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Recommended: new papers on third-party litigation finance

Three important new papers highlight the dangers of the fast-growing practice of third-party litigation finance. The Chamber of Commerce's Legal Reform Summit this week saw the release of a study (PDF) by Skadden's John Beisner, Jessica Miller and Gary Rubin entitled "Selling Lawsuits, Buying Trouble: Third-Party Litigation Funding in the United States" Executive summary:

"Third-party litigation financing" is a term that describes the practice of providing money to a party to pursue a potential or filed lawsuit in return for a share of any damages award or settlement. Litigation-financing companies provide financing for myriad litigation costs, including attorneys' fees, court fees, and expert-witness fees.Funding arrangements also may involve financing the party's living expenses while the trial and any appeals are pending. Third-party litigation financing is a growing phenomenon in the United States,and it has received much attention of late from both proponents and critics, including practicing lawyers, academics, jurists,and policy-makers. Although third-party funding is not widespread, it is playing an increasingly visible -- and potentially harmful -- role in U.S. litigation. If such funding becomes more prevalent, it will pose substantial risks of litigation abuse. This is particularly true in the context of class or mass actions, which are already very vulnerable to abuses.

The root problem with third-party litigation financing is that it introduces a stranger to the attorney-client relationship whose sole interest is a financial one.The stranger wants to protect its investment, and its interest lies in maximizing its return on that investment, not in vindicating a plaintiff's rights. Put simply: the stranger's motive is to pursue investments that will generate returns whether or not the claims underlying those returns lack merit. The stranger, like a law firm, is a repeat player in the lawsuit-financing game. But unlike a law firm, the stranger does not have a privileged, fiduciary relationship with the plaintiff.

Eventually, then, the stranger's presence will require a relaxation of the rules governing attorney professional responsibility, compensation, and the attorney-client privilege to accommodate these new realities.This relaxation threatens to chip away at -- and eventually eradicate -- critical safeguards against lawsuit abuse.

This paper begins with an overview of third-party litigation financing. It next examines current third-party financing practices in the United States. It then sets forth a critique of the practice, particularly the incentives it creates to engage in frivolous and abusive litigation. In this section, the paper also presents a case study on the Commonwealth of Australia, the first jurisdiction to permit third-party litigation funding, where such funding has dramatically increased litigation and given investors pervasive -- even total -- control over a plaintiff's litigation. Finally, the paper proposes that third-party litigation financing be prohibited in the United States to prevent these abuses. At the very least, the paper concludes, such funding should be banned in class actions and other forms of aggregate litigation.

Meanwhile, Northwestern's Searle Center is showcasing two excellent papers by Stephen Presser (Northwestern) and Paul Rubin (Emory) from a public policy roundtable on the topic held at Northwestern. From Prof. Presser's draft, which is entitled "A Tale of Two Models: Third Party Litigation in Historical and Ideological Perspective":

In this modest paper I argue that we have two different models of litigation in this country. One is a traditional model, best exemplified by Sir William Blackstone and Abraham Lincoln, that litigation is something pernicious that ought to be discouraged. A second model, one that has recently captured the popular imagination (or at least the imagination of our policy makers and elite lawyers), is that litigation is a noble tool that can lead to transformative social change, just as it did, for example, in the struggle for civil and educational rights in the fifties and sixties. What one thinks about third-party financing of litigation may turn simply on the choice of which model or ideology seems more appealing, and what is now happening in the American states is confusion over which of these models ought to predominate.

In addition to much interesting detail on the subject of societal views of litigation, Presser goes on to discuss key recent decisions on litigation finance from Texas and Ohio, and the general relaxation of restaints against champerty and maintenance.

From Prof. Rubin's paper, "On the Efficiency of Increasing Litigation", the abstract:

The common law has long forbidden third party investment in lawsuits based on "champerty" and related doctrines. More recently, these restrictions have been relaxed, although they may not have been entirely eliminated in the U.S. While it might appear efficient to allow such investment, in fact it is not. The effect of relaxing restrictions will be to increase litigation. When there are benefits of litigation these are deterrence of harmful activities. However, the U.S. already goes much farther than any other country in allowing class actions and other group based litigation, and so any benefits of increased litigation are likely to be small or nonexistent. There are two external costs from increasing litigation. First, the plaintiff must pay his own fees, but also imposes costs - sometimes quite significant costs - on defendants when a lawsuit is filed. In many cases, the costs imposed on defendants are greater than costs borne by plaintiffs, especially when plaintiffs are individuals or class members and defendants are business firms. Second, the type of lawsuits that would likely result from increased third party investment would probably move the legal system away from efficiency. Overall increasing third party financing of litigation is likely to be harmful.



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.