Third-Party Litigation Financing: Bane or Boon?

Corporate legal departments could soon see an increase in costly court battles due to growth in third-party litigation financing companies that are willing to fund plaintiffs' cases in hopes of taking a piece of the settlement or verdict.

But third-party financing isn't all bad for companies. “It could be very useful for in-house counsel, since it could help companies move some litigation off their balance sheet to free up capital,” says Maya Steinitz, an associate professor at the University of Iowa College of Law.

While litigation financing with roots in Australia and Britain in the 1990s isn't a new concept, only in the last five years has the practice emerged in the United States. Since then, a number of firms have begun offering third-party litigation financing, including two of the largest firms, Burford Group and Juridica Capital.

Third-party litigation financing works like this: Investors agree to pay the legal expenses of a plaintiff's lawsuit in exchange for a share of the potential judgment, settlement, or jury verdict. In the event that the funded party loses the case, the investors eat a portion or all of the costs, including attorney fees, court fees, and expert-witness fees.

Steinitz says that litigation financing is a practice that is “growing rapidly” in both the number and types of lawsuits that investors are willing to back. Additionally, she adds, “new firms are popping up all the time.” Parabellum Capital, a spinoff of Credit Suisse's finance group, just opened its doors last month.

“There is no question that the timing is right for this industry,” says Ken Doroshow, managing director at Burford.  The $300 million fund, now has offices in New York, Washington D.C., and San Diego and is increasingly funding cases in the United States, with over $200 million in 35 cases over the past two years.

“People are starting to realize that a litigation claim is a corporate asset just like any other corporate asset capable of being monetized and financed. Traditionally, that wasn't the case,” says Doroshow. He adds that the cases Burford takes on “run the gamut” of commercial business disputes, including breach of contract, fraud, trade secret theft, antitrust, and more.

Companies seek financing for other reasons, as well, he says. One of those reasons is to get a better handle on expensive hourly fees. In that regard, “companies have the benefit of a contingency fee arrangement, while still being able to maintain their relationship with their law firm,” says Doroshow.

The Downside of Funding

While several firms on the market provide financing to both plaintiffs and defendants, financing on the plaintiffs' side still is the larger market, “so many companies are right to feel that they often are the targets,” says Steinitz.

Critics of litigation financing say the practice is fraught with compliance and ethical concerns. Most outspoken about the issue has been the U.S Chamber of Commerce.

“This encourages the filing of frivolous claims. It invites testing questionable claims in court. It provides an incentive to prolong cases, and it raises serious ethical questions.”

—Thomas Donohue,

President & CEO,

U.S. Chamber of Commerce

In fact, as part of his annual “State of American Business” address on Jan. 12, Thomas Donohue, president and CEO of the business advocacy group, said one of its goals is to stop the “alarming rise of third-party litigation financing.”

“This encourages the filing of frivolous claims. It invites testing questionable claims in court. It provides an incentive to prolong cases, and it raises serious ethical questions,” said Donohue. “In our business, we hear dumb ideas every day of the week, but this one takes the cake.”

A paper released last October by the U.S. Chamber's Institute of Legal Reform, titled “Selling Lawsuits, Buying Trouble,” argues that third-party funding should be banned in the United States. The paper did not address business-against-business litigation directly, but many of the same concerns apply, says Page Faulk, vice president of policy and research for the Institute for Legal Reform. “We just think it shouldn't be allowed at all,” she says.

“Who is the duty to when you have a third-party investor in the case?” asks Faulk. She adds that any time an investor's return is tied to the plaintiff's recovery, the practice should be banned. Faulk says she is concerned that the aim of settling cases fairly is poisoned by the existence of third-party financing that has different goals than the two parties directly involved in the case.

“These arrangements are usually shrouded in secrecy with non-disclosure agreements,” often leaving corporate defendants in the dark about any financial pressures to resolve the case quickly, says Faulk.

THIRD-PARTY FUNDING ISSUES

The excerpt below from the U.S. Chamber of Commerce report examines “The Problems Inherent in Third-Party Litigation Financing.”

