October 29th, 2008

Litigation Financing Makes Plaintiff Pockets Deeper

Posted at 6:00 PM ET

Thomas Herde, Senior Vice President

The specter of American-style class action litigation looms large over Continental Europe. Many carriers worry that they could face larger claims—and increased legal fees—if this practice is adopted. Litigation financing is particularly daunting, as it provides a way to funnel capital to plaintiffs to support long, intense legal campaigns.

Through litigation financing, the risk of losing a case is commercialized. Investors provide the capital needed to advance the effort, giving plaintiffs access to vast resources that would be unavailable otherwise. Investors risk losing their initial capital if the plaintiffs are not successful. Also, the potential revenue stream from a settlement or verdict evaporates, and they could be liable for the defendants’ legal fees. On the other hand, the returns could be quite substantial, given the awards seen under the U.S. system.

This practice already exists in the United States, and the results have been understandably mixed. Used appropriately, litigation financing does make justice affordable for those in need of legal measures for redress. It also expedites class actions and may yield some legal pricing efficiency. But, the practice can also be abused. In the extreme, litigation financing could enable several long-shot lawsuits as a way to distribute risk. This could lead to economies of scale for plaintiffs that (re)insurers and other defendants would be unable to replicate.

Litigation financing is still in its infancy in Europe, but signs of development are evident. Typically, the funding source is entitled to participate in 20 percent to 30 percent of the proceeds (if the lawsuit is successful). Sometimes, the mechanism resembles an insurance contract against losses, though some schemes involve direct investments to pay for court costs, attorneys’ fees and expert reports throughout the case.

If U.S.-style class action laws are going to cross the Atlantic, it will take time for them to seep into the fragmented European legal culture. Nonetheless, litigation financing has arrived on the continent, facilitating large and costly plaintiff endeavors. But, the risk may contain its own remedy. Carriers may choose to invest in litigation financing in an effort to reduce their own potential losses by participating in them.
Guy Carpenter & Company, LLC provides this text for general information only. The information contained herein is based on sources we believe reliable, but we do not guarantee its accuracy, and it should be understood to be general insurance/reinsurance information only. Statements concerning, tax, accounting, legal or regulatory matters should be understood to be general observations based solely on our experience as reinsurance brokers and risk consultants, and may not be relied upon as tax, accounting, legal or regulatory advice which we are not authorized to provide.  All such matters should be reviewed with your own qualified advisors in these areas.

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