June 18, 2014

Investing in Litigation: Gains for Some… Losses for All


The following scenario illustrates the potential pitfalls to third-party litigation funding, a trend occurring in our civil courts. Unregulated, third-party litigation funding may result in compromises to our justice system, compromised legal ethics and attorney-client privileges, lost business, and unnecessary costs.

Richard is the former officer of one of Oregon's largest companies — let's call it Quorum — and is outraged by his abrupt and unexpected termination. Eager to take revenge on Quorum, Richard contacts an attorney and alleges various claims against his former employer. Richard provides his attorney with substantial information about his alleged claims and believes he is entitled to damages in excess of $50 million. Richard's attorney provides him with a written evaluation of the claims, stating that Richard's lawsuit has only a 10 percent chance of success because one claim is meritless and others are factually weak. The attorney asks Richard for a $100,000 retainer and indicates that it will probably cost from $1 million to $2 million to take this case through trial. Richard cannot finance his claims against Quorum so he seeks out a third-party litigation funding company, which agrees to pay all of Richard's legal fees in exchange for 50 percent of Richard's recovery. The third-party litigation funding company cannot get back the money it invests in Richard's lawsuit unless Richard wins.

Richard is not alone in his decision to use a third-party funding company to pay for his litigation. Third-party litigation funding is fast becoming one of the most significant trends in civil justice but the system and those who seek to find justice through it have nothing to gain and much to lose by this intermeddling of strangers, whose only motive is a positive return on investment. As we will see through Richard's story, third-party litigation funding, unless regulated, will lead to the erosion of fundamental legal principles and protections — making losers of us all.

Third-party litigation funding is a relatively new phenomenon in the United States because the common laws in most states previously prohibited it based on the principles ofmaintenance (support of litigation by a stranger) and champerty (support of litigation by a stranger for profit). Regulation of third-party litigation funding, if any, varies from state to state. Although champerty is allowed in Oregon, there are no statutes that regulate third-party litigation funding.

Third-Party Litigation Funding Does Not Lead to Justice

The third-party lender believes that if it did not finance Richard's claims, Richard would not have his day in court. A day in court, however, does not equate to justice. In Richard's case, the third-party lender's money is allowing nonmeritorious claims to be filed against Quorum. Oregon taxpayers pay for the increased costs to the court system and suffer when the resolution of lawsuits with merit are delayed. Oregon as a whole also suffers in another way, because instead of Quorum devoting itself to generating revenue and creating jobs, Quorum has to use its time and money fighting meritless claims.

Ethics Are at Risk

The third-party litigation funder insists on having some decision-making authority over Richard's claims so it can protect its investment. By allowing the third-party lender to "direct or regulate" his "professional judgment," Richard's attorney may be violating the Oregon Rules of Professional Conduct. If the attorney has contracted directly with the lender for the payment of his legal fees, the attorney has independent contractual duties to the lender that may very well run afoul of his duty of loyalty to Richard.

Third-Party Litigation Funding Encourages Frivolous Lawsuits

Third-party litigation funding increases the volume of litigation and, necessarily, the volume of questionable claims. The third-party lender claims it does not want to invest in meritless cases and will get involved only after a plaintiff has retained an attorney or filed a lawsuit. But, in Richard's scenario, the lender did not make its funding decision about Richard's lawsuit solely on the merits of the claims. The lender is a sophisticated investor and bases its decisions on the present value of its expected return, which includes not only the likely success of the lawsuit but also the potential amount of recovery. In Richard's case, if the minimum likely recovery is 10 percent, that is $5 million, 50 percent of which belongs to the lender. In addition, given the shaky claims asserted by Richard, the lender insisted on a higher percentage of recovery.

Third-Party Litigation Funding Discourages Settlement and Fosters Abusive Litigation

Third-party litigation funding creates a disincentive for Richard to settle. Because he must share the 50 percent of the proceeds of any recovery with the lender, he is likely to reject a fair settlement offer and hold out for a larger sum of money. Similarly, the lender is likely to pressure Richard to accept settlement offers that are sufficient to cover the amount financed after subtracting Richard's share of the recovery.

Because Richard is supported by third-party funding, he can afford to prosecute even his questionable claims through trial. His former employer, Quorum, however, is pressured to settle all but the most frivolous claims, even if on unfavorable terms, or incur hefty legal fees. By promoting coercive settlements in this way, third-party litigation funding increases the profitability — and therefore the likelihood — of abusive litigation.

Third-Party Litigation Funding Can Erode the Attorney-Client Legal Privilege

The attorney-client privilege protects communications between attorney and client. Before lender agreed to fund Richard's litigation, it required substantial confidential information from Richard. By sharing that information with the lender, Richard has probably waived the attorney-client privilege that may have applied to the information. In addition, because the lender demanded a copy of his attorney's initial evaluation letter to Richard, the privilege attached to that document is probably also waived. Consequently, previously privileged information is now discoverable and will probably be made available to the public.

We All Lose

At the end of the day, investing in litigation may appear lucrative. Richard's story, however, suggests that although a few parties may see some financial gains, the rest of us lose. Our legal system is designed for adjudicating claims on their merits. Third-party litigation funding, if not regulated and monitored, will allow strangers to manipulate the system for profit.

For more information on this topic, please contact marketing@jordanramis.com or call (888) 598-7070.

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