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In late 2022, the US Government Accountability Office (GAO) released a report titled Third-Party Litigation Financing: Market Characteristics, Data and Trends. The Congressional Investigative Division defined third-party litigation funding or funding (TPLF) as “an arrangement whereby a funder who is not a party to the litigation agrees to assist in the funding,” and considered the multibillion-dollar global Industry of concern to insurers and some legislators.
Summarizing emerging trends, challenges for market participants and the regulatory landscape, the GAO results primarily focus on the years between 2017 and 2021.
Why a regulatory lens is important for TPLF
The agency conducted this investigation to examine gaps in public information about industry practices and to address concerns about transparency and disclosure. Three members of the Republican Congress – Sen. Chuck Grassley (IA), Rep. Andy Barr (KY) and Rep. Darrell Issa (CA) – led the call for this venture.
However, because GAO is intended to serve the entire Congress, it is expected to be independent and impartial in its work. While insurers, TPLF insiders, and other stakeholders, including Triple-I, have researched the industry (as far as research into such a secretive industry is possible), the lawmaker-based agency is well-placed to apply a regulatory perspective.
The reporting methodology included several components, many of which other researchers have applied, such as: B. the analysis of publicly available industry data, reviews of existing grants, laws and court decisions. GAO investigated this further by convening a roundtable of 12 experts “chosen to represent, among other things, a mix of reviews and professional fields” and interviewed with litigation funders and industry stakeholders. Still, like researchers before them, GAO has faced a lack of public data on the industry.
Procedures for third-party litigation funding differ between consumer and commercial markets. Consumer cases are comparatively smaller loan amounts. The type of clients, use of funds and financial arrangements may also vary within each market.
While most published discussions of TPLF focus on TPLF going to plaintiffs, as public data indicates this to be the norm, GAO’s findings show that 1) lenders can fund defendants in certain scenarios, and 2) attorneys can use TPLF to to support their defense work and plaintiff clients.
How the lack of transparency in TPLF can create risks
Overall, TPLF is classified as a non-recourse loan because the loan does not have to be repaid if the financed party loses litigation or does not receive financial settlement. If the financed party wins the case or receives a financial settlement, the benefit comes from a relatively high interest payment or agreed-upon value over the original loan. So financial strategy boils down to someone betting on the outcome of a lawsuit or litigation with the express intention of making a hefty profit.
For some deals, those returns can soar as high as 220% — depending on financial arrangements — with most reports putting average interest rates at 25 to 30 percent (vs. the S&P 500’s average return of 10.15 percent since 1957). The New Times documented that the TPLF industry rakes in up to 33 percent of some of society’s most vulnerable wrongfully incarcerated.
Normally, this speculative investor has no connection to the civil litigation and would therefore not otherwise be involved in the case. However, the court and the other party to the litigation are usually unaware of the investment or even the existence of such an agreement. On the other hand, as the GAO report confirms, knowledge of the defendant’s insurance may be one of the main reasons third-party financiers decide to invest in the lawsuit. This imbalance in communication and the general lack of transparency worries TPLF critics. GAO collected information that highlighted some potential concerns.
Funded beneficiaries may stand up to greater comparisons simply because the lender’s fee (usually the loan repayment plus high interest) eats up the beneficiary’s share of the settlement. Attorneys receiving TPLF may be more willing to prolong litigation than they would have – perhaps out of dedication to a weak cause or a desire to try new legal tactics – if they had to bear their own costs .
Notwithstanding, the court, the defendant, and the defendant’s insurer would not normally be aware of the factors behind such costly delays, and would be unable to respond proactively. However, insurance customers would ultimately pay the price via higher rates or lack of access to affordable insurance if an insurer left the local market.
As the report acknowledges, a lack of transparency can also lead to other problems. If the court is not aware of a TPLF agreement, potential conflicts of interest cannot be identified and monitored. Some critics calling for transparency have cited potential risks to national security, such as: B. the possibility of funders backed by foreign governments using the funding relationship to strategically influence the outcomes of litigation, or co-opting the discovery process for access to intellectual property information that would otherwise be best preserved for reasons of keep national security out of their sight.
Calls for TPLF legislation
GAO’s findings from its comparative study of international markets show that the industry operates globally, essentially without much regulation. The report notes that while TPLF is not specifically regulated by US federal law, some aspects of the industry and lendership may fall under the purview of the SEC, particularly where lenders have registered securities on a national securities exchange. Some states have enacted laws governing the interest charged to consumers and, more rarely, in prescribed circumstances, require some level of TPLF disclosure.
Active, visible calls from elected officials for regulatory action toward transparency come primarily from Republicans, though from various levels of government. Sen. Grassley and Rep. Issa have attempted to introduce legislation, the Litigation Funding Transparency Act of 2021, that would mandate mandatory disclosure of funding agreements in federal class action lawsuits and in state multi-district litigation. In December 2022, Georgia Attorney General Chris Carr led a coalition of 14 attorney generals who issued a written appeal to the Justice Department and Attorney General Merrick Garland.
“By funding lawsuits that target specific sectors or companies, foreign adversaries could arm our courts to effectively undermine our nation’s interests,” Carr said.
Triple-I continues to explore social inflation and we examine TPLF as a potential driver of insurance costs. To learn more about third-party financing of litigation and its impact on access to affordable insurance, read Triple-I’s white paper, What is third-party financing of litigation and how it affects the prices and affordability of insurance out?