Third Party Litigation Funding: The New Gold Rush?

05th May 2015

By Lisa Rickard, President of the U.S. Chamber Institute for Legal Reform

Recently, the new Consumer Rights Act received royal assent. While not the most high-profile measure, the Act marks a major shift in the civil justice system by allowing U.S.-style class action lawsuits for violations of competition laws.

We can all agree on the law’s good intentions of delivering redress to consumers. But what happens if the law results not in redress for consumers, but profits for investment firms?

This is in danger of happening with the spread of third-party litigation financing (TPLF)—the practice of investment firms, with no connection to a dispute, financing litigation in exchange for a percentage of any award. The practice has been growing in the UK and globally, with the global market estimated at well over 1 billion GBP. And it could grow even more under the new class action system—with troubling consequences for both the cost and the integrity of the civil justice system. UK policymakers should act now to ensure that the industry receives proper regulation and oversight.

Having an outside, for-profit party involved in litigation raises a number of questions. Who controls strategies and decisions? What happens when the interests of funder and claimant diverge? Should there be limits on the amount of a settlement or judgment a funder can receive?  To what extent does funding increase the incidence of abusive and coercive litigation? If the investor’s role is not disclosed, how will courts and defendants know the real parties in interest?

These are concerns that warrant strong oversight of TPLF by policymakers. Yet the practice is almost completely unregulated—in the UK, the U.S., Australia, Canada and elsewhere.  Instead, like prospectors in the Wild West, TPLF providers are simply making their own rules.

The more established firms in England have formed an association with a code of conduct. Yet this voluntary, unenforceable code of conduct is virtually toothless. The only penalty for breach of the code is to be kicked out of the association—and membership in the association is purely voluntary.

Absent stringent, enforceable ethical guidelines, there is a palpable risk that the funder will control the litigation. Such control contravenes the ethical requirement that the client direct the litigation. Yet TPLF funders openly disclose their effective control of litigation.

For example, the “Code of Best Practices” of TPLF funder Bentham IMF, the U.S. arm of the world’s largest litigation financier, specifically contemplates that the funder may set litigation budgets, veto settlement decisions, and even withdraw funding if Bentham believes the case has become commercially non-viable. These actions materially affect the course and outcome of litigation, the very definition of control. And Bentham is now exporting its practices to the UK, having opened an office last September.

By increasing the funding pool for litigation, TPLF can also lead to more abusive lawsuits. One such example is the role of TPLF in the infamous oil pollution litigation against Chevron Corporation in Ecuador. The American lawyer for the Ecuadorian claimants succeeded in obtaining a US$9.5 billion judgment against Chevron. In a 20 November 2014 article in Bloomberg Businessweek, reporter Paul Barrett notes that the lawyer “sustained a two-decade legal campaign, in part, by accepting investments totaling close to $30 million from hedge funds and individuals.”

In March 2014, a U. S. federal judge ruled that the Ecuadorian judgment had been obtained using extortion, bribery, coercion and fraud. The American lawyer is appealing this verdict against him; meanwhile, he is trying to enforce the Ecuadorian judgment in Canada, Argentina, and Brazil.

The Chevron case is the rare example where a funding agreement was even known, let alone exposed to scrutiny. Because most TPLF arrangements operate in secrecy, it is nearly impossible to know the identities of the “prospectors” participating in the litigation gold rush. We know that in addition to TPLF-specific firms, they include individuals, hedge funds, and other entities seeking to capitalize on a new way to make money. This secrecy is wrong.  If TPLF is to be part of the legal system, at the very least, its use should be transparent.

The case also illustrates who really benefits when the gold is divided. Chevron has pledged never to settle, but according to Barrett, if Chevron were to pay $100 million, for example, the financiers would receive $69 million; lawyers and other advisers would share $22 million; and administrative expenses would take up $8 million. That would leave only $1.5 million for the claimants. While this distribution scheme is not illegal, it is disturbing.

The terms of the funding arrangement between the Chevron plaintiffs and TPLF provider Burford Capital demonstrate yet another problem with TPLF—how it encourages the parties to prolong litigation. The agreement sets a higher percentage of recovery for the investors if the case were to settle for less than $1 billion than if were settled for over $1 billion; thus, the claimants and their lawyer have significant incentive to prolong the case in the hopes of driving up its value.

Burford Capital withdrew from the Chevron case, but Chevron sued the funder and settled with Burford admitting it was “deceived” by the claimants’ lawyers. But even before Burford invested, no fewer than four U.S. courts found the Ecuadorian proceedings were tainted by fraud. This raises legitimate questions about whether litigation funders are really using cold-eyed judgment or simply prospecting on a huge gold rush.

Many of the problems of TPLF—funder control of litigation; encouragement of abusive, prolonged litigation; terms that benefit funders, not litigants—are magnified when applied to class actions. The sheer size of the classes makes it hard for any individual litigant or group of litigants to exert control, with the resulting power vacuum filled by the funders. In addition, the potentially massive judgments available from class actions make these cases extremely lucrative to funders.

This helps explain why TPLF providers now organize and fund a majority of securities class actions in Australia—while the number of such cases has increased tenfold over the last decade. With class actions now permitted in competition cases, the UK could see the emergence of similar problems.

It is long past time for the sheriff to bring order to the Wild West of litigation prospecting. The size and scope of the industry—and the existence of new players outside of the established TPLF firms—mean that suitable safeguards cannot be provided on a self-policing basis.  A government oversight scheme focused on preventing abuses, assuring transparency, and enforcing stringent ethical rules will go a long way to assuring that all litigation financiers are responsible actors in the civil litigation system.