When Hedge Funds Bet on Lawsuits, Society Loses
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When you think of “investments,” stocks, bonds, commodities, and real estate come to mind. What doesn’t are lawsuits, but that’s the new fad among some hedge funds and other investment firms. In a column appearing in The Atlantic, Lisa Rickard, President of the U.S. Chamber’s Institute for Legal Reform, looks at the unseemly practice of third-party litigation financing (TPLF)--betting on lawsuits.
She explains what TPLF is:
In essence, TPLF is the practice of hedge funds and other investment firms providing funds to plaintiffs' lawyers in order to conduct litigation. If the case is won in court or settled, the investor is repaid out of the proceeds of the lawsuit, usually with an extremely high rate of return. The investors, therefore, have a direct stake in the outcome of the case.
By betting on lawsuits, investors--and I’m using the term loosely--distort the incentives of plaintiff lawyers more than a figure in a Salvador Dali painting. Rickard explains [emphasis mine]:
For instance, the contracts often provide for "waterfall" payouts -- meaning that the TPLF investors take a higher percentage of the first dollars of settlement, while the plaintiff's share only rises as the total settlement figure reaches an amount pre-set by the investors. Thus, plaintiffs are pressured to hold out for settlements or judgments far above what they would have accepted otherwise in order to satisfy their investors. And defendants suffer as well, since they are forced to contend with longer and costlier litigation. This scenario stands the justice system on its head by putting the investor in the driver's seat while hurting the primary parties in the case.
TPLF also mangles the attorney-client relationship:
Lawyer Ethics 101 states that lawyers have a fiduciary duty to their clients. But this fundamental relationship is jeopardized when a third-party funder enters the picture. For one thing, when TPLF investors get involved in a case, they often front the plaintiffs' attorneys' fees. So when an attorney is managing a case, will they act in the best interests of their client, as they are supposed to do, or in the interests of the third-party funder paying their salary?
Litigants end up spending more time and money in court trying to maximize the investor's return on investment instead of seeking justice. TPLF investors and their trial lawyer friends roll the bones for a big jackpot while the rest of society feels like they’re on the bad end of some loaded dice.