US litigation funding and social inflation: the rising costs of legal liability

Third-party litigation funding is a fast-growing global industry, but we believe it can have potentially harmful economic and ethical consequences.

The US is the centre of the world’s third-party litigation finance (TPLF) industry, in which investors such as hedge funds and family offices finance legal action against companies. Of the USD 17 billion investment into litigation funding globally in 2020, more than half was deployed in the US. Litigation funding companies (LFCs) invest in consumer and commercial litigation by funding legal action in return for a percentage of a successful claim sum.

We see TPLF as a contributor to social inflation in the US, by incentivising litigants to initiate and prolong lawsuits. Higher claims costs drive up insurance premiums, can reduce the availability of liability cover, and lead to higher uninsured legal liability risks for US businesses. These costs are ultimately paid by consumers.
 
Our research finds that TPLF contributes to higher awards, longer cases and greater legal expenses. Longer cases increase claim costs, on average, due to higher legal expenses and compound interest on the litigation finance. TPLF also diverts a greater share of legal awards to the funder rather than the plaintiff. The result is an opaque, bottom-up wealth transfer from consumers to sophisticated investors and law firms.

 TPLF investments have produced internal rates of return (IRR) from 25% upward in recent years, outperforming even risky asset classes such as venture capital. Profit-seeking funders can create conflicts of interest and agency problems in attorney-client relationships. There are also major concerns about predatory lending, especially in the lightly regulated consumer segment.
 
We are concerned that TPLF is an expensive and blunt tool to enable legal disputes, with potentially harmful economic and ethical consequences, particularly when used by vulnerable individuals. Greater protection for consumers is required, as well as better regulation of the industry and more transparency about the involvement of TPLF in a case.

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The rising costs of legal liability

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