Recently, lawmakers and the insurance industry have called for transparency regarding third-party litigation funding (TPLF). Here we look at third-party litigation funding and how it has impacted verdicts and settlements and the cost of insurance.
What Is Third-Party Litigation Funding?
TPLF enables private equity firms and other financiers to invest in lawsuits in exchange for a portion of any settlement or verdict. The practice wasn’t begun in the United States but in Australia and was later extended to Europe and then here.
According to the Government Accountability Office (GAO), many third-party litigation financers are private institutions that specialize in this niche market, with some publicly traded companies and hedge funds. Many receive capital from various sources such as sovereign wealth funds, pension funds, and endowments. They are not parties to the lawsuit.
There are two types of funding categories:
- Commercial Arrangements. These arrangements are between funders and corporate litigants or law firms and represent most TPLF cases. In this scenario, a funder agrees to provide legal or business expenses funding in exchange for a portion of the court award if the plaintiff wins. The funding is typically in the millions of dollars. The disbursement goes straight to the plaintiff (or sometimes a corporate defendant) to cover legal costs, such as expert witnesses and attorney fees, in exchange for a percentage of the award, or to legal firms, in which case the money may be used to cover the costs of a single case or a portfolio of cases, depending on the funder’s agreement. There is no recovery if the case is lost. As a result, provisions in the funding agreement may often include a significant amount of the contingency fee or settlement and additional duties. This is the payoff that investors expect for accepting the risk. The sum also indicates significant entry hurdles (cost of legal evaluation skills, capital needs, etc.) and large-loss risk. The greater the settlement or verdict, the greater the return or profit on the original cash invested.
- Consumer Arrangements. These arrangements are between a funder and an individual, such as the plaintiff in a personal injury case. The funder provides a relatively small amount (typically under $10,000) to the plaintiff, who uses it for living expenses and medical costs. Before providing funds to the client, the investor may interview the attorney to determine the litigation’s legal strength and possible monetary worth. Funders then estimate the value of a case settlement and offer cash based on a percentage of that estimate. In exchange, they demand a monetary part in the eventual payment. As with commercial arrangements, recipients are not required to repay the funds if the lawsuit is dismissed or lost. If the beneficiary wins or settles their lawsuit, the funder will receive the sum distributed plus interest.
How Big Is the TPLF Market?
In a report by the Insurance Information Institution (I.I.I.), according to reinsurer Swiss Re, $17 billion was invested into litigation funding globally in 2020 and is expected to go as high $30 billion by 2028. More than half of the money invested in 2020 was in the U.S. market.
Funders in commercial litigation cases reportedly funnel their money to lawsuits involving intellectual property/patent infringement, whistleblowers, arbitration, business torts and contract breaches, personal injury, and class actions.
Litigation funders pay six figures or more to analyze the cases and legal portfolios they sponsor, according to the I.I.I. They use artificial intelligence (AI) tools and professional consultants to determine where to invest. Furthermore, rather than focusing on a single case, litigation financiers may build a portfolio-level relationship with a legal firm or corporation to spread the risk of loss across multiple cases and maximize earnings. Law firms can make fundraising deals to cover a combination of working capital, claim monetization fees, and costs in such arrangements.
Lack of Transparency with TPLF
There is no uniform mandatory disclosure requirement regarding whether a case involves outside funding. Few states or territories in the U.S. compel attorneys or their clients to disclose TPLF agreements to the opposing party. While disclosure of funding agreements may be required in some jurisdictions or cases, the overall lack of transparency in TPLF arrangements impedes fair play by making it difficult for opposing parties to manage legal risks and associated costs.
Increased Legal Costs, Rise of Nuclear Verdicts
Third-party funding litigation enables outsiders to use courtrooms as a trading floor, incentivizing the filing of frivolous lawsuits. Litigation is too expensive for businesses, so they will avoid it. As a result, regardless of whether or not the claims have merit, firms are often forced to settle rather than engage in protracted litigation.
Although it’s difficult to quantify due to the lack of transparency that exists with TPLF, the consensus is that it has contributed to a legal landscape where nuclear and thermonuclear-sized verdicts are increasingly commonplace. A new report from Marathon Strategies found that the median nuclear verdict against corporate defendants jumped from $21.5 million in 2020 to $41.1 million in 2022 while the number of verdicts doubled. Nuclear verdicts are jury awards that surpass $10 million.
The Impact of TPLF on the Insurance Industry
TPLF may also be a driver of social inflation, defined as an increase in insurance claim expenses that exceeds the overall economy’s inflation rate. Swiss Re observed a spike in multimillion-dollar claims in the general liability and commercial auto markets in the U.S. Third-party litigation funding incentivizes initiating and extending cases by directing a more significant share of earnings to the funder rather than the plaintiff. Because these additional expenses are challenging to foresee, insurers may find it difficult to quantify and minimize them.
As nuclear verdicts, which are paid by insurance companies, continue to climb, costs are then passed on to business owners and entities and ultimately to the consumer.
Calls for Greater Openness and Regulation in Third-Party Litigation Funding
In mid-September, insurance industry representatives, during a U.S. House Oversight and Accountability Committee hearing, called for more transparency into third-party litigation funding. In a letter to the Oversight Committee, the American Property Casualty Insurance Association (APCIA) described TPLF as “a dark money lending practice that allows unknown investors with no ties to the injured person to invest in lawsuits, and in some cases falsely inflate medical costs, for their own profit.”
The APCIA backed legislation from the previous congressional session that would mandate disclosure in all class actions and multi-district litigation in federal courts. According to the letter, the bill’s authors intend to reintroduce the measure this session. Another bill presently before the U.S. House would mandate disclosure of third-party lawsuit funding in highway accident cases, according to APCIA.
Indiana, Montana, Wisconsin, and West Virginia are among the states that have passed some form of third-party financing disclosure requirements. In addition, U.S. District Court judges in California, Delaware, and New Jersey have adopted disclosure policies in litigation.
Furthermore, Florida U.S. District Court Judge M. Casey Rodgers, who is overseeing 3M’s proposed $6 billion fund to settle product liability claims involving military-issued earplugs, stated that she would require disclosure of any third-party litigation funding agreements to ensure plaintiffs are not subjected to the “exorbitant fees and rates of interest” that can accompany such funding.