The Ethics of Third-Party Litigation Funding in U.S. Settlement Cases

In recent years, third-party litigation funding (TPLF) has emerged as a transformative force within the American legal landscape. This financial strategy, where an unrelated entity funds a legal case in exchange for a portion of the settlement or award, has sparked robust debate across legal, financial, and ethical circles. While it can level the playing field between under-resourced plaintiffs and deep-pocketed defendants, the involvement of outside funders in legal disputes raises profound questions about transparency, fairness, and influence over justice.

This article delves into the ethics of third-party litigation funding, specifically in the context of U.S. settlement cases, highlighting the benefits, risks, regulatory gaps, and evolving legal opinions surrounding this controversial practice.

What Is Third-Party Litigation Funding?

Third-party litigation funding involves an investor or funding firm—often a hedge fund, private equity firm, or specialized litigation funder—providing capital to a plaintiff or law firm in exchange for a portion of the future settlement or judgment. This funding can cover legal fees, expert witness costs, discovery expenses, and even operational support during protracted litigation.

Entities involved include:

• Litigants (plaintiffs or law firms)

• Funders (third-party financiers)

• Courts and judges

• Defense parties

While TPLF is most commonly used in class action, mass tort, commercial, and intellectual property litigation, it is increasingly making inroads into personal injury and whistleblower (qui tam) lawsuits.

The Rise of Litigation Funding: Why Now?

Several factors have contributed to the rise of TPLF in the United States:

• Access to justice: Plaintiffs with valid claims but limited financial resources can now afford to pursue lengthy legal battles.

• High litigation costs: As lawsuits become more expensive and complex, even well-funded parties seek to offload financial risk.

• Investor interest: The non-correlated nature of legal returns makes litigation funding attractive to investors seeking diversification.

• Globalization: Models successful in Australia, UK, and Canada are influencing the U.S. legal market.

Ethical Concerns in Third-Party Funding

Despite its practical appeal, third-party litigation funding raises critical ethical concerns, particularly when used in settlement cases where disputes are resolved out of court.

1. Conflict of Interest

One of the most debated issues is the potential conflict of interest between funders and claimants. Funders typically seek the highest financial return, which may not align with a plaintiff’s personal or moral goals in settling a case. A funder may discourage early settlement even if it's in the plaintiff’s best interest, exerting undue influence on litigation strategies.

2. Attorney-Client Privilege

Litigation funders often require access to sensitive documents to evaluate a case. This raises concerns about whether attorney-client privilege and work product doctrine protections are compromised. Some courts have ruled that certain communications with funders are discoverable, threatening confidentiality.

3. Transparency and Disclosure

Unlike contingency fee arrangements, TPLF agreements are not always disclosed to courts or opposing parties. This lack of transparency can lead to asymmetric information, where judges and defendants are unaware of external influences on the litigation process. The Federal Rules of Civil Procedure currently do not mandate such disclosures, although some courts and legislative bodies have called for reforms.

4. Churning Lawsuits

Critics argue that TPLF incentivizes frivolous litigation by encouraging funders to back weak or speculative cases in pursuit of high returns. This can clog the legal system, increase settlement pressure on defendants, and erode public confidence in the justice process.

Regulatory Gaps and Emerging Trends

While the U.S. lacks a unified regulatory framework for TPLF, the practice is drawing increasing scrutiny from state and federal bodies. Key trends include:

State Legislation

Several states have taken action:

• Maine, Nebraska, and West Virginia have passed legislation regulating consumer litigation funding.

• New York and California are exploring rules around disclosure and interest rate limits.

Federal Involvement

• The U.S. Chamber of Commerce Institute for Legal Reform has called for federal disclosure requirements.

• In 2023, a bipartisan bill was introduced in Congress to require disclosure of TPLF arrangements in federal civil cases.

Judicial Opinions

Courts are increasingly being asked to weigh in on:

• Whether funders can access privileged material

• If funding agreements must be disclosed during discovery

• Whether TPLF creates conflicts requiring judicial intervention

The Pros of Litigation Funding

Despite ethical red flags, third-party funding also brings significant advantages to the legal process.

1. Enhanced Access to Justice

By eliminating financial barriers, TPLF allows under-resourced plaintiffs to assert their rights. In mass torts and consumer protection cases, this can lead to corporate accountability and systemic reform.

2. Level Playing Field

In David vs. Goliath scenarios, litigation funding can provide plaintiffs with the firepower to withstand prolonged litigation, including appeals and delay tactics.

3. Risk Transfer

Law firms and businesses can offload financial risk by transferring some of the costs and potential losses to funders, preserving cash flow and balance sheets.

4. Innovation in Legal Markets

TPLF is also fueling the growth of legal tech, predictive analytics, and data-driven litigation strategies, as funders use AI and NLP tools to evaluate risk and optimize outcomes.

The Cons and Risks

Balancing the pros are serious risks that justify ethical scrutiny:

Best Practices for Ethical Use of Litigation Funding

To mitigate the ethical risks, stakeholders should adopt clear best practices:

• Mandatory Disclosure: Courts should require the disclosure of all TPLF agreements in civil cases.

• Attorney Independence: Lawyers must maintain control over litigation strategy without interference from funders.

• Conflict Avoidance: Funders should not make decisions that impact settlement timing or trial strategies.

• Transparent Contracts: All terms, including funding limits, interest rates, and rights to intervene, should be clearly stated.

• Regulatory Oversight: A self-regulatory organization or federal guidelines can ensure consistency and enforce ethical standards.

Future Outlook: Regulation, AI, and Accountability

The future of third-party litigation funding in the U.S. will be shaped by a combination of regulatory evolution, technological innovation, and judicial interpretation.

• AI tools may improve due diligence in case selection and risk profiling, reducing funding of meritless claims.

• The SEC and FTC may expand oversight of litigation funding as a financial service.

• Courts will likely continue to clarify the boundaries of discovery, privilege, and disclosure related to TPLF.

Ultimately, striking the right balance between innovation and ethics will be key to legitimizing this fast-growing practice.

Conclusion: Walking the Tightrope of Justice

Third-party litigation funding offers tremendous promise for increasing access to justice and democratizing legal outcomes. However, without clear ethical guardrails, it also risks distorting the delicate balance of the American legal system. Transparency, disclosure, and accountability must be prioritized to ensure that justice is not for sale but fairly served.

As regulators, judges, and attorneys grapple with the implications of TPLF, one thing remains clear: the debate over its ethical legitimacy is far from over.

Published by  Uorni – Thought Leadership for a Fairer Legal System