Gambling on Legal Verdicts | The Regulatory Review

The business of placing bets on lawsuit outcomes is becoming increasingly common in the United States, growing into a $13 billion industry in 2021.

Through an arrangement known as third-party litigation funding (TPLF), one party can finance a lawsuit brought by another in exchange for a share of any money they win. Typically, the funder either finances the litigant directly or finances the firm representing the litigant. In either scenario, the funded party faces minimal up-front costs, and if the lawsuit does not result in monetary recovery, they are not obligated to repay the funder. If the funded party wins, the funder’s bet pays off, and they are entitled to a share in the damages award.

Although TPLF can be a lifeline for plaintiffs struggling to finance expensive litigation, it also raises concerns about funders’ and litigants’ misaligned incentives and the influence that funders may exert over how the litigation is conducted.

Proponents of TPLF arrangements emphasize that the U.S. justice system “fails to serve most of the legal needs of the poor and many of the legal needs of middle-income Americans” due in large part to high litigation costs that could be addressed by outside funders. Some scholars argue that allowing greater nonlawyer involvement in legal services could reduce costs, increase quality, and consequently expand access to justice.

Critics of the practice argue that TPLF creates incentives for parties to file frivolous lawsuits in pursuit of undeserved settlements. TPLF may also violate the professional conduct rules governing lawyers by dividing attorney loyalty between funders and clients. Indeed, the American Bar Association has characterized nonlawyer involvement in the practice of law as a threat to the U.S. justice system. According to the American Bar Association, TPLF also threatens clients and the public by enabling parties that are not subject to lawyers’ ethical standards to interfere in client representation, creating “unavoidable tension” between clients’ interests and investors’ interests.

Advocates for reform also criticize TPLF for its lack of transparency. Because funders do not always disclose their identities, these advocates point out that many lawsuits proceed with undisclosed conflicts of interest between the funder and adjudicator.

Despite these concerns, TPLF remains largely unregulated in the United States. Some states adhere to common law doctrines that prohibit TPLF agreements altogether, and others have passed regulation governing the practice. But scholars have characterized the resulting framework as “a web of piecemeal regulations” that fails both to protect consumers and to facilitate access to the courts.

Against this backdrop, many commentators and policymakers agree that increased federal oversight is needed. Congress has made several attempts to pass TPLF legislation in the past, but none has gained traction. Most recently, House Speaker Mike Johnson (R-La.), Senator Joe Manchin (D-W. Va.), and Senator John Kennedy (R-La.) introduced a bill that would impose disclosure requirements on foreign funders. But, like its predecessors, the bill appears unlikely to become law.

In this week’s Saturday Seminar, scholars discuss concerns raised by the TPLF industry and propose regulatory solutions.

• In a recent report for the S. Government Accountability Office, Michael E. Clements finds that TPLF falls outside most state and federal finance regulation. He observes that there is no nationwide requirement to disclose TPLF arrangements to courts or opposing parties in U.S. federal litigation. Clements also notes that the U.S. Securities and Exchange Commission and the Consumer Financial Protection Bureau only have jurisdiction over TPLF under limited circumstances, such as when TPLF lenders register securities on national exchanges. Clements points out, however, that some states impose regulations on TPLF lenders, including interest rate caps and registration requirements. Clements also surveys regulations in Canada, Australia, and England and concludes that TPLF regulation is sparse in those countries as well.
• In a report published by the Deborah L. Rhode Center on the Legal Profession, Stanford Law School’s David Freeman Engstrom and several coauthors find that current rules governing the legal practice serve as economic barriers to service. Professional conduct rules limit a lawyer’s ability to form partnerships with nonlawyers that would unlock access to outside assistance and capital, the Engstrom team explains. The Engstrom team compares the regulatory reforms of Utah, which relaxed limitations on outside assistance and financing, and those of Arizona, which only focused on TPLF. Although reforms in both states led to changes in the ownership structure of legal service providers, the Engstrom team observes Utah’s dual reforms have expanded low-income clients’ access to litigation.
• In an article in the Journal of the Patent and Trademark Office Society, Paul B. Taylor argues that current laws allow litigation funders to “turn the patent litigation system into a house casino” by gambling infringement suits. He contends that TPLF agreements, like casinos, should be subject to special regulations. Taylor argues that where TPLF is involved in a case, the funder should have to cover the costs of litigation if its side loses the suit. Without such a cost-shifting measure, Taylor points out that the funder enjoys all the potential benefits of litigation without bearing any of its risks. Taylor also proposes adopting uniform burdens of proof for all litigants to eliminate one advantage plaintiffs alleging infringement currently enjoy.
• Foreign adversaries could use TPLF to conduct economic espionage and theft, threating U.S. national security interests, Michael E. Leiter and several coauthors warn in a U.S. Chamber of Commerce Institute for Legal Reform report. Although pending proposals, such as the Litigation Funding Transparency Act, would require attorneys to disclose the identity of the entity behind a TPLF agreement, none compel attorneys to reveal the source of funds used to finance the litigation, the Leiter team points out. They propose that the Foreign Agents Registration Act, which requires individuals to register as agents of a foreign government if their investment could influence the U.S. public, should be amended to explicitly apply to attorneys in TPLF agreements who receive funds from foreigners.
• Because TPLF is critical to plaintiffs’ ability to secure and enforce judgements, the European Union should adopt a recently proposed Directive to regulate and encourage use of TPLF, argues Rita Portenti, a J.D. candidate at Penn State Law, in a recent article in the Arbitration Law Review. Portenti notes that TPLF provides a path to securing and enforcing judgements for people who might otherwise lack the resources to do so, especially in complex disputes. She argues that even for solvent parties, TPLF could make litigation fairer and case law more equitable, and even stimulate economic activity. Portenti concludes that the Directive would limit some risks associated with TPLF by establishing minimum standards for financing litigation in European Union member states.
• Because there is no coherent international framework for regulating TPLF, funders can exploit gaps between different countries’ rules, Boston University School of Law’s Victoria Sahani observes in a Boston University Law Review article. By surveying existing regulatory approaches, Sahani extracts universal principles for ethical and responsible TPLF. Although she acknowledges that achieving complete global uniformity is impossible, Sahani contends that diverse regulatory approaches can be harmonized by creating a framework of generally agreed-upon principles. This customizable framework would address inequities between funders and litigants, reduce information asymmetries, and preserve confidentiality, Sahani explains. It would also encourage disclosure of funders’ identities to courts. Sahani suggests that such a framework could be implemented through an internationally applicable, locally enforced convention.