Third party litigation funding, or TPLF, is the practice of hedge funds investing money in lawsuits in exchange for a percentage of the settlement or judgment. TPLF is a global financial industry. What started in Australia, has spread to four other continents including the UK, the United States, Canada, Europe, and Asia. The litigation funding industry operates in the shadows, making it difficult to gauge just how much impact it is having on lawsuits. However, at the end of 2017, Woodsford Litigation Funding’s CEO told the Financial Times that worldwide £70 billion (or approx. $100 billion) was a reasonable estimate of the amount available to funders and firms. Read More...
Unlike other financial products, TPLF is not regulated anywhere in the world. This is problematic because litigation funding can have a material impact on the outcome of a case, and the involvement of third parties in litigation, solely for financial gain, presents numerous ethical issues and conflicts of interest.
For one, TPLF increases the volume of litigation. It is simple: more litigation funding means more litigation. For example, a study by NERA Economic Consulting found that the rise of TPLF is responsible for much of the exponential increase in securities class action litigation in Australia. Additionally the business strategy pursued by funders capitalizes on meritless litigation. Funding firms are increasingly utilizing a portfolio funding business model. This allows them to spread risk across a universe of diverse cases and take on cases that might be weak or dubious, but still hold the possibility of massive awards. The funder’s portfolios may span across multiple, different law firms.
TPLF can unnecessarily prolong litigation. In the instance of a settlement or judgement of a class action, typically the funder is paid first, then the attorneys, followed by the lead plaintiff. What is left is divided among the remaining class members. Based on this payment structure, plaintiffs may be driven to reject an otherwise reasonable settlement offer. This prolonged litigation hurts defendants, who are forced to divert additional time and money from productive activity to defending litigation.
Compounding the length of litigation is the fact that funding arrangements tend to operate in secret. Thus defendants may not even be aware that a funder is involved in litigation against them and judges may not be privy to the fact that funding is being used in his or her courtroom.
In addition, TPLF can undercut a plaintiff’s control of litigation. Funders have a major interest in the outcome of cases they invest in, so it is not unexpected that some funders seek to control a case’s legal strategy, both indirectly and directly. In one patent case, a funder sued the plaintiff for settling for an amount lower than what the funder demanded. In the infamous Chevron case in Ecuador, the funding contract with the plaintiffs stipulated that the funder would have veto power over the choice of attorneys and receive priority in the disbursement of any monetary award. Arrangements such as these place the interests of outside investors ahead of the interests of the parties in court.
Finally, TPLF creates ethical conflicts. Lawyers have a fiduciary duty to act in the best interests of their clients, but an ethical conflict arises when funders are fronting the fees for the claimants’ lawyers or when funders and law firms are structurally linked, or have portfolio arrangements. The lawyer-client duties can become secondary to the financial rewards pursued.
Litigation funding is rapidly expanding in the United States and shows no signs of slowing down. A September 2017 survey by funder Burford Capital claims the use of litigation financing in the U.S. grew 414% between 2013 and 2016. An industry expanding that rapidly and amassing funds across the globe it can then reinvest in lawsuits in any jurisdiction needs transparency and to be brought out of the shadows.
Safeguards are necessary to counter the many problems associated with TPLF in the U.S. In the white paper Stopping the Sale on Lawsuits: A Proposal to Regulate Third-Party Investments in Litigation, ILR suggests the following reforms regulating TPLF:
- Prohibiting investor control of cases;
- Forbidding direct contracts between investors and lawyers that do not also include the client; ;
- Banning law firm ownership of TPLF firms;
- Prohibiting the use of TPLF in class actions; and;
- Requiring disclosure of funding contracts in litigation.
In December 2016, ILR sent a letter to the Clerk of Court in the U.S. District Court for the Northern District of California supporting a proposed local rules amendment requiring the disclosure of TPLF agreements. In January 2017, the Northern District adopted a version of that proposed amendment, requiring the disclosure of TPLF agreements in all class action cases.
ILR also continues to advocate for a revision to the Federal Rules of Civil Procedure (FRCP) requiring disclosure of funding arrangements in which parties have a contingent financial interest to the court and litigants. In 2014, ILR and several other business and legal reform associations submitted a petition to the Secretary of the Committee on Rules of Practice and Procedure of the Administrative Office of the United States Courts calling for an amendment to the FRCP requiring disclosure of third party investments in litigation at the outset of a lawsuit.
