/>iEditor's note: NLR Publishing Partner, Much Shelist, P.C. was one of only eight law firms in the United States mentioned in 2024 by Chambers in the Litigation Finance Deal Counsel category. Of these eight, Much Shelist's group was one of only five to rank nationally. Of those five, it was the only group that had more than one person rank individually: Jonathan Friedland and Jeremy Waitzman, the co-authors of an NLR five-part series, Commercial Litigation Funding: A Guide for Plaintiffs & Commercial Litigators Seeking Funding in the United States. The NLR is pleased to present this series.
Commercial Litigation Funding Defined
Commercial litigation funding, also known as “third-party litigation funding,” is a form of financing in which a third party (funder) provides funds to either a party with a legal claim (fundee), against a third party (i.e., a defendant), or a law firm representing one or more parties with one or more legal claims against a defendant. In exchange for the funding, the funder gets to share any settlement or award that is obtained from that legal claim.
Commercial litigation funding (CLF) almost always involves funding the side of the plaintiff (while providing funding to defendants is theoretically possible, it is not common). We define the CLF industry as being comprised of such funders, the intermediaries that connect funders with plaintiffs and their law firms, and attorneys like us who represent funders and fundees in the deals they make with each other.
Why This Guide?
The way CLF works is generally the same regardless of who the funder is. There are, however, marked differences among funders, and great variations in the economic and legal terms they offer potential fundees. The industry is still relatively young, and funders tend to be guarded about their diligence processes and the terms they offer fundees. The result: a marketplace in which it is more difficult to know what terms are “market,” and legal documents that are far more bespoke than many other transaction types.
In addition to these issues, we’d be remiss if we didn’t channel our inner Sy Syms. That great American 20th century philosopher is, perhaps, best known for bequeathing to the world the adage, “an educated consumer is our best customer.” This is particularly apt where, as is common in the CLF setting, much negotiation between a funder and fundee is conducted by the funder and its outside counsel, on the one hand, and the fundee and its litigation counsel, on the other hand. This is often fine, but sometimes fundee’s litigation counsel will determine that it is either not experienced nor familiar enough with the market to advise on the CLF transaction itself; and other times fundee’s litigation counsel will be uncomfortable doing so because of conflict concerns.
As its title suggests, this resource is intended to serve as a guide, so to speak, for fundees in search of funders. It doesn’t give away any secrets, but it will help you understand in broad strokes how CLF works and how funders generally approach it.
Use of Proceeds
In CLF, the funder provides funds to cover litigation costs to pursue the fundee’s claims. Such costs may include legal fees, expert witness fees, court costs, and other expenses associated with pursuing the case. Sometimes, a small portion of the provided funds may be used for expenses not directly related to litigation, most often for general working capital purposes. So, the funder is the source of funds, and, most typically, the funds are used to fund litigation or litigation-adjacent expenses.
The Typical Fundee: Fundees That Need the Money
CLF is sometimes sought by fundees who lack the financial resources to pursue legal claims against a third party. CLF can thus fulfill the need of parties that cannot afford to pay attorneys by the hour, and law firms that cannot or will not take on a wholly contingent basis. In this way, litigation funding can help level the playing field in disputes involving large, well-funded defendants (think “David vs. Goliath”).
The Typical Fundee: Fundees That Don’t Need the Money
Many (maybe most) fundees, however, can afford to pay attorneys on an hourly basis but choose to use CLF. Why? The reasons can be put into two basic buckets:
- One reason is purely economic, of course, as is any risk-hedging decision. Stated differently, putting someone else’s money at risk has some obvious benefits over putting one’s own money at risk. This is particularly true given the potentially binary win or lose nature of litigation.
- A second goes to “sticking with one’s knitting.” Just as a company that makes widgets may decide to enter into a sale/leaseback transaction on the basis, in part, that it is not a landlord and its time is not best spent doing “landlord things,” and just as some owners of popular consumer brands that used to manufacture their products later evolved to become marketing-only companies that today rely on contract manufacturers because marketing is what they do best, so too might a company decide that investing capital outside its core competency does not present a highest and best use of its capital.
CLF offers other benefits to a fundee/prospective fundee.
For example, as Jeffery Lula, a principal at GLS Capital where he oversees the day-to-day for commercial litigation funding investments, has noted, “CLF can also provide internal accounting benefits by eliminating recurring legal expense that can be artificially lowering profitability and valuation.” Another example: the process of seeking CLF serves a “second opinion” function with respect to the subject litigation. That is, if you are looking for CLF and every funder you speak to takes a pass, that may tell you something about the merits of your case. According to Charles Schmerler, head of litigation finance at Pretium Partners and formerly an AmLaw 25 law firm litigation partner, “funders absolutely have a vested interest in being honest and direct with fundees and their lawyers at the earliest stages. No one wins if the case is not evaluated candidly and critically by an experienced funder right at the start.” Funders also do much more than just write checks. As we will discuss later, funders employ people who previously worked as senior litigators who can and do offer valuable advice during the course of the litigation.
