February 1, 2022
Is litigation finance a good thing for our legal system? On the one hand, it seems plain that litigation finance promotes access to the courts: parties with strong claims but small pocketbooks can now obtain great legal representation. On the other hand, some critics of litigation finance contend, in effect, that it results in too much access to the courts. Litigation finance, they claim, causes parties to file frivolous lawsuits.
Policymakers considering whether and how to regulate litigation finance need to examine all of litigation finance’s welfare effects. In this blog post, we look at how litigation finance may affect parties’ behavior after a legal claim accrues. In a later post, we’ll look at how funding might affect parties’ behavior before a claim ever arises.
Whether and Which Legal Claims Are Brought
Discussions about funding normally begin with the premise that more litigation finance means more lawsuits. This conclusion may seem intuitive. After all, litigation funding removes a financial barrier that precludes some claimholders from accessing the justice system.
But the story is considerably more complex.
Commercial litigation financers reject the vast majority (ninety percent or more) of funding requests they receive. And as our previous post explained, litigants have other ways to finance their litigation, including through contingency fees, or through debt or equity financing. It is likely that in the absence of funding, some, perhaps most, of the cases that funders currently finance would be litigated by a law firm in exchange for a contingent fee. Thus funding may not necessarily cause a significant increase in the number of cases that are filed. (This doesn’t mean funding has no impact on how cases are litigated; more on that below.)
Meanwhile, litigation finance may deter companies from breaching their contracts or committing wrongs in the first place. A subsequent blog post will explore this phenomenon in greater detail. If that’s true, then litigation finance may, in at least some ways, result in less rather than more litigation, since fewer actionable wrongs may be committed in the first instance.
Finally, given how stringently funders evaluate cases, funding may also act as a signal to claimholders and law firms who fail to secure funding. The failure to secure funding may indicate that a case is too weak to proceed, and thus may discourage these claimholders and their lawyers from self-financing the matter. In this way, too, litigation funding may result in a decrease in the amount of litigation.
In short, litigation finance’s net effect on the total amount of litigation in our system is unclear. Litigation finance may not necessarily result in a net increase in litigation, and indeed it might even cause a net decline in the number of cases filed.
How Claims Are Litigated and Resolved
This does not mean litigation finance has no effect on how cases are litigated.
For those relatively few cases that are strong enough to secure funding, litigation finance allows the claimant to hire the best lawyers and deploy the best litigation strategy. Many of the country’s best law firms are unable to litigate matters on a full contingency, but they are able to take on matters where a funder pays some or all of the firm’s legal fees. Thus, litigation finance expands the universe of law firms that can litigate plaintiff-side matters by helping to create a “partial contingency” market. Litigation finance also enables claimholders to access higher-quality support services, such as experts they need to maximize their claim’s value. Meritorious cases may therefore resolve more quickly and at less expense as defendants faced with stronger plaintiffs may be more willing to settle for the true value of the plaintiff’s claim.
The Price of Legal Services
Litigation finance is also likely to affect the price of legal services by introducing increased price competition into the market. With more law firms able to take cases on a partial contingency basis, clients can enjoy the benefit of more competition and lower pricing. Lawyers are also in competition with litigation financiers for the right to provide the capital needed to litigate a matter. Moreover, funders bring experience and expertise to litigation that can identify efficiencies and lower the cost of litigation, allowing financiers to further drive down the cost of legal services.
The Allocation of Risk and Capital
Litigation finance also helps bring a crucial function of the capital markets to litigation: it allows the risk of a capital-intensive project (here, the pursuit of litigation) to be borne by the parties most capable of bearing that risk. Pricing legal claims is hard, and so the financing of those claims may best be left to those with more expertise in that area. While companies may be confident in taking business risks to fulfill a contract, once the contract is breached, other entities may be better situated to bear the financial costs and risks of the litigation.
Having a third party offer strategic advice and expertise on when to sue, when to settle, when to go to trial, and so on infuses economic efficiency into the litigation process. In effect, litigation finance brings rigorous economic cost-benefit decision-making to the legal market.
Companies confronting constrained budgets, a lack of liquidity, and the high cost of litigation have to make difficult decisions about capital allocation. The claimholder does not specialize in litigation, and hence every dollar spent on litigation does not reap as much of a benefit as dollars spent on other projects where the claimholder has more specialized expertise. Litigation finance enables companies to effectively allocate resources to other areas of their business while not losing the opportunity to pursue their meritorious litigation.
In sum, litigation finance affects parties’ behavior after a legal claim accrues, in ways that should have net efficiency gains. Litigation finance may not actually result in more cases being filed, but it likely gives litigants with strong legal claims access to better counsel and better litigation strategies at lower cost.
This blog post is adapted from Suneal Bedi & William C. Marra, The Shadows of Litigation Finance, 74 Vand. L. Rev. 563 (2021).