Third Party Litigation Financing — Access to Justice or Something Else

The forms, forums and financiers of litigation in The United States have changed and are changing.   Although many lawyers particularly those practicing in small firms and government agencies which are most of the lawyers in Maryland may be generally aware of the emergence of a new capital market in which third parties provide financing for large commercial litigation and arbitration claims, they probably are not aware of the evolution, growth, and extent of those markets.  These comparatively new markets are situated in the financial sector of our economy.  They are known as “commercial litigation financing” (CLF).

Charles M. Agee II who is the CEO of WestFleet Advisors, a firm which by its own description “specializes in advising law firms and companies about litigation financing” in an article appearing in the November/December 2014 edition of Law Practice Journal entitled “Litigation Financing: A Business Development Opportunity” explains that in “CLF Transactions, a third party provides financing to a plaintiff or defendant — in a legal claim in exchange for a financial interest in the plaintiff’s recovery (or the defendant’s savings relative to its downside)” .  He further specifies that “financing proceeds are typically used to pay legal fees and expenses of litigation” and a client’s obligation to repay financing is contingent upon a “successful outcome”, i.e. a CLF provider stands to lose its entire investment of the claim is disposed of “unfavorably”.

This form of third-party litigation financing is not the classic or original form of third-party litigation financing which has existed in The United States.  The “cash-advance industry” as it has been labeled by among others, Steven Garber in a Rand Corporation Study, has been on the scene since the 1980’s and is much more familiar and better understood than the later models by average practitioners.  This form of third-party litigation financing offers pre-settlement funding agreements that are loans usually of a few thousand dollars ($2,000-$5,000) to personal injury victims while their lawsuits are pending.  This early method of third-party litigation financing was supplemented in the 1980’s by what Susan Lord Martin and Daniel C. Cox describe as the “syndicated lawsuit” in which plaintiffs could directly solicit individual lenders to invest in claims and share proportionally in the recovery.  Both of these forms of third-party litigation financing usually were “non-recourse loans” because the plaintiff only needed to pay back the loan if the lawsuit was “successful”.

The scale of these early models of third-party litigation financing ranged from a few thousand dollars for the “cash advance” loans to plaintiffs to the shared recoveries maxing out at the low hundred thousands in the “syndicated lawsuit” model.  The scale of these operations are now dwarfed by the new breed of third –party that has evolved in the United States.

Large litigation finance corporations now exist that will provide capital in exchange for a share of the eventual recovery by a corporate plaintiff.  According to legal researcher Jason Lyon, in an article entitled “Revolution in Progress: Third- Party Funding of American Litigation” in 58 UCLA Law Review (2010).  These new litigation finance corporations “routinely loan several million dollars in exchange for shares of recoveries that can be in the billion-dollars range”.

Is this good or bad?  Like so many issues, the threshold answer to this question is the lawyers response — It depends!  (In this case mostly on who you talk to).

The legal status of third-party litigation finance in the United Sates is not clear.  For centuries almost every states’ common law in effect prohibited third-party litigation financing by the doctrines of “maintenance” and “champerty”.  “Maintenance” is the provision of support for a lawsuit to which one is not a party.  “Champerty” which is a form of maintenance involves acquiring an interest in the recovery from the lawsuit.

Current laws and attorney disciplinary rules regarding maintenance and champerty vary from state to state and are in flux both in legislatures and courts in almost all them of the including Maryland where the issue of the ownership law firms by non-lawyers sometimes gets into the mix.

This is not to say that third-party litigation financing does not have substantial support in some quarters from both practitioners and legal scholars if not regulatory authorities.  In a nutshell the basis for their support is that third-party financing of litigation can reduce barriers to justice that result when risk-adverse, financially constrained plaintiffs are pitted against risk-neutral, well financed defendants.  By relieving a risk-adverse plaintiff of much of the litigation risk, third party financing can offset a risk- neutral defendant’s bargaining advantage and level the playing field in negotiations.

The scholars who make this argument and offer this theory may have a point, but there is a flip side to this argument that in effect suggests it is a theory in search of facts to support it and that reality turns the theory on its head.

We will explore whether that is the case in future columns with both a legal and economic analysis of that reality.