Spotting the Issues Associated with Third-Party Litigation Financing (Corrected)

Third-party litigation funding is a powerful tool that is increasingly popular and is allowing claims that would not have been financially viable to proceed through litigation. While increased utilization of third-party funding could signal more work for litigators, the practice is not without its ethical considerations. A panel at the ABA Spring 2018 National Legal Malpractice Conference in Washington, D.C., gave practitioners an overview of litigation financing and potential ethics issues.

Third-Party Litigation Financing

Nicole Berg, Vice President at Burford Capital LCC in Chicago, presented an overview of third-party litigation finance to conference attendees. Litigation finance refers to financial tools based on the value of legal claims as assets. The financing is non-recourse and repayment is contingent on a particular outcome in the litigation. Berg explained that litigation financing allows a litigant to “monetize what they recognize as an asset.” The rate of return for the funder depends on the risk of recovery.

Litigation financing is available to both claimants and defendants. While litigation financing on the plaintiffs side is easy to envision—functioning similar to a traditional contingency fee—it can be used for litigation defense as well. Berg explained that on the defense side it is simply necessary to “define what a win is.” When a litigant or law firm obtains litigation financing, it does not alter the underlying relationship between the client and law firm. The financing agreement with the funder is separate from the engagement letter between the client and law firm.

Litigants use financing for a variety of purposes, including to pay legal costs and expenses, generate working capital, and manage risk of negative outcomes. Litigation finance can ease burdens for litigants with “fee fatigue” or allow for alternate rate structures. Additionally, financing can be used at any point in litigation, including to accelerate litigation proceeds when an award or judgment is on appeal or awaiting collection. There are also hybrid structures available, where the funding is a combination of recourse and non-recourse financing. According to Berg, there are accounting advantages available when utilizing litigation funding, as it allows a litigant to improve operating cash flow by removing litigation cost from above-the-line expenses.

The use of litigation financing is on the rise. In 2013, seven percent of U.S. law firms reported using litigation funding. By 2017, that number had risen to 36 percent, according to a 2017 Litigation Finance Survey. As the litigation financing market is maturing, financiers are increasingly moving from single-case funding to portfolio arrangements. In explaining this trend, Berg explained that portfolio funding presents less risk to the investor and, in turn, is less expensive.

A Tool for Law Firms

Litigation financing also serves as a business development tool and a risk management tool for law firms. Berg said litigation financing can provide non-recourse capital to law firms and allows law firms to create “hybrid contingency structures” for hourly clients when there is pressure to reduce fees. Under such an arrangement, the law firm’s fees or a portion thereof are paid by the funder, who bears the risk of non-recovery. This allows law firms to pitch for cases that they previously would not have been able to because of the potential risk or cost to the firm. Likewise, Berg explained that attorneys who work on a contingency basis can monetize their anticipated fees before proceeding to trial, which provides working capital and can reduce their risk. Financing can also be used to accelerate litigation-related receivables, such as an attorney fee award pending court approval.

Which Matters?

Not all matters are created equal when it comes to third-party litigation financing. Berg explained that a funder’s evaluation of a matter will include looking at the type of matter, the merits of claim, the counsel, the jurisdiction and the potential damages.

Typically, meritorious commercial business-to-business disputes are best suited to litigation financing. In such disputes between sophisticated parties, the funder can do its own diligence to assess the strength of the claim, Berg said. She emphasized that funders will typically take notice of the counsel handling the case, as the funder is a passive investor and must rely on counsel to litigate the matter well. As for jurisdiction, litigation financing is typically available for domestic litigation and arbitration in recognized fora.

Berg placed particular emphasis on the role of damages in the financing decision. Not only does there have “to be something at the end of the rainbow,” it also has to be enough to make sure that the funder “gets paid and that the client has significant upside.” A “significant upside” for the client is necessary to ensure that the client is “incentivized to make rational decisions,” she said.

Ethical Considerations

The panel next discussed the ethical considerations that practitioners should consider when utilizing litigation financing. Panel moderator Laura Simon, executive vice president at Lawyers Protector Plan in Tampa, Florida, explained that there is no specific ethical rule addressing litigation fund and little ethics guidance is available on the topic. Simon recommended that practitioners proceed cautiously as there are many litigation funders popping up and they may not all follow best practices.

Potential Conflicts of Interest

To highlight potential conflicts of interest that could arise when negotiating a funding arrangement, the panel presented a hypothetical where a lawyer had represented a client paying an hourly rate in contentious litigation for a number of years. The legal fees had become so high that the client needed additional funding to continue paying the fees. The panel asked the audience whether the lawyer could take on negotiating a litigation funding agreement without a conflict waiver.

