Litigation Investment and Legal Ethics: What are the Real Issues? Anthony J. Sebok

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1 Litigation Investment and Legal Ethics: What are the Real Issues? Anthony J. Sebok Benjamin N. Cardozo School of Law, New York, NY, USA (Forthcoming in the Canadian Business Law Journal) ABSTRACT: One of the foundational principles of legal ethics is that the lawyer owes an obligation of undivided loyalty to the client, and no other interests or relationships can be permitted to interfere with the lawyer s exercise of independent professional judgment on behalf of the ent. The strongest objection to litigation investment by third parties is that it may compromise a lawyer s independence. This article examines this objection in the context of a recent report from Ethics Committee of the Commercial and Federal Litigation Section of the New York State Bar Association and argues that it misses the real legal ethics risks posed by litigation investment, which include the risk of self-dealing. The article compares the risk of self-dealing in commercial and consumer litigation investment in the United States with the risk of self-dealing in class action litigation investment in Ontario. It concludes by noting that courts in Ontario have properly identified the self-dealing risk in litigation funding for class actions and suggests that American courts and others concerned with the ethical risks for lawyers created by litigation investment can learn from the Canadian experience. 1. Introduction Litigation investment is has become increasingly more visible and controversial in the United States. One of the concerns raised in the U.S. is that litigation investment places lawyers at risk of acting unethically. In this short article I will address this concern. My argument, in brief, is that there are ethical pitfalls for American attorneys whose clients take litigation investment from third parties, but those pitfalls are not what some commentators and bar committees have identified. I will then frame the ethical pitfalls that I see as real and potentially serious, and make some tentative suggestions about how to solve them. As an initial matter, it is important to define litigation investment. The practice can mean different things to different people, and sometimes controversy over lawyers ethics in litigation investment is really disagreement over a practice that, regardless of its ethical status, is not really litigation investment (as I and many people understand it). In this article, I will define litigation investment narrowly. Litigation investment is an investment by a non-lawyer in the proceeds of 1

2 litigation. 1 Litigation investment is sometimes called alternative litigation finance ( ALF ) or litigation funding. 2 The term litigation investment is preferable simply because it emphasizes an ambiguity inherent in the practice. 3 Litigation investment may be intended to affect outcomes or it may simply be a way for someone with capital to place a bet on an outcome that is already likely to occur. In the former case, the investor is a coventurer with the litigant, providing funds (and maybe advice) that help the litigant achieve what the litigant would not have been able to do by herself. 4 One way of thinking of litigation investment intended to change litigation outcomes is as a form of venture capital. 5 In other circumstances the investment may not have any effect on the outcome of the litigation (either because it is not directly or indirectly being used to fund litigation-related expenses or because there were other resources at hand that would have been used had the funding not existed). In the latter case the investor is a pure speculator who purchases a future interest in an unrealized (and contingent) asset. Under this conception, the litigation investor takes advantage of the price differential between the expected value of the litigation when making the contract and its actual value when the case is resolved, in much the same way that an options trader takes advantage of the price differential between the current and future price of a barrel of oil in a commodities market or a real estate investor takes advantage of the price differ- 1 See Anthony J. Sebok, The Inauthentic Claim, 64 VAND. L. REV. 61, (2011) and Stephen Gillers, Waiting for Good Dough: Litigation Funding Comes to Law, 43 AKRON L. REV. 677, (2010). 2 See STEVEN GARBER, ALTERNATIVE LITIGATION FINANCING IN THE UNITED STATES: ISSUES, KNOWNS, AND UNKNOWNS 1 (2010) (describing the makeup of the litigation-investment market), available at RAND_OP306.pdf. 3 See Anthony J. Sebok & W. Bradley Wendel, Characterizing the Parties Relationship in Litigation Investment: Contract and Tort Good Faith Norms, 66 VAND. L. REV. 1832, 1833 (2013) (defining litigation investment). 4 Litigation investment s power to change the odds faced by a poor man against a rich man in court has been well understood since Bentham first wrote in its defense. See Lord Neuberger, Harbour Litigation Funding First Annual Lecture: From Barretry, Maintenance And Champerty To Litigation Funding, May 8, 2013 at 20 ) (available at docs/speech pdf) (according to Bentham, as long as litigation, access to the courts, remains expensive, then anyone who has a right that stands in need of vindication should be able to obtain funding from anyone willing to offer it and on whatever terms it is offered ). 5 See Maya Steinitz, The Litigation Finance Contract, 54 WILLIAM & MARY L. REV. 455 (2012). Steinitz is clearly correct that some contracts among commercial parties concerning the funding of litigation share certain features with the contracts between venture capitalists and high-tech state-ups. But where commercial litigation investment contracts lack those features they may be more usefully compared to contracts between lender and borrower or insurer and insured. See Sebok & Wendel, Characterizing the Parties Relationship in Litigation Investment, supra note and Anthony J. Sebok, Betting on Tort Suits After the Event: From Champerty to Insurance, 60 DEPAUL L. REV. 453 (2011). 2

