United States: Litigation Finance: A Brief History Of A Growing Industry

Last Updated: April 4 2016
Article by Amy G. Pasacreta

Litigation finance can provide the cash a plaintiff needs to prevail in court. Plaintiffs holding valid—and potentially quite valuable—claims sometimes do not have the resources to initiate a lawsuit or to see one through to a favorable resolution. Rules of professional ethics generally prohibit lawyers from providing clients with financial assistance.  A contingency fee arrangement with a lawyer can help reduce a plaintiff's out-of-pocket legal costs, but such arrangements are not always feasible. Even when they are, the lawyer may not have enough cash available to fully fund the costs of litigation.

Litigation financing (also known as professional funding, settlement funding, third-party funding, or legal funding) is the process by which plaintiffs can finance their litigation or other legal costs through a third party. This third party provides a nonrecourse cash advance to the plaintiff in exchange for a percentage share of the judgment or settlement. Litigation finance is used to fund all types of cases, including commercial litigation, intellectual property disputes, personal injury cases, class actions, whistleblower suits, and even high-profile divorce cases. And funders invest in early stage cases, cases pending appeal, and even finished cases.

Many investors, including big banks, participate in this sector. There are also firms dedicated solely to investment in litigations. These firms now invest about $1 billion a year, and the industry seems to be growing. Topping $1 Billion Mark, Big Litigation Funder Gets Bigger, Julie Triedman, The Am Law Daily, January 6, 2016. The industry's largest investor, Chicago-based Gerchen Keller, was formed in 2013 with $100 million in capital and now has more than $1.4 billion in assets under management.  In many ways, the firm operates like a typical hedge fund. It maintains several separate funds that invest private capital in portfolios of assets selected by the firms' managers. The major difference between it and more traditional hedge funds is that Gerchen Keller invests only in this new asset class—namely, interests in lawsuits.  In addition to investments by big banks and funds, accredited investors with as little as $2,500 to invest can get a piece of the action.  Specifically, LexShares, a crowdsourcing website, matches third-party funders meeting certain qualifications with litigants in need of funding.

The foregoing demonstrates that lawsuit investment is a new and burgeoning asset class. In spite of this, there is no uniform regulation.  Congress and state legislatures are looking to change this situation.

Regulation

Historical Defenses to Litigation Finance

Although litigation finance in its current form is a relatively recent phenomenon, the concept of a third party funding a lawsuit is not a new idea. Indeed, laws regulating the ability to do so, namely the laws of maintenance, champerty and barratry, which were used as defenses against third-party financing of lawsuits, have been around for centuries.  In 1978, the Supreme Court summarized the nuances surrounding these archaic-sounding terms as follows: "maintenance is helping another prosecute a suit; champerty is maintaining a suit in return for a financial interest in the outcome; and barratry is a continuing practice of maintenance or champerty." In re Primus, 436 U.S. 412, 424 n.15 (1978).  These laws originated in the Greek and Roman legal systems and developed under English common law during feudal times when the assignment of any cause of action was generally prohibited.  The purpose of these laws was to discourage frivolous litigation and to protect against extortion and harassment by wealthy funders.

Recent Case Law

Today, parties may assign their causes of action and litigation financing is a rapidly growing business. Courts have restricted the use of champerty, maintenance, and barratry defenses, thereby permitting the industry to grow. The Ninth Circuit Court of Appeals recently observed that the "consistent trend across the country is toward limiting, not expanding," the common law prohibition of champerty. Del Webb Cmtys., Inc. v. Partington, 652 F.3d 1145, 1156 (9th Cir. 2011).  For instance, while champerty is still outlawed in New York by Judiciary Law §489, many safe harbors exist to limit its application.  Recent New York case law also supports a narrow construction of any champerty defense.  See Justinian Capital v. Westlb, No. 6000975/2010, 2012 WL 3536247, at *4-6 (N.Y. Co. Aug. 15, 2012) (Werner Kornreich, J.) (finding "the ancient prohibition of champerty must be reconciled with modern financial transactions."); Trust for the Certificate Holders of Merrill Lynch Mortg. Investors, 13 N.Y.3d 200, 918 N.E.2d 889 ("[I]f a party acquires a debt instrument for the purpose of enforcing it, that is not champerty simply because the party intends to do so by litigation.").

Earlier this month, a Delaware Superior Court judge held that a plaintiff's agreement with Burford Capital, a litigation finance provider, did not constitute champerty or maintenance. In that case, Burford financed the plaintiff's litigation expenses in exchange for a percentage interest in any future proceeds of the litigation. The plaintiff also granted Burford a security interest in its claim as collateral. The court held that the arrangement did not constitute champerty because the plaintiff continued to be the bona fide owner of the claim, and Burford had no right to maintain the action on its own behalf. The action did not constitute maintenance because Burford was not "stirring up" the litigation, and, in fact, did not exercise any control over the claim or the litigation. Charge Injection Techs., Inc. v. E. I. DuPont de Nemours & Co., 2016 Del. Super. LEXIS 118.

Recent Congressional Inquiry

New regulation may soon reverse the course that courts have taken in recent litigation finance cases. Congress is concerned that third party funding lacks regulation and oversight. Last August, Senate Judiciary Committee Chairman Charles Grassley (R-Iowa) and Senate Majority Whip John Cornyn (R-Texas) sent letters to three of the largest litigation funders stating a concern that this ''burgeoning industry'' was ''largely unregulated and operates with no licensing or oversight.'' Because of this concern, the Senators requested information for the 2009–2014 period regarding, among other things, (i) the matters in which they invested; (ii) lawyers with whom they have entered into financing arrangements; and (iii) details about the resolution of the matters (i.e., how much money was paid to all parties).  The firms indicated a willingness to discuss these concerns, but they are also focused on avoiding any regulations on these investments.  Several litigation funding firms that comprise the American Legal Finance Association ("ALFA") focus on, among other things, making sure state and federal governments view litigation financing as an investment and not a type of loan subject to consumer protection laws.

States have also started to weigh in. In August of 2014, Tennessee was the first state to adopt a legislative scheme regulating consumer litigation finance arrangements and others have followed.  These laws include caps on the interest rates third-party funders can charge and provide detailed disclosure requirements.  Although many of these laws do not currently apply to litigation funding arrangements with businesses, expanding regulation could significantly limit the types of cases that litigation firms invest in.

Conclusion

The New York City Bar Association voiced support for litigation finance in 2011, stating that the practice provides "a valuable means for paying the costs of pursuing a legal claim, or even sustaining basic living expenses until a settlement or judgment is obtained." Critics of the industry argue that litigation finance preys upon the poor, encourages frivolous lawsuits, and discourages parties from settling cases.  While courts have been less inclined to enforce age-old defenses to litigation finance, state legislators and now Congress seem eager to have their say.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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