What Are Litigation Funders and Why Are They Legal?
Litigation funders go by many names. Also commonly called third-party litigation funders (TPLF), these companies specialize in financing civil litigation through non-recourse liens. This is an alternative to having a party self-finance the litigation costs or having the attorney front the costs through a contingency agreement. In fact, the arrangement between the client and the third-party litigation funder is similar to a standard contingency agreement. The TPLF makes small advances to plaintiffs to cover legal costs in exchange for a cut of the settlement or judgment.
What is litigation finance?
Generally, litigation finance is provided by litigation funders who are either consumer-facing or commercial-facing.
Consumer financers focus on individual plaintiffs in cases like personal injury.
One such funder is the site LawCash, which calls itself “The Nation’s Premier Pre-Settlement Funding Company.” Like many personal injury attorneys, LawCash sells itself by reminding its clients that insurance companies will spend a lot of money trying to delay or minimize their settlement. In other words, unless you plaintiffs have a source of funding, insurance companies will starve them out and force them to settle for less than they’re entitled to. Interestingly, LawCash advances can also be used to cover housing, medical, or incidental costs that arise during litigation. All of this, of course, in exchange for a bite out of the settlement.
Commercial financing, on the other hand, offers advances to either plaintiffs or defendants in commercial lawsuits.
One commercial litigation funder, Omni Bridgeway, markets to businesses: “We focus specifically on claims that require significant investment, offering our financing on a non-recourse basis to parties looking to mitigate the financial risks of litigation. Let us help you get the capital you need to achieve the result you deserve.”
Legalist is one of the more interesting funders. Founded by a Harvard dropout at age 20, Legalist “targets cases requiring up to $1 million in financing.” The company has invested in over 100 cases at an average of around $500,000 per case. The team is made up entirely of nonlawyers, and instead underwrites its cases based on machine learning and AI technology.
Typically, TPLF extend commercial financing opportunities to corporate clients involved in contract, patent, or anti-trust issues, but the goal is the same as the consumer side: provide up front costs in exchange for a share of the recovery. After a case is won, the payout typically starts with the investor, who receives the amount they invested, plus their proportion of the settlement. Then the attorney is paid their contingency fee, and then the client receives whatever is left.
The industry is growing so quickly that thirteen funders have recently announced the first global trade association to combat the U.S. Chamber of Commerce’s attempts to challenge their practices.
Is it legal?
If something smells fishy about the litigation finance industry, it’s probably because it hasn’t been widely regulated. Many proponents say that the practice actually increases access to justice where cost is otherwise prohibitive. That may be true, but in a legal system with so many ethical rules and regulations on professional conduct, it seems as though regulating this practice has slipped through the cracks. Attorneys adhering to their state’s rules of professional conduct might wonder, “If I can’t pay for my client’s interim expenses, why can a third party?” The possibly even more obvious question is, “If a third party has a stake in the litigation, am I allowed to share information about the case without breaching my duty of confidentiality?”
Part of the problem is the piecemeal way in which states have been trying to rein in these funders. Although the phenomenon seems new, it’s been used around the world for a long time and appears it’s here to stay. Under the common law, this practice would have been entirely illegal. The common law offenses of “maintenance and champerty” would prevent a third party from meddling in a lawsuit or taking on an interest in the judgment. Eventually, courts started to hold that litigation funding doesn’t constitute champerty, so at this point, there’s nothing particularly “illegal” about the practice.
There do remain some serious ethical questions, however, about how litigation financers fit into the professional responsibility framework lawyers must adhere to. A few of these ethical questions are covered below.
Confidentiality and Privilege
The confidentiality issue seems pretty clear on its face: an attorney cannot share client information with a third party unless the client gives consent. Presumably if a client wants to engage a third-party litigation funder, they’ll be willing to consent to their information being shared. But what if an attorney wants to engage a funder?
One Pennsylvania Bar ethical opinion found no confidentiality issue with sharing confidential client information with a third party as long as:
- The advantages and disadvantages of the arrangement are fully disclosed to the client
- The risk of waiving the attorney-client privilege and the consequences thereof are fully explained to and accepted by the client, and
- The attorney’s financial interest in the lender’s fee does not otherwise violate the rules.
