The Courtroom as Casino: Alternate Financing for Legal Fees

All litigation requires some form of funding, either by the parties themselves or by the law firm extending credit against the future proceeds of the settlement. But in an era where cash is king and clients and law firms sometimes run their financial lives close to the edge, the need for a cash infusion has spawned an entire industry of what are really venture capitalists. But instead of investing in tech start-ups, they invest in lawsuits.

The percentage of U.S. lawyers who say their law firms used litigation funders has grown by leaps and bounds – from 7% in 2013 to 11% in 2014 to 28% in 2015 (Litigation Funding on the Rise in Big Cases, ABA/BNA Lawyers Manual on Professional Conduct, 3/23/17, Joan Rogers). Who are these litigation funders? They can be companies on the Dow Jones like Burford Capital or they can be individual investors.  Yes, you too can be a litigation funder. But it is a risky business and most often it is hedge funds and large companies that fund bigger cases.

How does funding work? Well, it can be complicated and work in a variety of ways. Funders can provide tranches of cash at set intervals that the client can use to pay the lawyer.  Interest compounds on that cash monthly, at a far higher rate than a bank loan.  Another set up is where the funder pays 50% of a client’s legal fees and gets 20% of the recovery. But the client pays for costs. And the lawyer gets 20%. Or the funder can directly fund the law firm vs. the client.  Sometimes funders fund a basket of cases, so that if one fails, the money owed on the failed case can be taken out of the other cases. The funding is non-recourse, meaning that if the client loses her case, the funder cannot get back the funding they have provided.

Like going into business with your clients or buying a boat, the idea is always much better than the reality.  That is because the funding agreements can contain onerous provisions that serve as golden handcuffs. First, funding is an unregulated industry.  The SEC does not regulate it and it is not regulated by lending laws because the funders claim to not be lenders. Yet the funding is not free; interest on the funding can compound monthly depending on the type of funding.

And while funders claim to not assert control over the litigation, funding contracts often contain provisions allowing the funder to withdraw if they don’t feel the case will profit them as much as anticipated, and some allow the funder to get any money they invested back even if they don’t get the percentage fee. Other provisions allow for the funder to sit in on settlement talks, and forbid the client to change lawyers without their approval.  Funding released in stages allows for control, and clients have a duty to cooperate; a provision that can be a hammer.

A survey recently conducted jointly by Above and Law and Lake Whilans, a commercial funder in New York, revealed that 35% of respondents who had used funding would only recommend it with some reservation. More than 15% said they would not recommend it at all.  Oddly, 78 percent of associates were not satisfied with the experience of handling a case with a funder, but 86% of partners were. Perhaps the associates were bearing the brunt of the funder’s control. (The Recorder, Partners Give High Marks to Litigation Funding, But Ethics Fears Persist, February 23, 2017.)

Even worse? Try litigating a claim against a funder. Some contracts set jurisdiction in tiny islands in Europe so that fighting a funder becomes cost prohibitive.

But that is not all. Conflicts are rife in these agreements. Among the conflicts:

• When the attorney provides a letter identifying the worth of the claim (that lawyer might want to value it high to get funding);
• When the client wants to settle for quick cash to stay alive while the lawyer and/or funder wants to negotiate further to get more, while the client pays any applicable compounding interest rate;
• Where a lender wants to prolong the litigation to recoup their investment and wants to force it to arbitration;
• Where so much is owed that the lawyer or client simply must try for more at trial;
• Where funding is withdrawn and the attorney cannot afford to fund the discovery needed to prepare the case;
• When the lawyer may recover her fee but the client could potentially recover nothing because of what the client owes in interest;
• Where the funder wants a piece of the intellectual property at issue;
• Where the funder syndicates the investment to other investors.

The list can go on, but with all the different types of funding agreements and arrangements, it is impossible to name all the conflicts that can come up.  The Northern District of California is not averting its nose to the smell of fish and now mandates disclosure of third party funding in class action lawsuits (See Ben Hancock’s article in The Recorder “Northern District, First in Nation, Mandates Disclosure of Third Party Funding in Class Actions,” 1/3/17).  Hancock believes that this new law could mean a new body of case law around what is discoverable, and I agree.  States are at odds on what materials given to funders are protected by the attorney-client privilege and the work-product privilege.

Canada already requires that funding be disclosed and judicially approved. Perhaps they want to avoid the questions that arose when Peter Thiel, a Silicon Valley tech entrepreneur, provided Hulk Hogan with $10 million to fund his lawsuit about a sex tape vs. Gawker Media.  Hulk won $140 million, but the word on the street was that Thiel funded the suit as revenge for an article Gawker had written about him.  That is concerning, because it was akin to a SLAAP suit, and puts our supposed free press on guard.

On the plus side, funding companies are providing escape hatches for lawyers desiring a new line of work. And it may be recession proof  – if I made a guess it would be that when the economy tanks, people want to sue lawyers, insurance companies and big corporations but don’t have the resources.

When I recently sat on the Commission for the Revision of the Rules of Professional Conduct, I proposed that we include a comment to our current Rule 3-310 (f) about litigation funding admonishing lawyers to pay special attention to the conflicts involved. I could not get a single vote for that provision.  Am I a contrarian, or a woman who sees that the light at the end of the tunnel is an oncoming train?  Maybe both. But until this industry is scrutinized and regulated, it will be the Wild West for lawyers;  and their clients.