Third Party Financing and its Alternatives: An Economic Appraisal

Abstract

In this contribution we provide an economic approach to third party funding. We first explain why third party funding emerges. It can be considered as a remedy for the market failure that can occur in cases of so-called dispersed losses where rational apathy may occur, and also when individuals do not bring claims solely because they do not have sufficient funds. However, we argue that although TPF can help solve market failures, it can create also problems of its own. All the classic economic problems, such as the principal-agent problem, information and transaction costs may jeopardize the effectiveness of TPF. However, we argue that remedies can be designed to increase the effectiveness. We further compare TPF to other mechanisms that could equally cure the market failures, such as legal expenses insurance (LEI) and the transfer of claims. We also briefly compare TPF to contingency fee arrangements, although this is not the central focus of our contribution.