FINANCING LITIGATION AND ARBITRATION THROUGH TOKENIZATION: THE UNCERTAIN PRESENT AND A PROMISING FUTURE

The use cases based on blockchain technology is constantly growing. Initially viewed as a trustless and permissionless alternative to traditional fiat currencies, today blockchain applications have spread from decentralized finance to health care, real estate, encrypted communications, and decentralized autonomous organizations, just to name a few.

Meanwhile, third party financing of litigation and arbitration has played an important part in the development of the dispute resolution ecosystem. Is it time for litigation financing and blockchain technology to meet? This note addresses the recent innovation of claims tokenization for purposes of financing civil cases and investment treaty arbitrations.

Financing of civil litigation

The first known case of crypto financing through an Initial Litigation Offering (“ILO”) is Apothio LLC v. Kern County et al. in California (“Apothio case”). [1] In December 2020, Ava Labs, in cooperation with a New-York based law firm, Roche Cyrulnik Freedman LLP (“RCF LLP”), and an investment platform, Republic, announced the launch of the ILO through a public token sale on the Avalanche blockchain. [2]

The ILO aimed to raise funds to finance a civil claim by “tokeniz[ing] an economic right in such claim”. [3] Each token represented a legal claim to a part of the potential financial recovery, converted into a digital asset.

According to Ava Labs, the benefit of the ILO was twofold. First, it would allow claimants with potentially strong cases but no financial means of pursuing them, to find a financing source. Second, the ILO would give access to retail investors by “democratiz[ing] financial products”. [4] For RCF LLP, the ultimate goal of the tokenized offering was to contribute to a “greater access to justice”. [5]

At first glance, the ILO seems to be an innovative project pursuing noble goals. The conditions of the ILO contain a project term, traditional for crypto, that once the sale is closed the tokens will be locked up and will only become transferable after one year. [6] Interestingly, the recovery from the investment is conditional upon (i) Apothio prevailing in court, (ii) money being recovered, and (iii) the contingency fee and reimbursement of the expenses being paid back to RCF LLP. [7] At this juncture, the investment appears to be quite risky as in case of the claim’s failure, the investors receive nothing. Similarly, if only a small amount is recovered, this would cover only RCF LLP’s fees, the investor gets nothing.

In the end, in the Apothio case, out of USD 5 million announced in the agreement to be concluded at the ILO’s closure, only USD 345,888 was collected from 170 investors. [8] As of today, the case is still pending and definitely worth following. [9]

Inspired by this experience, the same partners, Ava Labs, RCF LLP, and Republic decided to launch a litigation financing platform called Ryval. [10] Its website was created in 2020 and according to the latest information, the start-up is expected to be launched in 2022. [11] As of today, the website doesn’t provide much information. It only includes the following announcement: “The stock market of litigation financing. Buy and sell tokens that represent shares in a litigation and access a multi-billion-dollar investment class previously unavailable to the public”. [12] It also promises a very optimistic 50 percent-plus annual return for investors. [13] The description is quite attractive and promising, but only time will tell whether it will be successful.

During the first year, Ryval will prioritise “access to justice and tak[e] on claims that [the founders] believe are good claims”. The platform also expects to attract investors interested in a “pro bono element”. [14] Kyle Roch from RCF LLP emphasized that it will make the US federal court more accessible for claims, especially for ordinary citizens. [15] The platform will be available to all law firms. RCF LLP will not be involved in every case, which avoids potential conflicts of interest.

Seen from afar, there are several advantages to tokenization: disruptive technologies are making the market liquid and transferrable, while at the same time, expanding access to justice and providing transparency of the financing. [16] However, the legal community has met this project with mixed feelings. Suneal Bedi, an assistant professor at the Indiana University Kelley School of Business, appears to agree that the general goal of providing better access to the capital and increasing the transparency of financing litigation is credible. [17] However, at the same time, he points out two important questions. First, whether an ordinary person can assess an ILO through a prism of a good or bad investment. [18] Second, whether a regular person unfamiliar with blockchain technology would understand the playground rules. [19] Another commentator, Lee Drucker, a principal at the litigation finance firm Lake Whillans Capital Partners, emphasizes the importance of providing more background information on the ILO, such as an explanation of how strong the legal claim is and what the applicable laws in this case are; none of this was revealed in the Apothio case. [20]

Kyle Roch however insists that the information provided in the ILO and the Apothio case docket, that included the legal filings of both sides in the litigation [21] is enough for an investor to make an informed decision. He adds that Ryval is nevertheless considering adding more information that would be important for decision making in future ILOs. He also considers that future ILOs will most likely involve experienced litigation funders as lead investors. [22]

Representatives of the arbitration community, Eric Chang (Chang Law) and Sean McCarthy (ArbTech) find this project promising while at the same time criticizing the terms of the funding agreement proposed in the Apothio case. They underline a number of innovative benefits that blockchain technology can bring to litigation finance. [23] Among the main advantages are the following: (i)  tokenization creates conditions for investments fluidity, (ii) the blockchain technology (such as smart contracts) provides efficient tools for a timely and quick payout, (iii) investments in tokens in a variety of cases would permit to diversify an investment portfolio and reduce risks, and (iv) a new level of opportunities to finance the environmental, social, and governance (ESG) related claims would be created to put the pressure on business in the social context. [24]

