Can I have some high-risk unpredictability, please?

It seems entirely fitting that it was a corporate partner at a magic circle firm that brought the latest innovation in external litigation funding to Legal Week’s attention, rather than a litigator.

The initiative, as detailed in a news story this month, revolves around external investors taking positions in litigation. But rather than previous attempts to use funding to bank-roll claimants, it has been used by a handful of pioneering defendants.

Understandably, the idea gets some lawyers scratching their heads – and left one reader to wrongly conclude that we were referring to litigation buy-out insurance, which has been used in a small number of major disputes in the US.

The defendant model does function a little like insurance, though the motives of the external parties and dynamics of the arrangement are very different from dealing with an insurance company. The investor is likely to be a hedge fund or special situations fund looking to make high-risk investments. The investor gets a fee or premium and effectively offers to fund a substantial chunk of the defendants’ liability. The attraction for defendants is hedging and managing their exposure, despite higher upfront costs. And by introducing an outside investor that will look at a legal opinion to gauge the merits and risks of the claim, a company can effectively put a ‘market price’ on their litigation risk.

The latter point is one reason that the model has drawn the attention of corporate lawyers, since such a hedging tool would have obvious benefits to a company that wants to do a major corp-fin transaction and doesn’t want the uncertainty of litigation liabilities screwing it up. Stretching the concept further, external funders could in theory trade or sell their positions to other investors, a fact that makes the model operate more like a capital markets instrument than conventional after-the-event litigation insurance.

Will it catch on? Well, some of those working on and with third-party funding believe it has far more potential than conventional claimant funding. It can also likely count on considerable support from leading City law firms, which have converted to the third-party funding cause with remarkable speed despite initial controversy. Widespread support for the general outside funding model is also in contrast to previous experience of conditional fees and after-the-event insurance in personal injury, where claimant and defendant counsel often bitterly opposed each others’ tactics.

But ultimately, the fate of defendant funding will rest on whether there are enough alternative investors willing to back the concept. Given the walls of cash that some hedge funds assessing litigation reportedly have to spend, the revolution could come very quickly.

alex.novarese@legalweek.com