In a world where access to justice often depends on money, legal finance makes justice accessible to claimants who would otherwise lack the resources to attain it on their own. Eighty-one percent of low-income Americans do not use legal assistance because they cannot afford the high fees associated with civil lawsuits, which some estimates place as high as $50,000 on average in the United States. As a percent of revenue, U.S. companies spend four to nine times more on litigation than their counterparts in foreign jurisdictions.
The high cost of litigation provides well-funded defendants with an overly potent weapon: financial asymmetry. Unrepentant defendants may engage in a costly war of attrition intended to exhaust and overwhelm a plaintiff’s limited resources. As a result, many individuals or companies may choose to defer or even abandon legitimate claims if they are unlikely to be able to provide for their families or keep themselves solvent while the litigation plays out in court.
Faced with the prospect of forfeiting their chance to redress their grievances, individuals and companies need a stakeholder in the outcome of litigation – a “law banker” to help plaintiffs monetize the outcome of their claims so they can afford the high costs of litigation. Third-party litigation finance provides a more efficient and equitable means of redistributing risk and equalizing the bargaining power of litigants by providing funding to undercapitalized plaintiffs through the use of novel financial products.
What is Litigation Finance?
At its most basic level, “litigation finance” is the practice where a third-party unrelated to the subject matter of a lawsuit provides money to a party involved in litigation to help further that party’s objectives in the legal claim in return for a financial reward. The capital provided by lawsuit investors may help individual plaintiffs pay for living expenses or directly pay for some of the costs of litigation, including attorneys’ fees, expert witness fees, court costs, and other expenses associated with a lawsuit. Capital from a legal finance provider may be used to fund operating expenses for companies involved in litigation. It can also be provided directly to law firms to finance their operations. The financial reward for investors can take different forms, including a flat fee, a multiple of the amount advanced, a percentage of the amount recovered, an interest rate when it is a loan to a law firm, or some other basis of compensation.
The History and Evolution of Litigation Finance
Various forms of third-party lawsuit investing have endured in the United States for many years. Patent investing involves the enforcement of patent rights by filing patent infringement lawsuits against anyone who uses commercially similar technology without paying royalties. Many investors who acquire or sell short stocks in companies party to a lawsuit do so with the expectation that the stock price will go up or down, depending on the lawsuit outcome. Direct lawsuit financing has been permitted since the NAACP provided the first direct lawsuit financing for civil rights litigation in the 1960s, so long as the funding organization does not control the litigation. Waterbed inventor Charles P. Hall successfully sued infringing manufacturers for $6.8 million in damages using a war chest of $750,000 obtained from his investors.
Direct forms of litigation finance, particularly the funding of lawsuit expenses by repeat players who are unrelated to the subject matter of a dispute, have emerged as an asset class only recently due to a degree of legal uncertainty that has historically discouraged investment in this area. The medieval English doctrines of “maintenance,” “champerty,” and “barratry” – all of them involving an arrangement where a party supports another to enable him or her to further a claim – historically prohibited third-party financing of lawsuits in the United States and most other common law countries.
Over time, as other means of controlling abuses of the legal system became more effective, the need for the prohibitions on champerty, maintenance and barratry receded. As parties in civil litigation are responsible for their own legal costs, the American civil justice system increasingly recognized that access to justice depends upon the broad availability of legal representation for all socioeconomic levels. The public policy for increasing access to the legal system for those that could least afford it overrode the concerns underlying the prohibition policies in many states. Today, widespread exceptions to these historical doctrines recognize that financial considerations often influenced access to justice. These include contingent fee arrangements, where an attorney is paid a fixed percentage of a recovery only if there is a favorable judgment or settlement, and tort lawsuit advances, where outside investors providing lawsuit funding in exchange for a fee if the case is won or settled.
Litigation Finance Today
Currently, the litigation finance industry offers three main product lines, with companies tending to specialize in each specific product. The first is the lawsuit advance for tort claims, which provides funding to individual plaintiffs for living expenses during protracted litigation. Second is funding for commercial matters in areas such as contracts, intellectual property, antitrust, and banking, among others. This funding may cover litigation expenses or maintain the working capital of businesses or personal expenses of the business owners. Third, a number of companies provide loans to underfinanced attorneys and law firms.
The slowdown of the global economy, combined with tightening credit markets, declining asset values, escalating legal costs, increased backing by institutional investors, and a growing receptivity in the legal industry to innovative financial products, has greatly expanded the both the practice and viability of investing capital in lawsuits. Over the course of a few decades, the legal finance industry has evolved into an alternative asset class with growing institutional participation, including several public companies, and an overall greater availability of financial products for individuals, businesses and law firms.