What is Litigation Finance?
Litigation finance, also called litigation funding or third party funding, is the provision of capital to a claimholder or law firm in exchange for a portion of the proceeds from litigation or arbitration. The key feature of litigation finance is that recourse is generally limited to the proceeds of the litigation/arbitration award or settlement, meaning that, the funded party only pays the litigation funder if the party successfully wins or settles its case.
Litigation finance redistributes all or a portion of the financial risk of litigation to the litigation funder. 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 or to pay down or refinance debt. Litigation finance thus frees up companies to allocate their capital resources to their highest and best use, investing in projects that optimize returns and promote economic growth.
There are many reasons why companies use litigation finance, including:
- 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 desire for off-balance sheet financing.
- Corporate opportunities that make it more advantageous for the business to allocate 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
- As a means of raising capital when the company’s underlying business has been damaged by the wrongdoing of another party and traditional capital sources are unable or unwilling to invest at a proper valuation until the dispute is resolved.
- To hedge risk
Litigation Funding 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 was 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, 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 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 of 1999. The 1999 Act made three important changes to the law. 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.
The U.K. 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.
To date, the law of litigation finance has largely been left to the states (see map below). 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.
Litigation Financing Arrangements (LFAs) in Canada
Litigation finance arrangements in Canada are gaining prominence. While Canada has in place in certain provinces (including Ontario) anti-champerty statutes that were thought to prohibit these arrangements, there has been a string of cases in recent years approving such arrangements. (Read about the first such case here). Canada shares certain features of the Australian and UK markets in that need for funding of class proceedings drove the initial demand for litigation funding and the Canadian rule that the loser pays costs has caused litigants to seek LFAs that transfer adverse cost risk to a funder. When asked to approve litigation finance arrangements (as is required to be done in the class action context , CCAA proceedings and has prophylactically been done in other commercial litigation) the Canadian courts have recognized that litigation finance can facilitate access to justice, but have also placed constraints on the size of the funders’ return (50% or less as a rule of thumb) and have required that funders do not control the litigation or settlement directly or indirectly and do not interfere with the attorney-client relationship or the attorney’s professional judgment and loyalty.
Third Party Funding in International Arbitration
Claimants in international arbitration have also recognized the benefit of litigation funding, particularly for long-running and expensive investor-state disputes. In 2017, Hong Kong and Singapore adopted legislation to permit third party funding for arbitrations seated there in order to compete with other commercial centers for arbitrations (New York, Paris, London) which already did not prohibit the practice of third-party funding. The use of funding in international arbitrations has stirred debate over various issues related to disclosure, conflicts of interest, privilege, and costs. The International Council for Commercial Arbitration and the Queen Mary University of London Task Force issued a report with recommendations on how tribunals should address these issues. The draft of the report is discussed here.
Third-party litigation funding provides benefit to plaintiffs, defendants, attorneys and law firms, and investors seeking to diversify their portfolios.
At its most basic level, litigation finance levels the legal playing field by providing resources to undercapitalized plaintiffs who otherwise could not pursue meritorious legal claims, or provides additional capital to in-progress cases where plaintiffs face funding shortages.
Strategically, litigation funding allows a party to better assign value to a claim, manage risk, optimize use of capital, and maintain operations, while deciding when and how to pursue meritorious litigation.
Specifically, litigation finance offers:
- Access to previously unavailable capital to pursue meritorious legal claims
- Access to premier legal talent that is otherwise inaccessible due to financial constraint
- Risk mitigation for the often long and costly litigation process
- An alternative to premature case settlement
Attorneys and Law Firms
- Opportunity to accept cases from underfunded claimholders
- Diversification in a portfolio of legal claims
- Additional resources needed for litigation expenses
- Access to new asset class
- Returns that are uncorrelated to capital markets
- Favorable historical returns compared with other alternative asset classes
- Moderate time to liquidity versus other alternative investments
Raising the Prospect of Litigation Finance with Clients
Third-party funding offers a number of benefits to claimholders who may lack funds to pursue litigation or who wish to hedge the risk associated with litigation (the two most oft-cited reasons to seek litigation finance per our survey). A lawyer may, but it is not obligated to, raise the prospect of litigation funding to a client as an option.
