This paper addresses regulatory and related considerations affecting or potentially affecting the commercial Claim Based Funding business in the US.
We do not address any regulatory issues affecting the consumer litigation funding business which provides funding to individuals who typically are victims of torts and require a modest amount of funding for personal expenses pending resolution of their personal injury claims. From a policy and regulatory perspective, the consumer and commercial financing businesses should be distinguished based principally upon differences in the sophistication of the client and the client’s access to competent financial and legal advice when contemplating a financing transaction.
No Federal or State Regulation or Viable Regulatory Initiatives
Commercial litigation finance in the US is not directly regulated by the Federal or any state government. It should be noted that some states have enacted legislation regulating consumer litigation finance, principally by requiring transparency and disclosure requirements. There is no indication that any such legislation would be extended to commercial litigation finance.
The most outspoken advocate for regulation of commercial litigation funders has been the United States Chamber of Commerce. The Chamber has claimed that litigation funding poses four threats to the “impartial and efficient administration of civil justice in the United States.” Critics of the Chamber’s position argue that it is a transparent attempt to protect the advantages of large corporations over smaller companies that have valid legal claims.
The four threats identified by the Chamber and the industry counterarguments are:
- Litigation funding will increase the volume of abusive litigation based on the premise that funders will finance speculative claims in hopes of large rewards. The industry has effectively countered this argument by pointing out that litigation funders only fund meritorious claims that are very strong on the merits because the funders only receive a recovery in cases that are successful.
- Litigation funding will undercut the plaintiff’s and its lawyer’s control over the litigation. Again this argument has been refuted by the industry because litigation funders have consistently respected the plaintiff’s right to control the litigation process and the lawyer’s duty to provide independent advice.
- Litigation funding will prolong litigation. This argument also fails. It is the large companies that employ scorched earth tactics that tend to prolong litigation in hopes of wearing down smaller plaintiffs. Leveling the playing field actually promotes settlements rather than prolonging litigation.
- Litigation funding compromises the attorney client privilege and diminishes the professional independence of attorneys. Litigation funders are very sensitive about protecting privileged material so as not to undermine the case and funders respect the lawyer’s ethical duty to remain independent.
Based on these assertions, the Chamber had proposed a registration process with a filing fee of $1M to defer the administrative cost of the regulatory process. It should be noted that the Australian Productivity Commission has recommended consideration of a similar registration requirement along with capital adequacy rules in Australia which is the subject of some current debate. On another front, the Chamber proposed on April 9, 2014 an amendment to Federal Rule of Civil Procedure 26 that would require disclosure of third party investments in Federal litigation.
As noted above, the Chamber’s arguments in support of these proposals have been effectively challenged and its efforts have not gained any apparent traction. It is very unlikely that the Congress will consider the Chamber’s proposed initiatives, much less pass them. Moreover, neither the registration requirement nor the disclosure requirement would have any meaningful negative effect on the US commercial Claim Based Funding business. Arguably, a registration requirement might be helpful as a barrier to entry against new participants.
A model that may make sense in the US is to follow the lead of the Association of Litigation Funders of England and Wales which currently has seven members including Burford and Juridica. The Association has elected to self-regulate and has adopted a Code of Conduct. This is similar to the American Legal Finance Association which is a self- regulatory group of funders in the consumer litigation finance space and has also adopted a similar Code of Conduct.
Champerty and Maintenance
Champerty and Maintenance are old common law doctrines which have decreasing applicability in the US legal system and have been completely done away with in Australia and the UK where the doctrines originated. Champerty is defined by Black’s Law Dictionary as “A bargain by a stranger to a suit, by which such third person undertakes to carry on the litigation at his own cost and risk, in consideration of receiving, if successful, a part of the proceeds or subject sought to be recovered.” Maintenance is defined as “an unauthorized and officious interference in a suit in which the offender has no interest, to assist one of the parties to it, against another, with money or advice to prosecute or defend the action.” The origins of the Champerty and Maintenance doctrines are arcane and these doctrines have been largely eliminated from modern jurisprudence.
As noted in the “White Paper on Alternative Litigation Finance” issued by the American Bar Association Commission on Ethics 20/20, “In the twentieth century an increasing number of state supreme courts have explicitly announced that their common law permits Champerty … Given the somewhat ancient status of the decisions in the remaining jurisdictions that prohibit Champerty, there may be more states in which Champerty is tolerated or where, if the issue were raised again in a modern context, a contemporary court would have little reason to preserve the doctrine …” As the ABA states, the doctrine of Champerty (and the related doctrine of maintenance) has been eliminated in most US jurisdictions and is likely to be eliminated in others. Among the vast majority of states where the doctrine has been eliminated are New York, New Jersey, California, Florida and Texas which alone were the jurisdictions of 1/3 of the civil cases filed in the Federal courts in 2013. Nevertheless the doctrines of Champerty and maintenance continue to have some vitality in certain US jurisdictions which may preclude litigation funding transactions in those jurisdictions or, otherwise, impose restrictions on how such transactions may be structured in those jurisdictions.