The overwhelming answer from the audience and from the panel was that it would be most prudent for the attorney to seek a conflict waiver from the client. John Storino, a partner at Jenner & Block LLP in Chicago, explained that particularly, in light of the information that the client could not have continued the representation without the funding, a waiver would be the best course of action. Storino explained that this fact pattern implicated Model Rule of Professional Conduct 1.7(a)(2) as there is a “[s]ignficant risk that the representation … will be maternally limited by … a personal interest of the lawyer.” In the hypothetical, the attorney has a personal interest to not aggressively represent the client in negotiating with the funder because if the deal with the funder falls apart, the lawyer may not be paid in the underlying litigation. Storino mentioned that New York City Formal Ethics Op. 2011-2 (June 15, 2011) advises that there is a possible conflict if, absent third-party funding, the client could not afford to start or continue the lawsuit.

The panel emphasized that a lawyer needs to examine the facts of each situation to assess whether waiver is necessary and sufficient to address the potential conflict. In some situations, a waiver may not be sufficient. Robert Cary, a partner at Williams and Connolly LLP in Washington, D.C., explained that if an attorney routinely receives referrals from a specific funder, it would materially change the conflicts analysis. Cary warned that malpractice plaintiffs’ attorneys are “always looking for a conflict,” and the best practice to avoid any appearance of impropriety is “disclosure, disclosure, disclosure.”

Legal Advice on Litigation Funding

If asked to negotiate a funding agreement, a lawyer should advise the client on the costs and benefits of third-party funding. Storino explained that an attorney advising on financing should counsel a client that fees charged on non-recourse financing may be excessive, relative to other financing options, as is suggested in New York City Formal Ethics Op. 2011-2. Additionally, Storino noted that an attorney should advise its client that the funding may consume nearly all of the recovery, citing to Francis v. Mirman, Markovits & Landau, P.C., No. 29993/10 (N.Y. Sup. Ct. Jan. 3, 2013). Cary added that in this area “the line between business advice and legal advice is easily blurred,” and that practitioners should document their advice.

Impact on Litigation

Increasing use of litigation financing means that there is both more litigation, because plaintiffs who could not otherwise afford litigation have funding to bring suit, and longer litigation because both parties have the resources to go to trial. Cary suggested that, due to litigation funding, this may be the “Golden Age for commercial litigation.” As the plaintiffs’ bar is better funded, the defense strategy of “waiting them out” is not going to work as well, according to Cary. Funding can also result in more aggressive litigation as the risk is transferred from a party to a funder that has resources for no-hold barred tactics.

As for the use of funding in legal malpractice suits, the panel explained that some funders will fund claims against lawyers and some will not. Berg noted that litigation finance firms are services providers to lawyers and may not be particularly eager to play a role in a suit against a lawyer. Cary noted that he has not seen a malpractice case that he knows received litigation funding, but notes that it can be costly to try the “case within the case,” which could make funding appealing.

Production of the Funding Agreement

Often in litigation, a defendant wants to know how a plaintiff is funding the litigation. Several courts have held that funding documents are protected under the work product doctrine. Even though defendants are particularly curious about funding arraignments, relevance may be the best argument against disclosure, according to the panel.

While there is currently little regulation or disclosure requirements for the financing industry, Cary explained that the regulatory environment is evolving and the U.S. Chamber of Commerce has become more involved. The Chamber has been pushing for legislation requiring disclosure of funding contracts and a prohibition on litigation funding of class action law suits. In 2017, the U.S. District Court for the Northern District of California adopted a new rule (the first of its type) requiring automatic disclosure of third-party funding agreements in proposed class action lawsuits.

Cary also highlighted that on April 5, 2018, Wisconsin passed a law requiring plaintiffs in all civil actions to disclose litigation financing agreements. The Wisconsin legislation is unique because it includes commercial litigation funding as well as consumer lending. Cary went on to explain that Nevada explicitly protects funding agreements from disclosure and that the majority of case law on the subject holds that funding arraignments need not be disclosed in discovery. Berg added that disclosure should not be necessary, explaining that commercial loans are not routinely disclosed and that litigation funders often take a more passive role in litigation than insurers.

Impact on Attorney Client Privilege

Cary warned practitioners that there is a potential risk that attorney-client privilege can be waived if the attorney provides confidential communications or work product to the funder. For example, in Miller UK Ltd. v. Caterpillar, any document that plaintiff shared with the prospective funder that was otherwise protected by attorney client privilege lost that protection. 17 F. Supp. 3d 711, 740 (N.D. Ill. 2014). Berg commented that a funder typically does not need to see attorney client communications, and often work product will be protected from disclosure. The panel advised that before disclosing privileged information, a lawyer should obtain the client’s informed consent, which requires explaining the possible waiver of privilege and other litigation consequences.