New Litigation Funding Rule: Transparency Boost Or Unnecessary ‘Sideshow’ Risk? 

The federal District Court for the District Of New Jersey adopted a new local rule on June 21 that requires the parties to a lawsuit to disclose all third-party litigation funding arrangements within 30 days of an initial pleading or transfer, or whenever the information becomes known.

New Local Civil Rule 7.1.1 became effective immediately, according to the order signed by Chief Judge Freda L. Wolfson. The disclosure applies to any person or entity that is not a party to the case but provides money for attorneys’ fees and expenses in exchange for a “contingent financial interest” based on the outcome.

Parties to cases pending when the district court’s order was signed have 45 days to provide their disclosure, which must identify any third-party funders with names, addresses — and if legal entities — the place of formation. 

The new local rule also requires a brief description of the financial interest the funders stand to gain if things go their way, as well as disclosure of whether the funders’ approval is required for litigation decisions or settlement. Parties may seek additional discovery of the terms of such an agreement “upon a showing of good cause that the non-party has authority to make material litigation decisions or settlement decisions, the interests of parties or the class (if applicable) are not being promoted or protected, or conflicts of interest exist,” the order said.

Proponents of the new local rule believe it is necessary because third-party funding agreements can pose ethical problems. In a letter in support of the rule, the U.S. Chamber Institute for Legal Reform and New Jersey Civil Justice Institute noted several reasons disclosure is a fine idea, including the avoidance of conflicts of interest and inappropriate fee-sharing between lawyers and non-lawyers. The letter also cited the need for parties to know the identity of their litigation adversaries, to know all information relevant to settlement efforts, and to know who may be exercising control or influence over litigation decisions. 

To the extent parties have sought disclosure related to third-party funding agreements through ordinary discovery, the letter noted that “plaintiffs generally object to providing it, and courts often do not compel production of the requested information.” With a rule in place, that is likely to change in the District of New Jersey.

“I think that what is evident is that two concerns animated this rule,” said Marla Decker, a managing director of Lake Whillans. “One is simply conflicts, which has been a topic in litigation finance in general and in particular, in the arbitration context where it is arguably more possible that an arbitrator (rather than a federal judge) has a relationship with a funder that could pose a conflict  . . . . The other concern is over who is really pulling the strings, who is controlling the litigation, which is a concern aligned with other rules aimed at disclosing the real parties in interest in a litigation.”

Lake Whillans, a commercial litigation finance firm, defines its practice as “the provision of capital to a claimholder or law firm in exchange for a portion of the proceeds from litigation or arbitration.” The firm notes a key feature is that any return on investment is generally limited to the proceeds of the litigation or arbitration award or a settlement. The litigation funder only gets paid if the party successfully wins or settles its case.

An ‘Imagined Problem’ 

Decker calls the idea that funders are regularly controlling litigation and not disclosing this to the courts a “bogeyman, an imagined problem.” 

While the New Jersey district court was no doubt trying to get out ahead of potential problems, Decker said, “my commercial experience is that it’s not happening.” 

She noted that claimants are usually very reluctant to give up control regarding litigation strategy or settlements. They have a built-in incentive to maintain control, Decker said: fear that the funders will serve their own interests and not the claimholders’ interests.

An issue litigation finance providers may have with this order, Decker said, is the possibility of a surge in onerous and unnecessary discovery.

“We did not have a knee jerk reaction to the order that we don’t want disclosure and that we would rather stay in the wings,” Decker said, “but we don’t want claimholders to be prejudiced by this rule and see cases be drawn into a sideshow over the litigation funder.”

The new rule states that requests for further discovery into a litigation financing agreement will be granted when there is “good cause,” but it doesn’t provide any guidance as to what that cause might be, she said.

“This is why we’d prefer it the way it’s been handled so far — courts taking these discovery requests on an individual basis and crafting an individual order as it would for any question or dispute based on the facts and circumstances,” Decker added. “The scope and regularity of disclosure in cases where it has been sought is simply not consistent and normalized enough to warrant a one-size-fits-all rule.” 

A ‘Commercial Reality’ 

On the other hand, a local rule like this one from the N.J. district court can be viewed as simply an expression of the state of things, where the court has chosen to err on the side of transparency.

“Litigation funding is being used and it’s here to stay,” Decker said. “It is a commercial reality.”

It remains to be seen if this new local rule will influence perceptions and normalize litigation finance practices. “It could be that it helps the industry by showing some of the concerns are overblown,” Decker said.

Such rules targeting litigation finance are rare in the federal courts, and this New Jersey measure is the broadest thus far at the district court level. A litigation-funding disclosure rule in the U.S. District Court for the Northern District of California applies only to class actions.

“Those cases are a little different,” Decker explained. “The court plays a different role where it has to protect the class and supervise those that have a financial interest.”

Will other districts take this up? She is not sure.

“Efforts to change the national [federal] rules have been examined several times but the rules committee has yet to adopt new rules aimed at litigation finance disclosure. . . . Perhaps the step taken by the New Jersey district court is part of the normalization of litigation funding. Inevitably, more courts will be looking at these questions.”