Litigation Financing: 10 Tips For Claims Executives

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Alternative litigation financing, also known simply as litigation financing, is the funding of litigation activities by entities other than the parties to a lawsuit themselves, their counsel, or other entities with a pre-existing contractual relationship with one of the parties, such as an indemnitor or a liability insurer.  The third-party financer provides capital to a litigant for living expenses or legal costs, and in return takes a portion (usually ranging from 5 to 40 percent) of the litigant’s financial recovery from the lawsuit.  A key component of litigation financing is that, unlike an ordinary loan, any payout to the financer is contingent on the successful outcome of the legal claim.

                        For attorneys and law firms, litigation financing presents a way to offer clients a contingency fee agreement without deviating significantly from its preferred financial model.  Individual plaintiffs often seek litigation financing to pay for living expenses and other bills through the course of litigation.  Plaintiffs also praise litigation financing because they claim that it provides greater access to justice and allows more cases to be decided on the merits (rather than by which party has the deepest pockets).  Defendants and insurers, on the other hand, argue that litigation financing prolongs litigation, discourages settlement, and presents myriad professional and ethical dilemmas for lawyers and litigants. 

            Despite the normative debate, however, litigation financing has, since its introduction in 1997, become increasingly widespread.  One leading litigation financing firm, Buford Capital, has estimated that 28 percent of law firms used litigation finance in 2015, up from 13 percent in 2013—a four-fold increase over the period. In addition, a number of courts across the United States in recent years have specifically weighed in on the use of litigation finance with approval.  Accordingly, claims professionals should be cognizant of how litigation financing works and should be aware of the following:

  1. Because litigation financing gives litigants access to funds otherwise beyond their wherewithal, it may have the effect of prolonging litigation in a given case or discouraging a party from settlement or engaging in ADR.[1]  To the extent practicable, a claims professional should obtain information as to litigation financing, either through discussions or discovery. 
  2. There are two types of litigation financing companies: consumer and commercial. Consumer litigation finance companies typically provide funds for living expenses to individual plaintiffs; commercial litigation finance companies often finance litigation activities directly (taking depositions, calling expert witnesses, etc.).  Despite the type of financing, there is a concern as to whether the direct financing of litigation expenses will lead to protracted litigation.  To the extent practicable, information with respect to the type of litigation financing should be obtained as it might impact the progress of litigation. 
  3. The American Legal Financing Association (ALFA) is a trade association that represents consumer litigation financing companies. ALFA promulgates a Code of Conduct for its members that includes provisions addressing such topics as attorney agreement approval, intentional over-funding, and outstanding balance negotiations.[2]  Claims professionals should be generally familiar with this code and consult with counsel when concerns over ethics or behavior arise. 
  4. Four states—Oklahoma, Vermont, Indiana, and Tennessee—regulate legal funding directly. Various regulations establish licensing requirements, require clearly articulated contracts in the borrower’s first language, prohibit the use of cash advances for legal fees, prohibit the funders from participating in cases, establish cancellation windows, require public reporting of all transactions, and establish forums for public complaint.[3] It is expected that other states will follow with regulations of their own.
  5. Although three medieval English doctrines (maintenance, champerty, and barratry) historically prohibited third-party financing of lawsuits in the United States and most other common law countries, a number of courts today largely regard these doctrines as obsolete.  Recently, in Miller UK Ltd. v. Caterpillar, Inc., the Court denied defendant’s motion to compel the plaintiff to produce documents as to plaintiff’s third-party litigation funding sources to support defendant’s claims for maintenance and champerty. 17 F. Supp. 3d 711, 728 (N.D. Ill. 2014), The District Court found the Illinois champerty statute could only be invoked by a party to the funding agreement, and that, because the funding agreement did not include defendant to support a claim of champerty or maintenance, the funding agreement was irrelevant to the legal issues in the case under Rule 26(b)(1).  Id.  That said, the issue is still being debated in a number of courts.    
  6. Because most litigation financing is structured as non-recourse investment (meaning that the financing companies cannot sue the consumer if their case fails), and not as a loan, the usury laws of many jurisdictions may very well be inapplicable to litigation finance agreements.  Claims professionals should not assume that financing agreements will be determined to be invalid under usury laws. 
  7. It is important for a claims professional to understand the percentages in a finance arrangement. As noted above, some litigation financing companies will take between 5 and 40 percent of any settlement, judgment, or award.[4]  Because the percentages can impact strategy and willingness to settle, to the extent such information is obtained, it should be noted, reviewed and considered.
  8. At present, there is an issue of whether litigants will be required to disclose third-party funding arrangements in discovery. Financing companies will fight that arrangements are protected or otherwise not capable of discovery because such information is irrelevant to liability and damages issues.  The issue of what will be required to be produced is one that is likely to be the subject of litigation or rule changes.[5]  The case law as to what must be disclosed during discovery is not fully formed. A claims professional should be aware of cases such as Mondis Technology, Ltd. v. LG Electronics, Inc. In that case, the court refused to compel production of documents provided to litigation investors.  2011 WL 1714304 (E.D. Tex.).  Similarly, in Devon IT, Inc. v. IBM Corp., a court held that discussions with litigation investors are covered by the attorney work-product doctrine.  2012 WL 4748160 (E.D. Pa.).  In that case, the court reasoned that because the investors and plaintiff shared a “common interest” in the case’s outcome and had confidentially entered the agreement, their communications were protected.  The claims professional should understand that costly discovery disputes can arise where requests for finance agreements are made. 
  9. Where litigation finance companies are involved, attorneys using such agreements must vigilantly safeguard against any waiver of confidentiality or attorney-client privilege. Under the ABA Rules, “any infringement on rights that clients would otherwise have, resulting from the presence of alternative litigation finance, requires the informed consent of the client after full, candid disclosure of all of the associated risks and benefits.”[6] Claims professionals should consider requesting documentation of communications with finance companies. To the extent privilege is claimed, then a careful review of privilege logs should be made to determine whether any claimed privilege has been waived.   
  10. The ABA cautions attorneys to “approach transactions involving alternative litigation finance with care,” so as to ensure that their duties to exercise independent judgment and avoid the influence of financial or other considerations are not compromised.[7]  If a claims professional believes that independent judgment is not being exercised, the issue should be discussed with counsel.

