Litigation Finance

The Reality Of Litigation Funding

The just-issued report on litigation finance represents serious effort, by a serious team, on perhaps the most serious issue confronting the legal profession today.

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A hallmark of an important professional development is when definitive statements proclaiming a new reality are made by serious sources. If anyone was unsure of whether the litigation finance phenomenon had reached that tipping point, they can now feel free to rid themselves of any uncertainty. No lesser a source than the New York City Bar Association Litigation Funding Working Group has spoken, declaring that “the New York Rules of Professional Conduct should be modified to accommodate the reality of litigation funding.” Lest you think that this impactful statement is the product of unserious thinking, please understand that the members of this working group include prominent academics, practitioners, litigation funders, and former jurists. A group that collectively worked over a year to conduct a “comprehensive study and review of the issues and practices surrounding litigation funding” before issuing their report, while also soliciting input on numerous occasions “from a range of guest speakers, including practitioners, scholars, and experts in the fields of commercial and consumer finance.”

Their just-issued report on litigation finance represents serious effort, by a serious team, on perhaps the most serious issue confronting the legal profession today. One that comes just after the City Bar’s Committee on Professional Ethics’ notorious (at least in litigation finance circles) prior decision that “non-recourse financing agreement secured by legal fees in a matter — i.e., an arrangement in which it is contemplated that the lawyer will make future payments only if the lawyer recovers fees — constitutes an impermissible fee-sharing arrangement” in violation of ethics rules. While that decision did not seem to have much of a chilling effect on the spread of litigation finance nationwide (or even in New York,) it did stand out as the clearest statement of concern that litigation finance arrangements could constitute ethics violations. Not the greatest messaging for a burgeoning industry attracting immense investor interest — or for the lawyers and firms eagerly lining up for a shot of that sweet nonrecourse manna being doled out by flush funders in an effort to generate returns for those investors.

But as I referenced above, the new recommendation is that the ethical rules be modified, not that litigation funding be restricted. Bending to the new reality, if you will. While serious questions still remain about the impacts on (distortions of) the attorney-client relationship that are engendered by litigation finance arrangements, it seems clear for now that both the bar and funding industry are committed to working together to minimize the potential negatives so that the glorious positives can be realized. Is there self-interest on all sides motivating the relationship? Of course. But there must also be a committed response to what is actually going on in the legal industry in the US — one that takes into account both the historical record and treatment of third-party funding of lawyers and claims, as well as the lessons that can be learned from the development and deployment of litigation funding overseas.

To that end, the Working Group’s report is a major contribution. At minimum, it serves as a handy primer on the historical concerns surrounding the use of third-party funding as a driver of litigation, along with a useful overview of how litigation funding is being handled by other common law legal systems such as Australia. For that alone it is a must-read for anyone whose practice is impacted  by litigation finance — i.e. nearly every litigator practicing today, as well as an increasingly wide swath of nonlitigators, such as in-house counsel or those corporate types who serve the litigation finance industry, just to start. But the report’s main contribution, at least in my view, revolves around its competing proposals for amending the ethical rules in New York to allow for certain permissible litigation funding structures. A detailed analysis of those proposals will have to wait for a future column, especially as they relate to the reality of litigation funding in today’s IP industry. For now, however, I think it is very important to highlight a few critical observations about the nature of litigation finance underlying the need to amend the ethical rules at all.

First, the report provides confirmation that the very existence of litigation funding implicates ethical concerns. Indeed, those concerns primarily manifest themselves in the answers to a simple set of questions, such as: Could a funder “improperly influence the legal representation?”

“Of course” is the only rational answer, which is why both proposals make clear that the existence of a funding relationship should not influence the decision-making of the lawyer, or somehow vest the funder with decision-making authority on critical issues such as settlement or litigation strategy. Whether a funder can advise on those issues is addressed more permissively, but there remains a fundamental unease with the idea that a litigation funder can somehow displace the “client” and become the lawyer’s true client just because they are contributing to the cause financially. For now, at least, the Working Group is endorsing ethical rules that would allow some forms of what I term “passive” litigation funding, Where that leaves funders and investors in favor of more activist approaches is a very important question that will likely need addressing over time.

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Second, the report is also a tacit acknowledgment of what has been said about the true aims of the litigation funding industry. Namely that it is effectively an elaborate workaround of the traditional ethical stricture around nonlawyer investment in law firms. In what I think is implicit recognition of that tension, it was not surprising to see a split between the two proposals on how litigation funding can be used. One proposal seeks to limit the use of litigation funding to only those expenditures incurred for the benefit of the client during the representation — and proposes limiting language to that effect. The second, however, suggests that a more expansive use of litigation funding be sanctioned, which would allow for law firms to make operational investments that more indirectly benefit the client’s interests. This is a critical issue, since we know that both funders and law firms are always looking for ways to diversify their exposure to the risks they each face, which has led to heightened interest in things like portfolio financing of a law firm’s entire contingency book of business, as just one example.

Ultimately, these are just preliminary thoughts based on an initial reading of the entire report. At the same time, just how important a contribution this report is to the vital discussion around the issue of litigation funding can’t be overstated. Those of us — particularly those of us in IP where litigation funding has already transformed the patent litigation landscape — have no choice but to become informed about all the contours of this career-defining issue. Because failure to accept the “reality of litigation funding” dooms uninformed lawyers — and their unfortunate clients — to both a difficult present and challenging future.

Please feel free to send comments or questions to me at gkroub@kskiplaw.com or via Twitter: @gkroub. Any topic suggestions or thoughts are most welcome.

Gaston Kroub lives in Brooklyn and is a founding partner of Kroub, Silbersher & Kolmykov PLLC, an intellectual property litigation boutique, and Markman Advisors LLC, a leading consultancy on patent issues for the investment community. Gaston’s practice focuses on intellectual property litigation and related counseling, with a strong focus on patent matters. You can reach him at gkroub@kskiplaw.com or follow him on Twitter: @gkroub.

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