Legislation on Horizon for Alternative Legal Financiers?

Bloomberg Law’s combination of innovative analytics, research tools and practical guidance provides you with everything you need to be a successful litigator.

By Nicholas Datlowe

Sept. 15 — The controversial business of alternative (or third-party) litigation financing is drawing attention from two federal lawmakers who are concerned that the industry is largely unregulated and operating without licensing or oversight.

This expression of concern about a growth industry with little federal supervision came from what some might consider unlikely sources—Sens. Charles E. Grassley (R-Iowa) and John Cornyn (R-Texas).

The issues surrounding alternative litigation financing seem to pit one traditional Republican cause—allowing industry to flourish in the absence of burdensome regulation—against another—concern that consumer litigation is bad for business.

The senators sent letters Aug. 27 to three large commercial litigation finance firms—Burford Capital, Bentham IMF and Juridica Investments. The letters seek a wide variety of information on topics including matters the firms have invested in, the structure of their financing agreements, and rates of return.

What Is ALF?

Broadly speaking, ALF is using outside sources of funding to enable litigants, often plaintiffs, to press their claims. Financiers gain a stake in the litigation, redeemable only, if at all, at its conclusion.

Companies may use ALF to commoditize or leverage legal claims. This allows them to put present cash to use, rather than leaving it tied up in a future, and uncertain, resolution.

Consumers can use ALF to enable them to litigate at all, or, once litigation has commenced, to pay living expenses while they await trial or settlement.

In either case, ALF funding is generally non-recourse, meaning that financiers recover nothing if the financed litigant loses. If the financed litigant wins, the financier collects some pre-arranged amount, usually the amount financed plus a fee, which may be pre-determined or based on an interest rate.

Corporate ALF providers may have general or subject-matter specific portfolios, such as patents or bankruptcy.

Consumer financing may be used for any claim, subject to financier approval, though financing personal expenses during the pendency of a personal injury trial is typical.

Opponents say that ALF “skews” the litigation calculus for the concerned parties, dragging out litigation and driving up the cost of settlements. They also suggest that fees on consumer ALF may be usurious, leaving the consumer worse off than he otherwise would have been.

But proponents say that ALF increases access to justice, allowing litigants to press valid claims they wouldn't otherwise have the means to, and allowing them to face off with better-funded opponents on more equal terms.

Shining a Light 

Some stakeholders believe that the industry is “operating in the dark,” and welcome the Congressional attention.

It's a “good thing to shine a light on the industry,” Matt Webb, a vice president of the U.S. Chamber of Commerce's Institute for Legal Reform, told Bloomberg BNA in a Sept. 9 phone call. The Chamber of Commerce is “very glad” to “see interest on the Hill,” he said.

Both he and the Aug. 27 letter from Grassley and Cornyn expressed concern about ALF's potential effects, suggesting that it raises ethical concerns and threatens to overburden an already overworked judicial system.

But proponents of ALF disagree with those assertions, and say that they're offering companies a way to contain legal budgets and hedge legal risk, as well as providing consumers with a valuable service in a time of need.

ALF providers for both companies and consumers say they welcome transparency, but suggest that there's reason to question the motivation behind the solutions that critics have proposed, such as increased discovery burdens on parties using ALF.

Ethics Conflicts?

Critics of ALF say regulation of the industry is needed because it creates conflicts of interest and encourages and prolongs frivolous litigation.

Conflicts of interest arise, especially when the funding is given directly to the attorney, because the funding gives an independent third party an interest in the litigation. That interest may conflict with clients' interests, whom attorneys are ethically bound to zealously represent.

Webb called this a “sticky situation” with “a lot of opaqueness.”

ALF supporters disagree. “I can't think of any reason that the lawyer's loyalty would be to the client's funder,” Lucian T. Pera, a partner at Adams and Reese LLP, Memphis, Tenn., said in a Sept. 2 e-mail.

“The only situation that comes close would be if the funder was funding lots of cases for the lawyer,” but even then Pera said a conflict is unlikely: “That's just not how plaintiffs lawyers are wired in my experience.”

Travis D. Lenkner, a managing director at commercial ALF provider Gerchen Keller Capital, agreed.

“No respectable law firm, financier or litigant enters into a situation where ethical issues are enhanced or zealous representation is compromised,” he said in a Sept. 2 phone call.

Contingency Comparison 

Pera compared the ethical situation to that of an attorney who is hired on contingency.

In a contingent representation an attorney may put stress on her finances to represent the client, but such a conflict, “even though it meets the technical definition of a conflict is simply not recognized by anybody as being a conflict that bothers us,” he said.

A lawyer representing a client with independent financing doesn't have a personal interest in the case, and “that should, I think, reduce the likelihood of a conflict,” he said.

In fact, as a part of its Ethics 20/20 project, the American Bar Association sought comments in 2011 about ALF, but determined “there was really no need for any changes in the ABA Model Rules of Professional Conduct to address any issues with litigation funding,” Pera said.

Webb wasn't convinced, however. “Financiers say they don't call the shots, but some do have a lot of control under the contracts” with their clients, he said. Even if they don't have direct control, “they have the power of persuasion and the power of the purse.”

Both Lenkner and Eric Schuller, Director of Government and Community Affairs for consumer ALF provider Oasis Financial disagreed, saying that the contracts they form with clients specifically disclaim any right for their organizations to participate in or direct settlement negotiations.

