Litigation Finance at Trial: Model and Data

Abstract

Litigation finance is a relatively new investment vehicle focused on legal disputes. We present a theoretical model of litigation finance, grounded in empirical insights about litigation, and derive key insights for this burgeoning field and its implications for legal practice. Based on an extensive dataset of civil lawsuits, we first present a set of stylized empirical facts related to litigation. Grounded in these insights, we build a base model for a litigation and a model extension that includes litigation finance. Using these models, we arrive at three main insights about the implications of litigation finance: First, compared to law firms, litigation funders prefer high-risk litigation, which can enable access to justice but also challenges the legal system by increasing the number of lawsuits. Second, we observe that case durations are highly variable and lead to a high degree of uncertainty in process costs which can, based on our models, cause increasingly risk-averse law firms to invest more into law suits to reduce variance in the outcome. Risk-averse law firms thus disproportionally benefit the plaintiffs. Third, litigation finance tends to increase the amount spent on litigation. These extra costs are carried by the funder alone as cost sharing between funders and law firms is sub-optimal. In summary, litigation finance increases access to justice but absent of legislation threatens to burden courts by increasing workloads.

Keywords: litigation finance, third-party funding, economics of litigation, investment

JEL Classification: K41, G11, G23, C55