Tripp Haston and Angelique Ciliberti, Bradley LLP
Civil litigation, once a realm confined to rules-based conflict resolution between adverse parties, has become profitable commerce in the US. Where commerce thrives, investors looking for healthy returns follow. Unlike other forms of commerce, and unlike other nations, litigation investment and funding in the US is largely unregulated with few disclosure requirements. Where darkness exists, ignorance and mistrust breed. Thankfully, a number of reforms are afoot to pull back the curtain on this opaque dynamic in the US civil justice system.
According to its self-involved pundits, the use of third-party litigation funding (TPLF) is growing at an exponential rate. One conspicuous TPLF player claims that in 2017, 36 per cent of large US law firms reported use of litigation finance. While virtually impossible to verify, that number stands in stark contrast to the asserted 7 per cent that was reported in 2013. (See Burford Capital’s 2017 Litigation Finance Survey, available at burfordcapital.com/2017-litigation-finance-survey.)
Ironically, the inability to objectively verify the extent of TPLF in the US is precisely because the industry has been so adamantly opposed to its disclosure in individual cases. Consequently, little is known about how these contracts affect the course of the litigation. Recently, however, the Federal Consumer Financial Protection Bureau (CFPB), a US agency responsible for consumer protection by regulating institutions in the financial sector, has taken an interest in the legal finance industry, and emerging case law reveals the importance of reforming our legal procedures to catch up with this change in the legal landscape. Moreover, a number of other legislative and rules-based reforms are in progress leading to the inevitability of TPLF disclosure.
This article will provide a brief explanation and history of TPLF in the US. It will then discuss the arguments advanced both for and against this industry and analyse recent case law in which TPLF issues arose. Finally, it will describe the growing movement toward disclosure of TPLF arrangements.
In its most basic form, third-party litigation funding is the investment in a lawsuit or pool of lawsuits by a stranger to the litigation (ie, not a party’s counsel, insurer, etc) in exchange for a contingent share in the proceeds from any judgment or settlement. In essence, TPLF converts the common contingency fee arrangement into an investment vehicle for non-lawyers who are not subject to ethics rules governing lawyers involved in such arrangements.
TPLF as an industry developed over the past 20 years in Australia, the UK and Europe. It has since migrated to the US, where it is the focus of substantial investment by companies such as Burford Capital (headquartered in the UK and traded on the London Stock Exchange) and Bentham IMF (headquartered in Australia). In 2016, Burford acquired competing TPLF firm Gerchen Keller for US$160 million. Since then, Burford has only grown more profitable. In 2017, Burford’s income from their investments reportedly rose 127 per cent to $318 million. (See Burford’s 2017 annual report, available at burfordcapital.com/investors/financial-reports-and-presentations/.
While single-case financing remains the traditional form of litigation finance, TPLF has developed into more complex forms. For example, Burford now offers portfolio financing, which allows a law firm to secure financing across a pool of cases, in exchange for returns tied to the pool. Burford’s 2017 Annual Report indicates that portfolio financing now dominates the company’s business. In 2017, Burford committed $726 million to portfolio financing, while only $73 million went to single-case financing. See Burford Annual Report 2017, available at burfordcapital.com/investors/financial-reports-and-presentations/.
TPLF advocates argue that the industry provides necessary funds to prosecute meritorious lawsuits in which the plaintiff does not have the capital required to advance her suit. For this reason, TPLF proponents contend that the practice “levels the playing field” against “deep-pocketed” defendants who may seek to litigate by attrition. TPLF may also allow parties and their counsel to offload some of the risk of litigation onto the funder in exchange for less of any recovery. Funders argue that encouraging frivolous lawsuits is not a concern because such litigation would not be a sound investment.
Conversely, opponents of TPLF argue that funders have no particular interest in funding meritorious litigation. Rather, a funder’s incentive is only to maximise the present value of its investment. That may mean bombarding a defendant with a mass of speculative litigation in hopes of overwhelming the defendant and forcing settlement, even when the underlying merits are dubious.
Further, funders may seek to exercise control over litigation strategy, including whether and at what number to settle a case. Non-lawyer litigation investors are not subject to ethical obligations as a party’s counsel, which could result in strategies that benefit the funder, but not necessarily the party. Critics of TPLF are also concerned that using the litigation as an investment vehicle will distort the purpose of the civil justice system – namely, resolving disputes. Ethical concerns are also present because judges are unable to adequately evaluate their potential conflicts of interest without being aware of a significant interested party to the litigation.
