Litigation funding raises issues of champerty, an arcane law dating back to feudalism that many states have abolished. Essentially champerty laws prohibit the buying and selling of lawsuits. Recently in New York, a case raised issues of champerty not in the context of litigation funding, but in the context of the assignment of claims in connection with the distressed debt and secondary loan market.

New York Judiciary Law Section 489(1) states in part that “no corporation or association … shall solicit, buy or take an assignment of, or be in any manner interested in buying or taking an assignment of … any claim or demand, with the intent and for the purpose of bringing an action or proceeding thereon.” A statutory safe harbor became effective in August 2004 to allow litigation rights to transfer from the creditor to the buyer of the debt.

Faced with ambiguous and uneven case law, the 2nd Circuit in Merrill Lynch v. Love Funding asked the New York Court of Appeals whether state champerty laws prohibit the buyers or secondary holders of distressed debt from bringing claims related to the debt in question. The 2nd Circuit itself conceded that the certification of questions to the state court of appeals was an “exceptional procedure,” but, “mindful … of the importance of New York law to the State’s preeminent role in world financial affairs,” one that was rightly invoked here.

In its Oct. 15 opinion, the New York Court of Appeals gave champerty a narrow reading, limiting its application and delivering relief for the distressed debt market. The ruling in Love Funding appears to clarify that arcane champerty laws won’t limit the litigation rights of buyers of secondary debt.

The state appeals court defined champerty as the purchase of claims for the purpose of bringing an action. It reiterated 1847 case law that the law’s purpose is “to prevent attorneys and solicitors from purchasing debts, or other things in action, for the purpose of obtaining costs from a prosecution thereof, and was never intended to prevent the purchase for the honest purpose of protecting some other important right of the assignee.”

The court also said the champerty doctrine does not apply to acquiring indemnification rights in past legal actions as part of a settlement, and that no New York case has found that champerty laws prevent the settlement of a dispute by accepting a transfer of litigation rights.

“In short, the champerty statute does not apply when the purpose of an assignment is the collection of a legitimate claim,” Judge Eugene Pigott wrote for the court. “What the statute prohibits … is the purchase of claims with the intent and for the purpose of bringing an action … where such claims would not be prosecuted if not stirred up.”