DANIEL NARCISO—On January 17, 2017, the U.S. District Court for the Northern District of California announced changes to its Standing Order that requires automatic disclosure of third-party funding agreements for proposed class-action lawsuits. In short, the court has made it a requirement that any outside party funding a proposed class action will have to disclose their involvement. Although the Northern District’s stance is unique, it might permeate through other districts as litigation financing becomes more prevalent.
Litigation financing, a field that has entrenched itself in the U.S. legal landscape over the past ten years, admittedly garners controversy. But, like all things, there is no black and white view. There are those that believe that this form of financing allows for the survival of non-meritorious actions while others see it as the way to allow more victims their day in court. There are also those that view the Gawker-Hulk Hogan case as the prime example of why litigation financing is unethical at its core. However, that view is wholly inconsistent with reality. Admittedly, there are a handful of erratic billionaires who might use this practice to satisfy their revenge-fueled desires. But, the fact remains that those regularly engaging in litigation financing do so for purely capitalistic purposes.
What is Litigation Financing?
At its core, litigation financing is the transfer of risk. Similar to insurance or hedge contracts, litigation financing allows a plaintiff to transfer the risk of uneven returns to an outside party in order to protect the predictability of its balance sheet. While this practice takes on a variety of forms, the most relevant form is one that deals with large corporations and classes of victims rather than singular tort victims.
In the usual case, a plaintiff will take on extra funding in order to pay an attorney who doesn’t wish to take on the plaintiff’s claim through an alternative fee-arrangement.. The financier will then distribute funds accordingly until the suit is resolved either in trial or through settlement. At the end of the day, the attorney retains his fees and limits exposure, the plaintiff is allowed to fully bring their claims, and the financier profits—or doesn’t—based on the outcome of the case. This form of financing is popular among class-action practitioners as well because it allows them to operate as traditional billable-based law firms without sacrificing a case due to potentially high-costs.
Recently, however, litigation financing has evolved past traditional plaintiff-side suits into other areas of law such as bankruptcy judgment actions and, most notably, defense-side litigation.
Defense-Side Litigation
Defense-side financing distributes the risk of protracted, expensive litigation and of a devastating judgment over a larger pool of lawsuits. This relieves the corporate defendant of litigation risk and thus allows it to return to productive economic activity.
This form of financing operates as a form of “litigation insurance.” While litigation insurance does exist for certain claims, litigation financing applies in those larger, riskier cases that insurance companies choose not to insure such as trademark infringement or anti-trust cases. It permits attorneys to not only advise on the nature and extent of risk associated with certain claims, but also to relieve risk-bearers of said risk by offloading it through market transactions. While the corporate defendant might view a suit brought against it as risk, the financier sees it as an opportunity for profit.
It acts as insurance because it absorbs risk. No matter if the financier seeks to incorporate defense-side into a portfolio-financing arrangement where it takes on all legal expenses for a corporation, or if the financier attempts to create a large pool of single-case financing opportunities—by combining a large number of legal events, it ensures that success in one will help offset a loss in another.
The biggest difference between plaintiff-side and defense-side financing is, of course, the availability of a monetary judgment at the conclusion of an action. While a plaintiff’s financier might have control over a portion of the judgment upon resolution, a defense-side financier would, alternatively, have to contract itself a benefit. This process starts with the defining of the term “successful resolution,” and proceeds from there.
For example, if a $100 million action is brought against a corporate defendant, a successful resolution might be the settlement of the claim for anything less than $50 million. If the claim settles for $35 million, then the financier might earn a certain percentage of the amount it saved the corporate defendant—in this case, $15 million. This amount could then be paid out as a lump sum, through periodic payments, or as equity shares in the corporation itself. This is a very basic example of what litigation financing enables: Corporations can now eliminate litigation expenses entirely from their balance sheets as well as protect itself from the monetary risks associated with extended litigation.
More importantly, this process allows a corporate defendant to continue to participate in its usual business practices without divesting money from profitable activities to pay for litigation expenses.
Conclusion
A recent survey revealed that the most commonly cited reason for ruling out the possibility of litigation finance was “ethical reservations.” While these ethical concerns do exist, they do not outweigh the benefits of litigation financing. By discharging risk associated with litigation onto willing third parties, all parties involved are allowed continue usual business practices. General Counsels, at the very least, must fully understand this emerging form of financing because it transforms a corporate legal department from an expense into a potential profit center.
The availability of financing will continue to grow as more corporate clients learn of the benefits. Soon, clients will begin to engage in financing without consulting attorneys. At that point, Litigation financing will have become mainstream and attorneys will be forced to adapt. Litigation financing is the future, and as such, a prudent attorney will begin to adapt before the future arrives.