3 ential between the current and future price of a parcel of land. 6 Of course, both kinds of motives could be at work where the facts allow it, and given the opacity of many litigation investments, certainty about motive is hard to come by. It is not clear that for most courts who permit litigation investment, motive matters, as long as the investor is not motivated by a prohibited (or improper) motive such a malice. 7 The current U.S. litigation investment market is almost fully bifurcated between the consumer and the commercial markets, and each reflects one or the other dominant motivation identified above. 8 In the consumer market an investor purchases a portion of a future recovery of a relatively small personal injury claim. The investment is structured as a one-time payment, or an advance, and the plaintiff who sells the portion of her claim agrees to pay to the investor a portion of her recovery calculated as a percentage of the advance times the number of months or years between the investment and recovery. The investment is not used to pay either the plaintiff s attorney or other litigation expenses, since in the U.S personal injury lawyers generally work on a contingent fee basis and advance litigation expenses. The plaintiff knows, or should know, that she is selling a portion of her future recovery at a large discount; her reasons for doing this do not fit into a single pattern, but many consumer litigation investors report that the money received by the plaintiffs with whom they transact are used for life necessities mortgage payments, health-related expenses, or food. 9 It is not clear why it should matter how plaintiffs use the funds paid to them by consumer litigation investors. A middle class personal injury plaintiff who merely wants to monetize her future recovery and a penurious personal injury plaintiff who leverages a portion of her future recovery to pay for necessities and stave off settlement pressures are motivated by different but equally respectable reasons. In fact, as a practical matter, the sale by the middle class personal injury plaintiff to the litigation investor might be better from a policy perspective, since the middle class plaintiff might be in a better position than a penurious plaintiff to choose and negotiate the sale of a portion of her recovery For example, in 1997 Golden State Bancorp issued Litigation Tracking Warrants tied to the outcome of a large lawsuit filed by one of its subsidiaries, Glendale Federal. See Richard B. Schmitt, Investors Betting On Judgment For Thrift Take A Hit In California Federal Ruling, WALL ST. J., April 20, 1999, at B11 and Maya Steinitz, Incorporating Legal Claims (unpublished manuscript, Nov. 12, 2012). 7 See Sebok, The Inauthentic Claim, supra note at 102 (on malice maintenance in the common law). 8 See Sebok & Wendel, Characterizing the Parties Relationship in Litigation Investment, supra note at n.2. 9 See GARBER, ALTERNATIVE LITIGATION FINANCING IN THE UNITED STATES, supra note at The degree to which the typical consumer is necessitous will determine to some extent the permissibility of paternalistic regulation of consumer litigation investment under consumer protection legislation such as usury laws. See Legal Finance Group, LLC v. Suthers, No. 12CA1130 (Colo. App. May 23, 2013). 3

4 In the commercial market the motive of the investor and the plaintiff are usually the inverse of their counterparts in the consumer market. The plaintiff in a commercial litigation investment is, first of all, usually not a natural person, but a commercial enterprise. The claim is not a small-value personal injury claim but a high-value commercial claim arising from a variety of causes of action, including fraud, contract, intellectual property rights, antitrust, and even qui tam. Given the frequency with which contracting commercial parties agree to binding arbitration and the cost of arbitration it is not unusual for the claim to be in arbitration. 11 Most significantly, rather than coming to the claim after a contingent fee attorney has been retained, very often the investor is approached by the plaintiff before an attorney has been retained. While contingent fee agreements in high-value commercial claims are permitted under the same rules that permit contingent fee agreements in low-value personal injury claims, as a practical matter the former are handled under the same hourly rate agreements as defense-side representation and without any offer of assistance from the plaintiff s attorney to advance litigation expenses. For this reason the investment is often critical to the plaintiff s decision process leading to whether to file a claim. Even where the commercial claimant is committed to litigating, the quality of the representation that it can afford can be significantly affected by the presence of a litigation investor. From this perspective, the claimant is not necessarily selling a portion of its future proceeds at a discount, since it may be the case that the expected value of the future proceeds without the investment is zero (if without the investment there would be no litigation) or much less than what, with the additional resources purchased by the investment, the claimant can achieve. Instead, the claimant and the investor may be growing the value of the claim through their joint contributions of legal right and financial wherewithal. The differences between consumer and commercial litigation investment described in the previous paragraphs are not inscribed in legal doctrine. They are functional. For example, unless specially required by considerations of public policy, contract law does not differentiate between consumer and commercial litigation investment agreements. 12 This article will argue that, to the extent that there are serious ethical issues raised by litigation investment for lawyers, these issues (and their resolution) may require courts and bar committees to distinguish between clients who seek consumer litigation investment and clients who seek commercial litigation in- 11 See LISA BENCH NIEUWVELD & VICTORIA SHANNON, THIRD PARTY FUNDING IN INTERNATIONAL ARBITRATION (2012). 12 See Sebok & Wendel, Characterizing the Parties Relationship in Litigation Investment, supra note (discussing reasons rooted in contract law for choosing certain default rules). Like consumer protection and/or usury laws that distinguish between consumer and commercial debt, the law of litigation investment could also impose different default rules on consumer contracts but not commercial investment contracts. This decision might be better left to regulators or the legislature. See Terrence Cain, Third Party Funding of Personal Injury Tort Claims: Keep the Baby and Change the Bathwater, 89 CHI.-KENT L. REV. 11, (2014) (discussing regulation in four American states). 4

5 vestment. It may be the case that, as with consumer protection law, the line between the two types of clients will sometimes be too formalistic and will be over- and under- inclusive in some cases, but this is no argument against adopting a rule that imposes different ethical obligations on lawyers whose clients clearly, in many cases, fall on one side or another of the line. It is just an argument for recognizing that the rule will fit imperfectly and may require discretion in its application. 2. Arguments Against Litigation Investment For centuries litigation investment was prohibited in the common law. 13 Originally, the prohibition was seen as a companion to the larger and more sweeping prohibition of the assignment of choses of action, a doctrine that, while analytically separate, was supported by the larger, general anxiety over the commercialization of litigation. 14 Modern common law does not limit assignment except in a few remaining areas of tort law. 15 Litigation investment short of assignment, however, is permitted in a large number of American jurisdictions; prohibitions present themselves in the form of common law and statutory prohibitions of champerty and maintenance in slightly fewer than half of the United States. 16 Resistance to litigation investment has been broad and varied over the centuries. 17 Blackstone strongly opposed any form of litigation investment; he objected that such investors were simply officious intermeddlers who would disturb the repose of defendants, and he repeated the concern, shared by many in the English bar, that wealthy and titled elites would encourage their tenants and retainers to sue their rivals by supporting the costs of the suits (and maybe even rewarding the tenant or retainer with a side payment). 18 Radin hypothesized that some of the resistance was rooted even more deeply than that; and that it reflected Christianity s vestigial hostility to litigation and secular courts. 19 As these arguments fell aside, they were re- 13 See Max Radin, Maintenance by Champerty, 24 CAL. L. REV. 48, (1936). 14 Sebok, The Inauthentic Claim, supra note at Id. at See id. at See Radin, supra note at (describing Roman legal prohibitions on champerty). 18 See 4 WILLIAM BLACKSTONE, COMMENTARIES * and Casserleigh v. Wood, 59 P. 1024, 1026 (Colo. App. 1900) (in Blackstone s time the wealthy and powerful would buy up claims, and, by means of their exalted and influential positions, overawe the courts, secure unjust and unmerited judgments, and oppress those against whom their anger might be directed ). 19 See Radin, supra note at 58 ( litigiousness [was] an indication of a quarrelsome and un-christian spirit ). 5

