Deminor Wiki - Legal Funding

History

The concept of legal funding has its roots in the doctrines of “Champerty” and “Maintenance”, which historically prohibited third parties from financing litigation in exchange for a share of the proceeds. These doctrines are rooted in English common law. Maintenance prohibited a third party with no legitimate interest in a case from supporting one of the litigants, whether financially or otherwise. Champerty was a specific form of maintenance in which the third party financed the litigation in return for a share of the proceeds. The purpose of these prohibitions was to prevent powerful or wealthy individuals from exploiting other people’s disputes for profit, manipulating the course of litigation, and encouraging frivolous claims. However, as litigation became increasingly complex and costly in the modern era, these doctrines were viewed as outdated obstacles to access to justice. Prohibiting all forms of third-party involvement meant that many meritorious claims could not be pursued simply due to a lack of resources. Legal funding began to gain traction in the late 20th century, particularly in jurisdictions such as Australia and the United Kingdom, where legal reforms and court decisions gradually relaxed restrictions on third-party funding. The industry saw significant growth in the early 21st century, with the establishment of specialised litigation funding firms, some with rather broad investment focuses, others specifically tailored towards certain types of claims, and the development of regulatory frameworks to ensure transparency and ethical practices.

Types of Legal Funding

1. Single-Case Funding: This involves financing a specific legal case. The funder provides capital to cover legal fees, expert witness costs, and other expenses related to the case. If the case is successful, the funder receives a portion of the proceeds.
2. Portfolio Funding: In this arrangement, a funder provides capital to a law firm or corporate client to finance multiple cases. The risk is spread across several cases, which can make this type of funding more attractive to both funders and recipients. Other types of portfolio fundings can include the pursuit of often very similar individual damages suits by consumers against corporations, e.g. in the areas of consumer protection law or product liability.
3. Law Firm Financing: This type of funding is provided directly to law firms to support their operations and growth. It can be used to cover working capital needs, expand practice areas, or invest in new technology. However, it still remains rare or controversial in many civil law jurisdictions due to concerns about lawyer independence, and often the applicable rules on professional attorneys conduct prohibit law firms and lawyers from accepting investments from non-lawyers.
4. Claim Monetisation: This involves selling a portion of the anticipated proceeds from a legal claim to a funder in exchange for immediate capital. This can be particularly useful for claimants who need liquidity before the resolution of their case. Monetisation and classic litigation funding can, in viable cases, also be combined, so that, e.g. the client first receives a certain upfront payment on the claim, plus an additional earn-out once the case has concluded with a positive outcome.
5. Appeal and Enforcement Funding: Specialised funding can be provided at the appeal stage or for the enforcement of judgments and arbitral awards, especially in cross-border disputes. Some specialised funders have sophisticated in-house teams experienced in asset tracing and recovery, and can support a client in identifying and seizing assets from the defendant.

Litigation Funding Context

Litigation funding plays a crucial role in the modern legal landscape. It provides access to justice for individuals and businesses that might otherwise be unable to afford the high costs of litigation, especially in a typical “David vs. Goliath” situation where the opponent has access to significantly more financial resources than the plaintiff. By enabling meritorious claims to proceed, legal funding helps to level the playing field between well-resourced defendants and less financially capable claimants.

In addition to providing financial support, funders can often bring valuable expertise to the cases they finance, subject to the regulatory environment in the respective jurisdiction(s) they provide their services in. They conduct thorough due diligence before committing to a case, assessing the merits of the claim, the likelihood of success, and the potential recovery. This rigorous evaluation process can help to filter out weak or frivolous claims, contributing to the overall efficiency of the legal system. While a decision by a funder not to fund a case may be based on a number of different factors, this can, as such, be a valuable data point for a prospective litigant in their decision-making on whether or not to pursue a claim.

Market Impact

The legal funding market has experienced significant growth in recent years, driven by increasing demand for alternative financing options and the rising costs, length and complexity of litigation. The industry has attracted substantial investment from institutional investors, private equity firms, and hedge funds, leading to the establishment of numerous specialised litigation funding firms.

The market impact of legal funding extends beyond the financial support it provides. By enabling more cases to proceed, legal funding can influence the behaviour of litigants and defendants, encouraging settlements and promoting more efficient dispute resolution. It also fosters innovation in legal services, as law firms and funders develop new strategies and approaches to managing and financing litigation.

