Monday, December 13, 2010

Financing Lawsuits - A Sound Investment?

Readers of this blog may have seen two recent posts on financing of lawsuits here and here. But it would be wrong to say that this is a recent trend. In fact, the financing of lawsuits by third parties has been a growing trend that began even before the start of the current recession in 2008.

Take a look at this NY Times article from 2006 – Hedge Funds Find Returns in Making Small Loans. Investing in lawsuits appears to be a profitable holdover from the prerecession low interest rate bubble. Now that rates are even lower than they were in 2006 the investment is even more attractive. If you read through the 2006 article by Jenny Anderson and Julie Creswell, you will see that the return on one of the loans mentioned in the story is set at 30%.

From the investment point of view there is probably nothing wrong with businesses – hedge funds and the like – loaning money to parties where the lawsuit has already been filed. An independent evaluator of the suit (the attorney who took the case, investigated the facts, found the relevant experts, and made a judgment about the merits of the case) has taken the initial step in determining whether a suit will result in a favorable settlement or verdict. The attorney’s risk is the investors’ risk. Individual investors will probably not look closely at the actual merits of the case but will look to the attorney’s experience and win rate, and the awards in the relevant jurisdiction to make their own determination of the risks involved. But there will, inevitably, be frivolous cases that will be financed by these loans/investments. Will the investors be safe from sanctions? Will a whole new form of jurisprudence spring up to protect society from big-money lawsuits? Or, will we renew and revise the old common law crime of barratry?

A lawsuit is always an uncertain thing. Recovery can turn on a witness' change of story, the plaintiff's whim, a change in the underlying law, or an attorney's off day. There is no "sure thing" in law or litigation. But then, of course, there have always been people ready to bet on a long shot. That's like buying derivatives made from sub-prime mortgages.

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