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ANALYSIS: For Litigation Finance, New Heights Are Within Reach

Nov. 16, 2020, 9:27 AM

Fueled by a relative lack of regulation and an upswing in market opportunities presented by the economic downturn, litigation finance — the practice by which third parties provide funding for litigation in return for a share of the proceeds in the event of a winning case — will become more widespread and better understood in 2021.

For an industry that has been facing calls for regulation for some time, it looks as though litigation finance is currently winning the battle to remain unregulated. That does not mean, however, that it will remain opaque; more familiarity will breed greater understanding and acceptance. Also, litigation funding deals will more regularly take on other forms beyond single-case financing for the fees and costs of a litigation, as funders aim to meet the needs of the moment.

No Move to Regulate

2020 has seen a notable absence of new regulation in the litigation finance industry, perhaps signaling an interest in the legal world to see where the relatively new industry will go if left unfettered. Despite the U.S. Chamber of Commerce’s longstanding criticism of the industry and push for oversight, no new states have passed legislation regulating commercial litigation funding agreements in 2020. A U.S. Senate bill introduced in 2019 that would mandate funding disclosure in certain lawsuits did not gain traction.

What’s more, the Uniform Law Commission, which studies timely legal issues and makes recommendations to states about legislating those issues, declined to propose uniform regulation of the industry, finding instead that differences among how states handled litigation finance were not problematic.

In moves that have encouraged rather than regulated the industry, Minnesota abolished its state champerty doctrine, a common law doctrine that made it illegal for third parties to take a financial interest in litigation, thus leaving more room for litigation finance arrangements in the state. And Arizona became the first state to abolish its version of ABA Model Rule 5.4, which many lawyers interpreted as possibly barring portfolio fee-sharing arrangements with nonlawyers. Similarly, earlier in the year, a New York City Bar Association working group issued a report recommending changes to New York Rule of Professional Conduct 5.4 in support of the litigation finance industry.

All of this points to a trend towards a hands-off approach to the industry, at least at a broad level. (Disclosure of funding arrangements, one of the main aspects of the industry that has the potential for regulation, can still be mandated by courts on a case-by-case basis. Though not a common occurrence, it remains a risk for certain matters.)

Edging Toward Transparency

As litigation finance becomes a more regular part of the legal market discourse, the industry is edging toward greater transparency.

Most notably, some of the leading players in the commercial litigation finance industry recently formed the International Legal Finance Association (ILFA). The association’s stated core mission is to make sure the industry is objectively understood, and their best practices include a focus on clarity.

Indispensable in Tough Times?

As predicted, the economic downturn is turning out to be a boon to the litigation finance industry. Results from the Bloomberg Law 2020 Litigation Finance Survey show that more than three-quarters of respondents from litigation finance companies said the economic downturn has resulted in increased business. And nearly half of law firm lawyers said the downturn has made it more likely that they would seek out litigation financing.

At the same time, almost half of law firm lawyers said that business has decreased as a result of the economic downturn, which means firms may be seeing cash flow problems — an issue that the litigation finance industry seeks to address. And 61% of those who had provided, obtained, or expressed interest in obtaining financing said that the litigation finance industry has provided needed funds during the economic downturn. The financial constraints felt by firms and corporate legal departments is an opening for the litigation finance industry to make itself indispensable.

Taking on Different Forms

2021 also will see an increase in funding deals that differ from the traditional model that has been the mainstay of litigation financing in the U.S.: single-case, three-party funding deals that cover the fees and costs of a given litigation matter.

Portfolio funding, in which three or more matters are bundled together for financing, will increase, as concerns that ethics rule 5.4 forbids such arrangements start to wane. These arrangements will be appealing to law firms in the coming months, as they allow access to a greater amount of capital than single-case funding. And more claims monetization deals, which differ from the industry’s bread-and-butter “fees and costs” financing model, will allow companies to access working capital while a case is in progress, on appeal, or in enforcement.

New Users and Providers

2021 may also see a rise in new client types. Large corporations might more frequently make deals directly with funders, as they seek to monetize their assets and increase restricted cash flow. And very large law firms, which have recently engaged more readily in alternative fee arrangements and other nontraditional or innovative billing and business practices, will take a closer look at litigation finance as another option to add flexibility to their downturn solutions.

Finally, more litigation financing will be provided from sources outside of groups solely dedicated to litigation finance — such as through litigation investment groups at hedge funds — as other investment professionals begin to eye this market as a new potential source of investment.

All in all, 2021 will see litigation finance become a bigger piece of the conversation surrounding the broader legal market — and, possibly, a bigger piece of the future of the legal industry as a whole.

Access additional analyses from our Bloomberg Law 2021 series here, including pieces covering trends in Litigation, Transactions & Markets, the Future of the Legal Industry, and ESG.

Bloomberg Law subscribers can find related content on our In Focus: Litigation Finance resource.

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