Alternative Litigation Finance, Part 2

Alternative Litigation Finance, Part 2 The Ethical Do s and Don ts: Best Practices When Clients Finance Fiduciary Litigation By Robert Barton and Wendy Walker Robert Barton is an associate in the Los Angeles, California, office of Holland & Knight LLP and vice-chair of the Trust and Estate Division Ethics and Malpractice Committee. Wendy Walker is Estate Funding Director/Legal Counsel with the Law Finance Group in California and New York. In Part 1 of this article in the September/October issue, the authors discussed a common problem among trust and estate litigators the difficulty in getting paid. For a variety of reasons intrinsic to this practice, consistent monthly bill payment can be a particular challenge for trust and estate attorneys. Part 1 also discussed a new tool for getting paid timely alternative litigation finance (ALF). ALF is an arrangement between the client and a third-party company under which the company funds litigation fees and costs up front in exchange for a fee. Although these companies have existed in the personal injury and commercial litigation fields for decades, it was not until relatively recently that these companies expanded with a focus on trust and estate litigation. ALF arrangements pose a number of interesting ethical issues that all practitioners should consider when litigating a matter funded by ALF. Of course, attorneys always must fulfill their ethical obligations to their clients, which at their core require that the client is properly advised of the implications of funding a matter with ALF, taking care to preserve the attorney-client privilege, protect attorney work-product, and maintain professional independence. This article sets forth these ethical points in a series of best practices for the practitioner when a client is funding a matter with ALF. Don t Get Hung Up on Inapplicable Doctrines As discussed in Part 1, many trust and estate attorneys ask if ALF arrangements violate usury laws or maintenance and champerty doctrines. Although the attorney should always make sure he or she understands any specific jurisdictional requirements, as a general matter, ALF contracts are legal and do not run afoul of these doctrines. Usury Although ALF arrangements might be referred to as loans, this is technically a misnomer. ALF contracts typically are nonrecourse advances or payments to the client, meaning the ALF company recovers only to the extent that the client recovers, and these advances or payments are not considered loans. The funder typically does not look to the client s other assets to satisfy the repayment of the funds, and Published in, Volume 29, Number 6, 2015 by the American Reproduced with 1

the ALF contract is repaid only from the trust and estate assets in dispute or recovered by the client through a settlement or judgment. Substantial risk is placed, therefore, on the ALF companies because repayment is contingent on recovery in the case. Because state usury laws apply only to loans (9 Williston on Contracts 20:18 (4th ed.)), a majority of courts hold that those laws are inapplicable to ALF contracts. ALF companies, providing nonrecourse financing, undertake a risk that they may not be repaid, and therefore courts decline to apply usury laws when examining the legality of these transactions, so long as the repayment is contingent and not a sure thing. Compare Kelly, Grossman & Flanagan, LLP v. Quick Cash, Inc., 950 N.Y.S.2d 723 (Sup. Ct. 2012), with Echeverria v. Estate of Lindner, 801 N.Y.S.2d 233 (Sup. Ct. 2005). And some states such as Idaho, New Hampshire, Nevada, Oregon, and Wyoming have abandoned usury prohibitions entirely. Maintenance and Champerty Maintenance is a historical doctrine that was designed to prevent third parties from maintaining suit on another s behalf. Champerty is a type of maintenance and is an [a]greement to divide litigation proceeds between the owner of the litigated claim and a party unrelated to the lawsuit who supports or helps enforce the claim. Black s Law Dictionary (10th ed. 2014). A majority of courts have refused to apply this historical doctrine to ALF transactions. See Toste Farm Corp. v. Hadbury, Inc., 798 A.2d 901, 905 (R.I. 2002) (collecting cases); see also George Bundy Smith & Thomas J. Hall, The Narrow Application of the Champerty Doctrine, 248 N.Y.L.J. No. 77, Oct. 19, 2012. Particularly when the attorney does not give up any control over the litigation, these doctrines will not apply. Do Feel Comfortable Suggesting a Funder When referring a client to a funder, the attorney s good faith is imperative. Attorneys should feel secure and comfortable in the decision to refer clients for consideration of financing, so long as they abide by their own professional independence and follow the applicable rules of conduct as an attorney. See, e.g., Client Funding Solutions Corp. v. Crim, No. 10-CV-482, 2014 WL 1292451, at *12 13 (N.D. Ill. Mar. 31, 2014); Francis v. Mirman, Markovits & Landau P.C., No. 029993/2010 (N.Y. Sup. Ct. 2012); N.J. Advisory Comm. on Prof l Ethics Op. 691 (2001); Fla. State Bar Ass n Op. 00-3 (2000); Comm. on Prof l Ethics of the N.Y. State Bar Op. 666 (1994); Philadelphia Op. 91-9 (1991). Further, courts have found that it is not impermissible financial assistance to the client for an attorney to help the client obtain funding, but the attorney should never take an interest in the repayment from the client in these transactions. See Model Rules of Professional Conduct, Rule 1.8(i). Do Select a Trustworthy Funder As a general matter, it is imperative that practitioners pay close attention to the practices and procedures of the particular funder involved. Attorneys should make sure the funder is aware of, and complies with, the practitioner s obligations to the client. An inquiry into the funder s prior experience with trust and estate matters is recommended. Published in, Volume 29, Number 6, 2015 by the American Reproduced with 2

