Investing in litigation: Gambling on civil claims

By Lauren McNitt

ProducersWEB


Lawsuits are expensive. Really expensive. In cases with expert testimony and scientific evidence, the amount can be in the hundreds of thousands.

Therefore, it is no surprise that many individuals, despite having meritorious claims, cannot afford to pursue civil action.

Not for long. Investors, attracted by the opportunity to make a profit, are swooping in to lend these plaintiffs the funds to pursue their claims. And with this trend comes a controversy on the ethics of such investments.

As the New York Times titled their series on the outcome of an investigation into the practice, these investors are literally “betting on justice.” And something about that sounds ethically questionable.

But, there are several sides to any controversy.

As the practice of lending money to attorneys and plaintiffs to bankroll civil suits increases in popularity, so does the outcry against the practice. For example, the U.S. Chamber’s Institute of Legal Reform (ILR) in its paper "Selling Lawsuits, Buying Trouble: Third-Party Litigation Funding in the United States,” says the following issues are present:
  • Third-party financing prolongs litigation: It may encourage claimants to reject a reasonable settlement offer because of the obligation to pay back the loan plus interest to the lender. Additionally, third-party lenders will expect the settlement to reimburse their investment, and enable them to gain a profit from the investment.
  • Third-party investing reduces claimants’ risk of testing questionable claims in court, and lenders will hedge against risk by demanding a larger percentage of the settlement in cases of questionable claims.
  • Third-party financing raises questions regarding attorney-client privilege and the investor’s place in that relationship.
  • Third-party funding poses risks of abuse to class and mass action suits. By helping potential plaintiffs with their expenses, third-party funding encourages attorneys to test questionable claims at trial. Attorneys may anticipate that the financial devastation of a potential loss at trial will lead defendants to settle rather than risk all at trial.
An Inside Counsel magazine article brings up a few more issues:
  • Champerty laws: These laws restrict buying an interest in someone else’s litigation. However, most jurisdictions no longer have such laws.
  • The hedge fund must “remain a passive investor” and “respect attorney-client and work-product privilege.” This seems somewhat unrealistic: Given the investor just put a large sum of money into the case, it is reasonable to expect they will want to know each detail of the case as it progresses.
The New York Times in collaboration with the Center for Public Integrity investigated third-party funding in the U.S. to date. The first article on the outcome of their investigation sheds light on a few more problems:
  • High interest rates on the loans, often exceeding 15 percent per year, result in costs that at times exceed the winnings. Additionally, lawyers who borrow from investors (rather than the client borrowing the funds) are allowed to bill clients for the interest payments in most states.
  • Lawyers are not required to disclose to clients that they have borrowed money. The client, therefore, may have no clue that the lawyer is under financial pressure to resolve the case quickly.
  • In most cases, the borrower is expected to pay even if they lose their case.
  • Cases can be initiated and controlled by investors, although the article gives an example where a judge discovered this and ordered the investor to pay the defendant's legal fees.
  • Investors are not bound by attorney-client privilege. If a client or lawyer shares private information about the case with an investor, it is no longer protected and a judge can order the information be given to the defendant.
If benefits to investing in lawsuits didn't extend beyond a simple profit for investors, then the practice would not be gaining in popularity in the U.S., particularly among corporate plaintiffs. Additional benefits include:
  • Third-party financing allows plaintiffs with limited funds to compete with corporate defendants with more resources at their disposal. In theory, these cases are more likely to be decided on merit than resources since the investor’s money levels the playing field.
  • Investors are unlikely to fund cases where the merits are questionable, since they will be less likely to see a return on their investment.
  • Large commercial litigation is expensive. The option of giving a percentage of winnings to an investor is more attractive than giving the legal department a multi-million dollar budget for one suit.
  • Third-party funding allows individuals to pursue claims that they would not have the money to litigate otherwise.
So, while at this point the cons appear to outweigh the pros, witnessing the progression of third-party litigation funding should be interesting. While none of us want our society to become even more litigious than it already is, we do want everyone to have a fair shot at obtaining compensation if they’ve been wronged.