Funders typically structure their returns in different ways, reflecting the risk and duration of the case. The most common models include a percentage of the recovery (often ranging between 20% and 50%), a multiple of the invested capital (for example, two or three times the amount funded), or a hybrid approach combining both methods. These pricing structures are designed to balance the significant risk borne by funders in non-recourse arrangements, while ensuring that claimants retain the majority of any recovery. However, while these are the standard models used within the industry, individual funding deals can be very tailormade to the needs of the client and the case, and also include other calculation methods for the funder’s return, such as a (fixed or variable) interest to be paid on the investment amount, or even comprise of shares in a corporation, i.e. the funder’s client, or future dividends.

Regulation

The regulation of legal funding varies by jurisdiction, reflecting different legal traditions and policy considerations. Most jurisdictions across the globe do not provide a specialised legal framework for third-party funders as such, but some have opted to apply regulations designed for certain types of investment funds to third-party funders as well. In some countries, legal funding is subject to specific regulatory frameworks designed to ensure transparency, protect the interests of litigants, and maintain the integrity of the legal system.

For example, in the United Kingdom, the Association of Litigation Funders (ALF) has established a voluntary code of conduct that sets out best practices for funders, including requirements for capital adequacy, conflicts of interest, and disclosure. The ALF's code of conduct is designed to promote ethical behaviour and build trust in the industry. ALF requires funders to avoid litigation control. This makes litigation funding a fair and reliable tool for access to justice.

In the United States, the regulation of legal funding is more fragmented. At the federal level, there is no overarching framework; however, certain courts require disclosure of funding agreements, with different states adopting varying approaches. Some states have enacted specific legislation to govern legal funding transactions, while others rely on existing consumer protection laws and court rules.

In continental Europe, litigation funding has also become increasingly established. Germany, France, and the Netherlands have seen significant growth in third-party funding, particularly in the context of consumer mass claims and collective redress actions, such as the Dieselgate litigation in Germany. On 13 September 2022, the European Parliament adopted a resolution calling for binding EU legislation to regulate TPF, especially in the context of collective redress. The resolution emphasised transparency, capital adequacy, and the protection of claimants. However, it remains a non-binding recommendation, and to this date, no EU-wide framework currently exists or has been sent into the legislative process.

As third-party funding often “levels the playing field” between consumers, or smaller corporations on the one side, and large international businesses on the other side, discussions on whether and how third-party funding should be regulated also always have a significant legal policy dimension. It is advisable to always also understand and assess the interests of certain stakeholders who advocate for very strict regulation of third-party funders, which may also lie in simply trying to prevent well-founded claims from being pursued at all.

Finally, in the context of Commercial Arbitration, institutional rules increasingly require a party to an Arbitration that receives third-party funding to disclose the existence and identity of the funder, in order to ensure the tribunal’s impartiality and independence.

Broader Industry Context

The litigation funding industry is part of a wider trend towards the commoditisation and financialisation of legal claims. As legal costs have risen and the complexity of disputes has increased, the demand for alternative financing solutions has grown. Litigation funders have responded by developing innovative products and services, including:

• Funding for Arbitration: Supporting parties in arbitration, particularly in international commercial and investment arbitration, where costs can be substantial and enforcement issues complex.
• Enforcement Funding: Providing capital to enforce judgments and arbitral awards, particularly in cross-border contexts.
• Law Firm Lending: Offering loans and credit facilities to law firms, secured against future fee income. This model, however, remains rare and controversial mostly in civil law countries due to professional conduct rules.

The industry is characterised by increasing sophistication, with funders employing teams of legal, financial, and risk management professionals. The use of data analytics and technology, including artificial intelligence, is also becoming more prevalent, enabling funders to assess cases more efficiently and manage portfolios more effectively.

Conclusion 

Legal funding has emerged as a vital component of the modern legal landscape, providing essential financial support to litigants and law firms. By enabling meritorious claims to proceed, legal funding promotes access to justice and contributes to the efficiency of the legal system. The industry has experienced significant growth and innovation, attracting substantial investment and developing new financing models.

As the legal funding market continues to evolve, regulatory frameworks will play a crucial role in ensuring transparency, protecting the interests of litigants, and maintaining the integrity of the legal system. By adhering to best practices and ethical standards, legal funders can build trust and confidence in the industry, fostering a more equitable and effective legal system for all stakeholders.

Reviewed by:  Dr. Malte Stübinger, General Counsel Germany 

Disclaimer: The sole purpose of this article is for general information, and its contents should not be considered as legal advice, as legal frameworks / systems vary from country to country. The article is based on publicly available information and while care is taken in compiling this, no warranty, express or implied is given, nor does Deminor assume any liability for the use thereof.