Third party litigation funding (“TPLF”) is, beyond a doubt, here to stay. In bankruptcy cases, TPLF arises in a number of contexts. First is the TPLF as a pre-petition secured or unsecured creditor—i.e. the TPLF source funded litigation and thereby acquired property rights in litigation proceeds or perhaps otherwise as a result. Second, in a post-petition context, the TPLF source may be sought to finance post-petition litigation for a debtor in possession (“DIP”), trustee or post-confirmation creditors trust. It is a relatively new development in the US, and creates numerous issues which are developing in real time. The focus of this article is the concept of ethical and fiduciary obligation issues that arise from TPLF situations in the bankruptcy context. As these are developing legal and practical situations, this article likely raises more questions than it answers. That said it is still important to consider them.
Numerous players have entered into the TPLF marketplace. For example, Burford Capital, LLC (“Burford”); Bentham IMF, Gerchen Keller Capital (acquired in December 2016 by Burford); Therium Group Holdings (announced a $300 million fund for commercial litigation TPLF in April 2016), Longford Capital Management LP; Lake Whillans Litigation Finance LLC; Harbour Litigation Funding; Vannin Capital; Pravati Capital, Juridica; Icahn Capital L.P. and TownCenter Partners are just a few examples.
How lucrative is this area? Burford reported $378 million new investments in TPLF in 2016 (up 83%), with total investments in TPLF totaling more than $2 billion. See Barrett, “The Business Of Litigation Financing Is Booming”, Bloomberg Businessweek (May 30, 2017). Burford (publicly traded) announced a 75% increase in profits-after-tax for 2016 compared to 2015, and $216 million in cash from investment returns in 2016 (48% increase over 2015). See “Litigation Funder Burford Had 75% Profit Increase In 2016—And Thinks It Could Be Bigger”, ABA Journal (March 15, 2017). See also “Litigation Financing Co. Closes Second Fund At $500M”, Law 360 (September 18, 20-17) (reporting on a new $500 million TPLF fund by Longford Capital Fund II, LLP).
Love it or hate it, its big business with the potential for huge upside. Whether it’s the savior of underdog litigation for those without resources to protect and prosecute rights and claims, or contingency financing on steroids, it is here to stay as a practical matter, particularly in the bankruptcy arena. See McDonald, “A Rising Tide Lifting Seaworthy Boats In Litigation Finance”, Above The Law (August 15, 2017) (” Litigation finance is growing rapidly and shows no sign of stopping anytime soon.”). Moreover, the issues identified herein, by no means exclusive, represent real time issues and developments in the law, and are presented in no particular order of priority. As publicized by Burford: “The only limits are your imagination!” See “MagCorp Bankruptcy Trustee On Litigation Finance: “The Only Limits Are Your Imagination'”, Burford Capital Press Release (May 1, 2017).
While TPLF is a relatively new concept in the U.S. (originating in Australia about 10 years or so ago), it is something whose underpinnings are not a new concept—the old English legal principles of “champerty” and “maintenance”.
Before you scramble for your 1968 edition of Black’s Law Dictionary, here’s the gist: “Maintenance” is essentially “generally assisting another in litigating a lawsuit”, and “Champerty” is a form of maintenance, and is maintaining a lawsuit in exchange for a financial interest in settlement or judgment of the suit.
Not being true capitalists, old English law prohibited maintenance/champerty because they encouraged potentially fraudulent/baseless litigation. While such prohibition had its roots in old English common/statutory law, in the US some states still prohibit or materially limit it (e.g. Alabama, Colorado, Kentucky, Mississippi, North Carolina, Minnesota, New York and Pennsylvania ), while others allow it (perhaps with some restrictions) (e.g. Florida, Indiana, Ohio, New Jersey, Tennessee, and Texas). See Pribisich, “Maintenance, Champerty and Usury: Ethical Issues Of Alternative Litigation Financing”, ABA Presentation (2015). The foregoing notwithstanding, other courts have recognized the social benefit of TPLF. See, e.g. Lawsuit Funding, LLC v. Lessoff, Index No. 650757/2012, 2013 WL 6409971, at *6 (N.Y. Sup. Dec. 9, 2013) (litigation funding “allows lawsuits to be decided on their merits, and not based on which party has deeper pockets or stronger appetite for protracted litigation.”); Hamilton Capital VII, LLC, I v. Khorrami, LLP, No. 650791/2015, 2015 WL 4920281 at *5 (N.Y. Sup. Aug. 17, 2015) (“Modern litigation is expensive, and deep pocketed wrongdoers can deter lawsuits from being filed if a plaintiff has no means of financing her or his case. Permitting investors to fund firms by lending money secured by the firm’s accounts receivable helps provide victims their day in court.
