What if litigation funding reduces litigation?

The House Committee on Oversight and Accountability held a hearing earlier this month on litigation funding, which is the practice where a third party finances the legal expenses or other capital needs of litigants in exchange for a share of case proceeds.

Rep. James Comer (R-Ky.), the committee’s chairman, acknowledged that “the complexity and expense” of modern litigation means that for some, “litigation funding is necessary to enable them to pursue justice through the legal system.” Professor Maya Steinitz, the lead witness and a thoughtful commentator on litigation funding, similarly testified that litigation funding “is an important service that can provide access to justice to parties that cannot afford to bring their disputes to court.”

But Comer, Steinitz, and others also expressed concern that litigation funders might clog the courts with “frivolous” litigation, charge customers excessively high prices, and protract litigation, driving up litigation spend and increasing the cost of legal services.

The same day as the hearing, an opinion article in these pages similarly suggested that litigation funding might cause “excessive litigation and waste of limited judicial resources.”

These are common criticisms of litigation funding. But recent scholarship allays these concerns, demonstrating that funding is more likely to expedite case resolution, reduce litigation spend, lower the cost of legal services, and deter frivolous lawsuits.

Some participants at last week’s hearing suggested funding might lead to prolonged, more expensive litigation. For example, Professor Steinitz testified that third party funding “may [ ] protract litigation, driving up defendant’s costs.”

But the opposite is likely true, as demonstrated by a recent paper by Harvard and Stanford business professors published in the prominent Journal of Financial Economics.

Professors Samuel Antill and Steven Grenadier presented a game theoretic model that found litigation financing may actually “expedite lawsuits and deter defendant spending.”

Instead of increasing defense spending, they found funding is more likely to “deter[ ] wasteful bullying” and discourage defendants from incurring “large litigation costs simply to secure negotiating advantages over an underfinanced plaintiff.” Rather than prolong litigation, funding can actually “expedit[e] the resolution of lawsuits,” as defendants settle weak claims rather than grind down their adversaries in motion practice and other dilatory litigation tactics.

Comer and others expressed the related concern that funders might increase the cost of legal representation by charging claimholders excessively high fees, harming litigants and delaying settlement.

In reality, litigation funding is more likely to reduce the cost of legal services, by introducing additional competition into that market for legal services. And the increase in the number of litigation funders over the past decade has no doubt increased price competition and lowered cost for those in need of litigation funding.

No surprise then that Arizona’s state supreme court actually eliminated the ban on non-lawyer ownership of law firms, welcoming third-party financing into the state, for the stated purpose of increasing innovation and driving down the cost of legal services.

As for the familiar refrain that litigation funding clogs courts with frivolous litigation, recent scholarship rejects this notion too.

Antill and Grenadier showed that “litigation financing does not necessarily encourage high-risk frivolous lawsuits.” They even concluded that funding “can encourage lawsuits that are less frivolous than existing lawsuits.”

Unsurprising, since funders that back frivolous lawsuits will quickly go out of business.

Their findings are consistent with a paper we published in the Vanderbilt Law Reviewshowing that litigation funding likely results in a net increase in welfare.

We demonstrated that funding should reduce litigation costs and screen out frivolous litigation, because defendants are more likely to settle when they know the plaintiff is well-financed, and because funders’ refusal to finance weak cases will deter litigants from self-financing those cases in the alternative.

Antill and Grenadier explicitly excluded from their analysis how litigation funding might impact “the defendant’s ex-ante actions that lead to litigation.” Our paper studied these ex-ante effects, concluding that litigation funding likely deters defendants from breaching their contracts with impecunious counterparties, and thus can lead to increased compliance with the law and fewer legal disputes.

Our paper and Antill and Grenadier reach similar conclusions by focusing on different parts of the litigation process.

Policymakers should consider these arguments as they weigh regulation of an industry that levels the playing field and gives many litigants better access to the courts.

Suneal Bedi is an assistant professor of business law and ethics at Indiana University’s Kelley School of Business. William C. Marra is a director of litigation funding at Certum Group, a provider of litigation funding and legal insurance solutions.