Is Third-Party Litigation Financing a National Security Problem?

Introduction

The practice of third-party litigation financing (TPLF) has recently come under increased scrutiny amid growing concerns that foreign entities could exert influence on U.S. litigation, moving legislators to advance a bipartisan bill that would require the disclosure of foreign entities investing in litigation in federal courts. Opponents of the legislation argue that it is based on fearmongering, and that there is good reason for “geopolitical actors to use funding to engage in America.” Proponents, on the other hand, contend that foreign-sourced money could allow adversarial governments to advance their strategic interests in the United States, to the detriment of U.S. national security.

Overview of TPLF

TPLF is a practice in which a financial arrangement is made between a party to a legal case—typically the plaintiff—and a litigation funder that is not party to the case. The litigation funder agrees to finance the legal expenses related to the plaintiff’s legal case with the promise of financial return in the event of a successful suit. Litigation funders typically obtain their capital from a variety of investors.

The practice of TPLF was introduced to the United States around 2010, according to a report from the U.S. Government Accountability Office (GAO). While the practice was mostly absent in the United States before then—owing to common law doctrines that have existed since the nations’ founding—U.S. states have relaxed their restrictions, allowing TPLF to grow significantly.

Litigants funded by TPLF firms range from large commercial actors to consumers and individuals. Those who receive TPLF funding and win their case typically repay the full amount of support plus an additional percentage that litigation funders take as return on their original investment. If the litigant loses their case, they do not need to make a repayment. In the commercial TPLF market, funders have disclosed to GAO that their investors are typically large, sophisticated private entities, such as pensions, endowments, and sovereign wealth funds. In 2022, $3.2 billion was deployed into the U.S. market by litigation funders, representing a 16 percent increase over the previous year. There are 44 active funders, according to reporting from Reuters, and they hold a combined $13.5 billion in assets under management.

The literature on TPLF describes several benefits provided to the legal system. First, TPLF gives poorer plaintiffs—often individuals—access to the capital required to have their day in court, including paying for living expenses if an injured plaintiff cannot work during a lawsuit. Underfunded corporate plaintiffs can also use TPLF to litigate difficult cases more effectively. Third-party financing also helps shift risk away from plaintiffs and onto financial speculators, creating a safer environment for individuals to litigate their claims without the potential for significant financial losses. Lastly, TPLF can allow plaintiffs to monetize their claims by realizing the claims’ value up front instead of waiting to win a case.

However, TPLF also has disadvantages. For one, TPLF can be expensive to obtain given the high amount of risk incurred by funders. Litigation costs for defendants may increase, and trade associations often assert that TPLF can encourage the filing of frivolous lawsuits, creating needless legal costs for defendants. Lastly, funders may seek to exert influence over a case; likewise, the presence of funding could create a conflict of interest for an attorney, who may prioritize the funder’s interests over the plaintiff’s.

The Legal and National Security Implications of TPLF

In recent years, there has been a growing debate over the legal and national security implications of foreign TPLF. There are several vulnerabilities that TPLF introduces into the U.S. legal system, related to skewed incentives, lack of transparency, and enhanced access for malign foreign actors. When operating properly, the legal system incentivizes fair settlement of grievances between parties. However, as mentioned above, TPLF can skew the incentive mechanisms. Strategic legal decisions—for example, choosing whether to accept a settlement agreement—may be impaired by the influence of the financier, who is motivated by maximizing return on investment.

Details of TPLF agreements are, due to a lack of legally required transparency mandates, hidden from public view. To date, there are no federal rules that explicitly require the disclosure of TPLF funders, despite strong public appeals by industry groups to create such regulations. Given this inaction, some state governments have proposed and even implemented their own TPLF disclosure laws. In 2023, for instance, Florida proposed a sweeping “consumer protection” act on litigation financing, which would require, among other things, a series of disclosures. Also in 2023, Montana enacted TPLF disclosure requirements in the recently approved SB 269.

Another vulnerability that TPLF introduces into the U.S. legal system is a potential backdoor for foreign powers to access sensitive information that arises from a lawsuit. A 2022 report from the U.S. Chamber of Commerce assesses the risk of adversaries leveraging TPLF to abuse the court system. The report offers a hypothetical scenario in which China’s sovereign wealth fund provides capital to a TPLF firm, which then funds a lawsuit against a major U.S. technology company. The chamber argues that there is no legal recourse to stop the China from accessing sensitive information that comes out of the lawsuit. Access to TPLF also gives foreign adversaries the opportunity to tie up major U.S. companies in expensive and time-consuming litigation, giving their foreign competitors an advantage.

Former House Armed Services Committee chairman Howard McKeon (R-CA) argues along similar lines in a 2023 essay, stating that litigation financing disproportionately targets intellectual property cases. Disclosure and regulation must be consistent across jurisdictions to be effective, McKeon argues, rather than the patchwork set of exploitable state regulations that exist today.

Support for federal regulation of TPLF has reached the U.S. Congress, with Senators John Kennedy (R-LA) and Joe Manchin (D-WV) introducing bipartisan legislation in September 2023 aimed at stopping “foreign entities and governments from funding litigation in America’s courts.” The bill requires disclosure of all TPLF funding, bans foreign governments from participating as third-party funders, and requires the Department of Justice to author a report on TPLF. Companion legislation was simultaneously introduced in the House.

Conclusion

It is clear that foreign TPLF could present some dangers to the legal system. The practice risks skewing litigation incentives by encouraging maximum financial return over fair reparation for plaintiffs, which could needlessly increase prices for defendants and, at worst, provoke frivolous lawsuits. The lack of transparency, moreover, adds uncertainty to the kinds of entities accessing the legal system, potentially giving nefarious actors undue exposure to sensitive information belonging to U.S. firms that is critical to national security. While the government should not attempt to shut legitimate foreign actors and investors out of the U.S. legal process, a positive step would be establishing transparency rules at the federal level. To that end, the Protecting Our Courts from Foreign Manipulation Act of 2023 takes a step in the right direction.

Thibault Denamiel is an associate fellow with the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Matthew Schleich is an intern with the Scholl Chair in International Business at CSIS. William Alan Reinsch holds the Scholl Chair in International Business at CSIS.

The Scholl Chair thanks John Strezewski for his helpful research contributions to this commentary.

Matthew Schleich

Intern, Scholl Chair in International Business