Combine the high cost of war of attrition litigation (which may have material monetary benefits if won) with financially strapped litigants, and new and inventive ways to finance such litigation with its high risks, and high possible economic reward for those willing to do such risky financing, and TPLF arises (and an industry is spawned). And where best to find financially distressed litigants than the bankruptcy arena, where finding financially distressed litigants is as common as finding ill people in a hospital! See, e.g. Frankel, “Litigation Funding In Bankruptcy Should Be In Every Trustee’s Toolkit”, Reuters (March 14, 2017).
In the U.S., before the arrival of TPLF, there were essentially two ways for the financially distressed litigant to prosecute claims—the class action suit where lawyers were paid a sizeable portion of the recovery, or in smaller matters, the straight contingency fee retention agreement. TPLF has added a new way whereby the litigant can prosecute claims where the lawyers are not taking the financial risk. Understandable, lawyers will be keen to utilize this method of financing litigation, and clients (who already, by necessity, are giving away part of the recovery as the cost of pursuing a claim they cannot afford to fund) are also willing to explore TPLF.
While there are numerous issues related to bankruptcy realm TPLF, presented for the reader’s consideration is the issue surrounding ethical/fiduciary obligations of lawyers and bankruptcy estates when utilizing TPLF. Specifically, depending upon the nature of the TPLF arrangement, and specifically the issues of control over litigation strategy and related issues (such as settlements, etc.), participants in this brave new world need to be mindful of the ethical and fiduciary duties owed by counsel and estate fiduciaries when working with TPLF sources in bankruptcy litigation. Not surprisingly, some industry groups are calling for increased disclosure of TPLF relationships in litigation, while the TPLF industry disseminates numerous articles and related pieces refuting any such need for such additional regulation, scrutiny or oversight.
In a situation where a TPLF is in place pre-filing, and given the possibility of extreme close connection between the TPLF source (access to confidential information, control over the financed litigation, communications with counsel, and similar dynamics), can the TPLF be considered a non-statutory insider as someone in control of material aspects of the plaintiff? This is certainly a possibility for parties looking to either challenge a lien or claim of a TPLF in bankruptcy cases. It is understandable from the TPLF perspective why such control is needed (to manage the “investment”)—that said, the ethical and legal overlay makes this particular “investment” not the usual cookie cutter deal to be managed.
TPLF is at its core an as yet unconventional DIP financing or post-confirmation exit financing for litigation assets — rather than being secured by tangible assets, it is “secured” by the proceeds of the litigation being financed. Related to the all of these issues, and as underscored by Judge Montali in the Blue Earth situation discussed above, an issue with TPLF on a post-petition basis is who controls the litigation and directs counsel once the TPLF is in place? DIP/Trustees are of course fiduciaries. The terms of certain TPLF agreements give control and discretion to the TPLF (perhaps understandably given the risky nature of the investment in uncertain and costly litigation). Herein lies the issue in that estate fiduciaries can never abandon their fiduciary duties. See, e.g. In re Mushroom Transp. Co., Inc., 247 B.R. 395 (Bankr. ED Pa 2000);Bankruptcy Code§ 327. Because TPLF is a relatively new, unregulated form of post-petition financing in most cases with huge potential costs associated with it, the TPLF’s control over the subsequent funded litigation could be viewed as a delegation of the estate’s fiduciary duties.