6 placed by modern arguments that reflected the concerns over the newly emerging market economy. 20 The modern arguments can be grouped into three categories: (1) fear of negative social consequences, (2) concern over commodification, and (3) jurisprudential. The consequentialist argument typically focuses on the perverse incentives created by the introduction of self-interested third parties, who are not themselves lawyers, into litigation. 21 The fear is that, by allowing self-interested non-lawyers to support litigation, the quality of litigation will decline, thus producing an increase in the amount of litigation that is fraudulent, frivolous, or specious. 22 A variant of this argument is that self-interested third parties will exploit vulnerable claimholders, taking from them a huge portion of their expected recovery in their litigation in exchange for a paltry amount. 23 This variant of the consequentialist argument is made almost exclusively against consumer litigation investment and is really a form of paternalism. It is the same argument that has been made to support state-imposed limitations on various selfregarding actions in the marketplace, whether minimum wage and maximum hour legislation, or limitations on subprime mortgages and payday lending. 24 Bentham was one of the first to observe the family resemblance between the paternalistic laws prohibiting usury and champerty. 25 The concern over commodification avoids making predictions about the economic effects of litigation investment. Instead, it takes the position that litigation investment must be prohibited because it is inconsistent with certain moral principles, and that (to take but one variation of 20 Ibid at 72 (new arguments against champerty included its tendency to induce improper litigation; the likelihood that claimholders would be subjected to hard bargains, and its tendency to degrade the profession). 21 For a careful overview of consequentialist arguments against litigation investment, see Jason Lyon, Revolution in Progress: Third-Party Funding of American Litigation, 58 UCLA L. REV. 571, (2010). 22 See Jeremy Kidd, To Fund or Not to Fund: The Need for Second-Best Solutions to the Litigation Finance Dilemma, 8 J.L. ECON. & POL Y 613, (2012). 23 [T]he main justification for [litigation investment] is that the practice is proconsumer, but the reality is that [it] benefits only one group of people the investors and it does so at the expense of all the other parties involved in litigation. Testimony to the House Committee on Judiciary & Civil Jurisprudence Hearing: Public Policy Implications of Lawsuit Lending and Its Effects on the Civil Justice System, John H. Beisner, Skadden, Arps, Slate, Meagher & Flom LLP, on behalf of the U.S. Chamber Institute for Legal Reform, April 18, 2012 and Kidd, To Fund or Not to Fund, ibid at Litigation investment has been compared at various times to usury, subprime lending, and payday lending. See Julia H. McLaughlin, Litigation Funding: Charting a Legal and Ethical Course, 31 VT. L. REV. 615, (2007) (usury); Susan Lorde Martin, Litigation Financing: Another Subprime Industry That Has a Place in the United States Market, 53 VILL. L. REV. 83, 83 (2008) (subprime lending); Richard L. Abel, How the Plaintiffs' Bar Bars Plaintiffs, 51 N.Y.L. SCH. L. REV. 345, 366 (2006) (payday lending). 25 Jeremy Bentham, Letters XII, in IN DEFENCE OF USURY (1787). 6

7 this argument), litigants should be prevented from debasing themselves by selling their proceeds or (to take another variation), society should not be allowed to develop the view that legal rights are just another commodity that can be bought and sold. 26 A problem with the concern over commodification is that it depends on strong claims about morality that might strike us as not only somewhat arbitrary but also question begging. Michael Sandel is the latest political philosopher to attempt to build some kind of rigor into our intuitions over commodification. 27 He makes his argument by pointing out the many places where we feel uncomfortable allowing the market to govern the distribution of goods. His examples include some commonplace activities; such as purchasing short cuts to government services (fast-track security lines in airports) or medical care (concierge doctors). 28 Sandel s argument is not that any one of these incursions of the market into a previously nonmarket sphere of activity is wrong in itself, but rather that the accumulation of market incursions can destroy the vocabulary of nonmonetary value theory that perfectionism both identifies and endorses. Sandel argues that markets change the character of the goods and social practices they govern. 29 Sandel s crowding out argument provides an answer to someone who might argue that market transactions should be permitted as long as they occur between consenting adults in the absence of force or fraud. There is no such thing as a wholly self-regarding act, argues Sandel, since our shared non-economic value system is a public good, which, if available to be enjoyed by one is by necessity enjoyed by all, and vice-versa: Its rejection even by a few of us limits its availability to everyone else. 30 The anti-commodification critique of litigation investment seems to be based on the claim that litigation is a sphere of activity where commodification is especially dangerous. It stands on the same footing, therefore, as the commonplace claim that a market in judicial outcomes is wrong. 31 But the reason we intuitively understand that it is wrong for a judge to sell her judgments is not only because money is exchanged in its doing that is too simplistic a test but because in addition to money changing hands, we see that there is something amiss about a judge making a decision for a citizen for no other reason than that citizen paid her the most money. Legal judgment is about the meaning of law, the weight of the facts, etc. and amount of money 26 See W. Bradley Wendel, Litigation and Commodification, 64 DEPAUL L. REV. (forthcoming 2014) (available at 27 MICHAEL J. SANDEL, WHAT MONEY CAN T BUY: THE MORAL LIMITS OF MARKETS (2012). 28 Sandel lists a number of examples. See ibid at Id. at Id. at See, e.g., Ian Ayres, The Twin Faces of Judicial Corruption: Extortion and Bribery, 74 DENV. U. L. REV (1997). 7

