Invest in a Lawsuit? Startup Matches|Cash-Strapped Plaintiffs With Benefactors

SAN JOSE, Calif. (CN) — A Silicon Valley startup aims to use lawsuit data to determine which civil cases are likely to succeed in an effort to help investors who want to fund such cases for a portion of the proceeds.

Legalist was founded by Harvard grads Eva Shang and Christian Haigh, who are developing an algorithm to scour legal databases and analyze and identify the likelihood of a given's case success.

"What we are trying to do is give an approximation of how a lawyer looks at a case," Shang said in an interview earlier this week.

Data in hand, the company will invest in selected lawsuits in hopes of reaping profits from the judgments.

Legalist already has invested $75,000 in a case with the potential for a $1 million judgment, Shang said. The company has 10 more cases it hopes to fund in the coming month, investing anywhere from $50,000 to $500,000 with the potential to earn up to 33 percent of the awarded damages.

It's a controversial business model, particularly in the wake of the former pro wrestler Hulk Hogan's lawsuit against online new site Gawker.

A jury awarded Hogan $140 million in damages over Gawker's posting of his sex tape without his consent. The award bankrupted Gawker, which shut down its site for good last week.

Peter Thiel, a billionaire founder of PayPal founder and member of the Facebook board, bankrolled Hogan's lawsuit. Thiel, who was not personally involved in the case, is believed to have bankrolled it as payback for Gawker outing him as gay in 2007.

Thiel's involvement has spurred hand-wringing in the legal and media worlds, causing consternation over the degree to which people or corporations with deep pockets can use the legal system to drive enemies out of business.

Shang, who ironically used a Thiel Fellowship when developing Legalist's algorithm, acknowledged the controversy around third-party funding of lawsuits. But she said her company will not fund litigation brought by individuals, instead focusing on small businesses.

Specifically, Legalist hopes to fund cases where big corporations essentially refuse to pay small contractors, since they can afford to drag out litigation until the little guy drops because he can no longer keep up with attorney's fees and court costs.

"Our company levels the playing field," Shang said. "The need we're hoping to address, it doesn't exist in the market right now."

Eric Goldman, a professor of law at Santa Clara University, said that while Shang's point may be true, the implications of creating efficiencies in the emerging market of third-party funding and lawsuit investment carries broader implications for the administration of justice.

"I think you have to start with the goals and purposes of litigation," Goldman said. Goals include offering victims a chance at redress and reforming and deterring bad behavior.

"The question becomes, are those goals advanced when you have some 'Moneyball' statisticians looking to get a piece for themselves and make a quick buck?"

Goldman said there is a real concern that intermediaries' quest for profit may warp the legal system, spurring frivolous litigation and undermining the justice system's ostensible purpose.

Meanwhile, Legalist — with its 52 employees and all-important computer — is not the first or only game in town. Other companies, including LexShares and TrialFunder, offer similar investments in lawsuits, though the sector of civil law and the degree to which they rely on analytics differs.

Other more traditional investors such as Buford Capital resemble Wall Street firms more than Silicon Valley startups, but also allow third parties to invest in civil litigation in the hope of large returns.

Headquartered in New York and London, Buford Capital was founded in 2009. The firm recorded $42 million in profits in 2013, and $82 million in 2014.

While Buford Capital and others employ a team of lawyers who analyze cases, Legalist wants to cut out that overhead through the employment of its data, hoping to hit the industry standard 90 percent success rate to stay in business.

Aside from the social implications of third-party funding of lawsuits is the overarching question: Is it legal?

The question is complicated, but there is a legal term "champerty and maintenance" which explicitly renders third-party funding of lawsuits illegal. The term originated in English common law and was enacted to prevent frivolous lawsuits, specifically to outlaw buying interest in someone else's lawsuit.

Most legal experts say the prohibition has been superseded by modern legal ethics and is archaic. However, some states have explicit champerty and maintenance laws that prevent nonparties from investing in a lawsuit.

In a high-profile Ohio case, Rancman v. Interim Settlement Funding Corporation, an appellate court held that it was illegal for "advance of funds secured solely by an interest in a pending lawsuit and at a contracted return exceeding 180 percent per year" to be used.

"Such an agreement constitutes champerty and maintenance and thus is void under Ohio law," the court wrote in 2003.

Ohio, however, appears to be an anomaly, as third-party funding and other more widely accepted practices such as contingency fees are broadly accepted.

"These are 18th century laws and third-party funding has faced regulations," Shang said. "It is explicitly legal in 30 states."

Institutions such as Buford Capital say champerty and maintenance laws should be relegated to ancient common law doctrines, calling them "old laws" which are a "last-ditch protection against meritless litigation."

Buford Capital, Legalist and their industry cohorts say they are offering support to plaintiffs with lawsuits that are long on merit but short on money.

But as litigation investment evolves, regulators and ethics watchdogs are taking notice.

The U.S. Chamber Institute for Legal Reforms released a white paper in 2012 calling for limits on investor control of cases, prohibition of contacts between third-party investors and attorneys without the presence of the clients, and full disclosure of third-party funding contracts in all litigation, among other regulatory changes.

For many experts like Goldman, the implications and questions surrounding third-party funding of lawsuits should hinge on whether the "rise of a professional class of profit-seeking intermediaries" adds value to the justice system.

There is no single easy answer, Goldman said.

"Creating more efficiencies in the way plaintiffs assess cases could be a good thing, but it could be problematic," Goldman said.

For instance, in patent law there are plaintiffs who "depend on defendants' willingness to settle as a core revenue stream," and "creating algorithms that make that market more efficient does not advance the patent system," Goldman said.

In fact, it could stifle innovation.

While Goldman worries that professional plaintiff-supporters and their quest for profit could undermine the values of the civil justice system, Shang says Legalist will help small commercial entities whose only impediment to legal vindication is money.

No matter the view, third-party funding of lawsuits is on the increase. And as Silicon Valley seeks to make it more efficient, others will continue to question its social cost.

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