Investing in Lawsuits
Should It Be Allowed?

March, 2014

Champerty is the practice of investing in a lawsuit. At one time it was made illegal or was highly restricted in England and the United States, but it has been making a comeback as the laws change step-by-step. Technically the U.S. practice of attorneys working for a percentage-based contingency fee can be called champerty. This is because the attorney (or his firm) is essentially financing the case in exchange for a variable return. They are betting on a big settlement or large damage amount awarded by the court or jury.

Contingency fees in other countries are not always like this. In fact, the U.S.-style contingency fees were first allowed in England about a year ago. More common is the "pay if you win" model, where a set fee or hourly rate is paid the attorney only if he wins the case.

But the system here has developed well beyond just having law firms carry the cost of litigation for plaintiffs. Now there are companies that loan the money to the law firm or plaintiff in order to finance a lawsuit. Of course they get paid well if the lawsuit succeeds.

The reason that champerty was originally outlawed is that it had a tendency to corrupt the legal process. Two hundred years ago in England, for example, a man with a weak lawsuit might go to a well-known and powerful political figure or baron and ask for him to invest. The assumption was that juries and judges would be more inclined to side with the plaintiff's side when the powerful person was joined to the lawsuit in this way. In other words, verdicts were being bought by powerful people who then made a nice return on their investments. The practice was outlawed to prevent abuses like this.

Times change, and the law started to change again. The biggest change was facilitated by
Supreme Court decisions in the 1960s which held that civil rights organizations had the right to further their aims by investing in relevant lawsuits. Poor workers, for example, who might be wronged by a large employer because of their race, might not have the money to sue. But a civil rights group could step in and finance the case, taking a percentage of the proceeds to cover their costs and perhaps bolster their bank accounts.

Now that ability to invest in lawsuits has gone even further. Many states have reduced restrictions and allow companies to invest in lawsuits. Most of the instances where this is done are legal liability suits, or what are called "slip and fall" cases. Companies make loans to plaintiffs' attorneys and typically charge interest rates of 20% or more. Several large outfits are getting into the game now, and are making loans totaling tens of millions of dollars annually.

It is speculated that as the industry grows, it will provide funding for lawsuits which would not have otherwise happened. A recent article in Bloomberg Businessweek reports on one case where a company invested $6 million in a breach-of-contract lawsuit. The plaintiff, a real estate developer, paid the investor $18 million when the case was concluded. With returns like that, champerty might cause a growth in lawsuits in the coming years.

It is possible that these changes are encouraging frivolous lawsuits. But some proponents of the changes suggest that investors are likely to invest only in lawsuits with valid claims, since they can lose a lot when a case fails. In fact, the Business Week article also reported on the millions of dollars in financing provided in 2010 to keep the lawsuit against Chevron alive. The suit was being pursued on behalf of indigenous groups in Ecuador, and may not have gone forward without the money provided. About a year later the judge awarded the plaintiffs $18.2 billion dollars (the award is still being contested).

Allowing investing in lawsuit creates some problems perhaps, but it also means the little guy might have a chance against the big guy.

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