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Ethics for Litigation Financing in the 21st CenturyTM

Joseph DiNardo, Esq. Counsel Financial

6400 Main Street, Suite 120 Williamsville, NY 14221

716-‐568-‐0070 [email protected]

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Ethics for Litigation Financing in the 21st Century™ 1. Need for Funding

a. Nature of Contingent Fee Litigation

i. ABA Model Rules of Prof’l Conduct, R. 1.8(e) “Client-‐Lawyer Relationship” 1. Permits a lawyer to pay court costs and expenses of litigation on behalf of the

client, the repayment of which may be contingent on the outcome of the case 2. Contingent fee case expenses are not deductible for federal income tax

purposes unless the case is lost1 a. If the case is resolved successfully, the expenses are never deductible

because the client repays them out of his portion of the award2 ii. Recognizes the financial reality that clients are not in a position to repay case expenses iii. By very nature of contingent fee litigation, law firms can suffer from:

1. Intermittent cash flow problems a. Difficulty of accurately assessing the flow of clients and the cash needs of

their cases as they move through the judicial system 2. Huge expenses

a. Cost of expert witnesses, technology, forensic displays, etc.

b. Rise of Third-‐Party Litigation Funding i. Third party litigation financing first emerged as an industry in the United States in the

early 1990s, when a handful of small lenders began providing cash advances to plaintiffs involved in contingency fee litigation3

ii. Within a decade, as many as one hundred companies were offering financing to lawyers, their clients, or both4

iii. This industry has continued to grow, as to both the number of lawsuits financed, and the types of financing available

1. The aggregate amount of litigation financing outstanding is estimated to exceed $1 billion5

2. Types of Financing Available

a. Recourse vs. Non-‐Recourse Financing

i. Recourse – Lender must be repaid irrespective of success or failure of a case ii. Non-‐Recourse – Lender has no claim for repayment if the suit does not eventually end in

a recovery for plaintiff that exceeds the amount of the advance

1 IRS Field Service Memo, 1997 FSA LEXIS 442 (I.R.S. 1997). 2 Id. 3 NYC Eth. Op. 2011-‐2, 2011 WL 6958790 (N.Y.C. Ass’n. B. Comm. Prof’l. Jud. Eth.). 4 Id. citing Terry Carter, Cash Up Front: New Funding Sources Ease Strains on Plaintiffs Lawyers, ABA Journal 34-‐36 (Oct. 8, 2004), available at http:// abajournal.com/magazine/article/cash_up_front/. 5 Id. citing Binyamin Appelbaum, Investors Put Money on Lawsuits to Get Payouts, New York Times (Nov. 14, 2010), available at http:// www.nytimes.com/2010/11/15/business/15lawsuit.html.

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b. Loans or Revolving Lines of Credit (typically recourse) i. General Purpose – Working capital line ii. Limited Purpose – For actual out-‐of-‐pocket expenses and case disbursements, experts,

and other case costs

c. Bank Loans (recourse) i. Difficult to obtain the amount of financing the law firm actually needs

1. Lack of collateral – Bank looks to personal assets of attorney (home, pension, stocks, etc.)

2. Contingent case fees generally not permissible collateral ii. Bank regulations require certain actions that may not coincide with lawyer’s cash flow

(i.e. annual pay-‐off of loan)

d. Attorney Lending Company Loans (recourse) i. Lenders are often attorneys who have better understanding of the nature and timing of

contingent fees and the actual value of a law firm’s cases ii. Can typically be more flexible than banks on terms because lenders are often private

lending groups that are not subject to banking regulations iii. Interest is higher than a bank because of the increased risk and cost of funds

e. Loans from Banks and/or Attorney Lending Companies

i. Collateral for loans may include the law firm’s receivables 1. The fees due to the law firm, contingent or otherwise

a. Lien is not against specific cases per se 2. A secured interest in collateral consisting of a right to payment from

contingent attorneys’ fee contracts is an “account”, and therefore can be regarded as “collateral” under UCC § 9-‐1026 a. The UCC defines collateral to include:

i. (A) proceeds to which a security interest attaches; ii. (B) accounts, chattel paper, payment intangibles, and promissory

notes that have been sold; and iii. (C) goods that are subject of a consignment”7

b. The characterization of “collateral” not only includes accounts and chattel paper, but was specifically expanded to incorporate proceeds subject to a security interest, payment intangibles, and promissory notes that have been sold8