But the Aug. 27 letter echoed Webb's concern, saying that “the terms and fundamental structure of [ALF] agreements that are publicly available call into question these assertions.”

A Frivolous Matter 

The letter pointed to the decision in Chevron Corp. v. Donziger, 974 F. Supp. 2d 362 (S.D.N.Y. 2014), which Webb called the “poster-child” of frivolous litigation.

In that case, an attorney who had secured a fraudulent multi-billion dollar environmental tort judgment in Ecuador sought to enforce it in the U.S. To do so he enlisted the help of a large law firm and litigation financing from Burford, a recipient of the Aug. 27 letter.

Such litigation hurts the integrity of the legal system, Webb said. It also hurts the company that has to defend such litigation, turning resources it would otherwise reinvest in itself into “dead weight loss,” he said.

Burford “probably wishes they'd never heard of Chevron,” Schuller suggested, calling it a “bad case.”

However, generally—and in consumer ALF specifically—“no one will be crazy enough to fund a frivolous lawsuit, or they'll lose money,” Rob Johnson, Executive Director of the Alliance for Responsible Consumer Legal Funding (ARC), said in a Sept. 10 phone call.

ARC calls itself a “coalition established to ensure the proper regulation of legal funding industry.” Oasis Financial is a member.

Johnson also said that there's no proof that ALF prolongs litigation.

Terrence Cain, a law professor at University of Arkansas at Little Rock William H. Bowen School of Law, agreed in a Sept. 9 phone call.

He also noted that even before ALF, defendants always complained that there was too much litigation. ALF, however, does remove the incentive for consumer plaintiffs to settle for artificially low settlement amounts, lowering the chance of being forced to accept a low offer based on the “externality of running out of money,” Cain said.

Transparency? Unclear 

Though Schuller rejects arguments that consumer litigation funding is unethical or a threat to the functioning of the judicial system, he acknowledges that, like any financial product, some regulation is warranted “to make sure consumers accept and businesses offer responsibly.”

“There are bad actors in any business,” he said.

Because of this, “transparency is welcomed,” Lenkner said, calling it “healthy and good.”

Though it seems most agree that transparency is a virtue, stakeholders disagreed about what transparency entails.

In a 2014 law review article, Cain suggested a model federal law that would require certain written disclosures from ALF financiers to their clients, including interest rates and notification of a right to rescind the contract. The article is Third Party Funding of Personal Injury Tort Claims: Keep the Baby and Change the Bathwater, 89 Chi.-Kent L. Rev. 11 (2014).

ARC has also drafted a model law, although it is targeted at state legislatures. This law would require similarly written disclosures, including a maximum amount that consumers would be required to pay, and would codify that funders would have no say in the settlement process.

Nebraska recently passed an ALF regulation law, based on the ARC model.

Disclosures and More 

Webb suggested that this was not enough, and urged that the existence of ALF be disclosed to the court and to opposing parties in litigation.

Such disclosures happen already when claims that may be covered by insurance are involved, he noted. This will allow courts and litigants to examine if financiers are influencing the litigation, he said.

Cain responded that a claim's “merits have nothing to do with the funding,” which is why the existence of an insurer in a case is disclosed to the parties, but not disclosed to a jury.

Lenkner said that proposals to change discovery rules to require notification of financiers are likely “not necessarily for the purposes of transparency.” He said that the motives of those proposing such rules “may not be pure,” and that they would probably oppose them in situations where reciprocal obligations would be placed on them.

Webb also suggested that the use of ALF in class actions should be prohibited. “Plaintiffs' attorneys have been very creative” in finding ways to finance such litigation, and there's “already plenty of economy of scale,” he said, noting specifically mass tobacco and asbestos litigations.

Move for Regulation?

Johnson said that there was interest in regulating at the state level in the previous term in a number of states, including Texas and Arizona. He said he expected that a similar number of states would at least consider ALF legislation in the coming term as well.

He also said, however, that there was no public clamor for such regulation. He said that there had been zero complaints against ARC members lodged with the Consumer Financial Protection Board, and that he had heard none from voters in his previous role as an Oklahoma state legislator.

As for whether there's interest at the federal level, “I just don't know,” said Pera.

A spokesperson for Senator Grassley said Sept. 11 that the Senate was in the “fact-finding portion” of its inquiry, and that any legislation would likely be “downstream.”

“Legislation is probably not necessary in the commercial [ALF] space,” Lenkner said, noting that the parties involved in ALF are sophisticated.

Cain said that given the “gravity of what can happen in litigation,” there should be national rules, applicable to both consumers and corporations, “with the same core protections,” not a “hodge-podge” of state laws.

He noted, though, that any legislation passed by this Congress is unlikely to be signed by President Barack Obama.

A future Congress under a Republican president might pass ALF legislation, but Cain noted the irony that “Republicans don't usually support regulating how much money one can make.”

In a statement on its website, Burford said it “will engage promptly with the senators’ staff in order to advance their understanding of litigation finance.”

The Aug. 27 letter requested responses by Sept. 18. Congressional action in the coming months will reveal whether there will be a sustained movement to regulate ALF at the federal level.

To contact the reporter on this story: Nicholas Datlowe in Washington at ndatlowe@bna.com

To contact the reporter on this story: Jessie Kokrda Kamens in Washington at jkamens@bna.com.

Request Litigation on Bloomberg Law