Third-party litigation funding (TPLF), also known as legal funding, third-party litigation finance, or alternative litigation financing, involves a third party investing in a lawsuit and receiving a percentage of the proceeds if the lawsuit is successful. TPLF can benefit both individual and corporate claimants. While the exact figures are uncertain due to the lack of transparency in this practice, Swiss Re, an insurance company, estimates that the global TPLF market will reach $30 billion by 2028, with the United States being the largest market. Swiss Re also reports that TPLF investments have recently generated internal rates of return of 25% or higher. As the prevalence of TPLF continues to rise, it is crucial to understand this trend and its implications.
How TPLF Works
TPLF typically involves financiers, such as Wall Street hedge funds, investing in ongoing litigation. They may provide funds directly to plaintiffs or law firms or work through brokers or specialized TPLF companies. Investors in TPLF offer nonrecourse loans against individual cases or portfolios of cases in exchange for an equity-like stake in the potential financial outcome. Funding can be provided at any stage of a lawsuit and is not dependent on the plaintiff obtaining a judgment or settlement. Litigation finance companies may establish relationships with law firms or use databases to identify cases suitable for financing.
Different Recipients of TPLF
Investors may target various types of cases for funding, and the utilization and distribution of funds depend on the specific claim financed. Extensive research is conducted by investors before selecting a case or portfolio of cases. Generally, funds are disbursed to corporate plaintiffs or law firms, which use the money to cover various expenses. These plaintiffs or firms typically receive funding regardless of the case’s outcome but agree to share a portion of the monetary award with the investor, which can be as high as 50%.
Commercial litigation receives the majority of TPLF investments, including cases related to intellectual property, arbitration, business torts, contract breaches, and class-action suits. Personal or consumer litigation funding occurs when investors provide funds to individuals for living or medical expenses during the litigation process. In some cases, funds may also be used for legal expenses if local laws permit. Funders analyze the potential value of a case and often focus on personal injury cases when providing financial assistance. Similar to commercial litigation, funding for personal and consumer litigation is generally on a nonrecourse basis, with the investor receiving a share only from awarded damages.
TPLF’s Impact on the Insurance Industry
Proponents of TPLF argue that it helps level the playing field by enabling underfunded plaintiffs to pursue legal action against well-resourced industries. However, critics claim that the practice leads to higher insurance rates and less favorable policy terms and conditions. Due to the lack of mandatory disclosure, the transparency of TPLF funding recipients is limited. This makes it difficult for insurance companies to calculate associated costs, assess legal risks, and may result in increased insurance costs for consumers.
Opponents of TPLF also argue that it can discourage efficient litigation since law firms may receive payments regardless of the case’s outcome, and funded claimants may modify their settlement strategies, considering the portion they must repay to the investor. Furthermore, the allocation of funds may not be fully apparent to juries when awarding damages, potentially influencing their decisions.
Data suggests that TPLF may contribute to social inflation, which refers to the increase in insurance claim costs exceeding the general inflation rate. Swiss Re highlights an increase in multimillion-dollar claims in the U.S. general liability and commercial auto sectors, attributing it to TPLF incentivizing the initiation and prolongation of lawsuits while diverting a larger share of proceeds to funders rather than plaintiffs. These escalated costs pose challenges for insurers in quantifying and mitigating risks, as they are difficult to predict. Opponents of TPLF advocate for more transparency and regulation in this practice.
To learn more and speak to a qualified insurance broker, contact DSP Insurance Services today.
