Second post in a series on social inflation and litigation funding
Litigation funding – in which third parties assume all or part of the cost of a lawsuit exchange for an agreed-upon percentage of the settlement – is often cited as contributing to social inflation. But, like so much else associated with social inflation, it’s unclear how widespread the practice is.
With historical roots in Australia and the United Kingdom, funding of lawsuits by investors has taken hold in the United States in recent years. On the positive side, it can let plaintiffs employ experts to develop effective strategies – options once only available to large corporate defendants.
But it also can contribute to cases making it to court based more on investor expectations than on plaintiffs’ best interests.
Erosion of common-law prohibitions
Litigation finance was once widely prohibited. The relevant legal doctrine – called “champerty” or “maintenance” – originated in France and arrived in the United States by way of British common law. The original purpose of champerty prohibitions – according to an analysis by Steptoe, an international law firm – was to prevent financial speculation in lawsuits, and it was rooted in a general mistrust of litigation and money lending.
There’s an irony here, in that a major societal force driving social inflation today – distrust of corporations and litigation – once motivated the prohibition of a practice now widely associated with the phenomenon.
These bans have been eroded in recent decades, leading to increases in litigation funding.
“If you are trying to understand how we got here, I would say start in the 1990s,” says Victoria Shannon Sahani, a professor of law at the Arizona State University Sandra Day O’Connor College of Law. “The United States isn’t really a big player on the scene yet, but you’ve got Australia and the United Kingdom independently making moves in their legislatures that paved the way for litigation funding to become more prevalent.”
Between 1992 and 2006, Sahani says, “It was sort of the Wild West of Australian law in the sense that if you engaged in litigation funding, you always ran the risk that your agreement might be challenged.”
In 2006, the High Court of Australia provided clarity, saying litigation funding was permitted in jurisdictions that had abolished maintenance and champerty as crimes and torts. It was even acceptable for a funder to influence key case decisions.
The practice took time to gain traction in the United States because champerty prohibitions are left to states. Some have abandoned their anti-champerty laws over the past two decades. Some, like New York, have adopted “safe harbors” that exempt transactions above a certain dollar amount from the reach of the champerty laws.
“Given the stakes involve in many cases, it will be interesting to see whether litigation funders refrain from direct involvement.”
– David Corum, vice president, Insurance Research Council
Uncertainty as to market size
There is no consensus as to how much investors spend on U.S. lawsuits each year, according to Bloomberg law, “but it is not $85 billion, a number recently put forward as the ‘addressable market’ for litigation finance by a publicly traded litigation financier.”
That’s because the industry spent only about 2.7% of $85 billion during a 12-month span that started in mid-2018, according to a Westfleet Advisors survey.
“Does that low penetration rate portend explosive growth ahead?” Bloomberg Law asks. “Or is it an indication that litigation finance is a niche product most plaintiffs and lawyers find unnecessary?”
A key determinant of growth may be the willingness of funders to remain uninvolved in managing cases, said David Corum, vice president with the Insurance Research Council: “Given the stakes involve in many cases, it will be interesting to see whether litigation funders refrain from direct involvement.”
Benefit, bane, or both?
While funders tout the “David versus Goliath” aspect of helping small plaintiffs against corporations, opponents worry about introducing profit into a process that is supposed to aim at a just outcome. A settlement may be rejected because of pressure exerted by profit-seeking funders, and a plaintiff may walk away with nothing if the trial goes against them, opponents say.
Laura Lazarczyk, executive vice president and chief legal officer for Zurich North America, called litigation funding “abusive” and said harm “will be largely borne by insurers in defense costs and indemnity payments and by policyholders in uncovered losses and higher premiums.”
Critics also decry a lack of transparency. While the U.S. District Court for New Jersey held that third-party funding must be disclosed, attempts to pass federal disclosure legislation have been unsuccessful.
“It’s a multibillion industry with no regulation and no requirements for transparency,” said Page C. Faulk, senior vice president of legal reform initiatives at the U.S. Chamber of Commerce. “It is essentially turning our U.S. courtrooms into casinos, which is why the chamber is calling for disclosure.”
Such concerns led the American Bar Association last year to approve best practices for firms engaging in litigation funding. The resolution is silent on disclosure, but it urges lawyers to be prepared for scrutiny. It also cautions them against giving funders advice about a case’s merits, warning that this could raise concerns about the waiver of attorney-client privilege and expose lawyers to claims that they have an obligation to update this guidance as the litigation develops.
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