Do we need regulation in litigation finance?

May 3, 2022

Do we need regulation in litigation finance?

Litigation funding is a hybrid between law and finance. As the legal part is formalized, even the finance industry has different views on the topic of regulation. Financial markets are regulated, however, commercial lending is unregulated, and banks generally do not owe borrowers a duty of care. As the litigation finance market grows, it will increasingly be targeted by regulators, but it would not be easy to establish rules. Is regulation really a remedy for all difficulties in litigation finance?

Clear rules and sanctions are required to effectively supervise the markets and prevent any misconduct. As described by Jacek Dybinski, a researcher at the Max Planck Institute for Procedural Law in Luxemburg: “There is a long history of failures in the markets and nowadays they are developing quicker than ever. Regulators are always a few steps behind the market, however, people can really lose money and as a consequence their faith in the system’, he stresses.

As the litigation funding market grows, it will increasingly be targeted by regulators, but it would not be easy to establish rules.

There are more specialist litigation finance firms in the UK than in any other country. Reportedly, the litigation finance market in the UK has doubled in the last two years. Society wants its financial sector to be accountable, and there is growing concern that national regulators may not be able to prevent financial scandals.

Without lawyers willing to take cases on a pure contingency basis – something English lawyers have traditionally shied away from, unlike their U.S. counterparts – litigation funding may be the only way some cases see the light of day. Would a class action even have happened without funding? Would class action reforms have even been considered in 2015 if it had not been assumed that litigation funding would be available?

Even in jurisdictions where litigation funding has traditionally been prohibited, there are signs of change as funding is now often available for arbitration or bankruptcy proceedings. It is certainly only a matter of time before all major litigation markets allow litigation financing in one form or another.

The financing market has also evolved significantly in recent years. It has evolved from the traditional scenario of funding one-off cases that the plaintiff could not otherwise afford, to more creative models. Litigation financiers began funding portfolios of cases as early as 2016, and more recently there has been an increase in the links between financiers and law firms.

Regulation of the litigation finance market-or the lack of any regulation-has always been an issue for critics of the system. In 2017, the government ruled out regulating the litigation finance market, saying it was “still at a relatively early stage of its development.” Given what has happened in the market since then and what is likely to happen in the next few years, regulation may be inevitable.

In England, litigation funders are not currently regulated directly. While some litigation funders are authorised by the Financial Conduct Authority (FCA) in relation to some of their activities, their core business is not regulated. There are, however, a number of indirect forms of control over litigation funders:

Numerous funders are members of the Association of Litigation Funders (ALF). The Association of Litigation Funders’ Code of Conduct ( ALF) provides for adequate capitalization of members, sets requirements for termination and approval of settlements, and reaffirms the rule that litigation funders may not control litigation. Internationally, there is the International Legal Finance Association, based in Washington DC, which has similar goals.

Solicitors are, of course, regulated by the SRA, including in relation to their dealings with litigation funders on behalf of their clients. They must act in the best interests of their client and not in the interests of the litigation funder. Lawyers are also now accustomed to asking litigation funders the right questions when it comes to securing funding.

Litigation funders are also subject to some scrutiny by the court, monitoring rules against litigation funders that control litigation and reserving discretion to order litigation funders to post collateral for costs.

There has been a healthy debate about whether these voluntary or indirect forms of regulation are sufficient or whether some form of mandatory regulation is needed.

While it is likely that some form of regulation will be introduced at some point in the future, there are several difficult questions that need to be addressed.

First, what should the regulations cover? The issues covered by the voluntary code ALF, such as capital adequacy and tightening the prohibition on funders controlling litigation, would probably not be very controversial, but there is the question of what real protection such regulation will provide to consumers beyond current practise.

Regulation of portfolio finance and the new breed of “in-house” litigators would be much more difficult if it is to go beyond the general rules governing the conduct of lawyers, especially if these firms are also listed on the stock exchange. There is also the international aspect – would the U.K. rules apply only to U.K.-based funders, or to all litigation in the English courts, regardless of where the funder is based?

Second, who will regulate the litigation funding market? It does not fit within the jurisdiction of either the FCA or the SRA, but overlaps with both. Even given the growth of the industry in recent years, it is doubtful that there is a willingness to set up an entirely new regulator that brings its own practical problems.

These are difficult issues that will need to be addressed when the government considers that the litigation finance market is sufficiently mature to consider regulation. Nevertheless, it will only bring transparency and benefits for the customers and the industry itself.

May 3, 2022