In June 2017, ILR, joined by 29 business groups and state chambers of commerce, submitted an updated petition to the Committee, again calling for a rules amendment mandating transparency. House Judiciary Committee Chairman Bob Goodlatte (R-VA) sent a letter to the Committee in advance of their November meeting, urging them to take action on the petition. At the November Committee meeting, participants discussed the ILR-led coalition’s TPLF transparency petition in depth. The Committee decided to establish a subcommittee to research the issue, which they will do over a 6- to 12-month period. Following the subcommittee’s work, the full Committee will decide whether to proceed with a formal rulemaking.
Significant legislative movement has also been made at the federal level with the Fairness in Class Action Litigation Act of 2017 (FICALA), which passed the U.S. House of Representatives on March 19, 2017, and is currently before the Senate. FICALA includes an important provision that implements mandatory disclosure of TPLF in all class actions.
Throughout Europe, both at the EU institution level and in key member states like the UK and Netherlands, ILR is advocating for the introduction of meaningful legislative safeguards restricting the use of TPLF in class actions.
In March 2017, ILR released The Groth of Collective Redress in the EU: A Survey of Developments in 10 Member States, which reviews how collective redress mechanisms (class action models) are being used in key EU Member States, including Austria, Belgium, Bulgaria, France, Germany, Italy, the Netherlands, Poland, Spain, and the UK. This report suggests several TPLF safeguards and highlights many of the major issues associated with TPLF in European collective redress. The recommended safeguards are as follows:
- Implementing licensing through a government agency
- Requiring capital adequacy
- Ensuring that claimants, not funders, control management of the case
- Requiring that funders act in the best interest of claimants
- Banning law firms from owning funders and vice versa
- Imposing costs liability
- Promoting transparency
- Placing limits on recovery
As a follow-up to the recommendations made in the March research report, ILR conducted consumer focus group testing and public polling on collective actions and TPLF in six key European markets. The results are published in Supporting Safeguards: EU Consumer Attitudes Towards Collective Actions and Litigation Funding.
The results of the survey show:
- 85% of respondents support the introduction of safeguards for collective action lawsuits. Only 5% of consumers oppose the introduction of safeguards and 10% ‘don’t know’.
- Nearly 80% of consumers feel it is important that collective action safeguards are made consistent across the EU.
- Just 5% of consumers believe that TPLF will ensure that collective action cases operate in consumers’ best interests.
- 81% of consumers support the introduction of safeguards for TPLF.
The issue of third party litigation funding was recently touched on by the EU Commission. In January 2018, the EU Commission released a report on the implementation of collective redress mechanisms in Member States. The report found that no Member State has regulated TPLF. Most notable, the report said that national regulation would be “a step in the right direction,” but may not be sufficient, as a funder based in one Member State can avoid the rules by funding collective actions in a Member State without stringent rules. In the report’s conclusion, the Commission says it will conduct further analysis on litigation funding. ILR is supporting this analysis and will continue advocating for TPLF safeguards with the EU Commission.
The litigation funding industry is growing rapidly in the UK. A 2016 market analysis by ILR found that the top sixteen litigation funders in the UK had approximately £1.5 billion in assets under management. Now there more than 25 funders operating, which together are estimated to hold £10 billion in assets, according to the Financial Times.
A recent collective action against MasterCard before the Competition Appeals Tribunal sought £14 billion on behalf of 46 million consumers who purchased anything from a merchant accepting MasterCard over the past 16 years. This came out to about 70% of the British population. The claim was backed by a £40 million funding agreement. The funders stood to make at least £135 million in return and as much as one billion pounds, with the size of their payment to increase with the lower the claimant take-up rate. In other words, the less the consumers claimed, the more the funders would receive. In this case, the judge voluntarily disclosed the funding agreement when issuing the ruling dismissing the case, but no obligation for disclosure of funding exists.
In 2011, the British government failed to pass an amendment to the Legal Aid, Sentencing, and Punishment of Offenders Act that would have regulated TPLF and ensured transparency. In their view it was still a nascent industry. Now there is ample evidence that the industry has experienced exponential growth and must be regulated.
