Litigation finance in today’s legal industry

While the use of litigation finance is now well-established in the legal industry, it still garners significant attention among both the media and practicing attorneys. In particular, there remains much discussion regarding the impact of litigation funding on the decision to initiate lawsuits as well as potential disclosure requirements for litigation funding arrangements.

The concept of litigation finance is relatively simple. Typically, a third party provides funding to a litigant to pay for attorney fees and other costs in exchange for a fee to be repaid dependent on the outcome of the lawsuit. By using litigation financing options, parties may be able to pursue litigation that they could not otherwise afford, or can minimize the risks associated with litigation by sharing the costs with a third party.

Many studies have confirmed the increasing use of litigation finance. One study reflected a staggering increase in the use of litigation finance by U.S. law firms in recent years -- 36% of U.S. law firms reported using litigation finance in 2017, compared with only 7% in 2013.

Both courts and legislators are taking notice. The U.S. District Court for the Northern District of California amended its Standing Order to require that parties in class action cases identify "any person or entity that is funding the prosecution of any claim or counterclaim." Notably, that court rejected a proposal that would similarly mandate disclosure of third-party funding for all litigation (not just class actions).

Lawmakers have also undertaken efforts to regulate the use of litigation finance, specifically with respect to the disclosure of such arrangements. In 2019, a bill titled the Litigation Funding Transparency Act was reintroduced in the U.S. Senate and would require disclosure of litigation funding arrangements in class action lawsuits and multi-district litigation. Wisconsin in fact enacted a law requiring disclosure of such arrangements even in the absence of a discovery request seeking such information.

Notably, there is nothing inherently unethical in pursuing litigation financing. Indeed, there are advantages to these arrangements and many large firms are using them with success. However, there can be risks for lawyers and their clients. With appropriate precautions, litigation finance can be an effective tool for law firms.

Traditional Concerns

The rise of litigation finance had legal scholars dusting off old textbooks to consider the application of principles such as champerty and maintenance. Under common law, champerty refers to a bargain between a third party and a litigant whereby the third party agrees to carry on the litigation at her or his own expense in exchange for part of the proceeds.

Prohibitions against champerty may remain the law in certain states but are rarely invoked to invalidate litigation finance contracts. Further, courts addressing the issue have often limited the prohibition against champerty as applied to modern litigation funding agreements. For example, in 2016, a Delaware court found that a litigation finance agreement was not champertous because the third party did not have the right to control the litigation.

Given the litigation finance boom, it is likely that more courts will have occasion to consider the impact of these longstanding principles on litigation funding as it exists today. Thus, litigants may have to review the status of their state's common law on champerty before considering the terms of a financing agreement.

Comparison to Liability Insurance

Although some in the legal industry have expressed concerns over the use of third-party funders related to confidentiality or the scope of the relationship, many of those concerns have already been addressed in another context: liability insurance. A liability insurance policy similarly creates a situation where a third party has a financial stake in the outcome of the lawsuit and inevitably gives rise to complicated questions when the interests of the third party and the litigant diverge.

To the extent such issues arise in litigation financing arrangements, courts can borrow concepts that have been extensively addressed in the context of insurance law. Just as the insured and its insurer are united in seeking to limit the insured's liability, a litigation funder and the litigant will typically be united in their desire to maximize the proceeds of the litigation. However, when disputes arise, the law is well-developed regarding the obligations an insurer owes to its insured, and thus similar principles can apply to the extent issues arise between a litigant and third-party funder.

In fact, there is arguably less cause for concern in the context of litigation finance, given that litigation funders typically do not assume the same level of control (if any) over the litigation as insurers, who often exercise control over the defense of the lawsuit, including with respect to the selection of defense counsel and settlement decisions.

Privilege Concerns

As part of its determination regarding whether to fund a lawsuit and in monitoring the progress of a lawsuit, a litigation funder may sometimes receive privileged documents from the litigant or its attorneys. As a result, some have expressed concern that a party could inadvertently waive attorney-client or work product protection for documents by providing them to the funder.

However, courts have largely held that documents shared with a litigation finance company are protected under the common interest doctrine or the work product doctrine. To potentially provide additional protection, the litigation funding agreement can contain provisions to protect the privilege or the litigant may choose to limit the documents provided to the funder so as to counter any suggestion of a broad waiver.