Legal finance as it has evolved in the U.S. over the last decade reflects a market-based solution to a business need of companies engaged in litigation domestically and around the world. Now a widely used financial product, perhaps the only novel aspect of legal finance is the recent increase in commentary about the topic. But that speaks more than anything else to the seismic shifts in the legal services market and to businesses’ demand for corporate finance for those services.

As demonstrated by the discussion at the Litigation Practice Group’s recent panel on this topic, legal finance (also known as “litigation funding”) can take many forms. It generally refers to a transaction through which the asset value of a litigation claim is used to secure capital from a finance provider in exchange for a return tied to the outcome of a case. Commercial legal finance, which is the focus of this piece, refers to the provision of such capital to law firms and businesses represented by sophisticated counsel, typically in the form of multimillion-dollar non-recourse investments. Because the provider’s return is dependent on a successful outcome and because these agreements do not constrain or interfere with a funded party’s ability to resolve the underlying matter at any time or for any amount, providers will by definition fund only the most meritorious matters; if they do not, they will quickly find themselves out of business.

But commercial legal finance encompasses much more than simply the financing of litigation for corporations and the law firms that serve them. Capital from such an arrangement may be used for fees or expenses associated with litigation—on either side of a pending claim, or to recover millions in otherwise lost value through judgment enforcement, or to budget in the face of economic or legal uncertainty. It also provides large law firms with traditional hourly fee structures the means to offer clients different economic models, and boutiques and smaller firms with new ways to manage their cash flows to share risk with clients and invest in expansion, hiring and business development.

In essence, commercial legal finance is unremarkable, akin to financing that a business might obtain to collateralize assets like real estate, equipment or inventory.

Yet even as its use grows—a remarkable 237% between 2012 and 2018[1]—there remains the need to correct misconceptions and misrepresentations about legal finance. For example, there should no confusion about the distinction between commercial legal finance and the entirely separate consumer litigation funding industry, in which companies provide individual lawsuit loans to people with personal injury or other similar claims. The two are as distinct as investment banking and payday lending. Nevertheless, a narrow but vocal interest group deliberately conflates the two in their effort to obtain overbroad regulation, make it more difficult for private businesses and companies to purchase a legitimate financial product on the open market, and to one day “outlaw” all legal finance. Recently, they have gone so far as to include so-called “public nuisance” lawsuits under the same umbrella, when the reality is that they have no valid connection whatsoever to commercial legal finance. These critics have never offered anything other than a parade of hypothetical horribles in support of their proposed regulation,[2] but marching in the bogeyman of public nuisance lawsuits is certainly one way to capture the attention of busy policymakers who may not have time to discern critical distinctions.

Happily, the vast majority of courts and legislatures have rejected such regulation, recognizing the potential adverse effect of such regulation on businesses and the legal industry, including slowing and increasing the costs of litigation and exposing proprietary business information. This is not surprising. In a free market economy, parties are at liberty to contract and should be free to do so without being forced to disclose their confidential financial arrangements—particularly to an adversary in litigation. It is also an implicit recognition that regulation is not necessary, as the presence of legal finance does not present any novel ethical or evidentiary issues that could not be adequately addressed by the U.S. justice system’s clear and robust discovery and professional conduct rules.

For example, potential conflicts relating to legal finance agreements are no different than any other potential conflict. The assertion that legal finance may result in attorneys breaching their duties of loyalty and confidentiality to their clients is pure speculation, as no one has ever offered an example of this actually occurring. Nor has anyone offered any real-world examples of judicial conflicts of interest; judges are acutely aware of their ethical responsibilities and would be well advised to avoid investing in legal finance entities. And even if a judge were to have a relationship that rose to the level of warranting disqualification, he or she would be fully equipped to issue an individual practice rule or standing order requiring disclosure of any relationship with that company.

Likewise, materials created for and provided to a potential finance provider as a consequence of the litigation are protected under existing work product doctrine in the United States and considered privileged materials in other jurisdictions.[3] And, as the Federal Rules Advisory Committee has repeatedly observed in rejecting proposals to change the Federal Rules to force automatic disclosure of financing agreements, if a judge were to determine that such an agreement was relevant to a proceeding, he or she currently has the authority to obtain the information necessary.[4]

Relatedly, the assertion that legal finance providers “effectively become real parties in interest” to a lawsuit has been thoroughly considered and rejected.[5] Although providers benefit if a case is resolved successfully, it is black-letter law that such benefit is insufficient to transform an entity into the real party in interest, as legal finance providers do not “hol[d] the substantive right sought to be enforced,”[6] because the litigant continues to hold the claim and prosecute it itself. Commercial legal finance providers do not purchase a party’s claim, interfere with the attorney-client relationship, or dictate settlement strategy.[7] To illustrate, Burford Capital structures its transactions to make explicit that it does not obtain any contractual right to control the decisions of the litigant and its counsel with respect to the litigation.[8]

Conclusion

Despite the best efforts of pro-regulation special interests, the demand for legal finance is growing and it has been embraced as “corporate finance for law” by ever broader business constituencies. As previously noted, reported use by law firm and in-house lawyers has skyrocketed, and a more recent survey of Chief Financial Officers and other finance professionals, 95% of whom said they would recommend use of legal finance in their companies,[9] suggests that growth will continue as legal finance becomes familiar in corporate functions beyond the legal department. All of the evidence suggests that, in the decade to come, legal finance will continue to be recognized not only an essential and ethically sound business, but also celebrated as pro-business—because it is helping law firms better serve their clients and more efficiently run their businesses, and because it is helping companies use their capital more efficiently and deliver more value to their businesses, enhancing shareholder, employer and client value.

