News that Allianz, Europe’s largest insurer, is coming to London to set up a third-party litigation fund has provoked familiar but misguided hostility.

Litigation funding allows people with money to “fund” court cases (and, increasingly, arbitrations) on behalf of others who lack either the resources — or the appetite — to pay themselves.

The funders, typically sophisticated institutional investors, take a slice of the winnings if the case is successful and share the pain if not. Since litigation in the UK is expensive and success is not guaranteed no matter how strong your case is, surrendering a share of the potential upside in return for some downside protection is attractive.

Detractors base their suspicion on two main arguments:

First, that there is something distasteful, some say unethical, about a third-party that has no involvement in a legal dispute being allowed to profit from it.

Second, that the availability of third-party funding removes some of the fear of losing and so encourages people to bring groundless lawsuits. If an unsuccessful litigant no longer has to pay, opponents say, they have nothing to lose and the courts will be overrun with baseless claims.

Neither of these arguments is fair. A closer look at the litigation funds operating in the London market, Allianz’s included, reveals that they are seeking to invest in commercial rather than personal disputes.

Helping one company to sue another and possibly profiting from it is simply not the same thing as helping the victim of a car accident to sue the driver at fault. One is a personal dispute that may have involved tangible human suffering; the other involves a business managing commercial risk.

Look at this another way. Suppose a British businessman owns a chain of shops in the UK and decides to open an outlet in France. His French customers will pay in euros that will at some point need to be converted back in to sterling so the businessman can claim his profits.

Any sensible businessman will be aware that because the exchange rate fluctuates, he could be caught out if it moves against him. But since he probably knows when he will need to send the money back, he can solve this problem by buying a foreign exchange forward contract that allows him to swap his euros for sterling at a pre-agreed rate on a future date.

Although the exchange rate could in fact swing in his favour, buying the forward contract gives the businessman a degree of certainty and removes the distraction of watching the currency markets. Put another way, it allows him to reduce, or manage his business risk.

But the reduction of risk, at least in the business world, does not come free. To protect his French takings from a weakening euro, the businessman will have to pay a foreign exchange broker a fee for the forward contract. Since the broker is an independent businessman, he has no involvement in the retailer’s currency “problem” but he earns a living from helping to reduce it. Billions of pounds worth of forward currency contracts are bought by businesses every day and currency brokers rarely, if ever, get lambasted from profiting from someone else’s problem.

Litigation funding for commercial disputes works, in essence, on the same principle. Litigation is expensive and uncertain. It can be crippling if you lose. If a third party offers to help you reduce this risk in return for a fee, it makes sense to at least investigate it.

Of course, the fee structure is slightly different: currency brokers typically take a fixed fee at the outset whereas a litigation fund will agree to a fixed share of the eventual winnings. But these two contracts are fundamentally the same because at their core they both involve one business paying another business to offset a degree of risk.

If the head of an international business who does not manage his currency exposure is criticised as inept, why should we criticise the head of another business who does manage his litigation risk through the use of third party funds?

The second major criticism of third party funding is that by removing downside risk, it will encourage baseless claims. Again, this is unfounded. Litigation funds may claim to help the underdog and widen access to justice, but it is no secret that they are run for profit.

It is precidely because these businesses are run according to profit-making principles that fears of a proliferation of baseless claims are misguided. Although they will have a portfolio of cases and can therefore afford to lose some, litigation funders will scrutinise claims with extreme diligence. Since they are looking to make a profit it makes no sense to back a weak claim and they will refuse to entertain them.

If anything, litigation funding might encourage an atmosphere of closer scrutiny across the litigation spectrum and actually reduce the number of spurious lawsuits.

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