Your factory is flooded and manufacturing line destroyed. A hacker breaks into your computer system and erases customer data even though you paid the ₿1,000 ransom in bitcoins. A jury just returned a $5 million verdict against your company and an employee who got into an accident while texting and driving to a client meeting. These may all be insured events, but how long can your business survive while you wait until your insurance company decides whether to pay your claim?
You need to get your business back up and running immediately. You need funds in your account sooner rather than later. From seemingly endless requests for information and complex proof of loss forms, to assertions that numerous insurer-drafted exclusions limit coverage, many policyholders find themselves facing an uphill, lengthy and costly battle to get their claims paid. It can sometimes be weeks, months or even years before a claim is fully paid—if ever.
Insurers have a financial incentive to prolong the time before paying out on a covered claim. They profit by investing premium revenue, and profit more the longer they hold onto your money. In 2018, for instance, Warren Buffett’s Berkshire Hathaway reportedly earned investment income on over $122 billion it maintained in such insurance operations “float.” Although insurers cannot control when a loss will occur, they can control how quickly they pay the claim. For very large claims, investment income off the float often exceeds the costs insurers incur in prolonging or litigating a coverage payout.
Litigation funding, however, is a rapidly growing tool that policyholders might consider adding to their arsenal to help level the playing field against an insurer that is incentivized to delay paying claims.
What is litigation funding?
At its core, litigation funding involves an upfront payment by a third-party investor in exchange for a share in the claimant’s ultimate recovery on a claim. Typically, a portion of the investor’s funds are reserved for paying legal fees and other expenses necessary to pursue the claim. The policyholder is then free to deploy the remaining capital however it sees fit—either toward restoring its business to pre-loss conditions, or by investing in other new opportunities. Funding arrangements are typically structured as a non-recourse loan—meaning the investor recovers nothing if the claim is ultimately not successful.
Is litigation funding permissible?
Litigation funding has been gaining wider acceptance in the United States, although care must still be taken to ensure that a particular arrangement complies with applicable state laws and allows the policyholder’s attorney to meet ethical rules.
Historically, third parties were prohibited from supporting someone else’s legal dispute—a response to the practice of wealthy barons in medieval England who would buy or support frivolous legal claims to harass their enemies. In many jurisdictions, attorney ethical rules and modern remedies of abuse of process or malicious prosecution are considered sufficient to address concerns about frivolous litigation. Thus, many jurisdictions recognize litigation funding as a permissible practice. There are still a few jurisdictions, however, where third-party funding of litigation may be prohibited or invalid. Courts in Minnesota, Ohio and Pennsylvania have recently invalidated litigation finance agreements. Alabama courts have held that litigation finance agreements are akin to gambling and void as a matter of public policy. And Kentucky has a statute that expressly voids litigation finance contracts.
Finally, policyholders will want to confirm that assignment of their right to receive insurance proceeds is allowed under the terms of the policy. Although insurance policies often contain anti-assignment clauses that may seem to preclude such a transaction, most jurisdictions have held that such clauses apply only to assignments that take place before a loss—and that post-loss assignments are still permissible. In these jurisdictions, a policyholder’s post-loss claim is viewed as a form of personal property—a “chose in action” (similar to an endorsed check)—that remains freely assignable, regardless of what the policy says.
What are some downsides to litigation funding?
First, litigation funding may not be the most cost-effective option. If your claim is successful, you are giving up a share of your total net recovery in exchange for the funding and some risk mitigation.
Second, communications with a litigation funder might be discoverable. Although some courts have held that communications with a funder are protected by the attorney work-product doctrine, many jurisdictions have not squarely addressed the issue. At a minimum, a nondisclosure agreement should be in place before sharing confidential information with potential funders, and the nature and extent of information shared should remain limited.
Finally, the policyholder’s and funder’s interests could diverge. While some funders allow the client to retain sole control over litigation strategy and settlement decisions, that may not always be the case. And disputes might arise if resolution of the claim includes non-monetary considerations.
While litigation funding is not right for everyone or every claim, it’s another tool policyholders can use to level the playing field against an insurer.