Don t Accept a Referral Fee Attorneys should not seek or receive a fee in exchange for referring a client to a particular litigation finance company. See ABA Comm. on Ethics 20/20, White Paper on Alternative Litigation Finance (Feb. 2012), www.americanbar.org/content/dam/aba/administrative/ethics_2020/ 20111212_ethics_20_20_alf_white_paper_final_hod_informational_report.authcheckdam.pdf, at 18 ( The acceptance of referral fees very likely constitutes a material limitation on the representation of the client, resulting from a personal interest of the lawyer ). Depending on the jurisdiction, these fees may be prohibited outright, but, if not, the attorney must disclose the fee to the client, and the client must provide informed consent to the arrangement. Even when a fee is not received, but the attorney consistently works with the same litigation finance provider, the ABA has suggested that disclosure of this information to the client is desirable and, in some cases, may be required. See ABA White Paper, at 17 18. Do Avoid Conflicts of Interest A lawyer has an obligation to provide impartial advice to the client, to be loyal to the client, and to avoid conflicts of interest. Model Rules 1.7; 1.8. This can get tricky when the client asks the attorney s advice on whether he or she should enter into an ALF transaction. After all, the lawyer s fees will be paid from this arrangement. To avoid the potential for conflict, the preferable arrangement, from both the lawyer s and the funder s perspective, is that the terms of the agreement be negotiated directly between the client and the funder. A cautious attorney also might consider whether certain terms in the ALF contract could be construed as favoring the attorney over the client. In such cases, the attorney should take care to obtain the client s informed consent if any term could be construed as a material limitation on the attorney s representation of the client. Model Rule 1.8(a). Do Recommend Your Client Seek the Advice of Independent Counsel Once a practitioner is comfortable with the general legality of a client paying attorney s fees via an ALF provider, the attorney then may ask: is it my job to determine if this is good for the client? A practitioner must make it clear to the client whether representation includes advising on the ALF contract. In the majority of cases, the fiduciary litigator s engagement agreement will be limited in scope to asserting the client s claims and defenses related to the trust and estate dispute. The ALF contract will not, under most circumstances, be within the scope of representation. A practitioner will need to either advise the client that such advice falls outside the scope of the representation or amend the engagement agreement to specifically include the negotiation of the contract. Although the decision rests in the hands of the attorney and the client, it is a best practice to recommend separate counsel. In either case, the scope of the representation should be made clear to the client in the engagement letter. This will insulate the attorney from liability in the event of a later disagreement between the client and the funder. See Client Funding Solutions Corp. v. Crim, 943 F. Supp. 2d 849 (N.D. Ill. 2013). Published in, Volume 29, Number 6, 2015 by the American Reproduced with 3

