Legal Financing: Can private capital unlock the hidden asset of local government affirmative litigation?

• Author: Farrar, Grant
• Position: RETHINKING REVENUE

Legal action is an important lever for local governments to achieve policy goals, enjoin harmful activity, and receive monetary compensation for damages suffered. However, the cost of litigation and greater legal resources available to well-funded defendants means that many local governments cannot realize the full potential of litigation. Legal financing is an established practice among private firms for financing and reducing the risk of litigation. Could it be time for local governments to start using legal financing to pursue lawsuits that seek to vindicate the public's interest ("affirmative litigation") and receive compensation that could be used to help address community problems? This article explores the potential of legal financing by asking and answering questions about this new-to-government tool.

WHAT IS LEGAL FINANCING? WHY IS IT NEEDED?

Like any private entity, local governments exercise their right to sue in state and federal courts. In many cases, as exemplified by the tobacco and opioid litigation, this can result in a monetary award to the government by a court-ordered judgment or a settlement between the parties. Where these cases address a broader public interest and not just the local government's corporate interests, these actions are known as "public sector affirmative litigation." Perhaps the most well-known example of public sector affirmative litigation is the tobacco litigation that led to the 1998 Tobacco Master Settlement Agreement, which yielded over $200 billion for state and local governments. Currently pending are hundreds of cases relating to opioids, brought by states and thousands of local governments. In some instances, these cases have already settled for hundreds of millions of dollars. This illustrates the potential large financial impact of public sector affirmative litigation. In addition to opioids, other subject matters for affirmative litigation include:

([right arrow]) Revenue recovery--litigation against streaming television companies to recover franchise fees for use of public rights-of-way;

([right arrow]) Vaping--litigation against vaping manufacturers and retailers for misstatement of addictive potential and harms to underage consumers;

([right arrow]) Environmental matters-litigation against manufacturers and users of PFAS and PCB for water contamination, perchlorate run-off (usually related to agriculture), air pollution, and climate change;

([right arrow]) False claims actions-litigation against individuals and entities who cheat taxpayers and defraud the government by inflating charges for goods and services and falsely certify the completion or quality of work;

([right arrow]) Data breach/electronic privacy--litigation against government vendors who negligently permit data breaches and/or improperly use government and taxpayer data;

([right arrow]) Antitrust/anticompetitive conduct--litigation against social media platforms for monopolistic conduct, vendor collusion harming the government procurement pricing/process;

([right arrow]) Consumer protection--litigation to prevent and recover damages against companies that harm consumer health through failure to ensure proper food/ drug safety; and

([right arrow]) Medical services--litigation to recover excessive pricing for drugs and medical services.

Local governments are taking on more responsibility to address issues, like the ones outlined above, that impact the communities they serve. (1) For some of these issues, the losses to local government are general and arise from injuries to members of the community that the local government must address; whereas for other issues, the damage to the government can be more direct. Whether direct or indirect, these issues affect the local government's fiscal resources. One way to address these issues is through the courts. However, access to the courts requires time, money, and resources that are often in short supply. In many instances, governments are opposed by well-funded defendants with large legal teams that seek to wear down their opponents. These barriers can prevent local governments from pursuing cases, even when those oases have great merit. However, a worthy legal claim is an asset, just like anything else, and it can be monetized and leveraged as such.

This is where legal financing (or "legal funding") comes into play. Legal financing refers to an outside AUGUST 2022 | GOVERNMENT FINANCE REVIEW 35 investor providing financing for attorneys' fees and litigation costs to bring litigation to resolution. This financing is "nonrecourse," which means that if the litigation is unsuccessful, then the entity that advanced the funds loses its invested capital, with no return, and the recipient of the funding has no further obligation to the funding entity. Legal financing is in common use by private firms and individuals, so much of the groundwork for local governments to use legal financing already exists.

With legal funding, the government does not lose money if there is no recovery. This is similar to the contingent fee model of litigation. If the litigation results in a recovery, the entity that provided the legal funding gets a share of the litigation proceeds. As we will discuss later in this article, legal financing can offer important advantages over traditional contingent fee litigation.

WHO ARE THE FINANCIERS? WHAT IS IN IT FOR THEM?

Think of legal financing like venture capital funding for lawsuits. Investors provide money to the legal financing fund, and the fund seeks out lawsuits that have a high chance of winning a sizable award. The return on the investment is tied back to the amount of money from the litigation recovery (either a settlement or award). The percentages vary, but where only a single case is financed, the amount is typically between 20% to 40% of the recovery. This is similar to contingent fee models of litigation, where fees are around 20% to 40%. Legal funds could accept lower percentages of a recovery if they are funding a portfolio of cases, which provides investors with diversification. This protects against the risk of a single case going badly and makes it more likely investors will get a consistent return. Portfolio funding of legal financing is becoming common and makes the investment...