A recent New York City Bar opinion, N.Y. City Formal Op. 2018-5 ("Opinion 2018-5"), shocked both the investment and the legal communities by throwing a monkey wrench into what has become an increasingly popular area of focus for high yield investment firms and an easy, cost-efficient source of financing for law firms: the provision of financing to law firms with recourse solely to the proceeds of one or more successful litigations. Not surprisingly, Opinion 2018-5, which states that such arrangements may constitute an ethical violation by the funded attorney, was promptly met with strong disagreement from the litigation finance community and some legal ethicists, who declared it is simply "wrong" or, at a minimum, overly broad and misguided. Once Opinion 2018-5 is put in the proper context, however, funders and law firms should be better able to structure future transactions to minimize the risks presented by the opinion's seemingly broad brush.
On July 30, 2018, the New York City Bar announced in Opinion 2018-5 that the prohibition in Rule 5.4(a) prohibits nonrecourse financing arrangements between lawyers and litigation funders because the lawyer's payments to the funder are contingent on the lawyer's receipt of legal fees. Opinion 2018-5 explains that these arrangements, in which non-lawyers are repaid only if the underlying litigation generates proceeds, give non-lawyers a stake in the legal fees from particular matters and create an incentive, and more importantly, an ability for non-lawyers to improperly influence the lawyer's independent judgment. See also Utah State Bar EAOC 97-11 (1997) ("Once a security interest in the recovery of contingent fees from a particular case is granted, Rule 5.4 is implicated" because the lender's rights in the recovery would "compromise the lawyer's judgment in a number of ways," including "creating potential conflicts between the lawyer and the lender" and "undermining the lawyer's duty of independent professional judgment and the duty of client loyalty.").
While Opinion 2018-5 is obviously cause for concern for attorneys who have previously obtained, or who are looking to obtain, such financing, it is important to understand the opinion's limitations: it is a New York ethics advisory opinion that, in general, applies only to New York attorneys who are directly financed through nonrecourse funding agreements. In addition, it does not carry the weight of a court opinion, and it does not issue a blanket prohibition. Rather, it permits recourse loans to the law firms, loans where the timing of repayment depends on resolution of the underlying litigation, and loans where payment is secured by a firm's overall receivables. See Opinion 2018-5 n. 9. Indeed, as noted in Opinion 2018-5 itself, New York courts have, in the past, actually upheld funding arrangements that Opinion 2018-5 would suggest are prohibited. See Lawsuit Funding, LLC v. Lessoff, 2013 WL 6409971 (Sup. Ct. N.Y. Cty. Dec. 4, 2013) (upholding a settlement agreement where lawyer agreed to repay the lender a set amount based on fees earned in eight other lawsuits, despite Rule 5.4(a)).
Litigation funders have already begun to push back. See, e.g., Andrew Strickler, "Funders Decry NYC Bar's Litigation Finance Warning," Law360 (August 13, 2018). But Opinion 2018-5, issued by a well-regarded ethics committee in an important jurisdiction, may cause lawyers in New York, as well as in other jurisdictions, to shy away from pursuing nonrecourse lending arrangements to avoid the risk of disciplinary action or other exposure. But the strong pushback to Opinion 2018-5 suggests that this story may be far from over.