If the fiduciary litigator and the client agree that the litigator will give advice on the specific terms of the ALF contract, whether the attorney believes that the contract is unfair or prejudicial for any reason, the practitioner should advise the client against such an arrangement and decline to be involved in the transaction. See, e.g., N.Y. Formal Op. 2011-2; ABA Model Rules 1.2(d). If independent counsel is retained, the litigator can be assured that the client s interests are being protected. Don t Be Surprised by Requests for Information If a client wants to seek third-party funding and pay for litigation fees by currently realizing some of the value of the future beneficial interest in a trust or estate, he or she will submit an application and the matter will be evaluated, or underwritten. The trust or estate assets, the client s interest in such, and the legal merits will be analyzed, and, if the application is accepted, the ALF funder and the client will come to a deal on the transaction terms. As part of the underwriting process, the ALF funder undoubtedly will require information from both the client and the litigator. This information will include, at a minimum, the substance and merits of the claim, the current status of the litigation, and how much of the client s share is vested. An attorney must be aware whether providing this information potentially conflicts with the attorney s duty of confidentiality. The safest practice is for the practitioner to assume that anything provided to the funder later will be discoverable. Although responsible funders are sensitive to issues of privilege and confidentiality, only filed documents, pleadings, and other nonprivileged information should be provided to the ALF provider. Attorneys have a duty to prevent the disclosure of the client s confidential information and to safeguard against the waiver of the attorney-client privilege and attorney work product. Model Rule 1.6. Don t Violate the Attorney-Client Privilege Attorneys, especially those engaged in litigation, should be particularly mindful of the possibility of a waiver of the attorney-client privilege. Among courts that have considered the issue, the sharing of privileged information with an ALF funder constitutes a voluntary waiver of the attorney-client privilege. See ABA White Paper at 33 37; see also Leader Techs. v. Facebook, Inc., 719 F. Supp. 2d 373 (D. Del. 2010) (refusing to extend the common interest doctrine to disclosure of information to a funder, because the common interest needs to be a legal interest, as opposed to a business interest). Privileged information should never be provided to a funder, and attorneys should be wary of any funder who requests such information. Do Execute a Three-Party Confidentiality Agreement The meaning of confidential information can vary widely depending on the jurisdiction. Under the Model Rules, however, the term is construed quite broadly and includes any information relating to the representation of a client. Model Rule 1.6(a). Under this broad construction, confidential information can include the materials necessary for a transaction to be underwritten. An attorney should be sure to obtain his or her client s informed consent before disclosing any confidential information to a potential funder. Model Rule 1.0(e). Published in, Volume 29, Number 6, 2015 by the American Reproduced with 4

One less intuitive area of protection is attorney work product. Recently, courts have been willing to extend protection to attorney work product shared with ALF funders. This is because the waiver rules for attorney work product work differently from those of privilege. In the case of work product, only disclosures that substantially increase the likelihood of documents falling into the hands of an adversary in litigation are deemed to waive the protection of the work product doctrine. Miller UK Ltd. v. Caterpillar, Inc., 17 F. Supp. 3d 711, 732 33 (N.D. Ill. 2014). In a series of federal court decisions, litigants have successfully prevented the disclosure and discovery of attorney work product documents shared with ALF funders because the sharing of these documents by the clients to the funder did not substantially increase the likelihood that an adversary would come into possession of the materials. See Carlyle Inv. Mgmt. L.L.C. v. Moonmouth Co. S.A., No. 7841-VCP, 2015 WL 778846, at *9 (Del. Ch. Feb. 24, 2015) (because the negotiations between the client and the funder involved the lawyers mental impressions, theories and strategies about the case, which were only prepared because of the litigation, the documents from the funder were entitled to protection under the work product doctrine); Doe v. Soc y of Missionaries of Sacred Heart, No. 11-CV-02518, 2014 WL 1715376 (N.D. Ill. May 1, 2014) (confirming that the work product doctrine is not waived when information is shared with a funder under a confidentiality agreement); accord Miller UK Ltd. v. Caterpillar, Inc., No. 10 C 3770, 2014 WL 67340 (N.D. Ill. Jan. 6, 2014); Devon IT, Inc. v. IBM Corp., No. 10-2899, 2012 WL 4748160, at *1 n.1 (E.D. Pa. Sept. 27, 2012); Mondis Tech., Ltd. v. LG Elecs., Inc., Nos. 2:07-CV-565-TJW-CE, 2:08-CV-478-TJW, 2011 WL 1714304, at *1 3 (E.D. Tex. May 4, 2011). To provide maximum protection for the client, at the outset of a new matter, an attorney should request a written confidentiality agreement among the funder, the client, and the attorney. The agreement should provide the express recognition that any nonprivileged, but confidential, information that is shared is done so with the intent to maintain its confidential nature. Although not a full guarantee against future disclosure, such an agreement does demonstrate the intention of the parties and has been a persuasive argument to courts evaluating disputed discovery issues. Do Be Mindful of Who Controls the Litigation A lawyer must always exercise independent professional judgment on behalf of a client. See Model Rule 2.1. A lawyer also must not permit a third party to interfere with the exercise of independent professional judgment. Model Rule 5.4(c) (lawyer may not permit fee payor to direct or regulate lawyer s professional judgment). These issues are not unique to ALF arrangements an attorney always must be mindful whenever a third party is paying fees on behalf of a client. Certain funders, however, might attempt to include provisions in their contracts that provide for exercising control over the decisions in the case. For example, a funder might require approval before a client can settle. The Model Rules, however, provide that the client holds this authority to decide whether to accept a settlement. Model Rule 1.2(a). Although courts have not categorically found these control mechanisms per se invalid, they do raise serious ethical implications (particularly for independent judgment). Further, state laws with retained prohibitions on champerty and maintenance could be implicated to the extent the funder is considered the real party in interest. Attorneys should be very wary of any attempts by the funder to control the strategy or outcome of the case. Published in, Volume 29, Number 6, 2015 by the American Reproduced with 5

