The following article was originally published in Italian on Dirittoegiustizia.it, the online outlet of Giuffrè Francis Lefebvre, which provides daily updates, analyses, and insights on legislation, case law, and legal doctrine.
We are now pleased to share an English language version of the article below:
by Giacomo Lorenzo – Head of Italy & Senior Legal Counsel, Deminor
The use of litigation funding is progressively consolidating in Italy as an innovative tool for managing disputes and allocating legal risk. This mechanism consists of the provision of capital by a third party – the litigation funder – who, based on a prior analysis of the dispute, assesses the probability of success of the action and the actual recoverability of the claim or compensation. If the assessment is positive, the funder assumes the responsibility of fully covering the costs of the judicial or arbitral procedure, including legal fees, expenses for technical consultants, and any evidentiary costs, obtaining, in the event of a favorable outcome, a share of the recovered amount.
The disputes of interest can range from class actions to international arbitration proceedings and complex commercial disputes, which require significant financial resources and the involvement of highly specialized professionals. In this way, litigation funding enables parties who, in the absence of financial support, would not be able to initiate or sustain legal action, to protect their rights.
Due diligence as the cornerstone of case selection
The central element of this investment activity is the case selection process. The funder carries out an in-depth due diligence on the dispute, evaluating various economic and legal aspects.
This article will analyze in detail the main criteria used by litigation funders in the selection of cases, in order to provide a clear overview of the logic that guides such decisions and the implications that result for the parties involved in the process.
It should be noted that the following considerations are based on the author’s direct experience and may not fully coincide with the practices adopted by all litigation funders.
Why the due diligence phase is fundamental in litigation funding
Litigation funding, by its nature, constitutes a high-risk investment activity, since the funder’s remuneration depends not only on the favorable outcome of the case, but also on the actual possibility of recovering the amounts awarded. Uncertainty is heightened, in civil law jurisdictions, by the absence of a formal stare decisis principle, which allows judges to deviate from established case law, making outcomes less predictable than in common law systems.
To this must be added several factors that can compromise the success of the operation. These include possible errors in judicial assessment, the duration of proceedings – which in some jurisdictions may last many years – and, above all, external factors unrelated to the merits of the case, such as the solvency of the defendant or the difficulties associated with enforcing the decision in jurisdictions where enforcement mechanisms are complex or inefficient.
Rigorous selection of disputes
All these elements, often difficult to predict, must be the subject of careful analysis in the context of due diligence, in order to minimize investment risk and allow the funder to make informed decisions consistent with its return objectives.
In this context, litigation funders constantly receive a large number of requests from parties interested in externalizing the costs of litigation. However, only a very small percentage of such proposals pass the preliminary assessment stage: industry experience shows that, on average, only about 5% of submitted cases result in an actual investment by the funder.
The reason for this selectivity lies in the strictness of the requirements imposed. Funds with a conservative approach tend to invest only in disputes with an estimated risk of losing equal to or less than 30%, privileging cases with solid legal foundations, robust documentary evidence, and a claim value proportionate to the costs involved.
Nevertheless, there are funds with more aggressive strategies, willing to accept higher risk margins – even above 40% – in exchange for the prospect of greater economic returns.
Due diligence represents the fulcrum of the decision-making process: it is at this stage that the funder measures the balance between risk and return, defining not only whether to invest, but also the economic and contractual conditions of the involvement.
Key elements examined in the due diligence phase
In order to assess whether the risk of losing is compatible with the level of risk the funder is willing to take on, and to verify whether the dispute has the prerequisites to qualify as a sustainable and profitable investment, multiple legal, economic, and evidentiary elements are examined.
The due diligence process begins with the identification of the parties, in order to verify the absence of conflicts of interest. Once this review is passed, the analysis focuses on the financial situation of the parties involved. It is essential to ascertain, on the one hand, the reliability of the potential client, who in case of success must fulfill contractual obligations towards the funder, and, on the other, the solvency of the counterparty. A case, even if legally sound, would be economically useless if the losing party did not have attachable assets on which to obtain satisfaction.
The other aspects subject to review can be grouped into two macro-areas: legal issues and economic-financial issues.
Legal issues
From a legal perspective, the facts of the case, the applicable law, substantive and procedural issues underlying the dispute, and any preliminary defects (lack of jurisdiction, lack of standing, etc.) are examined. The likelihood that a fund will invest in a case increases significantly if the client’s claim is also based on consolidated legal principles supported by favorable precedents.
Due diligence is also conducted on the orientations of the competent court in the relevant matter or, in the case of arbitration, on the experience of the arbitrators, if already appointed. Another significant factor is the quality of the professionals involved: the lawyers engaged must have proven experience in the specific area of the dispute, just as any economic experts called upon to quantify damages must have solid technical expertise.
All these elements contribute to the evaluation of the legal asset that is the subject of the investment, enabling the litigation funder to verify the soundness of the claims brought and to realistically estimate the risk of losing in court.
Economic-financial issues
On the economic-financial side, a first key element is the value of the dispute. Most litigation funders operate with a minimum investment threshold and tend to exclude disputes below certain values. Some funds do not consider cases with a value below €5 million, while others focus exclusively on very large disputes, exceeding €30 million. At the same time, there are also specialized operators that direct their resources to smaller cases, focusing on lower-value investments.
