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The Rise of Third-Party Litigation Financing in the United States

Litigation financing is a central concern for parties before any serious litigation is undertaken. Given the high costs associated with high stakes litigation, many law firms are willing to create financing plans with clients that will enable the parties to move forward with their cases. Arrangements where law firms work on a contingency basis have been widely used in the United States for many years and have been the basis for the introduction of a new source of raising funds for litigation. ((Jennifer Banzaca, Litigation Funding: In Turbulent Markets, Hedge Fund Managers Turn to Litigation Funding for Absolute, Uncorrelated Returns, 2 The Hedge Fund L. Rep. 25 (June 24, 2009), available at http://www.juriscapitalcorp.com/images/Hedge%20Fund%20Law%20Report%20Article.pdf.))

Third-party litigation financing introduces outside and independent investors into the litigation process by allowing them to provide the required funding for the case in exchange for a return on their investment upon the achievement of a successful verdict. ((Id.)) As in a case where the attorney represents a party on a contingency basis, someone other than the litigating party assumes the risk and potential benefit from pursuing an active case. ((Id.)) Australia and the United Kingdom have accepted this practice as a legitimate investment opportunity and an asset to their legal systems but it has been slower to gain recognition in the United States. ((Steven P. Blonder, Litigation: Are lawsuits the newest commodity, Inside Counsel (May 2, 2013), http://www.insidecounsel.com/2013/05/02/litigation-are-lawsuits-the-newest-commodity.)) However, in recent years, third-party litigation financing has been gaining popularity with both litigation parties as well as investors in many parts of the US. ((See Id.))

Backers of such cases often consist of private equity funds, hedge funds, and both individual and institutional investors. The benefit to the investor can be quite substantial; the majority of returns fall within the thirty to sixty percent range. ((Id.)) The investment potential was originally given attention only by specialized litigation investment firms, but as those firms have been seeing favorable returns on their investments, hedge funds and other traditional financing companies have begun to take part in the process as well. ((Emily Madoff, Analyzing the Fundamentals of Litigation Funding, N.Y. L.J. (Aug. 19, 2013), http://www.newyorklawjournal.com/id=1202615608032?slreturn=20140108124701.))

Like any other investment, a significant amount of due diligence is completed before the investors select viable cases. One of the earlier companies that began investing in litigation cases is Juridica Capital Management. Richard Fields, Juridica’s CEO, identified several criteria that his company considers when selecting its cases. ((Banzaca, supra note 1.)) It considers (1) the strength of a case, (2) the creditworthiness of a defendant, and (3) the potential size of any damages or settlement awarded. ((Id.)) It also considers potential political and legislative changes than might affect the outcome of the case. ((Id.)) Juridica will hire outside counsel to conduct analyses on the legal, legislative, political, and social issues. It also considers the time frame and history of the type of case. For instance, if there is no history of settlements, the firm is less likely to provide funding. Apart from examining the merits of the case, Juridica also focuses on other aspects of the litigation that might interfere with its success, such as the representing counsel. It will ensure that those who play a role in the case will increase the chances of a successful verdict and, as a result, high returns. The entire process often takes between two to three months to complete. ((Id.))

While the return on investment can be substantial, there is also significant risk involved. If the case takes a downward turn, the investor suffers a loss of its entire investment, which often involves millions of dollars. ((William Alden, Looking to Make a Profit on Lawsuits, Firms Invest in Them, N.Y. Times Dealbook (April 30, 2012, 6:07 PM), http://dealbook.nytimes.com/2012/04/30/looking-to-make-a-profit-on-lawsuits-firms-invest-in-them/.)) The nature of litigation introduces an additional facet of unpredictability and risk to the investment process. For instance, in the past year, two big cases financed by third-party investors were dismissed: Both Excalibur Ventures’ $1.5 billion claim and Stan Lee’s $5.5 billion claim against The Walt Disney Company. This resulted in an enormous loss to their litigation backers. ((Cathleen Flahardy, Litigation funding proves risky, Inside Counsel (Sept. 16, 2013), http://www.insidecounsel.com/2013/09/16/litigation-funding-proves-risky.))

Apart from the risks inherent in these investments, there are also many criticisms of this type of investment structure. The US Chamber of Commerce has stated the potential for these third-party investors to improperly influence how the case proceeds. ((Alden, supra note 11.)) Some investors respond that although they require transparency and to be kept aware of the material aspects of the case, they do not have access to all pertinent information, such as privileged info (i.e., attorney client privilege is protected). ((Banzaca, supra note 1.)) As such, they argue an investor’s involvement in an ongoing case is limited.

Another criticism is that this investment scheme will result in a proliferation of litigation and encourage frivolous suits. ((Blonder, supra note 4.)) The response is that investors will only put money into a case if they think there is a sufficient high chance of winning the suit. The profit is dependent on the success of the litigation and therefore will discourage frivolous suits that which will not bring investors any return. ((Id.)) Additionally, it is argued that third-party litigation financing is beneficial to the legal system in that it encourages the pursuance of cases with merit; that it helps to balance out situations where one of the parties has an advantage in its access to litigation funding. ((Id.))

These are only two of the many criticisms in the market. Some other concerns involve the de facto assignment of causes of action that cannot be assigned, which may lead to increased dismissals of cases. ((Id.)) There may also be a potentially negative impact on the number of settlements that occur. Since settlements are often driven by the high cost of litigation, that there is steady stream of financing may diminish any inclination to settle. ((Id.))  Finally, there is a concern about the resulting impact on damages that are distributed to class action members. After the payout to the investors, the pool available for distribution to the class will be significantly smaller. This is especially a cause for concern as it is not possible to consult the entire class about the funding arrangement. ((Id.))

Despite the criticisms, it appears that interest in third-party litigation financing has not begun to diminish. In January 2014, Gerchen Keller Capital, LLC announced its new $250 million commercial litigation finance fund. ((William Alden, Litigation Finance Firm Raises $260 Million for New Fund, N.Y. Dealbook (Jan. 12, 2014: 10:33 PM), http://dealbook.nytimes.com/2014/01/12/litigation-finance-firm-raises-260-million-for-new-fund/.)) A survey conducted in late 2013 by Buford Capital, an established litigation financing firm, reveals that while not many corporate leaders and counsel have utilized this method of financing litigation, corporate leaders are increasingly receptive to the idea: they want their legal counsel to offer this payment structure as an option. ((Jennifer Smith, What Do Lawyers and In-House Counsel Really Think About Litigation Finance?, Wall St. J. (Jan. 15, 2014, 4:39 PM), http://blogs.wsj.com/law/2014/01/15/what-do-lawyers-and-in-house-counsel-really-think-about-litigation-finance/.)). Only time will reveal whether third-party litigation financing will continue to gain popularity and recognition.

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Jessie Chen

Vol. 3 Associate Editor