IN THE PUBLIC EYE

The Growth of Litigation Funding and the Impact on Social Inflation 

Author: Ricky Pray, Alliant 

 

Over the last decade, third-party litigation funding has gained some momentum in the United States. In fact, according to research by Swiss Re Institute, the United States is the world’s largest third-party litigation funding market.  It has evolved from a practice which was somewhat frowned upon within the judicial system to a booming industry valued at an estimated $17 billion globally.

 
What is Third-Party Litigation Funding?
Litigation funding is an investment/funding mechanism that allows third-party investors to invest and fund lawsuit expenses in exchange for part of the judgment or settlement. The most common type of litigation funding is plaintiff-sided litigation funding, and in these transactions, funds are funneled to the plaintiff in return for a portion of the settlement or award.
 
There are two basic classes utilizing litigation funding.
 
  1. Consumer-utilized funding – An individual involved in a lawsuit with individual interest, typically a personal injury lawsuit. In these situations, litigation funding can be used to help plaintiffs pay for their day-to-day living expenses giving them less incentive to settle quickly, which may increase the size of their settlement or verdict.  (Samrat 2016)
  2. Commercially-utilized funding – Due to the costly nature of litigation, a commercial entity, either in the private or public sector, may have to put forth large amounts of capital during the litigation process. Instead of using its own money to fund the litigation process, a commercial entity can enlist the services of a litigation funding company to advance the funds. This allows the entity to continue operations and protect its cash flow. (Samrat 2016)
 
In both instances, the litigation funding company earns their return on their investment from the ultimate settlement or verdict in the case they have funded.  
 
The Impact of Litigation Funding
In recent years, there has been a significant increase in the use of litigation funding companies in the United States. During the same period, nuclear verdicts have increased in frequency and severity (verdicts with awards over $10 million). Some have argued a significant factor in this increase in nuclear verdicts is a result of plaintiffs' access to litigation funding. Others attribute these large verdicts and settlements to social factors that have created "Social Inflation," Regardless of causation, there appears to a positive correlation between the rise in litigation funding and the increase in these types of verdicts. As a result, there is a significant concern for public and private entities, including:
 
  • Rising insurance premiums
  • Erosion of tort protection in the public sector
  • Increase in the number of lawsuits
  • Inflated settlements to avoid the courtroom
  • The increased cost of litigation
 
The Rise of Defense-Sided Litigation Funding
Until the last few years, third-party litigation funding has focused on plaintiff-sided funding. There are obvious reasons for this: remuneration is easy to define, returns on investments are directly linked to winning a case, most individuals do not have access to high-powered representation like corporations do, and the belief it gives plaintiffs better access to equitable outcomes.  
 
However, a new industry has developed in litigation funding over the last few years: defense-sided litigation funding. This type of funding is much more complex than plaintiff-sided funding, but it can provide a unique benefit for those willing to navigate the complexities. 
Image source: Swiss Re Institue 2021, From US litigation funding and social inflation: The rising costs of legal liability, December 9, 2021.
How Does Defense-sided funding work?
In essence, defense-sided litigation funding can be qualified as post-event risk management. The goal of defense-sided funding is to transfer the risks and costs of litigation away from the defendant to the litigation company, which is more prepared to carry the financial burden. Not only can litigation companies absorb the cost, but they also can provide access to resources and expertise that an entity may not be able to access on its own. One of the key benefits of this to a defendant is they are not responsible for paying the litigation expenses until the lawsuit has been finalized allowing them to continue funding their regular operation without the significant financial burden. For the funding company, there is an obvious financial incentive, but they are structured much more creatively than plaintiff-sided funding.  In these instances, agreements usually have heavier incentivization built in for dismissals. (Agee 2019)
 
A hypothetical example:  A plaintiff is asking for 30 million dollars to settle a case. The mutual definition of success between the defendant and the litigation company is settling for anything below $18 million. If that occurs, the litigation company gets the litigation fees plus 30% of the difference between the asking and final settlement. With help from funding and resources from a litigation company, the defendant settled for $15 million, which would trigger their agreement to pay $4.5 million plus the litigation costs.
 
The Future of Public Entities and Defense-Sided Litigation Funding
Up to this point, public entities and insurance companies have been on the losing end of litigation funding and crippling nuclear verdicts. As the defense-sided litigation funding market grows and more options become available, it may be beneficial for public entities to partner with litigation funding companies. Some of the potential benefits of defense-sided litigation funding include:
 
  1. Improve the entity's settlement position and mitigate the cost of settlement
  2. Gain access to national expertise and resources.
  3. Protecting capital and day-to-day business operations during litigation
  4. Possibly deter frivolous lawsuits (Levine 2022)
 
The volume of lawsuits against public entities shows no evidence of slowing down, and the risk of nuclear verdicts is exponentially intensifying. As a result, public entities should be prepared to exhaust every viable option to protect its people, property, and the public. If defense-sided litigation funding can provide a vehicle to accomplish those objectives in the future, the leadership of these entities will want to recognize the benefits of partnering with these litigation companies.
Samrat, Emily, “The Business of Defense: Defense- Side Litigation Financing,” 2016 https://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?article=5980&context=uclrev
Davis, Tom, “Insurers: Third Party Litigation is Fueling Rise in Shock Verdicts,” March 2022, https://news.ambest.com/articlecontent.aspx?refnum=317592
Levine, Jason, “A Primer on U.S. Defense-Side Litigation Finance,” March 7th, 2022, https://omnibridgeway.com/insights/blog/blog-posts/blog-details/global/2022/07/07/a-primer-on-defense-side-litigation-finance
Agee, Charles and Lowe, Gretchen, “Litigation Finance Client Types,” December 31, 2019
https://pro.bloomberglaw.com/brief/practical-guidance-litigation-finance-client-types,