The world of lawsuits and investment has witnessed its new curveball.
In a legal dispute, too often, a party clearly in the right has to regrettably fold because it could not rival the party who could afford to fight for a longer period. It will be a cold day in hell before a common plaintiff can successfully bear the cost of the lawyer’s fees, loads of paperwork, diversion of integral resources, research, and miscellaneous activities for years on end. So, does this financial constraint imply the end of litigation?
Not with the entrance of ‘Litigation Financing'. Though still a rising phenomenon, it has been in practice for several decades. In essence, it refers to third-party funding of some or all the legal expenses required in a legal dispute in exchange for a fraction of monetary returns that are recovered from the proceedings. Before sliding further into it, it is imperative we discern that this financing is not a “lawsuit loan” (although some refer to it as one). Rather, it is non-recourse finance i.e., if the claimant loses, he/she along with the litigation funder receive a null amount and may even have to pay the defendant. However, because of the high risk, the third-party financiers can earn as much as four or five times their principal investment.
The idea of a third-party profiting from litigation that does not concern it directly or indirectly has been around since the medieval period. English feudal lords would engage in frivolous actions to put off their competition by financing inoperative lawsuits and overburdening the courts. Laws regulating Third-Party Funding (TPF), namely, maintenance (i.e., financially supporting defending individuals in legal proceedings without having any interest in the matter) and champerty (i.e., a more aggravated form of maintenance where one is funding litigations for profit) have been enforced to discourage whimsical litigation and to prevent extortion and harassment by wealthy funders.
However, the world is no longer controlled by feudal lords. Courts have restricted the use of these archaic laws to promote TPF. For instance, a Delaware Superior Court judge refused to constitute champerty or maintenance on a plaintiff who was in an agreement with Burford Capital, a litigation financier, because the plaintiff was a bona fide owner of the claim, and that Burford had no active hand in stirring up the claim or litigation. Thus, Burford Capital continued to fund the expense of the legal dispute for a % interest in any future proceeds.
Where there is money involved, rarely does the funder invest without certain prerequisites. When assessing a claimant's case for litigation funding, a funder focuses on certain essentials. Initially, the merits of the claim are to be assessed. This is the initial step in determining the type of case, its significance, and understanding the complications in the case.
Moreover, analysing the claimant is almost as crucial as analysing the case because the funder must ensure that the claimant is appropriately involved in the case.
Next comes the legal representation: the financier reviews the legal team to ensure that both the plaintiff and the legal firm are on the same plane and have the same interests.
Fourth, the budget: there is a cap on the amount of funding that differs from firm to firm, which when overrun is on the claimant or the counsel.
Fifth, expected damages that would be incurred in case the legal verdict is not in their client’s favour and whether the reward would be higher than the funding.
Sixth, ensuring that the client does not settle for an out-of-court settlement as it would be a nightmare and a sunk cost for the funder. Lastly, funders would prefer to invest in cases that seem to have a quick resolution over a dispute that would be highly prolonged as it will only increase uncertainties and impede the chances of getting their returns.
Investors consider litigation financing to be an attractive option because it is far removed from business cycles. During recessionary phases, while other investors suffer from a lack of benefits on investment, litigation funders seem unaffected.
Burford Capital has generated an ROIC of 92% and an Internal Rate of Return (IRR) of 30% from the $831 million they invested since 2009 whereas Litigation Capital Management reported an ROIC of 135% and an IRR of 78%. These high returns, albeit with a high risk, have made litigation financing much more beguiling for investors. Plaintiffs, too, have a well-meaning reason to pursue legal funding. Undercapitalised claimants can fight meritorious cases and get justice against defendants with a lot of capital. Having more liquidity of working capital allows plaintiffs to have greater access to top legal firms in order to strengthen their cases. Therefore, this funding is a boon to both the funder and the funded.
The colossal problem is that most people are still unaware of litigation financing. The question of whether it’s legal or illegal remains. Proponents of TPF say that many litigants do not have access to funds and funding them is an appeal to justice. However, the uncertainty on whether funders would be keen on investing in smaller cases or would keep an eye on the bigger ones persists. Nonetheless, firms’ inclination towards litigation financing has only increased and with the required regulatory framework, this industry has the potential to grow way higher.