3. Some courts have specifically held “unmatured contingency fee agreements are a form of ‘contract right’ and thus are ‘accounts’ . . . fall[ing] squarely [within] Article 9”9

6 UCC § 9-‐102(a)(12). 7 Id. 8 Id.; see also UCC § 9-‐102, comm. 3(a). 9 U.S. Claims, Inc. v. Flomenhaft & Cannata, LLC, 519 F. Supp. 2d 515, 522 (E.D. Pa. 2006). See also American Nat’l Bank & Trust Co. v. Holstein (In re Holstein), 2000 Bankr. LEXIS 293 (Bankr. N.D. Ill. 2000) (holding that contingency fee contracts are “accounts” for which a security interest did attach pursuant to Article 9 of the UCC); PNC Bank, Delaware v. Berg, Del. Super LEXIS 19 (Del. Super

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a. As the court in U.S. Claims v. Flomenhaft & Cannata, LLC stated, “where a fee contract is involved, no such contingency exists because there is nevertheless a right to payment, even if that right is rendered more speculative by the fact that the amount of payment earned by further performance depends on a favorable resolution of the underlying legal action”10

4. UCC-‐1 Financing Statement generally will be required by the lender in the state where the attorney/law firm is situated to perfect lender’s interest in collateral

ii. Upon default, lender has the right to collect collateral and the proceeds thereof11 1. A law firm cannot eliminate a creditor’s interest in the collateral by

transferring client files a. For instance, in Cadle v. Schlichtmann12, partners of a law firm were

unable to eliminate the creditor’s security interest in the firm’s anticipated contingency fees by transferring their client files, whether by dissolution of the partnership or otherwise13

i. The First Circuit held that an attorney’s departure from the firm and his assumption of responsibility for the case did not wipe out the creditor’s right to follow the collateral—the fee from the case14

b. Likewise, in In re Holstein, the Seventh Circuit upheld the district court’s decision that a creditor’s security interest, which expressly included accounts, attached to a law firm’s rights to receive fees under its contingency fee contracts and would remain attached to that collateral or its proceeds even if the contracts were assigned or otherwise transferred to another firm15

i. While court held that the contractual right to receive a full contingency fee became inoperative when the law firm closed its doors, the court determined that it would not preclude the creditor’s recovery under a quantum meruit theory16

iii. Pay Attention to Loan Covenants

Ct. 1997) (holding that both the hourly billing and contingency fee contracts meet the definition of “contract rights” and therefore are “accounts” within the meaning of Article 9 of the UCC). 10 U.S. Claims v. Flomenhaft & Cannata, LLC, 519 F. Supp. 2d at 523. 11 See UCC §9-‐315(a), §9-‐507(a). 12 Cadle v. Schlichtmann, 267 F.3d 14, 19 (1st Cir. 2001). In Cadle the firm dissolved and Schlichtmann agreed with his former partner to take over the [secured matters] in exchange for 1/3 of any recovered attorneys fees; see also PNC Bank, Delaware v. Berg, Del. Super LEXIS 19 (Del. Super Ct. 1997) (holding that unless PNC Bank authorized the transfer, [the creditor] retained rights in the collateral pursuant to the UCC and also went on to conclude that additional expense and effort by the [third party] has “absolutely nothing to offer on the issue of the [creditors] security interest.”) 13 Id., 267 F.3d at 19 (1st Cir. 2001). 14 Id. 15 In re Holstein, supra, 2000 Bankr. LEXIS 293. The creditor in In re Holstein, had a priority security interest in the debtor law firms accounts, contract rights, general intangibles and other receivables, “and for the most part the receivables consisted of the law firm’s right to be paid for services rendered in personal injury and class action litigation that the firm was handling before it closed its doors.” 16 Id.

