How Litigation Funding Groups are Changing the Landscape

As seen in DRI, The Voice of the Defense Bar

I.       Introduction 

        Champerty and maintenance are common-law doctrines, often referred to as “antique laws,” which have long prohibited the outside financing of litigation. Maintenance is the act of a disinterested party to promote, encourage, or maintain a lawsuit. Dictionary of Law (6th ed.). London: Longman. p. 260. ISBN 0-582-43809-8. Champerty is a form of maintenance – referred to as maintenance for profit – and is defined as a “bargain between a stranger and a party to a lawsuit by which the stranger pursues the party’s claim in consideration of receiving part of any judgment proceeds.” BLACK’S LAW DICTIONARY 231 (6th ed. 1990) (citing Alexander v. Unification Church, 634 F.2d 673, 677 (2d. Cir. 1980). Some may argue that soliciting personal injury suits or assignment of malpractice claims constitutes champerty. See Frank v. Tewinkle, Pa. Super. Ct., 45 A.3d 434 (Pa. Super. Ct., 2012). 

        The doctrines of champerty and maintenance date back to the middle ages, and some argue as early as the ancient Greece and ancient Roman eras. Jason Lyon, Revolution in ProcessThird-Party Funding of American Litigation, 58 UCLA LAW REVIEW 571 (2010). In the Middle Ages, bringing suit was viewed as aggressive and cantakerous behavior that cut against Christian values. Over time, there has been a shift in individuals’ attitudes towards litigation, and the doctrines of champerty and maintenance began to decline. Id. Today, jurisdictions are split as to whether they enforce common law prohibitions against champerty and maintenance. One thing is clear, however, that third-party litigation funding is on the rise.

II.     Litigation Funding Groups 

        Third-party funding began in Australia, made its way to the United Kingdom, and is now becoming more prevalent in the United States. See Belated ‘Clean Up’ for Litigation Funders in Australia, U.S. Chamber of Commerce, (Sept. 17, 2014):http://www.instituteforlegalreform.com/resource/belated-clean-up-for-litigation-funders-in-australia/. (Discussing that Australia has begun to reform its litigation funding industry); See also Lisa Bench Nieuveld, Third Party Funding – Maintenance and Champerty – Where is it Thriving (Nov. 7, 2011), http://kluwerarbitrationblog.com/blog/2011/11/07/third-party-funding-%E2%80%93-maintenance-and-champerty-%E2%80%93-where-is-it-thriving/. Third-party litigation funding is funding, by an outside party, of all or part of a plaintiff’s litigation in exchange for a portion of the recovered proceeds. In some cases, law firms finance litigation by securing funds from a litigation funding group. The third-party funding group that finances the litigation recovers a portion of the settlement or judgment as payment. If the suit is unsuccessful, however, the funding group recovers nothing. Because there is no repayment obligation, these cash advances are not considered “loans” in the traditional sense, but rather, are nonrecourse debt. 

        A typical third-party funding scenario is as follows: a hedge fund or other investment group loans funds to a plaintiff to cover the costs of litigation. The benefit to the plaintiff is two-fold: 1) they may not have otherwise been able to afford to file suit; and 2) if their claim is unsuccessful, they often times do not have to repay the third-party funding group. If successful, however, the third-party funding group receives a high rate of return. The share of proceeds varies based upon a number of factors: 1) the amount of money involved; 2) the length of time until recovery; 3) the projected value of the plaintiff’s claim; 4) and whether the claim is settled, goes to trial, or is appealed. Lawrence S. Schaner and Thomas G. Appelman, The Rise Of 3rd-Party Litigation Funding, Law 360 http://jenner.com/system/assets/publications/130/original/The_Rise_Of_3rd-Party_Litigation_Funding.pdf?1312815913. In order to protect their interests, litigation funding groups often investigate the merits of an individual’s legal claims and the likelihood of success prior to making cash advances. 

        Some litigation funding groups, such as Burford Capital, have actively sought to minimize the reach of the common law doctrines of champerty, maintenance, and barratry. In an ethics article, Buford stated: 

“[T]hose old laws are last ditch protections against ‘meritless litigation’ assigned to and controlled by a stranger the purpose, not merely the effect, of the stranger’s involvement is to stir up litigation’ and have been used in ‘only a handful of cases … in the United States in the last  one hundred years.’”

