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A guide to litigation funding

Litigation funding is an asset class with enormous potential. Learn more about it with our guide.

Litigation funding is not a new market, but it’s one many experts predict will see strong growth over the next five years, with a broader array of funding options serving an increased demand for legal financing.

According to the International Legal Finance Association (ILFA), the first global association representing the commercial legal finance sector, over $10 billion in commercial litigation funding assets are under management by its members alone.

In the coming years, experts predict, on the one hand, that the number of claimants seeking legal funding will increase in the post-pandemic landscape, and regulatory reform around the world will make it possible for more people to access financing for their claims. On the other hand, the sector is growing, and with more funders in the market looking both to capitalise on significant potential returns and to seek alternative investments insulated from the wild fluctuations of the markets, more will look to gain a competitive edge through innovation, using algorithmic and AI-based technology to open up new efficiencies and possibilities.

In this guide we provide an introduction to litigation funding, define key terms, parties and structures, trace the sector’s growth, consider ethical issues, and look towards the future.

 

Jump to:

An introduction to litigation funding

A glossary of key terms

The ethics of litigation finance

The evolution of litigation funding: key dates

The future of litigation funding

Reimagining litigation funding

 

An introduction to litigation funding

What is litigation funding?

Litigation funding is where a third party finances a litigation claim in exchange for a portion of any costs and damages awarded or agreed in a settlement.

Through litigation funding, investors can treat legal claims as financial assets, where the potential returns of any claim proceeds must be weighed against the risk of losing the claim. It is an alternative asset class, not correlated to traditional capital markets.

How does litigation funding work?

Litigation funding is a simple process involving an agreement between two parties: one is the claimant, who is involved in a legal dispute, and the other is the funder, who provides funding for the litigation claim.

The contractual agreement between the funder and the claimant is called a Litigation Funding Agreement (LFA). The LFA outlines the amount the funder will provide to finance the litigation and sets out the share of any award the funder will receive in the event the litigation is successful, or in cases where the claim is settled. The funder agrees to cover some of the cost of a claim in exchange for a share of any court award or settlement.

 When a claim reaches a successful judgment, or when a claim is settled early, funds are paid to the law firm representing the claimant, before they are distributed, first to the funder, according to the terms of the LFA, and then to the claimant.

 If a case is unsuccessful, the amount of capital the funder provided is not returned. For this reason – to limit the funder’s exposure in case of an unsuccessful outcome – claims may be backed by After The Event (ATE) insurance, which will cover adverse legal and disbursement costs.

 

A glossary of key terms

Litigation funding, legal financing, litigation financing, third-party funding:  Financing for a litigation claim from a third party who will receive an agreed amount of the proceeds of the claim if it is settled or it reaches a successful judgment.

Claimant: The plaintiff in a legal dispute. The claimant is the party who might seek legal financing.

Funder: The funder is the third party who provides financing for a litigation claim.

Commercial litigation funding: Third-party financing of corporate litigation claims.

Consumer litigation funding: Third-party financing of individual or a collection of private litigation claims.

Scheme funding: This refers to financing a volume of claims, usually smaller cases pooled to create an attractive investment.

Litigation Funding Agreement (LFA): This is the name of the contract between the funder and the claimant. The LFA defines the agreed amount of funding and the share of the recovery to paid to the funder in the event of a successful judgment or early settlement.

After The Event (ATE) insurance: This is a form or insurance that provides protection against losses in the event of a lost claim.

 

The ethics of litigation finance

As it has become more prominent, litigation funding has provided many benefits while rightly attracting scrutiny, and a number of areas warrant close attention.

What are the risks?

Funders aim to select claims with merit – ones with a high likelihood of success. The better they can predict the outcome of claims, the lower their risk and the higher their chances of a return. This has led to some voicing caution over potential ethical problems for lawyers if they are encouraged to divulge confidential client information to funders.

Other concerns have included those to do with usury laws, which prevent lenders from charging excessive rates of interest and fees. Although non-recourse litigation financing is not a loan and therefore not subject to usury laws, critics assert financing agreements where a very high share of the recovery is paid to the funder could be considered usurious.

The historical legal doctrines of maintenance and champerty, dating back to the 1400s, have hindered litigation funding becoming widespread sooner. Maintenance describes the financing of legal cases by those not party to it, and champerty is essentially maintenance with the intent of profiting. To prevent interference in legal cases, these practices were historically considered illegal. However, later legislation and practices have altered these laws and provided clearer guidance for permitted arrangements and structures. Much of this legislation has aimed to improve access to justice.

Questions such as the regulation status of the funder, whether the amounts due to the funder are disproportionate, and whether the funder exerts any control over the litigation are important checks to ensure ethical practice is maintained.

What are the benefits of litigation funding?

It can fill a resource gap and increase access to justice

The costs of litigation can be high – so high they exclude those with valid claims from seeking justice, especially if they are up against deep-pocketed defendants. Litigation funding can level the playing field.

It can reduce risks

Instead of the claimant using and risking their own resources, a litigation funder takes on the risk in return for a share of the claim proceeds if it’s successful.

It isn’t like a loan

Legal financing is not a loan. It’s non-recourse: if a claimant loses a claim, they don’t owe the funder anything.

It can be effective accounting

Litigation funding can be an effective accounting solution for companies engaged in litigation claims, as it means legal expenses will not figure in their balance sheets.

It gives claimants time to reach a better outcome

With financial backing, claimants can be less concerned with mounting costs and hold out for a more acceptable settlement or wait for judgment on a claim.