Don t Waive Withdrawal or Substitution of Counsel Rights A client always must be free to terminate the representation without restriction or a showing of good cause, except that court approval may be necessary if the attorney has appeared in the action. Model Rule 1.16(a)(3). An ALF agreement permitting the funder to select or control counsel may limit the client s right to terminate his or her attorney, which could violate Model Rule 1.16. The client should remain free to substitute counsel. See Abu-Ghazaleh v. Chaul, 36 So. 3d 691, 693 (Fla. Dist. Ct. App. 2009) (funder controlled the selection of the plaintiffs attorneys ). Attorneys also should remain free to withdraw from a representation if the attorney feels it necessary and has sufficient grounds under governing professional responsibility rules. See Model Rule 1.16 (mandatory versus permissible withdrawal). An attorney should not be asked by a funder to waive those rights or duties. Do Ask About Recording Statutes or Security Instruments Attorneys should be aware of any filings or court approvals that a funder will seek or make on funding a case. Jurisdictions have differing rules regarding the making and recording of assignments of inheritances, necessary court notice before executors or trustees receive financing on behalf of the estate or trust, court approval of the attorney s fee amounts, and various other subjects. See, e.g., Cal. Prob. Code 11604.5 (California statute regarding inheritance assignments); and N.Y. Est. Powers & Trust Law 13-2.2(a); N.Y. Real Prop. Law 274 (recording requirements). A funder also might file statements under the Uniform Commercial Code to perfect its security interest in the case and inheritance. A prudent attorney will ask the funder what documents will be filed and what procedural requirements exist. Do Discuss Repayment with Your Client An ALF funder pays ongoing attorney s fees and waits until the trust or estate distribution or liquidation for repayment. Once the case has been settled or finally adjudicated, in the ordinary ALF transaction, the client then will repay the funder. In these transactions, if the client does not receive any distribution from the trust or estate and has a total loss on the case, the funder will not be repaid. The absorption of this risk is what is offered by the funder and paid for by the client in its fees. When the client does receive rights to a trust or estate distribution or settlement payment, the funder ordinarily has priority to receive the first of those proceeds. The funder may ask the attorney to accept all such payments of proceeds into its trust account, so that the funder can be repaid. The attorney should feel comfortable with this repayment, so long as the client agrees and has directed the attorney to make such payment under the agreement s terms. If the attorney agrees to this, then he or she should make sure to comply with those promises. Conclusion The modern civil justice system and, specifically, trust and estate litigation are expensive and require financial stamina to reach resolution. ALF funders can assist clients with meritorious claims by unlocking some of the value of inheritances early so clients can afford to pay attorney s fees until the case reaches resolution. Practitioners are encouraged to consult the ABA s recent White Paper on the issue of Published in, Volume 29, Number 6, 2015 by the American Reproduced with 6

ALF, as well as the numerous state bar ethics opinions that recently have been issued on the subject. See, e.g., ABA Comm. on Ethics 20/20 (Feb. 2012); Ky. Ethics Op. KBA E-432 (2011); N.Y. Formal Op. 2011-2 (2011); Fla. Ethics Op. 00-3 (2002), revised Aug. 24, 2011; Pa. Comm. on Prof. Resp. Informal Op. 99-107 (1999); Ohio Ethics Op. 94-11(1994); S.C. Ethics Op. 94-04 (1994); S.C. Ethics Op. 92-06 (1992); Ariz. Ethics Comm. Op. 91-22 (1991). If an attorney has a case or potential new case, but the client is unable or unwilling to pay fees out of pocket, perhaps a funder could be the answer. n Published in, Volume 29, Number 6, 2015 by the American Reproduced with 7