Litigation Finance Explained

Litigation finance refers to funding provided by third party investors to plaintiffs involved in lawsuits, legal claims, or anticipated legal disputes. The investors provide upfront capital in exchange for an agreed upon share of the financial settlement or judgement if the case succeeds.

If the plaintiff loses the case, the funder typically loses their investment as well. Litigation funding aims to provide plaintiffs access to justice that they might not otherwise be able to afford, while providing funders an opportunity to profit from successful cases.

How Litigation Funding Works

The litigation funding process involves several key steps:

• Initial Case Assessment
• Contract and Financing Terms
• Case Progression Support
• Settlement and Judgement

Initial Case Assessment

Potential cases are submitted to a funder for review. The funder analyzes the merits and risks associated with the case.

Key factors assessed include:

• Type of case – Personal injury, contract disputes, class actions etc. Some cases like personal injury may have more predictable outcomes.
• Potential damages – Funders estimate the potential judgement amount if the case succeeds. Higher potential rewards merit greater levels of investment risk.
• Evidence and merits – The strength of evidence supporting the plaintiff’s claims is analyzed. Strong evidence that proves wrongdoing makes a case more compelling.
• Defendant’s ability to pay judgement – The ability to collect on a successful result factors into the analysis.

After assessing these and other case dynamics, the funder decides whether to finance or reject a case.

Some startups such as Legalist are building technology for assessments and funding of cases.

Contract and financing terms

For approved cases, the funding provider negotiates contract terms with the plaintiff or plaintiff’s law firm.

Key terms typically include:

• Amount of capital provided – This may cover attorney’s fees, expert witnesses, case expenses, and plaintiff’s basic living costs. Funding ranges from a few thousand dollars to over $10 million.
• Success fees – If the case succeeds, funders are compensated via an agreed upon share of the financial judgement or settlement, often in the range of 20-50%. Funding is considered non-recourse, so fees are only paid from litigation proceeds.
• Payment options – Some contracts have tiered success fee rates. For example, lower fees for early settlements versus higher fees for judgements/settlements achieved after completing lengthy trials.
• Case control options – Funders usually aim to protect their investment via some control provisions. Contracts outline rights that funding firms have over key case decisions and overall strategy.

After agreeing to contract particulars, financing capital is provided to the plaintiff. This capital is often dispensed in multiple installments over the course of a potentially lengthy legal process.

Case Progression Support

Once financing is secured, funders have an active interest in monitoring case progress and key milestones. Reasonable capital support is often provided to fund activities required to successfully resolve or litigate claims. Such activities may include:

• Paying attorneys and law firms hourly fees
• Covering expenses related to evidence gathering
• Funding expert witnesses and testimony
• Enabling plaintiff basic living expenses during trials
• Paying court and case-associated costs

By supporting these functions over months or years, funders aim to put plaintiffs on equal footing with well-resourced defendants to achieve favorable case outcomes.

Settlement or Judgement

Litigation funding contracts remain in force until a case outcome is determined. Critical milestones include:

• Early settlement – Defendants sometimes make settlement offers shortly after cases are filed to avoid costly litigation. Funders support plaintiffs in reaching optimal settlements.
• Dismissals – Courts can dismiss cases for reasons like lack of evidence. An unsuccessful dismissal typically requires plaintiffs to re-file stronger cases to continue.
• Summary judgements – Judges occasionally award plaintiffs damages without requiring full case trials when evidence claims is highly compelling.
• Trial verdicts – Jury awards for plaintiffs that win trials. Compensatory as well as punitive judgements are possible.
• Trial settlements – Defendants commonly make improved settlement offers before, during or after lengthy trials to avoid the risks of losing jury verdict decisions. Funders advise clients on whether to accept such mid-to-late stage settlement offers.

For successful outcomes like settlements or plaintiff trial verdicts, funders receive their contracted fees pursuant to the financing agreements. Fees and capital repayments are made directly from case proceeds with net amounts going to plaintiffs.

For unsuccessful outcomes like dismissals or defense verdicts, funders typically lose 100% of invested capital and all potential success fees. Defendants also have opportunities after losses to recover their legal costs from plaintiffs who received funding support.

