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Litigation
Third-Party Litigation Financing: Its Time to Let clients choose

www. NYLJ.com
Monday, septeMber 13, 2010

By Louis M. soLoMon

HIRD-PARTY litigation financing refers to a variety of techniques by which persons or entities other than the party itself, the partys counsel, or a related source of financing are tapped to fund the significant costs of litigation, whether court costs and out-of-pocket disbursements or legal fees. In the United States,

Louis M. soLoMon is co-chairman of the litigation department at Cadwalader, Wickersham & Taft. Joseph MueLLer, a summer associate, assisted with the preparation of this article.

the issue has been controversial. It is a hotly discussed topic of late. Lawyers, academics and pundits of various kinds have expressed views ranging from unbridled enthusiasm to unequivocal condemnation, as usual, with most landing somewhere in between. Critics of third-party litigation financing have depicted it as a deceptively dangerous practice that appears too good to be true,1 while actually posing substantial risks of litigation abuse.2 In contrast, its supporters have suggested that litigation finance is an industry whose time has come and that it will increase access to justice and encourage private enforcement of the law.3 In many quarters the debate is an emotional one,

made more complicated because of the variety of third-party financing techniques available and the different types of claims it can be used for. Third-party litigation financing is on the rise, in Europe, Australia and in the United States.4 Yet to many, its future in this country remains uncertain and, indeed, suspect. Market forces are encouraging the industrys growth, while perceived legal regulations, but mostly value judgments, are restraining it.

How Different Is It?

Litigation financing from sources other than the party itself is not a new concept. We dont even include a companys use of its own capital

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even though that capital is borrowed from thirdparty stockholders, bondholders, banks, or other financial institutions. Quite apart from that, we have seen in the United States the growth of techniques such as lawyers themselves funding litigations. The contingency-based fee arrangement puts the law firm in the role of financier. In a contingency feebased case, the law firm clearly has a tremendous third-party interest in litigation; a firm invests the capital required to litigate its clients claim in exchange for an interest in a potential recovery. Or, as another example, consider duty to defend arrangements or litigation insurance, both of which shift the financial responsibility of providing litigation services to a third-party. At some level of generality, arent these techniques fairly called third-party litigation financing? It is true, and obvious we suppose, that law firm-funded litigation differs from arguably more removed types of third-party litigation financing. Special obligations surround the attorney-client relationship, including fiduciary duties that lawyers owe to their clients. Yet contingent fee contracts are routinely upheld by courts, and parties are permitted to contract concerning how the special lawyer-client relationship should be interpreted and applied in the context of a lawyers creation of value for the client. Another obvious difference is that the involvement of an additional party, beyond the law firm and the client it represents, may introduce conflicts of interest that could influence and theoretically taint the litigation process. Yet there exist long and established doctrines for limiting what legislatures and courts believe constitutes abusive behavior in this context. Doctrines of champerty and maintenance are examples. Under the doctrine of champerty, courts characterize certain investments in litigation as being against public policy because they grant a nonparty an impermissible interest in a suit.5 Although some jurisdictions still apply strict rules prohibiting champerty and fee-sharing, the trend has been to relax these rules. Many jurisdictions have taken a more cautious approach to applying restrictions such as champerty or abandoned them altogether.6 As another example, the Model Rules of Professional Conduct directly prohibit lawyers from sharing fees with non-attorneys.7 But to the extent third-party funder and litigant can structure their relationship to avoid fee-splitting, is it desirable to condemn the practice of financing nonetheless?

The potential for conflicts is hardly limited to third-party financing. Firms represent a great many clients, many of which have or potentially could have conflicting interests. These are typically remedied by a fully informed consensual waiver. And a common example of non-attorney involvement occurs when malpractice insurance providers issue policies to attorneys that essentially dictate, or certainly influence, how they must practice in order to be covered. The reality is that the practice of law is already rife with potentially conflicting interests and nonattorney involvement. We tolerate these because of a deep-seated belief that client freedom in choosing a lawyer is a paramount ingredient in the successful administration of justice.

