Non-recourse commercial litigation funding has clear public policy benefits. It enables claim holders to pursue litigation they cannot otherwise afford, as well as match resources of deep-pocketed defendants in David vs. Goliath disputes.
Rarely discussed, however, is the impact of existing creditors on a plaintiff’s ability to obtain funding. Funders routinely decline to invest in matters, regardless of legal merit, where senior lienholders would encumber the litigation proceeds. That is because encumbrances on a plaintiff’s recovery enhance the risk that a valuable judgment—even if collectible—may be insufficient for a funder to receive an investment return. Resource-lacking litigants are therefore deprived of access to justice, and considerable claims are left to lapse.
A solution to the credit problem is what is known as “lawyer-directed” litigation finance. Instead of contracting with a litigant in a classic “client-directed” or “single-case” transaction, a funder contracts with contingency counsel. Senior liens are less problematic due to the statutory priority (or even super-priority) of charging liens.
Although lawyer-directed funding has grown in popularity, critics point to potential fee-splitting concerns under the Rules of Professional Conduct. The purpose of this article is not to address the merits of the various technical and ethical arguments lodged in support of and against lawyer-directed funding. Instead, it is to discuss the largely unappreciated access-to-justice benefits that lawyer-directed funding can provide.
Overview of Funding Structures
Both “lawyer-directed” and “client-directed” structures usually involve the funder and law firm sharing the risk of affirmative litigation. The main differences are (1) the parties to the transaction and (2) the source of the funder’s return.
In “lawyer-directed funding,” a funder directly finances a law firm’s contingency cases. In exchange, the funder’s collateral consists of the firm’s contingent fee recoveries.
In “client-directed funding,” a funder transacts with a claim holder rather than counsel. The funder provides non-recourse capital to or on behalf of the client. In return, the funder is compensated from proceeds received in the underlying litigation.
Properly-structured client-directed transactions are commonly accepted as permissible in most jurisdictions. Because client-directed funding does not implicate fee-splitting concerns, some commentators have deemed lawyer-directed funding unnecessary in light of a claim holder’s ability to directly obtain funding.
Difficulties Securing Funding
Although well-capitalized businesses are increasingly leveraging litigation funding, a substantial segment of the market remains financially-constrained claim holders that require third-party capital to pursue their claims. Absent outside funding, such claim holders are either unable to file suit, are forced to disengage from litigation once it becomes prohibitively expensive, or must choose between continuing to fund business operations or litigate.
Unsurprisingly, claim holders lacking the financial wherewithal to pay for litigation are often indebted to others. Indeed, a claim holder’s poor financial condition is often caused by the events underlying the litigation for which it seeks financing. As a result, such claim holders frequently have various all-asset creditors, including taxing authorities.
Such claim holders face difficulty in obtaining client-directed funding. Despite the strength of a claim holder’s legal claims, litigation funders routinely decline to enter into transactions where another entity possesses a lien that would encompass the litigation proceeds. The result is an unfortunate situation where a claim holder has valid legal claims worthy of investment, yet cannot obtain funding to pursue them.
While contingency attorneys exist, they may be unable or unwilling to assume the full risk of a litigation for various reasons, including costly expenditures required in complex litigation. A client may also insist upon counsel that does not have the risk appetite for a full-contingency engagement.
The Priority of Attorney Charging Liens
Unlike litigation funders, attorneys may assert charging liens on litigation proceeds. Charging liens, which arise under state statutory or common law, prevent the disbursement of settlement or judgment proceeds until fee claims asserted by the attorneys prosecuting the case are satisfied. The liens thus ensure that some portion of any monetary recovery will pay for the attorneys who helped generate it.
While charging liens differ somewhat from state to state, many jurisdictions recognize that properly-perfected charging liens are superior to other creditors’ liens. Washington, for example, holds that charging liens are “superior to all other liens.” Other jurisdictions, such as Georgia, recognize them as superior to all liens other than state tax liens. The Internal Revenue Code itself recognizes the super-priority of attorneys’ liens over federal tax liens.
Courts acknowledging the priority of charging liens typically cite the role played by counsel in creating the source of recovery. The New York Court of Appeals described an attorney’s charging lien as not merely “an enforceable right against the property of another” but “an equitable ownership interest in the client’s cause of action.” LMWT Realty Corp. v. Davis Agency Inc., 85 N.Y.2d 462, 467 (1995).
It also found an additional “equitable factor” favoring priority—“the attorney’s services created the fund at issue, and under those circumstances the attorney’s charging lien must be given effect, even though a prior lien against the specific fund exists.”
Ohio courts have similarly recognized that failing to afford attorneys’ liens priority risks “leaving without remuneration of any sort the attorneys but for whose efforts, presumably, the fund would not have been procured or made available for the payment of the creditors either of the firm or the individuals composing it.” See Cuyahoga Cty. Bd. of Commrs. v. Maloof Properties Ltd., 197 Ohio App. 3d 712, 716 (2012).
The Delaware Supreme Court has likewise recognized “the public policy that without the services and skill of the attorney, there would be no recovery” as a historical basis for affording charging liens priority over other claims. Doroshow, Pasquale, Krawitz & Bhaya v. Nanticoke Mem’l Hosp. Inc., 36 A.3d 336, 345 (Del. 2012).
Lawyer-Directed Funding as a Solution
The policy rationale for the priority of charging liens should also apply to litigation funding. In cases involving litigation funding, no less than cases in which attorneys must look to proceeds to justify their fee claims, parties assume risk to generate litigation proceeds that may not otherwise exist.
However, no statutory priority currently exists for client-directed funding. Accordingly, at least in jurisdictions that acknowledge the priority of attorney charging liens, lawyer-directed funding can afford claim holders a solution to credit issues that would otherwise preclude their ability to pursue their legal claims.
The promotion of access to justice should therefore be an important consideration in the debate of whether lawyer-directed funding should be permitted. While technical fee-splitting concerns may exist, the established public policy benefits of litigation funding should not be restricted to certain classes of claim holders.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Dai Wai Chin Feman is director of commercial litigation strategies and corporate counsel at Parabellum Capital LLC, a litigation finance firm in New York.
John C. Martin is a partner and litigator at Sugar Felsenthal Grais & Helsinger LLP, a Chicago law firm.