Fundamentals of Sound Litigation Financing

As more and more capital is directed to litigation finance, there are increasing calls for regulation that would make litigation finance “safe.”  As in other aspects of the economy, however, the first question should not be how to regulate but, rather, whether it is necessary to regulate at all.  When litigation financiers follow some fundamental best practices, much of the purported dangers of litigation financing disappear.

One of the most vociferous and influential proponents of regulation is the United States Chamber of Commerce.  The U.S. Chamber has outlined some central principles of regulation that it believes should be adopted nationwide.  One of these core regulations would require a litigation finance company to pay other side’s legal fees if the other side wins the case.  In addition, as a means of assuring such fee payments, this proposal would require litigation finance companies to post a bond worth 25 percent of the damages claimed in the case.  The U.S. Chamber also advocates authorizing the Federal Trade Commission to issue regulations controlling the business practices of litigation finance companies.  The main idea behind these reform proposals is that litigation financiers should be discouraged from supporting cases with any meaningful risk of loss.

But there are good reasons to think that sound business practices make this kind of regulation unnecessary.  In one such practice, litigation finance companies would define the limits of their investments by the quality of the cases rather than the amount of available funds.  In other words, if a litigation finance company has $10 million of capital available for investment, it should not decide to invest all of it in the best available cases.  Rather, it should set a standard for minimum case quality and invest only in those cases that meet the standard, even if the company is unable to invest all of its available funds.

Another prudent practice depends upon the principle that a litigation finance company should set a standard for investment that it would only participate in cases where it could earn a worthy return without taking more than half of the recovery.  For example, one prominent and successful litigation finance company has averaged a 35 per cent share of the recoveries in all of the cases in which it has invested.  Of course, there is no way to guarantee this allocation of the recovery in any particular case. But with careful planning and analysis, an investor can aim at taking cases where its preferred rate of return would be less than half of the likely recovery.

These practices provide an argument against two of the U.S. Chamber’s main complaints about litigation financing: that an influx of third-party money perverts a plaintiff’s objectives in a case and that it prolongs litigation as plaintiffs seek higher settlements.  If investment flows only to strong cases, an infusion of capital from a third-party may make life easier in the short-run, but it will not change the litigant’s objectives.  Similarly, if litigants know that they can count on taking the lion’s share of the recovery, they will not persevere unnecessarily in the hope that they can get a better result, one in which the investor will have a smaller share.  In this way, sound business obviates the need for onerous regulations.

Topics:  litigation finance, legal reform, third-party funding, litigation costs, lawsuit loans, non-recourse financing, law reform, licensing, consumer regulation, U.S. Chamber of Commerce

 Works Cited:

Roy Strom, Numbers Never Lie – Or Do They? Chicago Lawyer (February 2015) available at http://www.chicagolawyermagazine.com/Archives/2015/02/Litigation-Funding-Business