The Social Utility of Third-Party Funding

With the cost of litigation and arbitration increasing, the idea of seeking funding from a third party in exchange for a share of the judgment has become more and more appealing to litigants. With this growing phenomenon comes much debate surrounding the benefits and detriments of allowing an outside party to finance a legal claim.

Third-party funding has been credited for having a number of advantageous effects. Some of these include: (1) increasing access to justice, (2) spreading the financial risks of arbitration, (3) equalizing bargaining power claimants and respondents, and (4) filtering out meritless claims.

First, third-party funding increases access to justice for those parties who have meritorious claims but shallow pockets. Studies have shown that the high upfront costs of arbitration have a deterrent effect and often prevent claimants from filing claims. Furthermore, third-party funding aids those defendants with sound defenses from surrendering to a more financially equipped plaintiff who may pressure the defendant into an early (one-sided) settlement.

Second, third-party funding provides a way to share the financial risks associated with arbitration. Contracts with lenders may be structured in a way that allocates risk among various parties. Additionally, lenders who have experience assessing risks are better equipped to manage them than most parties.

Third, third-party funding equalizes bargaining power of both claimants and respondents. This in turn increases settlement leverage for the funded party. Fourth, lenders act as “gatekeepers” by filtering out meritless claims because lenders assess all aspects of a claim such as assessing its likelihood of success, before providing financing. Thus, a third-party financer’s due diligence reassures that only those claims that are “worthy” enough progress through the legal system.

Critics often argue that third-party funding gives rise to ethical issues such as breaches of confidentiality and the undercutting of client control over a claim. However, these arguments have been overstated and are resolvable. With respect to the confidentiality argument, a lawyer must obtain the client’s informed consent before releasing information to a third party. Additionally, communications with lenders may still be protected by the work product rule if they were made in “anticipation of litigation.”

Finally, with respect to the undercutting client control argument, common law allows parties to give up control over legal claims by contracts and third-party financing contracts will dictate the lender’s level of control. Additionally, the lender and client’s interest in most cases are aligned. Therefore, lenders have no need to take away control from the client.

Topics: third-party funding, advantages of third-party funding, critics of third-party funding

Work Cited: Collin R. Flake, THIRD-PARTY FUNDING IN DOMESTIC ARBITRATION: CHAMPERTY OR SOCIAL UTILITY? Dispute Resolution Journal (2015).