8 offered by a party to the legal dispute is simply irrelevant to the question the judge is supposed to answer. None of these concerns are raised in the case of litigation investment, where the court s relationship to the case in unaffected by the fact that strangers will benefit from the correct legal resolution of the case. The jurisprudential argument is that litigation investment introduces the wrong sort of reasons into the legal system, and as a result, the parties outcomes diverge from what the law, ideally, should produce. Jurisprudential arguments are very familiar they are exemplified by the scholarship produced by Blackstone and Holmes when they wrote about the common law. A critic of litigation investment making a jurisprudential argument can be much more modest than critics making consequentialist or anti-commodifcation arguments. She can claim to be doing nothing more than describing the essential features of our legal system, conceding, at least implicitly, that these features were ultimately at the most fundamental level, contingent. The jurisprudential argument is that litigation investment threatens to compromise the integrity of the U.S. judicial system. 32 It does this by interfering with the plaintiff s control over her litigation. There are three subsidiary arguments that comprise the jurisprudential argument. These are (1) litigation investment interferes with the lawyer-client relationship; (2) litigation investment interferes with the plaintiff-defendant relationship; and (3) litigation investment interferes with the party-court relationship. Critics of litigation investment have claimed that the control granted to third parties in litigation investment either destroys or impermissibly complicates these relations, and that the cumulative effect of the episodes of interference that occur as a result distorts the legal system to the point where it no longer serves it fundamental rule of law function. This article will focus on the first of these three subsidiary arguments since it is the main concern of the bar associations that have raised the question of the conflict between an attorney s ethical obligations and litigation investment. 3. Interference With the Lawyer-Client Relationship The chief concern by those who raise rule of law objections to litigation investment is that it will interfere with the relationship between the party who has the claim and her lawyer. The Institute for Legal Reform has argued that litigation investment undercuts plaintiff and lawyer control over litigation because the [litigation investment] company, as an investor in the plaintiff s lawsuit, presumably will seek to protect its investment, and can therefore be expected 32 Comments of U.S. Chamber Institute for Legal Reform to the Am. Bar Ass n Working Group on Alternative Litig. Fin. 3 (Feb. 15, 2011) (on file with author). 8

9 to try to exert control over the plaintiff s and counsel s strategic decisions. 33 This concern is echoed by those who are concerned about whether an attorney can fulfill her ethical obligations in a case where her client has signed a litigation investment contract. 34 There are two very different arguments being made here. The first is that litigation investment contracts may require lawyers to violate their ethical obligations to their clients. The second is that even if a lawyer can ethically represent a client who has contractual obligations to a litigation investment, the relationship between the lawyer and the client will be affected in a way that somehow interferes with the basic goals of the common law. 35 As will be demonstrated below, so far bar committees in the United States have limited their focus on the first argument. 36 I will examine both arguments in this article. 4. The Bar Confronts the Ethical Challenge of Litigation Investment: An Example On April 16, 2013, the Ethics Committee of the Commercial and Federal Litigation Section of the New York State Bar Association (the Committee ) published a report On the Ethical Implications of Third-Party Litigation Funding (the Report ). The Report is the latest 33 U.S. CHAMBER INSTITUTE FOR LEGAL REFORM, STOPPING THE SALE ON LAWSUITS: A PROPOSAL TO REGULATE THIRD-PARTY INVESTMENTS IN LITIGATION 2 (2012) (available at 34 See, e.g. Maine Board of Bar Overseers Professional Ethics Commission, Op. 191 (12/21/06) ( the lawyer must guard against any risk that the financing company will attempt to control the litigation or otherwise interfere with the lawyer s exercise of professional judgment ) and see Mich. Comm. on Prof'l and Judicial Ethics, Op. RI-321, 2000 WL (2000) and McLaughlin, Litigation Funding: Charting a Legal and Ethical Course, supra note at 651 (litigation investment contracts threaten to undermine the duty of loyalty owed to a client by creating a contractual relationship with a third party. ). 35 On this second argument, see, e.g. U.S. Chamber Institute for Legal Reform, Stopping the Sale on Lawsuits supra note at 15: 36 Third party control over lawsuits reduces a system designed to adjudicate cases on their merits to one that is effectively controlled by parties who are interested solely in profit. After all, third party financiers are nothing more than investors in the claimant s case. And because their primary goal is to protect their investment, they will inevitably seek to exert control over strategic decisions. In addition to the report of the Ethics Committee of the Commercial and Federal Litigation Section of the New York State Bar Association (discussed in this article), other relevant reports include the American Bar Association Commission on Ethics 20/20 and an opinion of the New York City Bar Association. See Informational Report to the House of Delegates, published by the American Bar Association Commission on Ethics 20/20 on December 27, 2011 (co-authored by Prof. W. Bradley Wendel and the author) and New York City Bar Association Formal Opinion