Time Frame Considerations

Litigation funding firms need patience and financial resources to sustain drawn-out legal processes required to resolve major cases. While simple personal injury cases may resolve in under a year, complex commercial lawsuits often involve multi-year efforts.

Over 95% of all civil lawsuits settle before final trials so funders concentrate on driving optimal plaintiff settlements during early, middle and late phase case progression milestones. Optimal case outcomes often involve well-timed settlements rather than risky, uncertain trial verdicts.

Major categories of litigation with typical duration time frames include:

Funders need sufficient operating capital to finance multi-year case efforts and cannot easily liquidate their investments before final resolutions. The capital is illiquid and at high risk, that’s why funders expect significant discounts. Extended time frames also impact annual funder return calculations.

Cost Structures

Litigation finance is an operationally intensive funding category involving significant due diligence efforts, multi-year support services, specialized legal counsel, uncertain outcomes, and long holding periods. As a result, cost structures and fees are higher than many other private funding alternatives.

Litigation finance is not for investors looking for low risk fixed income returns. Litigation finance involves highly variable returns that may materialize years in the future based on unpredictable case events and judicial decisions. However, successful outcomes can deliver outsized returns well above typical investment targets.

From a plaintiff’s perspective, funding receipt involves no direct upfront costs. Contractual success fees paid from litigation proceeds equate to effective returns of 100% or less. These returns contrast favorably with expensive credit cards, pre-settlement borrowing, or case abandonment due to lack of financial resources.

How Litigation Funders Get Paid

As highlighted earlier, litigation funding firms earn returns via pre-determined contractual success fees tied to case financial recoveries or net litigation proceeds. On winning outcomes, fees owed to funders and reimbursed capital get collected directly from gross award payments before net amounts are released to plaintiff parties.

Since funding contracts involve no upfront payments, the funders assume risks of losing 100% of the deployed principle on unsuccessful case efforts. To offset such downside risks, funders demand and structure higher success fees from plaintiffs versus typical financing fee rates.

Beyond headline success fee rates funders negotiate in contracts, the ultimate returns achieved depend on multiple case factors:

Length to Resolution

Funders need patience to support cases over multi-year legal processes but extended durations impact annualized return calculations. A 50% fee on a $10 million case settlement at 1 year equates to 50% annualized internal rate of return. At 7 years until resolution, the IRR converts to under 7% yearly return.

Size of Awards

Larger ultimate awards or settlement amounts contribute to greater dollar fee payments, holding headline return rates equal. Awards well above originally estimated levels can drive windfall funder performance.

Accumulated Expenses

Reimbursable plaintiff support expenses often accumulate significantly over the course of long running cases funded by third parties. At settlement, larger reimbursed expenses decrease net litigation proceeds available for funder fee payments.

Settlement Avoidance

Optimal funder returns often involve settlements vs. risky trial verdicts. However, some funder contracts penalize plaintiffs agreeing to early low settlements by boosting fee rates on amounts above initial settlement offer levels rejected on the funder’s advice. This dynamic incentivizes plaintiffs to hold out for much larger awards.

Tiered Fee Structures

Some contracts provide graduated fee rates tied to the size of plaintiff awards or length to resolution. This improves headline returns for fast or low settlement outcomes achieved versus extended efforts that culminate in extremely large jury verdicts after lengthy trials.

In assessing fair market value funder return rates, reported averages range from 20% to more than 50% of gross litigation proceeds collected by successful plaintiffs. Returns accrue only from winning cases while losers result in total write-offs so blended internal rates across thousands of matters likely approach 25-35% for established fund managers.

Deal sizes also influence returns with larger funding amounts involving some volume based savings discounts. Smaller retail individual plaintiff cases may bear effective fees up to 50% while complex commercial funding arrangements are often arranged at lower headline rates under 30% on multi-million dollar funding levels.

Litigation Finance Market Size

The litigation finance market is rapidly growing. With better technology and more data, companies are improving outcome predictions. So funders are confidently able to invest in cases with a high likelihood of winning.