Detractors Arguments
Detractors of third-party financing argue that such funding will increases frivolous litigation (i.e., claims that are not meritorious or have a low probability of prevailing). The argument goes that at least in some cases plaintiffs and lawyers may be more willing to bring frivolous claims

Increased third-party financing may theoretically make more money available for litigation, but would responsible investors competing in a robust marketplace ever cause increased frivolous litigation?
when litigation is being financed by a third party, because some of the risk of loss in bringing such claims is being born by the investor. In our experience, the reality couldnt be more different; those analyzing potential investments are experienced, savvy lawyers and other professionals. The hurdle rates they typically set for cases is so high that, if anything, cases that are just meritorious wont get funding. In any event, why would a third-party financier knowingly or more willingly invest in frivolous claims? Put another way, is an independent third-party investor significantly more likely to do that than a litigant itself or the law firm it retains to handle the case? If there is an asymmetry in information between the plaintiff and the investor, it is true that adverse selection is theoretically possible, and the investor may essentially be lured into investing in a low-probability claim. But how many times will that happen?

Moreover, an investor that properly researches and evaluates litigation, as most businesses investing in commercial litigation do, typically will want to invest in higher-probability or higherpayout claims; markets reward intelligent and diligent investors. It is true that increased third-party financing may theoretically make more money available for litigation, and thus there may be increased levels of litigation. But it is not clear why responsible investors competing in a robust marketplace would ever cause increased frivolous litigation. Another argument against the use of thirdparty financing is that it will adversely affect the settlement of cases. Issues pertaining to settlements are important because a vast majority of civil claims settle before trial. Current studies on the effects of third-party financing on settlements and bargaining power are decidedly mixed; most vary depending on the situation and timing of the funding.8 Indeed, one possible effect on settlements is that, in commercial litigation, which is typically wellresearched and forecasted, third-party financing may be a powerful signal to the other party that a claim is strong. Thus, financing might have the effect of encouraging settlement, to the extent a third-party funding source is known to the adversary. At this juncture, a concern over settlement frequency appears too theoretical. Critics also argue that in certain situations third-party financing may facilitate the exploitation of vulnerable plaintiffs. The argument is most commonly made in situations where relatively small claims are brought by individuals who do not have the funds to finance litigation themselves. Paradigmatic examples might include medical malpractice and personal injury tort claims. In these situations individuals often will lack the ability to finance their own litigation. Thus, in order to bring a suit they will have to obtain financing from a third party, often a law firm. Because these litigants are often desperate for funding, are not sophisticated businesspersons, and may lack the correct information to make informed choices, they have little bargaining power with which to negotiate for favorable financing deals. As a consequence, they may be vulnerable to being taken advantage of by predatory lenders. It is comforting when the defense bar exhibits such sympathy for plaintiffs, but we think the concern is misplaced. The current debate over third-party funding does not center on medical malpractice and personal injury tort claims. The horse left that barn years ago, and there

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exists today a developed, robust market for the financing of those claims. Today, the concern is far more over the potential proliferation of patent, antitrust and government fraud and related qui tam actions. We have found no concrete data supporting the contention that claimants are being exploited. Nor is it clear that limiting a clients choice of lawyer will lead to less rather than more abuse (we could argue the point either way). Abuse is theoretically possible in many types of lawyerclient relationships. We do not condemn them outright because of that. Finally, critics are concerned that pressure from funding companies may affect actual litigation strategy. When an attorneys work is being financed by the party involved, he assumedly will always act in the way that is best for the client. On the other hand, the argument goes, the advent of extensive third-party financing in litigation may unavoidably inject additional considerations into the decisionmaking process of litigants and their counsel. This is because the introduction of a third-party financier, to a certain extent, separates the ownership and control of a claim. We think this would be a harder issue were it not for two facts: First, because the existence of thirdparty financing better enables the client to choose a particular lawyer or law firm to handle the claim, it would to some extent undermine that choice to then have the funding organization interfere or act with a heavy hand. We are not aware of any reason why this should happen; all parties involved in fact want to rely on the perceived abilities of the chosen law firm. Second, based on our observation, as the industry is developing, the control issue is not being tested; in our experience, third-party financing organizations leave the litigating to the lawyer and law firm chosen by the client. Even in the absence of third-party financing, the interests of a client and the attorney can sometimes become unaligned. We do see a difference between the professional obligation a lawyer has to a client; it is something quite extraordinary and unique. But the lawyer will still have those obligations even in the presence of a third-party funding source. And, in addition, the parties may get a serious financial professional looking at the case evaluation as well.

