Duty in the Litigation Investment Agreement: The Choice between Tort and Contract Norms When the Deal Breaks Down

Abstract

Litigation investment, which is also known as “litigation finance” or “third party litigation finance,” has grown in importance in many common law and civilian legal systems and has come to the United States as well. While many questions remain about both legality and social desirability of litigation finance, this paper starts with the assumption that the practice will become widespread in the US and explores the obligations of the parties to the litigation finance contract.

The first part of the article uses an example to illustrate the risks imposed by one of the other party on the other which should inform the formation and enforcement of the litigation investment contract. The risks are: (1) Information Asymmetry; (2) Shirking; (3) Control; and (4) Opportunities Forgone. As we explain in the article, it is not obvious that careful contract drafting can do anything other than minimize these risks. Since their elimination is impossible (or at least prohibitively costly), the question the article turns to is how should disputes over the realization of any of these risks be handled by the courts?

The article canvasses a range of legal responses, including tort, contract, and regulation, and focuses on the tort and contract regimes as resources for legal doctrine to provide guidance to lawyers and judges. We review the history of tort liability in pure economic loss cases involving the performance of contracts, and focus in first and third party insurance “bad faith” doctrines as the most promising analog. We conclude that, despite some superficial similarities, the relationship between a claim owner and an investor in a legal claim are sufficiently different from that of an insurer and an insured such that tort law should not be followed in the case of litigation finance disputes.

Finally, we review the possibility of using contract law to resolve disputes between funders and claim owners. The key challenge to anyone who defends the adequacy of contract law is to properly define the nature of the contract, since different kinds of contracts yield different obligations and different remedies. We argue that litigation investment contracts are ‘relational contracts’ since they possess certain features that are a hallmark of this legal family, such as a concern to allow for the renegotiation of terms in order preserve the contract as an ongoing relationship. With this in mind, we conclude by drawing upon the relational contract literature to sketch out broad contract law principles to apply to disputes over the performance of litigation investment contracts and the remedies that courts should order in the event that a contract breach is found.