Litigation soars—and along with it, the rise of legal finance

Oct 03, 2019

Written By Jan Hill

As the volume of litigation continues to grow and costs continue to rise, many law firms and in-house legal teams are turning to third-party finance to fund advocacy efforts.

All litigation, even cases pursued on a pro se basis, requires some degree of monetary funding. Although most entity clients pay on an ongoing basis for the work their lawyers perform, certain plaintiffs’ claims—personal injury tort claims, for example—are typically funded by the lawyer, who advances the value of his or her time as well as the expenses of the litigation to the client. These funds are recouped later from the proceeds of a judgment or settlement if the claim was successful, according to the terms of the contingency fee agreement entered into by the lawyer and the client.

However, commercial litigants are sometimes unable to back the cost of legal services from their operating budgets or existing lines of credit, and instead must tap into different sources of capital to pay legal expenses as they are accrued. As the volume of litigation continues to grow and costs continue to rise, many law firms and in-house legal teams are turning to third-party legal finance to fund their advocacy efforts.

What is third-party legal finance?

Also known as litigation funding, third-party legal finance is an arrangement in which a third party with no prior connection to the litigation agrees to finance all or part of the associated legal costs in return for a share of the financial recovery (usually either a percentage or a flat fee). Third-party legal finance can be used to pay directly for some of the costs associated with litigation, to fund working capital for companies and even to help business owners pay their personal expenses.

Third-party legal finance is an option in many markets around the world, including the UK, Australia, Germany, Spain and many US states as well. According to New York Supreme Court Justice Eileen Bransten, litigation funding “allows lawsuits to be decided on their merits, and not based on which party has deeper pockets or stronger appetite for protracted litigation”, unlocking the value of legal claims by providing funds to a plaintiff before the case resolves to pay for some of the costs of the litigation, such as investigations, lawyer’s fees, expert witness fees, court expenses and sometimes even personal expenses of the party.

The use of third-party finance in England and Wales

London is considered one of the most expensive and risky litigation markets in the world. According to a January 2018 Financial Times report, third-party litigation funders operating in the UK have raised over £10bn and have involvement in prominent cases such as the lawsuit being pursued against Volkswagen related to its emissions-testing scandal.

The nine members of the Association of Litigation Funders of England and Wales (ALF)—Augusta Ventures, Balance Legal Capital, Burford Capital, Calunius Capital, Harbour Litigation Funding, Redress Solutions, Therium Capital, Vannin Capital and Woodsford Litigation Funding—control the market for litigation funding in England and Wales. These funders focus the majority of their investments on cases involving commercial litigation and arbitration; most plaintiffs are commercial entities, experienced professionals or business people; and no funder member of the ALF contracts with personal injury claimants.

The 2018 Litigation Funding Research conducted by Burford Capital found that 75% of UK solicitors considered litigation finance to be a “key marketing tool”. The researchers also concluded the following:

- Two-thirds of UK lawyers said they were very familiar with litigation finance.

- Approximately 63% of UK respondents said their organisation’s use of legal finance has risen over the past two years.

- Four in ten UK in-house respondents reported that their companies are very likely to use legal finance in the next two years.

- Compared to other areas, 79% of the UK respondents agreed that litigation finance can potentially help turn in-house legal departments from necessary costs to profit centres.

In September 2018, AxiaFunder, a crowdfunding platform for litigation funding, was launched in the UK. LexShares pioneered the platform for accredited investors who are willing to invest a minimum of $2,500 in individual disputes or a portfolio of cases, and aims to make litigation finance more mainstream, yet still deliver high returns.

Legal finance in the corporate world

From a corporate standpoint, there are many reasons to employ a legal team within an organisation. However, despite the important role that in-house legal teams play, they almost never generate profits and are usually viewed as unavoidable expenses associated with running a business.

According to the Burford research, 81% of UK in-house lawyers say cost management is a major issue for them, and the need to manage the sheer financial risk of litigation was a significant factor behind in-house interest in litigation finance. Seventy-two per cent of the study respondents admitted that their company had chosen not to pursue certain claims because of the negative impact that the associated legal costs would most certainly have on the organisation’s bottom line.

Benefits of litigation finance

Many potential plaintiffs are unable to pursue their claims because of the high costs associated with litigation, and in much of the world access to justice requires significant capital. Due to prohibitive costs, a huge imbalance of resources commonly exists between common and wealthy litigants, leading to a distortion of legal outcomes for those who cannot afford to seek legal recourse.

Third-party legal finance provides a way to access capital to fund legal matters, and offers a number of important benefits to plaintiffs, solicitors, law firms, investors and corporate legal departments:

Plaintiffs. Legal finance helps underfunded plaintiffs further their cases or inject capital into previously filed cases that lack sufficient capital. Providing this type of funding helps reduce the risk of settling a case quickly for less than what it might actually be worth, provides cash-strapped plaintiffs with a cushion for unforeseen personal expenses and gives them greater access to top legal talent.

