It is undeniable that litigation funding is taking the legal world by storm. In 2017, 36 percent of U.S. law firms reported using litigation funding, which was a 414 percent increase in use since 2013 when only 7 percent of law firms reported using it. 2017 Litigation Finance Survey, Burford Capital, p. 8. In its most basic form, litigation funding allows a plaintiff or a lawyer to obtain a cash advance from a third-party lender in exchange for a percentage of the proceeds recovered from the litigation. Id. at p. 4; see also ABA Commission on Ethics 20/20 Informational Report to the House of Delegates, p. 1. Typically, the advances are nonrecourse in that the lender cannot recover anything outside of the litigation. ABA Commission on Ethics 20/20 Informational Report to the House of Delegates, p. 5–6. Therefore, if the amount recovered in the lawsuit is less than the total amount owed to the lender, the lender may be entitled to the proceeds recovered, but nothing more. Similarly, if the case fails for whatever reason, nothing is owed to the lender.
Funding companies advertise their services to a wide-range of players, including individual plaintiffs pursuing claims against a corporate defendant with deep pockets (often referred to as "David v. Goliath" lawsuits by those in favor of litigation funding), class action plaintiffs, plaintiffs engaging in expansive litigation requiring significant out-of-pocket expenses, and plaintiffs' lawyers and law firms. The advances received from the funding company can be used to fund litigation or for non-litigation related expenses, such as the payment of rent, groceries, and other necessities by individual plaintiffs. Id. at p. 5. While litigation funding may allow greater access to "justice," it is clear that litigation funding is rife with potential ethical issues and dilemmas, including the potential for inappropriate relationships between lawyers and funding companies, third-party control over litigation, and possible interference with the attorney–client privilege. Id.
The Ongoing Debate: How Litigation Funding May Interfere with a Lawyer's Independent Judgment
Rule 5.4 of the Model Rules of Professional Conduct (the "Rules") prohibits a lawyer from sharing legal fees with a nonlawyer and from permitting any person who recommends, employs, or pays a lawyer to render legal services for another to direct or regulate the lawyer's professional judgment in rendering such legal services. ABA MODEL RULES OF PROFESSIONAL CONDUCT, 5.4(a) and (c). The purpose of the foregoing rule is to "protect the lawyer's professional independence of judgment." Id. at Comment 1.
In 2018, the New York City Bar Association issued a controversial opinion concluding that funding agreements between lawyers and funding companies were unethical under Rule 5.4 because the Rule forbids a funding arrangement in which the lawyer's future payments to the funder are contingent on the lawyer's receipt of legal fees or on the amount of legal fees received. Formal Opinion 2018-5: Litigation Funders' Contingent Interest in Legal Fees, New York Bar Association, p. 4. The Bar Association explained that "when non-lawyers have a stake in legal fees from particular matters, they have an incentive or ability to improperly influence the lawyer." Id.
In essence, the New York City Bar Association's opinion suggests that funding agreements between lawyers and funding companies may interfere with the lawyer–client relationship and the duties owed by the lawyer to the client. However, in 2020 the New York City Bar Association issued another report on litigation funding, which endorsed the practice of litigation funding and proposed changes to the Rules "to regulate portions of the burgeoning industry." Report to the President by The New York City Bar Association Working Group on Litigation Funding. The Arizona Supreme Court took this concept one step further and completely eliminated Rule 5.4 effective January 2021. The Arizona Supreme Court explained that "lawyers have an ethical obligation to assure that legal services are available to the public and that if the rules stand in the way of making those services available, the rules should change. At the same time, the changes must maintain the professional independence of lawyers and protect the public from unethical and unprofessional conduct." News Release, Arizona Supreme Court, Arizona Supreme Court Makes Generational Advance in Access to Justice, Aug. 27, 2020.
