If someone knocks on a whistleblower’s door offering money to “invest” in a case, one of the first questions to ask is whether that individual is a “venture capitalist” or a “vulture capitalist”?
What’s the difference?
Both venture capitalists and vulture capitalists are investors that charge extraordinarily high interest rates to cover the cost of potential failure.
The difference is that a venture capitalist is putting up money to grow something that is likely to expand. An example might be providing the "seed money" for the first 50 acres of corn to be grown, with the expectation that 5,000 more acres might be put under production in a few years’ time.
Vulture capitalists, however, are looking to buy a distressed asset from a distressed person for a song, and to carve it up for a big profit at the end.
The vulture capitalist is not expanding a business – he is looking to break it up, or to drain cash from it at usury rates of interest.
Vulture capitalists are attracted to a whistleblower's door by the distress that accompanies the government declining to join a case.
Because False Claims Act cases must first be filed under seal, simply disclosing to a potential investor, or anyone else, that a case has been filed against a company is a violation of the seal until the court has lifted the seal.
What about cases that come out from under seal because the government has joined the case or declined it?
If the government has joined a case, a whistleblower should probably not be looking to financiers at all.
When the U.S. Department of Justice joins a case, there is a better than 95% chance that the case will resolve with a favorable settlement or judgement. Instead of talking to litigation vultures who will "buy" a portion of the case at what is likely to be usury rates of interest, whistleblowers should cut back on expenses, get a job, and borrow from family, friends, a retirement account, or a bank.
If the government has declined a case, the probability of success drops significantly, and so too does the likelihood that the case will be resolved for a very large sum of money. What that means is that the risk-to-reward ratio for lending or borrowing on such a case shifts dramatically for whistleblower and lender alike.
Let’s walk through the numbers to understand the math.
If an investor makes a series of $2 million “non-recourse” loans on False Claims Act cases, and these cases collapse just 25% of the time (an extraordinary level of success), the interest rate that has to be charged on the successful cases, in order for the lender to make any profit at all, has to be astonishingly high.
Even when a loan is “small” and a case is “big,” the math can go south very fast.
Suppose a whistleblower has a case they believe is worth $75 million in single damages. This would be a phenomenally large FCA case – potentially a top-ten case in any given year. The inexperienced optimist will assume the case will be settled for treble damages, and that a $225 million recovery will eventually be in the offering. If a whistleblower borrows just $1 million dollars with that idea in mind, and gives up $3 million in future compensation in exchange, misery may follow.
Why is that?
Simple: when the government finally settles the case, it may not be for $75 million in single damages, but for $50 million. Instead of settling the case for treble damages, the government may settle the case for double damages. And what if there is more than one whistleblower, as is quite common in large cases? There may very well be three other whistleblowers that neither your lender, nor your lawyer, will know about when "the deal" is inked.
Assuming a 17% relator share, the total whistleblower award in the case, described above, may total $17 million, a sum that will be divided by four, resulting in just $4.25 million per whistleblower.
After the lawyers take their contingency fee (assume 40%), and the state and federal governments take out taxes (assume 40%), the whistleblower will be lucky to walk away with $1.5 million – and that’s before the “investor” is paid a dime.
The bottom line: after as much as a decade of litigation, the whistleblower may walk away with nothing, which is a very bad story, not only for the whistleblower, but for the False Claims Act itself.
Obviously, the numbers offered here can be quibbled with, but the main thrust of this post cannot: “Vulture” lenders are NOT there to help whistleblowers find justice, but to make a very large profit off of their immediate financial distress.
Caveat emptor – buyer beware.