Once the value of the dispute is determined, attention shifts to the ratio between the requested budget and the overall value of the claim. According to established industry practice, the adequate ratio is at least 1:10, meaning that for every euro invested, the dispute should be worth at least ten. If the budget is excessively high compared to the size of the claim, the operation risks becoming economically unsustainable: in such cases, it becomes difficult to define a profit-sharing percentage that both ensures the fund a fair return relative to the risk taken and leaves the client a significant share of the amount eventually awarded.
The risk of losing and insurance protection
Another aspect to consider concerns the risks associated with losing, i.e., the possibility that the client may be ordered to reimburse the opposing party’s legal costs. In high-value disputes, such costs can be substantial, significantly affecting the overall exposure of the claimant.
To mitigate this risk, litigation funders often offer their clients the option of taking out After the Event (ATE) insurance, which serves to protect the client’s assets and cover legal costs in case of defeat. The premium for these insurance products, usually substantial, is included in the overall budget of the operation financed by the fund, thus ensuring comprehensive coverage of the dispute’s economic risk.
Duration of proceedings
Finally, a determining factor is the duration of the proceedings, which directly affects the Internal Rate of Return (IRR). This estimate is complex, but can rely on statistical data published by national judicial authorities: for example, in Italy the Ministry of Justice regularly publishes average durations of civil cases in different courts, providing a general indication of timelines. Some funds exclude investments in cases expected to last more than five years, while others, with greater tolerance, accept to operate in jurisdictions characterized by longer proceedings.
Thus, due diligence does not limit itself to an abstract assessment of the legal merits of the claim and the strength of the arguments, but integrates this analysis with the evaluation of the economic value of the claim, the actual chances of recovery, the risk of losing, the overall costs, and the estimated duration of the dispute. The combination of these factors allows the funder to balance risk and return and make investment decisions based on legal coherence and sound economic rationale.
The role of lawyers in the due diligence process
A decisive role in the due diligence phase is played by lawyers. Most requests for litigation funding come from law firms which, on behalf of their clients, approach different funders to identify the most suitable partner and the most favorable contractual conditions. The initial dialogue almost always takes place between the fund’s professionals and the client’s lawyers, who are responsible for presenting the case in a clear, structured, and documented manner, providing the necessary information and evidence to substantiate the claim. The ability of the law firm to coherently organize documentation and highlight the strengths of the claim can significantly affect the likelihood that the request will pass the initial evaluation phase.
In addition to the client’s lawyers, litigation funders frequently rely on external legal consultants tasked with drafting a second legal opinion on the case. This independent opinion is intended to resolve any interpretative uncertainties, to explore particularly complex legal issues, or to confirm – through an autonomous analysis – the solidity of the arguments already presented. This verification represents an additional safeguard for the fund, as it reduces the risk that critical aspects of the dispute may compromise the favorable outcome of the action and, consequently, the financial return of the investment.
Phases and timing of due diligence
The due diligence process normally unfolds in two phases.
The first, preliminary phase begins with the completion of the litigation funding application form, containing all the information necessary for an initial review of the case. Once the documentation is received, and in the absence of significant issues, the file is submitted to the Review Committee, an internal decision-making body that discusses critical aspects with the case manager and determines whether the conditions exist to proceed to the next phase.
This first phase is generally streamlined and quick: if there are no issues, within 10–20 days of receiving the relevant information, the fund can provide the client with a non-binding indicative offer, i.e., a non-binding proposal containing the hypothetical investment terms, subject to confirmation of the data provided. If the client accepts the proposal, an exclusivity period is usually agreed upon, during which the client cannot start negotiations with other funders, settle the dispute without notice, or enter into agreements with third parties. This period allows the second, more in-depth phase of due diligence to begin.
The second phase can include several activities, depending on the characteristics of the case: from a detailed analysis of the documents and evidence that will form the basis of the legal action, to specific investigations into the counterparty’s assets. In this latter case, the fund’s internal professionals – with the support of specialized consultants – carry out asset tracing activities, aimed at identifying attachable assets and the jurisdictions where enforcement might be necessary. Moreover, when uncertainties remain on crucial legal issues, the fund may request an independent legal opinion, aimed at reducing the risk of losing. As an in-depth analysis activity, the second phase of due diligence is generally longer and may last two or three months, depending on the legal complexity of the case and the amount of documentation to be examined.
At the end of this phase, if the results are positive, the file is submitted to the Investment Committee, which collectively evaluates the legal and economic aspects of the case, as well as the residual risks, and decides definitively whether to proceed with the investment. The decision of the Investment Committee marks the final stage of the due diligence process and the actual start of financing.
Conclusions
Due diligence represents, for litigation funders, the decisive phase of the investment process, as it allows them to balance risk and return and to identify the cases with the best prospects of a favorable outcome and economic recovery.
Understanding the criteria considered decisive by the fund – both legal and economic-financial – is also fundamental for clients and law firms: the ability to present a well-structured claim, supported by strong evidence, convincing legal analysis, and a clear identification of risks, increases the chances of obtaining funding.
The accuracy of this activity directly affects the sustainability of the funds: superficial evaluations may lead to investments in disputes with little real chance of success, with consequent loss of resources. Conversely, rigorous and methodologically advanced due diligence processes increase the selection of meritorious cases, strengthening return prospects and fostering solid long-term growth.
Get in touch with Senior Legal Counsel Giacomo Lorenzo to learn more about how Deminor Litigation Funding can help your Investment Recovery, Antitrust Damages and Commercial Litigation claims within Italy.
