The Justice Case for Litigation Finance

• Date: 01 October 2022
• Author: M. Todd Henderson

Published in Litigation, Volume 49, Number 1, Fall 2022. © 2022 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be

copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.33

The Justice Case for

Litigation Finance

M. TODD HENDERSON

The author is the Michael J. Marks Professor of Lawat the University of Chicago Law School.

The legal system is no t known for i nnovation. Status quo bias

is practica lly built into the law, which relies on precedent a nd

reasoning by analogy. Add in an interest group that has managed

to establish and preserve a cartel, and the result is that the law

today looks a lot like it did in the 1960s, when Neil Armstrong

walked on the moon. By contrast, each of us now carries around

a tiny phone in our pocket that operates 100,000 times faster

than the computer that got him there.

But change is afoot. A new way of funding lawsuits—known as

litigation finance—is transforming the staid legal world, threat-

ening to drag it into the 21st century. Change upsets the expecta-

tions of incumbents, and they are certain to push back. That too

is now happening in the law. The battle will determine the future

of litigation, which in turn sets the boundaries of law and society.

Sharing R isk

Much of the well-being produced by modern society can be traced

to the sophisticated ways in which we share risk. There are things

that we would not do on our own, simply because the risk is too

great for any single person to bear. But, if we could get others

to cooperate with us, to share the downside while also sharing

the potential upside, then we could do much more. Training and

the brotherhood of soldiers probably explains risk sharing in

a foxhole, while a different type of brotherhood explains it in

families. But among strangers and in commercial relations, it is

modern tools of finance that enable unprecedented risk sharing

in our world.

Recent innovations in finance, from factoring to syndications

to derivatives, are key mechanisms for risk sharing across the

economy. The average person might not realize what goes on

behind the scenes to enabl e a home or car purchase or the use of

a credit card. But in each case, risk-sharing tools make it possible

at accessible prices. Individual assets—whether they are home

loans or credit card accounts—are risky collateral, while pooled

assets allow risk to be spread and therefore reduced.

If a bank were unable to share the risk of a mortgage loan on

a particular house, it would charge a much higher interest rate,

which is its estimate of risk plus a market return on its invest

-

ment. In today’s world, the bank can pool the loan with thousands

of others, selling the risk off in slices. The adage “don’t keep all

your eggs in one basket” works for home mortgages, auto loans,

and, as it happens, legal cases. Finance enables risk reduction,

which lowers the costs of home ownership or whatever it is that

is being funded for the system as a whole.

These insights from finance have recently come to the law.

This was inevitable. Potential and meritorious legal claims can

be viewed as valuable, yet risky, assets, just like first homes or