The litigation financing industry has been careful to characterise the agreements as non-recourse financing, instead of loans. Of course, without routine disclosure this is yet another unverifiable assertion. Based on ad hoc disclosures that have been made, some funders’ high interest rates, which they call “funding fees” or disguised as part of a payment schedule, have resulted in recoveries that barely benefit the consumer, while the majority of the recovery inure to the benefit of the consumer’s attorneys and the third-party funder. (See generally Obermayer, Rebmann, Maxwell & Hippel v West, No. CV 15-81, 2015 WL 9489791, at *1 (W.D. Pa. Dec. 30, 2015), aff’d Obermayer, Rebmann, Maxwell & Hippel v West, No. 16-1376, 2018 WL 1074310 (3d Cir. Feb. 27, 2018) (plaintiff was required to pay $373,885 after borrowing a total of $164,000 from litigation funders, due to “Pay-Off Amounts” that increased every six months from the anniversary of each TPLF agreement). Funders justify the high “funding fees” as necessary because they claim to take on the most risk. In most contexts, these “funding fees” would often be considered usurious, but because of the industry’s tactical terminology, litigation funders maintain that the agreements are not subject to banking rules, regulations or lending laws. And their tactics appear to be working.
On 27 February 2018, the US Court of Appeals for the Third Circuit affirmed the validity of a TPLF agreement that financed a legal malpractice suit against the law firm Reed Smith. John West enlisted the financial support of Fastrak Investment Company in the malpractice suit. In exchange for their purchases of portions of the litigation proceeds, Fastrak paid West $158,000, and later, an additional $6,000. After the case settled, Fastrak sent West a pay-off letter, which showed he owed a sum of $373,885 from the settlement proceeds. West refused to pay Fastrak, claiming that the TPLF agreement was unenforceable because it was usurious. The Third Circuit disagreed with West and declared that the litigation funding agreement, which carried no guarantee of repayment, did not qualify as a loan and was therefore not subject to New York’s usury laws. (See Obermayer, Rebmann, Maxwell & Hippel v West, No. 16-1376, 2018 WL 1074310 (3d Cir. Feb. 27, 2018).
The Third Circuit’s decision may affect a recent action brought by the CFPB and the New York Attorney General against RD Legal Funding, two of its affiliates and their principal. The complaint alleges that litigation settlement advances offered by RD are disguised usurious loans that are deceptively marketed and abusive. Specifically, the complaint alleges that the transactions were falsely marketed as assignments rather than loans, and that the transactions could not possibly be assignments because the underlying settlements expressly prohibit assignment of claimant recoveries. Although the lawsuit is currently pending, it may foreshadow a broader regulatory effort by the CFPB and state attorney general.
As litigation financing has become increasingly widespread, legislators and courts have wrestled with the question of whether parties must disclose the presence of a litigation financing agreement. Recent developments demonstrate that courts and legislators are moving towards mandatory disclosure of TPLF agreements in civil litigation proceedings.
The move towards required disclosure began with a focus on class actions. In January 2017, the Northern District of California updated one of its standing orders to require the disclosure of TPLF agreements in all class action cases. Similarly, on 9 March 2017 the US House of Representatives passed the Fairness in Class Action Litigation Act of 2017, which contains a provision that would require disclosure to the court and parties in all class actions of the identity of any person or entity with “a contingent right to receive compensation from any settlement, judgment, or other relief obtained in the action”. The bill is now in the US Senate’s hands.
In parallel, many public policy organisations are advancing efforts to amend the Federal Rules of Civil Procedure to require disclosure of all TPLF arrangements in all civil litigation, not just class actions. In June 2017, the US Chamber Institute for Legal Reform (ILR), along with 28 other organisations, renewed its 2014 proposal to amend the rules to require the initial disclosure of any agreements under which any person “has a right to receive compensation that is contingent on, and sourced from, any proceeds of the civil action, by settlement, judgment or otherwise”. In 2014, the Federal Courts’ advisory committee on civil rules (advisory committee) ultimately opted not to proceed with formal consideration, given the uncertainty about the frequency of TPLF’s use in US litigation. The ILR renewed its proposal citing the substantial growth of TPLF arrangements in the US, and the concern that “absent robust disclosure requirements, TPLF will continue to operate in the shadows” and conceal serious conflicts of interests and parties of interest who “may be steering a plaintiff’s litigation strategy and settlement decisions”. (See Letter from US Chamber Institute for Legal Reform et al on Renewed Proposal to Amend Fed. R. Civ. P. 26(a)(1)(A) to Rebecca A Womeldorf, Secretary of the Committee on Rules of Practice and Procedure of the Admin. Office of the US Courts (1 June 2017), available at uscourts.gov/sites/default/files/17-cv-o-suggestion_ilr_et_al_0.pdf.) Given the evolution of the TPLF industry, the Advisory Committee may decide it is time to act.
Lawyers for Civil Justice has made a similar request for rulemaking to the advisory committee, noting that many civil cases, and especially multidistrict litigation cases, are strongly influenced by litigation funders that are “largely unknown to courts and parties despite having become a fixtures in the federal justice system”. (See Request for Rulemaking from Lawyers for Civil Justice on Adapting the Federal Rules of Civil Procedure to MDL Cases to the Advisory Comm. on Civil Rules (10 August 2017), available at uscourts.gov/file/22437.)
Although TPLF industry members have vociferously opposed disclosure of their arrangements in the US, their self-trumpeted prevalence in US litigation has triggered policy makers’ and governmental entities’ keen interest. The recent actions of legislators and courts signal an inevitable move toward disclosure and potential regulation of third-party funding arrangements in all US civil ligation.