Leveraging Litigation: How Shareholders Can Use Litigation Leverage to Double-Down on Their Investment in High-Stakes Securities Litigation
Gojkovich, Lauren Deysher, Stanford Journal of Law, Business & Finance
Your client is an activist shareholder who wants to hold the board of directors accountable for actions that pose a likely breach of fiduciary duty. Faced with the prospect of months, if not years, of litigation, your client is hesitant to assume the massive legal costs of a lawsuit with an uncertain outcome. If only it were possible to shift your client's cost-benefit analysis so that even given the uncertainty of litigation, the potential benefit is so great it is still a wise decision to litigate the claim. Well, today it is possible to increase the risk-adjusted rate of return on securities litigation by engaging in what this author terms "litigation leverage."
In the context of securities litigation, a litigant's return on their investment in a lawsuit has historically been subject to an unavoidable fixed cost - namely, the market price of the securities on which their claim is based. However, following the groundbreaking decision of the Delaware Court of Chancery in Emerging Communications,'1 it is now possible to move this cost floor below the market price of the physical shares by purchasing only one stick in the bundle of rights associated with stock - the litigation rights.
The purchase of litigation rights is in effect similar to the purchase of a call option: the investor takes a position based on a positive view of the target, expending fewer resources to achieve the same exposure as if they owned the physical shares, while limiting their downside to the purchase price of the option. In the case of a litigation rights purchase, a litigant with a bullish view of litigation can pay original claim holders a fraction of the market price of the physical shares to purchase the litigation rights, thus achieving the same exposure to an eventual award as if they owned the shares outright. This transaction is further like the purchase of an option in that risk is limited to the purchase price of the litigation rights. The similarities between the purchase of a call option and a litigation rights purchase have led this author to term the purchase of litigation rights the use of litigation leverage.
This Article will present a roadmap for those investors who seek to minimize their risk and maximize their return when using litigation leverage. Part I of this Article will describe the successful use of purchasing litigation rights as seen in Emerging Communications. For those investors who remain wary of such a strategy, this Article will explain why engaging in litigation leverage is something that should be considered by all sophisticated shareholders seeking to maximize their return on investment in litigation. Part II of this Article will discuss the strategic ways those using litigation leverage can avoid one of the major legal obstacles that is present in the context of litigation rights purchases - the defense of champerty. Part III will discuss how the standing requirements for derivative suits will present unique obstacles that may limit the successful use of litigation leverage. Finally, Part IV of this Article will present other hazards inherent in the use of litigation leverage and offer strategies for avoiding these risks. Those who appreciate the potential for great upside presented by the use of litigation leverage should feel confident that if they follow the advice of Parts H-IV, they will succeed in minimizing many of the risks of this transaction.
I. The Benefits of Litigation Leverage
Today, the benefits of using litigation leverage seem clear to those who study its use; however, the success of such a strategy was not assured when Greenlight Capital, L. P. ("Greenlight") brought a fiduciary duty action in the Delaware Court of Chancery in part on behalf of its purchase of other claim holders' litigation rights.2 For the first time in the court's history, the Delaware Court of Chancery in Emerging Communications had to consider the standing of a plaintiff who had engaged in litigation leverage. …