Finally, many commentators have noted that TPLF creates potential ethical issues for counsel proposing it to a client, as well as the counsel prosecuting the litigation that is being funded. Who is the “client”, and to whom does the duty lie? See, e.g. Steinitz, “Whose Claim Is It Anyway? Third Party Litigation Financing”, 95 Minn. L. Rev. 1268, 1291-1292 (2011); Decker, “A Litigation Finance Ethics Primer, Above The Law (March 9, 2017) (an article interestingly sponsored by a TPLF, Lake Whillans). See also ABA Report discussed below.
TPLF is in many respects a financing mechanism in uncharted territory—contingency fee financing without the usual regulation. It is, in the end, contingency fee financing in an arena on steroids—bigger, more aggressive, the potential for huge returns, all with as yet uncharted ethical constraints. As it unfolds and evolves, the legal issues surrounding it will develop as well.
In the words of Guns N’ Roses: “Where do we go now?” Where do we go indeed?
Copyright 2017, Thomas J. Salerno. All rights reserved. The opinions expressed herein are those of the author. See, e.g. Henry Meier, “Litigation Costs Go Third Party”, Los Angeles Business Journal, July 4, 2016(“[TPLF] industry growth has been rapid.”); Matthew Fechik & Amy G. Pasacreta, “United States: LitigationFinance: A Brief History Of A Growing Industry”, Mondaq, Apr. 4, 2016 (“[TPLF] firms now invest about $1 billion a year, and the industry seems to be growing.”).  Burford is a public company. With returns like this, it is only a matter of time before the same folks that brought securitized mortgage securities to the investing market (dicing and slicing mortgages in ways only a mathematical whiz can comprehend) will find ways to offer securitized litigation recoveries for every pension plan. On the plus side, interest in the judicial system will skyrocket as investors will demand all large trials be televised (pay per view anyone?) so they can monitor their investments much like one watches a football game on which one has wagered. Of course, the judiciary will need to accommodate commercial breaks.  Of course, in the U.S., but for baseless litigation many lawyers would have no work at all! Indeed, at least one definition of the “adversarial system” is that out of the clash of lies truth will emerge. But the author digresses.  Canada is apparently not particularly friendly to TPLF. See e.g. “Rebuke Of Bentham Deal May Chill Canada Class Suit Funding”, Law 360 (September 18, 2017 ) (“A recent decision by a Toronto judge throwing cold water on a third-party funding deal from Bentham IMF for plaintiffs in a medical device case may severely hamper interest from commercial funders in backing future Canadian class actions, experts say. In August, Ontario Superior Court Judge Paul M. Perell, one of just two jurists who oversee class actions in the country’s foremost financial and business hub, called for significant changes to an “uncapped” deal between international litigation funder Bentham and a couple suing over allegedly faulty heart implants, finding that an open-ended termination provision would allow Bentham “to control whether and how this litigation will proceed.” While a challenge from the plaintiffs is already in the works, the August ruling invites strict court limits on returns for commercial investors and will likely set a precedent for tight control over deals deemed too favorable to investors, according to experts.”).  California is not as restrictive. See, e.g. Del Webb Communities, Inc. v. Partington, 652 F.3d 1145, 1156 (9th Cir. 2011) (“‘Champerty’ generally refers to an agreement in which a person without interest in another’s litigation undertakes to carry on the litigation at his own expense, in whole or in part, in consideration of receiving, in the event of success, a part of the proceeds of the litigation. […] The consistent trend across the country is toward limiting, not expanding, champerty’s reach.”) [Citations and internal quotation marks omitted.]; Abbott Ford, Inc. v. Superior Court, 43 Cal. 3d 858, 885 (1987) (“California… has never adopted the common law doctrines of champerty and maintenance.”); Pac. Gas & Elec. Co. v. Bear Stearns & Co., 50 Cal. 3d 1118, 1136, 791 P.2d 587 (1990) (“In fact we have no public policy against the funding of litigation by outsiders. […] Our legal system is based on the idea that it is better for citizens to resolve their differences in court than to resort to self-help or force. It is repugnant to this basic philosophy to make it a tort to induce potentially meritorious litigation.”)  