While those in favor of litigation funding argue that there is no ethical difference between a non-lawyer's security interest in a contract right (fees not yet recovered from the lawyer) or accounts receivable (fees earned by the lawyer) and that regulation of such relationships undermines the ability of non-wealthy people to prosecute civil claims, it is not irrational to worry that litigation funding companies may be improperly influencing a lawyer's representation of her clients. Anthony E. Davis and Anthony J. Sebok, New Ethics Opinion on Litigation Funding Gets it Wrong, August 31, 2018. As explained by the Institute of Legal Reform, litigation funding "undercuts plaintiff and lawyer control over litigation because the [funding] company, as an investor in the plaintiff's lawsuit, presumably will seek to protect its investment, and can therefore be expected to try to exert control over the plaintiff's and counsel's strategic decisions." U.S. Chamber Institute for Legal Reform, Stopping the Sale on Lawsuits: A Proposal to Regulate Third-Party Investments in Litigation (2012) at p. 3.
To better illustrate the control that a third-party funder may exercise over a pending litigation, let's consider a real-life example from Gbarabe v. Chevron, 14-cv-00173-SI (N.D. Ca. 2014), where plaintiffs' counsel entered into a funding agreement with Therium Litigation Funding LLC ("Therium"). Id. at Declaration of Craig E. Stewart in Support of Chevron Corp.'s Motion to Compel Plaintiffs to Produce Litigation Funding Documents and Comply With Rule 3-15, at ¶ 20, Exhibit 19; see also a copy of the Litigation Funding Agreement.
Pursuant to the Gbarabe funding agreement, plaintiffs' counsel agreed that they (1) would provide accurate information regarding the litigation to Therium; (2) would not fail to disclose any information, document, or evidence relevant to Therium's decision to enter into and remain bound by the agreement; (3) would prosecute the case according to the litigation plan and budget in the agreement and would not make changes thereto without Therium's consent; (4) would not hire any experts without the prior approval of Therium; and (5) use all "reasonable endeavors, consistent with the professional conduct of the Claim in accordance with the terms of this Agreement, to recover the maximum possible Contingency Fee in respect to the Claim." See Litigation Funding Agreement, at p. 6–7. The funding agreement also allowed Therium to receive traditionally privileged attorney–client information, challenge any invoice for services that it did not consider "reasonable," and terminate funding for any material breach of the agreement. Id. at pp. 8–10.
If we unpack the legal terms in this agreement, we can easily see that it allows Therium (a non-party to the litigation) to exercise a significant amount of control over the litigation and the litigation strategy. For example, while the agreement does not specifically state that Therium has the ability to "control" the decisions being made in connection with the litigation, the agreement allows Therium to pull funding if it doesn't agree with any decision, including the overall litigation strategy or the experts hired. The terms of the agreement essentially ensure that counsel will run every decision by Therium in an effort to maintain the funding needed to continue with the litigation.
Another cause for concern is the fact that plaintiffs' counsel owes a contractual duty to Therium, which is independent from the duties owed to the plaintiffs. Id. at p. 6, ¶ 3.1.2 (stating that the lawyers must "comply diligently with the terms of, and their obligations under this Agreement."). Because plaintiffs' counsel must jump through certain hoops to fulfil their contractual obligations owed to Therium, there is a potential that counsel would be unable to fulfill their duty of independent judgment owed to their clients. For example, counsel would most likely discuss the hiring of any expert with Therium and may even decide to forego hiring an expert they believed critical to their clients' case if they knew Therium did not approve of the proposed expert to be hired. In fact, one of plaintiffs' expert witnesses testified at his deposition in the Gbarabe case that his report had not yet been provided because plaintiffs "were putting the money in place for the work to proceed." Ben Hancock, How Jones Day Unmasked a Litigation Funding Deal and Won, October 29, 2017. Thus, it appears that the expert's work would not have proceeded if plaintiffs did not receive the necessary funding, which we know was coming from a non-party to the lawsuit.
Additionally, the funding agreement requires the lawyers to recover the largest possible fee as soon as reasonably possible, which suggests that counsel was in communication with Therium regarding settlement offers made and the acceptance of any such offers and could promote prolonged litigation and the consideration of interests other than the best interest of their clients. Moreover, the fact that the lawyers had a financial stake in the outcome of the litigation beyond the recoupment of traditional legal fees suggests that a potential conflict of interest existed under Rule 1.7(a), which prohibits a lawyer from representing a client if there is a significant risk that the lawyer's own interests or the lawyer's duties to a third person will materially and adversely affect the representation of the client. (Model Rules of Professional Conduct, Rule 1.7(a)). There is no question that lawyers who are parties to funding agreements such as that in the case of Gbarabe v. Chevron could have a financial interest in the outcome of the litigation that interferes with their duty to provide honest, impartial advice to the client.