How Do Funders Find Fundees?
The best funders don’t need to find fundees; fundees find them. Right? Wrong.
The most prominent, well-regarded professional service firms spend a ton of money on marketing and PR. This is true across every industry. From accounting to financial advisory, from banking to law: virtually every “white shoe,” “magic circle,” and “bulge bracket” firm spends significantly on making sure that potential clients think of them as a go-to firm. This is not intended to denigrate; it’s just intended to remind you that funders need customers, too, and fundees are their customers (clients).
With that as background, all you really need to know as a potential fundee is that funders spend a great deal of time writing articles, speaking at conferences and webinars, and trying to be mentioned in articles that are attended/read by attorneys who litigate complex commercial disputes. So, one of the better ways to access funders is to ask your law firm for referrals. However, funders also spend time trying to access in-house counsel, so if you’re a C-suite executive, your general counsel may already have views on the industry.
Who Are the Funders?
Funders are specialized group of professional investors, either at a CLF firm or a litigation funding department within a larger hedge group, who focus largely, if not exclusively, on investing in legal risk.
Many, if not most, of the people at funders with whom you will interact are former senior litigators or other legal subject matter experts who were formerly at sophisticated law firms, and others are quants. They tend to be extremely smart, honest, and professional. However, they are in the business of making as much money for their investors as possible, and many have sharp elbows.
Above all else, ‘better’ funders do not outsource the job of the legal underwriting the merits of your (the fundee’s) litigation. The experience and skill to do this are the ‘alpha’ that funders bring to their investors. Asking a funder whether it outsources this function is, in our view, not all that different from asking an investment advisor whether it outsources the function of coming up with investment advice. If the answer to either question is yes, then keep walking. We do not mean to suggest, however, that any outside help is verboten. Just as plaintiffs’ counsel are likely to have cause to rely on subject matter experts, so may funders.
Who Invests in Funders? How Are Investments Valued?
CLF is an example of an alternative asset and a highly uncorrelated asset. Because of how most CLFs are organized and how most raise money, their investors generally must be accredited investors. These facts come together to result in most investors in CLF being institutional investors and very affluent families/individuals. If this sounds like the universe of investors that invests in traditional private equity, that’s because it is. In addition, just like most alternative assets and other illiquid assets that are the targets of private equity, the manner of valuing these investments before they mature requires a detailed evaluation of likelihood of success and value of the ultimate recovery – which is a similar process used by the funder in its underwriting process.
History of Litigation Funding: Ancient History and Historical Objections
The origin of litigation funding can be traced back to medieval Europe, where wealthy individuals would finance legal disputes in exchange for a share of the winnings or sometimes just to harass other noblemen. And this type of lawsuit funding was commonly viewed as objectionable due to the common law doctrines of champerty and maintenance.
Both doctrines were intended to prevent the wealthy and powerful from using their financial power to influence legal proceedings and undermine the fairness of the justice system. The concern was that by funding lawsuits, third parties could exercise undue influence over the litigation, leading to unjust outcomes or frivolous claims. These doctrines were exported to the colonies and, thus, were in the background of United States common law from its beginning.
In the modern context, courts generally view litigation funding as permissible so long as the funder does not exert undue influence over the litigation. Many jurisdictions have enacted laws or regulations, and certain judges or legal divisions have implemented rules that clarify the circumstances under which litigation funding is allowed, and provide safeguards to ensure that the funder's interests do not conflict with the interests of the litigants.
Modern History and the Modern Trend
The modern history of litigation funding started in Australia and the United Kingdom in the mid-1990s. This was due to a confluence of laws and legal rulings that made those countries particularly fertile to the development of this industry.
Given the porousness of money and people, especially among the English-speaking finance hubs of Sydney, London, and New York, it was only a matter of time before litigation funding gained traction in the United States. And that started to happen in the United States commercial market in the mid-2000s.
As the industry grew in the United States, the application of the old doctrines of champerty and maintenance became more limited; courts facing the issues recognized that there are legitimate reasons for third parties to provide financial support to litigants. The fact of the matter is that pursuing a lawsuit can be prohibitively costly, making it difficult for parties harmed by some wrong to pursue a legitimate legal claim.
Protracted discovery is expensive and is a drain on the parties' resources. When a defendant enjoys substantial economic superiority, it can, if it chooses, embark on a scorched earth policy and overwhelm its opponent. Indeed, the reason for the “proliferation of alternative litigation financing in the United States” is “partly due to the recognition that litigation funding allows lawsuits to be decided on their merits, and not based on which party has deeper pockets or stronger appetite for protracted litigation." The alternative of hiring an attorney on contingency is not always possible, and, even when it is, it can be far more expensive than CLF.
