Reputation markets can play a large and crucial role in the healthy functioning of a litigation finance market. One way reputation markets can emerge, given the current secrecy that characterizes this market, is through brokers, who by their repeat play with multiple funders would be positioned to facilitate the emergence of a reputation market. That is, brokers can be reputation agents, giving plaintiffs access to the kinds of information that a reputation market would provide about funders, such as the various funding terms each offers.
In addition, brokers can help level the bargaining power playing field by arranging bidding wars. As we’ve discussed before, the “hold up” problem in the analogous venture capital market is solved by syndicating later funding rounds, a tactic that is not common in litigation finance. In litigation finance it is more typical that, once funded, a plaintiff receives additional funding, or negotiates for that additional funding, from a single funder. That makes the initial bidding war particularly important in preventing the hold up problem.
While using brokers imposes additional transaction costs–one more party getting paid–given the current state of the market the net effect would probably be to lower financing costs for plaintiffs. The lack of transparency in the current market makes it relatively easy for funders to negotiate for bigger profits than a transparent, competitive market would allow. Until the market becomes competitive, a broker can save the plaintiff more than its fee by bringing competition to the initial bidding process. Indeed, plaintiffs would do well to pay the brokers themselves (rather than, e.g., having them be compensated by funders) because brokers present their own agency costs, especially since they are repeat players. So for brokers to play an effective role mechanisms that align their interest with the clients must be in place.
Brokers of litigation funding already exist; some in the consumer market, such as Law Leaf, and others in the commercial market we focus on, such as Claim Trading, The Judge, and Litigation Funding. Notably, the commercial brokers are all outside the U.S.
In his work arguing for a defense-side marketplace of risk transfer, Professor Jonathan Molot argued that lawyers should become litigation finance brokers. However he notes that the rules of professional conduct that currently inhibit it:
“When lawyers straddle the roles of client advisor and deal broker, they risk breaching their professional obligations and subjecting themselves to professional sanction. If we think litigation-risk transfers could be of value, it is important that professional standards be interpreted to permit lawyers to facilitate these risk transfers.”
While he concludes that for one off-transactions, the rules allowing conflict of interest waiver should protect lawyers who comply with them, Molot argues that a lawyer specializing in brokering deals would be in trouble under the professional standards that currently exist, and thus he recommends changing them.
Regardless of which professionals play the role of broker, the litigation finance marketplace–particularly the U.S. marketplace–could benefit from their services to speed the development of a transparent and competitive marketplace.