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1. Monthly payments 2. Principal & interest deferral 3. Auditing procedures

a. Required tax returns, case lists, financial statements, etc. b. Information requests

i. Technical defaults for failure to send info

f. Asset Purchase Agreements (non-‐recourse) i. Direct Funding to Clients

1. Plaintiffs may be willing to transfer part of their property rights in a lawsuit to a third party in exchange for having the risk of a potentially unfavorable outcome eliminated, thus increasing the expected value of his claim17 a. Companies invest in individual cases which need a significant infusion of

capital that neither the plaintiff nor their law firm is able to come up with

2. Rates of return can run from 3% to 10% or more per month 3. Mostly provided by private lenders 4. Future proceeds of tort cases are assignable in most states18

ii. Other types of Asset Purchase Agreements 1. Judgment

a. Lender purchases the judgment at a steep discount depending on credit-‐worthiness of the defendant, likelihood of appeal, and length of anticipated appeal

b. Plaintiff can sell the whole judgment outright c. A company can advance money to a law firm to cover their expenses

while they wait for the eventual payment of the judgment 2. Post-‐Settlement

a. Lender purchases a portion of a settlement 3. Appellate

a. Amount and interest rate will vary depending upon issues on appeal, jurisdiction, and potential of subsequent appeals

4. Structured settlements 3. Ethical Considerations

a. Overview i. Discussion will include how litigation funding interplays with general ethical

considerations, such as: 1. Attorneys advancing funds directly to clients; 2. Attorneys borrowing from third parties to fund client expenses; 3. Dealing with clients who have borrowed against their potential awards; 4. Protecting a law practice against interference with an attorneys’ professional

judgment or services; and 17 Marco de Morpurgo, A Comparative Legal and Economic Approach to Third-‐Party Litigation Funding, 19 Cardozo J. Int’l & Comp. L. 343 (2011). 18 Andrea G. Nadel, Assignability of the Proceeds of a Claim for Personal Injury or Death, 33 ALR 4th 82 (1984).

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5. Fee splitting ii. Consideration will be given to the application of individual jurisdiction’s laws, both

statutory and case law, the Model Code of Professional Responsibility, and the various State Bar Association opinions as the sine qua non of ethical practice

1. **ALWAYS check with your state’s code of professional responsibility** iii. The ethical implications of champerty; maintenance, barratry, usury, conflict of interest,

and confidentiality will be discussed by another presenter in detail later in this presentation

b. Attorney Advances to Clients

Is it ethical for a lawyer to advance litigation expenses on behalf of his client? i. Under the ABA Model Rules of Prof’l Conduct, Rule 1.8: “A lawyer shall not provide

financial assistance to a client in connection with pending or contemplated litigation”19 1. The ABA opined that a lawyer may gain an “undue personal interest” in the

claim or “if publicized, constitutes a holding out by the lawyer of an improper inducement to clients to employ him...”20 a. However, the ABA’s strict interpretation of this rule has since been

rejected, narrowly interpreted, followed, and ignored, depending on the court21

2. The NYC Bar Ass’n suggested, “that an occasional loan may be permissible, as long as the practice does not become known, inducing clients to seek the lawyer’s services based on his willingness to provide financial assistance”22 a. However, “a client must remain ‘ultimately liable’ for the expenses of

litigation”23 ii. Exception – Litigation Expenses

1. Under the ABA Model Rules of Prof’l Conduct, Rule 1.8(e): a. (1) a lawyer may advance court costs and expenses of litigation, the

repayment of which may be contingent on the outcome of the matter; and

b. (2) a lawyer representing an indigent client may pay court costs and expenses of litigation on behalf of the client”24

2. In a 1976 decision in Louisiana State Bar Ass’n v. Edwins, “the court was troubled that an ethics rule’s prohibitions would cause an impoverished person to be unable to proceed with his claim or to be forced to settle for an inequitably small amount because of his financial problems”25 a. The court classified living expenses as being permissible under DR 5-‐

