Litigation finance

What Is Litigation Finance?

Litigation finance, also known as third-party funding or legal finance, is the practice where an unrelated third party provides capital to a litigant or law firm to cover legal costs associated with a lawsuit, in exchange for a portion of any eventual financial recovery. This form of third-party financing falls under the broader category of legal finance, a financial services sector that addresses the funding needs within the legal ecosystem. Unlike traditional debt financing, the capital provided in litigation finance is typically non-recourse, meaning the funder is repaid only if the case is successful. This structure transfers the financial risk management of pursuing a claim from the litigant to the funder. Litigation finance can enable plaintiffs to pursue meritorious claims they might otherwise be unable to afford, thereby potentially improving access to justice.

History and Origin

The origins of modern litigation finance can be traced back to the English common law doctrines of maintenance and champerty. Historically, maintenance involved an uninterested party providing financial support for litigation, while champerty was maintenance for a profit. Both were largely prohibited to prevent external interference in legal proceedings. Over time, courts in England gradually relaxed these prohibitions, recognizing the evolving needs of society.¹³

The modern form of litigation finance first emerged in Australia in the mid-1990s. This development was significantly spurred by the enactment of insolvency legislation that recognized legal claims as a corporate asset, allowing insolvency practitioners to finance litigation. The legalization of class-action lawsuits in Australia in 1992 further propelled the growth of this industry, as litigation funders stepped in to support these large-scale claims.¹² Around the same period, the United Kingdom also saw developments with the decriminalization of maintenance and champerty through the Criminal Law Act of 1967 and the introduction of conditional fee agreements (CFAs) in 1990 via the Courts and Legal Services Act. These changes paved the way for the emergence of a specialized litigation finance industry.¹¹ While relatively newer in the United States, commercial litigation finance began to grow significantly in the mid-2000s, becoming a global phenomenon.¹⁰

Key Takeaways

• Litigation finance provides non-recourse capital to litigants or law firms to cover the expenses of a lawsuit.
• Funders receive a share of the financial recovery only if the case is successful, transferring the financial risk from the claimant.
• It can improve access to justice for parties who may lack the immediate cash flow to pursue valid legal claims.
• This financial tool allows businesses and law firms to manage their balance sheet and optimize capital allocation.
• The terms of a litigation finance agreement are typically negotiated, considering the potential recovery and the costs involved.

Interpreting Litigation Finance

Interpreting litigation finance primarily involves understanding its role as an investment vehicle in legal claims. Funders conduct extensive due diligence on the merits of a case, the potential for success, and the estimated financial recovery before committing capital. The funder's decision is based on a projected return on investment (ROI) derived from a share of the potential settlement or judgment.

For litigants, understanding litigation finance means recognizing it as a strategic financial tool. It allows them to pursue complex or costly legal battles without draining their own resources or incurring debt that requires repayment regardless of the outcome. The non-recourse nature means that if the case fails, the litigant owes nothing to the funder. This mechanism effectively converts a contingent future legal entitlement into immediate capital, enabling ongoing operations or other investments while the legal process unfolds. The terms of these agreements are crucial, influencing the ultimate payout to the litigant and the funder's profitability.

Hypothetical Example

Consider "InnovateTech Inc.," a small technology company, which discovers that a much larger competitor, "GlobalCorp," has infringed upon its patented software. InnovateTech has a strong case with significant potential damages, estimated at $20 million, but lacks the $2 million needed for extensive litigation, including attorney fees, expert witness costs, and court expenses. Pursuing this case would severely strain InnovateTech's existing cash flow and divert resources from core business development.

InnovateTech approaches a litigation finance firm. After thorough due diligence and valuation of the patent infringement claim, the funder agrees to provide the $2 million needed for the litigation. In return, the agreement stipulates that the funder will receive 30% of any successful recovery.

The lawsuit proceeds, and after two years, InnovateTech wins the case, securing a $15 million settlement from GlobalCorp. From this amount, the litigation finance firm receives its $2 million advanced capital plus its 30% share of the remaining $13 million (which is $3.9 million), totaling $5.9 million. InnovateTech, after repaying the funder, receives $9.1 million ($15 million - $5.9 million). This hypothetical scenario demonstrates how litigation finance allowed InnovateTech to pursue a valuable claim without upfront financial burden, ultimately resulting in a significant recovery despite its initial liquidity constraints.

Practical Applications

Litigation finance is increasingly applied across various sectors, offering strategic financial solutions for managing legal disputes.

