Although still something of a “hot” topic, litigation finance is no longer a new concept in the legal industry. Both the growth of litigation finance operations and the widespread acceptance of the use of litigation finance by firms both large and small indicate that litigation finance is an accepted part of the modern practice of law.
Litigation finance can occur in many different ways, but the concept is relatively simple. In most instances, a third party provides funding to a litigant to pay for attorney fees and other costs in exchange for an interest in the outcome of the lawsuit. Litigation finance thus allows parties to either pursue litigation that they could not otherwise afford, or to minimize the risks associated with litigation by sharing the costs with a third party.
Recent studies support the conclusion that the use of litigation finance has become more common than ever. A 2017 study conducted by ALM Media, publishers of the Recorder, found that 36 percent of U.S. law firms used litigation finance in 2017, compared with 28 percent during the prior year. The 2017 results also represent an astounding increase from 2013, when only 7 percent of law firms reported using litigation finance resources.
Courts have responded to the rise in the use of litigation finance. For example, the U.S. District Court for the Northern District of California amended its standing order to require that parties in class action cases identify “any person or entity that is funding the prosecution of any claim or counterclaim.” Notably, that court rejected a proposal that would similarly mandate disclosure of third-party funding for all litigation (not just class actions).
As the use of litigation finance increases, litigants may begin seeing that change reflected in discovery. For example, litigants may seek discovery on the identity of third-party funders, notwithstanding the use of confidentiality agreements between the third parties and the litigants. Although every situation is unique, litigants have discovered advantages to these litigating finance arrangements. With appropriate precautions, litigation finance can be an effective tool for law firms and their clients.
The rise of litigation finance had legal scholars dusting off old textbooks to consider the application of principles such as champerty and maintenance. Under common law, champerty refers to a bargain between a third party and a litigant whereby the third party agrees to carry on the litigation at her or his own expense in exchange for part of the proceeds.
While prohibitions against champerty remain the law in certain states, there is no such prohibition in California. Indeed, the California Supreme Court has observed that California has “no public policy against the funding of litigation by outsiders,” see Pacific Gas & Electric v. Bear Stearns & Co., 50 Cal. 3d 1118, 1136, 791 P.2d 587, 597 (1990). Even where there are prohibitions on champerty, some states distinguish modern litigation funding agreements from the historic concerns underlying the policy. For example, in 2016, a Delaware court found that a litigation finance agreement was not champertous because the third party did not have the right to control the litigation.
However, courts in other states (such as Pennsylvania) have relied on champerty to question litigation finance contracts. Thus, depending on the jurisdiction, it may be expected that courts will weigh in on these structures.
Similarities to Liability Insurance
One concern that is commonly expressed with respect to litigation finance is the impact on confidentiality as well as the scope of the relationship with the litigation funder. Some observers have noted, however, that these concerns exist and have been exhaustively addressed in another context: liability insurance. Comparable to a litigation finance agreement, a liability insurance policy creates a situation where a third party has a financial stake in the outcome of the lawsuit and inevitably gives rise to complicated questions when the interests of the third party and the litigant diverge.
Thus, insurance law concepts may provide a roadmap for handling similar issues to the extent they arise in connection with litigation financing arrangements. There may actually be less cause for concern about the risk of a potential conflict in the context of litigation finance, given that litigation funders typically do not assume the same level of control (if any) over the litigation as insurers, who often exercise control over the defense of the lawsuit, including with respect to the selection of defense counsel and settlement decisions. Further, any obligations owed by a third-party funder to a litigant are likely limited by their contract, unlike an insurer whose obligations are defined by contract and also by common law.
Another issue that may arise is the application of the attorney-client privilege where protected information is shared with the litigation funder, who is a third-party to the attorney-client relationship. Specifically, some have expressed concern that a party could inadvertently waive attorney-client or work product protection for documents by providing them to the funder.
However, courts have held that documents shared with a litigation finance company are protected under the work product privilege or the common interest doctrine. See, e.g, Carlyle Investment Management v. Moonmouth, No. CV 7841-VCP, 2015 WL 778846, at *7 (Del. Ch. Feb. 24, 2015) (citing cases); but see Acceleration Bay v. Activision Blizzard, No. CV 16-453-RGA, 2018 WL 798731, at *2 (D. Del. Feb. 9, 2018) (holding that the work product and common interest privileges did not apply to the negotiations between a party and a litigation funder that occurred before a deal was reached and before litigation was filed).
Additionally, the litigation funding agreement can contain provisions to protect the privilege or to limit the documents provided to the funder so as to counter any suggestion of waiver.
These issues will continue to be litigated as a more fulsome body of law addressing litigation finance develops.
Shari L. Klevens is a partner at Dentons US and serves on the firm’s US Board of Directors. She represents and advises lawyers and insurers on complex claims, is co-chair of Dentons’ global insurance sector team, and is co-author of “California Legal Malpractice Law” (2014).
Alanna Clair is a partner at Dentons US and focuses on professional liability defense. Shari and Alanna are co-authors of “The Lawyer’s Handbook: Ethics Compliance and Claim Avoidance.”