103(b)’s “expenses of litigation”, setting four requirements: 19 Model Rules of Prof’l Conduct R. 1.8 (e)(2012); FL Ethics Op. 65-‐39 (2011); See also FL Ethics Op. 68-‐15 (1968). 20 ABA Comm. on Prof’l Ethics and Prof’l Responsibility, Formal Op. 288 (1954); See also New York City Bar Ass’n Comm. on Prof’l & Judicial Ethics, Op. 781 and 779 (1953). 21 Moliterno, James E., Broad Prohibition, Thin Rationale: The Acquisition of an Interest and Financial Assistance in Litigation Rules, 16 Geo. J. Legal Ethics 223 (2003). Faculty Publications. Paper 924; page 236. <http://scholarship.law.wm.edu/facpubs/924>. 22 Id., 16 Geo. J. Legal Ethics at 236. 23 N.Y. State Bar Ass’n Comm. on Prof’l Ethics Op. 666, citing N.Y. State 553 (1983); N.Y. State 464 (1977). 24 Model Rules of Prof’l Conduct R. 1.8 (e). 25 Moliterno, 16 Geo. J. Legal Ethics at 238.

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i. The financial assistance wasn’t promised as an inducement to obtain employment;

ii. The advancement was reasonably needed iii. The client remains liable for repayment; and iv. The attorney did not encourage public knowledge of the

assistance26 b. Following this decision, a few states created an exception or amended

their rules regarding financial assistance, allowing it when it is reasonably necessary to allow litigation to be settled on the merits rather than because of financial hardship of a client27

3. Under the ABA Model Rules of Prof’l Conduct, Rule 1.2(a), it is up to the client to decide the objectives of representation and an attorney must comply with the client’s decision regarding settlement28

c. Attorney Borrowing to Finance Client Expenses

Is it ethical for a lawyer to borrow from a third party lender, and then pass the interest and finance charges of the loan to their client? i. Borrowing from a Third Party and Passing Costs on to Clients:

1. NY Ethics Op. 754: A lawyer may borrow to finance litigation expenses in a contingent fee matter and pass on to the client the interest costs incurred in connection with such borrowings if: a. client remains ultimately liable for the expenses b. lawyer has no interest in the lender c. client confidences are not compromised d. terms of the borrowing are on adequate advance notice to the client e. time periods after which interest is charged and the interest rate are

reasonable f. client consents in advance (ie: in retainer) g. client may avoid the interest charge by paying the disbursements and

the disbursements are themselves appropriate29 ii. In Texas, the Commission on Professional Ethics has stated, “an attorney may properly

borrow money from a lending institution for case expenses for a personal injury client, and charge, or pass on, to the client the actual out-‐of-‐pocket interest or finance charges of the lending institution”, assuming:

1. The attorney was hired on a contingent fee basis; 2. The attorney and/or his firm does not own or control the funding company to

the extent the company only loans to the attorney’s clients; and 3. The borrowing is not used to advertise attorney’s services or continue the

attorney’s employment by the client30

26 Id. 27 Id. at 239 citing Minn. R. of Prof’l Conduct R. 1.8(e)(3); Tex. Disc. R. of Prof’l Conduct R. 1.08(d). 28 Model Rules of Prof’l Conduct R. 1.2(a). 29 N.Y. State Bar Ass’n Comm. on Prof’l Ethics Op. 754 (2002). 30 Tex. Comm. on Prof’l Ethics, Op. 465, V. 54 Tex. B.J. 76 (1991).