See     http://www.burfordcapital.com/wp-content/uploads/2014/01/Ethics-1-Champerty-12.5.13.pdf (last visited January 5, 2015). Buford Capital describes itself as a “specialty provider of investment capital and risk solutions for litigation.” Further, Buford states that it “supplies corporate finance solutions to enable meritorious commercial cases to proceed with high quality counsel” and that it can be used to fund “some or all of the costs of litigation…” Litigation Finance: An Introductionhttp://www.burfordcapital.com/wp-content/uploads/2013/08/Booklet-Intro-to-Litigation-Finance-FINAL-Web-2013-08-16.pdf. 

        On the other side of the coin, the U.S. Chamber Institute for Legal Reform issued a white paper in October of 2012, suggesting changes to third-party litigation funding. Among the suggested changes are limits or prohibition on investor control of cases, forbidding all contact between the third-party funding group and lawyers without the inclusion of the client, banning law firm ownership of third-party funding groups, and full disclosure of funding contracts in litigation. John Beisner and Gary Rubin, Stopping the Sale on Lawsuits: A Proposal to Regulate Third-Party Investments in Litigation, U.S. Chamber for Legal Reform (Oct. 24, 2012), http://www.instituteforlegalreform.com/uploads/sites/1/TPLF_Solutions. 

        Third-party litigation funding is small, but it is growing. According to Buford Capital, the “world’s largest provider of investment capital and risk solutions for litigation,” they had more than three times the number of investment commitments in 2014, as compared to 2013. In addition, they reported doubled cash receipts from investments, and a 60% net return on invested capital. With numbers like that, it is easy to see why this is a growing industry.Litigation Finance: An Introduction, supra. Treatment of third-party funding arrangements by the courts varies wildly across the jurisdictions. 

III.   Types of Loans 

        One type of funding is direct funding to consumers, where the third-party litigation funding group provides a nonrecourse loan to an individual to help the plaintiff absorb the costs of litigation. Absolute Legal Funding, LLC describes a nonrecourse loan as follows: 

 “Non Recourse Funding means that a lien is placed on the lawsuit’s pending settlement or verdict. Our non recourse funding provides  personal-injury victims or lawsuit plaintiffs with the money needed to cover their every day living expenses while waiting for a case settlement or verdict. Our case disbursement funding allows attorneys to manage their cash flow by providing them with the funds needed throughout the litigation process. Of course, if you don’t win the case, you owe us nothing. The risk is ours, not yours!” 

See http://www.absolutelegalfunding.com/ (last visited Dec. 13, 20014). Another advertisement of sorts as to how a third-party funding group forwards money to individual plaintiffs can be found on Law$uit Financial Corp.’s website, which states: 

“Victims may experience sever injuries and disabilities, significant, unaffordable medical expenses, disability from work or future loss of earning capacity. They often have difficulty paying for the basic necessities of … You have a terrific lawyer (if you don’t have an attorney, Lawsuit Financial’s trial lawyer CEO, Mark M. Mello, can refer you to the best in the industry, nationwide) and a great case; what you don’t have is time…” 

See http://lawsuitfinancial.com/general-injury-case-lawsuit-financing.html (last visited Nov. 10, 2014). As one can glean from the above-descriptions, with these cash-advance type loans, there is little restriction on how the money can be spent. 

        Another type of loan is loans to law firms, where the third-party litigation funding group provides a loan to a law firm that has a portfolio of related cases. This is sometimes referred to as “defense funding” loan, where the litigation funding group assists with cash flow issues that face firms when entrenched in large-scale litigation. Defense funding loans have become more prevalent amongst third-party litigation funding groups. Unlike the cash-advance type loans, the money obtained through legal defense funds are used solely to fund litigation and related legal costs. 

        There is also funding to corporations, where the third-party litigation funding group purchases a stake in the company’s litigation for a share in the recovery. Often times, the funding group contracts directly with the corporation and oversees the efficiency of the law firm litigating the matter. A benefit from this type of arrangement is that it shifts the risk and expense of litigation outside of the corporation. 