10 among a series of efforts by major bar associations to come to grips with the rapidly growing practice of litigation investment. While this Report is by no means the only or even the most complete discussion of legal ethics and litigation investment, it is the most recent and it captures nicely the confusion and concern that surrounds this new practice in even the most sophisticated American jurisdictions. In this section I will briefly describe the context in which the Report was drafted and note its shortcomings. Then I will use the Report s weaknesses as guideposts for a discussion of what I think are the genuine issues in legal ethics raised by litigation investment. The Report is very comprehensive in fact, its only flaw, I would suggest, is that it is too comprehensive. The Report lists some putative ethical concerns that are pure fiction, and thereby provides a pretext to those whose real objection to litigation investment is that they simply don t like it as a matter of public policy. Five issues are identified by the Report: (1) conflicts of interest, (2) privilege and confidentiality, (3) control over the proceeding, (4) champerty and maintenance, and (5) fee-sharing with non-attorneys. Only some of these reflect the real ethical issues that confront lawyers whose clients receive litigation investment. Some pruning is therefore in order. The category of conflicts of interest is one that gets a lot of attention in the Model Rules and litigation. But actually, there is not much opportunity for conflicts of interest between a lawyer and her client in the context of litigation investment. The Report mentions referral fees paid to lawyers by funder, but these are a red herring. First, there is almost no evidence that they are paid in New York, and second, it isn t even obvious that there is any incentive for a lawyer to take a referral fee from a funder (rather than, in truth, the reverse). Dig a little deeper, and the real conflict of interest identified by the Report arises in the commercial litigation context [where]... agreements are often entered into directly with the attorney or law firm rather than with plaintiff and thus, the attorney or law firm has contractual duties to the corporate [litigation funder] that are independent of the attorney s professional duties to the plaintiff. There are two problems with this sentence. First, it simply states, in more general language, the third ethical issue in the list above. The first victim of a side-agreement with a third party would be the lawyer s duty under ABA Model Rules of Professional Conduct Rule 5.4(c), the lawyer s duty of independent professional judgment owed to the client. But second, and more important, the concern is based on a myth. Litigation investment in New York does not involve side-agreements between lawyers and funders. It is extremely unlikely that such agreements are sought outside of New York, either. Whether or not they are permissible, and if they are, what ethical issues they raise, is simply beside the point they are a myth. Litigation investment involves a contract between just two parties: the claimholder and the funder. The claimholder s lawyer is not part of the transaction, has no duties to the funder, and remains at all times the claimholder s agent with undivided loyalties to the claimholder. 10

11 While conflicts of interest may arise between the lawyer and her client if the client seeks funding, they don t arise because the lawyer is ever under a (conflicting) contractual or ethical obligation to the funder. So, ethical issue (3) collapses into (1). This insight also tells us that ethical issue (5) fee-splitting with non-lawyers is a fiction. 37 If the lawyer has no contract with the funder, then obviously the lawyer isn t transferring money to the funder, and so the risk of fee-splitting is eliminated. 5. Separating the Genuine from the Fake The Report does identify ethical issues that need to be addressed. The first concerns the real conflicts of interest that may arise when the client seeks the lawyer s frank and honest advice about whether the client should take funding (and under what terms). The second concerns the malpractice risks that arise on numerous fronts, including (but not limited to) the scope of the lawyer s obligation to competently advise a client who is attempting to get outside funding about whether to take funding, the terms of the investment agreement, the legality of the underlying investment agreement, and the risks to the client s case posed by allegations of waiver of privilege by the opposing party for any documents or communications provided by the client or the lawyer to the funder. Finally, although this is not technically a matter of concern for legal ethics, there is a larger concern about the social consequences of litigation investment, and consequently what role these concerns should play in the interpretation of the law and rules of professional responsibility. For example, if there were objective reasons to believe that consumers were illequipped to understand the costs and benefits of what they were selling when they sold contingent shares of their future personal injury recoveries, it might make sense to either interpret existing New York laws and regulations or demand new laws or regulations to protect consumers. a. Issue One: The Self-Dealing Problem It is easy to see how the first concern, which I shall call the Self-Dealing Problem, might arise. Litigation investment can make the difference to a cash-strapped plaintiff whether she will initiate or continue litigation (this is typically true for commercial but not consumer litigation investment). Defenders of litigation investment (like myself) therefore focus on its benefits the claimholders. But of course, there is another group of beneficiaries, too the attorneys. Since the lawyers who represent plaintiffs in commercial litigation rarely work on a straight contingent fee and rarely advance costs, funding can be critical to whether and how commercial litigation is conducted. A decision by a funder to advance one or two million dollars for legal expenses is good news for the attorney(s) who will now have more income. 37 See ABA MODEL RULES OF PROFESSIONAL CONDUCT Rule 5.4(a). 11

12 There is nothing unethical in wanting more work from one s client. However it would be naïve to act as if the interests of a claimholder and her attorney are always in alignment when the question arises whether litigation should begin or be continued. But it would be equally naïve to think that there is anything new about this ethical conflict. It exists all the time it is an inescapable feature of the fact that law is a business. The Self-Dealing Problem presents itself when a commercial client first walks into her attorney s office and asks whether a lawsuit (drafted by the attorney charging an hourly rate) should be filed. It presents itself when the commercial client asks her attorney whether in the attorney s opinion, a motion for summary judgment which will add $50,000 to the cost of the case should be filed. The Self-Dealing Problem is a problem, but it is not a problem limited to litigation investment. b. Issue Two: The Malpractice Problem The second ethical issue, which I shall call the Malpractice Problem, is also not really new, although I won t deny that the adoption of litigation investment may increase the risk that an attorney will breach a professional obligation to her client. If a client asks her attorney for advice about litigation investment, the attorney can respond by limiting the scope of her representation to exclude any legal advice relating to funding. 38 If the attorney does this, she may be under an obligation to advise the client to seek separate counsel from an attorney who specializes in the law of litigation finance. Already one court has held that an attorney owed no duty to their client to advise them on a litigation investment transaction. 39 The Malpractice Problem really has two dimensions. First, who should bear the cost of guaranteeing that clients receive competent advice about litigation investment? If the law of professional responsibility makes it very easy for the attorney to limit her scope of representation, then the only reason why lawyers will assume the responsibility of advising clients on litigation investment (other than they receive separate payment for the advice) would be to market themselves and to keep clients from jumping to attorneys who bundle this advice into their general legal services. Clients will bear the cost of discovering what they need to know to protect themselves. If the law of professional responsibility makes it very hard for the attorney to limit her scope of representation, then lawyers will assume some additional malpractice risk and clients may not receive the best advice. Worse yet, a general fear of liability of attorneys part may create a situation where in addition to the generic Self-Dealing Problem described above, attorneys steer their clients away from litigation investment that would benefit the client simply to minimize their own costs. So getting the balance right in the Malpractice Problem is crucial to the vitality of litigation investment See ABA MODEL RULES OF PROFESSIONAL CONDUCT Rule 1.2(c). See, e.g. Francis v. Mirman, Markovits & Landau, P.C., No.29993/2010 (Sup. Ct. NY, Kings, 2012). 12