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d. Client Borrowing against Potential Award – Attorney’s Role Is it ethical for an attorney to refer a client to a litigation funding company? i. Independent Judgment under the ABA Model Rules of Prof’l Conduct

1. “A lawyer shall not acquire a proprietary interest in the cause of action or subject matter of litigation the lawyer is conducting for a client, except that the lawyer may: (1) acquire a lien authorized by law to secure the lawyer’s fee or expenses; and (2) contract with a client for a reasonable contingent fee in a civil case”31

2. “In representing a client, a lawyer shall exercise independent professional judgment and render candid advice. In rendering advice, a lawyer may refer not only to law but to other considerations such as moral, economic, social and political factors that may be relevant to the client’s situation”32

ii. Lobbying or Solicitation 1. “In general, a lawyer is not expected to give advice until asked by the client…a

lawyer ordinarily has no duty to initiate investigation of a client’s affairs or to give advice that the client has indicated is unwanted, but a lawyer may initiate advice to a client when doing so appears to be in the client’s best interest”33

iii. Protecting Confidentiality and Independence 1. In New York, the Board of Ethics has decided:

a. An attorney can refer a client to a litigation financing company that advances the client cash in return for a portion of an eventual settlement or judgment received by the client, provided that:

i. client confidentiality in connection with disclosure of information to the lender is not compromised

ii. lawyer has no interest in the lending institution, and iii. lawyer receives no fee for the referral

b. An attorney can represent the client in such a litigation financing transaction and may charge the client a fee for such representation in addition to the contingent fee agreed to for the underlying representation34

2. Florida Ethics Op. 00-‐3 advises that an attorney shall not: a. Recommend a client’s matter to the funding company, nor initiate

contact on the clients’ behalf35 b. Have any ownership interest funding company or receive any

compensation or other value from the funding company in exchange for referring clients

3. “A mere referral to the lending institution would not be unethical per se”36

31 Model Rules of Prof’l Conduct R. 1.8(i). 32 Model Rules of Prof’l Conduct R. 2.1. 33 Id., Comment [5]. 34 NY Ethics Op. 769, confirming NY Ethics Op. 666 (1994). 35 Florida Ethics Op. 00-‐3 (2002) citing FL Ethics Op. 75-‐24 (1975). 36 N.Y. State Bar Ass’n Comm. on Prof. Ethics Op. 666.

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a. It is acceptable for a lawyer to refer clients to a funding company that would assess the clients’ cases and make loans based on the assessment37

b. It is unethical for an attorney to refer clients to a funding company to fund a client’s living expenses pending outcome of litigation where the attorney guarantees payment of the loan38

i. It is acceptable where the repayment of the loan is contingent on the successful resolution of the client’s claim for personal injuries39

c. The attorney cannot own an interest in the lending institution, nor can the lawyer be paid a fee by the lending institution40

Is it ethical for a lawyer to be a part of the loan process between a client and a third party lender? iv. “A lawyer may suggest to a client where the client may try to obtain financial help to

individual needs…but the lawyer should not become part of the loan process…”41 v. Florida Ethics Op. 00-‐3 further advises that an attorney shall not:

1. Co-‐sign or otherwise guarantee the financial transaction42 2. Provide the funding company with an opinion regarding the worth of the

client’s claim or the likelihood of success (i.e. let the funding company make its own independent decision)43

e. Protecting against Interference with Professional Judgment or Services

Do litigation funding companies interfere with the professional judgment of attorneys? i. Under ABA Model Rules of Prof’l Conduct: “A lawyer shall not permit a person who

recommends, employs, or pays the lawyer to render legal services for another to direct or regulate the lawyers professional judgment in rendering such legal services”44

1. Florida Ethics Op. 00-‐3 advises that an attorney shall not allow the funding company to direct the litigation, interfere with the attorney-‐client relationship, or otherwise influence the attorneys’ independent professional judgment

ii. “Notwithstanding the existence of a concurrent conflict of interest…a lawyer may represent a client if:

1. The lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client;

2. The representation is not prohibited by law;

37 Id. citing Philadelphia Op. 91-‐9 (1991). 38 Id, citing Cf. Fla. Op. 75-‐24 (1975) 39 Id. 40 Id. citing Cf. S.C. Op. 92-‐06 (1992). 41 FL Ethics Op. 75-‐24. 42 FL Ethics Op. 00-‐3 citing FL Ethics Op. 70-‐8 (1993). 43 Id. citing FL Ethics Op. 75-‐24. 44 Model Rules of Prof’l Conduct R. 5.4 (c).

