An expected flood of litigation triggered by the credit crunch has prompted the formation of a number of new companies that finance lawsuits.

Litigation funders provide financing to companies embroiled in business disputes that would be unable to meet spiralling legal bills. In return, the litigant hands over a share of any compensation awarded by the courts.

In the past six months several new litigation funding companies have sprung up and hedge funds have also backed lawsuits on an ad-hoc basis.

Burford Capital, which is chaired by Sir Peter Middleton, former chairman of Barclays, recently raised £80m by listing on Aim and has just started to fund lawsuits.

Therium, another UK-based litigation funder set up by former lawyers including Neil Purslow has also started to fund legal cases. Juridica, which listed on Aim in 2007, recently raised £35m to fund new cases, including three in the UK.

Calunius Capital, co-founded by former investment bankers Mark Wells and Mick Smith, last month announced the launch of a third-party litigation fund that will invest in the costs of large-scale commercial disputes.

Mr Wells, Calunius Chief executive said “This is the ideal investment environment for litigation funding. Corporate conduct during the credit bubble is driving an increase in disputes, while widespread financial distress means that more businesses will need assistance to start claims.”

Well-established litigation funders are diversifying into new areas. Harbour Litigation Funding, which was founded by Susan Dunn, one of the pioneers in this area, has based 66 commercial cases.

James Delaney, Director of TheJudge, one of the UK’s largest independent risk transfer brokers, which place cases with litigation funders, said it had arranged litigation insurance and funding packages for more than 10 banks.

“We’ve seen a significant increase in the number of financial investment cases in the past six months being litigation both domestically in the UK and internationally,” he said, adding that the fastest growth had been in litigation insurance.

The big attraction for investors is that the fall-out from the credit crunch has led to a growing number of disputes – particularly around financial services. Litigation usually picks up when economies begin to come out of recession.

The increase in lawsuits comes as a squeeze on corporate costs has led to some companies turning to more cost effective third-party funding.

“It’s a combination of the potential for high returns and the fact that the asset class is uncorrelated to equity markets,” said Christopher Bogart, a founder of Burford. “In addition it is of interest because it is a new asset class.”

For private equity and institutional investors, lawsuits are an alternative asset class with sometimes double-digit returns that can be delivered in three to four years.

A recent proposed shake-up of litigation costs by Lord Justice Jackson was seen as broadly positive for companies providing litigation funding.

“It’s natural for it to attract private equity as the case has a variable duration and returns are rated equal to private equity returns,” said Mr Puslow.

UK investment funds are already taking stakes. Invesco Perpetual has taken a 45 per cent stake in Burford, while Baillie Gifford has a 10.7 per cent holding.

Much of the risk lies in the litigation funders picking winning cases. They tend to focus on civil disputes between large companies and eschew shareholder class actions or personal injury claims.

“This is not like personal injury, it is not a volume business and no one is doing a large volume of cases. We think the key thing is to select and manage the cases,” Mr Purslow said.

However, while litigation funding does allow companies to shift much of the risk and expense of litigation on to specialist providers, it is largely predicated on the funders’ ability to pick cases that generate some financial upside.

One of the biggest cases to be lost was last summer when the House of Lords dismissed a negligence lawsuit brought against a City accountancy firm for allegedly failing to detect a massive fraud at Stone & Rolls, a trading company that collapsed in the late1990s.

Furthermore, some funds require claimants to have after-the-event insurance to cover the defendant’s costs if a case is lost. The long legal process also means that money is tied up in cases for some time.