III.     Status of Champerty in the United States 

        There is variation amongst the fifty states, with some states upholding the common law doctrines of champerty and maintenance, others engage in a relaxed form of enforcement, while the remainder have abolished the doctrine altogether. According to a survey conducted in 2010, 28 of 51 states permit champerty. Anthony J. Sebok, The Inauthentic Claim, 64 VANDERBILT LAW REVIEW (2011). In abolishing champerty, the South Carolina Supreme Court stated: “[w]e abolish champerty as a defense because we believe it no longer is required to prevent the evils traditionally associated with the doctrine as it developed in medieval times. Osprey, Inc. v. Cabana Ltd. Partnership, 532 S.E.2d 269, 273 (S.C. 2000). Recently, however, the South Carolina Department of Consumer Affairs tightened regulation of third-party litigation funding, requiring lenders to comply with traditional lending regulations. South Carolina Agency Rules Lawsuit Loans Are Traditional Loans Subject to State Law, Legal Newsline Legal Journal (November 17, 2014) http://legalnewsline.com/news/253390-south-carolina-agency-rules-lawsuit-loans-are-traditional-loans-subject-to-state-law. In doing so, third-party litigation funding groups are subject to limitations on the interest rates that can be charged. Oklahoma and Maine have signed similar bills regulating the often exorbitant interest rates charged by third-party litigation funding groups. The Colorado Attorney General launched a successful lawsuit against Oasis Legal Finance, aimed at treating the third-party funding group as a traditional lender. Id. Ohio and Maine have also enacted laws that require third-party funding groups to register with state authorities, report the fees charged for such loans, and assurances from the lender that the funder will not make any decisions that would influence the course of the litigation. See Me. Rev. Stat. Ann. Tit. 9-A §§ 12-104, 12-106; See also Ohio Rev. Code Ann. § 1349.55. 

        Instead of reform, some jurisdictions have decided to do away with champerty altogether. In Massachusetts, champerty has been abandoned in its entirety. Specifically, inSaladini v. Righellis, the Massachusetts Supreme Court recognized a contract as champertous, but declined to void it on that basis alone. Report on the Ethical Implications of Third-Party Litigations Funding, submission by the Ethics Committee and Federal Litigation Section of the New York State Bar Association (April 16. 2013). Other states have simply refused to acknowledge the existence of champerty. States such as Arizona, California, Connecticut, New Jersey, New Hampshire, New Mexico, and Texas take the position that the doctrine of champerty was never adopted, and thus, it does not apply. Id. 

        A commonly touted benefit of litigation funding groups is that they can be extremely helpful in providing access to the courts. Like South Carolina courts have done, proponents of litigation funding groups have pushed for disclosure as a means to protect the plaintiff, and states condoning litigation funding arrangements have followed suit. New York has not eliminated the doctrine of champerty in its entirety, but encourages more disclosure with such arrangements and as a result, New York courts rarely find that an action is champertous as a matter of law. Id. (The New York City Bar Association cautioned of 5 potential pitfalls with litigation-funding arrangements, including: 1) the legality of the arrangement; 2) the attorney’s failure as an advisor; 3) conflicts of interest; 4) failure to obtain a waiver of privilege; and 5) losing control of the direction of the litigation). Jurisdictions such as Connecticut, New Jersey, Pennsylvania, Missouri, and Maryland require certain client-disclosures, pursuant to their state bar ethics committees. Specifically, if an attorney advises his or her client to seek litigation funding, the client should be made aware of the potential waiver of the attorney-client privilege when disclosing information to the funding company. Id. at 3. 

        Delaware and Minnesota are among a remaining subset of states that rigidly apply the doctrine of champerty. Id. at 11. In fact, the Court of Appeals in Minnesota has held that if repayment of a litigation loan is dependent upon a plaintiff’s recovery in that litigation, that loan is champertous. Johnson v. Wright, 682 N.W.2d 677 (Minn. Ct. App. 2004). 

        It is not just individual states that are tightening regulations on third-party litigation finance. At the federal level, there have been proposed amendments by the U.S. Chamber Institute for Legal Reform, the American Tort Reform Association, Lawyers for Civil Justice, and the National Association of Manufacturers to the Federal Rules of Civil Procedure, including required disclosure of third-party financiers at the outset of a litigation through Rule 26 disclosures. TPLF Transparency: A Proposed Amendment to the Federal Rules of Civil Procedure, U.S. Chamber of Commerce (July 6, 2014), http://www.instituteforlegalreform.com/resource/tplf-transparency-a-proposed-amendment-to-the-federal-rules-of-civil-procedure/

IV.     Litigation Funding Considerations 

            A. Vexatious or Prolonged Litigation 

                1. Prolonged Litigation 

        There is the concern that third-party litigation funding can prolong litigation, because a plaintiff may be reluctant to settle for a certain amount if the plaintiff realizes that a substantial portion of the settlement will go towards repayment. 

