Third-Party Litigation Funding
Abrams, David S., Regulation
Imagine a world where, in addition to investing in shares of corporations or trading oil futures, markets existed that allowed for the exchange of litigation shares. In this world, an individual with a legal claim would benefit by obtaining funding for the claim and reduce the risk from an adverse verdict. Investors would be able to diversify through portfolios of litigation shares spread across a variety of locales and legal doctrines. They might particularly focus investment in areas where the law is most uncertain, which could otherwise deter risk-averse plaintiffs.
Would such a world result in the encouragement of frivolous suits, excess litigation, and unethical attorney behavior? Until now there has been virtually no empirical research to answer those basic questions. This should come as no great surprise, as pure litigation trading markets as described above still do not exist. But recent developments in legal systems allow us to begin addressing these questions for the first time.
In a new working paper that I've co-authored with Duke University law and economics professor Daniel L. Chen, we make an initial investigation into the way third-party funding has functioned in Australia. We use data from the largest Australian litigation funder, the Australian courts, and citation information to begin to understand how third-party funding can affect the legal environment.
Developments| Several recent legal changes in different countries have moved our world closer to the one described above. The 2006 Fostif decision by the Australian Supreme Court legalized third-party litigation funding in that country. Australia also became the first in the world to have a publicly traded law firm. Just last month a new law went into effect in England that will allow non-lawyers to be part-owners of law firms for the first time. In the United States there has been tremendous growth in the past several years in the fledgling alternative litigation finance (ALF) industry and discussions about prospective legal reforms that could promote it.
In the United States, as in countries with common-law legal systems, the doctrines of maintenance and champerty have long prohibited outside financing of litigation. Those doctrines, with medieval origin, prohibit entities without interest in a legal proceeding to be able to share in its proceeds. The rationale for the prohibition is sensible: one might worry that justice could be perverted by wealthy outsiders bribing lawyers and plaintiffs to bring false claims. But in an era where defendants may have substantial resources themselves or have backing from well-financed insurers, there is concern that the expense of litigation may deter the pursuit of worthy claims.
The type of ALF that I investigate is third-party litigation funding, where an entity unrelated to the parties or attorneys provides funding to the plaintiff in return for some share of the eventual settlement or jury award. Deals are usually structured so that the plaintiff maintains at least a third of the settlement (and usually over 50 percent) in order to ensure that the interests of the funder and plaintiff are aligned. This way, the plaintiff still has strong incentive to produce evidence, assist attorneys in the preparation of the case, and provide testimony.
One of the great promises of ALF is that it may provide a mechanism for financing legitimate claims that would not otherwise be possible. In this way, third-party funding could work in favor of the pursuit of justice. For example, poor or credit-constrained plaintiffs may have worthy claims, but lack the funding to pursue them. A third-party funder could provide the resources necessary to allow these cases to proceed. Even entities that do not lack funds may be unwilling to pursue potentially valuable claims if they are risk-averse. A risk-neutral funder could vastly reduce the uncertainty in the outcome by providing a floor for the settlement and thus making it worthwhile to pursue the claim. …