If you haven’t heard of litigation funders, then stay tuned. I’m sure you will soon. They’re here to make sure your next big case gets the cash it needs to stay alive to victory or settlement.
Or are they just here to see if they can make a buck? Or both?
If you have heard of litigation funding, then I’d like to hear what you think.
What is ‘litigation funding?’
What is a “litigation funder?” These are financiers that provide one of two types of litigation funding to plaintiffs: either by cash advances to individual plaintiffs or funding to plaintiffs’ firms, helping them trade future risk for current cash flow.
In other words, they offer the cash to plaintiffs and plaintiffs’ firms to make it possible for litigation to go forward when it might not otherwise due to the cost of litigation.
The best part is that plaintiffs and plaintiffs’ firms need only pay it back if they win.
The cost? Funders can charge between 36% and 150%, per year, though, according to Kirby Griffis of Hollingsworth LLP, higher rates are not unheard of. They get away with it and avoid usury laws by advancing the cash on a non-recourse basis, requiring repayment only if the plaintiff wins or gets a settlement in their favor.
The Legal and Ethical Gray Area
The main problems–ethically and legally–arise under the legal doctrines of maintenance and champerty. As summarized by Griffis, maintenance is “the giving of assistance to a litigant in pursuing a lawsuit, and champerty is a form of maintenance in which the party giving assistance does so in exchange for an interest in the outcome of the lawsuit.”
Cases, such as Rancman v. Interim Settlement Funding Corp., have found that “a]n intermeddler is not permitted to gorge upon the fruits of litigation.” 789 N.E.2d 217 (Ohio 2003). As a result, the industry has formed a lobby to legitimize litigation funding. The American Legal Finance Association (or the ALFA) approaches legislatures and lobbies them to endorse “voluntary” codes of standards through codification.
ALFA has been successful, even overturning Rancman by statute in Ohio. Maine and Connecticut allow litigation funding by statute, and similar legislation is pending in Kentucky. Texas, Florida, New Jersey, Mississippi, Massachusetts, North Carolina and South Carolina and New Hampshire courts have allowed litigation funding contracts.
So, in some places it’s legal, others it’s not…but what is the effect?
It’s not healthy for our system, Giffis says. Third-party litigation funding disrupts the normal operation of litigation and will increase litigation in the U.S. He cites three reasons for the disruption, as well as an explanation for the potential increase in litigation:
1. Conflicts of interest: the objectives of the funders and those of the individual plaintiffs are not necessarily aligned.
[I]t is difficult to believe that plaintiffs’ firms that receive a large portion of their funds from a third party will not come under the influence of that third party to at least some extent. Funders may want to hasten settlement to recoup their investment, delay settlement to increase their interest charges, and steer cases toward monetary and away from injunctive relief, among other things.
2. Displacement of Risk: The opportunity for certain cash (which is only repaid from proceeds of a victory) from funders may create an incentive for plaintiffs’ firms to shift risks to third-party funders, trading future uncertainty for secure cash flow in the present.
3. Confidentiality conflicts: The involvement of third-party funders “risks the disclosure of confidential information.” Like any investor, funders will want as much information as possible about the case they are financing, and right now the case-law “strongly suggests” that there is no privilege for communications with a third-party funder. What does this mean for defenders against such law suits?
[I]f you are defending a case in which the plaintiffs’ firm has litigation funding, go after the communications with the funder.
Why Increased Litigation? The Bottom Line
These are some of the ways litigation funding distorts the legal system, but why could it result in increased litigation? Simply put, the best way for a litigation firm to protect its investment, much like a smart investor, is by spreading out risk.
For anyone who stands to make money from litigation, as much litigation as possible should happen…
Litigation funding enables plaintiffs’ firms that are reluctant to take on risky litigation to shift the risks of failure to investors, who are able to bear the risk because they can spread it around. Obviously that will cause more litigation to occur.
Is there another side to this? Without a doubt, there are plaintiffs that fail to hold defendants to account in court because of the prohibitive cost of litigation. Should they be prohibited from obtaining third-party funding?
(h/t to Kirby Giffis of Hollingsworth LLP whose comments were published in “The Metropolitan Corporate Counsel,” vol. 19, no. 7, July 2011)