It is axiomatic that, absent the ability to print money (such as the U.S. government) or having substantial insurance backing, litigation can be and is hugely expensive. Accordingly as a practical matter, all litigants may be deemed to be financially strapped to one degree or the other.  One TPLF provider suggested that TPLF is a way to overcome the so-called Jevic problem of dismissals that skip priorities. See e.g. Carmel, “If Jevic Is Your Problem, Litigation Finance Might Be Your Solution” ABI Journal (November 2017).  See, e.g. “Burford Clinches Portfolio Funding Deal With UK Law Firm”, Law 360 (July 31, 2017); “The Role Legal Finance Can Play In Firm Year-End Collections”, Law 360 (October 5, 2017).; “Using Litigation Finance: 12 Leading Lawyers Weigh In—Parts I and II”, www.BurfordCapital.com/blog/leading-lawyers-discuss-litigation-finance (October 3 and November 2, 2017).  See “Renewed Proposal To Amend Fed. R. Civ. P 26(a) (1) (A)” at pp. 2-7 (June 1, 2017), a letter from numerous groups to the Secretary of the Committee On Rules of Practice and Procedure of the United States Courts (hereinafter the “Chambers Letter”). The Chambers Letter was sent by the following groups: US. Chamber Institute for Legal Reform, the Advanced Medical Technology Association, the American Insurance Association, the American Tort Reform Association, the Association of Defense Trial Attorneys, DRI – The Voice of the Defense Bar, the Federation of Defense & Corporate Counsel, the Financial Services Roundtable, the Insurance Information Institute, the International Association of Defense Counsel, Lawyers for Civil Justice, the National Association of Mutual Insurance Companies, the National Association of Wholesaler-Distributors, the National Retail Federation, the Pharmaceutical Research and Manufacturers of America, the Product Liability Advisory Council, the Property Casualty Insurers Association of America, the Small Business & Entrepreneurship Council, the U.S. Chamber of Commerce, the Michigan Chamber of Commerce, the State Chamber of Oklahoma, the Pennsylvania Chamber of Business and Industry, the South Carolina Chamber of Commerce, the Virginia Chamber of Commerce, Wisconsin Manufacturers & Commerce, the Las Vegas Metro Chamber of Commerce, the Florida Justice Reform Institute, the Louisiana Lawsuit Abuse Watch, the South Carolina Civil Justice Coalition, and the Texas Civil Justice League.  See, e.g. “Critics Pushing Back On 3rd Party Funding Disclosure Rule”, Law360 (June 21, 2017); Chock, Harrison and Pai, “Big Business Lobby Tries To Hobble Litigation Finance, Again”, Law360 (June 6, 2017) (“The Chamber raises several supposed concerns about litigation finance to justify its overbroad proposed rule, which is rather obviously meant to reveal a plaintiff’s ability to withstand protracted litigation.”). See also Letter of Bentham IMF in response to Chambers Letter dated September 6, 2017 (“The Chamber’s radical proposal to invade parties’ financial privacy and their attorneys’ work product is inconsistent with the underlying purpose of the federal rules “to secure the just, speedy, and inexpensive determination of every action.”… The Chamber attempts to tag litigation funding with “problems” that largely either do not exist, or are in truth benefits. “Frivolous litigation” is the Chamber’s principal whipping boy. Nothing suggests that litigation funding causes cases of little or no merit to be filed in federal court, or that the Chamber’s automatic disclosure proposal would head off such filings. Litigation funding in fact encourages careful assessment of litigation prospects and costs—the antithesis of “frivolous litigation”—and therefore discourages frivolous litigation and promotes fair settlements, both in theory and in practice… Litigation funding represents only one of many ongoing developments in the evolution of litigation and dispute resolution. These developments include increased reliance on technology to perform tasks that formerly only lawyers performed, increased use of private resources in resolving disputes, increased control of litigation by the parties themselves, and increased focus on the resource constraints for litigation. These developments are largely beneficial. The Chamber’s proposal is an ill-disguised attempt to thwart perhaps the most significant and salutary of them all, namely litigation funding, and we urge the committee to reject it.”).  