Here’s the current expected market size for litigation finance:

• Current funded case levels > $15 billion globally based on experience and confidential surveys of major funders
• Estimated total capital deployed to date > $50 billion globally
• Projected total global market potential > $150 billion

Based on an analysis by RationalStat, the US litigation finance market size is expected to grow to $28 billion annually driven by increasing awareness.

The above figures exclude intellectual property legal funding which is tracked as a separate higher value funding category.

Leading litigation funders currently manage individual portfolio levels between $300 million to $7+ billion. With high returns possible from successful judgements, major institutional investors have directed multi-billion allocations into existing fund manager funds as well as new specialized litigation funding vehicles.

As plaintiffs become increasingly familiar with litigation financing options and as investor confidence grows, market usage levels are expected to expand substantially in coming years. Larger law firms are also likely to tap funding sources with greater frequency to initiate wider ranges of claims.

Leading Litigation Funding Firms

Dozens of institutional litigation funders currently operate in the United States across individual cases, class action litigations as well as bankruptcy and insolvency disputes. Different firms provide different funding focus areas in terms of:

• Case types – Some focus on specific categories like personal injury, contract breaches, securities lawsuits, anti-trust, product liability, or patent infringements. Others fund a diverse portfolio spanning different legal areas.
• Funding complexity – Some fund routine cases with capped upside while others concentrate on complex cases with higher reward potentials.
• Company stages – Well established multi-billion managers co-exist alongside mid-sized firms plus aggressive new entrants.
• Capital levels – Large institutional players have capacity for funding multiple individual cases up to $300 million. Mid-sized firms may fund at levels around $3 million – $30 million.

Select leading litigation finance firms in the US market include:

• Burford Capital – Publicly traded (NYSE: BUR) with multi-billion portfolio plus strong institutional investor backing.
• Bentham IMF – Australia based public fund manager with extensive US operation financing many major US lawsuits – taken private in 2021 at a $500 million valuation.
• Lake Whillans – Fast growing heavy focus on sophisticated commercial lawsuits and plaintiff recovery maximization.
• Longford Capital – Emphasis on complex commercial litigation funding supported by pooled investor capital sources.
• Therium Inc. – Independent fund management firm aligned with Therium Group based in London providing over $500 million in total case funding limits.
• Parabellum Capital – Significant portfolio of funded litigation cases recovered over $450 million for clients through trial verdicts and case settlements.
• Validity Finance – Emerging fund manager run by experienced attorneys focusing on law firms and case specific financing arrangements.

Legal and Regulatory Considerations

Litigation funding is regulatorily complex. These financing arrangements create financial connections between third-party investors and active legal plaintiffs. Appropriate regulatory guidelines, conduct, and best practices are still evolving. Many other industries like structured settlement went through similar regulatory development over the years.

A few areas scrutinized include capital adequacy, transparency, usury rate restrictions, legal fee sharing, interference with attorney judgement, case control contingencies, consumer protection, and client confidentiality maintenance.

Groups such as the American Legal Finance Association have emerged to advocate best practices and ethical standards across the litigation funding industry. Continued legal and regulatory clarification efforts will likely occur regarding appropriate funding standards and operations.

Many states allow alternative litigation finance if attorneys meet disclosure and conflict of interest requirements. For example, with client consent, attorneys can share case details with investors and honor written assignments of recovery proceeds. The New York City Bar Association recognizes litigation funding as a valuable funding option. So far over 30 jurisdictions have provided ethics guidance on litigation finance.

Litigation Funding Ecosystem

Beyond plaintiffs, attorneys, and funding providers, the litigation funding ecosystem encompasses a wider range of participants who enable and influence activities:

Plaintiff Support Groups

Specialized consumer groups provide information to potential plaintiffs regarding litigation funding options, credible funders to consider plus best practices for obtaining financing.

Investors

Institutional investors have dedicated multi-hundred million dollar mandates focused specifically on litigation finance as an emerging alternative asset class. Investor capital is deployed into funding firm funds or structured to finance specific cases on a joint basis.

Insurance Companies

Litigation insurance helps protect defendants against outsized plaintiff judgements. By potentially capping defendant liabilities, case dynamics and settlement decisions get impacted which flow indirectly to funders.

Public Relations Firms

Specialized PR firms help build public awareness of plaintiff cases and legal claims which indirectly supports funder positioning. PR messaging aims to pressure defendant firms to avoid risky public trials.

