The Litigation Finance Contract
65 Pages Posted: 2 May 2012 Last revised: 8 Mar 2013
Date Written: May 2, 2012
Litigation funding (“LF”) — for-profit, non-recourse funding of a litigation by a non-party — is a new and rapidly developing industry. It has been described as one of the “biggest and most influential trends in civil justice” today by RAND, the New York Times and others. Despite the importance and growth of the industry there is a complete absence of information about or discussion of litigation finance contracting, even though all the promises and pitfalls of litigation funding stem from the relationships those contracts establish and organize. Further, the literature and case-law pertaining to LF have evolved, in their entirety, from an analogy between LF and contingency fees, viewing both as ethically compromising exceptions to the champtery doctrine. On that view, such exceptions create risks of an undesirable loss of client control over the case, of compromising lawyers’ independent judgment and of potential conflicts of interest between funders, lawyers and clients.
This article breaks away from the contingency analogy and instead posits an analogy to venture capital (“VC”). It shows the striking resemblance of the economics of LF to the well-understood economics of VC. Both are characterized by extreme (1) uncertainty, (2) information asymmetry, and (3) agency costs. After detailing the similarities and differences of these two types of financing, the article discusses which contractual arrangements developed in the venture capitalism directly apply to litigation finance; which ones need to be adapted; and how such adaptation can be achieved. Since much of the theory, doctrine and practice of VC contracting can be applied or adapted to litigation finance, practitioners and scholars can be spared decades of trial-and-error in developing standardized contractual patterns.
In addition, the analogy turns most of the conventional wisdom in the field on its head. This article argues that funders should be viewed as real parties in interest; funders should obtain control over a funded litigation and; attorneys should take funders’ input into account. In return, funders should pay plaintiffs a premium for the control they receive, subject themselves to a compensation scheme that aligns their interests with those of the plaintiffs and enhance the value of claims by providing non-cash contributions. Courts and regulators should devise rules that enhance the transparency of the industry, in particular the performance outcomes of various LF firms and their ethical propensities. Such a legal regime will foster the emergence of a reputation market that will police the industry and support contractual arrangements.
Keywords: Alternative Litigation Finance, Third Party Funding, Contracts, Venture Capital, Civil Procedure, Civil Litigation, Law and Economics, Champerty, Legal Ethics, Litigation Costs, Chevron Ecuador, Professional Responsibility, Transnational Litigation, Access to Justice
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