Time to shine a light on litigation funding

By Carol Langford, The Recorder

The funding of class actions and other high-end litigation like patent matters no longer just comes from the firm itself or a law firm line of credit.

Alternative litigation funders-called "ALFs"-have seen the profits to be made and stepped up their funding efforts. Alan Zimmerman, president of Law Finance Group, said last year he "funded $9 million dollars in financings during Thanksgiving week alone with time off for turkey and stuffing.”

Litigation funding is not new. It was prohibited in ancient Greece, and then sprung up later in Australia and in England. It came to America in the 1990s.

But now, litigation funding is booming. It is also 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. Even most legal malpractice policies do not address the liability of a lawyer for issues involved in litigation funding.

The firms providing the funds are betting on the plaintiff winning, but it is a bet without any real chance of losing; they are both betting on the outcome and loaning funds based on what they consider winning chances. Either the lawyer or the client can get a loan. It is troubling if either gets it because of the lack of any guidance on what the lawyer must convey to the client about the client getting gouged by the lender, especially where the case goes on forever and the interest just racks up.

So what are the lawyer's duties regarding advising the client about the fact that a typical charge of 2.94 percent compounded monthly can end up being around 40 percent or more a year? And what happens when opposing counsel asks the client in an interrogatory if it was funded and when the answer is yes, opposing counsel claim the right to view all the documents the company gave the funder and to know everything it and its lawyer said to 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) an ethics opinions from the New York City Bar Association (Formal Opinion 2011-2) and an American Bar Association 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 its investment and refuses 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.

These issues are exacerbated by the fact that litigation funding is a completely unregulated industry. Look at the high-end funders that usually fund lawyers involved in commercial cases. One such funder is Gerchen Keller. Three of the four men behind that company are lawyers, the other an investment banker. One of the lawyers was a former analyst at Alyeska Investment Group. Gerchen funds corporations in lawsuits and assists "parties in evaluating the strengths and weaknesses of litigation claims or defenses, the potential costs of litigation, the range of potential damage awards, and the expected economic benefit or cost of maintaining particular claims or defenses," according to the company's website.

How do they do that without hurting the client by waiving confidentiality? They say that they enter into a "consulting" agreement with the party or law firm. "Thus, before any non-public information is shared ... we ensure that we share a common interest in the litigation."

Wait a minute. Isn't non-public information considered confidential information of the client too? Yes, it can be in California. Would the lawyer or the client want the world to know how the suit was funded? And how does calling yourself a "consultant" change what is discoverable? Is information told at the beginning of a case somehow not confidential?

 Frankly, I think it is all lawyer hokum.

There are similar problems with funding contracts with sophisticated investors as there are with low-end funders; look no further than the Chevron/Ecuadorian lawsuit that made news again this past week. There, the opposing counsel got the funding documents, all 75 pages, and found there were eight tiers of funders. Do you think the Ecuadorians would benefit much from any judgment? I doubt it. 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. True, their funding helped lawyers prosecute the recent BP oil cases. They argue that they are not subject to the usurious interest rate laws because they are making an investment and not a loan. They contend that a typical car or home loan is secured and is not near as risky as an investment in a lawsuit. They argue that they are taking on a big risk so they are entitled to 40 percent interest.

I could not disagree more. When passengers get on a United Airlines flight and the plane crashes due to a faulty engine repair they will definitely get some money from someone, whether it is United or Boeing. That is not much of a risk, especially where the funder comes in to fund after discovery closes. 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 take a lot.

ALFs argue that they are no different than an insurance company that is funded by a pool of law firms to provide defense of malpractice suits, or a fund set up by contractors to fund homeowner suits. The difference is this and it is essential: insurance companies are highly regulated. Funders are not regulated at all. And insurance companies don't charge 40 percent a year to people already hurt by someone (because that is usually why people sue).

Lastly, ALFs contend that the funding agreements are bespoke so it would be impossible to regulate them. But in reality, the agreements are not truly bespoke; there are typical template provisions that carry forth through them all. They 1) charge a usurious interest rate; 2) allow the funder to withdraw funding at any point if they are not pleased with how the case is going, leaving the client broke and without money and maybe counsel; 3) allow the funder to force the client and lawyer to arbitrate settlements the funder deems not good enough to give the funder the profit they want; 4) claim to not seek to control the lawyer or the litigation but contain provisions that actually can control the course of the case; 5) allow information sharing by the funder with other investors perhaps waiving the attorney-client relationship and 6) have negative covenants that disallow the plaintiff to execute any documents that might reduce the value of the funder's investment (even if the documents might be beneficial to the plaintiff).

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. This is assuming a lawyer should even try to get consent to such conflicts-particularly where the lawyer gets the funding. I have my doubts at the current rate of interest charged.

This greed must stop. When funders and lawyers have the potential to leave the damaged party client with little to show for the suit then it is time for regulation, both from the State Bar and from the Legislature.