The effects of a third-party funder’s presence on attorney-client privilege are still unclear. The common-interest doctrine of the attorney-client privilege rule allows parties with a common legal interest to share information with each other and their attorneys without waiving their right to assert privilege. Whether a plaintiff and a third-party funder share a “common interest” for purposes of this doctrine still has courts split. Ultimately, it’s a risk a plaintiff runs, but it seems as long as the attorney is clear about those risks, there’s no ethical confidentiality violation.
Paying a Client’s Costs
The ABA Model Rules also bar an attorney from paying a client’s expenses during litigation. This policy relates back to the common law problem of “maintenance” and “barratry,” or stirring up frivolous lawsuits. When the New York Bar Association was faced with the question of whether an attorney could refer a client to a third party who would front those expenses, it took no issue as long as the lawyer isn’t getting anything out of it. As long as the lawyer’s only role is to provide a referral, it’s ethically permissible for a third party lender to secure a loan with a lien on the judgment.
When the New York Bar Association was faced with the question of whether an attorney could refer a client to a third party who would front those expenses, it took no issue as long as the lawyer isn’t getting anything out of it. As long as the lawyer’s only role is to provide a referral, it’s ethically permissible for a third party lender to secure a loan with a lien on the judgment.
Sharing Fees with Nonlawyers
Another potential ethical problem with litigation funders is the ubiquitous prohibition on sharing attorney’s fees with non-lawyers. ABA Model Rule 5.4 generally provides that “[a] lawyer or law firm shall not share legal fees with a nonlawyer” with a few specific exceptions, including payments to a deceased lawyer’s estate, payment to nonlawyer employees like paralegals, or court-ordered legal fees shared with a nonprofit. How does a TPLF fit into this framework? The New York City bar, for example, concluded that a lawyer can’t enter into a financing agreement with a nonlawyer litigation funder when the future payment to the funder are contingent on the lawyer’s receipt of legal fees. Ethically, this rules out arrangements directly between the lawyer and the funder where the funder is getting a cut of the attorney’s fees.
Some states, like Wisconsin and West Virginia, require parties to disclose TPLF agreements. Class action and multi-district litigation were of particular concern to regulators, who worried that third parties might take on more of a financial interest in the litigation than the parties themselves. The organization Lawyers for Civil Justice has called for an amendment to Rule 26, which currently sets forth other mandatory initial disclosures, to also require disclosure of any TPLF’s involved. Their concern is that without this disclosure, defendants can’t really know who’s “on the other side of an action.” The dynamic in a civil action against an individual is drastically different than in one where an individual is being driven by a corporation with a financial interest in the outcome. A disclosure requirement would allow both sides to ensure they are fulfilling their ethical obligations to their clients and understand who they’re up against.
How to Regulate?
Right now, there is no comprehensive regulatory regime to tame the growing beast of litigation funding. Some states have passed legislation to regulate them, including Maine, Oklahoma, Nebraska, and Ohio. In addition to the state bar association ethics opinions slowly shaping the practice, states will most likely continue to pass piecemeal responsive legislation over time. So far, these regulations involve funders’ disclosure requirements, underwriting procedures, and some consumer protection measures for individual plaintiffs. Some states want to ban it altogether. Scholars and practitioners who have ventured into the murky world of litigation finance have called for a more comprehensive approach to keeping litigation funders in check.
One proposed federal bill, introduced in 2019 and entitled the Litigation Funding Transparency Act of 2019, would have required counsel in class actions to disclose to the court and opposing counsel the identities of any commercial enterprise that has the right to receive payment contingent on a damages award.
Other than proposed bills, there has been no movement at the federal level to regulate TPLF’s. Federal regulation would allow for a more uniform and comprehensive regime, “eliminat[ing] the need for choice-of-law and choice-of-forum clauses…” and treating all TPLF clients with equal protection. The Consumer Financial Protection Bureau (CFPB) is one agency that would be “well situated” to regulate TPLF’s. The goal of such regulation would really be to protect consumers from unfair agreements with aggressive funders, so a federal agency specifically authorized to protect consumers would seem like a logical choice. Other proposed regulations include keeping the TPLF’s out of the litigation strategy and limiting interest rates.
By no means are all litigation funders sharks. Certainly, many litigants have benefitted from an arrangement that allowed them to stay in the fight against much wealthier opponents. It’s no surprise, however, that bar associations and attorneys had no idea how to ethically work with companies that, under the common law, would have been completely illegal several decades ago. There’s a blurry line at which point TPLF’s cross into the jurisdiction of legal ethics, and that’s a line regulators should face head-on.