It means claimants can access better legal representation

Third-party financing can also provide claimants with access to a high-quality legal team they wouldn’t have otherwise been able to afford.

Can litigation funding provide wider benefits?

Both corporate and private investors are becoming increasingly interested in Environmental Social Governance (ESG) and Corporate Social Responsibility (CSR) investments. Litigation funding may have applications in these areas.

“This is an aspect of litigation funding we’re particularly interested in at VWM Capital,” says Mike Preston, CEO of VWM Capital.

He says: “There’s a David and Goliath scenario with litigation funding. By financing claims where claimants would otherwise struggle to take on defendants with a high level of resources, not only are we able to make an attractive investment with the prospect of high returns, but we’re also increasing access to justice.”

“Financing cannot win you a claim, but it can at least buy you a seat at the table. This means those claimants with a valid claim are not prohibited from contesting the claim because they’re up against a wealthy adversary.”

 

The evolution of litigation funding: key dates

Litigation financing is growing in the USA, but it is much more firmly established in the UK and in Australia, where legislation has been put in place that has supported its growth. The 1990s is when big changes started to take place.

UK

1967: The Criminal Law Act (CLA) abolishes the crimes and torts of maintenance and champerty, but uncertainties inhibit the growth of litigation funding.

1990: As part of legislation designed to improve access to justice, the Courts and Legal Services Act (‘CLSA’) allows CFAs (Conditional Fee Agreements), under which litigation fees or expenses are only payable in certain specified circumstances. DBA (Damage-Based Agreement) legislation is later introduced, allowing the payment of special financial benefits to representatives.

2002: The England and Wales Court of Appeals rules that litigation funding is not at odds with public policy.

2005: The England and Wales Court of Appeals clarifies that claimants and not funders should retain control of the litigation.

2011: The UK Association of Litigation Funders (ALF) is founded as a self-regulatory body for the sector.

Australia

1992: Domestic class action lawsuits become legal, in which plaintiffs have to actively opt in, meaning they can be identified and therefore enter into a litigation funding agreement.

Mid-1990s: Various states disregard maintenance and champerty offences, including in New South Wales in 1993 with the Maintenance, Champerty and Barratry Abolition Act.

2006: The High Court of Australia ruling on the Fostif case permitted litigation funding in those states where maintenance and champerty had been abolished.

2018: In a 2018 survey by Burford Capital, 83% of 75 Australian law firm and in-house lawyers surveyed say they “are most likely to agree that litigation finance is a growing and increasingly important area in the business of law.”

USA

With maintenance and champerty laws decided at local state level, litigation funding took longer to become established in the USA, but it has now firmly taken off.

1990s: Litigation financing first emerges in the USA.

2011: Aggregate litigation financing exceeds $1 billion in the USA.

September 2020: The International Legal Finance Association (ILFA) is founded. Based in the US, it is the first global trade body representing commercial legal financing.

October 2020: The first litigation funder is listed on the New York Stock Exchange.

 

The future of litigation funding

Over the last five decades, litigation funding has developed to enable better access to justice and evolved to become more sophisticated and better placed to respond to the needs of individuals and companies in an uncertain world. As the world emerges from the covid-19 pandemic, what will the future hold?

Expansion into other markets outside the UK, Australia and the USA is one possible direction for growth, and advances in technology seem certain to play a big part in the sector’s future.

While the automation of narrow tasks can lead to fewer inaccuracies and more efficiencies, opening up a degree of scalability in claims assessments and outcome predictions, introducing an element of machine learning would be much more complex.

As with any machine-led technology, while they remove the human error, they may also carry human bias from the input data and parameters, and the challenge for the future may be to manage and eliminate this bias as much as possible.

 Mike Preston says: “We’ve seen some dramatic developments in technology over the last 20 years, and the speed of progress is likely to increase.”

“Litigation funding is one area of the legal sector where automation technology can really transform our sector. At VWM Capital, we’re using it to create the investment grade equivalent of litigation funding.”

“By automating the preselection of cases we’re able to consider many more lower value cases for funding than traditional litigation funders. We leave the final selection to human experts, though, and require a panel of three independent legal experts to provide an opinion that a case has a strong likelihood of winning. We believe the best outcomes available, at present at least, are to be found when technology augments rather than replaces human capability.”

 

Litigation funding reimagined

At VWM Capital, we provide low-risk, protected investments underpinned by algorithmic logic, independent legal experts, and decades of experience in finance, banking and alternative investments.

Find out how it works.

 

Sources

A brief history of litigation finance, The Practice, Harvard Law School
Everything You Ever Wanted to Know About Litigation Finance, Litigation Finance Journal
How Litigation Finance is Helping David Beat Goliath, Litigation Finance Journal
Litigation finance finds its feet targeting returns up to 20%, Bloomberg
The emerging market for litigation funding, the Hedge Fund Journal
Litigation Finance Special Report, Peer2Peer Finance News
Litigation finance industry opens up to private investors, the Financial Times
Burford Capital makes debut on New York Stock Exchange, Bloomberg
Formal Opinion 2011-2: Third Party Litigation Financing, New York City Bar
Third-party litigation financing in the US, Aaron Katz, Parabellum Capital LLC and Steven Schoenfeld, DelBello Donnellan Weingarten Wise & Wiederkehr, LLP
Litigation funding explained, Parabellum Capital
Guide to litigation funding, Axiafunder
Legal finance 101, Burford Capital
Funding litigation: the good, the bad and the ugly, Field Fisher
Commercial legal finance industry leaders launch first-ever global association, ILFA