What is Litigation Finance?
Litigation finance (also called litigation funding) describes the provision of capital to a claimholder in exchange for a portion of the proceeds in a litigation or arbitration where recourse is limited to the proceeds of the litigation or arbitration at issue.
Litigation finance can help claimholders manage the costs and risks associated with bringing or defending a legal action. The capital provided by a litigation funder can be used not only to pay for the attorneys’ fees and expenses associated with prosecuting or defending a legal action, but also for business operations. Litigation funding is typically used by businesses facing one or more of the following challenges:
- A lack of financial resources to optimally prosecute or defend a litigation or arbitration; litigation finance affords companies the means to retain top legal talent. Read More
- A set of corporate opportunities that dictate that the business allocates its resources to projects other than the maintenance of a meritorious legal claim; litigation finance is a tool that helps businesses efficiently allocate resources to their highest and best use. Read More
- The company’s underlying business has been damaged by the wrongdoing of another party; capital is needed to sustain operations and/or growth, but traditional capital sources are unable or unwilling to invest at a proper valuation until the dispute is resolved.
History of Litigation Finance
Litigation Finance in Australia
Litigation funding, in its modern form, originated in Australia in the mid-1990s following the enactment of legislation permitting insolvency practitioners to enter into contracts to finance litigation characterized as company property. In response to this legislation, which recognized legal claims as a corporate asset, litigation funding companies began to spring up to service this new niche market.
The rise of litigation funding in Australia was also spurred on by the legalization of class-action lawsuits, which were introduced into the Australian legal landscape in 1992 as courts recognized the need for an efficient way to deal with group claims. Some litigation funders began to enter the class-action arena, though many were initially hesitant for fear that funding arrangements that did not fall under the specific permissions of the insolvency statute would be struck down.
Those concerns were allayed, and the widespread use of litigation financing enabled, in 2006 when the Australian High Court held that third-party litigation funding arrangements served a legitimate purpose in lawsuits and were not an abuse of process or contrary to public policy. With litigation funding now legitimized and the use of class-action lawsuits on the rise, litigation finance became a useful product. Today, nearly all major class actions in Australia are funded by private litigation finance companies.
The United Kingdom Adopts Litigation Funding
The rise of litigation financing in the United Kingdom occurred around the same period but took a different path following the passage of two significant pieces of legislation. First, the Criminal Law Act of 1967 decriminalized maintenance and champerty—two archaic laws that had long served as legal bars to third-party litigation funding —and did away with tort liability stemming from those legal doctrines.
Second, in 1990, Parliament passed the Courts and Legal Services Act, which made it legal for clients and lawyers to enter into conditional fee agreements (CFAs). Such “no-win, no-fee” arrangements were not previously permitted in the U.K. The removal of the CFA ban implicitly introduced the concept of litigation financing, as lawyers could now technically fund litigations with their time and skill in exchange for a share of the recovery. CFAs allowed clients, previously too cash-strapped to sue, the ability to go forward because a third party was now footing the bill. Together with the abolition of champerty and maintenance, the 1990 act opened the door to what would become modern litigation financing in the U.K.
The widespread rise of litigation financing came after the passage of the Access to Justice Act 1999, which was intended to offer alternatives to the traditional means of litigation funding in the U.K., which at the time were CFAs. It did so in three important ways. First, it excluded personal injury cases from receiving civil legal aid, on the premise that CFAs were a means for these litigants to obtain the third-party funding necessary to bring suit. Second, it allowed successful litigants to pass the success fees and insurance premiums associated with CFAs on to their opponents under the U.K.’s “loser pays” rule, which provides that the losing party must pay the winning party’s attorney’s fees. Third, it introduced After the Event (ATE) insurance, which allowed litigants to insure against the possibility of having to pay their opponent’s legal fees under the “loser pays” rule in the event that a case was unsuccessful. The combination of widespread “no-win, no-fee” arrangements and the ability to pass off an opponent’s legal fees under ATEs meant that litigants could essentially have all aspects of their suits funded by third parties, regardless of whether they won or lost. With these developments, a specialized litigation finance industry began to emerge.
Shortly after the passage of the 1999 Act, the courts all but endorsed litigation financing in a 2002 decision, stating that only funding arrangements meant to “undermine the ends of justice” should be viewed as unlawful. With the door to litigation funding now open, specialized litigation finance companies began to populate what has become a vibrant market for claim funding.
Litigation Financing Develops in the United States
Prior to the mid-2000s, the U.S. litigation financing industry was largely limited to personal injury cases. Specialized commercial litigation funding originated in 2006, when Credit Suisse Securities founded a litigation risk strategies unit (which has since disbanded). In recent years, the commercial litigation finance market has grown significantly and is now used by companies and law firms alike as a means to finance legal claims, raise capital and eliminate risk from the balance sheet.
To date, the law of litigation finance has largely been left to the states; Congress took an interest in early 2015 when it sought information from certain litigation funders, but has not acted since. At the state level, the trend continues to move towards normalizing the use of litigation finance in commercial litigation and arbitration. In states where champerty and maintenance were once utilized doctrines, the trend continues towards limiting their application to commercial funding arrangements, for example, as Delaware did in December of 2015. Courts have also recognized protection from disclosure for communications between funders and litigants and their counsel, most often as an extension of the work product doctrine. For more on these types of ethical issues, read our Ethics Q & A.
More on litigation finance at our FAQ page or visit these additional resources:
American Bar Association Commission on Ethics 20/20 White Paper on Alternative Litigation Finance
Anthony Sebok, The Inauthentic Claim, Vanderbilt Law Review (2011)
Steven Garber, Alternative Litigation Financing in the United States