvency laws and frameworks continue to develop in the region, the adoption of litigation funders is set to increase further.