As published in The Daily Report

In the legal community, one topic that has been the subject of significant commentary in recent years is third-party litigation finance. Although litigation finance can take many different forms, the concept is relatively simple. In most instances, a third party provides funding to a litigant to pay for attorneys' fees and other costs in exchange for an interest in the outcome of the lawsuit. Litigation finance thus allows parties to either pursue litigation that they could not otherwise afford, or minimize the risks associated with litigation by sharing the costs with a third party.

As recent studies demonstrate, there is good reason for the increased focus on litigation finance. A recent study conducted by ALM Media, publishers of the Daily Report, found that 36 percent of U.S. law firms used litigation finance in 2017, compared with 28 percent a year ago. The 2017 results also represent an astounding increase from 2013, when only 7 percent of law firms reported using litigation finance.

Courts are taking notice. For example, recently the U.S. District Court for the Northern District of California amended its Standing Order to require that parties in class action cases identify "any person or entity that is funding the prosecution of any claim or counterclaim." Notably, that court rejected a proposal that would similarly mandate disclosure of third-party funding for all litigation (not just class actions).

Thus, while some may still view litigation finance as a novelty, the statistics reflect that it is gaining widespread acceptance, particularly as reputable companies continue to enter the market. It may also be expected that litigants will seek discovery on the identity of third-party funders, notwithstanding the use of confidentiality agreements between the third parties and the litigants. Nonetheless, there are many advantages to these arrangements and many large firms are using them with success. Indeed, with appropriate precautions, litigation finance can be an effective tool for law firms.

Historic Concerns

The rise of litigation finance had legal scholars dusting off old textbooks to consider the application of principles such as champerty and maintenance. Under common law, champerty refers to a bargain between a third party and a litigant whereby the third party agrees to carry on the litigation at her or his own expense in exchange for part of the proceeds.

Prohibitions against champerty remain the law in certain states, including Georgia. See Ga. Code Ann. § 13-8-2(a)(5) ("Contracts deemed contrary to public policy include but are not limited to … [c]ontracts of maintenance or champerty.") However, such provisions are rarely invoked to invalidate litigation finance contracts, and courts addressing the issue have often limited the prohibition against champerty as applied to modern litigation funding agreements. For example, in 2016, a Delaware court found that a litigation finance agreement was not champertous because the third party did not have the right to control the litigation.

However, courts in other states (such as Pennsylvania) have relied on champerty to invalidate litigation finance contracts, and given the litigation finance boom, it seems likely that more courts will address the issue in the near future. Undoubtedly, the litigation finance industry will be monitoring these decisions closely.

Parallels With Liability Insurance

Although some in the industry have expressed concerns over the use of third-party funders related to confidentiality or the scope of the relationship, many of those concerns have already been addressed in another context: liability insurance. Comparable to a litigation finance agreement, a liability insurance policy creates a situation where a third party has a financial stake in the outcome of the lawsuit and inevitably gives rise to complicated questions when the interests of the third party and the litigant diverge.

To the extent such issues arise in litigation financing arrangements, courts can borrow concepts from insurance law. Just as the insured and its insurer are united in seeking to limit the insured's liability, a litigation funder and the litigant will typically be united in their desire to maximize the proceeds of the litigation. However, when disputes arise, the law is well-developed regarding the obligations an insurer owes to its insured, and thus similar principles can apply if a conflict over strategy erupts between a litigant and third-party funder.

There may actually be less cause for concern in the context of litigation finance, given that litigation funders typically do not assume the same level of control (if any) over the litigation as insurers, who often exercise control over the defense of the lawsuit, including with respect to the selection of defense counsel and settlement decisions. Further, any obligations owed by a third-party funder to a litigant are likely limited by their contract, unlike an insurer whose obligations are defined by contract and also by common law.

Privilege Issues

In evaluating whether to finance a particular lawsuit and in monitoring its progress, a litigation funder may receive privileged documents from the litigant or its attorneys. As a result, some have expressed concern that a party could inadvertently waive attorney-client or work product protection for documents by providing them to the funder.

However, courts have held that documents shared with a litigation finance company are protected under the common interest doctrine. See, e.g, Carlyle Inv. Mgmt. L.L.C. v. Moonmouth Co. S.A., No. CV 7841-VCP, 2015 WL 778846, at *7 (Del. Ch. Feb. 24, 2015) (citing cases). Additionally, the litigation funding agreement can contain provisions to protect the privilege or to limit the documents provided to the funder so as to counter any suggestion of waiver.

Indeed, many of the concerns relating to litigation finance are already addressed by existing law or can be addressed by the parties. The dramatic increase in the use of litigation finance certainly suggests that companies and law firms have overcome any lingering fears to embrace litigation finance as an important part of the legal industry.