Many of us first heard about of “litigation funding” though the 1995 book A Civil Action by Jonathan Harr. That book, later a movie starring John Travolta, featured the banker dubbed “Uncle Pete.” By extending credit to plaintiffs’ counsel, Uncle Pete enabled a mass tort action to proceed on behalf of various families exposed to a contaminated water supply.

Since then, the field of litigation funding has evolved significantly, from a niche, semi-formal credit arrangements with individual plaintiff lawyers to major investment vehicles directly impacting business litigation. However, despite this changing landscape, litigation financing remains somewhat esoteric in the eyes of most business and IP litigators.

Until recently, growth of litigation funding remained stunted due to the traditional hostility the “champerty,” an enduring common-law doctrine referring to the financing a stranger’s lawsuit in exchange for a share of the proceeds. Jurisdictions following the champerty doctrine prohibit — and in some cases even criminalize — third-party litigation funding. [For its part, California never adopted the champerty doctrine and is thus a jurisdiction friendlier to various third-party funding mechanisms.]

The growth of litigation funding should also be seen against the backdrop of the global investment environment. Over the last few years, the long, steady decline of bond yields to historic lows, and even in some cases to negative yields, has goosed investors to assiduously seek out novel opportunities to deploy capital.

In a nutshell, litigation funders provide capital for clients to pay legal fees and expenses. The funding is non-recourse, meaning that unless the litigation succeeds in the form of monetary settlement or award, the funder gets nothing. For its part, the funder follows a contingency model, with a portion of any award, from first dollar.

From an investment perspective, any individual lawsuit is an inherently risky endeavor. To begin with, litigation results are never guaranteed. A single decision by a judge on a seemingly routine motion can have profound effects on the dynamic and value of a plaintiff’s case. Anyone familiar with the litigation process is acutely aware of these risks; a skilled litigation team can only lessen those risks, and never wholly eliminate them. Moreover, ethical considerations generally preclude any outside influence over strategic decisions made during the course of the litigation. In other words, the fate of the investment is in the hands of litigation counsel and the client.

Thus, a litigation fund will invariably look for a strong litigation team, and will also attempt to ensure, upfront, that all interests are aligned toward the eventual presumed outcome — in other words, that the parties have a high likelihood of settling on terms that are not overbearing, and provide a high return on the capital deployed for the case. Thus, litigation funders strongly prefer (if not require) that litigation counsel share risk in the form of at least partial contingency participation.

Despite the speculative component of every individual lawsuit within an investment pool, industry analysts anticipate annualized returns of 15-20% for well-managed litigation funds. Obtaining such returns requires that each individual lawsuit within the pool not only have factual and legal strength, but also sufficient potential damages that the parties will be motivated to resolve the case on terms allowing for a multiple return on the capital deployed by the funder (i.e., a likelihood to generate a kind of “lottery” win to offset unsuccessful cases).

The massive returns sought by litigation funders should give pause to any practitioner considering this approach to financing a client’s litigation objectives. After all, the return to the investor comes from the compensation that the client would otherwise secure. Those returns can dwarf the attorneys fees and leave the client with a fraction of any settlement or recovery.

Additionally, many business cases are simply not amenable to funding. For example, litigation funders are unlikely to be excited about a case in which the client is seeking primarily non-monetary relief, since the value of an injunction is, at best, difficult to quantify.

But there are situations in which a business client has no realistic alternative. For example, where a client with limited financial reserves is being forced out of business by the demonstrably unscrupulous and illegal business practices of a competitor — in other words, a strong legal case, with high damages upside, with the company’s legal claims rapidly evolving into its largest asset. Put differently, a “bet the company” case.

Third-party litigation funding is growing rapidly and is playing an increasingly important role in commercial litigation, and a tool with which every business and IP litigator needs to be familiar. A working knowledge of this finance mechanism is useful not only for discussion in assisting our business clients in economically pursing their actionable legal claims, but also in assessing the countervailing drives that may be motivating an opponent.

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