To finance a dispute through ILOs in a way that is both successful and fair to an investor, three perspectives should be taken into consideration: (i) blockchain technology, (ii) the regulatory framework and (iii) the terms and conditions of an agreement between the platform and the investor. From a blockchain perspective, this project is disruptive with a lot of merits. Regarding the regulatory perspective and given that regulations are constantly evolving, it’s important to make sure that retail investors’ rights are protected, and that they have enough information to make an informed decision. When it comes to the terms and conditions of an agreement between the platform and the investor, the platform’s reputation will be at risk if the terms and conditions are too favorable to the platform at the expense of the investor’s interests.

The question remains whether non-professional investors, with no links to the legal profession, could accurately assess the chances of success of a claim even if they have access to all case materials. Kyle Roch’s idea that professional funders should participate and validate claims to be put on the platform appears to be a plausible answer to address the concerns of non-professional investors.

As for the possibility of token funding of arbitrations, given that commercial arbitration proceedings are confidential, and claimants are not allowed to disclose case details, the approach at this juncture will likely not apply to such arbitrations. However, the concept itself could be very useful in the arbitration context as well.

Tokens to finance an investment case

In March 2022, General European Strategic Investments (“GEST”) announced the launch of “the World’s first Arbitration Membership Token”. [25] The idea is similar to the Apothio case, which is to collect funding through an ILO.

While at first glance this project looks like an inspiring idea, a closer look through the lens of a blockchain investor at its website and its White Paper [26] raises numerous red flags:

(1) Lack of key information on tokenomics. Any person familiar with a blockchain project launch knows that in a public sale, the token price, the total token supply, the token value accrual, and the vesting schedule for private sale are the key elements to be announced to future investors. In the GEST’s project, this information is nowhere to be found. [27]

(2) Discord and Twitter communities are absent. Even if they are not mandatory, Discord and Twitter have become an indispensable part of any reputable blockchain project for communicating with community members. The GEST project website contains a link to an invalid Discord web link and a Twitter page with few followers and no activity.

(3) No information is provided on the estimated duration of the investment arbitration. Neither the White Paper, nor the project’s website mention anything about the length and stages of the investment arbitration proceedings.

(4) Very limited information on the factual background of the claim. GAR reported on this offering and described an investment claim that was previously rejected at the jurisdictional stage. [28] The website does not mention anything about this case, referring only to a US court judgement favourable to the claimant.

(5) The content of the video recorded to promote the project raises suspicions about the project’s seriousness. [29] It does not say anything about the risks and only promises high profits.

(6) Limited information on legal counsel. The White Paper mentions three reputable law firms. It does not provide any information on the distribution of roles among these law firms and whether these firms were previously engaged or not.

(7) Zero tokens have been sold in over two months.

The idea to finance an investment treaty arbitration through an ILO is appealing but its implementation as it stands now appears to be in a nascent stage. One of the main values in the crypto community is trust. From the crypto community’s perspective, this project does not seem trustworthy and its poor realization to date casts a shadow on this promising idea.

The use of ILOs in investment arbitration poses another theoretical risk, namely, that respondent states that are often faced with multimillion or multibillion claims, may acquire the tokens to reduce risks of recovery in case of loss.  Another risk is that a third party could acquire the tokens to put pressure on a state later by using them as a leverage in its favor. To prevent any abuses or potential conflict of interests, (i) the ILOs’ rules should include clear description of cases when physical and legal persons should be prevented from participation, and (ii) the investment agreements should contain a clause or mechanism (KYC or smart contract) obliging an investor to sell/transfer his/her tokens if his/her situation changes and the conflict of interests occurs after the acquisition.

High cost of litigation and arbitration proceedings serves as a disincentive for parties with small claims and/or small budgets. An ILO is a promising innovation that contributes to extending access to justice. As previously mentioned, to make it work in a fair and efficient manner, three aspects should be carefully considered by the ILOs organizers and potential investors: (i) blockchain technology (blockchain protocol), (ii) the regulatory framework and (iii) the terms and conditions of an agreement between the platform and the investor. We are at the dawn of the ILOs and it’s certain that the regulators all over the world will closely monitor these projects to keep up the regulation to protect a “weaker” party and prevent abuses.

 

Anna Guillard Sazhko is an arbitration practitioner based in Paris. She has experience in international arbitrations under the ICSID, UNCITRAL, SCC and ICC Rules with a particular focus on Ukraine and the Eastern Europe. Her experience includes investment treaty and commercial arbitrations counting representation of Ukraine in several investment arbitrations and a Ukrainian State Road Agency in set aside proceedings before the Paris Court of Appeal. Anna is a Board member of the Ukrainian Arbitration Association, Member of the ICC Commission on Arbitration and ADR, co-founder of Nash Arbitrazh and member of the Executive Committee of the Young ISTAC. Anna holds Ukrainian and French law degrees from the National University “Yaroslav the Wise Law Academy of Ukraine”, the University Panthéon-Sorbonne Law School and also completed the Oxford Blockchain Strategy Programme. She is admitted to practice in Ukraine and France and speaks English, French, Russian, Ukrainian and basic Turkish. Anna is featured in Who’s Who Legal’s Arbitration lists 2021 and 2022 as a “Future Leader” and was also named a winner of Lexology’s Client Choice Award 2021 for Arbitration – France. Follow on LinkedIn.