• Corporate Litigation: Businesses, from startups to Fortune 500 companies, utilize litigation finance to fund commercial litigation and arbitration claims. This helps them eliminate downside risk, accelerate expected entitlements, and unlock cash flow from pending claims, thereby transforming potential legal recoveries into tangible assets on their [balance sheet](https://diversification.com/term/balance sheet).⁹
• Law Firm Management: Law firms, including litigation boutiques and larger firms, employ legal finance to manage their own cash flow, particularly for contingent fee cases. It allows them to stabilize revenue, manage partner compensation for contingent work, and advance fees for outstanding receivables without pressuring clients or discounting fees.⁸
• Intellectual Property Disputes: High-stakes intellectual property cases, such as patent infringement or trademark disputes, often involve substantial costs. Litigation finance provides the necessary capital to pursue these complex actions, enabling patent holders or trademark owners to enforce their rights.
• Class Actions and Collective Redress: In jurisdictions where permitted, litigation finance plays a crucial role in funding large-scale class actions, providing the financial backing for numerous claimants to pursue collective legal remedies.
• Judgment Enforcement: Funders can also provide capital to assist with the enforcement of judgments or arbitral awards, helping clients collect debts when opponents attempt to hide assets or fail to pay.⁷

Leading firms in this specialized financial sector, such as Burford Capital, provide comprehensive legal finance solutions for both companies and law firms, focusing on optimizing legal assets.⁶

Limitations and Criticisms

Despite its benefits, litigation finance faces several limitations and criticisms, primarily concerning ethical considerations and regulatory oversight. One key concern revolves around potential conflicts of interest, particularly when a funder's financial interest might diverge from the client's best interest. The American Bar Association (ABA) has highlighted the importance of lawyers maintaining independent professional judgment, advising clients about any limitations imposed by funding agreements, and protecting client confidences.⁵ There are discussions about the need for lawyers to inform clients of potential risks, such as the discoverability of communications with funders, which could waive attorney-client privilege.⁴

Another area of criticism relates to the potential for funders to influence litigation strategy or settlement decisions, shifting the focus from the merits of the case to the funder's need for a specific profit. Some agreements have been criticized for potentially leading to under-compensation for the claimant, as a significant portion of the recovery goes to the funder.³

Regulatory frameworks for litigation finance vary significantly across jurisdictions, with some regions having minimal oversight. This lack of uniform regulation can lead to concerns about transparency and fairness. The European Parliament, for instance, has adopted a resolution calling for the European Commission to propose legislation to regulate third-party litigation funding within the EU, citing the need for greater transparency and oversight.² Critics also point to the potential for increased legal costs and extended duration of proceedings in funded cases.¹

Litigation Finance vs. Contingency Fee

While both litigation finance and a contingency fee arrangement allow a client to pursue legal action without significant upfront legal costs, they differ fundamentally in who provides the funding and their relationship to the legal case.

A contingency fee is an agreement directly between a client and their attorney. Under this arrangement, the lawyer agrees to represent the client without charging hourly fees, instead receiving a predetermined percentage of the financial recovery if the case is successful. If the case is lost, the client typically pays no attorney fees (though they might still be responsible for court costs or expenses). The lawyer's compensation is contingent upon winning the case, aligning the attorney's financial interest directly with the client's outcome. This is a form of payment structure for legal services.

Litigation finance, conversely, involves a third party (a litigation finance firm) that is external to the attorney-client relationship. This third party provides capital to the litigant or law firm to cover various litigation expenses—which can include attorney fees, but also expert witness fees, court filing fees, and other disbursements. In return, the funder receives a share of the proceeds only if the case is successful. The funder does not provide legal services, nor does it typically direct the legal strategy, maintaining a passive investment role. This arrangement is primarily a financial contract and a form of third-party financing.

The key distinction lies in the source of funding: a lawyer providing services on a contingent basis versus an external investor providing capital for the case expenses.

FAQs

How does litigation finance differ from a loan?

Litigation finance is typically non-recourse, meaning the funder is repaid only if the case is successful. If the case is lost, the litigant owes nothing to the funder, and the funder loses their investment. A traditional loan, on the other hand, usually requires repayment regardless of the outcome, often with interest.

Who uses litigation finance?

Litigation finance is used by a variety of entities, including individuals, small businesses, large corporations, and law firms. It can be particularly beneficial for parties who have strong legal claims but lack the immediate cash flow to cover the substantial legal costs associated with complex litigation or arbitration.

Are litigation finance agreements transparent?

Transparency in litigation finance agreements can vary. There is ongoing debate and increasing calls for greater transparency and regulation in the industry, particularly regarding the terms of agreements and the involvement of funders in legal proceedings.

What types of cases are typically funded?

Litigation finance firms usually fund commercial disputes with high potential financial recoveries, such as contract law breaches, intellectual property infringement, antitrust claims, and large-scale arbitrations. Funders assess cases based on their legal merits and the likelihood of a significant financial outcome.