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October 18, 2022 Feature

The Justice Case for Litigation Finance

The increase in the use of legal finance has begun to level the playing field for the search for truth.

M. Todd Henderson

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The legal system is not known for innovation. Status quo bias is practically built into the law, which relies on precedent and reasoning by analogy. Add in an interest group that has managed to establish and preserve a cartel, and the result is that the law today looks a lot like it did in the 1960s, when Neil Armstrong walked on the moon. By contrast, each of us now carries around a tiny phone in our pocket that operates 100,000 times faster than the computer that got him there.

But change is afoot. A new way of funding lawsuits—known as litigation finance—is transforming the staid legal world, threatening to drag it into the 21st century. Change upsets the expectations of incumbents, and they are certain to push back. That too is now happening in the law. The battle will determine the future of litigation, which in turn sets the boundaries of law and society.

Sharing Risk

Much of the well-being produced by modern society can be traced to the sophisticated ways in which we share risk. There are things that we would not do on our own, simply because the risk is too great for any single person to bear. But, if we could get others to cooperate with us, to share the downside while also sharing the potential upside, then we could do much more. Training and the brotherhood of soldiers probably explains risk sharing in a foxhole, while a different type of brotherhood explains it in families. But among strangers and in commercial relations, it is modern tools of finance that enable unprecedented risk sharing in our world.

Recent innovations in finance, from factoring to syndications to derivatives, are key mechanisms for risk sharing across the economy. The average person might not realize what goes on behind the scenes to enable a home or car purchase or the use of a credit card. But in each case, risk-sharing tools make it possible at accessible prices. Individual assets—whether they are home loans or credit card accounts—are risky collateral, while pooled assets allow risk to be spread and therefore reduced.

If a bank were unable to share the risk of a mortgage loan on a particular house, it would charge a much higher interest rate, which is its estimate of risk plus a market return on its investment. In today’s world, the bank can pool the loan with thousands of others, selling the risk off in slices. The adage “don’t keep all your eggs in one basket” works for home mortgages, auto loans, and, as it happens, legal cases. Finance enables risk reduction, which lowers the costs of home ownership or whatever it is that is being funded for the system as a whole.

These insights from finance have recently come to the law. This was inevitable. Potential and meritorious legal claims can be viewed as valuable, yet risky, assets, just like first homes or start-ups. If one has to fund them alone, the risks are higher, and thus the costs are higher as well. A litigation finance company can invest across a portfolio of dozens or hundreds of matters, just like a venture capitalist or an investor in home mortgages, reducing risk and therefore costs. As venture capital offers the possibility that an entrepreneur’s wealth won’t determine whether a valuable idea gets funded, so too does litigation finance open up the justice system to everyone on fairer terms. Ideas should matter in starting a business, not wealth. In court, perhaps even more so than in the business world, it should be one’s case that matters, not the size of one’s wallet.

Rules developed in medieval times—“barratry,” “champerty,” and “maintenance”—prevented nonparties from taking a stake in a legal dispute. The idea behind these rules was to prevent wealthy landowners from co-opting the courts to cause each other mischief by, for example, supporting a tenant’s frivolous claim against a rival landowner. But the impact was to deny parties with good claims the ability to assert or defend those claims or, at the very least, to give the lawyers who would represent them bargaining power over the fees. The law was more expensive than it would be in a world of effective risk sharing. While this arrangement benefits some in society, others are big losers.

Consider a party that believes it has an 80 percent chance to prevail at trial and to recover $1 million if it does. The claim is worth $800,000 in expectation. Now imagine it will cost $100,000 to take the case through trial and appeal. This is a good investment. The trial should happen. This isn’t just about doing justice for the parties. Law will be made as a result of the trial, and we all benefit from resolving the dispute in a way that gets to the truth of the matter. We want both sides ably represented to find that truth.

But what if the party doesn’t have $100,000 to fund the litigation with the best representation?

In the business world, this would not be an issue. If the asset was not a legal verdict with an expected net value of $700,000 but was instead the same amount of expected income from sales of a prospective product, third parties would finance the idea. The promoter could borrow the money from a bank at an interest rate reflecting the bank’s assessment of the risk and value of the project. If the project or the borrower were too risky, or if collateral was not available to mitigate the risk, the promoter could issue equity. In return for cash to fund the project, the investor would receive the right to share in the net benefits it produces. The wealth of the promoter doesn’t determine whether the idea gets funded or whether it has a chance to succeed. The quality of the idea and its expected execution do. Finance is the great equalizer.

Finance Comes to the Law

Traditionally, this tried-and-true approach was unavailable for legal projects because the law does not work like every other modern industry. In law, wealth determines one’s ability to assert or defend a claim and, more importantly, the shape of the law. This is because traditionally only clients and, in certain jurisdictions, lawyers could fund litigation.

