Why Has Private Equity Litigation Been Historically Uncommon?
Current trends in private equity point to an increase in private equity litigation in 2020. Historically, while disputes existed, litigation was infrequent for at least two reasons. First, General Partners (GPs) and Limited Partners (LPs) rely on their reputation in the industry to raise funds and commit capital respectively. Therefore, it has typically benefitted both GPs and LPs to resolve conflicts privately. And second, LPs, who often lack surplus resources, must cover their own legal expenses. Enter litigation funding, where investors raise funds to cover litigation expenses in exchange for a share of any recovery.
The Recent Increase in Litigation Frequency
Litigation funding has evolved from its class action roots to more creative and extensive uses, including private equity litigation. Indeed, litigation funding has grown exponentially in the past decade. Most private equity (PE) experts point to this as a main factor in the likelihood of increased litigation in the PE arena in 2020 and beyond. In short, litigation funding is providing LPs with an additional source of capital to pursue claims. Moreover, although the current market is benefitting the industry, in the event of an economic downturn where investors start losing money, even LPs reluctant to litigate have a fiduciary duty to make claims against a GP where it is warranted.
Another factor pointing to a likely uptick in private equity litigation is the increased interest and involvement of regulators in the private equity industry. PE analysts identify conflicts of interest and valuations as areas that were traditionally addressed privately between the GPs and LPs. However, they are garnering more attention from regulators as private equity firms grow and diversify. This also adds a level of complexity in the management of funds and of the private equity firm itself. This increased complexity creates more chances for mistakes and additional tensions between GPs and LPs, which ultimately results in increased litigation. These factors, among others, suggest an increase in private equity litigation for the upcoming year.