Litigation Funding: A Primer

Legal costs have long been a deterrent for people wanting to file lawsuits. In a country like America, the legal fees can be significant. A lot of good lawyers charge hourly fees. Many plaintiffs believe that in an hourly fee system, the lawyer is incentivized to drag the case for as long as possible. This is why clients prefer to pay a fixed retainer. Also, many times the law firm has to bear the expenses related to a case which is under trial. In such cases, law firms get paid off only after the case has been won and settlement amounts have been received.

However, there is another new type of financial arrangement which is used in financing lawsuits. This involves a third party and is called litigation financing. In this article, we will further explore the concept of litigation financing, its advantages as well as disadvantages.

What is Litigation Financing?

Litigation financing refers to an arrangement wherein a third party agrees to bear the legal fees related to a case in exchange for a bigger pay off later. Simply put, neither the plaintiff nor the law firms have to bear the cost of financing the lawsuit. Instead, there are specialized third-party investors who invest money by paying legal fees when a case is in progress. At the end of the case, if the side which is being backed by the investor wins, the investors get their payoff from the settlement money received. On the other hand, if the side which is being backed by the investor loses, the investors have to write down the losses with no recourse from either the plaintiff or the law firm.

Advantages of Litigation Funding

Some of the major advantages of litigation funding are listed below.

• High Returns: Litigation finance is known to provide extremely high returns to investors. This is why this field has been a favorite with institutional financers like investment banks. Of late, investors such as hedge funds have also shown interest in litigation financing. These high returns are primarily because of the low investment required compared to the high returns. If any corporation is found to be guilty, courts often order them to pay heavy damages. Investors are paid out a percentage of the final settlement. As a result, investors often end up with multiples of the initial investment that they had made. Only in cases, where the litigation time is very low, and the win is certain are the returns lower. Also, the risk involved in litigation finance is lower as compared to other investment classes.
• Not Correlated to Other Investments: From an investor’s point of view, litigation finance is a good investment because it isn’t related to any business cycles. Hence, during an economic downturn when the rest of the investments fall in value, litigation finance seems to be unaffected. In fact, during an economic downturn, the number of insolvencies increases. As a result, there is more litigation leading to more gains to investors. This is the reason why sophisticated investors have started hedging their portfolio with the help of litigation finance.
• Access to Judicial System: Litigation finance is good news from the consumer’s point of view as well. This is because litigation finance ensures that everybody has access to justice. Hence, even if a poor person has a good case, lawyers can take these cases with the help of a financier. The fear of litigation ensures that organizations create processes which are robust thereby avoiding inconvenience to the consumer community.
• Secondary Market: Lastly, litigation finance is not an illiquid asset class. Since there are a number of investors who buy such assets, it is possible to liquidate the investment. This means that financer A can sell their stake in a particular case to financer B. This provides investors with relief. It is good to know that if the case goes on for too long, investors can recover their funds by finding another buyer.

Disadvantages of Litigation Funding

Critics of litigation funding have highlighted a few disadvantages of this arrangement. The same have been listed below:

• Increased Regulation: The only problem with litigation financing is increased regulation. Most states in America make it mandatory to disclose any litigation financing interests involved. There are multiple levels of state and federal laws that litigation finance companies and law firms must comply with. Hence, the cost and effort involved while using litigation finance is not insignificant.
• Restrictions: In many states, there are restrictions as to who can provide litigation financing. These restrictions are because of a law which makes it illegal to share legal earnings with people who are not lawyers. In such cases, hedge funds and banks have to route their investments via a law firm.

The bottom line is that litigation financing is here to stay. In 2017 itself, the entire sector was worth more than $10 billion. Many funds have been created to take advantage of this opportunity. Estimates suggest that more than $2 billion have deployed in these funds. Hence, even with all the regulation involved, the business of litigation financing is expected to witness a major boom in the forthcoming years.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.