The American Bar Association’s Commission on Ethics 20/20 released an informational report on litigation finance, “if it is legal for a client to enter into the transaction, there would appear to be no reason to prohibit lawyers from informing clients of” the existence of litigation finance companies or referring clients to particular litigation funders.
Any potential conflict between her interest in having her fees paid and the client’s choice to use litigation funding, and any relationship with a funder, should be disclosed upfront, and informed consent should be obtained as necessary.
While some concerns of champerty may still exist, the prohibition on champerty–which has been defined by the U.S. Supreme Court as “[helping another prosecute a suit] in return for a financial interest in the outcome”– is fading in the United States where it ever existed at all. Federal law never adopted the prohibition, and most states either never adopted the prohibition, have abolished it, or construe the prohibition on champerty so narrowly that it would not normally apply to commercial litigation funding arrangements. Read more about champerty and ethics here.
Attorney-Client Privilege and Work-Product Protection
Communications with a funder are not per se protected by the attorney-client privilege, since the financier, while often comprised of trained attorneys, does not act as the client’s legal counsel. Whether or not the common-interest exception would apply is still unclear, as courts that have considered it are split on the issue.
The work-product doctrine usually protects most communications with a litigation funder or attorney analysis that would be pertinent to the funder’s analysis. Courts have repeatedly held this protection applies to communications with funders, particularly where there is an agreement in place to maintain confidentiality.
In 2015 this issue was examined in detail by The Delaware Court of Chancery, which held in Carlyle Investment Management LLC v. Moonmouth Company SA that the work-product doctrine protected the disclosure of communications regarding a litigation finance arrangement. The Court of Chancery reasoned that to convince a funder to provide financing, the claimholder would need to convince the funder of the merits of the case, which would necessarily involve sharing the “lawyers’ mental impressions, theories and strategies[.]” Similarly, the terms of the final agreement—such as the financing premium or acceptable settlement conditions—could reflect an analysis of the merits of the case. Ultimately, The Court of Chancery issued an apparent endorsement of the equalizing benefit of litigation funding.
Control of Litigation
Another concern often raised by lawyers is the degree of control the funder will exercise over the strategy of the case and whether that raises ethical issues. The guiding principle should be such that the lawyer should exercise independent professional judgement and render candid advice regardless of the involvement of a funder.
The Model Rules anticipate that a third party may pay the fees of another (think insurers for example) and instruct that a lawyer shall not permit a person who pays a lawyer for legal services on behalf of another to “regulate the lawyer’s professional judgment.” Model Rule 4.5(c).
While each litigation funding firm will have a slightly different process, there are generally-practiced steps in place to both protect the funding firm and the party who may receive funding.
Timing of Litigation Funding
Different litigation finance firms may have different requirements, but at Lake Whillans, we invest at any stage in both litigation and arbitration, from pre-filing to post-judgment.
During this first engagement, the funder discusses general information about the claim in order to quickly assess its fit within their portfolio of cases and to determine what due diligence steps to take. This is usually a phone call with the party and any attorneys already involved in the case.
It is not necessary to have a lawyer to approach a litigation funder. Sometimes a party may need funding in order to afford a good lawyer. But oftentimes lawyers are the ones to reach out to litigation funders.
The party and its lawyers should enter into a non-disclosure agreement (NDA) to ensure the confidentiality of information shared and maintain protection from discovery.
The funder now seeks to verify facts about the claim and to make sure it does indeed fit the portfolio of claims the investor is targeting. For example, a patent-infringement action will not be the same as a breach-of-contract claim. It is worth noting that:
- Due diligence factors to be examined will vary considerably depending on the case.
- Because the litigation financier has a different risk structure than a party to litigation, the funder is often better positioned to bear the substantial risk of litigation than the party is.
