Litigants without the necessary resources or desire to spend them may turn to a third party to finance their case. This third party contributes to the litigants’ legal fund in exchange for a share of the proceeds from the litigation.
This concept of “third-party litigation finance” generates disagreements amongst legal academics. One of the common complaints amongst its detractors is the potential for third-party litigation to exacerbate “agency costs” – internal costs that accrue when the interests of agents conflict with those of principals. In this particular circumstance, agency costs might arise if the financier were to meddle in the relationship between lawyer and litigant, perhaps for the sake of saving money.
A new paper co-authored by Vanderbilt Law Professor Brian Fitzpatrick and William Marra, Director of Litigation Finance at Certum Group, argues that this concern is unfounded. They begin by noting the ethical duties requiring lawyers to put their clients’ interests before a third party’s.
“Critics say this duty might be violated through explicit collusion or at least undermined by the invisible hand of the incentives of lawyers who repeatedly work (or want to work) on cases with the same financier. We argue here that this story gets things backwards,” the authors write.
The authors modeled common financing arrangements based on time to resolution, demonstrating that the most frequently agreed-upon arrangements seek to align the interests of financier, lawyer, and litigant, even if the alignment isn’t perfect.
Through this exercise, the paper uncovers a “beneficial, if not entirely surprising, side effect on the litigant-lawyer relationship”: the use of a hybrid payment formula, wherein lawyers collect an hourly fee in addition to a contingent percentage. This formula mitigates rather than exacerbates potential agency costs.
“The genius of this formula,” the authors explain, “is that it pits the hourly fees and contingent percentages against one another to improve upon them both: the percentage component of the formula incentivizes the lawyer to care about the magnitude and speed of the recovery, while the hourly component mitigates the incentive to settle prematurely.”
The introduction of this model in third-party financing scenarios creates stronger alignment between lawyer and litigant, to a degree that the authors believe explains the popularity of the third-party financing option.
“We believe one reason why financing has become so popular with litigants is because financiers are able to induce their lawyers to accept this hybrid compensation,” the authors conclude.
“Agency Costs in Third-Party Litigation Finance Reconsidered,” by Brian Fitzpatrick and William Marra, is part of the Vanderbilt University Law School Legal Studies Research Paper Series, Working Paper Number 23-45.