Charting The Rise Of Legal Financing

Over the past decade, legal financing has evolved from a niche market into a significant industry, fueled by its growing popularity, innovative new players, and evolving regulatory frameworks. It has overcome initial hurdles and criticisms to become a vital strategic and financial tool for litigants and law firms. Currently, we are partnering with a leading legal finance company to fill a Head of Tax position in New York, making this an opportune moment to review the industry’s progress over the last 10 years since I last wrote about it. Further details about the job and application process can be found at the end of this article.

Legal financing initially rose out of necessity due to rules governing champerty and maintenance in the United States. The concept of champerty derives from ancient Greece and Rome and is defined as the splitting of fees between the litigating party and a nonparty who funds or supports the lawsuit. Maintenance, the second offense, is the interjection of a third party who wields undue influence on a case. The two are intertwined and were codified in English Common Law to prevent the English elite from furthering and profiting from the lawsuits of commoners by overwhelming the courts with their clout.

Despite early concerns that legal financing would encourage frivolous litigation, the reality has been significantly more favorable. By funding meritorious claims under a non-recourse model, where repayment is contingent on the case’s success, financing firms have introduced a rigorous evaluation process to select cases with a strong likelihood of success, generally requiring at least a 60% chance of winning. Biglaw itself has become a champion of the industry, with 35% of commitments originating from Biglaw firms in 2023, compared to 28% in 2022. 

The industry has outperformed even the most optimistic forecasts from 2019. With assets under management reaching $9.6 billion in 2019, projections anticipated growth to $15 billion by 2025 based on an 8.3% compound annual growth rate. Remarkably, this milestone was achieved by 2022, three years ahead of schedule. Although 2023 saw a plateau in overall industry growth, many companies continued to expand at a steady rate. This plateau is attributed to broader financial market trends rather than a decline in demand for legal financing services, and a slight reduction in the number of funding firms from 44 in 2022 to 39 2023.

The Federal Reserve’s interest rate hikes have undeniably impacted the broader economy, including the legal financing sector. Specific segments, particularly those dealing with lower-risk credit transactions or significant mass tort agreements, have felt the pressure of rising interest rates on deal feasibility and pricing. Notably, such agreements have experienced either an uptick in capital costs or the introduction of clauses designed to shield investors from future rate fluctuations.

However, the industry is poised for continued growth, driven by its attractiveness as an investment that offers potential counter-market benefits. Legal finance firms engage in the acquisition of claims against both solvent and insolvent entities, with the ultimate value of these claims being closely tied to the litigation outcomes — whether the company is the plaintiff or the defendant. The structure of traditional funding agreements usually incorporates a “waterfall” mechanism, which prioritizes the return on the initial capital investments. This prioritization ensures that the foundational risk associated with these investments is kept to a minimum. Once the initial capital has been recouped, profits are then shared between the funder and the law firm or plaintiff involved in the claim, with the financing party generally receiving a preferential share of the returns. This strategic approach to investment and profit distribution underscores the industry’s potential for growth, backed by a model that mitigates risk while maximizing returns.

Interest in legal funding has expanded beyond financial investments to encompass a growing professional engagement within the sector. The establishment of the International Legal Finance Association in 2020 marked a significant milestone, highlighting the industry’s concerted effort to champion its interests and foster a collaborative environment. Further demonstrating this trend, the inaugural LITFINCON event took place in 2022, attracting attorneys nationwide to Houston. These developments signify a deepening professional engagement, facilitating dialogue, and collaboration across the legal community. These platforms enhance the industry’s stature and cohesion, reflecting a commitment to collective advancement.

Towards the end of the 2010s, the insurance sector recognized a burgeoning demand for its offerings within the legal financing landscape, leading to the introduction of products like judgment preservation insurance aimed at safeguarding against decision reversals. This move highlights the insurance industry’s position as the more risk-averse segment within legal financing. As legal finance entities have progressively yielded this particular market space to insurance firms, a new equilibrium concerning market share distribution appears to have been established. This shift underscores the evolving dynamics between legal financing and insurance companies, reflecting a strategic realignment and mutual adaptation that benefits the broader legal and financial ecosystem.

Concerns that regulatory measures might hinder the growth of the legal financing industry have, to a large extent, been mitigated by the relatively narrow reach of judicial decisions impacting the sector. The enactment of S.B. 269 by Montana Governor Greg Gianforte exemplifies a push towards greater transparency within legal financing, mandating enhanced disclosure requirements for funders. Further regulatory efforts include standing orders issued by Chief U.S. District Judge Colm Connolly of the District of Delaware, focusing on third-party litigation funding and patent ownership. Despite these initiatives, some judges have deemed such disclosures irrelevant or have outright rejected these mandates, suggesting that the industry’s operational norms may remain largely unchanged. This landscape indicates a nuanced regulatory environment where efforts to increase transparency and oversight coexist with a judicial inclination to maintain existing practices.

As the legal financing industry continues to flourish, we at Lateral Link are excited to announce a unique opportunity that aligns with this dynamic sector’s growth. We are in search of a distinguished Head of Tax for a leading legal finance company based in New York. This role represents a chance to join an organization at the forefront of legal finance, combining the resourcefulness of a large firm with the agility and creativity of a startup. Ideal candidates will bring a wealth of experience in complex financial transactions, international tax planning, and a keen understanding of cross-border transactions. This position offers a competitive salary aligned with the financial services industry, including incentive compensation, healthcare benefits, and a 401k matching program. Read more about the requirements and apply here to embark on a rewarding journey in a role that promises not just professional fulfillment but the chance to shape the future of legal finance.

Reach out to explore how Lateral Link can transform your career trajectory or bolster your team with unparalleled legal talent. With a focus on excellence and a commitment to your success, Lateral Link is redefining legal recruitment, one successful placement at a time.