Contingency fees are the way the law and lawyers address this problem. There are issues, however, that make it an imperfect solution. First, it only works for one side—only plaintiffs generally fund litigation with contingency-fee arrangements. Second, lawyers who “fund” cases using contingency fees take on large risks; they do not get paid if they lose. This means they will be picky about the cases they choose, going only for sure things. Third, lawyers can only “invest” in cases in which they act as lawyers; their ability to reduce their risks through diversification is limited by the amount of time they have to spend on cases. A lawyer who can take on five cases at a time might be able to suffer a loss, but not more than that. By contrast, an investor who could invest in 100 cases might be able to tolerate many more losses and still earn a positive return.

Finally, the riskiness of the contingency-funding model likely distorts the choice about not only which cases to bring but how to press the claims and how to settle the litigation. A lawyer who is paid only for “wins” may be willing to settle early or for a lower amount than the client would prefer, if the client knew all the facts. A collateral effect of these factors is that certain types of suits end up getting gobbled up by plaintiffs’ lawyers, while other, meritorious but risky, suits don’t. This bias distorts the law and leaves certain parties without access to the legal system.

In the past decade, however, finance has come to the law. Not surprisingly, investors are interested in legal assets. The numerical example above presents an attractive investment, and it does not matter whether the asset is a legal claim or a new iPhone app or an oil field. Investors want to turn money into more money. This is fine, as it goes, but the reason society (in addition to the party and the investors) would be interested in allowing these investments is if financing makes the legal system better able to find the truth. In law, financing enables the right cases to be brought, without regard to the wealth of the parties, in significant part because the capital provider must do an independent analysis of both the strength of the claim and the competence of the party’s counsel to resolve the matter favorably.

Even more importantly, from the standpoint of the administration of justice, the availability of legal finance helps ensure that the cases that are brought are decided on the best arguments and evidence available for both sides. This means hiring good lawyers, retaining experts, and funding the expensive discovery process. Modern litigation is very expensive. If the search for truth is premised on an adversarial system, as ours is, truth depends on ensuring the fight is fair. Money is not randomly distributed in our society, so enabling those with good claims (both from the perspective of the litigant and in terms of social progress) to bring them and have them tested in court with the best possible representation is critical to a fully functioning legal system.

The increase in the use of legal finance in the United States and across the globe has begun to level the field for the search for truth. The relative wealth of a party should not determine the outcome of a case—the merit of the claim should. To be sure, this puts pressure on getting substantive law “right.” If there are bad legal rules from a social standpoint, making those rules easier to vindicate through litigation might be a bad thing. But this is not so much an argument against financing legal claims as against bad laws. If litigation finance makes it easier to enforce a bad law, the solution is to repeal or reform the bad law, not to arbitrarily restrict plaintiffs generally and in all cases, good and bad.

Change threatens those with a vested interest in the status quo, and so too here. Those vested in the status quo dislike disruptors, who threaten to upset existing ways of doing things that work well for them and that they understand and have optimized their institutions against. Taxis don’t like Uber. Hotels don’t like Airbnb. Walmart doesn’t like Amazon. This does not tell us whether these new players or ways of doing things are good or bad. That large companies are opposed to something does not say much, especially when these same companies benefit from the status quo.


It comes as no surprise, then, that some large corporations have begun to push back against the rise of litigation finance—even though many are themselves users of litigation finance as a risk-spreading tool in the bringing of and defending litigation. Over the past few years, the battle has been fought over disclosure, with defendants seeking to require plaintiffs to disclose the details of financing. They have tried in individual cases, in Congress (through the Litigation Funding Transparency Act), before the U.S. Courts’ Committee on Rules of Practice and Procedure, and in the court of public opinion. The argument is simple: Parties should know who has a stake in the litigation, and sunlight is, as Louis Brandeis said, the best disinfectant.

If transparency were necessary to protect victims in search of representation, then that would be one thing. An argument could be made that those with potential claims in search of a lawyer to represent them are vulnerable and in need of some consumer-protection intervention. Of course, this would apply not just to those offering litigation funding but also to lawyers offering contingency arrangements. After all, as noted above, contingency fees are just a type of litigation funding.

But the push for disclosure of litigation funding is not about protecting victims of torts or others with potential litigation claims. If it were, it would require information disclosure to individuals choosing whether to engage litigation financing companies, and it would cover plain-vanilla contingency cases as well. Instead, it is about giving information to the other party (mostly defendants) in cases brought by those who finance their claims using litigation financing companies.

Why do the opposing parties need information about how the other side is funding litigation? We do not generally require this kind of disclosure. Plaintiffs do not have to disclose the deal they struck with their lawyers, in terms of what percentage the lawyer is taking, whether expenses are covered as well, or the like. This is because it is irrelevant to the case.

