The Rise of Third Party Litigation Funding: Profits Over Justice?
As the costs of legal liability in the US soar, there are increasing concerns of the impact third-party litigation finance (TPLF) might have on insurers and consumers and this had led to action being taken towards mitigating the effects of social inflation.
The growing emergence of litigation funding companies (LFCs) in the United States is adding fire to the growing problem of social inflation in the country — higher jury awards, more liberal workers’ compensation claims, as well as new negligence concepts.
LFCs back the cost of a dispute in consumer and commercial litigation in return for a percentage of a successful claim sum. This is resulting in higher settlements and driving up premiums, which is having an impact on the availability of many insurance covers.
There is a huge risk of predatory lending to families or individuals that are in distress and in a financially vulnerable position. We advocate for more regulation to protect the users of litigation funding.
Swiss Re recently launched a report which delved into the third party litigation funding (TPLF) industry. Thomas Holzheu, chief economist for the Americas at Swiss Re Institute said: “We want to raise awareness as this is an industry that's not well known. It was quite difficult to get the information we needed.
“Litigation funders do very thorough underwriting and go after big potential awards, selecting cases that have a very high probability of success. Funding can step in at all different stages of litigation so it is often cases that are seasoned.
“The industries that are exposed to large verdicts will become more difficult to insure and so the availability of cover will be less.
“Defendants face longer legal action, more steps of discovery and more expert witnesses, so preparing the case is expensive and investing more money will result in longer cases. We have seen a higher frequency of very large cases and those require substantial preparation ahead of the trial.”
According to James Whittle, vice president and counsel at the American Property Casualty Insurance Association (APCIA) the impact will be profound in the long-term. He said: “The inherent nature of increasing expenses of a claim will certainly impact businesses and consumers in the long run. Services will be more expensive and products will be more expensive. It impacts the rates that we file with our regulators.”
Trends in Litigation Finance
According to Praedicat CEO Robert Reville, there are four key trends in litigation finance: non-recourse loans to plantiffs, loans to plantiff law firms, financing provided to support litigation by state, local and tribal governments and the increasing sophistication of litigation finance.
Explaining these trends, Reville said: “One key trend is non-recourse loans to plaintiffs. In other words, a plaintiff can get a loan that they will only have to pay back if they win the lawsuit. The lender is compensated with a very high interest rate.
“Another trend is loans to plaintiff law firms, which are paid back with a higher return to the lender when the law firm has higher contingency fees. This type of loan essentially acts as insurance against volatility in contingency fees. The types of firms with greater volatility in contingency fees are specialist law firms that invest heavily in expensive mass torts, such as RoundUp, PFAS, or talc. Thus this practice increases the attractiveness of mass torts.
“A further key trend is financing provided to support litigation by state, local and tribal governments in return for a fraction of the outcome. Governments have driven the opioids litigation, as well as the new climate litigation. The availability of financing to city and state attorneys has facilitated these types of litigation and will continue to drive them in the future.
"Lastly, the increasing sophistication of litigation finance is another trend. Bundles of lawsuits are securitised, and derivatives are created on the securities. This makes investment in litigation finance attractive to institutional investors like pension funds.
Reville noted that these trends mean more capital is available to plaintiffs to drive more litigation, and more mass torts, and to stay the course until jury verdicts are won.
US general liability and commercial auto lawsuit data reveal a strong rise in the frequency of multimillion-dollar claims over the past decade.
Holzheu said: “We have seen for years now the rising claims trends. The average combined ratio for commercial auto liability in 2020 was 104%. And that is 10 years of underwriting losses. So this is an industry that has been particularly affected by this but general liability combined ratio was 105.7% and medical liability 117.5%. So these liability lines exposed to large claims have been affected and incurred significant underwriting losses.”
Reville said Praedicat is working with insurers to identify emerging mass litigation risks that can create attractive investments for litigation finance.
He said: “We help them to manage the aggregations, and underwrite the risk at the portfolio level in addition to at the account level. Praedicat is also working with Aon to develop new reinsurance products that can help spread the risk of aggregation associated with social inflation.”
We are educating people on TPLF so they understand what goes on with these arrangements – where financiers have relationships with doctors or lawyers and are steering business to one another."
While TPLF offers greater access to justice it also poses ethical considerations , which begs the question is the industry putting profits over justice?
Whittle said: “Some of the legislation that litigation financers have suggest the claimants’ lawyers to have an attorney-client relationship with the financiers.
“When you're talking about wealthy people, and hedge funds and others profiting off of personal injuries or business-to-business problems, people can examine the facts and the examples that exist of the problem.
