Abstract: This paper is primarily concerned with the question of how judges make decisions. The particular focus is on the application or the lack thereof of basic economic principles in judicial decision-making. The paper addresses this issue through an examination of decisions on insolvency litigation funding. While third-party funding of commercial litigation as an investment vehicle has been well-established in certain jurisdictions for some time, its use in the United States in the insolvency context is still a relatively recent phenomenon. Litigation funding allows litigators to move forward when they may otherwise be financially precluded from doing so. While litigation funding may provide benefits which could ultimately yield greater assets for creditor distribution, insolvency litigation funding also comes with a host of legal, ethical, and financial concerns. United States bankruptcy judges have been somewhat routinely authorizing requests for litigation funding without much analysis to justify their decisions. In particular, judges have frequently both overlooked basic economic considerations and failed to recognize the potential impact on all relevant parties. The decisions in these cases follow an unfortunate pattern in U.S. insolvency law. In two other critical areas of insolvency – the so called “new value” exception to the absolute priority rule and cross- collateralization – judges have been similarly short-sighted and flawed in their reasoning.

This paper begins by analyzing the economics and ethics of bankruptcy judges authorizing third party litigation funding in insolvency. In particular, the paper will examine the incentives of all of the parties, the potentially significant externalization of costs, and the imbalance between the incentives of the decision-makers and those who are likely to suffer financially in the event of adverse consequences. After considering the implication of these issues for United States law, the paper concludes with a comparative examination of the these issues in Australia, England, and Wales, jurisdictions where insolvency litigation funding is far more established.