A Market for Justice: The Effect of Litigation Funding on Legal Outcomes

The sale of litigation claims to third parties has historically been banned in almost every legal system. While this ban reduces the likelihood of frivolous, negative expectation suits, allowing such litigation may be welfare enhancing overall. A number of recent theoretical papers have proposed that the creation of a market for litigation would increase welfare, through the increased access to the courts for individuals who are risk averse or credit constrained. Until recently this question remained a theoretical one, as there was no venue to empirically test the impact of litigation sales. But recent court decisions in Australia have led to the formation of litigation funding corporations, which buy claims (or fractions) from third parties. In this paper, we attempt the first empirical investigation into the impact of litigation funding. We analyze data obtained from the leading litigation funding firm in Australia, as well as from the Australian state and federal courts. Using this data we test several economic theories of litigation. If litigation trading alleviates credit constraints, litigation trading should stimulate the filing of more costly suits. If litigation trading allows the smoothing of risk, litigation trading should stimulate the filing of lower probability suits. We make use of the changes in the law in Australia as natural experiments, which alter the cost of litigation. Specifically, we examine the impact of litigation funding on settlement rates and amounts, time to settlement, volume of litigation, conditional fees, establishment of precedent, and development of law. The findings are important to understanding the welfare implications of liberalizing litigation funding laws, currently under consideration in a number of countries.