Explainer: Third Party Litigation Funding 

Third party litigation funding (TPLF) allows entities that are not party to a lawsuit to make a financial stake in a lawsuit’s outcome. Outside funders, including hedge funds and other financiers invest in lawsuits in exchange for a percentage of any settlement or judgment.

This explainer examines TPLF and its effect on the legal system.

What is Third Party Litigation Funding? 

Third-party litigation funding (TPLF), also referred to as lawsuit lending, is when an entity or individual finances a lawsuit in return for a portion of the settlement or awarded damages.

The federal Government Accountability Office reports that many funders involved in TPLF are private institutions. Others include publicly traded companies and hedge funds. These funders often draw funds from diverse sources, including foreign countries’ sovereign wealth funds, pension funds, and endowments.

These funding entities are not parties to the lawsuit, but they have a stake in the lawsuit’s outcome since they receive compensation based on their funded party’s status. 

Different types of funding

There are different types of TPLF. One type is a loan geared toward plaintiffs in a personal injury or tort case who use the loan to finance their living expenses while waiting for a lawsuit to settle. The other type centers on large-scale commercial or mass-tort cases. These types of cases might attract large financial backing from institutional investors, sometimes with ties to foreign governments. 

In the large-scale commercial litigation space, funders often finance multiple cases managed by a single lawyer or law firm, with their return on investment coming from the settlement or judgment of one or more cases. Portfolio funding enables funders to support all or part of a law firm’s cases in exchange for a share of the proceeds. This strategy mitigates risk for funders by spreading it across several cases.

The terms

Lawsuit loans often come with steep interest rates far above what would typically be allowed under most states’ consumer credit laws. 

Opponents of lawsuit lending argue the high interest rates encourage plaintiffs to extend litigation even when a fair settlement is on the table because the plaintiff is attempting to pay off their loan.

Lenders claim their financing is “non-recourse,” meaning the borrower is not responsible for paying off the loan if they lose their lawsuit. 

Opponents argue that this encourages frivolous lawsuits because plaintiffs do not bear the risk of legal costs. 

Is TPLF disclosed to the court? 

These agreements are usually not required to be disclosed except in some states and federal districts. Momentum for reform is growing, however. Last year saw three states adopt disclosure laws

According to the Institute for Legal Reform, disclosure is typically handled in one of two ways: disclosed only to the judge or disclosed to the opposing party. Such disclosure enables the court and the parties to identify the litigation funder. There are also concerns when funders are not disclosed, including potential conflicts of interest. 

The status of TPLF in Arizona 

TPLF is currently legal in Arizona. Last year HB 2638, the Litigation Investment Safeguards and Transparency Act was proposed but did not advance through the legislative process. The legislation would have required litigation financing to be disclosed to an attorney’s clients, the court, all parties in litigation, lead counsel in mass litigation, and members of a class action.

State Sen. Vince Leach (R-SaddleBrooke) this year has introduced S. 1215, an attempt to reform TPLF. His bill would:

  • Preserve consumer control: It ensures that litigation financiers cannot influence decisions regarding the course of legal actions, settlements, or legal counsel. It also mandates that financiers cannot receive a larger share of proceeds than the parties involved.
  • Mandatory disclosures: It requires the disclosure of litigation financing agreements to involved parties, the court, and other stakeholders. It also mandates detailed reporting about foreign entities or sovereign wealth funds involved in litigation financing.
  • Consumer protections and enforcement:  It mandates that litigation financiers indemnify consumers against adverse legal costs and sanctions, except in cases of intentional misconduct. The bill voids agreements violating its provisions and treats violations as unlawful practices subject to enforcement and penalties.

The business community view

Arizona Chamber of Commerce & Industry Executive Vice President Courtney Coolidge: “These loans have a distorting effect on lawsuits. They drive up costs, extend the length of litigation, and interject an unwelcome new element into the relationship between plaintiffs, defendants, their attorneys, and the court. Courtrooms shouldn’t be treated as a casino, nor as an opportunity for foreign funders to gain a competitive business advantage during the discovery process. The least we can do is disclose to all parties that a lawsuit is being funded by an outside entity.”

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