Are litigation hedge funds a problem?

The NYT discusses hedge fund litigation financing. The chief executive of a leader in the field, Juridica, crows that “[i]t’s always a good time to invest in litigation.” Juridica is up 24% since December 2007. Is this a bright spot in an otherwise murky investment environment.  If so, is it a problem?  

Walter Olson objects that “this innovation will, of course, encourage the filing of more litigation,” and squirms at a remark by Brooklyn’s Anthony Sebok that this financing will make "funding available for cases that are good cases, cases that from a God's-eye point of view, so to speak, should've been brought." Olson adds:

Don't you love that "God's-eye" wording, with its premise that God wants us to bring lawsuits when we have legal grounds to do so, and is disappointed when we instead decide to forgive, or shy away from the process for fear of hurting someone, or just want to get on with our lives?

So the basic question is whether funding litigation is like feeding pigeons.

The Times of London discussed this development when Juridica was launched in December 2007 and I discuss it in my draft paper on the evolution of law firms as an example of the move toward outside financing of law practice. I had also earlier discussed on this blog nonrecourse financing of litigators.

Litigation financing can be viewed as simply another way for the capital markets to help firms exploit productive assets. Of course there are special problems relating to outsiders stirring up claims by simply funding actions by others (maintenance), particularly where the investor gets some of the proceeds (champerty) or the claims are groundless (barratry).  Also, confidentiality and privilege rules may forbid disclosure of litigation information to outside funders, making these particularly difficult investments. The basic problem, as discussed in my earlier blog post, is that "it turns litigation into a business rather than the search for corrective justice."

With respect to the excessive litigation point, it's worth noting that the hedge funds aren't financing the most abusive types of strike suits. These aren’t consumer class actions, but b2b litigation. For example, the NY Times article discusses a case by isp WaKuL against Ericsson for breach of contract. WaKuL won $3 million in arbitration and was able to use outside financing to fight off a challenge by Ericsson. The article says that the hedge funds focus on readily valued claims, and avoid jury cases or novel issues.

On the other hand, the financing discussed in my earlier blog post and an AmLaw article did support tort class actions. Anthony Sebok, who was also quoted in the NYT article, told AmLaw the loans were a "a safety valve for tort reform."

For yet another approach to litigation funding, see the discussion in this article with Kobayashi of “dumping and suing,” where the lawyer in a securities or derivative suit in effect capitalizes the lawsuit by selling short the corporation that is the subject of the suit and then buying back after the suit is announced.

So what should we think of all this?  it’s important to keep in mind that, like it or not, litigation is a legitimate business. Like other basically legitimate businesses, it can turn bad. The question is whether the problems should be addressed directly by rules constraining improper litigation practices or indirectly by constraining firms’ ability to pursue the litigation.

I would opt for the former. Consider that, as discussed in my recent draft and earlier blog post, the current system clearly permits financing of litigation by lawyers via contingency fees. We have seen, e.g., with Milberg, how the reality of lawyer financing clashes with rules based on the pretense of client control of litigation to produce abuse (see my paper with Kobayashi on that).  I'm not sure outside litigation financing produces worse results.

The NYT article tells us that Juridica focuses on steady cash flows – that is, fairly solid claims whose results can be predicted – rather than novel theories or jury cases. Outside financing of cases like WaKuL's permits exploitation of claims the system has decided clearly should be brought (like Mr. Olson, I’m not sure about God, though). Indeed, financing this b2b litigation arguably helps the law deter socially inefficient opportunism.

Moreover, as discussed in my draft and blog post, there are other potential benefits of outside litigation financing.  Litigation funders could provide expertise and investigation that increases litigation's accuracy and deterrence value. This funding also helps eliminate the potential conflict of interest between a corporate client with diversified investors and a risk-averse lawyer who may have an incentive to settle cases that could be productively litigated.

To some extent, particularly outside the b2b context, outside litigation financing might increase the amount of socially inefficient litigation.  But even in those cases there is a question whether this financing increases the quality of such litigation as compared with a world without outside financing.

Given these many uncertainties about the costs and benefits of litigation financing, I would prefer to to go slow in regulating it, focusing instead on fixing abuses inherent in the underlying litigation.

Comments

[Max Kennerly]

"To some extent, particularly outside the b2b context, outside litigation financing might increase the amount of socially inefficient litigation."

You're right: when a consumer or injured person files a lawsuit, it's a frivolous attempt to capitalize on jackpot justice, but when a business files a lawsuit, it's an appropriate exercise of their legal rights.

There's no shortage of patent, copyright, antitrust and securities regulation defense attorneys willing to opine that those "b2b" areas are as ripe with abuse as any other legal field. Do you have any basis for your elevated concern about non-b2b suits?

[Larry Ribstein]

I did not make the statements you attribute to me in your second paragraph.

In answer to the question in your third paragraph: Yes.