13 c. Issue Three: The Social Problem Finally, we come to the third issue. Assuming that attorneys can solve the Self-Dealing and Malpractice Problems, how should they think about litigation investment if they believe that their clients appetite for this new financial product is not in society s general interest? I call this the Social Problem. My framing of the Social Problem assumes something that I don t actually believe that litigation investment, all things considered, produces a net loss of social welfare (more on this below). But, to take the counterfactual at face value, what if it were true? What should an attorney (or a bar association, or a judge) do then? The answer to this question has to be placed in the context of the obligation and authority of the legal profession to interpret the law and their obligations as lawyers. Lawyers surely have an obligation to practice in a way that promotes justice, but does this commitment require that they refuse to help clients pursue financial ends that benefit the client at the expense of society? To my knowledge, the answer is no. 40 To invoke an a recent example, if an attorney had qualms about non-fraudulent collateralized debt obligations (CDOs) during the real estate bubble before 2008, he had the right to voice those qualms to his client and perhaps even refuse to take on clients seeking to market CDOs. But once having been retained, the attorney s obligation was not only to provide competent and truthful advice about the law, but to faithfully help his client to sell CDOs. Some might disagree with how I analyze the Social Problem in the CDO example about. The key point I want to make is that, in the case of litigation investment, the Social Problem assumes a false conflict. Unlike CDOs, litigation investment actually helps society. Or at least there is every reason to believe so. This article is not the place to prove my assertion my own and others academic writings have tried to do that elsewhere. 41 A discussion of whether attorneys ought to be concerned with a Social Problem conflict with litigation investment should begin by noting that outside the United States there has been a growing consensus about the positive role that litigation investment can play in a common law legal system. 40 All I mean to claim by this statement in that this is the answer that would be produced by the so-called standard conception of legal ethics. See, e.g. Stephen L. Pepper, The Lawyer's Amoral Ethical Role: A Defense, a Problem, and Some Possibilities, 1986 AM. B. FOUND. RES. J The standard view may actually be in error, but that is a topic far outside the scope of this article. For recent defenses of the standard conception, see TIM DARE, THE COUNSEL OF ROGUES? A DEFENCE OF THE STANDARD CON- CEPTION OF THE LAWYER S ROLE (2009) and W. BRADLEY WENDEL, LAWYERS AND FIDELITY TO LAW (2010). 41 See, e.g., Jonathan T. Molot, Litigation Finance: A Market Solution to a Procedural Problem, 99 GEO. L.J. 65, 107 (2010) and Lord Neuberger, Harbour Litigation Funding First Annual Lecture, supra note. 13

14 Recently the President of the UK Supreme Court argued in a major address that the same reasons that originally compelled the English legal system to suppress champerty and maintenance (e.g. litigation investment) now compel the opposite: The public policy rationale regarding maintenance and champerty has turned full circle... [public policy] appears positively to support the development of litigation investment, as a means of securing effective access to justice. 42 Rather than viewing litigation investment with suspicion, Lord Neuberger called on attorneys and judges to embrace it, albeit with the appropriate protections and regulations that would accompany any new innovative financial product Comparing New York and Ontario Courts in Ontario have taken the jurisprudential concerns raised by American critics of litigation investment very seriously, and so it might be argued that these criticisms should be taken seriously in the United States as well. This argument is superficially persuasive, and in this section I will argue that the differences between the kinds of litigation investment that currently takes place in Ontario is so different than the litigation investment that takes place in an American jurisdiction such as New York that the jurisprudential concerns of the Ontario courts cannot be easily translated into American context. a. Litigation Investment in Ontario As some of the articles in the volume in which this article appears explain in greater detail, Ontario s history with litigation investment both parallels and diverges from the American experience. Like the United States, in Ontario there has been increasing interest in consumer and commercial litigation investment. 44 Recent cases such as Giuliani v. Region of Halton evidence the presence of consumer litigation investment in Ontario, although the court s hostility to the precise details of the funding contract in that case suggest that courts in Canada are quite sensitive to the risk of exploitation of consumers by funders. 45 There is also anecdotal evidence that a 42 Lord Neuberger, Harbour Litigation Funding First Annual Lecture, supra note at Ibid. at See Jasminka Kalajdzic, Peter Kenneth Cashman and Alana M. Longmoore, Justice for Profit: A Comparative Analysis of Australian, Canadian and U.S. Third Party Litigation Funding, 61 AM. J. COMP. L. 93, (2013) (describing recent developments in Ontario litigation investment law) and Ava Chisling, The Loan Arrangers, CANADIAN LAWYER (Nov. 2011), available at (same) ONSC 5119 at para. 56 ( [t]his... agreement does nothing to advance the cause of justice... it is difficult to believe that any lawyer would refer a vulnerable client to such a lender ). Compare with Rancman v. Interim Settlement Funding Corp., 99 Ohio St. 3d 121, 125 (2003) (court troubled by 14

