Crowdfunded Litigation Financing: Out of Semi-Obscurity and Into the Wall Street Journal

Big black hole that sucks much money

Lawyers have been using a number of litigation funding mechanisms for awhile. There are several different ways this happens. For big cases and big firms, hedge funds will put down seven or eight figures in the hopes of a big payout in enormous $100 million-type cases. For smaller cases, clients can take out non-recourse loans in anticipation of a share of the proceeds in their case. This often happens in the context of personal injury litigation.

Even lawyers can get in on the action and protect themselves against a loss. Some enterprising attorneys recently created insurance coverage that will pay you if you lose a case. This allows you to set aside worries that you’ll end up with nothing on a case you worked on for ages if things go south.

Crowdfunding of litigation, however, is a bit of a different animal. It isn’t loans from traditional loan companies or an insurance policy. Instead, it’s like a high-stakes Kickstarter, where individual investors provide  a piece of the funding for the litigation and the crowdfunding company facilitates putting all of those individual investments into one package. However, it’s only open to what the Securities and Exchange Commission terms “accredited investors”–people who have made over $200,000 in the past two years or have at least $1 million in assets, excluding their primary residence. So, it’s crowdfunding, but only for the well-heeled masses.

Up until now, litigation crowdfunding has largely been a curiosity–something the profession has been watching to see (a) if it will work and (b) if it ends up creating enormous ethical issues.

A few days ago, though, it passed into the realm of finance-side coverage when the Wall Street Journal ran a piece about how the practice has moved “into the mainstream.”

Here’s a quick takeaway: there are at least some investors out there who love the possibility of the ridiculously high returns and are willing to take the risk that they end up with nothing.

Once reserved for hedge funds and other deep-pocketed investors, litigation funding is moving into the mainstream through startups like LexShares in Boston and Los Angeles-based Trial Funder Inc., a website that raises funding for personal-injury and civil-rights cases.

With promises of double-digit returns, the platforms have attracted thousands of investors looking for profits that aren’t influenced by the broader investment market. […] For [an individual investor] one investment already has paid out, at a rate of return around 60% after fees. “Nothing pays back that well,” he said.

Another investor invested $1000 and says he hopes to see returns of 30-40%.

While this is an interesting development, is it really becoming much more widespread? A company like LexShares facilitates crowdfunded litigation that is intended to cover cases that need anywhere from $100,000 to $1 million in funding. That’s funding, not payout, but they are cases that are still too small for the hedge funds and other big dogs. That amount isn’t entirely absurd for a small firm to end up spending on a case.

When we first wrote about LexShares a year ago, they’d fully funded three cases and had a fourth in the pipeline. A year later, they’ve funded 15 cases and settled three. So, it isn’t going gangbusters, but it is growing.

Trial Funder covers funding for much smaller cases.

Attorney Sarah Garvey helped her client, Joseph Rosales, raise $20,000 on Trial Funder to defray costs in a lawsuit against Chico, Calif., over allegedly excessive use of force by a police officer, which was recorded by onlookers. […] Investors doubled their money when the case settled in January for $165,000.

Plaintiffs who take money personally from the site must pay back the principal amount plus fees of 3.5% compounded monthly if their case is successful. If the money goes directly to a law firm to fund case expenses, Trial Funder investors get between 10% to 25% of any recovery, after the initial investment has been repaid.

Trial Funder has funded cases with costs and expenses as low as $2000, so they are much more in line with what solosmall firms might need.

If these cases are well-vetted, they end up being a possible win for everybody. Lawyers get funding for cases that seem relatively sure to be settled favorable or win at trial, and investors get enormous returns if the payout is big. However, it doesn’t look like there’s a huge sustainable market if the growth in funded cases is as slow as it currently appears. To increase growth, companies like LexShares would likely have to get a bit more permissive in their case evaluation, which possibly to higher possibilities of losses, which leads to investors perhaps deciding to put their money elsewhere.

We haven’t even started to deal with the possibility that some state bars might begin to forbid the practice entirely, while others would be just fine. No matter what, crowdfunding is worth keeping an eye on as a potential money source for cases you would want to take, but just aren’t sure you can afford.

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