Litigation Finance: What Lawyers Need To Know
Litigation finance is on the rise, so now's a good time to educate yourself.
We’ve written extensively in these pages about litigation finance, both positively and negatively. Regular readers of Above the Law are quite familiar with this growing trend in both law and finance.
For folks who are new to litigation funding, however, a panel I attended at the 2016 Annual Meeting of the Association of Corporate Counsel (ACC) offered a nice overview of the subject. It featured the following participants:
- Theresa Coetzee (moderator), Vice President and Assistant General Counsel, Marriott International, Inc.
- Martha Binks, General Counsel and Director of Legal Services, Allstate Insurance Company of Canada
- Matthew Harrison, Investment Manager, Legal Counsel, Bentham IMF
- Bradley Wendel, Professor of Law, Cornell Law School
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The last time I attended a conference discussion about litigation finance, the general feeling in the room was one of support for the practice. This session was a bit different. Harrison, as someone who works in litigation finance, and Wendel, who advises litigation funders, tried to be advocates for litigation funding. But the distinct sense I had in this room full of in-house lawyers was that most audience members are not fans of litigation finance. Presumably these attorneys, representing corporations that are often defendants in litigation, viewed litigation funding as giving rise to more cases they need to defend (and pay outside counsel for defending).
Most members of the audience were new to litigation finance. The panel used a polling program to survey the attendees and learned that under five percent of them have used litigation funding, and only 25 percent of them have been parties to litigation in which they knew about a funding arrangement.
Matthew Harrison of Bentham described the two main flavors of litigation finance: consumer, which focuses on funding plaintiffs in personal injury cases, and commercial, which focuses on funding large commercial cases. Harrison noted that the two types of financing do share one thing in common: the funding is provided on a non-recourse basis, meaning that the funder gets paid only if the claimant gets paid in the litigation (i.e., the funder has no recourse to other assets of the claimant).
How much does the funder receive? Payment is typically a percentage of what the claimant recovers in the litigation. The exact amount will also depend on such factors as the length of the case and how much the funder has put into the matter. The transaction is structured not as a loan, but as a type of asset purchase, and the parties to the agreement are the claimant in the litigation and the funder (not the claimant’s lawyer; there’s no issue here of fee splitting).
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In the commercial space, funders are happy to support cases of many different types, including breach of contract, breach of fiduciary duty, intellectual property, and general commercial litigation. They are also open to funding international arbitration, which often involves high stakes and a (relatively) quick resolution. What they generally don’t fund: cases where there’s not much documentation (making the claim hard to evaluate), cases claiming attorney malpractice (they don’t like to go after lawyers), and cases alleging defamation. (But see Peter Thiel, the billionaire who secretly funded privacy and also possibly defamation litigation against Gawker Media.)
Cases typically come to funders through the lawyers who are working on them (who have already vetted the cases and decided they’re worthwhile). If the funder is interested, the claimant and the funder enter into a non-disclosure agreement (NDA), and the funder starts due diligence. The parties will then enter into a non-binding term sheet, typically a page or two, outlining how much money the funder will deploy and what kind of return it will receive.
Then the funder conducts deep due diligence — given that a typical case might last two and a half years and involve an investment of a few million dollars, diligence is essential. This process would include meeting with the claimant, reviewing relevant documents, and possibly hiring outside experts (especially if the subject matter of the case is new to the funder). If this due diligence turns out well, then the funder and claimant execute their contract. After that transaction is closed, the funder steps back and basically monitors its investment, checking in perhaps once a month, as well as following major case events.
Matthew Harrison and Bradley Wendel emphasized the passive role of the funder once the investment has been made: the funder should not control the litigation strategy or influence the independent professional judgment of the lawyer representing the claimant. Ensuring that litigation financiers don’t interfere with the professional judgments of counsel is, according to Wendel, the fundamental ethical issue in this space.
This concern was also, Wendel explained, the driving force behind the old common-law bans on “maintenance” and “champerty.” Maintenance is providing any kind of financial support to a party in litigation, and champerty is doing that in exchange for a share of the proceeds. These practices were prohibited at common law because of the problem that arose in medieval England of nobles lending their names to bolster doubtful or abusive claims — “officious intermeddlers” in other people’s litigation.
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Today, however, more than 30 states now allow some form of litigation funding (and even the other 20 states don’t all prohibit it, but just make it more difficult). But because the practice is fairly new, at least in terms of large-scale, commercial funding, there’s not a lot of law out there about it, and the regulatory scheme is uncertain.
Another objection raised to litigation finance: promotion of frivolous litigation. Supporters of litigation funding respond that this should not be a major problem because funders won’t fund frivolous litigation; they won’t make money if a claim gets dismissed.
What about a Peter Thiel situation, where someone funds litigation to settle a score? Concern over such a scenario might explain the calls in some quarters for mandatory disclosure of litigation funding arrangements. There was even a proposal to amend the Federal Rules of Civil Procedure to require automatic disclosure of financing, but it was not adopted (although judges have the discretion to call for such disclosure if relevant in a specific case).
Litigation funders oppose such proposals. They argue that a funding arrangement is rarely relevant to the claims and defenses in the case and just gives rise to a distracting discovery sideshow — which can, as a practical matter, chill information flow and ultimately increase the expense of litigation funding (which funders argue is a bad thing because litigation financing is a way of improving access to the courts).
When parties have tried to obtain discovery into litigation financing arrangements, they’ve generally not succeeded. Most courts have relied upon the attorney work product doctrine to protect, for example, litigators’ evaluations of the strengths or weaknesses of a case.
As noted, the audience of in-house lawyers seemed a bit skeptical or suspicious of litigation finance. In polls taken by the panel, 63 percent expressed the view that a funder’s interests are not aligned with a claimant’s interests, and 92 percent expressed concern over the possibility of a funder controlling the course of a litigation.
Harrison and Wendel gamely tried to make the case for litigation funding to in-house lawyers. It’s not always a matter of supporting someone suing a corporate defendant, prolonging a litigation and increasing its cost. Litigation finance can be used by one company to sue another, so that the general counsel’s office can become a revenue generator instead of a cost center, and it can also be used to cover potential liabilities arising out of an existing case. If in-house counsel think creatively, they can turn litigation finance from burden to benefit.
2016 ACC Annual Meeting [Association of Corporate Counsel]
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David Lat is the founder and managing editor of Above the Law and the author of Supreme Ambitions: A Novel. You can connect with David on Twitter (@DavidLat), LinkedIn, and Facebook, and you can reach him by email at dlat@abovethelaw.com.
