I admit I’ve never heard of “litigation finance” before now.   American law largely prevents it, although that may change as trial lawyers discover the new and exciting cases they can pursue with OPM (Other People’s Money), even without having the case itself be fraudulent.  As Fortune senior editor Roger Parloff reports today, a great many British families might have their life savings invested in a class-action lawsuit that an American judge has ruled shows sufficient evidence of fabrications, collusion, and fraud:

Now, who are all these people we say have been investing in this malodorous case without even realizing it? Well, some are American or British high rollers who put their money into aggressive hedge funds like Reservoir Capital of New York or Eton Park of London; others, however, seem to be mainly British mums and dads who hold mutual funds managed by trusted names like Fidelity International, Invesco Perpetual, Baillie Gifford, or Scottish Widows. These six institutions together own about 80% of a publicly listed investment firm called Burford Capital, based on the British island of Guernsey. Burford, in turn, invested $4 million in the Ecuadorians’ case against Chevron last November in exchange for a 1.5% stake in any recovery, with the stated goal of increasing its outlay to $15 million, entitling it to a 5.5% share.

At the time Burford invested, four U.S. courts had already issued rulings that found evidence of fraud by the plaintiffs’ lawyers. In fact, three months before Burford invested, a law firm for the plaintiffs advised the fund that the Ecuadorian judgment would be hard to enforce in the U.S. because of the “jaundiced eye” with which U.S. courts were viewing the case. Those lawyers were nevertheless optimistic that if the plaintiffs threatened to disrupt Chevron’s operations by peppering it with enforcement actions around the globe — trying to, say, seize Chevron’s tankers in the Philippines or Singapore and its wells and pipelines in Chad or Kazakhstan — they could still pressure it into settling.

Though the identity of investments is usually kept confidential by Burford and companies like it, Burford’s involvement in the Lago Agrio case has been dribbling into public view since December, thanks to a series of wildly improbable events, which we’ll get to later. For anyone curious about the young, controversial, and highly opaque field of litigation finance, this fortuitous development provides a rare opportunity to see how it works in practice.

Thanks to a complicated funding structure, Burford and other investors become the primary beneficiaries of any settlement reached.  In fact, if the settlement comes in low enough, the investors may be the only people who get paid.  They have a claim on the first $55 million at a mathematical floor of $69.5 million, and the rest would go to other investors, thanks to a “distribution waterfall” that puts the Ecuadorian peasants on whose benefit the suit was filed at the back of the bus — after the investors and lawyers.

If this sounds sleazy, well, yes it is.  In fact, the notion of litigation finance was so offensive at one time that American law barred it as “champerty,” according to Parloff.  But the times, they are a-changing, and the lawyers are leading the way:

Basically, financing someone else’s lawsuit was considered immoral because “intermeddling” in the disputes of others fomented discord for pecuniary gain.

Though these practices may still carry a stigma with older lawyers, about half the 50 states have either repealed the laws or shredded them with exceptions. Meanwhile, England and Australia have embraced litigation financing even more enthusiastically than America has. The majority view in the U.S. today seems to be that bans on third-party funding are Puritanical archaisms. …

So there has arisen in recent years an array of litigation-finance businesses that serve a variety of niche markets. At least six companies, according to a 2010 Rand Institute for Civil Justice study, now specialize in making investments in “commercial disputes,” which Rand analyst Steven Garber defines as “business-against-business” cases. In addition to Burford, they are Juridica Capital (another Guernsey-based publicly traded hedge fund), Calunius Capital, Juris Capital, ARCA Capital, and IMF (an Australian-based publicly traded fund). Some diversified financial institutions, like Credit Suisse (CS), Allianz , and Deutsche Bank (DB), also have units that specialize in litigation financing.

Most of the time, these financial arrangements remain confidential, which is one reason why this practice hasn’t yet permeated the public consciousness.  Thanks to the ineptitude and self-promotion of the plaintiffs’ attorney in this case, though, the lid finally came off:

Burford’s agreement with the Lago Agrio plaintiffs was subject to confidentiality restrictions at least as severe, which were supposed to last for seven years after the contract’s termination. But thanks to lead U.S. plaintiffs’ lawyer Steven Donziger, it’s now come to light. When Donziger invited that moviemaker into his strategy and bull sessions in 2006, he inadvertently waived the attorney-client privilege to everything that took place there and more. After viewing hair-raising outtakes from the documentary (subpoenaed by Chevron) along with other evidence, three U.S. judges found that privileges protecting other documents had also been waived under an exception that applies when lawyers might be involved in a fraud or crime. Finally, Judge Kaplan ruled that Donziger had waived privileges to still other information through gamesmanship in responding to Chevron’s subpoenas.

For students of litigation finance, Donziger’s Keystone Kounsel act has been a godsend. It has lifted the veil on practices that are usually pondered only as sterile abstractions. Burford is, moreover, “the largest and most experienced international dispute funder in the world,” as its promotional materials state, so we’re not looking here at some aberrational outlier in the field. Since launching in 2009, Burford has raised $300 million in two public offerings on the London Stock Exchange’s AIM market for emerging companies. Burford’s investment advisory group boasts an all-star management team: Its CEO, Chris Bogart, is a former general counsel of Time Warner (TWX) (Fortune’s publisher’s parent); its nonexecutive chairman, Selvyn Seidel, founded the New York office of Latham & Watkins, a top-drawer U.S. law firm; and its “special ethics counsel” is Geoffrey Hazard Jr., a Sterling professor of law emeritus at Yale Law School and “perhaps the primary figure in legal ethics in the country today,” according to Burford’s website. For those reasons, we can be assured that Burford’s conduct probably represents the very best practices the young industry has to offer.

Be sure to read the long and complicated story in its entirety, and consider this point as you do.  Should we allow investors to incentivize nuisance claims and shakedown class-action suits and further damage our economic strength just to transfer money from corporations to other investors using the poor as a strawman?  Or should we give the Puritans some long overdue credit and start cracking down on “champerty” again?

Update: I credited the story to Forbes, but it should have been Fortune.