5 Ethical Issues With Litigation Finance

What ethical problems does the rapidly growing field of litigation funding present?

The rapidly growing field of litigation finance could transform the world of litigation for the better, in a whole host of ways. But like any new and innovative area, it presents a number of ethical questions.

I recently attended a conference, Litigation Funding: The Basics and Beyond, at NYU School of Law. Based on the symposium proceedings, I previously wrote about six virtues of litigation finance. Once again drawing on the conference discussions, I’d like to discuss the vices — or if not vices, at least some possible pitfalls or perils that might arise in connection with litigation funding.

1. Will litigation finance lead to a proliferation of dubious or meritless cases?

That’s the argument of the U.S Chamber of Commerce, frequently invoked at the conference as the principal foe of litigation funding. As Lisa A. Rickard, president of the U.S. Chamber Institute for Legal Reform (ILR), puts it, “Litigation financing is a sophisticated scheme for gambling on litigation, and its impact on American companies is unambiguous: more lawsuits, more litigation uncertainty, higher settlement payoffs to satisfy cash-hungry funders, and in some instances, even corruption.”

What would proponents of litigation finance say in response? As Joshua Schwadron of Mighty said, the outcome of a case shouldn’t be determined by who has more money — if you have suffered a legal wrong, you shouldn’t be denied redress simply because you don’t have the funds to sue.

What’s to prevent litigation funding from leading to a flurry of junk cases? Something that libertarians (and presumably the Chamber) love: the market. Litigation financiers profit when the cases they back succeed; if the cases fail, they suffer losses. So as Travis Lenkner of Gerchen Keller Capital noted, why would funders want to finance meritless litigation? “If we are that bad at our jobs, we’ll go out of business.”

2. Do litigation funders exert too much influence over the cases they back, including decisions about whether to take a given settlement?

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Patent litigation god John Desmarais, the former head of Kirkland & Ellis’s IP practice who five years ago launched his own very successful (and high-paying) boutique firm, outlined an interesting scenario. In a contingency-fee case, the interests of the lawyer and client are clearly aligned: the lawyer takes a percentage of the pot of gold at the end of the case, so she wants that pot to be as big as possible. But when a case has litigation funding, things get trickier.

In a funded case, according to Desmarais, the funder generally takes “first dollars” — e.g., if the funder provides $10 million in financing, they take the first $10 million out of any proceeds from that litigation, plus some specified return on everything above $10 million. This arrangement changes settlement dynamics in important ways. Take a case with a potential judgment of $50 million that the funder backed with $10 million. The defendant offers to settle for $10 to $15 million. Depending on how long the case has dragged out and how its prospects look going forward, the funder might be happy to take this offer because it will get its full $10 million back, plus maybe a little extra. But the plaintiff might not find this very appealing; after repaying the funder, he’d receive little or nothing on a claim with a potential value of $50 million.

In our legal system, the decision of whether to settle belongs to the party, absent some other arrangement. Is it a problem for this decision to be made instead by a funder, whose financial interests might diverge from the plaintiff? And how far can a litigation financing agreement go in giving control to the funder? Is it okay for an agreement to provide for financial consequences to the plaintiff if the plaintiff refuses to go along with a settlement that the funder supports?

These are interesting issues — although not completely novel, litigation funders would argue. As Alan L. Zimmerman of Law Finance Group pointed out, we already have outside money involved in the litigation process: it’s called liability insurance. Insurers are non-party funders who agree to pay the costs of a litigation; take control of the litigation, by picking the lawyer, negotiating the fee, and deciding whether to settle; and engage in all of this in the hopes of earning a profit. So litigation funding is really not that different from liability insurance — and whatever ethical safeguards are used to protect the interests of defendants can be applied on the plaintiff’s side as well.

3. Do litigation funders take advantage of plaintiffs by charging too much for access to capital?

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After Lee Drucker of Lake Whillans — a litigation finance “rock star,” in the words of his panel moderator, Selvyn Seidel of Fulbrook Capital Management — gave a very interesting talk on how to value a claim, Seidel raised a related issue: how does that value get allocated? Seidel mentioned that some critics of litigation finance argue that certain funders are “gouging” plaintiffs by charging too much for financing, i.e., driving bargains that are too hard. NYU law professor Stephen Gillers, an expert in legal ethics, expressed concern over the scenario described by Desmarais in which a funder walks away with millions and the client — the client, who’s owed loyalty from the lawyer — gets nothing or next to nothing.

This can be a problem — but it will probably weaken as the litigation finance industry expands, according to Alan Zimmerman. As more companies enter the space and competition between funders increases, plaintiffs should be able to get better deals, in terms of both how much the funder charges and how much control the funder exerts over the case.

4. Are litigation funding arrangements discoverable in the litigation being financed — and could their revelation lead to embarrassing or problematic disclosures for the party being funded?

Several panelists, including John Desmarais and Stephen Gillers, raised this issue. As Desmarais noted, when a financing arrangement is being negotiated the funder and the plaintiff are adverse to each other, so you’d think documents related to funding wouldn’t be protected under the attorney-client privilege.

But as many privilege-log-preparing junior associates well know, the attorney-client privilege isn’t the only way to keep documents out of discovery. There’s also the attorney work product protection. And the general trend in the case law, according to Georgetown law professor J. Maria Glover, has been to protect financing-related documents as attorney work product, prepared in anticipation of litigation. Professor Glover said that courts seem to be reasoning that allowing discovery into funding arrangements would be extremely costly to plaintiffs and would effectively “tax” the use of litigation financing, which some judges see as beneficial in helping to level the playing field between plaintiffs and defendants.

5. What about litigation funding in the class-action context?

What would be the ramifications of bringing litigation financing to the world of aggregate litigation? This was the focus of several conference speakers, including two class-action gurus — Professor Catherine Piché of the University of Montreal, who generally seemed in favor, Professor Brian Fitzpatrick of Vanderbilt, who generally seemed opposed — and veteran class-action lawyer Michael Fishbein.

Fishbein raised a whole host of challenges to integrating litigation financing into class actions. Is it a violation of legal ethics, in terms of either splitting fees with non-lawyers or agreeing to an excessive interest rate? Will the funding arrangement disturb the alignment of the lawyer’s interests with the client’s interest or impair the lawyer’s professional judgment in the case? How should funding affect the appointment of class counsel? If a funder wants too much control over a case, will that prevent the class-action lawyer from providing the class with fair and adequate representation?

But these are, at least for now, problems for another day. Litigation financing hasn’t made major inroads into the world of U.S. class action litigation, and it probably won’t for a while — due in part to the complexities identified by the panelists.

Thanks again to NYU’s Center on Civil Justice and Journal of Law & Business for a day of enlightening conversations (and free lunch, cookies, and CLE credit).

Litigation Funding: The Basics and Beyond [Center on Civil Justice / NYU Journal of Law & Business]
How to Value a Litigation or Legal Claim [Lake Whillans Litigation Finance]
The Real and Ugly Facts of Litigation Funding [U.S. Chamber of Commerce Institute for Legal Reform]
Litigation Finance: Doing Well by Doing Good? Or Just Doing Well? [Mighty]

Earlier: 6 Virtues Of Litigation Finance
Litigation Finance: The Next Hot Trend?
New York to $180K. I’m Totally Serious.
Prior ATL coverage of litigation finance