An Examination of Litigation Funding and Contingency Fee Agreements
A plaintiff needing help funding a lawsuit has a number of funding options today including third-party litigation funding and contingency fee arrangements. Litigation financing involves a third-party funder who extends a nonrecourse loan to the plaintiff. If the claim is successful, the funder receives a portion of the recovery. The funder’s share may be calculated by considering the following factors: the amount of money involved; the length of time until recovery; the estimated value of the plaintiff’s claim; and whether the claim settles, proceeds to trial or is appealed. If the claim is unsuccessful, the funder may not seek reimbursement for the litigation costs. In essence, third-party litigation funding extends contingency fees to the plaintiff.[i] In a case funded by a third-party, the funder is usually entitled to the “first dollars.” That means that if the funder invested $5 million to finance a case, the funder has a claim to the first $5 million of the proceeds of the litigation, plus a specified return on everything over $5 million. Thus, a litigation funding arrangement has the ability to change dynamics in important ways. For example, in our current legal system, the decision of whether to settle belongs to the client, absent some other arrangement. Litigation financing often places this decision in the hands of the funder, who often has financial interests that differ from a plaintiff.[ii]
Where a contingency fee is involved, the interests of the attorney and client are perfectly aligned as both have the same end goal: favorable recovery leading to payment. The attorney does not collect any fees from the client. Instead, the attorney will agree to a percentage of the judgment received, thus would clearly want the amount to be as large as possible.
Litigation funding and contingency fee arrangements have been viewed as ethically compromising exceptions to the champerty[iii] doctrine. Creating such exceptions increases the risks of a client losing control over the case, of compromising a lawyer’s independent judgment, and of potential conflicts of interest between funders, lawyers, and clients.[iv] In theory, litigation finance and contingency fee arrangements serve the same function. However, limits are imposed on the amount an attorney may recovery in a contingency fee case. For example, the Model Rules of Professional Conduct prohibit charging unreasonable fees. Also, contingency fee arrangements often lead to frivolous lawsuits being filed whereas in litigation funding cases, a funder will not get involved if the case is not likely to prevail.[v]
Neither litigation funding nor contingency fee arrangements really benefit smaller claimants.[vi] Also, the imbalance of bargaining power results in inaccurate litigation outcomes. While litigation funding may address the issue by providing support to smaller plaintiffs, it is unlikely in cases with risk-averse plaintiffs and the amount of damages may not be estimated accurately such as personal injury actions. The perfect example involves an individual plaintiff in a slip-and-fall case against Wal-Mart. Wal-Mart, a repeat player with endless resources, holds all the bargaining power over the plaintiff often putting all its eggs in one basket. Wal-Mart can afford to stretch out the duration of the litigation and increase costs so that a plaintiff cannot afford it, ultimately pressuring a plaintiff who is unwilling to take a risk into settling. Because the cost of a loss would be less devastating to Wal-Mart than it would be for the plaintiff, plaintiffs tend to settle instead of taking risks.[vii] Thus, this imbalance impairs the accuracy of proceedings as the plaintiff usually ends up settling for an amount less than he or she would have received. Litigation finance firms usually do not fund cases for small plaintiffs involved in a situation where the award varies, as only a small number of plaintiffs obtain large judgments, while roughly half receive nothing at all.[viii] [ix] For example, Wal-Mart does not have an incentive to settle for an amount greater than the expected value of a judgment at trial, whereas the plaintiff, reluctant to take a risk of receiving a bad result at trial, will settle for a substantially smaller amount.[x]
The litigation financing market in the United States is less developed than the markets in other parts of the world, such as Australia and England. However, the Australian and English examples do not represent the future for the United States. Contingency fees are forbidden in a majority of cases in Australia and most of Europe while they are the dominant form of compensation for plaintiff’s attorneys in the United States. Also, litigation financing is more common in other parts of the world because plaintiff’s firms are unlikely to be willing and able to self-finance a case. Additionally, in contrast to the American Rule in the United States, where each party bears its own legal expenses, Australia and Europe utilize the English Rule, which requires the losing party to reimburse the legal expenses of the winning party. The English Rule greatly amplifies the risks of an unsuccessful suit, especially in cases where the plaintiff bears all of the risk of an adverse costs allocation and only a pro rata share of any recovery. Litigation financing decreases the additional risk caused by the English Rule. As such, Australian and English litigation finance firms regularly invest in a wide variety of cases. Also in Australia it is common for the funder to exercise substantial control over the selection of the attorneys and the conduct of the litigation.[xi]
[i] Lawrence S. Schaner, Law360, Jan. 21, 2011, http://www.law360.com/articles/218954/the-rise-of-3rd-party-litigation-funding.
[ii] David Lat, Law360, 5 ethical issues with Litigation Finance, Dec. 2, 2015, http://abovethelaw.com/2015/12/5-ethical-issues-with-litigation-finance/.
[iii] Champerty involves an intermeddler who makes a bargain with one of the parties to the action to be compensated out of the proceeds of the action.
[iv] Maya Steinitz, The Litigation Finance Contract, 54 Wm. & Mary L. Rev. 455 (2012).
[v] Matthew Bogdan, The Decisionmaking Process of Funders, Attorneys, and Claimholders, 103 George Town L. J. 197 (2014).
[vi] Charles R. Korsmoa & Minor Myersaa, Aggregation by Acquisition: Replacing Class Actions with a Market for Legal Claims, 101 Iowa L. Rev. 1323 (May 2016).
[vii] See Jonathan T. Molot, Litigation Finance: A Market Solution to a Procedural Problem, 99 Geo. L. J. 65, 84 (2010) (“A one-time, risk-averse party will be more fearful of the worst-case scenario than a repeat player because the risk-averse party cannot absorb and redistribute the costs imposed by an adverse ruling, unlike the repeat player who holds a diverse pool of litigation risk.”).
[viii] Id. at 85.
[ix] Robert J. MacCoun, Media Reporting of Jury Verdicts: Is the Tail (of the Distribution) Wagging the Dog?, 55 DePaul L. Rev. 539, 543 tbl.2 (2006); Molot, supra note 7, at 85.
[x] See Molot, supra note 7, at 86—87.
[xi] Korsmoa, supra note 6.
