Litigation Finance: an asset or A liability to the Future of Lawsuits?

Author: Sydney Auteri, Associate Editor

Rule 1 of the Federal Rules of Civil Procedure calls for the “just, speedy, and inexpensive determination of every action and proceeding.” [i] A civil lawsuit, however, can be extremely expensive depending on the complexity and the motives of the parties involved. With the burden of high costs, litigation finance (also called litigation funding) may help resolve issues surrounding the expensive nature of litigation but may pose problems of its own.

Litigation finance is a relatively new concept that has evolved in response to the ever-changing legal landscape. In short, litigation finance is when a third-party, unrelated to the lawsuit, provides funds to a plaintiff in exchange for a financial reward on a non-recourse basis.[ii] In other words, if the plaintiff wins, the third-party receives payment, but if the plaintiff loses, nothing is owed to the lender.

For a lender, there is another less risky option known as legal funding loan agreements. A loan is a transaction in which one party provides an asset to another for a finite period on a condition of return, usually with interest.[iii] Even though the loan might not be repaid until post-settlement, a legal funding loan differs from litigation finance because the plaintiff is responsible for repayment regardless of how the case turns out.

Often users of litigation finance are not single plaintiffs, but rather Fortune-500 companies and other business of all sizes.[iv] Typically, under generally accepted accounting principles (“GAAP”), companies must report liabilities, which include pending lawsuits. [v] Therefore, publicly traded firms outsource the costs of litigation so that no capital is lost on the balance sheets.[vi] This practice may be deceiving for investors or stockholders, but the practice is becoming quite common.

As of March 2022, litigation financers managed $12.4 billion in assets[vii], drawing the attention of potential financer as well as lawmakers. While litigation finance brings the benefit of allowing enterprises of all sizes the ability to address wrongdoings without financial constraints, there are potential ethical concerns.

Litigation funding was once widely prohibited, although it was known by a different name: “champerty.” Champerty is defined as “an agreement to divide litigation proceeds between the owner of the litigated claim and a party unrelated to the lawsuit who supports of helps enforce the claim.”[viii] The prohibition of champerty dated back to the Middle Ages in Europe to prevent feudal lords from funding their underlings to harass their rivals.[ix] Over time, lawmakers eventually allowed outside interests to fund expensive class actions.[x] These investors then began financing other cases, and the practice of litigation finance was reborn a century later with a new name.

Now, the motivation behind litigation finance must once again be examined. Are these third-party financers merely capitalizing on potential profits, or is there a hidden agenda? The financer is intended to be a passive outside investor with no control over the case. Questions regarding the influence of litigation financers as well as the proliferation of frivolous cases have yet to be answered, but there are concerns of how to regulate litigation finance and what disclosure requirements to impose.

Rule 26 of the Federal Rules of Civil Procedure requires disclosure of a range of information during litigation, but it does not require the disclosure of a litigation financing arrangement.[xi] The U.S. Chamber of Commerce proposed an amendment to Rule 26 to require parties to disclose the identity of a third-party financer and the terms of the agreement, but the Federal Rules Advisory Committee rejected the amendment, claiming that disclosure should be up to the litigant.[xii]

While the status quo in the court system is to restrain disclosure based on Rule 26, the legislature seems to disagree. The Litigation Funding Transparency Act of 2021 is a proposed bill to require plaintiffs to provide the court and other parties in class action lawsuits and federal multi-district litigation with any agreement that entitles an outside business to receive payment contingent on the lawsuit’s outcome, as well as the identity of the financer.[xiii] This bill would amend Title 28 of the United States Code to increase transparency and oversight of third-party litigation funding.[xiv] Although there are identical bills in both the House and Senate, there has been no action since October 2021.[xv]

Although action has stagnated for the time being, the push for transparency and oversight is far from over. When used appropriately, litigation finance can be an excellent tool for both litigants and investors alike. However, without regulation, meritless lawsuits may be advanced and congest court dockets, and third-party financers may influence claimants’ decisions. Courts and lawmakers will soon be forced to evaluate the future of litigation financing as the practice becomes more prevalent in lawsuits across the country.

[i] Fed. R. Civ. P. 1

[ii] John J. Hanley, United States: Litigation Finance 101, Mondaq Ltd. (May 14, 2021), https://www.mondaq.com/unitedstates/performance/1068204/litigation-finance-101.

[iii] A Loan Versus Litigation Finance: How They Differ, GLS Capital, https://www.glscap.com/loan-versus-litigation-finance/#:~:text=Litigation%20finance%20is%20an%20alternative,of%20any%20award%20or%20settlement (last visited Aug. 3, 2022).

[iv] Hanley, supra note at 2.

[v] Id.

[vi] Id.

[vii] Roy Strom, Big Law Warms Up to Litigation Finance as Deals Pot Hits $2.8B, Bloomberg Law (Mar. 23, 2022), https://news.bloomberglaw.com/business-and-practice/big-law-warms-up-to-litigation-finance-as-deals-pot-hits-2-8b.

[viii] Champerty, Black’s Law Dictionary (11th ed. 2019).

[ix] How Litigation Finance Works, Bloomberg Law (Feb. 24, 2020), https://pro.bloomberglaw.com/brief/how-litigation-finance-works/.

[x] Id.

[xi] Fed. R. Civ. P. 26

[xii] Another Effort To Amend Federal Rule 26 With A One-Size-Fits-All Litigation Finance Disclosure Requirement Does Not Persuade The Federal Rules Advisory Committee, Above the Law (Jan. 20, 2022), https://abovethelaw.com/2022/01/another-effort-to-amend-federal-rule-26-with-a-one-size-fits-all-litigation-finance-disclosure-requirement-does-not-persuade-the-federal-rules-advisory-committee/.

[xiii] Litigation Funding Transparency Act of 2021, H.R. 2025, 117th Cong. (2021); See also Litigation Funding Transparency Act of 2021, S.840, 117th Cong. (2021).

[xiv] Id.

[xv] H.R.2025- Litigation Funding Transparency Act 2021, https://www.congress.gov/bill/117th-congress/house-bill/2025/actions (last visited Aug. 3, 2022).