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3. The representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or other proceeding before a tribunal; and

4. Each affected client gives informed consent, confirmed in writing”45 iii. A concern surrounding litigation financing is that the attorney’s loyalty will be

transferred from his client to the entity funding him46 1. “There is no evidence that attorneys who enter into litigation funding

agreements represent their clients less effectively as a result”47 a. “Litigation funding companies do not knowingly advance funds to

incompetent attorneys because incompetent attorneys are unlikely to obtain favorable settlements or judgments in their cases, and thus diminish a funding company’s chance of a return on its investment”48

2. Like a bank, litigation funding companies are advancing funds that the attorney has agreed to repay; they are not paying or employing the attorney in any way49

3. The funding company cannot fire the attorney on behalf of any client50 4. Litigation funding cannot be a settlement disincentive because the decision to

settle belongs solely to the client51 f. Fee Splitting

Does obtaining third party financing constitute fee sharing with a non-‐lawyer? i. ABA Model Rules of Prof’l Conduct, Rule 5.4 provides: “A lawyer or law firm shall not

share legal fees with a non-‐lawyer, except that: 1. An agreement by a lawyer with the lawyer’s firm, partner, or associate may

provide for the payment of money, over a reasonable period of time after the lawyer’s death, to the lawyer’s estate or to one or more specified persons;

2. A lawyer who purchases the practice of a deceased, disabled, or disappeared lawyer may, pursuant to the provisions of Rule 1.17, pay to the estate or other representative of that lawyer the agreed-‐upon purchase price;

3. A lawyer or law firm may include non-‐lawyer employees in a compensation or retirement plan, even though the plan is based in whole or in part on a profit-‐sharing arrangement; and

4. “A lawyer may share court-‐awarded legal fees with a nonprofit organization that employed, retained or recommended employment of the lawyer in the matter”52

ii. Litigation funding agreements do not constitute fee splitting 1. “Because the attorney can repay the funding company from any source of

funds, the attorney is not sharing fees with a layperson”53

45 Model Rules of Prof’l Conduct R. 1.7 (b). 46 Douglas R. Richmond, Other People’s Money: The Ethics of Litigation Funding, 56 Mercer L. Rev. 649, 676 (2005). 47 Id. 48 Id. 49 Id. at 670. 50 Id. 51 Id. at 672. 52 Model Rules of Prof’l Conduct R. 5.4 (a).

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2. “The amount the attorney is required to pay the funding company is unrelated to the amount of the attorney’s fee”54

3. An attorney who borrows from a bank to finance litigation is not considered to be engaging in fee splitting, likewise, an attorney who chooses to borrow from a specialized lender cannot be considered to be fee splitting with the company55 a. When third party litigation funders lend to a lawyer or law firm based on

the firm’s interest in their pending cases it does not violate the prohibition on fee splitting because while the attorney is obligated to repay the loan, the lender has no right to a percentage of any particular fee56

4. “The threat of undue influence purportedly linked to fee splitting should be addressed on a case-‐by-‐case basis”57

g. Other Model Rules of Professional Conduct to Consider:

i. Rule 1.1 Competence ii. Rule 1.2 Scope of Representation and Allocation of Authority Between Client and

Lawyer iii. Rule 1.3 Diligence iv. Rule 1.4 Communication v. Rule 1.5 Fees vi. Rule 1.6 Confidentiality of Information (to be discussed at length by the next speaker).

4. Confidentiality Concerns in the Lending Process

a. Conflict may arise between lenders, who must conduct due diligence on cases that will generate

the underlying fee collateral, and the law firm borrower or plaintif, who must maintain attorney-‐client privilege and confidentiality

b. Recourse Financing

i. Before Applying 1. Ask: what sort of information must be disclosed to the lender to obtain the

financing prior to and subsequent to obtaining the loan? 2. Remember: attorney client privilege must be preserved while describing the

value of your portfolio of pending cases a. Attorney-‐client privilege is a creature of state common law, unless

superseded by the U.S. Constitution, a federal statute or rule proscribed by the Supreme Court58

53 56 Mercer L. Rev. 649, 676 (2005). 54 Id. 55 Id. at 677. 56 Burford Group Limited, Litigation Financing in Commercial Disputes 12 (2011). 57 56 Mercer L. Rev. at 676. 58 Fed. R. Evid. 501.

