Beyond Champerty: Why Old Doctrines Aren’t Necessary to Regulate Third-Party Funding

As noted before in this blog, the common law doctrines of champerty and maintenance have long been used to prohibit third parties from financing the legal costs of one of the parties in a litigation matter.  In many situations, the continued reliance on these medieval doctrines is justified by the argument that they are necessary to protect litigants from predatory behavior by well-heeled financiers.  But courts in several states have abandoned these doctrines, making it clear that they are not necessary to protect parties who need financial help in their pursuit of justice.

In 1997, in Saladini v. Righellis, the Massachusetts Supreme Court eliminated the doctrines of champerty and maintenance.  In that case, the parties entered into an agreement under which the plaintiff would support the defendant in litigation involving real estate.  After the defendant successfully settled the real estate matter, he refused to pay the plaintiff according to the agreement.  When the plaintiff sued to enforce the agreement, the defendant argued that the agreement was invalid as contrary to the doctrine of champerty.  Although the trial court relied on the doctrine of champerty to rule in favor of the defendant, the Massachusetts Supreme Court overruled it.  According to that court, modern doctrines of contract law, such as public policy, duress, and good faith, along with rules prohibiting misconduct and frivolous lawsuits were sufficient to address any issues arising from an allegation that a particular contract was improer and unenforceable.

The Supreme Court of South Carolina adopted a similar rationale in Osprey Inc. v. Cabana Ltd. Partnership. It held that “[w]e are convinced that other well-developed principles of law can more effectively accomplish the goals of preventing speculation in groundless lawsuits and the filing of frivolous suits than dated notions of champerty.”  Like the court in Saladini, the Osprey court noted that state rules of professional conduct, contract law, and the doctrines of unconscionability, duress, and good faith are more appropriate ways to challenge questionable litigation finance agreements.

California takes a similar approach to litigation financing.  In Abbott Ford, Inc. v. Superior Court, the California Supreme Court upheld an agreement for third-party litigation financing, noting that California courts had never adopted the doctrine of champerty.  The Abbot Ford court then employed the doctrine of good faith to conclude that there was no obstacle to enforcing the litigation finance agreement.

These cases show that the doctrines of champerty and maintenance are rather like your appendix.  They once served an important function, but that time is past, and they now have no practical value or serve any contemporary purpose.  There are plenty of legal rules that prevent parties from maintaining frivolous lawsuits or exploiting counterparties in contractual agreements.  It is those contemporary rules, not medieval doctrines, that should be applied to determine the legality of litigation funding agreements.

Topics:  litigation finance, legal reform, third-party funding, litigation costs, legal costs, champerty, maintenance, consumer protection,

 Works Cited:

Saladini v. Righellis, 687 N.E.2d 1224 (Mass. 1997)

Osprey, Inc. v. Cabana Ltd. P’ship, 532 S.E.2d 269 (S.C. 2000)

Abbott Ford, Inc. v. Superior Court, 714 P.2d 124; 43 Cal. 3d 858 (1987)

Third-Party Financing and a Victory for the Little Guy

On Good Friday in 2006, a hailstorm across Indiana caused more than a billion dollars in damage and provided an opportunity to show how litigation finance can be an instrument for justice.  When an insurance company violated its duties to its policyholders, a courageous plaintiff and a litigation funder made it possible to hold the insurance company accountable.  To be sure, the funder made a significant profit.  But justice was done where it might not otherwise have been.

One of the biggest home insurers in Indiana is State Farm Insurance, which has its headquarters there.  It received almost fifty thousand claims for property damage and rejected more than seven thousand of them. Joseph Radcliff noticed something funny about those rejections.  A roofer, Radcliff had been hired by three hundred or so State Farm policyholders. He noticed that some of his clients whose claims had been rejected by State Farm lived next door to homeowners whose claims had been approved by other insurance companies. Radcliff reported State Farm to Indiana insurance regulators.

