When Lawsuits Are Investments. Uncovering the Pernicious Toxicity of Litigation Funding

Factors like the increasing popularity of third-party litigation funding are contributing to rising litigation costs in the U.S.
By: | June 18, 2023

Litigation costs are on the rise across the U.S.

These increased costs have an impact on federal, state and local governments — and on insurance carriers and policyholders.

One of the key drivers of increasing litigation costs is the rapid rise in popularity of third-party litigation funding (TPLF), a practice defined by the U.S. government as “an arrangement in which a funder who is not a party to the lawsuit agrees to help fund it.”

These arrangements often keep the identity of the funder a secret from the rest of the parties involved with the lawsuit, meaning the hidden entities behind third-party litigation funding could be anyone, anywhere — including bad actors with malicious agendas.

Foreign-sourced money being washed through TPLF schemes is a growing concern, especially with the privacy privileges granted to the funders.

And even without the fear of a shadowy quasi-government figure or political group with ulterior motives providing funding, the rules for third-party litigation funding lack transparency.

It is possible, for example, that an entity could fund part of a lawsuit without the knowledge of the judge, attorneys, plaintiffs and defendants.

If the involved parties in the lawsuit don’t know of the existence of the funding firm, they also may not be aware of its influence over the lawsuit. While some funding firms are interested in the large profits they stand to make if the lawsuit succeeds, others may have more nefarious motives.

A webinar held by the Travelers Institute addressed the topic of rising litigation costs and its key drivers.

Hosted by Joan Woodward, president of the Travelers Institute, and featuring speakers Lauren Sheets Jarrell, Esq., director & counsel for civil justice policy at the American Tort Reform Association, and Alexia Cruz, senior vice president and claim general counsel at Travelers, the hour-long discussion focused on how third-party litigation funding is changing the claims and judicial landscape.

Motives Behind Third-Party Litigation Funding

The obvious motive for funding lawsuits is to make money. The investment is risky, but lucrative when it pays off.

Since there is hardly a guarantee that lawsuits will resolve favorably, third-party litigation funders are gambling with their investment. But when these third parties provide part or the majority of the funds for a multimillion-dollar lawsuit that wins, the payout is significant.

Portrait of Alexia Cruz

Alexia Cruz, senior vice president and claim general counsel, Travelers

A 2021 Swiss Re Institute study found TPLF investment globally had risen 16% year-over-year to equal a total investment of $17 billion in 2021. More than half (52%) of this investment was in the U.S.

In addition to hoping for a payday, some third-party funders may have other motives. Foreign entities may use these lawsuits to access sensitive information from private U.S. companies. They could also steer the direction of cases or influence lawsuits through selective funding.

Right now, few courts have imposed rules about transparency when it comes to third-party litigation funding, which means there is a broad lack of oversight.

“There’s a growing concern that foreign governments or companies may invest in these lawsuits to access intellectual property and sensitive information,” Cruz said, referencing a U.S. Chamber of Commerce report citing the national security risk of third-party litigation funding.

“By investing in specific cases or a portfolio of cases, or through crowdfunded litigation financing, foreign governments and companies may seek to fund, encourage and control U.S. litigation in a manner that harms U.S. companies and critical sectors.”

Types of Third-Party Litigation Funding and Their Impacts

Cruz described the different types of third-party litigation funding: “There’s commercial funding. Think of that as an investment firm or hedge fund that’s supplying capital to a large-scale business dispute. That could be the mass torts, the class actions, the product liability or the big intellectual property cases you see in the news, and that’s an exchange for a payment based on the legal outcome of the case,” she explained.

“Then there’s two types of consumer funding we see on a regular basis. One is direct loans to the plaintiff in a personal injury case. Then we see the medical financing consumer funding loans, and those are loans for expenses medical providers are given.”

Cruz pointed out that the interest rates on both types of loans are high — and in many cases unregulated: “It can have a real effect on the claim cost by creating longer cycle times, higher settlement demands and higher verdicts.”

In addition to these challenges to the claims process, injured parties also suffer. The unclear terms mean consumers don’t always understand the high interest rates they will be charged. “With a lack of transparency regarding the repayment terms, we are seeing plaintiffs owe money at the end of a case, as opposed to receiving money for their injuries,” Cruz said, “and that’s not serving the consumer in a responsible way.”

Sheets Jarrell pointed out the impact on commercial enterprises, saying, “We’ve seen businesses leave states because of lawsuit abuse. [For example,] we’ve seen it in Louisiana with the energy industry. They’ve lost jobs and they’ve moved because of all the coastal litigation.”

She also described the consumer tort tax, an annualized cost to consumers based on the increased litigation in their state: “The lawsuit abuses we’re seeing across the country and these rising costs are creating an individual tort tax that is being passed on to consumers, and it’s also equating to job loss and GDP costs.” States with the highest tort tax include Washington, D.C., at $2,300; Massachusetts at $2,150; and California at $2,120, based on 2022 data, according to Sheets Jarrell.

Portrait of Lauren Sheets Jarrell

Lauren Sheets Jarrell, Esq., director & counsel, civil justice policy, the American Tort Reform Association

The elevated costs, delays and potential financial harm to injured consumers make TPLF a controversial topic. But in some cases, it may be helping people.

Litigation Funding as an ESG Enabler?

Litigation funding is used in all kinds of lawsuits, including class action cases and commercial litigation.

Sometimes, the funds are used to support socially conscious class action cases that otherwise may not have gone to trial. Without funds from third-party investors, some plaintiffs cannot afford extended court cases, attorney fees and other litigation costs.

For example, third-party litigation funders provided the money for a large class-action lawsuit in Brazil after a mine collapsed, killing 19 people and polluting the countryside.

The $12 billion lawsuit is scheduled for trial in April 2024.

Third-party litigation funding is changing the process, timeline and costs of claims and litigation. The lack of transparency and the potential for IP theft raises critical safety and privacy concerns — but when TPLF is used to fund socially conscious, “morally good” causes, do the potential rewards outweigh the clear risks? &

Abi Potter Clough, MBA, CPCU, is a keynote speaker, author and business consultant focused on Insurtech, leadership and strategy. She has over 15 years of experience at a Fortune 500 company with expertise in P&C claims operational leadership, lean management consulting, digital communications and Insurtech. As the past chair of the International Insurance Interest Group of the CPCU Society, Abi remains involved in many international initiatives and projects. She has published two books about change management and relocation. Abi can be reached at [email protected].

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