What Is Litigation Finance?
Litigation finance is a financial arrangement in the realm of legal finance where a third party, unrelated to the lawsuit, provides capital to a plaintiff or law firm to cover legal expenses in exchange for a portion of any future settlement or judgment awarded. This mechanism allows claimants to pursue valid legal claims without bearing the full financial risk management of the dispute. Essentially, it is a non-recourse investment, meaning if the case is unsuccessful, the litigant owes nothing to the funder. Litigation finance can democratize access to justice by enabling individuals and businesses that might otherwise lack the resources to litigate against well-funded adversaries.
History and Origin
Third-party litigation funding, while seemingly modern, has roots that can be traced back centuries to concepts like champerty and maintenance, which historically prohibited external involvement in lawsuits. However, the organized commercial industry of litigation finance began to emerge in Australia in the mid-1990s. From there, it gradually expanded its presence globally, reaching the United States approximately a decade later.13 Over the recent past, litigation finance has experienced substantial growth, evolving into a multi-billion-dollar global industry.12 The proliferation of complex and costly commercial disputes, along with the increasing sophistication of financial markets, contributed significantly to its adoption. Initially, it gained traction among claimants who lacked sufficient resources to pursue meritorious claims, but it has since expanded to include sophisticated businesses and law firms seeking to manage their balance sheets and litigation liability.
Key Takeaways
- Litigation finance involves a third party providing funds for legal costs in exchange for a share of the proceeds if the case is successful.
- It is typically a non-recourse arrangement, meaning the funder loses their investment if the case fails.
- This funding mechanism helps claimants manage the financial risks of litigation and can enhance access to justice.
- Litigation finance is a growing global industry that includes funding for single cases and larger portfolios of claims.
- Concerns exist regarding funder control over cases, transparency, and potential ethical implications.
Interpreting Litigation Finance
Litigation finance is interpreted primarily as a tool for capital allocation and risk management within the legal system. For claimants, it represents a way to transform a contingent future asset (a potential claim) into immediate liquidity, covering ongoing legal expenses or even operational costs. The terms of litigation finance agreements are crucial for interpretation, as they dictate the funder's return on investment and any rights they may have concerning the case. Funders conduct extensive due diligence on the legal merits and potential recovery of a case before committing funds, treating the claim as a specialized form of asset for their portfolio. The valuation and structure of such deals reflect the inherent uncertainties of legal outcomes.
Hypothetical Example
Consider a small technology startup, "InnovateTech," that has developed a groundbreaking new software. A much larger competitor, "GlobalCorp," allegedly infringed on InnovateTech's intellectual property, threatening their market position. InnovateTech has a strong case, but their limited cash flow means they cannot afford the multi-million dollar legal expenses required for a protracted patent infringement litigation against GlobalCorp's deep pockets.
Instead of abandoning their claim or seeking debt financing, InnovateTech approaches a litigation finance firm. After conducting thorough due diligence on the merits of the case, the litigation funder agrees to provide $5 million to cover InnovateTech's legal fees and expert witness costs. In return, the agreement stipulates that if InnovateTech wins or reaches a settlement, the funder will receive their $5 million back plus a predetermined percentage (e.g., 30%) of the gross recovery. If the case is lost, InnovateTech owes nothing to the funder, and the funder absorbs the entire $5 million investment. This arrangement allows InnovateTech to pursue justice without jeopardizing its financial stability.
Practical Applications
Litigation finance is increasingly prevalent across various legal domains, showing up in commercial disputes, international arbitration, class actions, and intellectual property litigation. It is utilized by plaintiffs who seek to offset the significant financial burden of pursuing complex claims, but also by corporations looking to manage balance sheet liability by moving legal costs off their books. Law firms may also use portfolio funding, where a funder provides capital against a basket of cases, allowing the firm to take on more matters or invest in growth.11
Some jurisdictions and courts have begun implementing rules regarding the disclosure of litigation funding arrangements to promote transparency. For example, in April 2022, the Chief Judge of the District of Delaware introduced a standing order requiring litigants receiving non-recourse litigation funding to disclose funder identities, any control over the litigation or settlement decisions, and a brief description of the funder's financial interest.10,9 Such initiatives highlight the growing recognition and scrutiny of this financial mechanism within the legal system.
Limitations and Criticisms
Despite its benefits, litigation finance faces several criticisms and perceived limitations. One primary concern revolves around the potential for funders to exert undue influence or control over the litigation process, including strategic decisions or even settlement negotiations, potentially conflicting with the client's best interests or the lawyer's fiduciary duty.8,7 While many funding agreements explicitly state that control remains with the litigant and their counsel, the financial stake of the funder can introduce complexities.
Another area of debate concerns transparency. Critics argue that the non-disclosure of funding arrangements can create an uneven playing field, where opposing parties are unaware of the true financial motivations or backing behind a claim.6 There are also historical legal doctrines, such as champerty and maintenance, which in some jurisdictions historically prohibited third-party involvement in lawsuits due to concerns about encouraging frivolous claims or profiteering from disputes. While these doctrines have largely faded or been reinterpreted in many places, they underscore foundational ethical debates that continue to surround litigation finance.5 Some critics further suggest that litigation finance could incentivize more lawsuits, potentially burdening court dockets.4 The evolving regulatory landscape and ongoing discussions reflect efforts to balance the benefits of access to justice with these ethical and practical considerations.3,2
Litigation Finance vs. Contingency Fee
While both litigation finance and a contingency fee arrangement involve a payment to a third party only if a legal case is successful, a fundamental difference lies in who the third party is and the nature of the financial relationship. In a contingency fee arrangement, the third party is the attorney or law firm representing the client. The attorney agrees to defer their fees, taking a percentage of the final settlement or judgment as payment. If the case is lost, the attorney typically receives no fee for their time. In contrast, litigation finance involves a third-party investor (a funder) who is not providing legal services. This funder provides capital to cover legal expenses, which can include attorney fees, court costs, expert witness fees, and other disbursements. The funder's return is a share of the proceeds, distinct from the attorney's fees. Thus, a litigant might engage a lawyer on a contingency fee and secure litigation finance to cover the disbursements of the case or to reduce the law firm's financial risk management by offloading case costs to a funder.
FAQs
What types of cases typically use litigation finance?
Litigation finance is commonly used in commercial disputes, intellectual property cases, international arbitration, and large-scale class actions. It's especially beneficial for cases with high anticipated legal expenses and a strong likelihood of a substantial judgment or settlement.
Is litigation finance regulated?
Regulation of litigation finance varies by jurisdiction. Some countries and specific court systems have introduced rules requiring disclosure of funding arrangements to increase transparency. The debate around comprehensive regulation is ongoing, with discussions often centered on balancing investor interests with ethical considerations and access to justice.1
What are the main benefits for a plaintiff?
For a plaintiff, the main benefit is the ability to pursue a valid legal claim without bearing the upfront financial burden or the full risk management of losing the case. It can level the playing field against well-resourced opponents and allow businesses to preserve their own capital for core operations rather than tying it up in litigation.