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Should Third-Party Litigation Funding Be Regulated or Banned?
January 15, 2020

In mid-November, an article was published on the St. Louis Record’s website entitled “Third-party litigation funding ‘should be regulated or banned outright,’ tort reform advocate says.”

According to the Chamber of Commerce, such secrecy allows outside investors to hide their influence over a lawsuit and settlement decisions, “while blinding courts to potential financial conflicts of interest. And for corporate defendants, there are tactical advantages in knowing if an adversary has funding, particularly in settlement talks.” (source)

Funders believe that such a disclosure rule could unfairly expose a plaintiff’s litigation budget. In addition, defendants might decide to bombard plaintiffs with unnecessary demands to pry into investor communications and funding agreements.

Since legal funding is a relatively new industry, it lacks the regulation of more established and traditional financial vehicles. Therefore, most legitimate legal funding firms welcome reasonable regulation, as this helps flush out the few bad apples that give the entire industry a bad name. According to Eric Schuller, Director of the Alliance for Responsible Consumer Legal Funding, “We would love to have 50 regulations in 50 states because it sets parameters on what consumers get themselves into.” (source)

However, banning third-party funding outright would eliminate an important financial option for both consumers and businesses alike. But before getting any deeper into the discussion, let’s establish a definition of third-party funding.

According to The Essential Guide to Legal Funding, third-party litigation funding is “the process through which both plaintiffs and law firms can finance litigation or other legal related expenses through a third-party finance firm. These funding companies advance money to their clients in return for a portion of their award, settlement, legal fee or judgment. According to the Litigation Finance Journal, such transactions are “non-recourse, meaning that if the client loses the case, the funder cannot pursue the client’s other assets unrelated to the litigation to gain satisfaction.”

It is important to note that there are several different types of third-party legal funding serving different end users. Commercial litigation funding serves corporations. Attorney funding, as the name implies, finances lawyers and law practices. Consumer legal funding is the most popular form of third-party funding, and helps mainly personal injury plaintiffs access a portion of their anticipated settlement.

As a result, regulation of the third-party funding industry isn’t as simple as employing a “one size fits all” approach. For example, commercial litigation funding is used by businesses involved in lawsuits to help fight deep-pocketed defendants. The article states that “third-party litigation funding is a ‘global industry’ in which about $100 billion is made available to fund litigation.” This is true. However, the vast majority of this money is financed to large corporations via commercial litigation funding, through mega-funders in the form of multi-million dollar advances. 

On the other hand, consumer legal funding provides plaintiffs with small advances (usually no more than a few thousand dollars, generally not to exceed 10% of the anticipated award value). Therefore, it is imperative to have different rules and regulations to match the specific type of third-party funding.

As the legal finance industry continues to flourish, consumer legal funding is the subject of increasing legislative and regulatory action at both the state and federal level. So you can’t blame some commercial litigation funders for worrying that they could be swept up in the backlash.

As quoted in the article, “transparency when there are third party interests in the litigation is always a good practice,” Missouri Civil Justice Reform Coalition Executive Director Richard AuBuchon said. “However, by the time these agreements for funding are in place, they have already done the harm to the individual by taking away any real chance of recovery, made the case more difficult for the lawyers to reach settlement and driven up costs for all involved.”

In the above quote, Mr. AuBuchon seems to be referring more to the consumer legal funding industry, which as we’ve previously mentioned, mostly provides small advances to plaintiffs involved in personal injury claims. It is in the next paragraph, then, where he refers to the third-party funding industry as a $100 Billion industry. 

The Chamber of Commerce seems mainly concerned with regulating the consumer legal funding industry. So why not just give an estimate of the consumer legal finance space? In my opinion, it makes their cause seem more important by throwing around big numbers, even though the vast majority of that $100 billion figure accounts for commercial, not consumer, litigation.

The consumer legal funding space is also where most of the industry’s “bad apples” crop up. We, along with consumer legal funding industry groups like ALFA and ARC, believe that there should be fair regulations on pre-settlement advances.

However, because of the non-recourse nature of pre-settlement funding, companies providing such financing can lose their entire investment if a case doesn’t settle. Thus, it is very difficult to classify these transactions as loans. How can you apply the same usury laws intended to protect consumers when applying for car loans or a credit card to these types of transactions with no securitization of collateral?

Mr. AuBuchon makes some valid arguments in his article. Yet, like others before him, that argument contains broad generalizations across the whole legal funding industry and an attempt to classify such financial transactions within a framework that doesn’t quite fit. The answers to questions of how to regulate the legal funding industry are not easy, and a real debate requires more text here than this brief article could allow.

Like many in the legal funding industry, we welcome continued debate and discussion and hope that fair regulation can be achieved in the near future.

Written by David Smethie, Senior Marketing Director at Balanced Bridge Funding. Edited by Richard Heilshorn, Senior Investment Analyst at Balanced Bridge.

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