In the wake of Gawker.com's downfall, a host of start-ups are rushing to bring litigation finance to Main Street with a business model that could have far-reaching ramifications for both investors and the legal system.
Until the news broke that tech billionaire Peter Thiel was funding former pro wrestler Hulk Hogan's suit against (now-defunct) gossip blog Gawker for outing him as gay nearly a decade ago, most people were unaware that third parties — traditionally, hedge funds — could bankroll a lawsuit against a person or business
As a result, start-ups in the field of litigation-finance investment have gained prominence, with a simple pitch to investors: Put up as little as $5,000 to fund lawsuits, and make money.
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An industry is born
Founders of these sites say their business model benefits investors because investing in lawsuits is decoupled from the broader market, meaning that economic downturns wouldn't hurt their returns, and they argue that the field is still open enough for them to be very selective in the cases they take on.
"Historically, this would have been a nonstarter," said Stephen Gillers, a professor at New York University School of Law. "There never would've been such a thing as litigation funding because the courts took the view and lawmakers took the view that the courts exist for the purpose solely for enabling people whose rights have been violated to get relief of some kind," he said.
Over the past 15 or 20 years, though, hedge funds and venture capitalists have woken up to the idea that lawsuits can be lucrative, and have poured money into the cases themselves as well as a push for legitimizing their involvement.
It's a position that makes strange bedfellows, pitting hedge funds and consumer advocates against groups like the U.S. Chamber of Commerce, which strongly objects to the practice.
"Plaintiffs who are in great need are often forced to settle for substantially less than their case is worth because they can't hold out — and defendants know they can't hold out," Gillers said, so they'll often use whatever legal delaying tactics they can to drag a case out.
"If the defendant knows a funder has put millions or hundreds of thousands of dollars in the case... and that an investment company, a savvy investor, has decided that the case has merit, that may lead to quicker settlement," he said.
Most litigation-funding investment sites focus on either commercial suits — breach of contract and the like — or personal suits like civil-rights violation and injury cases. They engage in various ways of vetting the most likely prospects out of the hundreds of applicants that contact them.
"Our team's been investing in legal claims since the late 90s, we have a tried and true underwriting process to vet these claims," said Jay Greenberg, CEO and co-founder of LexShares.com, a litigation finance company for commercial cases.
There are three main criteria Greenberg said his company weighs when determining whether or not to fund a case. "The first thing we're looking at is through the legal merits of the case. We're also looking at the plaintiff's counsel's track record," he said. The final aspect is the defendant's creditworthiness, since winning a case against an insolvent defendant wouldn't really be a victory in the sense that investors wouldn't be able to get a return on their investment.
Some litigation-funding startups are betting that big data will help them find the cases most likely to be decided in their favor. Legalist, a Y Combinator startup, plans to lean on 15 million data points and algorithms to ferret out the cases with the best profit potential.
"All the people involved and the events in the case, all the motions that are filed can be tracked," said Eva Shang, who was an incoming senior at Harvard University before dropping out to pursue Legalist. "What we're trying to do is automate the process," she said. Shang said Legalist also uses data like who the judge is and how many cases they have on their plate at the time.
"We've met with hundreds of personal injury and mass tort attorneys to survey the field for underwriting. We built financial models around it," said Anoush Hakimi, CEO of TrialFunder.com, which focuses on civil rights, labor, injury and other personal cases. "For each specific type of case, we have various algorithms and formulas," he said.
"For funders to be profitable, they need to do a good job of vetting," said University of Iowa College of Law professor Maya Steinitz. This imperative that becomes even more important when funders are soliciting investments from other institutions and individuals to back the cases they choose.
"I think it may be possible to do some data crunching that would have some validity but I think the question of whether a lawsuit is likely to prevail really depends on the subject matter of the case," she said. "Usually, lawsuits are a very unpredictable matter… The human factor is so great."