Iowa Law Professor Says Regulation Needed for Lawsuits-as-Investments

Released: 1/10/2012 11:45 AM EST
Source Newsroom: University of Iowa
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Citations Minnesota Law Review

Newswise — Some invest their money in stocks, some in bonds, some in real estate.

Increasingly, investors are also putting their money into lawsuits, and University of Iowa law professor Maya Steinitz said federal and state governments need to adopt laws soon that regulate this growing market.

"Litigation finance is an industry whose time has come," says Steinitz. "Third- party financing of litigation will increase access to justice for everyone and encourage private enforcement of the law. It will open the court system to parties who don't otherwise have the resources to file a lawsuit against an offender and giving the 'have-nots' as equal a shot at justice as the 'haves.'"

In litigation financing, the lawsuit becomes an investment for a third-party financier, who pays for the plaintiff's legal expenses in a lawsuit and then receives an agreed-upon percentage of whatever results from a damages award. The investment is a great deal riskier than most, however, because the financier will receive nothing if the defendant wins.

Litigation financing has been used in other countries—primarily the United Kingdom and Australia—and many large financial services companies like Credit Suisse and Allianz invest in lawsuits. But the practice has only recently come to the United States, and so is addressed by a hodgepodge of state laws around the country, with some prohibiting the practice entirely and others not addressing it all.

In some places, it's prohibited by a concept called champerty, which prevents third parties from financially benefiting from a lawsuit in which they have no interest. Steinitz said proponents of champerty wish to discourage what they regard as excessive or speculative litigation, and to prevent unfair dealings in which a party in the financially dominant position can realize excessive profits from another's claim. The fact that the funder's relationship with the funded party is not legally defined also creates an opportunity for exploitation.

However, Steinitz says that third party funding as its advantages in that it opens the court system to parties who don't otherwise have the resources to file a lawsuit against an offender. It thus allows them both to have their day in court and also to shape the development of the law through the court system.

She says litigation financing is already showing how it can help people without resources pursue a lawsuit. Financiers are helping rural Ecuadorans seek justice against Chevron for environmental damage caused by oil drilling in the past by Texaco, which Chevron now owns. The plaintiffs are mostly poor and would never have the funds available to take on a multinational company like Chevron without the help of their financiers. In return, the investors will share in the Ecuadoran court's $18 billion judgment against the company if it survives appeal.

Litigation financing is also helping women level the playing field in divorce cases where the husband controls the family's financial resources and is able to dictate terms so that the settlement is unfair for the wife. Investors can help the wife win a fairer settlement and share in the award.

The market for litigation financing is growing, she says. Some firms are now selling litigation funding shares to the public on the open market, and she thinks litigation funding-backed securities may not be far behind. Because the market is going to expand, she said state and federal governments need to start developing common forms of oversight for the practice soon and put laws and regulations in place to protect the interests of the investors and the litigants.

She says those regulations should be tailored so that the good parts about litigation funding—primarily, increasing the bargaining power of the have-nots—is left in place while limiting abuses.

Her suggested changes in the law include: eliminating the prohibition against champerty; extending the protections of the attorney-client privilege to the attorney-client-funder relationship, as well as the fiduciary duties that come with them, and allowing attorneys to work directly with funders instead of relying on the client as a go-between; applying consumer protection principles to funding agreements; and requiring court supervision over the attorney-client-funder relationship.

Steinitz's paper "Whose Claim is This Anyway? Third-Party Litigation Funding" was recently published by the Minnesota Law Review. It's available online at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1586053.


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