Investing In Lawsuits, Part III: Here Come The Banks and Hedge Funds

On Sunday, the New York Times returned to third-party funding of lawsuits with “Investors Put Money on Lawsuits to Get Payouts:”

Large banks, hedge funds and private investors hungry for new and lucrative opportunities are bankrolling other people’s lawsuits, pumping hundreds of millions of dollars into medical malpractice claims, divorce battles and class actions against corporations — all in the hope of sharing in the potential winnings.

Total investments in lawsuits at any given time now exceed $1 billion, several industry participants estimated. Although no figures are available on the number of lawsuits supported by lenders, public records from one state, New York, show that over the last decade, more than 250 law firms borrowed on pending cases, often repeatedly.

The rise of lending to plaintiffs and their lawyers is a result of the high cost of litigation. Pursuing a civil action in federal court costs an average of $15,000, the Federal Judicial Center reported last year. Cases involving scientific evidence, like medical malpractice claims, often cost more than $100,000. Some people cannot afford to pursue claims; others are overwhelmed by corporate defendants with deeper pockets.

A review by The New York Times and the Center for Public Integrity shows that the inflow of money is giving more people a day in court and arming them with well-paid experts and elaborate evidence. It is helping to ensure that cases are decided by merit rather than resources, echoing and expanding a shift a century ago when lawyers started fronting money for clients’ lawsuits.

On the one hand, it’s hard for me to say much new about these issues, since I’ve already discussed the issue twice in “Investing in Lawsuits” – The Free Market Counterpart to Liability Insurance and Investing In Lawsuits, Part II: New Law Review Article On Third-Party Litigation Funding.

In short, there’s nothing novel or interesting about the idea of a third-party funding litigation — we already have a multitrillion dollar industry devoted to the practice, it just happens to be devoted entirely to litigation defense. We call it “liability insurance.”

Since we permit defendants to have a third-party fund their defense and indemnify their liability, it stands to reason and to fairness that we should permit plaintiffs to reach financial agreements with third-parties to fund their claims and to share the proceeds of those claims. Anything less would deny plaintiffs a fair resolution of their cases on the merits, since the lack of resources would preclude many plaintiffs from pursuing meritorious claims, just like the lack of defense insurance would force defendants with inadequate resources to settle.

It’s refreshing to see that many of the people invited to comment in the “Room for Debate” connected to the article — alas, not one of which is a practicing attorney — get the analogy between insurance and plaintiff-side funding. Here’s Prof. Susan Lorde Martin:

Defendants in lawsuits often have insurers to finance their litigation expenses; litigation finance firms merely play that same role for plaintiffs, leveling the playing field. Such financing can allow a plaintiff to remain in the legal battle long enough to have a realistic opportunity to achieve legal success. It can also serve as an alternative way for businesses to manage risk and cash flow associated with legal proceedings.

There is no public policy reason to deny businesses the opportunity to share litigation risks with interested lenders or investors in exchange for some of the proceeds. Individuals who receive such financing are represented by lawyers, and if they lose their lawsuits they keep the money advanced to them and do not have to pay anything back.

Prof. Anthony Sebok takes this analogy one step further, and sees the possibility of litigating financing spreading to the masses, opening a world of civil litigation previously denied to everyone who either isn’t rich or didn’t suffer enough in economic damages to encourage a plaintiff’s lawyer:

While I am concerned about the overall cost of litigation, I am more concerned about the imbalance of resources available to the average American. Right now, our system depends on lawyers who take on plaintiffs’ cases to carry the costs of the cases. This is one reason the contingency fee has become an indispensable part of our civil litigation system.

I have nothing against lawyers financing litigation, but I do not understand why lawyers are the only option available to plaintiffs seeking capital from an outside source. Non-lawyer funders (litigation financing firms and/or third-party investors in lawsuits) might even be able to provide this capital more cheaply and more transparently so that lawyers would charge only for their time and nothing more. Non-lawyer funders could also help finance litigation costs for defendants as well.

Indeed, one of the main reason contingent fee lawyers charge so much is because their work is so risky. Plenty of cases end with lawyers spending hundreds or thousands of hours, and tens or hundreds of thousands of dollars (sometimes millions), and ending up with nothing. Consider A Civil Action. A lot of patent infringement lawyers learn the hard way when they invest more than a million dollars in a case in just expenses, not to mention attorney time.

Even some of the tort reformers have had some sense knocked into them. Prof. Richard Epstein — who has proven himself to be wholly unfamiliar with the American legal system — admits that his key concern is an empirical one, and that he doesn’t have the data to reach a conclusion either way:

The key question is whether these new aggregations of wealth are sufficient to force defendants to settle cases on disadvantageous terms because they cannot afford to pay the legal fees needed for defense. That question is exceedingly difficult to answer because the legal system already affords some protection against burdensome document production and endless depositions of expert witnesses. It is hard to say in the abstract whether that is enough.

It’s difficult to answer that question in the abstract, but consider this: in the vast majority of cases, the costs are low enough that attorneys don’t need to use third-party financing. Major investment in a case usually only occurs in mass tort cases brought against huge corporate defendants — the article in The New York Times gives an example of a case brought by “residents of the faded Texas factory town” against BNSF Railway, “the nation’s second-largest railroad company.”

Does anyone have trouble distinguishing David from Goliath there? Does anyone really believe that BNSF Railway doesn’t have adequate funds to defend the case? If BNSF Railway ends up settling it, it will be because the company is worried about liability, not because it can’t afford the costs of defense.

But there’s always someone willing to complain about a good idea, and this time it’s Prof. Paul Rubin, an economist:

The main effect of allowing third party finance is to increase the number of lawsuits. This will happen for two reasons. First, some lawsuits are too expensive or too risky for law firms to finance themselves. A law firm paid on a contingency basis finances the lawsuit, but if a lawsuit is too expensive and too risky no law firm will be able to undertake this financing. Thus, allowing third party finance will enable these expensive lawsuits to proceed.

In other words, it’s a good thing that meritorious cases will not be brought because they are “too expensive and too risky” to take on. Let the victims eat cake.

Prof. Rubin doesn’t seem to have enough familiarity with the tort system to know what makes a case “too expensive and too risky,” but I can tell you the two biggest factors: the amount of damage caused by the potential defendant and the ability of the defendant to over-litigate the case. In general, the more widespread the damage, the harder it is to prove the damage within the rigorous standards demanded by courts, and the more will need to be spent on the investigation and the experts.

To take one example, environmental cases are notoriously expenses and risky, and companies fight them to the death — just ask Erin Brockovich, who is heading back to her hometown after “a large plume of water laced with the offending hexavalent chromium, or chromium 6, has been found spreading beyond an agreed containment boundary and towards residents’ homes.”

But let’s move on to Prof. Rubin’s other factor:

Second, allowing third-party finance will create an interest group — those with experience in financing lawsuits. As an interest group these financiers will act so as to increase the amount of lawsuits in society, and to resist efforts at reform. Since we already have excessive litigation in the U.S. anything which increases the amount of litigation like third-party finance is likely to be harmful.

I suppose there’s some truth to that — and there’s even more truth to the fact that we already have an “interest group” that acts to decrease the amount of lawsuits and liability in America, despite the merits of those cases.

It’s called the insurance industry.

Does Prof. Rubin think they should be banned, too?

Or is this a heads-defendants-win, tails-plaintiffs-lose type of argument?

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