An Empirical Investigation of Third Party Consumer Litigant Funding

Abstract

This is the first large-scale empirical study of consumer third-party litigation funding in the United States. Despite being part of the American legal system for more than two decades there has been almost no real data-driven empirical study to date. We analyzed funding requests from American consumers in over 100,000 cases over a twelve year period. This proprietary data set was provided to us by one of the largest consumer litigation funder in the United States.

Our results are striking and important. We find that the funder plays an important role in the American legal system by screening cases. Our funder rejected about half the applications, as well as was cautious about investing too much in a single case, thus preserving the incentives of the client and her lawyer to exert optimal effort. We find that the funder suffered losses in 12% of the cases primarily because of complete defaults. Even in the cases the funder made profit we find a surprising gap between the markup that the funder was supposed to receive from consumers based on the contract between them and the markup the funder actually received. This gap stems both from clients’ defaults as well as from haircuts that the funder gave to the clients.

On the troubling side we find that the funder used controversial techniques to calculate the amount due from the clients. Specifically, the funder used various types of interest compounding, minimum interest periods, interest buckets and fees to add costs to the contract. Accounting for defaults, haircuts, fees, etc., we find that the funder makes about 44% a year on each case. We are also the first to shed light on the role lawyers play in this industry. We find that some law firms are better than others in getting better treatment of their clients both before and after they received funding.

This study provides important concrete and specific data to policymakers and legal scholars interested in litigation finance. While we cannot assess whether the overall welfare effects from funding is positive or negative, we suggest that consumers should be better protected by reducing the opacity and complexity of the funding contracts as well as by requiring lawyers to do more to protect their clients who seek third party funding.

Keywords: litigation, consumer protection, empirical legal studies, legal ethics