[1] Jayme Herschkopf, Federal Judicial Center, Pocket Guide Series, Third-Party Litigation Finance 1 (2017), https://www.fjc.gov/sites/default/files/materials/34/Third-Party_Litigation_Finance.pdf.

[2] American Legal Finance Association, The ALFA Code of Conduct, https://americanlegalfin.com/alfa-code-of-conduct/.

[3] American Legal Finance Association, Frequently Asked Questions, https://americanlegalfin.com/about-alfa/faqs/.

[4]See, e.g., Legalist, Litigation Finance Guide 2, https://www.legalist.com/guides/guide-to-litigation-finance/ (“In the interest of increasing industry-wide transparency, Legalist generally takes a stake between 15% and 40% where attorneys are not taking the case on full contingency. When working with contingency attorneys to front expert witness costs, Legalist generally takes a stake of 5% to 20%.”).

[5] Committee on Rules of Practice and Procedure, Judicial Conference of the States, Memorandum 13 (Dec. 6, 2017), http://www.uscourts.gov/sites/default/files/2017-12-6-civil_rules_committee_report.pdf (“The U.S. Chamber Institute for Legal Reform and 29 other organizations have re-submitted a proposal to add a new rule 26(a)(1)(A)(v) that would require automatic disclosure of:  ‘any agreement under which any person, other than an attorney permitted to charge a contingent fee representing a party, has a right to receive compensation that is contingent on, and sourced from, any proceeds of the civil action, by settlement, judgment or otherwise.’”); see also Herschkopf, supra note 1, at 9 (“There are currently no federal rules requiring disclosure of the use of third-party funding in any particular litigation.  There have been calls to amend the Federal Rules of Civil Procedure to make disclosures about third-party funding part of the initial disclosures under Rule 26, but so far, this has not happened.”).

[6]Id.

[7] ABA Commission on Ethics 20/20, Alternative Litigation Finance 4 (Oct. 19, 2011), https://www.americanbar.org/content/dam/aba/administrative/ethics_2020/20111019_draft_alf_white_paper_posting.authcheckdam.pdf.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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