        Some argue that non-recourse loans lead to increased failure of settlement negotiations. The argument is that because the plaintiff has nothing to lose, he can afford to take a more aggressive stance, and may reject what may otherwise be a fair settlement offer under traditional litigation funding structures. While repayment amounts may come into the equation when deciding to settle, this true in the traditional attorney-client relationships. For example, if a plaintiff has $20,000 in legal fees, he is unlikely to settle for less than $20,000. While this does not necessarily change the value of the case, it does alter the plaintiff’s thought process in negotiating (i.e. what is the bottom line). 

        In Rancman v. Interim Settlement Funding Corp., the Ohio Supreme Court voided a third-party funding agreement stating that the arrangement was “evil” and had the effect of “prolong[ing] litigation and reduc[ing] settlement incentives.” Rancman v. Interim Settlement Funding Corp., 789 N.E.2d 217, 221 (Ohio 2003). In Rancman, the plaintiff was advanced $7,000 to pursue and automobile accident claim against her insurer. The terms of the non-recourse loan were that the litigation lender agreed to advance $7,000 to the plaintiff, and the plaintiff agreed to repay the lender $19,600 if the suit was resolved within a year. Id. at 218-219. Ultimately, the plaintiff settled for $100,000, and then subsequently sought to void the contract with the litigation funding group, claiming that the contract was unconscionable. The court agreed with the plaintiff, holding that the $19,600 repayment, along with the $7,000 advance effectively prevented the plaintiff for settling for anything less than $28,000. Id. at 220-221. 

                2. Increased Volume of Litigation 

        Some may argue that third-party litigation funding necessarily increases the volume of litigation. With more litigation funding, it is likely that there will be more litigation, but third-party litigation funding groups argue that they carefully select litigation, and because of this diligence, the majority of suits are turned down. Interestingly, most third-party litigation groups are run by lawyers, who are arguably able to access the merits of an individual claim. 

            B. Ethical Considerations 

        Concerns regarding an attorney’s ethical obligations also arise with the use of third-party funding groups. These concerns include waiver of privilege and ethical duties of loyalty. While the attorney’s obligation is to the plaintiff, the lines can become blurred when the attorney is being paid directly by the third-party litigation funding group. Because the attorney/client privilege protects only communications between an attorney and her client, disclosure of these communications to anyone other than the privileged person waives that privilege. 

        Client information is highly relevant to the third-party litigation funding groups and directly impacts their underwriting decisions and case valuation. Thus, there is an urge on the part of third-party litigation funding groups to have as much information as possible. While this is a natural desire, the attorney must balance third-party funding groups’ requests for information with potential waiver of the attorney/client privilege and the ramifications this waiver may have on discovery. Emily Madoff, Analyzing the Fundamentals of Litigation Funding, NEW YORK LAW JOURNAL, (August 23, 2013) http://www.litinsider.com/PubArticleCLI.jsp?id=1202616621254&Analyzing-the-Fundamentals-of-Litigation-Funding. An example of this is Leader Technologies v. Facebook, where the District of Delaware upheld a magistrate’s finding that the attorney/client privilege by passing client documents along to the third-party funding group.Id., citing Leader Technologies v. Facebook, 719 F. Supp. 2d 373 (D. De. 2010). By entering into a nondisclosure agreement with a third-party litigation funding group prior to entering into any funding agreement, such pressures can be minimized. Id. 

        Another ethical consideration involves the duty of the attorney to the client. This can of particular concern when the third-party litigation funding group entered into a funding agreement with a law firm, as opposed to a plaintiff. By entering into such agreement, the law firm (or attorney) owes contractual duties to the third-party funder, and these duties may ultimately conflict with the ethical duties owed to the plaintiff. When entering into such arrangements, it is important to keep American Bar Association Model Rule 5.4(c) in mind, which states: 

 “A lawyer shall not permit a person who recommends, employs, or pays the lawyer to render legal services for another to direct or regulate the lawyer’s professional judgment in rendering such legal services.” 

        ABA Model Rule 5.4(c). To avoid the appearance of impropriety, third-party funding groups may disclaim any rights to interject themselves into litigation, whether or not they plan to influence litigation decisions. 