Proponents of third-party litigation financing argue that the practice promotes access to justice. But this focus on access to justice ignores an obvious point—third-party litigation funding increases a plaintiff's access to the courts, not to justice. This is an important distinction because increasing plaintiff access to the courts also increases the likelihood that any potential defendant will be hauled into court on a meritless claim. Although the popular vision of U.S. litigation among proponents of third-party financing is of David-like plaintiffs pitted against Goliath-like defendants, this vision is not true to reality. In truth, potential defendants come in all guises: motorists, professional-services providers, small-business owners, and corporate stockholders. Practices like third-party funding increase the overall litigation volume, including the number of non-meritorious cases filed, and thus effectively reduce (not increase) the level of justice in the litigation system.

As discussed below, third-party funding is particularly troubling in the area of aggregate litigation. Class and mass actions in the United States are inherently more vulnerable to litigation abuse than other types of litigation procedures because they permit aggregation of the claims of many litigants in a single proceeding. As a result, a defendant in aggregate litigation frequently faces exposure exponentially greater than what it would face in a proceeding with just one individual plaintiff. Such large exposure often can compel defendants to settle aggregate lawsuits rather than seek adjudication on the merits, regardless of the validity of the claims at issue. Moreover, aggregate litigation already poses the risk of being driven by profit-seeking attorneys rather than legitimately injured and interested plaintiffs—a problem exacerbated by third-party funding. For these reasons, third-party litigation funding, which permits plaintiffs and their attorneys to offload risk and thus encourages them to test non-meritorious claims, would be particularly damaging to the orderly administration of justice in the aggregate-litigation context.

The dangers and perverse incentives presented by third-party funding are on full display in the Australian civil litigation regime. There, with High Court sanction, investors are allowed to stir up controversy for the purpose of making profits, including inducing plaintiffs to sue defendants and exercising total control over those plaintiffs' cases.

Source: U.S. Chamber of Commerce.

The potential of a third party financing a case is “something that general counsels really need to start educating themselves about,” says Steinitz. That may mean tailoring discovery to find out whether investors have a stake in the case.

Falk cites the long-running lawsuit against Chevron as an example. In that case, citizens of Ecuador turned to several investors to help finance their multibillion dollar claim against the oil giant over damage caused to the Amazon rainforest as a result of oil drilling in the region.

Through the discovery process, Chevron found that several investors have helped keep the 18-year legal battle going. In addition to $4 million from a Cayman-based Burford subsidiary, plaintiffs also received $4.25 million from Torvia Limited, a Gibraltar company owned by online-poker billionaire Russell DeLeon, according to a 44-page brief filed by Chevron detailing the plaintiffs' funding arrangements.

Several other funders invested smaller amounts in the case, ranging from $150,000 to $1 million. In return, the investors will share in the Ecuadoran court's $18 billion judgment against Chevron, which has so far lost three appeals court rulings, if the judgment stands.

Another concern, critics of litigation financing argue, is that having a third party involved creates a greater chance of jeopardizing attorney-client privilege. In general, the courts have taken a hands-off approach to litigation-funding arrangements, leaving the states to create a complex web of laws, some of which allow the practice under certain circumstances, whereas other states prohibit it entirely, including Maine, Mississippi, and Nevada.

Steinitz says she believes the process “should be legal, but it should be regulated.” For example, investors should be required to be more transparent about their funding arrangements and should be required to include standard contracts that clients can negotiate. “This is an aspect of the financial industry, and we need to regulate it like the financial industry,” she says.

Those who are in the business of funding respond that much of the criticism is ill informed. To the extent criticism is about interference with the course of litigation and litigation strategy, “that's simply not how modern commercial funding happens,” says Doroshow. “We are passive providers of finance.”

“It's not unlike the financing you'd get from a bank,” Doroshow adds. He uses the analogy that getting a lease on a car doesn't mean the bank tells you how to drive it. “We don't tell you how to litigate the case.”

“We provide the financing and leave intact the lawyer-client relationship,” he says. “We don't control settlement decisions and litigation strategy.”