The Litigation Finance Contract

Litigation funding—for-profit, nonrecourse funding of a litigation by a nonparty—is a new and rapidly developing industry. It has been described as one of the “biggest and most influential trends in civil justice” today by RAND, the New York Times, and others. Despite the importance and growth of the industry, there is a complete absence of information about or discussion of litigation finance contracting, even though all the promises and pitfalls of litigation funding stem from the relationships those contracts establish and organize. Further, the literature and case law pertaining to litigation funding have evolved from an analogy between litigation funding and contingency fees. Much of that literature and case law views both forms of dispute financing as ethically compromising exceptions to the champerty doctrine. On that view, such exceptions create the risks of an undesirable loss of client control over the case, of compromising a lawyer’s independent judgment, and of potential conflicts of interest between funders, lawyers, and clients. This Article breaks away from the contingency analogy and instead posits an analogy to venture capital (VC). It shows the striking resemblance of the economics of litigation funding with the wellunderstood economics of VC. Both are characterized by extreme (1) uncertainty, (2) information asymmetry, and (3) agency costs. After detailing the similarities and differences between these two types of financing, this Article discusses which contractual arrangements developed in the area of venture capitalism can be directly applied to litigation finance, which ones need to be adapted, and how such adaptation can be achieved. As much of the theory, doctrine, and practice of VC contracting can be applied or adapted to litigation finance, practitioners and scholars can be spared decades of trial and error in developing standardized contractual patterns. In addition, the analogy turns most of the conventional wisdom in the field on its head. This Article argues that funders should be viewed as real parties in interest, funders should obtain control over a funded litigation, and attorneys should take funders’ input into account. In return, funders should pay plaintiffs a premium for the control they receive, subject themselves to a compensation scheme that aligns their interests with those of the plaintiffs, and enhance the value of claims by providing noncash contributions. Indeed, on the suggested view, noncash contribution—as much as if not more than, capital contribution—should be seen as a key benefit of litigation finance. Courts and regulators should devise rules that enhance the transparency of the industry—in particular the performance outcomes of various litigation funding firms and their ethical propensities. Such a legal regime will foster the emergence of a reputation market that will police the industry and support contractual arrangements