State Farm struck back at Radcliff with a vengeance. The company manufactured allegations that he had vandalized roofs as a basis for fraudulent insurance claims; and the allegations led to Radcliff’s arrest on fourteen felony counts, including corrupt business influence and attempted theft.  The company also made sure that these allegations were covered in the press.  The criminal charges were dismissed, but only after the publicity destroyed Radcliff’s business.

State Farm wasn’t done.  It sued Radcliff for fraud and racketeering.  But Radcliff countersued for defamation, abuse of process, and tortious interference with business relationships. In 2011, a jury entered a verdict for Radcliff on his own claims and on State Farms, awarding him $14.5 million in damages, one of the largest defamation verdicts ever delivered in the United States. Of course, State Farm did not simply pay the judgment; it filed an appeal.

That’s when litigation finance came in.  Radcliff’s legal costs had been extensive, and he was without a business.  It would have been difficult for him to wait several years for the appeal process to run its course before he could finally collect.  So a litigation finance company gave him $2.27 million, so he could pay off his and his wife’s debts and start a new business. In addition, he agreed to let the funder pick his appellate lawyer, and the funder agreed to pay an additional two hundred thousand dollars for the appellate lawyer’s fee.

In 2013, an intermediate appellate court ruled for Radcliff.  In 2015, the Indiana Supreme Court affirmed the decision and ended the case.  State Farm ended up paying Radcliff over $17 million, including interest on the original verdict amount; the funder took home its promised amount.  And State Farm was held accountable for attempting to wrongfully destroy a public-spirited whistleblower.

 Topics:  litigation finance, legal reform, third-party funding, litigation costs, legal costs, law and economics, fairness, State Farm, appeals, insurance

 Works Cited:

Lincoln Caplan, Lawyers and the Ick Factor, New Yorker (July 9, 2015).

More Third-Party Litigation Funding Means Better Third-Party Litigation Funding

In many cases, third-party litigation funders receive a high rate of return for their investment in a plaintiff’s claim.  For many critics, such a high rate of return is seen as proof that there is something unseemly – maybe even usurious – about third-party litigation funding.  But the high rates of return for third-party investment may not mean that such investment is a problem.  To the contrary, it may mean that there should be more of it.

It is often assumed that the high rates of return for many third-party funders reflect unfairness.  According to these assumptions, underfunded plaintiffs are in a weakened and disadvantageous position, and they agree to pay high rates of return because they lack bargaining power.  This leads to the criticism that third-party investment is unfair and exploitative.

But, in reality, the reasons for high rates of return have more to do with market forces than individual bargaining relationships.  Many third-party funders focus on smaller-stakes cases, where they make modest investments, usually averaging about $4000 per case.  Because these investments are small, funders have fewer resources and less incentive to conduct thorough due diligence about the actual prospects for the claim; and less due diligence means higher risk in a non-recourse investment.

The real problem here is that the third-party funder lacks sufficient information about the real chances of success for the plaintiff’s suit. The funder minimizes the risk of low information in two ways.  First, the investment is structured so that the plaintiff assumes a significant amount of self-insurance.  That is, because the average investment amount is small, the typical plaintiff must bear much of the financial burden of surviving until judgment or settlement.  Second, the funder demands a high rate of return.

A bigger market for third-party funding could change this dynamic. If there was more competition among funders, there would be more avenues to collect information about claims.  With more information available, rates might go down and the amount loaned might go up.  In this way, the solution to the problem of high rates in third-party funding is not to put more restrictions on funders.  It is to open up markets and make more funding available to more plaintiffs.

Topics:  litigation finance, legal reform , third-party funding, litigation costs, legal costs, law and economics, usury, non-recourse funding, consumer rights

 Works Cited:

Michael I. Krauss, Alternate Dispute Financing and Legal Ethics: Free the Lawyers! 32 Miss. C. L. Rev. 247-266 (2013)

 

Does Third-Party Funding Really Lead to More Frivolous Litigation?

