Third-Party Litigation Funding with Informative Signals: Equilibrium Characterization and the Effects of Admissibility

Abstract

Litigation funders provide nonrecourse loans to plaintiffs who repay these loans if and only if they prevail. The loan’s interest rate reflects the funder’s information about the strength of the plaintiff’s case. We analyze a monopoly and a two-firm Bertrand model. Bertrand competition does not eliminate funders’ profits or inefficiency. Making the funding contract admissible evidence enables the funder to increase its chance of recovery by reducing the interest rate to signal to the court that the plaintiff has a strong case. Under monopoly, there is only a separating equilibrium without admissible funding. With admissible funding, there is either a pooling equilibrium or a separating equilibrium, but either increases the joint welfare of plaintiffs and funders. Under Bertrand competition, admissible funding increases joint welfare if courts can make adverse inferences from the absence of funding contracts. Plaintiffs are generally better off under admissibility if they discount the future sufficiently.