(Reuters) – An agricultural research and commercial hemp operation called Apothio LLC is officially the first plaintiff to attempt to fund a civil case by asking individual investors to buy crypto tokens in a crowdfunded “initial litigation offering.”
That’s not any kind of official terminology, but it is the catchphrase you’ll find at the crowdfunding site Republic, which launched Apothio’s $5 million public offering on Tuesday. Apothio is hoping investors want a piece of its lawsuit accusing California officials of improperly destroying its $1 billion hemp crop in 2019.
The ILO tag was devised by Apothio’s lawyers at Roche Freedman, who worked with Republic and the blockchain platform developer Ava Labs to structure and implement the offering after first announcing the concept last December.
The offering breaks new ground in several ways. It’s the first time that small investors can put up as little as $100 to acquire a stake in the outcome of civil litigation. (Individual investments are capped at $500,000.) The funder LexShares similarly allows individuals to invest in litigation finance deals, but those investors must meet the U.S. Securities and Exchange Commission’s accreditation criteria.
The Apothio offering, by contrast, is not limited to accredited investors because, in a milestone for litigation finance, the offering was registered under the SEC’s Regulation CF, which allows companies to raise as much as $5 million through crowdfunding without the formal rigamarole of a traditional securities offering.
The Apothio offering also appears to be the first time that litigation funding has been “tokenized” through a blockchain. Apothio’s litigation investors will be issued Avalanche ILO tokens. If the company ends up winning the case and receiving a payout, investors will be paid their share via their Avalanche tokens.
As of Wednesday afternoon, a day after the offering went live, 85 investors had agreed to put $156,500 into Apothio’s case. That’s more than 60% of the minimum target of $250,000 that Apothio set in its SEC registration of the offering.
“I have never done this before and am interested how this all works,” one investor said in a comment posted at Republic. “Sounds like it could be a fun ride.”
Apothio lawyer Kyle Roche of Roche Freedman said in an email statement that the new crowd-sourced litigation finance model will allow more plaintiffs to tap pools of capital.
“The rise of litigation funding in the United States has provided individuals and smaller organizations access to the resources necessary to assert their legal rights against well-funded entities,” Roche’s statement said. “The advent of the ILO has the potential to provide even greater access to justice.”
For an unbiased assessment of the crowdfunded litigation finance model, I reached out to Charles Agee, the CEO of litigation finance advisory firm Westfleet Advisors. Agee has a more holistic view of the commercial litigation finance industry than anyone else I know. He told me he’s generally in favor of innovation that democratizes and expands the market for litigation funding and is intrigued by Apothio’s concept.
But he also said he has two big concerns about the offering.
Agee’s first fear is that small investors don’t have enough litigation savvy and inside information to make informed investment decisions. In big commercial litigation finance deals, Agee said, funders often have access to non-public information that helps them decide if the case is a good bet. In Apothio’s offering, Republic is providing links to public filings from its case in federal court in Fresno, California, but no insider take on litigation risk.
Agee said he’s also worried that crowdfunding may open the door to dubious suits. (He was speaking generally, not voicing a view of Apothio’s case.) Commercial litigation funders, Agee said, are effective gatekeepers precisely because they make sophisticated evaluations of litigation risk. After all, when commercial funders back a case, they usually put up a lot of money – an average $4.5 million for single-case deals, according to Westfleet’s analysis of 2020 transactions. Individual investors who are chipping in as little as $100 may not be as risk averse, Agee said.
The Apothio deal does protect investors from the imminent risk that the case will be dismissed. Apothio sued Kern County, the Kern County sheriff’s office and the California Department of Fish and Wildlife after government officials ordered its 500-acre hemp harvest to be bulldozed in October 2019. The company, which conducts research on hemp and has research and internship agreements with two local community colleges, contends that the crop was legally grown and illegally destroyed. It is asserting violations of its rights under the U.S. and California constitutions.
Both Kern County and the state have moved to dismiss Apothio’s case, arguing, in broad terms, that Apothio was growing an illegal marijuana crop for commercial distribution. (Hemp and marijuana are variations of the same cannabis species, cultivated to contain different levels of the psychoactive chemical THC.) Marijuana, the defendants argued, remains an illegal controlled substance under federal law and is only allowed to be grown for recreational use under state law. Apothio’s crop, they said, was contraband that does not give rise to property or constitutional claims.
The underlying law and facts, including the nature of Apothio’s relationships with the community colleges and interpretations of the federal law exempting hemp from the Controlled Substances Act, are complex, and U.S. Magistrate Judge Jennifer Thurston seems to be in no hurry to rule on the defendants’ dismissal motions. They’ve been fully briefed since the summer of 2020 but the next hearing in the case isn’t scheduled to take place until next January.
If the case is dismissed, Apothio investors will lose only 20% of their investment, under Apothio’s investment contract. Until Thurston issues a decision on the defendants’ motions to dismiss, Roche Freedman will hold 80% of investors’ funds in an escrow account. If Apothio loses, the law firm will return investors’ money. If Apothio loses at a later stage, investors are out of luck.
The Apothio experiment may turn out to be short-lived. But even if so, I don’t think this will be the last use of the crowdfunding model in litigation finance.
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