Volume 25, Issue 2

A common criticism of third-party litigation finance is that it can increase agency costs for litigants. One reason critics give for this is their belief that financiers will do something they are prohibited from doing: meddle in the litigant-lawyer relationship. But we think this gets things backwards. Because financiers cannot meddle in the litigation, they try instead to align their interests with the lawyers and the litigants. As we show here, although financiers do this imperfectly, the happy side effect of their efforts is very often to better align the litigants with their own lawyers. They do this by introducing hybrid fee arrangements that prior scholarship has shown to be superior to the contingency or hourly fees that litigants would have otherwise paid their lawyers. For these reasons, we believe much of the concern in the third-party litigation finance literature over exacerbated agency costs and who controls the litigation has been unfounded.

A recent dispute regarding a litigation funder’s right to veto the plaintiff’s proposed settlement of a funded claim provides an opportunity to consider what plaintiff-side funders can learn from the law governing liability insurers’ right to control the defense and settlement of lawsuits they insure. Liability insurance law supports the view that sophisticated plaintiffs should be permitted to assign settlement rights to their litigation funders, and those funders should be permitted to enforce that assignment through injunctions. More broadly, the article makes and supports the claim that liability insurance companies were the original commercial third-party litigation funders and, thus, liability insurance law provides useful precedents for courts deciding disputes in the context of the emerging plaintiff-side commercial third-party litigation funding market.

Third-party litigation funding (“TPLF”) is controversial. To its detractors, TPLF creates serious ethical and national security risks, and results in defendants paying out large “blackmail settlements” based on marginal (if not wholly frivolous) claims. To its supporters, TPLF helps ensure access to justice by putting plaintiffs and their lawyers on a more equal footing with well-resourced defendants, and the willingness of sophisticated third parties to invest their own money is an unambiguous signal that a plaintiff’s case has merit. Our Article makes three contributions: we begin by identifying the similarities in political economy of the campaign against TPLF to the campaigns waged in favor of tort reform. Second, we evaluate the substantive merits of certain arguments against TPLF, treating the rules of professional responsibility as instrumental, rather than ends in themselves. Finally, we explore the importance of agency costs in the market for TPLF. We conclude with some recommendations on how to regulate TPLF.

How much control may a third-party litigation funder exercise over the conduct of litigation by the funded party? The conventional answer is “none whatsoever,” and that litigation funders must be purely passive investors. From the point of view of the ethics of the lawyer-client relationship, however, I do not see a problem with the client having contractual relationships with third parties that have an impact on the client’s litigation strategy or otherwise on the instructions the client gives to the lawyer about its interests. Legal ethics similarly is not responsive to any duties of care—call them tort, fiduciary, or nonfiduciary norms of good faith and fair dealing—existing between the claim owner and a third-party funder. Lawyers should not second-guess these instructions and do not have duties of loyalty or independence to inquire into the reasons the client may have for encumbering its decision-making authority in one way or another. It is also an analytical mistake to import the protections for the lawyer-client fiduciary relationship into the relationship between the claim and a litigation funder. This is true whether the source of regulatory authority is principles of legal ethics or a common-law doctrine like champerty and maintenance. Following on a 2013 article co-authored with Professor Anthony Sebok, this Article contends that contract principles, including implied terms of good faith and fair dealing, are adequate to address the risks to both parties arising from litigation investment agreements.

Third-party legal finance is one of the most controversial modern developments in civil justice, both in the United States and across the globe. It is particularly controversial when mentioned in the same breath as aggregate litigation. Current debate trains on a series of repeated questions: whether and how to ban litigation finance in aggregate litigation; whether the use of litigation finance should be disclosed in discovery; and whether litigation finance is allowed under various (and often ancient) legal doctrines. Obscured from view is what I believe to be the most fundamental question: What is the proper role of litigation finance in the U.S. civil justice system, particularly for resolving aggregate disputes? Addressing this foundational question requires nuanced and in-depth analysis of the intersection between this new legal finance industry and the dynamics of the United States aggregate litigation landscape. This work is needed now: the outcry against litigation finance, aggregate litigation, and the prospect of the two combined has captured the attention of federal and state legislatures, judges, and rule-makers across the United States. With a few notable exceptions, though, input from complex litigation scholars has been scant. The nascency of the scholarship stands in stark contrast to the often fever-pitched calls for reform. This Article steps into the breach. Its analysis integrates our developing understanding of the third-party litigation finance industry with well-developed knowledge about the U.S. aggregate litigation landscape. This Article’s analysis reveals that many of the questions currently being debated most often might be misdirected, and it elucidates the “right” questions about third-party litigation finance in United States aggregate dispute resolution, which will help point scholars, lawmakers, and judges in the right direction.

