Litigation Finance in the United States: How It Started

The large and growing litigation finance industry that we see today is only a couple of decades old. Although YieldStreet currently focuses solely on the U.S. litigation market, the industry actually first arose in Australia and the United Kingdom in the 1990s.

The catalyst in both countries was legislative. In Australia, Parliament recognized legal claims as assets–a move intended as an exception to help bankrupt companies. By allowing third-party legal funding in the limited realm of bankruptcy proceedings, Parliament made it possible for lawyers to pursue claims against creditors and company officers despite representing companies that were out of cash.

In the United Kingdom, Parliament removed a ban on conditional fee arrangements, which had been the last standing barrier to the non-recourse (“no win, no pay”) loans that litigation funders provide. Contrary to the Australian Parliament’s focus on corporate bankruptcies, the U.K.’s goal was to provide access to justice for middle-income individuals. These individuals did not qualify for Legal Aid, but also could not afford expensive litigation on their own. Conditional fee arrangements–and litigation finance in particular–became especially needed when Parliament altogether abolished Legal Aid for personal injury plaintiffs in 1999.

In both countries, litigation funding exploded into a booming industry. In Australia, litigation funding expanded beyond its original testing grounds (bankruptcy proceedings) to personal injury and class action lawsuits.  Australia’s High Court endorsed the industry in 2006 and again in 2009, and nearly half of all class actions brought in the country are now backed by litigation funders. The total Australian legal funding market reached an estimated $3 billion in 2015. In the United Kingdom, litigation funding has expanded in the opposite direction–while it was created to help individual plaintiffs, it now serves businesses as well. Financiers deployed over £1.5 billion in total into legal cases by 2016, and the rate of deployment increased sharply from 2015 to 2016, suggesting the industry is continuing to grow. A U.K. Court of Appeal referred to the industry earlier this year as simply “a feature of modern litigation.”

Funders in the United States, quickly drew inspiration from the overseas models. In the mid- to late-1990s, finance pioneers launched grassroots efforts in disparate areas of the country to provide meritorious plaintiffs with access to courts while generating financial returns.

Early litigation funding arrangements were not always well-recorded, and there are competing claims as to who first backed American personal injury plaintiffs. There are several known examples of innovators who, seemingly independently, began some of the country’s first litigation funding operations.

The early pioneers operated in a sort of “wild west” period, and with their success came skepticism. Observers began worrying about the industry’s ethical implications for lawyers and fairness toward litigation parties. The industry responded by proactively self-regulating. The American Legal Finance Association (AFLA) was formed in 2004 and now includes 37 member companies that provide legal funding to individuals. The member companies created the AFLA Code of Conduct in 2005 to formalize ethical standards, fair business practices, and rules around transparency and disclosure. They continue to collaborate to standardize deal documents, ensure cases are not over-funded, and institute state-tailored legal and regulatory frameworks. Legislatures, courts, and society at large are increasingly recognizing funding agreements as legitimate, mutually-beneficial contracts between investors and plaintiffs.

Litigation funding’s self-regulatory framework has provided guardrails as the industry quickly expands. Although many of the early pioneers were individual investors, more established institutions—including large banks, hedge funds, pension funds, and insurance companies—soon added litigation to their portfolios. Hedge fund EJF Capital LLC, for example, raised hundreds of millions of dollars to create a new arm that invests solely in class action lawsuits. In the words of one finance professional, these institutions recognized litigation as a potential “unicorn of non-correlated absolute returns.” Additionally, rising pressure from investors for funds to be socially responsible made litigation finance–which provides access to justice for plaintiffs and may incentivize better, less risky corporate behavior–even more attractive. Beyond existing institutional investors, new, highly-specialized hedge funds, like Gerchen Keller Capital, sprouted up specifically around litigation funding.

Beyond these large institutional funds, which are often focused on commercial litigation (backing major corporations or corporate law firms), investors focused on individual personal injury plaintiffs and class actions also proliferated. The 2012 JOBS (Jumpstart Our Business Startups) Act allowed funders to solicit accredited investors online. The Act enabled consumer-funding-focused marketplaces like YieldStreet, which in turn enabled individuals to access this innovative asset class.

Once consumer lawsuit funders were operating widely on the market, plaintiffs quickly saw the benefit in their offerings. These were avenues to justice for victims who were outsized and out-resourced by the defendants who had injured them. Often, these victims seek funding as groups, not just individuals, in cases brought as class actions or mass tort litigation cases.

Today, the litigation funding industry is an American staple in both commercial and personal injury lawsuits, and is poised for further growth. In 2015, a legal news site reported that litigation finance “is here to stay;” a year later, the Wall Street Journal referred to the industry as “mainstream.” According to a survey conducted by Burford, 75 percent of lawyers in the United States believe the litigation finance market will grow in the next five years, as funders increasingly back the some-280,000 new civil claims filed each year.

Here at YieldStreet, we have seen the growth firsthand. Our portfolio offerings continue to attract investors almost instantly. We expect that lawyers, plaintiffs, and investors alike will only increasingly reap the benefits of litigation funding.

 

Sources

1. Terrence Cain, Third Party Funding of Personal Injury Tort Claims: Keep the Baby and Change the Bathwater, 89 Chi.-Kent L.

2. Victoria A. Shannon, Harmonizing Third-Party Litigation Funding Regulation, 36 Cardozo L. Rev. 861.

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