Since the litigation finance industry began rising in popularity over the past decade, the field has been described by some scholars and commentators as “new,” “nascent,” a development that “takes getting used to,” and even a “new twist on legalized gambling.” This assertion that litigation finance is a novel innovation lies at the heart of opponents’ efforts to impose burdensome regulations upon the industry.

But is litigation finance really new?

In truth, third-party funding of legal claims has long existed in the law – and indeed it is regularly recognized as a positive aspect of our legal system. For centuries, litigants have found ways to share the costs of litigation with third parties, as explained below. This is consistent with parties’ behavior outside the legal system, where companies and individuals rely on third-party financing all the time to manage their liquidity and risk constraints.

A long tradition of third-party financing

Many methods of third-party financing are well-established, salutary, and uncontroversial features of our legal system. The most familiar method of third-party financing is the contingent fee, which allows lawyers to finance their clients’ litigation in exchange for a share of case proceeds. Contingency fee agreements allow illiquid or risk-constrained litigants to permit a non-party to the litigation—lawyers—to bear some or all of the financial costs and risks of litigation in exchange for the attorney receiving a share of the rewards if the matter succeeds.

Pro bono litigation provides another example of third-party financing. The ACLU, the NAACP Legal Defense Fund, the Becket Fund, and many other organizations are third parties to litigation that raise funds from donors and then use those funds to finance litigation on behalf of claimholders. Pro bono litigation is not viewed as a bug in the legal system. It is instead considered an indispensable and highly desirable feature of the legal system.

There are other common methods of third-party financing of litigation. Imagine you have a good legal claim but are strapped for cash. A family member, a friend, or your employer can pay your litigation expenses. Parents can pay for their adult child’s divorce fees. A wealthy benefactor can help a friend injured in a car accident bring a civil claim against the reckless driver. Companies frequently pay the defense costs of (and money judgments against) directors or officers sued for breach of fiduciary duty. State and federal governments typically pay the legal defense costs of (and often judgments against) officers sued for violations of constitutional rights.

In insurance subrogation, an insurer pays a claimholder (say, the victim of a botched medical procedure or car accident) and then sues the wrongdoer to recover the money it paid the claimholder. Bankruptcy claims trading allows creditors to freely sell their claims to third parties willing to undergo the time and expense of litigating those claims. Parties may assign their contract rights, and creditors may sell their right to collect a debt to third parties. Each of these instances involves a claimholder sharing with a third party some or all of the financial risks of litigation, and all are accepted legal practices.

Unequal access to litigation funding

Even if we center the discussion on corporate claimholders – the types of claimholders Validity funds – we can see that these claimholders have long been permitted to access the capital markets to finance their litigations. For example, they can seek out new equity investors or creditors who provide capital the company needs to litigate its claims. Healthy companies may be able to raise such financing on the strength of their core businesses, irrespective of the strength of their legal claims. Very weak companies with negligible market value may also be able to raise such financing by selling equity based primarily on the value of the litigation asset, which happens often in patent litigation. The funds they raise in the capital markets may then be used to fund litigation.

Nonetheless, many companies are less capable of raising such equity and debt financing. For example, a company may not have a robust enough core business to attract investors, even if the company is worth more than the value of the litigation claim. In a world without litigation finance, these claimholders might not be able to obtain financing for their meritorious claims, even as other companies secure funding, through general debt or equity fundraising, for weaker legal claims. This would be an untoward result, and likely a suboptimal result from an efficiency perspective. That is because any ban or limitation on modern litigation finance will be underinclusive, arbitrarily precluding some claimholders with meritorious claims from obtaining financing while allowing others (those with better access to other corners of the capital markets) to obtain the funding they need.

Litigation finance is an evolution, not a revolution

Since we not only tolerate, but embrace, the many long-standing forms of third-party financing discussed above — contingency fee litigation, pro bono litigation, bankruptcy claims trading, equity and debt financing, and so on—a theory is needed for why modern commercial litigation finance ought to be regulated differently than these other forms of financing.

The truth is that litigation finance is not different or new in kind, as third-party financing has long been a mainstay of our legal system. But the modern litigation finance industry may be different in degree from prior methods of third-party financing. The rise of litigation finance as an asset class has allowed large pools of capital to be specifically dedicated to facilitating corporate claimholders’ access to the courts.

Claimholders who previously have been unable to obtain the various other forms of third-party funding may now obtain modern litigation funding. And even claimholders who could obtain the other forms of third-party funding may find that litigation finance provides a more efficient way to finance their litigation.

This blog post is adapted from Suneal Bedi & William C. Marra, The Shadows of Litigation Finance, 74 Vand. L. Rev. 563 (2021).

The post What’s So New About Litigation Finance? first appeared on Validity Finance.