Litigation Finance: The Problems with Betting on Justice

Litigation Finance: The Problems with Betting on Justice

James Grant Sharp, KLJ Staff Editor[1]

In recent years, litigation finance has grown from a rare practice to a booming new investment opportunity.[2] However, many people, lawyers included, are unfamiliar with this industry.

What exactly is litigation finance? Broadly speaking, litigation finance describes the situation in which a third-party financier provides funding to a plaintiff in exchange for a financial stake in the outcome of the plaintiff’s case.[3] The financing is generally structured as a non-recourse cash advance, meaning that if the financed party is unsuccessful in receiving a settlement or judgment in its favor, the financier gets nothing.[4]

Proponents of litigation financing argue that it provides justice to cash-strapped personal injury plaintiffs[5] and provides corporations the funds necessary for the growing cost of complex litigation.[6] Although this practice has undoubted benefits in increasing access to the legal system, it also raises a number of complex problems. These problems include possible prejudice to the attorney-client privilege, an increase in frivolous lawsuits, and the influence of financiers on a plaintiff’s decision to settle.

Another notable problem is the extraordinarily high interest rates litigation financiers often charge plaintiffs. Typically, usury laws protect consumers from high interest rates on loans, but these laws usually only apply when the debtor has an absolute obligation to repay.[7] Litigation financiers may escape these limitations because their financing does not create an absolute obligation to repay and only requires repayment if the debtor receives a settlement or judgment.[8] As such, and due to the vulnerable nature of cash-strapped plaintiffs, litigation financiers often charge interest rates in excess of 100% annually.[9]

Fortunately for consumers, various jurisdictions are seeking to remedy this situation. In 2015, the Colorado Supreme Court found that litigation financing was akin to a loan, and, as such, subject to the state’s consumer protection laws.[10] Also in 2015, a number of state legislatures began considering regulating the industry.[11] In 2011, the Kentucky legislature considered its own bill that would provide litigation finance consumers with some protections.[12] One criticism of the bill was that it did not cap interest rates; unfortunately, Rep. Jeff Hoover’s (R-Jamestown), proposed amendment that capped rates at 36% annually was defeated.[13] Regardless, the bill eventually died in the legislature, leaving Kentucky without any meaningful regulation of litigation finance.[14]

Ultimately, the rise of litigation finance should be applauded. It both increases access to the courts and provides a new investment opportunity. However, much like the rise of any new industry, litigation finance brings with it a number of complicated issues. Hopefully, these issues will be dealt with in a thoughtful manner that both allows access and protects those seeking financing, while also allowing financiers to get their cut.

[1] J.D. expected May 2017.
[2] See Tom Bailey, Litigation Finance on the Rise, World Fin. (Jan. 13, 2016), http://www.worldfinance.com/wealth-management/the-rise-of-litigation-finance.
[3] ABA Comm’n on Ethics 20/20, Informational Report to the House of Delegates (2012).
[4] Courtney R. Barksdale, All That Glitters Isn’t Gold: Analyzing the Costs and Benefits of Litigation Finance, 26 Rev. Litig. 707, 713 (2007).
[5] Id. at 733-34.
[6] See Mattathias Schwartz, Should You Be Allowed to Invest in a Lawsuit?, N.Y. Times Mag. (Oct. 22, 2015), http://www.nytimes.com/2015/10/25/magazine/should-you-be-allowed-to-invest-in-a-lawsuit.html?_r=0.
[7] Susan Lorde Martin, The Litigation Financing Industry: The Wild West of Finance Should be Tamed Not Outlawed, 10 Fordham J. Corp. & Fin. L. 55, 58-59 (2004).
[8] See Id. at 59.
[9] See Martin Merzer, Cash-now Promise of Lawsuit Loans Under Fire, Fox Bus. (Apr. 19, 2013), http://www.foxbusiness.com/features/2013/03/29/cash-now-promise-lawsuit-loans-under-fire.html.
[10] Daniel Fisher, Lawsuit Finance Contracts Are Loans, Colorado Supreme Court Rules, Forbes (Nov. 16, 2015), http://www.forbes.com/sites/danielfisher/2015/11/16/lawsuit-finance-contracts-are-loans-colorado-supreme-court-rules/#6ea8eceb42d6.
[11] Heather Morton, Litigation or Lawsuit Funding Transactions 2015 Legislation, Nat’l Conf. of St. Legis. (Jan. 8, 2016), http://www.ncsl.org/research/financial-services-and-commerce/litigation-or-lawsuit-funding-transactions-2015-legislation.aspx#Resources
[12] John Cheves, Regulation of ‘Lawsuit Funding’ Industry Faces Uncertain Future in Senate, Lexington Herald-Leader (Mar. 2, 2011), http://www.kentucky.com/news/politics-government/article44082204.html.
[13] H.B. 412, 2011  Gen. Assemb., Reg. Sess. (Ky. 2011) (text and history of bill found at at http://www.lrc.ky.gov/record/11rs/hb412.htm).
[14] Id.
*Featured image by Gage Skidmore, licensed under CC BY-SA 2.0.