The Effect of Third-Party Funding of Plaintiffs on Settlement

46 Pages Posted: 7 Jan 2013 Last revised: 1 Mar 2013

See all articles by Andrew F. Daughety

Andrew F. Daughety

Department of Economics, Vanderbilt University

Jennifer F. Reinganum

Vanderbilt University - College of Arts and Science - Department of Economics

Date Written: January 7, 2013

Abstract

In this paper we use a signaling model to analyze the effect of (endogenously-determined) third-party non-recourse loans to plaintiffs on settlement bargaining when a plaintiff has private information about the value of her suit. We show that an optimal loan (i.e., one that maximizes the joint expected payoff to the litigation funder and the plaintiff) induces full settlement. Furthermore, in contrast with the more standard (no-loan) settlement bargaining models, there is no revelation of information created by the bargaining process: all plaintiff types (where the plaintiff’s type is her level of harm) make the same demand and, since no types go to trial, private information is not revealed. Implementation of the loan may entail a very high interest rate; we show that a high (enough) rate is necessary if one wants to obtain full settlement for all types of plaintiffs even when there is asymmetric information. We also find that plaintiffs’ lawyers benefit from such financing, as it reduces their costs by eliminating the need to take the case to trial due to bargaining breakdown. We further show that regulation of such loans, in the form of caps on the interest charged, may result in settlement failure or elimination of the litigation-funding industry itself.

Keywords: settlement bargaining, litigation funding, non-recourse loan, signaling

JEL Classification: K41, D82, C78

Suggested Citation

Daughety, Andrew F. and Reinganum, Jennifer F., The Effect of Third-Party Funding of Plaintiffs on Settlement (January 7, 2013). Vanderbilt Law and Economics Research Paper No. 13-8, Available at SSRN: https://ssrn.com/abstract=2197526 or http://dx.doi.org/10.2139/ssrn.2197526

Andrew F. Daughety (Contact Author)

Department of Economics, Vanderbilt University ( email )

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Jennifer F. Reinganum

Vanderbilt University - College of Arts and Science - Department of Economics ( email )

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