A growing market niche where investors profit from others’ legal troubles is getting a boost from Covid.

Distressed-investing funds and litigation-finance boutiques are likely to be spoiled for choice after a landmark U.K. court ruling last month rejected pleas from insurers looking to dodge pandemic payouts. They’re looking to finance or buy denied Covid-19 insurance claims for policyholders without the means or stomach for taking their insurers to court.

“This is going to be huge,” said Steve Cooklin, chief executive officer of London-based litigation funder Manolete Partners Plc, whose biggest shareholder is veteran distressed investor Jon Moulton. “It’s hard to say at this stage how big exactly this issue is, but it’s probably going to be in the hundreds of millions of pounds.”

Insurers have warned that Covid-19 coverage claims could top as much as $100 billion –- potentially the industry’s largest loss in history. Business-interruption coverage, which protects against losses when companies have to shut for a period of time, has been one of the most costly and contentious policy lines in the pandemic. U.K. virus-related claims, including on business-interruption policies, could exceed $2 billion.

The New York company, which filed for bankruptcy, claims it’s owed more than $175 million from business interruption policies and says proceeds from selling the claim will help repay creditors after it closes for good.

For investors in a zero-yield world of spiraling stock prices, the insurance payout battles present opportunities that can pay off regardless of how debt and equity markets perform — they’re “uncorrelated,” in the jargon of the trade.

Assets held by litigation funders in the U.K. hit a record high of 1.9 billion pounds ($2.6 billion) last year, an analysis by law firm Reynolds Porter Chamberlain LLP shows. It’s a market that has lured hedge funds including D.E. Shaw & Co., Fortress Investment Group and Elliott Management Corp.

“Sustained tailwinds” are in store for litigation funders, according to Bloomberg Intelligence analyst Tamlin Bason. “The uncorrelated, counter-cyclical nature of those returns could make litigation finance an attractive hedge during periods of market volatility.”

The focus is likely to be the U.K. While many U.S. judges have found policies don’t cover Covid-19 losses, Britain’s main financial regulator challenged insurers, with the outcome hailed as a resounding victory for consumers. The ruling means firms such as Hiscox Ltd. and RSA Insurance Group Plc, which initially rebuffed Covid-19 claims, now must honor them.

That may translate into plump payouts for investors picking through arcane policy wording. Policies written by insurers vary in their language, with only a handful clearly saying whether they would or would not cover firms in the event of a pandemic.

“There is quite a variety of different approaches to this that insurers have taken and some of them are going to be happy and some are going to be miserable,” Andrew Lundberg, a managing director at Burford Capital Ltd., the biggest litigation funder, said in an interview.

Retail Crisis

New York-based Cherokee Acquisition is in talks with a number of U.K.-based retailers over purchasing their claims on behalf of investors, having looked at similar transactions in the U.S. For many of Britain’s retailers, the shuttering of main street was the final nail in the coffin. Arcadia Group, the retail empire founded by billionaire Philip Green, collapsed into insolvency late last year.

The Supreme Court ruling “will result in more sale interest from larger claimants whose calculation of damages is being disputed by the insurers, rather than smaller claimants whose claim amounts have already been reconciled,” said Bradley Max, a director at Cherokee. “It’s an opportunity for a seller to get the bird in the hand.”

A trade can work like this: First, a company that had business-interruption coverage is rebuffed by its insurer, which argues the policy excludes coverage of pandemics or doesn’t cover the type of damages sought. A judge often must parse the policy, and that can take years and hundreds of thousands of dollars — if not millions — in legal fees.

Making a pitch to save policyholders time and money, litigation funders offer to immediately buy the Covid-19 claim at a discount, sometimes for less than a third of the total value. The funds make money by taking the dispute to court, betting the ultimate payout will dwarf the purchase price.

The practice is routine in U.S. bankruptcy cases, said Chuck Tatelbaum, a Florida-based bankruptcy lawyer who represents big-name clients, such as Toyota Motor Corp., in Chapter 11 cases. “It’s very much like commodities trading,” he says.

A real-world example involves bankrupt U.S. department-store operator Century 21’s decision to sell its rejected business-interruption claim for $59 million in December, according to court documents. The Gindi family, which owns the retailer, bought back the right to the $150 million policy, betting it will pay off in the long run.

So far, insurers are faring well in the U.S. courts, where judges have backed coverage rejections at a rate four times higher than the claims are being allowed, according to an analysis by a University of Pennsylvania researcher.

The key to making this new form of litigation arbitrage pay is a cold-eyed policy assessment by seasoned insurance lawyers to find language backing up coverage demands, said Stuart Grant, head of Bench Walk Advisors, a litigation funder with offices in New York and London.

“These are challenging investments,” said Grant. “Since this is bespoke financing, you have to tread carefully.”

–With assistance from Irene García Pérez.

Top Photo: Pedestrians walk past shuttered shops along a near-deserted street in the City of London in January 2021. Photographer: Tolga AKmen/AFP/Getty Images