Whether the plaintiff’s claim is being funded by a litigation finance company is a red herring in most cases because the typical litigation financing provides funders with no control over the litigation. They are entitled solely to an economic return for sharing the risk. Funders generally do not try to influence what theories are propounded or what evidence is used to prove a claim or whether to settle or on what terms. Decisions about running the case remain with the client and the client’s lawyer. This is industry standard, as it must be. All that financing does is help ensure that the case is brought or that its pursuit is continued and that the very best arguments and strategies can be used in pursuit of the right result.

Who is providing financing is irrelevant if the only thing being provided is money. There is no obligation to disclose to the other side if the money for lawyers is being provided by a loan from a bank, a rich aunt, or some other source, so long as the money comes with no strings attached. What matters is not where the money comes from, but who is deciding legal strategy, whether and on what terms to settle, and other matters central to the dispute.

In other areas where financing parties are disclosed—such as in securities filings—the disclosure requirement is motivated by the fact that money and influence are inexorably intertwined. But if the client and law firm are not controlled by the funders, who ultimately pays the bills matters not at all. If Fund X were choosing the lawyers, determining the strategy, dictating the terms of settlement, and so on, then it seems reasonable and in pursuit of the truth to allow the other side to know this. But if the money and the control are separate, if the money is just paying the bills, then it is an input as irrelevant to the litigation as where the law firm has a revolving line of credit or even who supplies the copier paper or the electricity that powers the lawyers’ computers, neither of which is disclosed in any litigation.

The Costs of Funding Disclosure

Conversely, there are real costs to forced disclosure. Most obviously, the scope of disclosure would have to be very carefully delineated to avoid revealing proprietary or privileged information about how the funders make money. Case selection is the secret sauce of litigation finance, just as picking entrepreneurs or ideas is for venture capitalists. To reveal the methods of doing so would be to give an advantage to the party seeking the disclosure.

But there is a bigger concern. Once the identity of funders is forced into the public, the door is open to costly collateral litigation about the funding and its role in the case. After all, learning that Fund X has invested in a matter is just the opening move in a discovery sideshow of the style that is familiar to all seasoned litigators. That barebones disclosure will lead to discovery regarding contract terms and communications, in significant part to uncover the financing firm’s views of the merits of the litigation. Even more fundamentally, these inquiries will be aimed at undermining the privacy of the financial arrangement itself.

This is quicksand. It goes right to the most sensitive and privileged communications, not to mention the business methods of litigation finance companies. This is the prototypical fishing expedition, which not only wastes judicial resources but raises the costs for the plaintiff—which is, after all, the real point. The more onerous the defendant can make the use of litigation funding for the plaintiff, the more it can exploit its often inherent financial advantage.

Risk sharing is one of modern society’s most important innovations. Financial tools that permit others to invest in risky assets enable the global economy to function, enable individuals to put roofs over their heads, and enable economic opportunity to be allocated (more or less) according to the quality of ideas, rather than the identity or wealth of the individual behind them. Finance is the great equalizer.

This is true in the law as well. We are all familiar with the unfortunate conventional wisdom of rich-man’s justice. The law is expensive (in part because of the inability to share risk among lawyers), and this means that the scope of the law is distorted by the preexisting wealth of the parties. Litigation finance holds the promise to upend this. Not only can it make routine litigation for individuals and businesses alike more predictable and less risky (acting as a risk-pooling mechanism), but it also gives those who lack financial resources but have strong claims access to justice.

There is a big difference, however, between portfolio theory as applied to homes and credit cards and the same theory applied to the law. The law is adversarial, meaning that reducing costs and increasing access to the legal system creates winners and losers. Everyone benefits when the costs of borrowing money to finance a house or a car or college are reduced. But those who benefit from denying people access to courts can be expected to resist litigation risk sharing.

This resistance is being offered today in demands for transparency, which is both unnecessary and a Trojan horse to make litigation yet more expensive for claimants who have already suffered harm. Disclosure is not an unalloyed good. It has costs and benefits, just like everything else. In the case of current disclosure demands, the costs overwhelm any purported benefits. Industry practice is for litigation financiers to play no role in funded cases, merely to pool those investments with others to diversify risk and lower costs. In that environment, disclosure is the start of a fishing expedition, meant to burden the party choosing to finance a claim and the funder with burdensome discovery. In the absence of any evidence funders are meddling or driving litigation outcomes, calls for transparency are simply strategies to tilt the field back in favor of those who want to close the courthouse door to claimants who have in litigation finance a newfound ability to protect their rights.

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M. Todd Henderson

Professor of Law

The author is the Michael J. Marks Professor of Law at the University of Chicago Law School.