According to the Chambers Letter, “Bentham’s own 2017 ‘best practices’ guide contemplates robust control by funders. Specifically, it notes the importance of setting forth specific terms in litigation funding agreements that address the extent to which the TPLF entity is permitted to ‘[m]anage a litigant’s litigation expenses’, ‘[r]eceive notice of and provide input on any settlement demand and/or offer, and any response’, and participate in settlement decisions.” Chambers Letter at 16-17. According to Bentham: (1) the Chamber mischaracterizes Bentham’s Code of Best Practices; (2) Bentham’s Code does not provide that a funding agreement should give the funder control over the litigation or settlement, but only that a funding agreement should be clear about whether or not the funder has control over the litigation; and (3) Bentham’s funding agreement expressly provides that it does not have control over the litigation or settlement. In any event, regardless of broad policies, extent of control will be a function of the actual TPLF agreement.  The concept of non-statutory insider (as opposed to statutorily defined insiders) is accepted. See, e.g. In re The Village of Lakeridge, LLC. , 814 F.3rd 993 (9th Cir. 2016). See also “A Sui Generis Approach To ‘Insider’ Status In Bankruptcy”, Chapman Insights (February 18, 2016).  Judge Wanslee’s Epicenter Memorandum Decision held that a claim secured by estate assets by Burford sold pre-filing to a subsequent transferee, was “cleansed” by transfer to the non-insider, relying on Village of Lakeridge. The decision is interesting in that the creditor (CPF Vaseo Associates. LLC—”CPF”) purchased two claims (secured by first and second liens on the estate asset). The first was the Burford TPLF claim, in first position. The second was a claim of the prior litigation counsel (Simpson Thatcher Bartlett—”STB”) for unpaid legal fees, secured by a second lien on the assets. The Epicenter Adversary was filed to characterize the claims as insider claims, equitably subordinate and disallow the two secured claims held by CPF. The Court dismissed the claim seeking to characterize (and subordinate) the CPF claim related to the prior Burford TPLF claim, but did not do so as to the STB secured claim that essentially arose from the same pre-filing litigation, and also acquired by CPF. Arizona has no law related to ultimate enforceability of TPLF claims as violative of champerty/maintenance laws.  Of course, there is nothing that says TPLF could not also be secured by traditional assets (real estate, etc.). This is what essentially happened in the Epicenter Partners case above (TPLF modified after judgment from a percentage of the litigation proceeds to a lien against real estate and other assets) See note 12, supra. In any event, the issues discussed in these materials are further complicated by such an arrangement as the potential for huge returns are more questionable if the “risk” is mitigated because of the existence of other collateral.  The Chambers Letter further suggests that without strict disclosure of TPLF sources/entities, there exists the possibility that judicial conflicts of interest may arise as judges do not have sufficient information to determine if recusal is needed. See Chambers Letter at 15-16.  “It is alleged that on numerous occasions, STB actively worked against the interests of its client, causing duress. For instance, STB told Mr. Gray, the principal of its client, that he was ‘ion no position to negotiate’ [regarding the TPLF]….STB threatened to resign as [client’s] counsel unless [client] agreed to [Burford’s] demand, thus further violating its general duty of loyalty to [its client]. Worst of all, STB negotiated a contract with a party holding adverse interests to its client [i.e. the TPLF] without consulting its client, or permitting its client to suggest changes [to the terms of the TPLF]….After the [litigation] settlement, [Burford] began demanding payment from [the client]. Rather than protect its clients’ interests, STB refused to perform any work and instead demanded a settlement between [the client and Burford].” Epicenter Memorandum Decision at 24-25 (emphasis in original).  Available at: http://www.americanbar.org/content/dam/aba/administrative/ethics_2020/20111212_ethics_20_20_alf_white_paper_final_hod_informational_report.authcheckdam.pdf  Sweet Child Of Mine, Guns N Roses, Appetite For Destruction (1987).
Thomas Salerno brings thirty-five years' experience to resolving complex issues in commercial corporate restructurings and recapitalizations, advising lenders, distressed companies, committees and acquirers of assets in both out of court restructurings and in bankruptcy cases.
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