The Complications Associated with Third-Party Litigation Funding Indicate a Need for Legislative Action as Funding Continues to Unabatedly Increase
Adam Peoples, Hall Booth & Smith, P.C. and Connor Wiseman, Summer Associate
Third-party litigation funding is “an arrangement in which a funder that is not a party to a lawsuit agrees to provide nonrecourse funding to a litigant or law firm in exchange for an interest in the potential recovery in a lawsuit.”1 This method of funding has increased immensely in recent years and demand amongst litigators for such funding continues to grow. According to Westfleet Advisors (an advisor to lawyers and clients who are exploring litigation financing), new capital commitments from the litigation finance industry to law firms increased by 16% in 2022, which was the largest year-to-year growth rate Westfleet Advisors had ever reported since they began tracking in 2019.2 This growth is the result of 44 currently active funders with $13.5 billion in assets under management, with $3.2 billion in commitments to new deals coming in the last year.3 The commitments from funders are distributed to single matters as well as in a portfolio form where the litigation funder finances multiple cases belonging to a lawyer or law firm and receives a return on the invested capital either through individual settlements or through a group of cases.4 While litigation funding initially was allocated primarily in single-matter deals, portfolio funding has become more common since 2019 and currently represents 68% of new capital commitments, with each new deal averaging about $10.5 million (up from $8.5 million in 2021).5 Given the prevalence and depth of litigation funding, particularly in portfolio transactions, there are obvious concerns as to the integrity of litigation backed by third-party funders and the consequences of this rapidly popularizing funding model. These concerns include an overemphasis on profitability, ethical considerations and conflicts of interests, an impact on settlement dynamics, limited transparency and disclosure, insufficient regulation and monitoring, and a potential impact on access to justice.
Portfolio funding makes litigation less risky for both funders and litigators given that funds can be spread across multiple cases. This decreased risk has the potential to encourage frivolous lawsuits driven by financial gain rather than merit. Not only would this needlessly overburden the court system in general, but defendants would also face an altered set of options. In essence, with the backing of litigation funding firms, plaintiffs would be enabled to pursue even highly dubious claims at trial. In this environment, defendants would be pressured to settle all but those most frivolous suits at amounts higher than the merits would traditionally justify.6 This disrupts established customs and expectations by driving up costs through inefficiencies and puts defendants in a comprised position regardless of guilt or innocence.7 Ultimately, in the case of insurance, premiums will rise to compensate for increased litigation costs, thereby negatively impacting unaffiliated consumers. While a counterargument to this assertion is that investors would be unlikely to invest in a frivolous lawsuit when recovery is contingent on success, the National Association of Mutual Insurance Companies argues that focusing solely on the probability of success “overlooks the fact that funding companies can negotiate for a larger share of any proceeds that result from a less-meritorious lawsuit, in the same way that investors are able to demand higher yields from the issuers of so-called junk bonds.” 8 It remains a worthwhile venture for funding companies to invest cases with low probabilities of success if there is a large enough damages figure due to the fact that, through the portfolio approach, the funding company is able to spread risk across lawsuits and therefore avoid instances of overexposure.9 Therefore, there is little reason to expect third-party litigation funding to decrease independently.
While the threat of increasing frivolous lawsuits is problematic, perhaps of chief concern is a compromised attorney-client relationship as a result of third-party funding. Litigation funders are positioned to exert an undue influence on litigation strategy and potentially prioritize financial gain over the client’s best interests. This is possible because funders, unlike attorneys, do not owe a fiduciary duty to plaintiffs.10 An example of this may occur when a funding agreement allows the funder to decide when to settle, even if the plaintiff would rather proceed to trial.11 This dynamic could arise in any number of critical decisions relating to the direction of the lawsuit. Not only is the attorney-client relationship potentially compromised, but there is also the possibility of conflicts of interest and breaches of ethics. The money in portfolio funding by its definition is allocated to numerous different lawsuits. It follows that through the funding of multiple cases simultaneously, there could be conflicts of interest that involve conflicting parties or legal positions. This jeopardizes the integrity of the legal system and shifts the ultimate objective from justice to profit with no regard for congruence. Often, the court and defendant are unaware of a funding agreement, which prevents monitoring. Without transparency, there is little incentive for funders to behave ethically and there is relatively little chance of recourse. Further, the set of circumstances that results leads to the potential for portfolio funding to widen the gap between those who can afford access to justice and those who cannot, thereby perpetuating existing inequalities in the legal system. Portfolio funding may also lead funders and attorneys to prioritize cases with higher potential returns, potentially diverting resources away from cases with significant societal impact but lower financial prospects. Each of these issues is an indicator that additional regulatory attention needs to be given to third-party litigation funding.