Using a unique private dataset from one of the largest consumer litigation financing firms in the U.S., we are the first to explore the impact of states’ regulatory activity (statutory or judicial) on funders’ behavior and consumers’ welfare. Our comprehensive dataset includes data on over 105,000 third-party funding agreements from 2000 throughout 2020 and data we compiled ourselves from court decisions, state legislation, and regulatory actions. Our analysis shows that laws or court decisions that loosen restrictions on LTPF are generally associated with greater funding activity, while restrictions on the interest rate that funders can charge are generally associated with less funding activity. However, in the cases that are funded, the funder tries to circumvent restrictions on the funding agreement by altering other terms. For example, when legislation prohibits compounding or limits how long funders can charge interest, the funder responds by increasing the posted monthly interest rate. Although these interest rate increases are not enough to completely offset the impact of the other restrictions on the funder’s returns, the funder nevertheless has higher returns than it would have without the attempted circumvention. More generally, our analysis reveals that restrictive court rulings and regulations generally induce funders to either leave the jurisdiction or to adjust other terms in the funding agreement in an effort to maintain their returns. As in the classic Whac-A-Mole game, funders try to maintain their pre-regulation per-funding-return no matter how states’ regulatory activity tries to get rid of it. Although the funder is not always successful in circumventing regulation, policymakers must be aware of funders’ responses to restrictive regulation to ensure that policies are achieving their desired result.

A handful of states, including Texas, have Rules of Professional Responsibility which permit attorneys to provide cash advances to their own clients. In previous work, we suggested that if more states permitted law firms to offer this sort of funding to their clients it would increase competition within the consumer litigant funding market, to the benefit of consumers. We also hypothesized that relaxing these existing prohibitions would better enable tort claimants to decline low-ball settlement offers from defendants in one-off cases. This Article offers some initial insights into these questions. It reports the findings of our modest empirical study involving semi-structured interviews with four established Texas plaintiffs’ firms, each of which represents a large number of mass-tort claimants as well as varying numbers of single-event claimants. We obtained confidential information on the circumstances, frequency, and financial terms under which these sophisticated and well capitalized firms provide cash advances to their clients. We also sought information on each firm’s views on third-party advances to their clients, including their willingness and ability to negotiate repayment haircuts with third-party funders on behalf of their clients. We found great diversity among the four Texas firms in their approach to the opportunity provided by Texas Rule 1.08(d) to advance “reasonably necessary medical and living expenses” to their clients. Our findings suggest that clients are likely to benefit from – and are unlikely to be harmed by – a relaxation of the strict prohibition against attorney advances to their clients that exists in the vast majority of states and in ABA Model Rule 1.8(e).

Legal responses to litigation funding could take many forms—consumer protection, regulation of interest rates and fees, perhaps even prohibition (as under the old doctrines of champerty and maintenance). In the U.S., procedural responses, often emphasizing disclosure of funding, have featured prominently. From the perspective of one directly involved in the U.S. rulemaking effort, this Article explores the challenges of designing such a rule. Among other things, it notes that litigation funding actually could support important law-implementation features of American litigation. But a host of uncertainties mean that for the present, the future of mandated disclosure of funding remains unclear, as it also does in Europe.

The landscape of third-party litigation funding (TPLF) within the European Union is undergoing significant changes, characterized by growing market maturity and increased regulatory scrutiny. This Article examines recent advancements, including the European Parliament’s study and a preliminary analysis of TPLF in selected EU member states. It delves into critical areas such as capital adequacy requirements for funders, TPLF agreements, potential conflicts of interest, and the evolving role of courts in TPLF processes. The feasibility of the EU Parliament’s Proposal for a Directive, especially regarding the involvement of courts and restrictions on party autonomy in TPLF agreements, is questioned. In response, the European Law Institute (ELI) Principles are emerging as a guiding light for TPLF development in the EU.