15 commercial litigation investment market exists in Ontario. 46 But it would be inaccurate to say that the litigation investment market in Ontario looks like the litigation investment market in an American jurisdiction like New York. The differences are greater than the similarities. First, it appears that, unlike in New York, consumer litigation investment exists primarily to fund litigation expenses even though lawyers are permitted, as they are in the United States, to advance litigation expenses to their clients. 47 The funding of litigation costs is, as was explained above, virtually never the purpose of consumer litigation investment in the United States. Second, the relative size of the commercial litigation investment market to the consumer litigation investment market is (apparently) small compared to the United States, where commercial litigation investment occupies a major (if not significantly larger) portion of the total litigation investment market. 48 Third, and of most importance, the Ontario litigation investment market is dominated by the funding of class actions a market which has simply failed to develop yet in the United States for a variety of reasons. 49 To the extent that much of the attention of both the judiciary and policymakers has been on the emergence of litigation investment as a solution to a specific problem posed by class action litigation in Ontario, the parallel between American and Canadian litigation investment breaks down (at least to the extent that litigation investment in Canada is dominated by civil litigation in Ontario). There is certainly reason to think that the attention of the judiciary and policymakers has been focused on litigation investment in class action litigation. Recent Canadian court cases have focused on litigation investment in class actions, as have most recent academic commentary. 50 Before comparing the divergent directions taken by commentators in Ontario and champertor's earning a handsome profit by speculating in a lawsuit and by potentially manipulating a party to the suit ). 46 See Chisling, The Loan Arrangers, supra note ( Lexfund, the company mentioned in the Giuliani case, no longer advertises the funding of individual plaintiffs, although it does continue to fund commercial litigation ). 47 The money received by the plaintiff in Giuliani was purportedly necessary to the prosecution of the case. See Giuliani at para. 47 ( [w]ithout such a litigation loan the plaintiff would have been precluded from taking her case through trial... [t]he plaintiff s law firm could not afford to carry the disbursements through trial ). 48 See CHRISTOPHER HODGES ET AL., UNIV. OF OXFORD & UNIV. OF LINCOLN, LITIGATION FUNDING: STATUS AND ISSUES (2012), available at 49 Compare Kalajdzic, et. al., Justice for Profit, supra note at with HODGES ET AL., LITIGATION FUNDING: STATUS AND ISSUES, supra note at 45 and Samuel Issacharoff, Litigation Funding and the Problem of Agency Cost in Representative Actions. NYU School of Law, Public Law Research Paper No , available at 50 See, e.g., Fehr v Sun Life Assurance Co of Canada, [2012] OJ no (Sup Ct); Fairview Donut Inc. v The TDL Group Corp, [2012] OJ no 834 (Sup Ct); Dugal v Manulife Financial Corp, [2011] OJ no. 15

16 (for example) New York, it is worth noting that the class action/non-class action distinction reflects the fact that Ontario has a loser pays rule while the United States does not. 51 The indemnification of an adverse cost award, which would in theory be charged against the class s lead plaintiff, and in practice paid by the class s attorney, has been identified as the primary motive for third-party funding in the Canadian context. 52 b. Ethical concerns concerning litigation investment in Ontario compared with NY Because so much of recent litigation investment activity in Ontario concerns class actions, the ethical concerns raised in the Canadian context start off on a very different footing than the discussion of ethical concerns outlined above in New York. The main concern of the Canadian courts that have reviewed litigation investment recently reflects the governance problem which bedevils all class or mass litigation where an agent controls the distribution of the litigation gains between the agent and a diffuse set of principals. 53 Beginning with Gildan, courts have expressed concern over not just the absolute rate of return earned by funders (which was at issue in Giuliani) but also the balance of control between the funder and the class, as represented by the lead plaintiff and the lawyers representing the class. For example, the court held that the funder could not demand that it attend settlement discussions. 54 As noted by Wright and O Brien, in later cases like Dugal, the litigation investment contracts were upheld as drafted because the funders did not attempt to take control of the litigation; they sought at most the right to be advised of various aspects of the progress of the litigation. 55 Some of the same real ethical issues I identify above in New York arise in the Ontario class action cases, but the differences are greater than the similarities. In both jurisdictions there 1239 (Sup Ct); Metzler Investment GMBH v Gildan Activewear Inc., [2009] OJ no (Sup Ct); and Kalajdzic, et. al. supra note ; Michael J. Trebilcock & Elizabeth Kagedan, An Economic Assessment of Third Party Litigation Funding of Ontario Class Actions at. 51 See Trebilcock & Kagedan, An Economic Assessment Of Third Party Litigation Funding of Ontario Class Actions, ibid, at [4]. 52 See Kalajdzic, et. al., Justice for Profit, supra note at 118. But see Charles M. Wright & Anthony O Brien, Third Party Funding for Class Actions and Control Over the Litigation at [3] (noting the possibility that litigation investment might go beyond indemnification of adverse costs to the actual funding of disbursements and/or legal fees ). 53 See, e.g., Samuel Issacharoff, The Governance Problem in Aggregate Litigation, 81 FORDHAM L. REV (2013). 54 Metzler Investment GMBH v Gildan Activewear Inc, [2009] OJ no 3315 at para. 58 (Sup Ct). 55 Wright and O Brien, Third Party Funding for Class Actions, supra note at [6 7] (citing Dugal v Manulife Financial Corp. and Labourers Pension Fund of Central and Eastern Canada (Trustees of) v Sino-Forest Corp., [2012] OJ no 2219 (Sup Ct)). 16