In April 2016, ILR Released Before the Flood: An Outline of Oversight Options for Third Party Litigation Funding in England and Whales. This paper explores some of the overarching themes and issues regarding TPLF and explains why meaningful oversight is desirable and could be achieved. It also considers specific ethical and practical issues related to the use of TPLF in litigation. Finally, the paper identifies some of the options for an oversight structure, including through financial or legal services structures.
In the UK, ILR also established the "Justice not Profit" campaign with the support of leading academics and business leaders. This multimedia communications campaign highlights the pitfalls of TPLF in the UK, especially in opt-out class actions - a combination that mixes two practices already prone to abuse, as shown in the MasterCard case above.
As the birthplace of third party litigation funding, ILR has been pressing for regulatory oversight of TPLF in Australia for many years, in hopes of slowing the rapid growth of this practice globally.
In 2017, Martin Pakula, the Attorney General for the Australian state of Victoria, asked the Victorian Law Reform Commission (VLRC) to review the rules covering litigation funders to prevent unfair conduct in civil proceedings, including class actions. This request was prompted by a case where the majority of the plaintiffs' $5 million award was split by their lawyers and Sydney-based LCM Litigation Funding. The attorney general has requested the VLRC answer several inquiries on TPLF.
The VLRC review, titled “Access to Justice – Litigation Funding and Group Proceedings,” asked stakeholders for submissions on the issue of collective actions and funding. ILR submitted its comments in September 2017, calling attention not only to class action issues but also to the major issues with TPLF, such as conflict of interest and more substantial awards going to funders than to consumers. The comments also suggest reforms to funding and methods for implementing those reforms
The VLRC has until March 30, 2018 to publish its final report, which will then be submitted to the state government and subsequently tabled in the Victoria Parliament.
The state level review of TPLF has in turn sparked action at the federal level. In December 2017, the Australian Attorney General George Brandis took notice of the VLRC’s review and announced that he is launching a similar review of TPLF by the Federal Australian Law Commission. Since this announcement, Attorney General Brandis resigned, but the review will continue under the new Attorney General, Christian Porter.
ILR’s advocacy work in Australia for an oversight regime is backed by our research on the unchecked growth and risks of the litigation funding industry for the civil justice system.
In September 2013, ILR released Improving the Environment for Business in Australia: A Proposal for Reforming Oversight of Third Party Litigation Financing, which outlined an oversight regime of TPLF that would include:
- Licensing requirements;
- Ensuring that claimants, not funder, control the management of their cases;
- A requirement that the funder act in the best interest of claimants; and
- Banning law firms from owning funders and vice versa.
In October 2013, ILR released a second paper entitled, TPLF in Australia: Class Actions, Conflicts and Controversy, building additional support for an oversight regime by illuminating the pitfalls of TPLF.
More recently, in March 2014, ILR released Ripe for Reform: Improving the Australian Class Action Regime, suggesting reforms to class action procedures and rules that would restrain the use of TPLF in class actions and reduce conflicts of interest and ethical concerns.
Canada has experienced an increase in TPLF, especially in class action litigation. Recent court decisions, including those by the Ontario Superior Court, have approved specific TPLF agreements. These decisions have articulated important safeguards to protect class members and shine much needed light on TPLF arrangements. However, these are piecemeal standards at best; overall, the use of TPLF threatens to undermine the check on frivolous lawsuits imposed by “loser pays” cost regimes in various Canadian provinces.
In October 2017, ILR released a research paper on Canadian class actions and potential reforms, titled a Recipe for Reform: A Proposal for Improving Canadian Class Action Procedures. The paper lays out a dozen reforms for class action legislation, including transparency and other oversight requirements for TPLF.
ILR filed comprehensive comments to the Hong Kong Law Commission in January 2016 relating to the rule proposal the Commission was considering allowing third party funding (TPF) of international arbitration. The comments expressed ILR's strong agreement with the long-standing view of the Hong Kong judiciary that TPF is inappropriate in court litigation matters and should be prohibited in that context. ILR argued that if TPF was to be permitted in arbitration proceedings, such activity should be subjected to common-sense regulations to prevent potential negative consequences.
In October 2016, the Commission released a Report on Third Party Funding for Arbitration calling for "light touch" regulation and disclosure of TPF in arbitration. While this is an important first step and may lead to global recognition of the need for meaningful oversight in the litigation funding industry, "light touch" regulation will not suffice. ILR will continue to urge the Hong Kong Legislative Council to strongly consider adopting litigation funding rules that ensure proper enforcement.