As U.S. stock markets enter their 10th straight year of growth, counter-cyclical assets and those in which performance is not correlated to other market cycles are increasingly in demand. The privately negotiated field of third-party litigation funding appears to fall into the latter category.
An emerging investment sector, worth billions
Most forms of litigation funding were historically banned in common law jurisdictions, under the torts of “maintenance” and “champerty.” These torts are now more narrowly enforced in many jurisdictions, creating an opportunity for carefully drawn litigation funding arrangements. As a result, the sector of litigation finance has grown dramatically, and especially in the past two decades where it has become a global industry worth billions.
The need for third-party funding is rooted in the increasing size and complexity of litigation. As contingency fee agreements become less sustainable for law firms, and as proceedings take longer to resolve, clients with legitimate claims are often faced with an immediate need for resources to support their suits. An influx of capital from a litigation finance provider can make the difference and allow a party to continue to pursue its case.
Global leaders in the field, such as Bentham IMF and Burford Capital, have promoted their value to the corporations and firms that they finance in different ways, including promoting their funding as a means to shed risk from their balance sheets, or to accelerate growth by freeing up capital tied up in ongoing cases.
Law firms are also becoming increasingly familiar with this resource. Last year, over a third of U.S. law firms used litigation finance — more than triple the percentage from four years ago, according to the 2017 Litigation Finance Survey conducted by Burford. Funding is typically provided on the plaintiff’s side, though defendants will occasionally resort to funding to cover their legal costs as well.
Why invest in litigation funding?
From an economic perspective, litigation finance is attractive to investors for two reasons:
- It is uncorrelated with market cycles. This means it provides protection against a potential economic downturn, because litigation doesn’t follow changes in monetary policy or the financial markets. It might even be inversely correlated with the state of the financial markets, if litigation increases during a recession — namely due to a higher number of insolvencies.
- It provides high yield, at a potentially lower risk. Litigation finance often provides double-digit returns, a comparatively high yield for an investment category that usually carries less risk due to the high number of settlements.
In the early days of litigation funding, investors were mainly global banks, but they have since been surpassed by alternative asset managers such as hedge funds and special situation investors. Asset managers will typically fund commercial litigation, but are increasingly providing funding to litigate so-called “mass torts.” These are consumer class actions which feature a large number of plaintiffs who have suffered personal injury from consumer products, medications or medical devices.
Recently, commercial funders have been making larger investments in broad portfolios of cases, as opposed to individual suits. Of the litigators who obtained third-party funding in 2017, nearly 40% used the capital received to finance portfolios containing several cases. Some providers, such as Burford, make the majority of their capital commitments to portfolios. Another key sign of the commodification of litigation finance is its burgeoning secondary market: since litigation may take years to resolve, funders sometimes exit their positions by selling their stake in ongoing litigation.
State of play: strong investor demand despite new regulatory scrutiny
The litigation funding sector’s growth, and increased focus on consumer litigation, has led to more scrutiny from state and federal regulators, as well as the legal ethics community. The New York City bar’s ethics committee issued an opinion which cautioned against funding arrangements directly between a lawyer and a litigation funder that are tied to specific future legal fees, because these arrangements may contravene long-standing prohibitions on fee-sharing with non-lawyers. Meanwhile, at least 12 states have adopted laws regulating some aspects of the business of litigation finance. For example, Wisconsin requires all litigation funding arrangements to be disclosed.
Despite increasing regulatory scrutiny, the litigation finance sector is estimated to be worth approximately $10 billion in the U.S. alone. Alternative asset managers are increasingly crowding this field, as approximately 30 funds were created in the past two years to invest in litigation. These new funds have raised over $2 billion.
This growing sector has the potential to level the playing field in the courts by allowing plaintiffs more access to the judicial system. More competition and more regulation in this field will likely provide more choice and better protection for litigants in the years to come, while investors will have a range of options to diversify their portfolios.