 

[1] 2018 Litigation Finance Survey, available at https://www.burfordcapital.com/2018-litigation-finance-survey/
[2] One frequent—and easily dismissed—hypothetical concern is the notion that the availability of financing indiscriminately promotes litigation that would otherwise not be pursued. During the panel discussion, for example, one panelist rightly observed that the goal of finance providers is to “make money,” but then later speculated that there is “the potential, if not the eventuality, that litigation finance will increase the number and amount of meritless lawsuits.” Both cannot be true. Business necessity requires providers—who most often invest on a non-recourse basis—to be rational actors who are highly selective and provide capital only to meritorious matters. In this way, legal finance actually provides a valuable vetting function that is beneficial to the civil justice system overall. Further, experience shows that legal finance promotes settlement efforts between parties. Jason Lyon, Revolution in Progress:  Third-Party Funding of American Litigation, 58 UCLA L. Rev. 571, 597 (2010) (“[T]here is considerable evidence that the existence of third-party funding actually tends to promote settlement.”); Douglas R. Richmond, Other People’s Money:  The Ethics of Litigation Funding, 56 Mercer L. Rev. 649, 661 (2005) (“Both the public and the justice system benefit when litigants with legitimate disputes face one another on a level playing field.”). Moreover, even as its use increases, legal finance arrangements make up a very small percentage of the total spending on litigation in the U.S. It is estimated that $436 billion is spent on U.S. legal fees annually, about one-third of which ($144 billion) is attributable to litigation. Thomson Reuters Legal Executive Institute, “The Size of the US Legal Market,” 2016. (These numbers, of course, exclude damages and only include money spent on lawyers.)
[3] Most legal finance arrangements require sharing of some attorney work product:  Since finance providers do not control matters and typically provide capital on a non-recourse basis, they must carefully diligence a matter. Similarly, deal documents embodying a finance transaction are protected because they were created due to the litigation, and the terms of such agreements reflect the information provided in work-product protected documents, such as lawyers’ mental impressions, theories and strategies about the underlying litigation. For an overview of caselaw affirming work product protection for communications with legal finance providers, see “Work product protection for legal finance,” available at: burfordcapital.com/blog/work-product-protection-for-legal-finance/.
[4] Meeting of Advisory Committee on Civil Rules (Apr. 2-3, 2019); Report of Advisory Committee on Civil Rules (Dec. 4, 2018), available at https://www.uscourts.gov/sites/default/files/cv12-2018_0.pdf; Minutes of Advisory Committee on Civil Rules (Apr. 14, 2016), available at https://www.uscourts.gov/sites/default/files/2016-04-14-civil_rules_minutes_final_0.pdf; Report of Advisory Committee on Civil Rules (Report of Advisory Committee on Civil Rules (Dec. 2, 2014), available at https://www.uscourts.gov/sites/default/files/fr_import/CV12-2014.pdf.
[5] Miller UK Ltd. v. Caterpillar, Inc., 17 F. Supp. 3d 711, 728 (N.D. Ill. 2014) (quoting Farrell Constr. Co. v. Jefferson Parish, La., 896 F.2d 136, 140 (5th Cir. 1990)) (following prevailing legal definition of real parties in interest under FRCP 17(a) that “the person holding the substantive right sought to be enforced, and not necessarily the person who will ultimately benefit from the recovery”).
[6] Id.
[7] Jonathan T. Molot, Litigation Finance:  A Market Solution to a Procedural Problem, 99 Geo. L.J. 65, 92 (2010) (“Funders generally do not control the course of litigation or unduly interfere with the attorney-client relationship.”); Anne Rodgers, et al., Emerging Issues in Third-Party Litigation Funding:  What Antitrust Lawyers Need to Know, 16 Antitrust Source 1, 4 (2016), http://app.antitrustsource.com/antitrustsource/december_2016/?pg=14&pm‌=2&u1=friend (The “[u]ltimate decisions regarding settlement and [other] legal strategy are always in the hands of the claimant and lawyer.”); Joanna S. Bailey, et al., Third-Party Litigation Financing, 8 J.L. Econ. & Pol’y 257, 276 (2011) (emphasis added) (Legal finance providers “are not in control of the litigation; they are not investing in the litigation; they are investing in the potential outcome of the litigation.”).
[8] Burford's agreements state that we neither control nor will not seek to control strategy, settlement or other litigation-related decision-making, nor direct a counterparty to settle a case for a particular amount, or at all. We will not withhold contractually required funding for strategic reasons. See, e.g., Burford Capital LLC, Frequently Asked Questions, http://www.burfordcapital.com/faqs (stating that Burford does not “get any rights to manage the litigation in which we invest. . . .  Just as a leasing company does not tell you how to drive your car, we don’t drive the litigation.  Nor do we get any rights to control the settlement of the litigation, which remains wholly in the litigant’s control.”
[9] 2019 Managing Legal Risk Report: A survey of CFOs and finance professionals, available at https://www.burfordcapital.com/managing-legal-risk-report-2019/