Themis has a retainer agreement with renowned legal ethics scholar, Geoffrey Hazard, to advise on Champerty issues and help Themis avoid those jurisdictions in which Champerty remains a viable impediment to litigation finance or to structurally address those impediments.
State usury laws regulate the interest rate at which money can be loaned in various circumstances. Because Themis’ investments are typically made on a non-recourse basis usury laws are generally inapplicable.
To the extent that Themis considers investments on a recourse basis from time to time, the applicability of usury statutes will have to be considered. State laws vary but most states have exemptions or more favorable standards under their usury laws in the case of large commercial transactions.
The New York City Bar Association issued formal opinion 2011-2 on the issue of Third Party Litigation Financing. The opinion stated that “It is not unethical per se for a lawyer to represent a client who enters into a non-recourse litigation financing arrangement with a third party lender.” The opinion went on to caution lawyers to remain cognizant of ethical issues that could arise in connection with such transactions. Specifically lawyers were advised to avoid compromising confidentiality and waiver of attorney-client privilege, to be aware of potential conflicts of interest, to respect the client’s right to control the legal proceedings and to provide the client with the lawyer’s independent legal advice. Various other legal regulatory bodies have issued similar opinions.
None of those ethical considerations negatively affect Themis’ ability to conduct its business.
Risks of Discovery of Communications between the Lawyers/Plaintiffs and the Funder
Several courts have addressed circumstances in which the communications and documents exchanged between the lawyers and the funders may be subject to discovery by the defendant. The case of Miller UK Ltd. V. Caterpillar, Case No. 10 C 3770, 2014 WL 67340 (N.D. Ill Jan. 6, 2014) (Cole J) provides a comprehensive analysis of this issue. The court addressed the following questions:
- Is attorney work product material discoverable if it has been shared with the funder,
- Is Attorney – Client privileged material discoverable if shared with the funder, and
- Are the litigation funding documents discoverable by the defendant?
A high level summary of the court’s conclusions are:
- Federal Rule of Civil Procedure 26(b)(3)(A) defines protected attorney work product as ”Documents and tangible things; prepared in anticipation of litigation or for trial; by or for another party or by that party’s representative (including attorney, consultant, surety, indemnitor, insurer or agent)” and Rule 26(b)(3)(B) also protects the “mental impressions, conclusions, opinions, or legal theories of a party’s attorney or other representative concerning the litigation.” The conclusion of the Caterpillar court was that attorney work product is protected from discovery as long as it was shared with the expectation that it would be kept confidential. Themis requires an NDA between the parties before the exchange of substantive due diligence materials and, accordingly, work product shared with Themis should not be discoverable.
- Specific communications between the attorney and the client are subject to the attorney client privilege. This privilege can be lost if the communication is shared with third parties. The common interest doctrine allows parties sharing a common interest in a litigation (such as co-plaintiffs) to share information subject to the attorney client privilege without losing the privilege. The Caterpillar court concluded that funders, while sharing an economic interest with the plaintiff, do not share a legal common interest and, accordingly, the attorney client privilege would be waived if attorney client privileged material was shared with the funder. Although the court in Devon IT, Inc. v. IBM, No. 10-2899, 2012 WL 4748160, (E.D.Pa. Sept, 29, 2012) reached the opposite conclusion that the common interest doctrine did apply to protect attorney client interest protected documents, Themis and the plaintiff’s attorneys with whom it works are sensitive to protecting this privilege by limiting sharing of the details of specific client communications. Themis is comfortable that it can access sufficient information under the work product doctrine. In a circumstance in which the attorney client privilege would prevent Themis from getting information it felt was essential to its due diligence, Themis would not proceed with the investment. Other cases addressing the common interest doctrine in the context of litigation funding relationships are Leader Technologies, Inc. v. Facebook, Inc., 719 F Supp 2nd 373 (D. Del. 2010) and Mondis Technology, Ltd. V. LG Electronics, Inc., No. 2:07-cv-565, 2011 WL 1714304 (E. D. Tex., May 4, 2011).
- The Caterpillar court also concluded that, absent a specific factual need (e.g. proving the time at which plaintiff became aware of a cause of action for purposes of determining the applicability of the statute of limitations), the litigation funding documents and arrangements between the funder and the plaintiff were irrelevant to the litigation and were not subject to discovery. Accordingly, it is quite unlikely that the particulars of Themis’ funding transaction would be disclosed to the defendant in discovery. It is even more unlikely that any information about Themis’ investors would be deemed relevant for discovery purposes.