- Due diligence should be expeditious, and notice of a decision as timely, as practicable. At Lake Whillans, this is in our Code of Conduct.
- Depending on the funder, the complexity of the case, and the litigant’s situations, the timeframe for this process is often between one and two months.
You can read more about how litigation funders value a legal claim, but these are some of the factors:
- Probability of success on the merits
- The damages to investment ratio
- How long it is likely to take
- Risk factors outside of the litigation itself
Investment Terms and Documentation
At this point, no matter what happens, the business and its attorneys have a more thorough understanding of the merits, strengths, and weaknesses of the claim. With a successful due diligence process completed, the litigation funder now circulates proposed terms.
The party and its lawyers should look at the content of the terms — especially whether the funding is recourse or non-recourse and whether it is a percentage of the proceeds or a fixed amount. Non-recourse funding means that the party only pays if they receive a settlement or an award. They should also thoroughly review the finalized agreement, and expect to sign documents. A company should also consider these principles in seeking litigation funding and evaluating terms:
- Settlement Authority
- Reserve Capitalization
- Commitment to Fund
- Attorney Independence and Confidentiality
The way funding proceeds is dependent on the transaction structure the party and the funder agree to, and it can vary depending on the specifics of the underlying litigation.
It is common for the litigation financier to invest directly in the claimholder, and
provide separate funding for fees, expenses, and operations. There are many ways to customize transactions to fit a party’s needs and circumstances, for example: Lawyers may still also carry a contingent interest in the litigation or sometimes the claimholder prefers to pay a fixed return from an award or settlement rather than a percentage of it.
The party and its lawyers should look for access to funds against which they can charge
litigation fees and expenses, direct investment in the company, or both depending on the
transaction structure they arranged:
- if the party seeks operating funds, the litigation funder will invest directly in the business.
- If the party seeks litigation funds, the litigation funder creates an account against which to bill them.
The funder then monitors the case at a high level as it proceeds through court. They do not exercise control over what the attorneys or clients do beyond the terms of their agreement with the client.
The party and its lawyers should expect to keep the litigation funder appraised not of tactical legal matters but of any settlement or award.
If the party settles or obtains a favorable decision and receives an award, they then pay the litigation funder any amounts agreed upon, obtaining a return on their investment.
If the party obtains nothing, and the funding was non-recourse, the party pays nothing to the funder.
When a party or lawyer is ready to discuss litigation financing, it is helpful to know what to look for in litigation funding firms. Considerations in choosing a litigation financier include:
1. The Right Fit: The best results will be achieved when there is mutual trust, respect and a sense of partnership among the claimholder, its lawyers and the funder.
2. Unique Terms: While you may be offered broadly similar economic terms by different funders, each is likely to have certain terms that may be unique.
3. Flexibility in Structuring: Think about what structure the funder is offering and whether that structure best suits the needs of the claimholder.
4. Subject Matter Expertise Different funders tend to target different types of cases and industries, which leads to varying expertise among funders that can be valuable when paired with the right claimholder.
5. Speed: talk to potential funders upfront about their process and the time they expect it will take to get through diligence and investment documentation.
6. Reliability: You will want to be assured that the money is going to be there when you need it.
Our article on How To Choose A Litigation Funder goes into more detail on each of these considerations.
As courts and legislators around the world strive to keep pace with advances in technology and increasing complexity in business, the legal environment will continue to respond. As such, litigation funding promises to offer greater access to justice for those parties whose innovation is vital to a thriving economy.
Although litigation finance dates back to medieval England, it is still a young practice in its current form and will continue to evolve as more and more litigators choose to seek alternative financing opportunities for their clients.
You can find new and relevant content on litigation finance on our blog if you are interested in keeping up with this changing landscape.
Note: This page has been updated with new content to provide better context on the history and rapid growth of litigation finance.
If you or your client are considering litigation finance as an option, talking with us directly is the best way to determine if it is the right choice. We would be happy to discuss your case with you.