One of the most prevalent arguments against third-party legal financing is that the number of frivolous lawsuits will increase when plaintiffs have access to financial resources that will cover litigation costs.  This argument is based on the idea that a plaintiff will be more likely to pursue litigation if a third-party is footing the bill in return for a right to share in the recovery.  Evidence from the Netherland suggests that this is not the case and that this argument against third-party litigation funding will not increase the number of frivolous lawsuits.

The legal system in the Netherlands has some important differences with its American counterpart, especially in the context of personal injury cases.  In the Netherlands, lawyers are generally not permitted to take cases on a contingent fee basis.  Consequently, a plaintiff who wants hire a lawyer to defend his or her rights must have access to substantial financial resources at the outset of a case to pay for both the attorney’s fee and other litigation costs.

Given the continuing restrictions on contingency fees, legal expenses insurance has recently become more popular in the Netherlands.  Legal expenses insurance, also known as pre-paid legal insurance, is a type of insurance which covers policyholders against the potential costs of legal action brought by or against the policyholder. The policyholder pays a regular premium and receives a guarantee that certain legal expenses, including attorneys’ fees, will be paid on the policyholder’s behalf.  In this respect, legal expenses insurance can be the practical equivalent of third-party litigation funding in that it relieves a party from the financial risk of engaging in litigation.

The expanding reliance on legal expenses insurance in the Netherlands has not led to a corresponding increase in legal claims, however. Between 1999 and 2003, the number of policies for legal expenses insurance increased by over 30 percent, but the number of personal injury claims remained stable.  Thus, even though more Netherlanders had the opportunity to sue without bearing the costs of the suit, they did not exploit it.

The lesson from the Netherlands experience is obvious.  Empowering plaintiffs by providing them with financial resources does not promote frivolous lawsuits.  Regardless of the vehicle for providing those resources, people sue when their rights have been violated.  Making resources available to them will not create an unwarranted burden the legal system, but it will make it easier to achieve justice.

Topics:  litigation finance, legal reform , third-party funding, litigation costs, legal costs, mass tort, personal injury litigation, alternative legal financing, legal expenses insurance, prepaid legal services, frivolous litigation

 Works Cited:

Michael G. Faure, et al., Funding of Personal Injury Litigation and Claims Culture: Evidence from the Netherlands, 2 Utrecht L. Rev. 1 (2006).

Historical Precedents for Third-Party Litigation Funding

Too often, third-party litigation funding is described as an entirely new development that departs from established legal traditions.  This description is a way to make third-party litigation funding seem less legitimate and more controversial.  But, in recent years, there has been no controversy when lawyers have received non-recourse funding to cover litigation costs; so it is hard to understand why there is so much criticism when the client instead of the lawyer is the party to the funding agreement.

Of course, the contingency fee is one way that lawyers have, in effect, provided financing to clients.  In a contingency fee agreement, the lawyer advances his services in return for a share of the client’s recovery; and, in many cases, the lawyer will also advance litigation costs, such as expert witness fees and discovery costs.  But the lawyer gets no guarantee that he will be compensated for either the services or litigation costs.

In the last few decades, in cases where litigation costs are extraordinarily large, lawyers have found ways to obtain financing for those costs when the client is unable to cover them.  In some situations, especially mass tort cases, lawyers have created financial partnerships between firms to share both litigation costs and the contingency fee.  For example, in the 1990s, the plaintiffs’ lawyers in the tobacco litigation created a common fund to cover litigation costs.  The financial power from this common fund helped bring about a successful result.  Similarly, in the recent litigation against American Home Products involving the diet drug fen-phen, one attorney was representing thousands of plaintiffs in parallel cases and became financially depleted while waiting for some of the proceeds from the early settlements.  To cover this shortfall, he partnered with an experienced and well-funded plaintiffs’ attorney, who contributed $2 million in return for a 7.5% share of the contingency fee.  The cash flow permitted the plaintiffs’ cases to go forward to a successful result.

In the last few years, investors have begun to offer non-recourse funding to lawyers in potentially lucrative contingency cases.  As with non-recourse funding for plaintiffs, these investors provide funds for specific cases in return for a right to repayment from the recovery.  When the case does have a successful result, the fees paid to investors can be quite large.