17 is a genuine risk of self-dealing. In the commercial context in NY there is a risk that hourly rate attorneys will be tempted to encourage clients to obtain litigation investment because more litigation by the client increases the attorneys income. In the class action context in Ontario there is a risk that class action attorneys who do not typically work on an hourly rate will be tempted to encourage clients to pursue litigation investment because the litigation investment will take on an indemnification risk that would otherwise be borne by the attorney. The malpractice risk is very different in the US than in Canada. In the US, the malpractice risk relates to the duty a lawyer has to counsel a client seeking a sign either a commercial or consumer litigation investment agreement of the risks posed by the transaction to a potentially wide (and indeterminate) range of interests, including the client s legal interest in the success of the underlying lawsuit and the financial terms of the litigation investment deal. In the Canadian class action context this risk is minimized by two factors. First, per current practice, all litigation investment contracts are reviewed by the court early in the litigation and certainly prior to certification. 56 Second, while champerty is still illegal in Canada, the legal consequence of a finding of champerty is that the transaction is set aside or reformed as a loan not that the party who received the funding loses the underlying suit which was funded. 57 The social risk looks very different in the Canadian context compared to the American context if the question of litigation investment is limited to class actions in Canada. The general assumption among both courts in Ontario and commentators is that there is still a need to promote access to justice among low and middle income Canadians ; this is evidenced in part by the way court spoke of access to justice as a goal in Giuliani and the continued support for the Ontario Class Proceedings Fund. 58 As Trebilcock & Kagedan who are not hostile to some of the argument made by American critics of litigation investment point out, the social benefits of promoting class actions are somewhat concrete, while the social costs of litigation investment otherwise identified by its critics in the American context are relatively speculative in the Canadian context, which is, after, mostly limited to class actions Wright and O Brien, Third Party Funding for Class Actions, supra note at [3] (citing Fehr). 57 Poonam Puri, Profitable Plaintiffs: Aligning Third-party Investment in Litigation with the Normative Function of the Canadian Judicial System at [4]. 58 Kalajdzic, et. al., Justice for Profit, supra note at Trebilcock & Kagedan, An Economic Assessment of Third Party Litigation Funding Of Ontario Class Actions, supra note at [29] ( there are deterrent benefits associated with third-party financing, as the social cost of wrongful conduct with uncertain legal outcomes may be more fully internalized by defendants... [f]urther, to the degree that funding privately increases class counsel s bargaining capacity at settlement, there is a corresponding social benefit in the optimality of settlements: that is, blameworthy but cash-rich defendants may be forced to internalize a more accurate estimation of their damage ). 17

18 On the other hand, the self-dealing risk may be even more pronounced in the class action context than in the commercial litigation investment context in the US for the simple reason that litigation investment is only one among many sources of capital for clients considering paying their hourly rate attorneys in the commercial litigation context in the US (other sources of capital include sale of assets, borrowing, and litigation tracking warrants). Other than the public option -- the Ontario Class Proceedings Fund mentioned above it appears that the class action bar in Canada have no option for off-loading the indemnification risk, since as a practical matter, no lead plaintiff will accept the risk (or could afford to satisfy it) and no bank will lend on a nonrecourse basis to fund a class action in Canada. The risk of self-dealing seems unavoidable as long as lawyers have influence over their clients (and potential clients ) decisions to employ lawyers. It seems to me, at least, that the risk to a client that her lawyer will steer her towards funded litigation when the client s best interest is either not to litigate at all or to litigate without funding (presumably because the lawyer will provide some of his own resources) is greater than the risk that a lawyer s independent judgment will be compromised under pressure from the funder after the funding is obtained and the litigation has begun. Yet in both the United States and in Canada most of the concern expressed by both courts and commentators over the legal ethics risks created by litigation investment focuses on the risks to lawyers and clients of third party control. If I am correct, and the real legal ethics risk is one of self-dealing, then the next question that follows is whether this risk is so great as to justify the prohibition or limitation of litigation investment. The self-dealing risk is greatest when there is a weak client: one who cannot protect her own interests, either because she is lacking in resources or in not motivated to police her interests against the predations of a self-dealing attorney. In the United States there is virtually no incentive for self-dealing in consumer litigation investment since, as explained above, lawyers do not directly benefit from the introduction of third party capital into litigation if anything, they sometimes resent it because it can incentivize a client away from reasonable settlements. 60 The risk of self-dealing is greatest in commercial litigation finance, where the client s lawyer is very likely to be depending on the investment for his billings. But in commercial litigation investment the client is usually sophisticated and may even have its own lawyers on staff watching outside counsel; they are, relative to most consumers of legal services, strong clients. There is no reason to believe that the same dynamic does not repeat itself in Canada among individual personal injury plaintiffs and commercial corporate plaintiffs. But in Canada there is one more 60 The same dynamic has been observed in Ontario by contingent fee attorneys whose clients take funds from consumer litigation investments firms. See Chisling, The Loan Arrangers, supra, note (quoting one lawyer who called litigation finance a lose-lose proposition : [i]f my client has borrowed $50,000, he cannot then settle and end the case for $20,000. The settlement value drops. In these cases, I recommend that the client settle, but they cannot... ). 18

19 client, the class, in a class action. Can it be described as weak or strong? As in the United States, the typical representative plaintiff is, like most consumers, unsophisticated and resourceconstrained. In that sense, the class in a class action is a weak client. Further, the decision to seek litigation funding, like in the United States, will reduce the class s recovery if the third party financing is charged against the award in the event the class recovers. 61 This explains, I think why courts in Ontario have scrutinized litigation investment agreements negotiated by class counsel on behalf of the class: They are concerned that a self-dealing class counsel will take advantage of a weak client. 7. Conclusion Litigation investment raises serious ethical issues for attorneys. All of the issues that are genuinely raised by litigation investment have analogs with which the legal community has come to terms, for better or for worse. We should view litigation investment in the same light: as presenting challenges that require careful and creative solutions, but not as an alien transplant in tension with the basic values of American common law. However, as the experience in courts in Ontario has demonstrated, judicial vigilance is warranted when the possibility of litigation investment creates a risk that lawyers can profit from self-dealing at the expense of weak clients. When and if those conditions are present in the United States, then courts should not assume that the Model Rules of Professional Conduct will be enough to protect vulnerable clients. 61 This was on of the reasons the court did not accept the litigation funding proposed by class counsel in Gildan. The court s objection that the class should not be bound by an agreement negotiated on its behalf by its attorney is very similar to the objection sounded by the court in In re World Trade Center Disaster Site Litig., where the court held a loan arranged by plaintiffs counsel to be unenforceable against the plaintiffs themselves, and reformed the loan so that its interest payments were to be paid by counsel from its legal fees. See Hearing Transcript, In re World Trade Center Disaster Site Litig., 21 MC 100, 102, 103 (S.D.N.Y. Aug. 27, 2010), at 7 and see Nora Freeman Engstrom, Lawyer Lending: Costs and Consequences, 63 DEPAUL L. REV. (forthcoming 2014), available at 19

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