Of Babies and Bathwater in Kentucky
In a poorly reasoned decision arising from a set of unusual facts, a federal district court in Kentucky recently ruled that litigation funding contracts are void under Kentucky law. This decision depends upon some profoundly misinformed ideas about how litigation funding works, and it makes the mistake of invalidating all litigation funding contracts just because one example of such a contract was problematic. It is a classic example of throwing the baby out with the bathwater.
In this case, Boling v. Prospect Funding Holdings, LLC, a plaintiff received $30,000 in a series of funding transactions over a period of four years. The funding company, Prospect Holdings, determined its fee as 5% of the advance, compounded monthly. After the plaintiff won a recovery, Prospect Funding claimed that he owed it about $300,000. When the plaintiff refused to pay, Prospect Funding sued to enforce its contract.
The district court had two bases for concluding that the contract was unenforceable: (1) that it violated Kentucky’s common-law rule against champerty, the practice of “intermeddling” in another person’s lawsuit by paying for litigation expenses; and (2) that it violated Kentucky’s rule against usury. In reaching its conclusion about champtery, the court asserted that litigation funding contracts are contrary to public policy because they provide a disincentive to settlement. In this connection, the court thought that litigants would be less willing to settle if they had an obligation to pay a litigation funder, preferring to roll the dice on winning a judgment at trial.
This decision is profoundly flawed for several reasons. First, it invalidates an entire class of contracts because one contract was abusive. To be sure, Prospect Funding’s fee structure was excessive. But the company is a rogue operator. It is not a member of the American Legal Finance Association (ALFA) and therefore does not follow industry-standard best practices, which mandate dramatically lower fees. The court’s decision is akin to outlawing all bank loans because a loan shark called himself a “bank.” Second, the court’s unfounded speculation about settlement prospects reflects a misunderstanding of how litigation funding works. Litigation funding levels the playing field, and a level playing field does not discourage settlement. To the contrary, when a wealthy litigant knows its opponent is underfunded, it will not make a reasonable settlement offer, hoping that financial pressure will make its opponent accept an unfair offer. Funding increases the prospects for settlement because it creates a more equitable economic dynamic between the parties. Thus, litigation funding is consistent with the public policy favoring settlements, not contrary to it. Third, the court’s ruling on usury simply casts aside the fact that litigation funding is an investment, not a loan. As many other courts have ruled, usury law does not apply to litigation funding because there is no absolute right of repayment.
Because the decision comes from a federal court trying to anticipate what Kentucky courts would do, and because it is so poorly reasoned, there is a good chance that this decision will have little precedential value. But it stands as an example of how sloppy thinking about litigation funding can have bad results. The existence of one bad actor should not be a basis for outlawing an entire class of transactions.
Topics: litigation finance, legal reform, third-party funding, litigation costs, non-recourse financing, alternative litigation funding, Kentucky, champerty, usury
Works Cited: Boling v. Prospect Funding Holdings, LLC, No. 1:14-CV-00081-GNS-HBB, 2017 U.S. Dist. LEXIS 48098 (W.D. Ky. Mar. 30, 2017)