"I believe they will generally agree there needs to be more understanding around this practice. They are interested in seeing cases go on for longer because if the damages build up they can profit more from that.”
"It is clear to see the impacts in terms of social inflation, in terms of the size of personal injury claims and the size of business to business claims. Litigation funders are not transparent with what they do because they are trying to profit off somebody else's claim.”
As the lawsuit lending industry has expanded, there have been a number of cases where litigation funders target consumers who are already entitled to fixed compensation after litigation ends and a settlement is reached.
The Consumer Financial Protection Bureau (CFPB) and the New York Attorney General highlighted this issue in the case of the September 11 Victim Compensation Fund and NFL Concussion Litigation Class Settlement. It noted in some examples effective interest rates exceeded 250%. In one case, a severely disabled 9/11 first responder received an advance of US$35,000 but was expected to pay a financier US$63,636 or US$28,636 over the advance when he was compensated.
Whittle said: “In many instances, very little is known certainly in an aggregate or a data driven way. There are, many anecdotal examples of the abusiveness litigation financing. The whole practice is built in a way to avoid what are the customary regulatory systems that apply to certainly consumer lending and even business lending to a certain extent.”
Whittle pointed out that the litigation finance industry first began in earnest in Australia and then the concept was adopted in the US, Canada, the UK and the EU. According to Swiss Re, in 2020 more than half of the $17 billion investment for litigation funding globally was deployed in the US.
Litigation finance is a relatively new concept in the US compared to the UK where the litigation finance industry has developed significantly.
In April 2018 the European Commission proposed a legislative package that aimed to enhancing the protections generally afforded to consumers in the EU, which included the proposal of the "Directive of the European Parliament and of the Council on representative actions for the protection of the collective interests of consumers."
A report by global law firm Kennedys that looked at the directive, which entered into force in 2020, in more detail stated: “The directive is designed to promote access to justice for citizens and companies but without the perceived excesses of US-style class actions, and is shaped around the increasingly digitalised consumer market, covering areas such as data protection, financial services, travel and tourism, energy and telecommunications.”
Calls for Greater Transparency
Reville points out that giving consumers more access to financing is not necessarily harming consumers, but it’s the transparency of the process that is a problem. He said: “It is not automatically true that more financing available to sue companies that harm customers or the public will hurt consumers.
"The largest issue with TPLF is that it is not disclosed in litigation. Disclosure of litigation investments would provide greater transparency to juries and to the public. In addition, reforms to promote better science used by courts, and other appropriate tort reforms, may be necessary to avoid excesses.”
“We believe that the insurance industry will rise to this challenge, much as they have risen to the challenge of increased property catastrophe risks. We expect to see innovative new insurance products, and we expect reinsurance to play a more critical role to spread casualty risks.
Holzehu agrees with his sentiment. He said: “The important message is that there are unintended consequences for consumers. We are not arguing against litigation funding. It's well established and the concept is widely used in other countries like the UK and Australia. We are asking here for transparency for the sake of the proceeds of each trial, but then also so policymakers or industry analysts can assess what is actually happening.
"There is a huge risk of predatory lending to societies or families, individuals in distress – they are in vulnerable position financially. We advocate for more regulation to protect the users of litigation funding."
We believe that the insurance industry will rise to this challenge, much as they have risen to the challenge of increased property catastrophe risks.
Swiss Re projects that TPLF could be a US$30 billion industry by 2028, less than ten years from now.
The industry is working towards educating and protecting consumers against social inflation. For example, the APCIA is educating public policy decision makers and the general public on this practice and its impact on businesses and consumers.
Whittle said: “We are educating people on this practice. We want them to understand what goes on with these arrangements – where financiers have relationships with doctors or lawyers and they are all steering business to one another."
Whittle highlighted local jurisdictions are adopting disclosure obligations. He said: "New Jersey and California have obligations directly related to litigation finance. Many US appellate courts have obligations that any enterprise that has a financial interest in the outcome of litigation has to be disclosed.
"There is a similar obligation in many of the US district courts as well. A law has passed on this in West Virginia and Wisconsin. And we have a number where legislation is pending. So we are starting to make good progress.”
He added: “The US Department of Justice is now inquiring about this practice in litigation. We are starting to see progress and people understand inherently what happens to a claim if you bring in a third party that wants to make money.
“We now have legislation requiring disclosure of these practices requiring limitations on self-dealing, requiring a variety of consumer protections.
He added: "Reputable financiers should not care — if this is a legitimate practice, even a positive one, like they say, what are they hiding from? As there is so much money being made in this space the financiers are fighting incredibly hard to embed this practice in US civil service statutes.”