Non-recourse funding to lawyers has not drawn the same kind of hue and cry that accompanies non-recourse funding to plaintiffs.  Given that the differences between these two kinds of funding are nominal, it is hard to understand why there should be controversy about such funding when it goes to plaintiffs instead of lawyers.  Indeed, it seems as though the opposition to third-party funding for plaintiffs is not the product of a principled devotion to legal tradition.  Instead, it seems more like an attempt to preserve the status quo that favors defendants.

Works Cited:

Nora Freeman Engstrom, Re-Re-Financing Civil Litigation: How Lawyer Lending Might Remake the American Litigation Landscape, Again, 61 UCLA L. Rev. Disc. 110 (2013).

Can Litigation Financing Fees Be a Recoverable Cost? An English Court Says, “Yes.”

A recent English court decision has held that the cost of litigation funding can be a recoverable cost in arbitration.  Although there are a number of unique circumstances in this case that might make it an outlier, the court’s analysis is suggestive.  In the right situation, there may be compelling arguments for including litigation funding expenses as a recoverable litigation cost.

The case was Essar Oilfield Services, Lt’d v Norscot Rig Management PVT Lt’d.  There, the claimant and respondent had been parties to an operations management agreement.  The arbitrator found that Essar was liable for a repudiatory breach of the agreement.  In addition, the arbitrator found that Essar’s conduct in breaching the agreement had involved a deliberate attempt to deprive Norscot of resources that could be used in the arbitration. As a result, Norscot had to seek litigation funding of nearly £650,000 from a third party, on terms that if the arbitration succeeded the third party would receive three times the amount advanced or 35% of the amount recovered.

The arbitrator’s award was $12 million in damages and $2 million in litigation costs.  The arbitrator determined that the cost of the litigation funding could be included in the recoverable costs, pursuant to an arbitration rule that provided for cost-shifting for “the legal or other costs of the parties.”  In making this determination, it was important to the arbitrator that Norscot had obtained the funding by engaging a broker and making a funding agreement at market rates.  In light of Essar’s misconduct and the necessity of Norscot’s actions, the arbitrator found that the litigation funding costs could be included as a legal or “other” cost.  An English court later affirmed the award, including the award of litigation funding costs.

Of course, there are many things about the Essar case.  The cost-shifting was undertaken according to a specific arbitration rule in a legal system that routinely makes the losing party bear the cost of the winner’s attorneys’ fees and other legal costs.  Consequently, this kind of cost-shifting could be seen as a product of circumstances simply not present in the U.S. legal system.

But Essar includes an important core principal that could make its way across the ocean intact.  This is the idea that when a party is impoverished by its opponent’s misconduct, the pursuit of litigation funding can be a necessary aspect of litigation.  As such, there can be a convincing argument that litigation funding fees are one of the costs that should be subject to fee-shifting, even under the traditional “American rule.”

Topics:  litigation finance, legal reform , third-party funding, litigation costs, legal costs, law reform, arbitration, cost-shifting

 Works Cited:

Essar Oilfield Services, Lt’d v Norscot Rig Management PVT Lt’d, 2016 EWHC 2361 (Comm) available at http://www.bailii.org/ew/cases/EWHC/Comm/2016/2361.html

Litigation Finance in Class Actions: Are Third-Party Funding Agreements Discoverable?

There is on-going uncertainty about whether and to what extent agreements for third-party litigation funding can be subject to discovery.  This is true in all kinds of litigation, but a couple of recent decisions have reached opposite results in the context of class actions.  This difference ultimately arises from different views about whether the existence of a third-party funder is relevant to class certification issues.

In Kaplan v. S.A.C. Capital Advisors, L.P., the defendants sought discovery about the relationship between the representative plaintiff, class counsel, and a third-party litigation funder.  According to the defendants, such discovery was necessary “to explore whether there may be a risk that the Elan plaintiffs’ funding arrangements could affect the strategic decisions they will make on behalf of the class, or could cause counsel’s interest to differ from those of the putative class members they purport to represent.”  In addition, the defendants argued that the discovery would be necessary to determine whether there was a potential for conflicts between the representative plaintiff and the class over the costs associated with litigation funding.  These arguments did not prevail, however.  The district court declined to compel the production of funding documents because the court found that class counsel’s representations about the adequacy of its resources were sufficient and that any questions about potential conflicts between the class and the representative plaintiffs was purely speculative.

