Financing Affirmative Litigation – Installment 3
Practical and Ethical Considerations
Thanks for patiently awaiting this third installment pertaining to financing affirmative litigation. To recap, the first two installments dealt with a general introduction to common options for monetizing affirmative litigation and a discussion as to the criteria that third-party funders (“TPF”) may use to analyze and underwrite their investments. This third installment speaks to some practical and ethical considerations pertaining to non-recourse advances. The next installment will give an example of funding a portfolio or matrix of litigation matters as well as some potential tax and financial considerations related to funding.
Litigation funding is another tool that can be used by attorneys and their clients. Like any other tool, however, funding should only be used in the right circumstances, and only after careful deliberation. The cost of the money alone can be prohibitive, and an improperly managed application process can be time consuming and laborious.
Funding may be appropriate for a single case where the plaintiff has a valuable, meritorious claim, but lacks sufficient resources to prosecute the case to completion. Budget limitations can arise internally (ex. – a corporate legal department’s annual litigation budget has been committed to other projects), or from a disparity between the relative resources of the litigants (ex. – David v. Goliath). When managing a portfolio of cases, litigation funding may be useful in mitigating or sharing risk, and (when used effectively) for reducing losses associated with unsuccessful cases.
Another factor to consider is vendor selection. Each TPF has a different tolerance for case types (some specialize only in IP claims whereas others may focus on class action litigation or even limit funding to more common breach of contract matters) and for case sizes (many TPFs will not consider requests for cases where the amounts in controversy are below $5M, or where the amount of the advance requested is under $500,000). The various TPFs will also have differing application and underwriting requirements that range from the sharing of some paperwork to a detailed presentation or “sales pitch” from the attorney or client.
Facilitators or brokers are a viable option. While going directly to the TPFs can avoid payment of facilitation or broker’s fees, facilitators or brokers may offer the choice of several funding sources (as opposed to only the one offered by a TPF). Effective facilitators and brokers have the ability to properly package and present funding requests to the appropriate TPF and are worth the fees they charge. (These fees can be rolled into the advance and thus subject to the non-recourse nature of the funding). Ineffective brokers may not adequately present the funding requests, resulting in rejections.
“Shopping” a funding request to (or through) a number of potential entities may not be an option and may likely be counterproductive. TPFs and facilitators/brokers can require some sort of exclusivity agreement, so the ability to bring the funding request to more than one entity may be contractually restricted. Additionally, if the funding request is provided to several facilitators/brokers, then the TPFs will likely be presented with the same request multiple times. If an otherwise good request was initially submitted by an ineffective broker and rejected, subsequent submissions of the same requests by more diligent facilitators may be rejected out of hand.
Most, if not all, jurisdictions have no ethical restrictions upon attorneys barring the use of third-party litigation funding. (Of course, lawyers are ethically prohibited from extending loans to clients). Ethical rules may apply with respect to communication, confidentiality, conflicts of interest, and interference with loyalty or independent professional judgment.
When litigation funding is being considered, the attorney should explain any proposed funding arrangements with client, including any potential implications related to the funding, repayment, and the application process. Part of that discussion should involve the risk of inadvertently waiving attorney client privilege. Any financial interests the attorney has with the TPF should also be disclosed.
Attorneys have an ethical obligation to be truthful when communicating with the TPF. This goes beyond the avoidance of making false statements, but also includes a duty to disclose material facts to avoid fraud. After all, the TPF uses information provided by the attorney to make the decision whether to invest in a case, so that information needs to be reliable.
A TPF, or broker/facilitator will need information from the attorney and client in order to make a decision whether to fund a case, and under what terms the funding should proceed. A non-disclosure agreement should be executed to protect sensitive and potentially confidential information and work product. For example, the NDA can restrict the information shared with the TPF to exclude anything subject to privilege or work product, and only involve information in the public domain, pleadings, or information subject to discovery. Attorneys should also be aware of the applicability (or non-applicability) of the common legal interest doctrine for these types of circumstances.
Once funding is obtained, the TPF does not become the client. Care must be taken by the attorney to ensure that the TPF does not affect the representation of the client and the prosecution of the case. For example, the client, not the TPF, makes settlement decisions. Additionally, the attorney should retain independent professional judgment without interference from the TPF.