Litigation Funders Set to Prosper in Proposed NY Rule Change

A New York City bar committee is pushing to change state rules to allow law firms to assign or pledge fees in exchange for outside financing.

Funding to law firms tied to the results of specific cases should be permitted, the New York City Bar Association’s Professional Responsibility Committee proposed last week in two amendments to Rule 5.4(a). The rule bans lawyers and law firms from sharing fees with nonlawyers.

If adopted, the amendments would resolve uncertainty over litigation funding deals in New York. Litigation finance has grown to a $13.5 billion industry in which investors fund lawsuits and take a portion of any successful awards.

The proposed amendments reiterate that lawyers must not allow their judgment be impaired by the relationship with a financial provider. It also would require law firms to notify clients of financial arrangements that could impact the representation of the client and field questions about it.

“To restrict how lawyers and law firms finance their practices by presupposing that one type of financing has the power to corrupt a lawyer’s professional ethics more than any other financial arrangement with a nonlawyer is an exercise in paternalism that the Committee, based on the Working Group Report and its own subcommittee’s research, cannot justify,” the committee wrote in its proposal.

The Professional Responsibility Committee examines legal ethics issues facing lawyers in New York and is comprised of 19 legal practitioners.

“This is like a very rational, logical recommendation,” said Dai Wai Chin Feman, managing director at litigation funder Parabellum Capital and a member of the litigation funding working group formed by the New York City Bar Association.

“It dispels the fiction of how people think that non-recourse funding will create more of a conflict of interest than loans,” he added.

Rule 5.4 was initially created as a safeguard to prevent lawyers’ judgment from being influenced by nonlawyers. It also bans law firms from going public or taking on private equity and other investors.

The rule has been modified in recent years in some states, which positioned looser restrictions as a way to increase access to legal services for lower and middle income populations. Litigation funders have also benefited from the relaxing of these rules.

Washington D.C. adopted a modified rule in 1991 and permitted partial nonlawyer ownership of law firms. Utah and Arizona changed their rules in 2020.

The Utah Bar created a pilot program allowing nonlawyer-owned entities to apply for a license to offer legal services. The Arizona Bar eliminated rule 5.4 and created a licensing requirement for firms partially owned by nonlawyers that provide legal services. Arizona law firms are also now allowed to split fees with nonlawyers, and some of the licensed structures are partially owned by litigation funders.

Early Roadblock

In New York, litigation funding for law firms was stymied by a 2018 opinion issued by the City Bar Committee on Professional Ethics that concluded funding agreements with law firms would violate Rule 5.4.

The 2018 opinion caused a stir in the litigation funding community and prompted the NYC Bar president to form the Litigation Funding Working Group later the same year. The goal of the group, which consisted of 25 lawyers, academics and funders, was to study litigation finance and provide a report with recommendations regarding its practices.

Their 90-page report, which was released in March 2020, presented two amendments to Rule 5.4. A separate Professional Responsibility Committee rejected the proposals as too complicated and overly broad.

“You get to the same point, but I think we get there in a more straightforward and simpler fashion,” said Aegis Frumento, former chair of the Professional Responsibility Committee, of the recent amendments.

The proposed amendments will now go the State Bar Association of New York, which if they agree, will then submit them for approval to the four appellate divisions of the New York State Supreme Court for adoption to the rules of professional conduct.