Given the multitude of potential issues with portfolio litigation funding and its ever-growing presence in litigation, the judicial system would be well served to pursue enhanced legislation regulating litigation funding, especially pertaining to the portfolio model. Transparency is a critical component in achieving this goal. In working towards transparency, Senator Grassley and Representative Issa introduced The Litigation Funding Transparency Act of 2021, which would “requir[e] mandatory disclosure of funding agreement in federal class action lawsuits and in federal multidistrict litigation proceedings.”12 Additionally, in December 2022, a coalition of state attorney generals issued a written call to action to the Department of Justice and Attorney General Merrick Garland, though no definitive action has been taken on the issue.13 Alternatively, efforts have been made to add a mandatory TPLF disclosure provision to Fed. R. Civ. P. 26(a)(1)(A).14 The effort has been led by the United States Chamber Institute for Legal Reform which has cited the following as reasons for the addition of the provision: “(1) alleged “mounting evidence” of funder control over litigation and settlement decisions; (2) growing use of TPLF arrangements as part of “all types of civil litigation” and increased funding amounts; and (3) the need to standardize and simplify TPLF disclosure approaches as part of a single disclosure rule.”15 As of May 8, a letter with 35 signatories (including American Property Casualty Insurance Association, the Association of Defense Trial Attorneys, the DRI Center for Law and Public Policy, and the National Association of Mutual Insurance Companies) was sent to the Advisory Committee reemphasizing the need for the added provision to Rule 26.16 The Advisory Committee will take the proposal under consideration, however, this provision has been proposed over the course of the past nine years to no avail.17 Ultimately, litigation funding has the potential to not only negatively disrupt the judicial system but also have a negative effect on the general public especially in the insurance marketplace where increased premiums could lessen affordability and accessibility to insurance for those who are wholly unaffiliated with litigation. Thus, more robust regulations and monitoring and enforcement of ethical standards in portfolio funding is necessary to promote justice and integrity in the legal system.
________________
1Third Party Litigation Financing: Market Characteristics, Data, and Trends (Report to Congressional Requesters) UNITED STATES GOVERNMENT ACCOUNTABILITY OFFICE 1 (Dec. 2022), https://www.goa.gov/assets/gao-23-105210.pdf
2The Westfleet Insider: 2022 Litigation Finance Report, WESTFLEET ADVISORTS 2 (2022), https://www.westfleetadvisors.com/wp-content/uploads/2023/02/WestfleetInsider-2022-Litigation-Finance-Market-Report.pdf.
3Id.at 3.
4What You Need to Know About Third Party Litigation Funding, U.S. CHAMBER OF COMMERCE INSTITUTE FOR LEGAL REFORM (Feb. 7, 2023), https://instituteforlegalreform.com/what-you-need-to-know-about-third-party-litigationfunding/#:~:text=Portfolio%20funding%20allows%20the%20litigation,thier%20risk%20over%20multiple%20cases.
5WESTFLEEt ADVISORS supra note 2 at 5-6
6Third-Party Litigation Funding: Tipping the Scales of Justice for Profit (Prepared by NAMIC State and Policy Affairs Department) NATIONAL ASSOCIATION OF MUTUAL INSURANCE COMPANIES (May 2011), https://www.namic.org/pdf/publicpolicy/1106_thirdpartylitigation.pdf
7Id.
8Id.
9Id.
10U.S. CHAMBER OF COMMERCE INSTITUTE FOR LEGAL REFORM supra note 4.
11Id.
12Tasha Williams, U.S. Study of 3rd-Party Litigation Funding Cites Market Growth, Scarce Transparency, INSURANCE INFORMATION INSTITUTE, (Mar. 23, 2023), https://www.iii.org/insuranceindustryblog/federal-study-of-third-party-litigation-funding-reveals-maturing-and-growing-markets-lack-of-transparence-and-scarce-regulation/.
13Id.
14Mark Popolizio, Several industry groups renew calls for a mandatory TPLF disclosure rule as part of the Federal Civil Rules of Procedure, Verisk (June 9, 2023), https://www.verisk.com/insurance/visualize/several-industry-groups-renew-calls-for-a-mandatory-tplf-disclosure-rule-as-part-of-the-federal-civil-rules-of-procedure/.
15Id.
16Id.
17Id.