            C. The Bottom-Line 

                1. Transfer of Risk Outside the Individual or Corporation 

        In-house litigation departments are often viewed as a cost center. Thus, general counsels have been more limited in the past regarding their ability to bring suit, rather than merely defend it. Limiting factors such as cash flow and capital have prevented corporations, and particularly smaller businesses, from pursuing certain types of litigation in the past. Litigation funding groups permit corporations to transfer the risk of litigation outside of the company, and the litigation becomes an asset, rather than a legal cost. Ward, Margaret,Third-Party Litigation Funding, For the Defense (July 2014), p. 12; See also Blog: The Transformative Power of Litigation Funding for GCs; The Global Legal Post, (Aug. 19, 2014), http://www.globallegalpost.com/blogs/corporate-counsel/the-transformative-power-of-litigation-funding-for-gcs-78600099/

                2. Shift of Recovery to Litigation Funding Group 

        While litigation funding groups may give plaintiffs more access to the judicial system for plaintiffs with financial constraints, they also may leave the plaintiff with little to no recovery. An extreme example of this is Elwin Francis, who brought a personal injury case, using two litigation financing groups to fund the litigation, namely: LawCash and Lawbuck$. He settled his personal injury case for $150,000, and ended up with only $111 dollars. Two thirds of the settlement went to went to funding companies, with the other third to his attorneys, fees, and expenses. Joan C. Rogers, Law Firm Wins Dismissal of Suit by Client Whose Litigation Loans Ate Up Settlement, 29 LAWS. MAN. ON PROF. CONDUCT (ABA/BNA) 53, 53 (Jan. 30, 2013), http://www.bna.com/law-firm-wins-n17179872101. Mr. Francis brought suit against his attorneys for malpractice, but ultimately the court dismissed the action, finding that: 

“Based upon the documentary evidence, which clearly demonstrates that the plaintiff was fully aware of his actions when he entered into the various loan agreements that resulted in large liens being placed against the proceeds of his underlying personal injury case, this Court is of the opinion that no amendments to the plaintiff's complaint will enable him to successfully plead a case of legal malpractice against these defendants.” 

Id. In sum, Mr. Francis borrowed $27,000, but with the exorbitant lending rates coupled with the amount of time it took to settle the matter, Mr. Francis owed the litigation funding groups $96,000. Ronen Avraham and Abraham Wickelgren, Third-Party Litigation Funding – A Signaling Model, 63 DePaul Law Review, 233 (2014). 

        Litigation funding groups benefit from not only personal injury plaintiffs, but also corporations who are disinterested or unable to absorb the expense of costly and complex litigation. An example of this is DeepNines. Patent Litigation Weekly: How to Win $25 Million in a Patent Suit – and End up with a Whole Lot Less (Nov. 2, 2009), http://thepriorart.typepad.com/the_prior_art/2009/11/altitude-capital-partners-altitude-nines-v-deep-nines.html. In 2007, Altitude Capital Partners loaned DeepNines $8 million to pursue a patent infringement claim. After paying its attorneys, Fish & Richardson, and Altitude Capital Partners, DeepNines walked away with only $800,000. Id. Fish & Richardson pocked over $11 million for handling the matter. Altitude received $10.1 million, but sued DeepNines for an additional $5.3 million, arguing that legal fees should not have been deducted prior to calculating Altitude’s contingency fee bonus. 

        In the end, DeepNines settled with Altitude Nines (Altitude Capital Partners set up a separate subsidiary called “Altitude Nines” to handle the Deep Nines deal). The Managing Partner of Altitude Capital Partners, stated he is “pleased that Deep Nines decided to resolve its dispute,” and that “Altitude Nines is satisfied with the terms of the settlement agreement between the parties and is glad both parties have respected the terms of the original investment agreement.” Deep Nines & Altitude Capital Portfolio Company Announce Settlement Ending Legal Dispute Between the Companies (July 22, 2011): http://www.prweb.com/releases/2011/7/prweb8663869.htm. After the settlement, DeepNines litigation resulted in a net loss. 

Conclusion 

        It appears, with the rise of litigation-funding groups, that third-party litigation finance is there to stay. Whether you support it or not, there is likely to be more controversy surrounding the applicability of the champerty and maintenance, and the regulation of an industry that is in its infancy in the United States.