funding could increase access to justice and the courts. And the increase might well be, not of frivolous cases, but of meritorious ones. A more efficient market would be enabling greater client choice. Users of third-party financing to fund commercial litigation claims may be benefitted in quite concrete ways. Sharing cost and risk is often desirable, and to the extent a client will not have to employ as much of its own capital to finance litigation, that capital can be put to other desirable uses. Additionally, a third-party financiers analysis as to whether a claim is worth investing in or pursuing may provide a company with additional information as to the soundness of its counsels legal advice. The speculation game can be played on both sides of this debate. One could argue, for example, that third-party litigation financing has the potential to bolster the bargaining position of parties that are typically disadvantaged. Some individuals or companies get pushed around in settlement negotiations or during other phases of litigation simply because they do not have the capital or leverage to finance the litigation of a relatively strong claim. These types of parties may include small companies (or individuals) who do not have the personal assets necessary to finance complex litigation. Thirdparty litigation financing provides these parties the opportunity to fully exploit the strength of their legal position without being hampered by their financial situation. Finally, third-party financing allows law firms to shift risk inherent in traditional billing arrangements. By having a third-party financier fund litigation that would otherwise require direct funding from a firm, the third party is essentially taking on a significant amount of direct financial risk. This may appeal to certain law firms. The situation is not meaningfully different from that of a company whose litigation is being financed by a law firm. Third-party financing allows parties who believe that they can better estimate the legal and economic utility of a claim to take on the financial risks of other and perhaps more risk averse parties.

Despite the potential, theoretical hazards presented by third-party financing, in our view the benefits outweigh the risks. This is especially true if such risks are mitigated not only by competitive market forces but also by reasonable oversight and regulation. In the end, we do not see a principled reason to mandate prohibition or even significant restriction of an industry that could potentially increase access to justice and law enforcement and that certainly will enhance the clients ability to choose lawyer and law firm. In analyzing how much to regulate third-party financing, the rules of professional conduct do not have to be left at the door. They are powerful checks on abuse and in our opinion are up to the task.

1. Courtney R. Barksdale, All That Glitters Isnt Gold: Analyzing the Costs and Benefits of Litigation Finance, 26 Rev. Litig. 707, 738 (2007). 2. John Beisner, Selling Lawsuits, Buying Trouble: ThirdParty Litigation Funding in the United States, U.S. Chamber Institute for Legal Reform, at 1 (October 2009). 3. Maya Steinitz, Whose Claim Is This Anyway? Third Party Litigation Funding, 95 Minn. L. Rev. (forthcoming 2011); see Julia H. McLaughlin, Litigation Funding: Charting a Legal and Ethical Course, 31 Vt. L. Rev. 615 (2007). 4. See Steven Garber, Alternative Litigation Financing in the United States: Issues, Knowns, and Unknowns, RAND Institute for Civil Justice Law, Finance, and Capital Markets Program, at 1 (2010). 5. E.g., Rancman v. Interim Settlement Funding Corp., 789 N.E.2d 217, 221 (Ohio 2003). 6. See, e.g., Osprey Inc. v. Cabana Limited Partnership, 532 S.E.2d 269, 278 (S.C. 2000) (We abolish champerty as a defense because we believe it no longer is required to prevent the evils traditionally associated with the doctrine as it developed in medieval times). 7. See ABA Model R. Prof. Conduct 5.4. 8. See Garber, supra note 4, at 32-34.

Let the Market Develop

Let the market develop within the benign but responsible limits of professional obligations that are already in place. In our view, we do a disservice to sophisticated clients when we put too heavy a thumb on the scale and interfere significantly in their choice of counsel.

What Are the Pros in Favor?

Third-party financing has the potential to provide clients with access to litigation counsel that might otherwise be cost or capital prohibitive. If the market is permitted to develop, third-party

Reprinted with permission from the September 13, 2010 edition of the NEW YORK LAW JOURNAL 2010 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877257-3382 or reprints@alm.com. # 070-09-10-23