Please note that the opinions and views expressed in or through this article are personal to the author(s). They do not reflect the opinions or views of any law firms, organizations, or other entities with which the author(s) is (are) affiliated.

 

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[1]   Jon Southurst, The ILO: Does someone want to tokenize Kleiman vs Wright lawsuit?. Apothio LLC is a company involved in the cultivation, medical research and commercialization of industrial hemp claimed that its hemp field was illegally destroyed, Business, 16 December 2020.

[2]   Avalanch, Initial Litigation Offerings to Bring $10B Asset Class to Avalanche and Retail Investors for the First Time, Medium.com, 14 December 2020; Jon Southurst, The ILO: Does someone want to tokenize Kleiman vs Wright lawsuit?. Apothio LLC is a company involved in the cultivation, medical research and commercialization of industrial hemp claimed that its hemp field was illegally destroyed, Business, 16 December 2020.

[3]   Avalanch, Initial Litigation Offerings to Bring $10B Asset Class to Avalanche and Retail Investors for the First Time, Medium.com, 14 December 2020

[4]   Avalanch, Initial Litigation Offerings to Bring $10B Asset Class to Avalanche and Retail Investors for the First Time, Medium.com, 14 December 2020

[5]   Avalanch, Initial Litigation Offerings to Bring $10B Asset Class to Avalanche and Retail Investors for the First Time, Medium.com, 14 December 2020; Jamie Redman, Report Highlights Tech Firm Ryval’s Avalanche-Powered Litigation Tokenization Concept,  News.Bitcoin.com, 13 January 2022.

[6]   Republic website, https://republic.com/apothio.

[7]   Republic website, https://republic.com/apothio.

[8]   Republic website, https://republic.com/apothio. Interestingly, the website contains 63 comments from the investors with their names and invested amounts being indicated.

[9]   Case Apothio, LLC v. Kern County (1:20-cv-00522), District Court, E.D. California, Court Listener.

[10]   Lyle Maron, A litigation finance stock market? This law firm plans to launch one, ABA Journal, 14 January 2022.

[11]   Twitter’s account of Ryval, https://twitter.com/ryvalmarket.

[12]   Website of Ryval, https://ryval.market/.

[13]   Website of Ryval, https://ryval.market/.

[14]   Maxwell Strachan, Tech Startup Wants To Gamify Suing People Using Crypto Tokens, Vice.com, 7 January 2022. “But at the end of the day, I don't think anybody should be the gatekeeper to who has access to the courts. I think access to the court system, access to the legal justice system should be something that is given to as many people as the justice system can handle”.

[15]   Maxwell Strachan, Tech Startup Wants To Gamify Suing People Using Crypto Tokens, Vice.com, 7 January 2022.

[16]   Ryan Weeks, A litigation financing investment token has launched on Avalanche's blockchain, The Block, 14 December 2020.

[17]   Lyle Maron, A litigation finance stock market? This law firm plans to launch one, ABA Journal, 14 January 2022.

[18]   Lyle Maron, A litigation finance stock market? This law firm plans to launch one, ABA Journal, 14 January 2022.

[19]   Lyle Maron, A litigation finance stock market? This law firm plans to launch one, ABA Journal, 14 January 2022.

[20]   Lyle Maron, A litigation finance stock market? This law firm plans to launch one, ABA Journal, 14 January 2022.

[21]   Case Apothio, LLC v. Kern County (1:20-cv-00522), District Court, E.D. California, Court Listener.

[22]   Case Apothio, LLC v. Kern County (1:20-cv-00522), District Court, E.D. California, Court Listener.

[23]   Eric Chang and Sean McCarthy, Litigation Finance and Crypto Tokens: How a Blockchain Startup Seeks to Create Financing Marketplaces for Disputes, Kluwer Arbitration Blog, 16 March 2022.

[24]   Eric Chang and Sean McCarthy, Litigation Finance and Crypto Tokens: How a Blockchain Startup Seeks to Create Financing Marketplaces for Disputes, Kluwer Arbitration Blog, 16 March 2022.

[25]   Wolfgang Rauball, General European Strategic Investments Launches the World's First Arbitration Membership Token Providing Support to Arbitration Proceedings to Be Filed Imminently with the World Bank's ICSID in Washington D.C., Newsfilescorp, 22 March 2022.

[26]   Gesi Token, White Paper, 29 July 2021.

[27]   Gesi token website, https://gesifoundation.com/#about.

[28]   Sebastian Perry, Mining company markets crypto tokens to fund ICSID claim, GAR, 22 March 2022.

[29]   Gesi Token Website, https://www.gesitoken.io/.