Opposition Groups

Critics such as the U.S. Chamber of Commerce argue litigation funders pervert civil justice processes by putting profit motives above ethical legal conduct. They lobby to limit funding access and address perceived abuses.

Legislators

Concern around extreme jury awards and interference in attorney-client relationships has led some US states to impose litigation funding caps or restrictions. However, no federally consistent standards exist.

Global Networks

Many multinational funders belong to groups that aim to unify standards and best practices for litigation finance internationally. These include groups like Association of Litigation Funders (ALF) in London and the International Legal Finance Association (ILFA).

The expanding number of entities supporting litigation funding reflects investor desires to participate in the high reward sector combined with increasing plaintiff lawyer willingness to utilize funding sources.

There are also concerns around ethical issues like potential interference with attorney independence and inflaming frivolous lawsuits solely for investor profits. As the asset class matures, supportive infrastructure and share standards are expected to develop in line with stakeholder interests.

Litigation Funding Pros and Cons

Like any financing solution targeting underserved markets, litigation funding delivers unique benefits along with some drawbacks to consider:

Benefits

• Plaintiffs access representation otherwise unaffordable for worthy cases
• Attorneys initiate more cases amid affordable client options
• Funds equalize power imbalances and drive fair outcomes
• Institutional involvement discourages frivolous lawsuits
• Predictable shared risk alignments optimize processes
• Specialized institutional investors enjoy uncorrelated returns from legal cases not available in other markets

Potential Disadvantages

• Higher costs than conventional financing reflected in funder fees from plaintiff proceeds
• Risks of interference with attorney independence and plaintiff interests
• Inflames unnecessary lawsuits further overburdening court dockets/judges
• Disproportionate funder influence over settlement processes
• Confidential case information protections weaken amid outside capital
• Questions around funder qualifications to guide key legal strategies

On balance, litigation finance appears to offer plaintiffs and attorneys reasonable funding alternatives to advance justice – particularly for underserved parties facing deep pocketed opponents. However, protections may be warranted to safeguard plaintiff interests and avoid enabling frivolous claims solely for investor profit.

Over time, market based best practices will likely emerge around appropriate funder engagement, aligned incentives, premium pricing and managed litigation risks.

Emerging Trends in Litigation Funding

With high headline returns possible and multi-billion capital inflows supporting market growth, litigation funding demand looks set for continued expansion.

Key trends emerging include:

Rising Class Action Litigation Funding

• Growing funder focus on mass tort disputes like product liability or negligence claims involving many plaintiffs against single corporate defendants
• Class actions involve specialized plaintiff attorney teams coordinating across claimant groups

Increasing Corporate Claim Funding

• Companies such as software vendors, energy firms and healthcare providers receive financing to pursue complex B2B lawsuits.
• Funding helps equalize litigation resource imbalances between corporations.

Expanded Investor Capital Sources

• Sovereign wealth funds, university endowments, hedge funds and family offices provide dedicated litigation funding allocations.
• Successful fund managers raise increased institutional equity/debt for specialty case financing vehicles.

Globalization of Funding Standards

• Groups like ILFA and ALF drive consistent operating practices across fund managers spanning different countries.
• Conferences and networks unify investor relations practices and reporting standards.

Heightened Due Diligence Focus

• Use of forensic accounting, proprietary data sources and expanded legal networks help funders better evaluate case risks.
• Bid ask spreads narrow amid improved institutional funder underwriting.

Market Expansion Beyond the U.S. and U.K.

• Australia, Canada, Europe, South America and Asia provide growth outlets for experienced litigation funders via jurisdictional diversification.

Enhanced Funder Platform Offerings

• End to end support around case analytics, plaintiff relations, attorney sourcing, trial logistics and settlement administration improves client retention.

Mainstream Adoption by Top Law Firms

• Leading U.S. trial law firms embed dedicated litigation funding personnel and Assigned portfolio MDs systematically incorporate funding options into case development practices.

As investor awareness grows around litigation finance merits and uncorrelated returns, greater capital inflows combined with institutional fund manager bandwidth promises to propel market development for years ahead.