Solicitors and law firms. Third-party funding gives lawyers and firms access to a new asset class by providing the necessary capital for all litigation expenses. Getting a third-party involved reduces the risk that the client will run short of money during the litigation, and allows law firms and lawyers to offer more flexible payment arrangements to potential clients.

Investors. Litigation funding provides investors with access to a new asset class that isn’t correlated to capital markets, and offers a moderate time to liquidity as compared to other types of investments. According to the American Bar Association, two public companies in this sector, Juridica and Burford, invest in claims owned by large corporate litigants represented by major law firms, and their investments are estimated to be in the range of $500,000 to $15 million.

Corporate legal departments. Due to budget constraints, corporate executives are usually not in favor of spending millions of pounds in legal fees to chase an uncertain outcome. But the use of third-party funding to pursue such claims can actually create revenue that would not otherwise be generated, without affecting cash flow. Therefore, third-party funding can enable a corporation to monetise its litigation portfolio in a way that was not previously possible.

Third-party legal funding brings with it a number of important benefits, but there are also certain ethical considerations that must be made when deciding whether or not to pursue such financing.

Professional obligations of lawyers related to third-party funding

Lawyers must approach transactions involving third-party legal finance with care, being mindful of several core professional obligations that they are subject to:

- Independent professional judgment must be exercised on behalf of a client, and financial considerations cannot influence how a case is handled.

- A third party must not be allowed to interfere with the exercise of a lawyer’s independent professional judgment.

- Vigilance is required to prevent the disclosure of confidential information.

- Reasonable care is required to safeguard against the inadvertent waiver of the attorney-client privilege.

- The terms of any funding transactions must be fully explained, and clients must be made aware of any risks that such transactions could present.

Case study: Litigation funding in antitrust matters

Several small service providers operating within an established market and a similar geographic region sought to bring a multi-faceted antitrust litigation against a large national company that was operating in a lateral market and offering a viable alternative to the plaintiffs’ products. The defendant was alleged to have practiced anticompetitive and predatory pricing practices intended to capture market share within the targeted geography and drive competitors out of the market.

Due to the scope and complexity of the litigation, the extremely high burden of expert costs and the fact that antitrust matters are extremely expensive to litigate, litigation funding was obtained to put the case on sound financial footing from the beginning. As the case moved forward, each expert was extremely involved in the preparation and presentation of the plaintiff’s case, as well as responding to the arguments presented by the defendant’s experts.

Antitrust matters appear to attract the most experienced solicitors and law firms, and many of these entities are increasingly willing to take these cases on a contingency basis and allow third-party funders to share the risk with them. Litigation funders don’t control the litigation; rather, their role is to relieve some of the financial pressures of antitrust matters, allowing the lawyers to focus on the merits of an extremely complicated dispute.

Case study: The champerty doctrine and third-party legal funding in the US

In the US, litigation finance law varies considerably from state to state. Many jurisdictions do not explicitly prohibit champerty—defined as “an agreement between the owner of a claim and a volunteer that the latter may take the claim and collect it, dividing the proceeds with the owner, if they prevail; the champertor to carry on the suit at his own expense”—while some have strict champerty doctrines and others have none at all.

Under the provisions of the champerty doctrine, parties are prohibited from funding litigation in certain cases to which they are not a party. In states that follow this doctrine, third-party litigation financing arrangements can be found champertous and third-party financiers should stay away from starting, inspiring, or directing litigation in which they lack direct interest.

Funders need to be aware that the champerty doctrine puts limits on litigation financing in some states, including Alabama, Delaware, Georgia, Minnesota, Mississippi, New York and Pennsylvania. In those states, the crux is on the interest the funder has in underlying assets and whether or not the funding agreement gives control of the litigation to a third party. Champerty concerns have even led some funders to direct their resources to actions being brought in states that do not recognize the doctrine, such as Arizona, California, Louisiana, New Jersey and Texas.

Third-party legal financing: a brave new world of possibility?

An increasing number of plaintiffs, solicitors, law firms and corporate legal departments are realising the benefits that third-party litigation funding has to offer. Not only does third-party funding cover costs as they are incurred and improve the bottom line for corporate litigants, but it can also maximise the value of claims since funders only generate a return on their investment if and when a matter is successfully resolved.

Litigation funding also gives litigants the opportunity to evaluate the viability of their claims and to maximise their potential value. When a case receives third-party funding, the money can be used to hire the best possible legal counsel, help deflect the delay tactics commonly used by a well-funded opponent and allow claimants to refuse low-ball settlement offers in favor of standing firm and letting their case be decided on its merits.

Key takeaways

Third-party legal financing is an increasingly popular way to fund commercial litigation in the UK, Australia, Germany, Spain and in many US states, although third-party funding arrangements are prohibited in some American jurisdictions. While investors don’t control or have any sort of stake in a case besides a financial one, litigation funding relieves some of the financial burden that’s typically shouldered by law firms, lawyers and clients. Third-party funding also provides expanded access to legal services to those who might not otherwise pursue legal action due to the high cost and risk associated with litigation.

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