Gbarabe v. Chevron Corp. arose from a fire on an off-shore oil drilling rig off the coast of Nigeria.  The plaintiff class was comprised of fishermen who alleged that their businesses and health were adversely affected by the fire.  As in Kaplan, the defendant argued that the disclosure of litigation funding agreements was necessary to determine the adequacy of class counsel’s representation.  Unlike Kaplan, however, the district court did permit discovery of the litigation funding arrangements.

But there were unique factual circumstances in Gbarabe.  Most importantly, there were serious questions about the adequacy of class counsel, who was a solo practitioner with no formal office or support staff.  Moreover, class counsel had missed deadlines due to lack of resources. In addition, the confidentiality provision of the litigation funding agreement, which class counsel had quoted in a brief to the court, seemed to contemplate that the agreement would be subject to discovery.

These two cases demonstrate that there is no single clear rule for determining the discoverability of third-party litigation agreements.  In the ordinary course, there are strong reasons for prohibiting discovery.  But, when there are real questions about the adequacy of class counsel, and when litigation funding is a crucial factor in assuring such adequacy, discovery may be warranted.

Topics:  litigation finance, legal reform , third-party funding, litigation costs, legal costs, law reform, class actions, discovery

 Works Cited:

Kaplan v SAC Capital Advisors, LP, 2015 U.S. Dist. LEXIS 135031 (SDNY, Sep. 10, 2015)

Gbarabe v Chevron Corp., 2016 U.S. Dist. LEXIS 103594 (ND Cal, Aug. 5, 2016)

 

Litigation Funding as a Tool for Better Business

Litigation creates problems for business.  Aside from the obvious risks associated with an adverse result, litigation is costly and disruptive for business.  But many of these costs, risks and problems can be reduced or eliminated when businesses finance their litigation costs from third-party funders.

The problems associated with litigation are well-known.  A company’s decision to start a lawsuit means that it will have to divert resources that would otherwise go to its own business operations.  In addition, the costs of litigation are substantial and hard to predict.  Of course, there are the direct costs, such as attorneys’ fees and discovery costs.  But the indirect costs can be just as burdensome, including information, monitoring, transaction, and decision costs.

Litigation financiers can solve or reduce most of these problems.  Most obviously, the litigation funder supplies the initial and ongoing investment to cover litigation expenses, eliminating the need for the company to divert its own capital (or credit capacity) from business functions. Moreover, litigation financiers will inform a business plaintiff about the relative strength of the company’s case and about realistic settlement options

Litigation financiers also have the capacity to reduce some of the potential conflict between the interests of the business and those of the law firm.  Litigation financiers often have leverage to encourage the law firm to accept a contingent fee, meaning that the law firm has the same incentive as the client to achieve a successful result and cannot count on profiting from a loss with a large hourly fee.

In the end, third-party investment in business litigation presents an enticing trade to business plaintiffs:  in return for surrendering the right to a portion of the potential gains from litigation, business plaintiffs can free themselves of all of the underlying risks and costs.  And there is little risk that business plaintiffs will be exploited in making this trade.  Because business plaintiffs are sophisticated parties with numerous options, it is unlikely that they will be taken advantage of in making an agreement with the investor.  To the contrary, both the litigation financier and the business can craft an investment relationship that can be mutually advantageous.

Topics:  litigation finance, legal reform , third-party funding, litigation costs, legal costs, law reform, economic efficiency, business practices, risk management, business capital

 Works Cited:

Joanna Shepherd and Judd E. Stone II, Economic Conundrums in Search of a Solution: The Functions of Third-Party Litigation Finance, 47 Ariz. St. L. J. 919 (2014)