The Siren Song of Litigation Funding

Abstract

For an investor, litigation funding is too tempting to resist. Litigation funding promises that most elusive of investment returns: those uncorrelated with an investor’s other investment returns. Litigation funding also invests in a world that seems fraught with possible pricing inefficiencies. It seems plausible—even likely—that a team of smart lawyer-underwriters can identify high-value litigation investments to generate superior returns for litigation funding investors. But more than a decade of experience suggests the promise of litigation funding is a siren song. The promise draws investors into the water, but the payoffs may be meager and rare. While litigation funding has always been controversial with defendants and business trade associations, the real problem is that the investment class is a poor one. First, high-stakes civil litigation is far more complex and random than most investors understand. There are an overwhelming number of ways that litigants can lose and far fewer paths to significant victories. Second, few good cases—from an investment perspective—are likely to find their way to funders. Third, litigation funding is probably prone to optimism bias, causing litigation funders to overestimate the probability of victory in their cases. Finally, litigation funding is fungible with little value added by the funder, suggesting that competition will drive down any significant previously-existing profits. While litigation funding serves a valuable social purpose when it finances meritorious cases that otherwise would not be pursued, we can expect investor success in the field to be rare and likely limited to those funders with the most litigation savvy and the best luck. Nevertheless, investors are unlikely to give up on the space despite the large prospect of poor returns.