Regulating Third-Party Litigation Funding? Weighing the Arguments in the Light of Extant EU Consumer Protection Safeguards

The EU debate on third-party litigation funding (TPLF) is increasingly framed as a consumer protection issue. That framing is misleading. Existing EU law already addresses most alleged risks, and a broad new regime would likely do more harm than good. In TPLF, consumer protection risks become a Trojan horse for regulation aimed at limiting collective redress. 

TPLF is the provision of capital by an external funder in exchange for a share of successful litigation proceeds. In the EU, its main use is collective redress, where it helps bundle dispersed claims in special-purpose litigation vehicles enabling viable actions. Apart from the Representative Actions Directive, TPLF has remained largely unregulated. Concerns that consumers may lose too much of their recovery, along with fears of a US-style ‘litigation industry’ and the ‘commodification’ of justice, gained political traction. Together with continued calls for EU regulation by industry bodies, they led the European Parliament to propose a TPLF Draft Directive in 2022.

Yet these regulatory efforts misjudge TPLF’s costs and benefits. Funders make collective redress workable by spreading risk and reducing agency costs in mass claims, while internalizing the ‘externality of precedent’ within a single plaintiff entity.

Frivolous Litigation with Non-Meritorious Claims Is Unlikely to Be a Problem at Scale

The oldest objection to TPLF is the fear of a flood of frivolous litigation. However, the absence of expansive discovery removes much of the nuisance value that can pressure defendants into ‘blackmail settlements’. Cost-shifting under the loser-pays rule makes weak claims expensive to pursue. Europe’s opt-in model also makes claim aggregation costly. Funders themselves have every incentive to screen cases rigorously: financing weak claims against well-funded defendants is bad business. 

In dispersed-harm cases, individual claimants underinvest in litigation because they ignore the positive externality of their case creating precedent for later claimants. A repeat-player defendant, by contrast, internalizes that externality because it expects to face the future cases too, so it fights the first case as if the full aggregate sum were already at stake. Aggregation of claims in a single entity internalizes the externality for claimants and rebalances incentives. This internalization is most effective where cases are similar so that one precedent determines the outcome of many future cases. That is why plaintiffs will ‘cherry-pick’ cases that are highly similar.

More Litigation, Less Innovation?

Another common criticism is that TPLF will create ‘too much litigation’ and chill innovation. The argument assumes current enforcement levels are socially optimal, so that more enforcement must reduce welfare. But in many areas, especially consumer and mass-harm litigation, the law is likely under-enforced. Individual claims are often too small or costly to bring. A more credible threat of enforcement may deter more illegal conduct and thereby in fact reduce, not increase, litigation. The relevant question is whether litigation moves closer to a socially desirable level not whether there is more or less.

Nor is the innovation argument persuasive on closer inspection. Where firms can externalize harm because enforcement is weak, market activity may be inefficiently high. Liability forces firms to internalize the costs of harmful conduct and encourages safer product development. The innovator is usually best placed to identify and mitigate risks at the lowest cost.

Limits of Mandatory Transparency through Disclosure

To protect original claimants from conflicted funders, some propose mandatory disclosure of funding agreements to courts and defendants. But it is odd to make defendants the guardians of claimants’ interests. If anything, disclosure can serve to deter frivolous litigation. Avraham and Wickelgren have argued that the costs of litigation funding may signal claim quality: sophisticated funders screen cases and price for risk, so the funder’s return may reflect the strength of the claim. On that view, disclosing the funder’s share could reduce information asymmetries in negotiations and facilitate settlement.

Still, funding terms are poor signals of claim merit. First, the price reflects more than merits: it also depends on counsel quality, litigation strategy, and—most importantly—plaintiffs’ incentives to invest in the litigation. The defendant can affect the rate too: a case may be risky because the defendant is especially obstructive despite weak substantive defenses. Reputational benefits from concealment may make such obstruction credible.

Second, any signal is often stale by the time the case reaches court. Collective-redress funding resembles venture capital: legal entrepreneurs learn about the project as they go. The funding agreement is usually struck at the project’s inception and only reflects what was known then.

Third, funding agreements serve two functions: compensating the funder for risk and constraining agency problems. For example, funding may be committed only through first instance. That allows parties to update terms as they learn more and it preserves a credible threat to terminate the project if lawyers or managers act opportunistically. So, does a short funding period signal a shaky case or severe agency conflicts on the plaintiff side?

The signaling benefits of disclosure are therefore doubtful, while its strategic costs are clear. It gives defendants a roadmap to exploit plaintiffs’ weaknesses—for example, by intensifying pressure near the point when funding expires or by aggravating plaintiff’s internal agency conflicts. Broad disclosure duties such as those in Art 16(1) of the TPLF Draft Directive are thus hard to justify.

Why EU Consumer Law Already Does the Job

Many alleged consumer-protection gaps in TPLF are already covered by existing EU law. The relationship between consumers and litigation vehicles is generally governed by the Unfair Terms in Consumer Contracts Directive (UTCCD), which applies to the standard-form contracts used in collective redress. Crucially, Art 6 UTCCD invalidates only the unfair term, not the entire contract. This avoids the paradox seen in early German ‘assignment model’ cases, where assignments were sometimes treated as wholly void, leaving consumers’ claims time-barred in the name of consumer protection. Art 14 of the TPLF Draft Directive risks recreating exactly that problem. Defendants could invoke consumer-protection rules strategically to attack funding structures and defeat otherwise valid claims. Consumer protection should protect consumers, not hand defendants procedural weapons against them.

Costs of Overregulating TPLF

The costs of overregulation are real. Higher compliance burdens for funders will likely reduce the number of financed claims and thus restrict access to justice, especially in consumer and mass-harm cases that would otherwise never reach court. Weak private enforcement, in turn, weakens deterrence and increases social costs by allowing firms to externalize the harm caused by unlawful conduct onto society. Absent concrete evidence of abuse, competitive funding markets are generally better placed than regulators to decide which claims are economically viable. From that perspective, the push for TPLF regulation risks protecting well-resourced defendants more than consumers.

The authors’ paper is available here. 

Alexander Morell is a Professor of Private Law, Business Law and Law and Economics at Goethe University Frankfurt and the Leibniz Institute SAFE. 

Daniel Schellenberg is a PhD Candidate and Researcher at Goethe University Frankfurt.