This is the second article in a series revisiting some of Lawyers Weekly’s best stories over the years, seeing how issues have evolved since we last covered them, and how well our stories anticipated future developments.
In May 2013, we looked at the innovative business of litigation financing—investment companies that front some of the costs of complex and expensive commercial litigation in exchange for a portion of any recovery.
Five years ago, litigation finance was a mere minnow swimming in the shadows of the massive U.S. litigation industry, and one that had yet to garner much notice. Today, although still a long way from being a whale, it is certainly a much bigger fish, and one in which law firms are increasingly taking a keen interest.
According to the 2017 Litigation Finance Survey published by Burford Capital, a leading provider of finance to the legal market, the use of litigation finance by U.S. law firms grew by 414 percent from 2013 to 2017 (if admittedly from a small base). That growth shows no sign of abating any time soon, as more law firms report that they’ve either used litigation finance already or expect to do so in the near future.
David Perla, managing director for Burford, says that the growth in litigation finance owes much to law firms’ embrace of innovation since the financial crisis. In the years immediately after the crisis, firms focused mainly on cutting costs. But in the last five years the focus has shifted to finding ways to increase revenue, which litigation finance does by allowing both clients and firms to pursue cases that otherwise they wouldn’t be able to.
“For many clients, this is the only way they can actually undertake a case and often the most efficient way that they can enforce their rights,” Perla said. “The other benefit is that they’re able to hire the law firm of their choice. Historically, if you didn’t have the money, you had to hire a law firm on contingency, so you were limited to firms who were willing to take your type of case on contingency. By opening up capital to the client, we’ve basically given them freedom of choice on counsel.”
The elevator pitch for litigation finance is that it allows firms to retain the benefits of hourly billing while allowing clients to access the benefits of the contingency fee model. Even firms that are willing to take some business litigation on the contingency model generally do so sparingly because of the risks involved, so shifting some of that risk onto investors is appealing for firms and clients alike. But as litigation finance has grown, it has also drawn critics who contend that it raises thorny ethical issues for attorneys.
Passive portfolio managers
For the most part, judges have looked upon litigation finance favorably, while many state bars and legislators in a few states have been more skeptical. One of the main areas of concern has been ensuring that lawyers, and not funders, retain ultimate control over the litigation.
Last year a U.S. bankruptcy court judge in North Carolina denied a trustee’s motion to obtain litigation financing because the proposed funding agreement would have required the trustee to make regular funding requests as the litigation progressed and seek the funders’ input and approval of strategic decisions. (Bankruptcy court is unusual in that trustees must get a court’s approval to obtain financing. In most cases a defendant won’t even know if the plaintiff has a financing agreement in place.)
Mike Adams of Parker Poe in Charlotte, who represented the party opposing the motion, said that it’s perfectly fine for financers to lend money and take an assignment of proceeds, but if financers have control over the litigation, such agreements would run afoul of common law doctrines such as champerty and maintenance that preclude third parties from inserting themselves into litigation. He also said he believed that such agreements could make cases more difficult to settle.
“Control is the key factor, the ability to control the decision-making in the litigation,” Adams said. “For an opponent, that’s an important issue because you don’t have as much opportunity to interface with the third-party funder as you do with the party, who should be making all of the decisions in the litigation,” he said.
Perla said that although his company has attorneys who can provide useful advice to a client’s counsel, its financing agreements spell out that it has no control over the litigation or the settlements, and he believed that most of the major players in the industry also follow the same practice. He also said that financers would actually prefer that a case reach a favorable resolution more quickly, so that the capital can be reinvested.
“If our advice is wanted, we’re happy to provide it, but we have no control over the litigation,” Perla said. “Most finance companies have moved away from any control.”
Perla also pushed back against another common criticism, that litigation funding could be used to fund the pursuit of meritless claims, saying that demand for litigation financing is still running well ahead of its supply. According to Burford’s annual report, it received 1,561 requests for capital in 2017, and it chose to finance just 59 of those cases. (Those numbers can’t be extrapolated to the litigation finance industry as a whole, however.)
Capital in the 21st century
Just as demand for capital is strong enough to afford litigation finance plenty of room to grow, supply of it has not been wanting, either. More investors are taking an interest in litigation finance, Perla said, because returns have been strong, and litigation finance is what’s known as an uncorrelated asset—unlike most places where you could stick your money, returns will most likely hold up fine the next time the economy goes into recession.
Rather, the biggest choke point for growth may be the vexing challenges inherent in underwriting requests for litigation finance. It’s difficult to find underwriters with both the financial acumen and the legal chops to decipher whether a case is worth funding. (Artificial intelligence isn’t very helpful either, at least not yet.)
Predictably, that has fired up demand for the services of those who do have this unique skill set. The Wall Street Journal reported last month that litigation finance is the “hot new law job,” with a flock of legal high-fliers moving recently from top firms to big funders.
“For a lawyer who could also analyze the data, that’s going to be a great niche,” said Michele DeStefano, a professor of law at the University of Miami, and the author of a new book on innovation in the law. “Litigation is one of those areas where not everything depends on the numbers … somebody who’s not a lawyer might not have the understanding of the legal aspects.”
The expense of due diligence will also likely restrict the range of cases that funders are willing to take on. Typically financers won’t consider a case worth pursuing unless the potential damages are in at least the tens of millions of dollars. While funders could potentially take on smaller matters than that, at some point the economics don’t work given the cost of properly vetting cases, Perla said. Underwriting is even knottier still when trying to price financing for defending claims, and so plaintiffs have received the vast majority of the capital so far.
The opacity of the litigation finance industry makes it hard to say how big the sector truly is. Burford has $3.3 billion in assets under management, but it funds litigation all over the world and doesn’t break down how much of that money is invested in the U.S. specifically. Most financers, though, are private entities inclined to keep mum about what’s on their balance sheets.
But unquestionably financers are backing both more cases, and a more a diverse range of cases, than they were just a few years ago, and their prevalence is almost certain to continue growing. Where there were once questions about whether litigation finance was just a passing fad, the questions now are about how big it will ultimately get, and how it might reshape the legal profession in the process.
Follow David Donovan on Twitter @SCLWDonovan