It is not clear why the legal battle between Nkosana Makate, the man who claims he invented the “Please call me” service, and telecoms giant Vodacom has so captured the imagination of the South African public.
Perhaps it is because of the classic David and Goliath proportions of the saga, or perhaps it is a celebration of ingenuity in the new South Africa.
But perhaps it is because everyone is baffled by how an “average Joe” has managed to sustain a legal wrangle with a massive corporation for the past decade without running out of money.
Makate, a former accounting intern at Vodacom who is suing the company for allegedly reneging on a revenue-sharing deal in return for his submission of the “Please call me” idea, initiated the legal battle in 2000. As the public awaits the closing arguments, due in September or October (13 years later), the inevitable question is: who is financing this?
It turns out Makate will be sharing 50% of the R700m he hopes to win with Sterling Rand, one of the few private entities in South Africa built on investing in legal disputes.
The litigation financing firm was founded by businessman Errol Elsdon, whose partners are finance specialist Tracey Roscher and attorney Chris Schoeman.
Its business model entails purchasing claims or judgments, “co-investing” with the creditor or claimant or, as in the Makate case, funding the litigation, negotiation and settlement of a claim. The company’s undertakings are bankrolled by a “private equity-style” fund that is financed by institutional investors and high net-worth individuals.
Sterling Rand — which has financed cases against the Democratic Republic of Congo, MTN and Standard Bank, Fifa and Momentum Life — approaches legal claims in the same way an analyst would scrutinise a potential investment.
“We do an in-house due diligence ourselves, the same way a financial due diligence would be carried out,” Roscher told the Mail & Guardian. After examining the arguments and evidence, the partners will only take the case if they are satisfied that there is at least a 70% chance of winning.
“Then we decide on which attorneys and advocates would be most appropriate for the case — we have a good network of people,” said Roscher. “They then do their own due diligence and decide whether to take on the case.”
In the light of recent media attention, Roscher said the company has been flooded with would-be litigants seeking funding. But “we are very cautious”, she said. Sterling Rand turns down between 60% and 70% of the cases it receives.
Funders will wait for up to three years before seeing a return on investment. Although the average private equity deal may have a shorter turnaround time, the potential returns offered in this scenario are highly worthwhile, said Roscher.
“The returns can be so high that it almost appears to be a Ponzi scheme,” she said. “It’s certainly not, of course.”
The company focuses on high-return cases because the time taken for large cases to move through the legal system is much the same as smaller ones. “So we look at the cases with bigger returns,” said Roscher.
“At the end of the day, obviously it’s important to make money for our investors. We want to attract funding going forward.”
Risky investment?
Warren Dick, an analyst for Trillian Asset Management, said the practice of litigation financing was reminiscent of the trend of “vulture investing” in the US.
“There are quite a few funds that focus on this. Firms try and pick up the debt of companies that are about to go under or are getting sued; or they use litigation to try and derive some form of massive settlements.
“It’s a different way of generating returns — one that I would certainly be interested in,” he said. However, if investors were required to put all their money into one case rather than into a range of cases it would become “a bit risky”, he said.
On the other hand, if the company acted as a legal “fund manager” and spread the investment over several legal cases, it would mitigate the risk. “If you have a fund that’s investing in 10 or 20 cases like this, it would be interesting to see the kind of returns they would get,” he said.
Nic Norman-Smith, chief investment officer at Lentus Asset Management, said the risk would be too speculative for his company to consider investing in such a venture. “There is significant uncertainty with an investment in something like that,” he said.
“I think you are backing the lawyers to quite a large extent. It’s all very well that they say they have done due diligence, but if it’s such a sure thing, then are they backing the case themselves? You need to ask: Where does the risk lie?”
But in determining the answer to that question, the commercial and ethical interests of litigation financing could be at variance with one another.
According to Jan van Rensburg, a councillor of the Law Society of the Northern Provinces, the firm financing the litigation should not also be the attorney of record. The situation could create a conflict of interests, he told Business Day.
It could be in the attorney’s interest to settle a case where there was little chance of winning, whereas an early settlement may not be to the greatest advantage of the plaintiff.
But according to financial analysts, some sort of vested interest by the lawyers is necessary to moderate the risk of the investment. “You want them to have their skin in the game,” said Dick.
While there is “no problem” with fund managers delegating lawyers to handle the case, it would be necessary to understand the relationships between all involved parties, he said. “You’d want to know who are the lawyers being appointed; why are they being appointed; how are they getting paid?” said Dick. “What’s the incentive to avoid losing their and our money?”
From this perspective, Norman-Smith believed the interests of the fund managers and the investors are aligned. “These guys clearly aren’t going to take a case on if they are going to lose it,” he said. “Broadly speaking, the concept is quite good.”
History of litigation financing
Until 2004, the funding of litigation in South Africa was illegal. In a landmark case that year, the supreme court of appeal allowed for external funding in a legal battle between finance company PwC and others, and the National Potato Co-operative.
In that case, champerty (the term that recognised litigation funding as illegal) was done away with, Errol Elsdon, founder of Sterling Rand, told the Mail & Guardian.
While lawyers are not allowed to take more than 25% of the total settlement, there is no law in South Africa that stipulates how the money awarded from a legal case should be split between the financial backer and the plaintiff.
In Nkosana Makate’s case, the total amount will be split 50-50 between himself and Sterling Rand. Makate will not be required to pay any legal fees at any point, nor will they be deducted from his portion of the final settlement fee.
“He is absolved from any further costs,” said Elsdon.
However, other cases may be structured differently, with a 60-40 split between the company and the plaintiff respectively, or an agreement that legal fees be deducted from the plaintiff’s portion of the settlement.
Tracey Roscher, a partner at Sterling Rand, said the breakdown was fair. “We carry the risk of financing the entire case.” — (c) 2013 Mail & Guardian
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