Third-party funding is a global phenomenon, although regulatory enforcement is local. Regulatory approaches vary widely from country to country and within countries, especially in federal legal systems, such as Canada, Australia, and the United States. In Canada, the federal government has not regulated funding at all. In Australia, after a period of state- and province-based experimentation, the highest court took the lead on legalization and instructed the Australian Securities and Investments Commission (ASIC) to license funders at the federal level and promulgate guidelines regarding avoiding conflicts of interest. The U.S. federal government is learning about third-party funding with an eye toward potential future regulation. Congress has been investigating funding, as evidenced by testimony in congressional hearings, proposed federal legislation, and a nonpartisan study on third-party funding by the Government Accountability Office. In addition, the U.S. Federal Civil Rules Advisory Committee has considered changing the Federal Rules to address third-party funding and recently formed a committee to consider the question further. The U.S. federal government is taking these steps against a patchwork quilt of regulations in various U.S. states regarding third-party funding along a broad spectrum with many conflicting regulations. This Article explores how federalism affects third-party funding in the U.S. Specifically, it explores the likely effects of third-party funding regulation at the federal level, state level, or both, including examining significant benefits and concerns. Moreover, it predicts whether the U.S. federal government will regulate third-party funding and, if so, how. Finally, this Article does not present a normative argument but rather is a thought experiment that presents various benefits and drawbacks that the U.S. federal government should consider when deciding whether to regulate TPF directly.

Many meritorious claims do not reach the courts due to the prohibitive costs that are associated with access to justice. While third-party funding, through nonrecourse loans, is often available, the market cannot help all claims. For instance, where the claim lacks clear monetary value (e.g., an injunction), or has little monetary value, market-based funding seems futile. Inspired by the third-party funding industry, we suggest public, nonrecourse funding. Contingent public funding could broaden access to justice; more importantly, it could bridge the gap between the social and private benefits of the use of the legal system. While private funders are profit-driven, public funding could take into account societal considerations, which should be reflected by the interest on the loan. Lawsuits that provide positive societal benefits—e.g., by clarifying the law and creating important precedents—deserve a lower interest rate. We demonstrate our suggestion through a simple mechanism, which could easily be integrated into the current system—a conditional waiver of court fees. Under our proposal, at the beginning of a case, judges would be able to defer the payment of court fees. In that case, and similarly to third-party funding, losing lawsuits would be exempt from fees; however, successful plaintiffs would be obligated to pay those fees at the end of the case, multiplied by a certain factor that reflects its social value. We discuss the desirability of such a regime and the ways to mitigate notable concerns, such as a flood of weak cases.

Most of the scholarship that seeks to elucidate the ethical implications of litigation finance focuses on legal ethics. That is, most research has focused on how lawyers, judges, and litigants are influenced by the presence of litigation finance. This Article seeks to elucidate the business ethics implications of litigation finance. It argues that litigation finance can be seen as a mechanism to promote business ethics, making companies behave more in line with both legal and ethical norms. It does this because it creates a large incentive for companies to follow private and regulatory laws. As the probability of being sued and facing damages increases, companies rationally seek to invest in actions that are going to decrease the likelihood of litigation occurring. To do this, companies must invest in legal compliance and other workplace programs to decrease the potential of a lawsuit that ultimately have the effect of aligning a company’s behavior with ethical norms prescribed by business ethicists and management scholars. As an upshot, this Article seeks to bring litigation finance into business scholarship with the hope that nonlegal scholars will also begin to engage with this market phenomenon. Ultimately, it provides a novel reason why litigation finance should be encouraged and promoted by regulators, businesses, and the marketplace at large.

Litigation entails substantial expenses, such as attorney fees and payment to experts. Third-party litigation funding aids individuals and enterprises who lack the financial means to pursue legal action by providing financial support to cover these expenses in return for a portion of the gains. The current literature focuses on direct, for-profit funding. This Article extends the discussion to other funding opportunities. Among these, concealed litigation funding alludes to a scenario where a funder’s investment decreases the costs for one of the litigants, but without any direct transfer of funds. In return, the funder acquires an indirect advantage, such as reducing its own liability risk or the liability risk of its investors. Several jurisdictions restrict direct funding, citing concerns about increased litigation, decreasing incentives to settle, and interference with litigants’ case management. This Article highlights the potential consequences of regulating only direct, for-profit funding. It suggests that other forms of funding, such as donations or concealed funding, distort litigation incentives more than direct funding. As a result, restricting direct funding harms litigants who do not have access to concealed funding without solving the problems of excessive litigation and unwillingness to settle.