Litigation Financing
Litigation abuse is fundamentally driven by financial incentives. The U.S. example demonstrates that, if parties can exploit a country’s litigation financing rules for personal financial gain, that country will inevitably face a growing market for abusive class action lawsuits.
Contingency Fees: In the U.S., lawyers most frequently finance lawsuits with contingency fees, meaning that they provide their services in exchange for a percentage (usually one-third and up to 40%) of any settlement or award. While the claimants’ law firm takes on some risk – that it will not be compensated for its time if the lawsuit is unsuccessful – contingency fees promise the opportunity to make significantly more profits than if lawyers were simply paid by the hour. In class action cases, law firms often make millions or hundreds of millions in contingency fees because the amount of lawyer effort can be concentrated as if it were a single case, with recoveries multiplied far beyond the usual single-case recoveries due to the huge number of plaintiffs. Most policymakers recognize that contingency fee arrangements make it profitable for plaintiffs’ firms to file class actions that are only marginally meritorious – or lacking any merit at all – because the prospect of defending this type of litigation can be so onerous to defendants that it coerces settlements, even where the case is frivolous. Other than in the UK, where Lord Justice Jackson recommended allowing contingency fees, thought leaders are looking for less problematic alternatives. To learn more about contingency fees and their consequences in the U.S., read ILR’s paper “Ensuring Effective Redress: The Importance of Litigation Financing in Preventing the Misuse of Aggregate Litigation Mechanisms."
Third Party Financing: A significant emerging litigation mechanism is third party financing, which allows a party unaffiliated with the lawsuit – usually a hedge fund or specialist funding company – to front a plaintiff’s costs in exchange for a portion of any award or settlement. The percentage that the funding company takes is usually decided on a case-by-case basis, depending on the amount of risk the company incurs. Third party financing of class (or collective) actions is most prevalent in Australia, where studies demonstrate that it has increased the volume of litigation. Now, financiers are looking to expand their markets in Europe and the U.S. as well.
The risk that third party funding will incentivize abusive lawsuits is particularly acute in the context of collective actions. Collective litigation is already prone to abuse because there is a tremendous amount of money at stake and very little accountability to the supposed claimants. Combining third party funding with collective actions would exacerbate the risks of such abuse by permitting would-be claimants to shift their costs to others and encouraging them to test claims of questionable merit, knowing that defendants often will choose to settle rather than risk trial. It also permits the funders to “pool" their investments in meritorious cases, with investments in more frivolous or high risk cases. Further, it raises ethical questions about who controls the lawsuit – the individual people bringing the claim or the company whose interest is not in justice but in turning a profit. To learn more, read ILR’s paper “Third Party Financing: Ethical and Legal Ramifications in Collective Actions."
