Litigation finance is here to stay. State and local bar associations that don’t want their lawyers, business communities, and consumers to suffer from lack of capital during the continued fallout of the global pandemic should reconsider paternalistic prohibitions kneecapping the overwhelmingly positive impacts of litigation finance for improving law firm stability and profitability, reducing risk for businesses, and increasing access to justice for consumers who wouldn’t otherwise be able to afford litigation.
In this article, we’ll review the growth, maturity, and acceptance of litigation finance in the legal profession, highlights from the legal ethics “Best Practices” outlined in the American Bar Association’s August 2020 report on third-party litigation funding, and how the coinciding rise of legal technology and the availability of court data will continue to aid the expansion of litigation finance.
Growth, Maturity, & Acceptance
Within the broad definition of the third-party financing of a lawsuit or lawsuits in exchange for an interest in the potential future recovery or successful defense of a claim on a non-recourse basis, litigation finance spans a sprawling range of funding structures and activities.
In the commercial context, outside of consumer litigation, funders are coalescing behind portfolio financing as the industry matures, because it allows for financiers to spread their risk and invest in a set of claims either held by the same claimant or handled by a single law firm. As Lake Whillans noted earlier this year, portfolio financing, the “Neapolitan” flavor of litigation finance, is also beneficial for the claimant or law firm involved, as they “can generally obtain funding at a lower cost of capital” due to funders being “willing to accept a lower return because investing in a portfolio is less risky than investing in a single claim with a binary outcome.”
This move toward investing in aggregated claims as portfolios may also may be a direct outcome of the increased appetite to invest that continues to fuel the impressive growth of litigation finance. With the launch of Pravati Capital’s $200 million fund this month, its fifth fund since 2013, firms in the litigation finance space have raised more than $1 billion so far in 2020, and there are still signs for continued growth this year due to an uptick in demand caused by COVID-19.
Along with steady growth and maturity in the litigation finance industry, there is also an expanding acceptance bubbling within the legal profession. In the insightful report Above the Law published recently in conjunction with Lake Whillans, The 2020 Litigation Finance Survey Report, one of the key indicators of lawyer acceptance is that the attorneys who used litigation finance unequivocally love it.
With lawyer satisfaction at a whopping 99.36% for those who used funding and would use it again, combined with a marked uptick of a 30% year-over-year increase in the percentage of survey respondents reporting first hand experience with litigation finance, it’s only a matter of time before a broader swath of accepting lawyers outpace naysayers and push to remove the remaining legal ethics barriers preventing much needed access to capital in the legal profession.
ABA “Best Practices” on Lawyer Independence & Portfolio Funding
As litigation finance and the legal ethics considerations it’s challenging continue to clash, the ABA formally adopted a new report entitled American Bar Association Best Practices for Third-Party Litigation Funding this August. The 33 page report covers a broad range of topics and provides helpful recommendations for lawyers interested in using litigation finance in their practices.
However, the ABA goes to great lengths in the report to spell out in explicit terms that the “Best Practices” and recommendations it elucidates aren’t really recommendations or positional stances on litigation funding or “whether litigation funding should be permitted, as a matter of law or legal ethics, in any particular jurisdiction or in any particular context.” Disclaimers aside, the ABA’s report does provide a thoughtful discussion of how litigation finance has created divisions among bar associations on the perennial issue of lawyer independence, and especially how lawyer independence is implicated in the context of portfolio financing.
Of the many barriers preventing innovation in the legal industry, Model Rule of Professional Conduct 5.4(a) and the state corollaries on lawyer independence have long acted as paternalistic prohibitions against splitting fees with non-lawyers, using the logic that lawyers, most of whom have gone through four years of undergrad, three years of law school, and then passed the intellectual marathon that is the bar exam, are clearly not smart enough maintain their independence when sharing fees with non-lawyers, so it needs to be prohibited. As the ABA report points out, the New York City Bar Association has taken this exact stance that the fee-splitting that would occur in lawyer-side portfolio financing is impermissible. But as the report also notes, “positions on fee splitting, however, are far from unanimous.”
More reasonable and forward-thinking state and local bar associations have moved past prohibitions on fee-sharing in litigation finance and portfolio financing, and have largely done so by taking one of two tacks. The first and more direct approach has been to modify the state or local version of 5.4(a) to exempt sharing fees with funders as long as: (1) the lawyer remains independent, and (2) the client remains in control of the lawsuit.
The second approach is geared around the premise that “the source of the payment should not be the key factor, but must focus upon ‘independence,’ and not the flow of funds.” The report goes on to explain that the second approach highlights two key features of ethically permissible law firm funding that help lawyer independence: (1) including language in the funding agreement explicitly noting the funder has no right to control litigation strategy or settlement decisions, and (2) including multiple matters, “typically three or more,” in a portfolio to be financed to separate the funder’s return from any one particular client’s matter.
In addition to being an attractive option for untying funder returns from lawyers’ fees for individual matters, the ABA also notes that structuring finance around multiple claims typically involves some form of cross-collateralization, which may allow law firms to secure funding more quickly on pre-arranged terms, and potentially at a lower cost of capital as funder risk is spread across multiple claims. Thus, further reaffirming the preferred choice of the “Neapolitan” flavor of litigation finance for lawyer-side funding.
While the jury may still be out on which approach on interpreting lawyer independence will become the “law of the land” for litigation funding, and while issues on conflicts of interest due to funding arrangements can pose real concerns lawyers should not shirk aside, the positive benefits of portfolio financing for lawyers, funders, and, ultimately, clients, are unambiguous and deserving of recognition.
Finding New Portfolio Opportunities with Court Data
Coinciding with the booming growth of the litigation finance industry, there has also been a parallel exponential growth in the availability of court data, as more mature legal technology companies are challenging the dominance of legacy legal research providers, and winning important legal battles to improve access to legal information.
In stark contrast to the gatekeeper roles legacy providers have long held over access to data in the legal profession, multiple legal tech companies offer lawyers, legal professionals, and litigation funders with bulk access to litigation data via Legal Data APIs. Rather than taking at face value the analytics of how well lawyers and law firms have performed in litigation, funders can easily download all of the underlying data for a target lawyer or law firm’s cases in a structured format, giving them the ability to conduct their own due diligence on their side of the firewall.
In the context of portfolio financing, bulk API access to court data provides funders with a streamlined method for unearthing new, potentially profitable litigation portfolios and the specific slices of lawyers’ practices with the highest likelihood of return. Most importantly, it can help funders scale their operations to identify and connect with a growing number of lawyers as the market’s interest in litigation finance continues upwards. And as new state and local bar associations open the doors to litigation finance and lawyer-side portfolio financing, funders can flip the switch and apply the same models they’ve developed to further scale their operations in those new jurisdictions using court data.
The demand for litigation finance is real, from the investors seeing a maturing asset class, to the lawyers who’ve used funding and overwhelmingly love it, and the businesses and consumers they represent in court. There are “Best Practices” available for state and local bar associations to model that squarely address the issues surrounding lawyer independence. And it’s time to drop the mask of protecting the public through prohibitions on non-lawyer fee-sharing and allow lawyers to take advantage of the same financing tools available to other industries as they navigate managing a law practice in the thralls of a global pandemic.
Jeff Cox is the Director of Content & Data Acquisition for UniCourt, a SaaS offering using machine learning to disrupt the way court data is organized, accessed, and used. UniCourt provides Legal Data as a Service (LDaaS) via our APIs to AmLaw 50 firms and Fortune 500 businesses for accessing normalized court data for business development and intelligence, analytics, machine learning models, process automation, background checks, investigations, and underwriting.