Additionally, the repayment terms of the funding agreement in Gbarabe v. Chevron could have influenced settlement recommendations made by Chevron's lawyers, settlement decisions made by the plaintiffs, and how the case proceeded through litigation. For example, if the plaintiffs succeeded in the Gbarabe litigation, plaintiffs' counsel would have been required to pay Therium $10.2 million plus all costs paid in connection with the litigation, which would have resulted in a total payment of $11.9 million to Therium. Hancock, supra. Although $11.9 million was nothing when compared to the purported value of the case, there is no world in which the repayment of $11.9 million does not play a part in the manner in which any settlement offer is presented to plaintiffs and the consideration of whether plaintiffs should settle or hold out for a larger settlement or verdict. The fact that the lawyers might take into account the amount they owed to the funder when discussing settlement options with their clients would render the lawyer incapable of providing unbiased advice as required under the Rules.
As you can see from a review of the funding agreement in Gbarabe, litigation funding agreements between lawyers and the funder have the potential to allow a non-party to influence and exercise control over various aspects of a pending litigation. While some litigation funding agreements may not be as far reaching as the terms in the agreement in Gbarabe, it is clear that the potential for influence by a non-party with a stake in the litigation should at the very least be discoverable in litigation and properly examined by the opposing party and the court.
How to Ensure that Litigation Funding Agreements Are Not Improperly Influencing the Trajectory of Your Litigation
Not every agreement involving a third-party funder will be relevant to your litigation or will disclose a relevant conflict, but, as you can see from the foregoing, it is imperative that defense counsel identify potential funding agreements and obtain copies of the agreements during discovery. To do so, defense counsel should incorporate questions about potential funding arrangements and agreements in their discovery to all plaintiffs, including individual plaintiffs. The request for such information and the receipt of any and all documents bearing on the issue of third-party funding are essential to the fairness of all parties involved in litigation.
However, if litigation funding is not discoverable in your state, parties can ask that the litigation funding agreements be disclosed to the court. For example, United States District Judge Dan Polster of the Northern District of Ohio issued an order to a multidistrict opioid litigation requiring the attorney to provide the third-party funding agreement to the court for an in camera review to confirm that the third-party funder was not controlling the litigation, influencing counsel's judgment, or creating a conflict of interest. See In re Nat'l Prescription Opiate Litig., No. 1:17-MD-2804, 2018 WL 2127807, at *1 (N.D. Ohio, May 7, 2018). The Eleventh Circuit Court of Appeals went even further, requiring the disclosure of litigation funding to the jury. See, e.g., ML Healthcare Servs., LLC v. Publix Super Markets, Inc., 881 F.3d 1293, 1302–03 (11th Cir. 2018) (upholding required disclosure of litigation funding to jury so that defendant could probe potential bias).
In addition to discovering the third-party funding relationship and the role that it may play in your litigation, it is also imperative that we continue to educate other lawyers, courts, and state legislatures on the potential ethical concerns with regard to third-party ligation funding. Right now, a number of states have either made changes or are considering making changes to the Rules so as to allow third-party funding while also ensuring that the funder does not inappropriately influence a lawyer's legal representation of her clients. See Report to the President by The New York City Bar Association Working Group on Litigation Funding, at pp. 16–18; see also Arizona Takes Next Steps Toward Scrapping Law Firm Ownership Rule, Jan. 31, 2020, Bloomberg Law. As the Georgia Court of Appeals stated, "while litigation funding engaged in by [parties to a lawsuit], with its associated fees and charges, may legitimately be labeled financially insidious, it is the General Assembly, not this Court, which must, if it so chooses, expressly promulgate laws to regulate this activity." See Cherokee Funding LLC v. Ruth, 342 Ga. App. 404, 410 (2017).
Originally Published by DRI's In Transit Newsletter, Volume 24 Issue 1
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
