You have a general litigation practice and sometimes take a plaintiff’s case if it sounds like it might bring in some real money. One morning, a client walks in and says that he patented a precursor to the smartphone long ago that is very similar to the latest model that Apple sells.
You know that taking on a behemoth like Apple will take some real cash, but you are sure that you can recover enough to make it worth your while. You tell the client that there are litigation funders that can loan him money for the lawsuit. He is a scientist/inventor type, and has never litigated before. He listens with interest.
Alternative litigation funders (ALFs) are not new; the idea originated in ancient Greece and eventually made its way to England and Australia. The funding concept came to America in the 1990s as a way to provide a few thousand dollars to plaintiffs in P.I. suits. Funding was not then used often for big lawsuits. But funding companies grew like mushrooms during the recession, when law firms needed quick cash to fund their cases.
The problem with the funding industry is that it is completely unexamined and unregulated, with even hedge funds getting in on the action. Surprisingly, there is little to no real guidance to lawyers on the ethical issues that arise from working with ALFs in California. This is true despite the fact that a typical charge of 2.94 percent compounded monthly can end up costing the client around 40 percent or more a year.
In addition, opposing counsel can ask if a client was funded, and when he says “Yes,” they might claim the right to view all the documents he gave the funder. Few courts have opined on the confidentiality of the funding process, but Leader Technologies, Inc. v. Facebook, 719 F.Supp. 2nd 373,376 (D. Del. 2010) and ethics opinions from the New York City Bar Association (Formal Opinion 2011-2) and an ABA informational report issued by the Ethics 20/20 Commission suggest lawyers must be mindful of waiving the privilege.
In addition, funding is infested with potential conflicts of interest traps for the unwary lawyer. Among them are:
- When the attorney provides a letter of the worth of the claim.
- When the client wants to settle for quick cash while the lawyer wants to negotiate further to get more, but the client pays the compounding interest rate.
- Where a lender wants to prolong the litigation to recover on their investment and refuse to allow the client to settle by forcing the settlement issue to arbitration.
- Where so much interest is owed that the lawyer simply cannot settle and has to 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 his fee but the client could potentially recover nothing because of what the client owes in interest.
Do these conflicts actually arise in a case? Yes, as they did in the Chevron/Ecuadorian lawsuit. There, the opposing counsel got the supposedly private funding documents, all 75 pages, and found there were eight tiers of funders. A verdict in favor of the plaintiffs was overturned, and Chevron plans to fight to the death that the original verdict is illegal. Do you think the Ecuadorians would benefit much from any judgment? Not after all the funders were paid.
What are the arguments in favor of litigation funders? Well, they provide money to people who would not otherwise have the funds to prosecute a lawsuit. But they argue that they are not subject to the usurious interest rate laws because they are making an investment and not a loan. They argue that they are taking on a big risk so they are entitled to 40 percent interest. I question that argument.
Buying 500 shares of Celgene stock at the opening of the market today was an investment, and definitely a risk (the market goes up and down). But when funders loan on an oil spill accident, they are going to recover. In truth, ALFs are giving non-recourse loans; they recover nothing if there is no recovery, but if there is any recovery, they take from it, and sometimes take a chunk.
Litigation funders also argue that they are like insurance companies, but insurance companies are highly regulated, and funders are not regulated at all. Moreover, insurance companies don’t charge 40 percent a year.
With no real guidance, lawyers must conduct themselves with the utmost care when referring a client to a funder or when seeking funding themselves. The lawyer should explain to the client specifically what issues can arise with a compounding interest rate.
Whether the client or the lawyer obtains the funding, potential discoverability of the statements and documents provided to the funder must be discussed along with the ramifications to the client’s case of discovery.
In addition, conflicts must be explored and consented to well in advance of the case getting to the point that any settlement would be too low to square the bill with both the funder and the lawyer.
Carol M. Langford is a lawyer who provides ethics advice and State Bar defense to lawyers in the Bay Area. She is a lecturer at U.C. Berkeley Boalt Hall School of Law and co-author of the textbook, Legal Ethics in the Practice of Law and The Moral Compass of the American Lawyer: Truth, Justice, Power and Greed.