Tort Litigation: Jeopardizing Businesses While Providing Commercial Opportunities

Tort litigation plays an important social role by providing compensation for injuries caused by wrongful conduct. However, if left unchecked, excessive tort litigation can cause more harm than good. While businesses can be negatively impacted by litigation, the litigation itself presents a business opportunity worth considering.

Snapshot of Tort Litigation in the U.S.

A report published by the U.S. Chamber of Commerce Institute for Legal Reform claims that the tort system in the United States – comprising both common law and statutory claims – amounted to 2.3 percent of the country’s gross domestic product (GDP), equivalent to $429 billion. (It should be noted that U.S. Chamber of Commerce’s studies have been criticized in the past, and that prior studies by different institutions have placed the total costs of tort litigation in the U.S. anywhere from $279 billion to $865 billion.)

Although that figure may seem shocking at first, a study conducted by Towers Watson shows that tort litigation costs totaled between 1.7 and 2.33 percent of the country’s GDP from the 1980’s to the 2010’s, for an average of 2.03 percent of GDP. This data shows that the cost of tort litigation expressed as a percentage of GDP has remained relatively constant over the last thirty years.

However, these results do raise some questions. Most importantly, the fact that only 57 percent of those $429 billion estimated to compose the costs of the tort system (according to the most recent study) raises question about the efficiency of American tort litigation practice. How efficient is a system that costs over 2 percent of the country’s GDP if only around half of that amount actually goes towards compensating damages? Moreover, what effect does this inefficient system have on business? Are there particular industries that have been affected by the tort system? How can this issue be addressed?

Businesses Most Impacted by Tort Litigation

The threat of litigation – and particularly the large sums awarded for punitive damages – can dissuade companies from entering into business in the U.S. Businesses that decide to operate in the U.S. are forced to internalize the costs of tort litigation, which leads to price increases. Ultimately, the cost of even the threat of tort litigation is borne by the American consumer.

That litigation costs and the risk of high awards can have an impact on business development and foreign investment is evident. The extent, however, is debatable. The U.S. Chamber of Commerce report puts forth that out of the $429 billion found to comprise the tort system, $300 billion relates to liability faced by businesses. Commercial automobile liability was found to be the most representative ($160 billion), putting an enormous stress on that sector. Manufacture was also singled out as being particularly strained, especially the pharmaceutical industry, with the report showing concerns that these costs may discourage foreign direct investment.

It is interesting to note, however, that those same industries seem to have been the most targeted by foreign investors in the same period. According to a report by the U.S. Department of Commerce, 41 percent of total foreign investment in 2016 was in the manufacturing sector, with particular emphasis on the pharmaceutical industry, which received approximately $498 billion.

The political nature of studies such as these cannot be overlooked. For instance, the study conducted by U.S. Department of Commerce under the previous administration on Foreign Direct Investment published in 2008 shows significant differences from the most recent one, specifically concerning the impact of tort liability in the American market, an issue that, in fact, has not even been addressed by the most recent reports. That the 2001-2009 Presidency put tort reforms high on the list of priorities only goes to further to illustrate the political nature of the study. Nevertheless, these reports are good indicators that an inefficient tort system can have serious consequences for U.S. businesses.

A Business Approach to the Issue: Litigation Funding

Managing the costs of tort litigation can be done in a number of ways. One of the more obvious methods is enacting legal reforms to correct the inefficiencies. That is, for instance, precisely what the U.S. Chamber of Commerce Institute for Legal Reform seeks to do. Although law reform (including in the areas of multi-district litigation and class action suits) seems to be an obvious solution, it can take several years or even decades to implement.

However, the litigation itself also provides a unique business opportunity. Third-party litigation funding is an arrangement through which a party that otherwise has no relation to the claim, agrees to provide non-recourse funds for the claim to be pursued in exchange for a portion of the amount received if the suit is won. This practice is not exactly a new phenomenon. In fact, a very common form of litigation funding, contingency fees, has been used extensively in the United States ever since 1908, when it was approved by the American Bar Association. The difference between a simple contingency fee and the use of third-party litigation funding is that parties unrelated to the claim have begun to view the claim as an asset, with the unrelated third-party actually investing in it.

Unlike other types of investment that are affected by fluctuations in the market, the risks in funding litigation are tied to events that have already passed, evidence of those facts and the law itself. In that sense, it is an investment that allows investors to practically isolate themselves from unforeseeable market oscillations.

It is with that perspective that businesses have started to invest in litigation. This is done either through highly specialized companies (such as Burford Capital and Bentham), units of investment banks (as Credit Suisse’s Litigation Risk Strategies Group) and, more recently, crowd-funding initiatives (like LexShares and CrowdJustice), giving parties a great range of options, irrespective of whether the claim is valued at a few thousand dollars or several million dollars.

Criticism of Investing in Litigation

The practice of investing in litigation has been criticized by both defendants and plaintiffs. Defendants believe that third-party funding will raise the number of frivolous law suits (the U.S. Chamber of Commerce strongly opposes third-party litigation funding, at least if not properly regulated). The extent to which such claims exist and whether litigation funding will actually generate such results is controversial. On the plaintiff’s side, the use of third-party funding has raised mostly ethical concerns – such as in the widely publicized funding of claims by Peter Thiel against Gawker Media – and the fear that lawsuits will become a form of security without any regard for the underlying parties.

Supporters of third-party litigation funding respond to the ethical concerns by claiming that there is nothing inappropriate about investing in lawsuits. In fact, they argue, for some claimants it may be the only way to have proper access to justice. Additionally, investors are unlikely to fund frivolous claims as they are unlikely to succeed, and thus they do not present an attractive investment opportunity. They also argue that there is nothing unethical about seeing litigation as a business opportunity, as long as there is no interference in the claim. The critique that third-party litigation funding is a “perversion of justice” ignores the fact that either the case would not have been brought in the first place due to lack of funds or, even if it were brought, the claim would develop in the same way as it would without the funding. If properly done, the funding will have no interference whatsoever on the lawsuit.

Recently, regulations designed to keep litigation funding in check have started to appear in jurisdictions across the U.S., including Arkansas, California, Indiana, Maine, Nebraska, Ohio, Oklahoma, South Carolina, Tennessee and Vermont. These regulations contain provisions concerning disclosure of the funding to avoid concerns of the judge’s impartiality, limitation on the funders’ control so as to not make it the real party in interest and the prohibition of referral fees. These regulations reflect a recognition by many courts that litigation funding is a legitimate and adequate solution to excessive tort litigation, albeit with some constraints.

Marcel Carvalho Engholm Cardoso is an LL.M. Candidate in the International Business Regulation, Litigation and Arbitration Program at New York University Law School. He is a graduate of Pontifical Catholic University of Sao Paulo and holds a Master’s Degree in Civil Procedure from the University of Sao Paulo. He practices litigation and arbitration in Sao Paulo, Brazil.