Litigation financing, also known as lawsuit funding, has been around for decades in one form or another, though it has been more pervasive in recent economic times. With the fallout from mortgage-backed securities comes an increase in available funds in this new and emerging financial market. In a very broad sense, litigation financing occurs when a claimant or claimant’s attorney obtains a loan to be repaid out of the proceeds from any settlement or judgment. These loans are frequently “non-recourse” loans, meaning the lender cannot seek repayment unless the claimant makes a recovery.

Two Flavors of Funding

Litigation financing exists in numerous forms. However, two basic types are emerging, each with its own impact on claims management. The first are relatively low-dollar claims, often in the bodily injury context and typically under $10,000. They are frequently made directly with the injured claimant and usually without the advice of counsel. The funds from these loans are commonly used for living expenses and maintenance of lifestyle where an injury may make it otherwise difficult.  However, there are usually no specific restrictions on the use of the funds and the claimants may be more frivolous with the proceeds.

The second and more sophisticated type of financing exists in commercial litigation, which typically involve high-dollar claims between corporations. Lenders like Juridica Investments, Ltd., IMF Australia, Ltd., and Buford Capital, Ltd. usually limit investments to business claims and do not fund bodily injury cases involving product liability, mass or toxic tort, general liability, or other similar areas of exposure. Funding from these lenders is specifically used to support expensive and protracted litigation, covering services such as hourly legal fees, document management, expensive discovery requests and responses, and other costs directly related to the litigation. Lenders will typically exercise more control over the use of these funds.

Both types of litigation financing depend heavily on an accurate analysis of the case being funded. Lenders will conduct a review of the strengths and weaknesses of the case, the likelihood of recovery, and an estimate of the amount deemed recoverable. They are essentially gambling that the outcome will exceed the amount of the loan. To a lender, it does not matter whether a resolution is reasonable and just, but rather if there is a likelihood of making money on the investment.

Interests at Stake

When a claimant, whether an individual or business entity, suffers a compensable loss, he or she essentially becomes a creditor to the person or entity causing the loss. Complicated issues of liability notwithstanding, the one harmed is the one whose interests are at stake in the claim, and that person or group of people can vary. A claimant has the incentive and motivation to be compensated. However, when he or she takes out a loan against the litigation, the lender becomes the stakeholder, either in part or in full, depending on the amount of the loan.

The issues driving the litigation can rarely be simplified to purely monetary considerations. Personal injury claimants usually have a significant emotional and personal component that drives negotiation and settlement. If the loans are close to the full value of the claim, the claimant may no longer possess a practical interest in the outcome. In that instance, the lender becomes the most concerned of anyone in the outcome of the case. In fact, some courts have taken the position that the lender is, in fact, a “real party at interest” and have allowed them to be added to the litigation, thus positioning them under the court’s jurisdiction. Loans in complex commercial claims, on the other hand, are designed to support the expenses of litigation and do not shift the incentive off of the claimant as much. There are still other business factors that can drive settlement, but they may not exist when litigation funding is in place.

Cost-Prohibitive Proceedings

The litigation finance industry has dealt with a great deal of criticism in recent years. It is most often cited for violating the common law concepts of champerty and maintenance, which prohibit gambling and investing in the outcome of litigation. But is this criticism always justified?

Litigation is often prohibitively expensive for many with a valid legal claim. One criticism frequently made against insurance companies is that they have the resources to finance litigation involving their insureds, though they do not provide financial assistance in this area for their claimants that cannot afford litigation costs. However, it is ultimately a pool of the premium dollars of the insureds that supports the litigation, not the profit of the company.

In other words, litigation support is not free for either party. Nonetheless, there may be some merit to the financing of litigation from the claimant side, where it allows access to the judicial system when it would otherwise be cost prohibitive. Keep in mind that this does not mean lenders are by any means neutral stakeholders. They can and do influence the handling and resolution of claims involving an array of risks.

The Winding Road to Settlement

It is apparent that a vast majority of claims never reach a jury, as litigation costs prevent some cases from going to trial. This increasing trend is indicative of parties’ desire to avoid uncertainty and arrive at a result that everyone voluntarily agrees on. Courts have long had a public policy to discourage litigation and encourage voluntary resolution. This has become even more evident over the past two decades with the increase of alternative dispute resolution and decreasing number of trials. 

However, when lenders charge exorbitant interest rates to fund lawsuits, it becomes more difficult to reach a voluntary settlement. In one case, a loan of $5,600 carried an effective annual interest rate of 79.38 percent, escalating the balance due to almost $20,000. A claimant is not going to settle for less than he or she owes on the loan. This becomes a huge problem when the loan balance exceeds the value of the case. When that happens, the claimant already has money in hand from the loan. Thus, there is no incentive for the claimant to compromise—a concept that is essential to alternative dispute resolution. Negotiation can become futile the longer a case drags on and the principal balance of the loan increases. Eventually, it will seem as though the defendant is negotiating against a brick wall over which he or she cannot see unless the loan and its terms are revealed in discovery. 

If a claimant can convince a lender to make a loan, it is as though recovery has already been made, and there is no incentive to cooperate in the resolution of the claim. If the claimant loses the case, then he or she nevertheless “wins” in a sense because the claimant has the loan proceeds, and the lender has no source of recovery. The plaintiff thus has the incentive to roll the dice at trial. With these kinds of loans, at least in the personal injury context, litigation and trial become more likely while settlement is discouraged. 

What Defense Council Must Know

Determining whether a pre-suit claim has a loan lurking in the background is nearly impossible. It is essential for your defense counsel to ask for this information when a case enters litigation. Claimants’ attorneys and mildly sophisticated claimants will not volunteer this information. They are not obligated to provide it outside of litigation. Exploring the possibility of a litigation finance loan should be a basic part of any written discovery.

The obvious first question should be whether there is any such loan. Defense counsel should ask if the claimant has received or obtained a loan against any recovery in the lawsuit or if they have otherwise been paid any sum in exchange for a future payment out of the proceeds of any recovery from the lawsuit. If the answer to any portion of that is “yes,” then there should be a series of follow-up questions that elicit information about the loan that would be sufficient to issue a subpoena to the lender. Among other things, the discovery should ask for the name, address, and telephone number of the lender, the loan or account number, the amount of such loan, the balance as of the current date, and the material terms of repayment.

Support for and Objections to Discoverability

There is always a possibility of an objection to this discovery request. Nevertheless, consider some very good arguments in favor of discoverability. First, the claimant has to apply for the loan, and the loan applications contain questions that directly address the claimant’s view of liability and damages. Most jurisdictions have case law allowing a broad right of discovery and would certainly encompass any such statements made by the plaintiff that would be discoverable. This information may not only be discoverable but also admissible at trial. Furthermore, if the loan requires a notarized signature by the claimant, then there is the argument that the claimant has made a statement under oath thus favoring discoverability.

The loans themselves may contain data that would not only be admissible at trial but would also lead to the discoverability of information. In most jurisdictions, the requirement for discovery is that it be reasonably calculated to lead to the discovery of admissible evidence. To fund only loans with a high chance of being repaid, lenders conduct their own investigations into claims. This may reveal additional treating physicians, lost wage information and other lien holders. While this same information may be available in basic discovery, if lenders have already obtained records from doctors, statements from witnesses, or sought opinions from doctors, then that information may be more complete than what you can obtain in initial discovery before taking the depositions of treating physicians.

It is clear that in some cases, the function of these loans in the litigation process can be an impediment to a fair and reasonable settlement. Be aware of them and find out if the claim you are handling involves one. Lenders may be willing to negotiate terms if you are able to make them a player in the negotiation.