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i. Although it may vary slightly from state to state, essentially the client has a privilege with respect to communications made to a lawyer in confidence for the purpose of enabling the lawyer to render legal services to the client

b. Work product privilege, established in Hickman v. Taylor, and now recognized in Fed. R. Civ. P. 26(b)(3), protects from discovery documents and tangible things prepared in anticipation of litigation or for trial by or for a party or by a party’s representative59

ii. Application 1. Can include questions concerning years in practice, areas of practice,

estimated value of cases at resolution, what stage your cases are in, size of law firm, marketing scheme (how do you bring cases in?), and background of law firm

2. Potential disqualifiers – Past bankruptcies, extensive criminal records, excessive litigiousness, too many liens already or inexperience as an attorney

iii. Post-‐Application Documentation 1. Can include case lists, tax returns, copy of malpractice and life insurance

policies, copy of your retainer agreements, press information, and disclosure of any other lenders

2. Attorney experience can include what school you graduated from, years in practice, specialty and business model

iv. Office Visit and/or Case File Review 1. Lawyer must preserve privilege and confidentiality

a. Common interest doctrine i. Some litigation finance companies purport to stand in “common

interest” with the plaintiff, which is considered an exception to the rule that attorney-‐client privilege is waived following disclosure of privileged materials to a third party60

1. Argument is similar to the principle allowing defendants to discuss cases confidentially with their insurers

2. The body of law that pertains to the common interest doctrine and disclosure of privileged materials to third party litigation financers is unsettled

ii. In June 2010, the U.S.D.C. for the District of Delaware held that a plaintiff who exchanged privileged documents with a prospective third party litigation financier waived privilege and had to produce documents61

iii. In September 2012, the U.S.D.C. for the Eastern District of Pennsylvania held that a third party litigation financer who entered into a Confidentiality, Commonality and Non-‐Disclosure Agreement with the Plaintiff before privileged information was

59 Hickman v. Taylor, 329 U.S. 495, 511 (1947). 60 Union Carbide Corp. v. Dow Chem. Co., 619 F.Supp 1036, 1047 (D.Del. 1985). 61 Leader Technologies Inc. v. Facebook Inc., 719 F.Supp.2d 373 (D. Del. 2010).

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shared, stood in common interest, thus disclosure was an exception to waiver62

2. Do not provide, or at least redact, client information of a personal nature from files, such as: a. Memos prepared in anticipation of, or in connection with, litigation b. Sealed files in Qui Tam cases c. Interview notes with clients or witnesses d. Notes regarding phone calls or meetings with adversary e. Expert reports or opinions establishing liability

3. Provide all non-‐confidential documents a. Any documents available from public court records, may be reviewed by

lender, ie: i. Pleadings, motions, court orders, etc.

b. Co-‐Counsel Agreements c. MDL or Mass Tort Participation agreements d. Personal opinions on the value of the case

v. Post Closing 1. Lenders will often require private case lists or audit reviews of the files. 2. Avoid lenders that refuse to comply with confidentiality

a. Some lenders will attempt to ask you for more information than you might like to otherwise disclose. Current case law is unclear on whether or not consulting with outside lenders for the purpose of case financing falls within the sphere of attorney-‐client privilege.

i. In United States v. Kovel, the 2nd Circuit ruled that a non-‐attorney accountant who consulted with both Plaintiff and his attorney was protected from answering questions concerning the consultation because his services fell within the sphere of attorney-‐client privilege63

ii. In Kovel, the court preserved privilege because “the presence of the accountant is necessary, or at least highly useful, for the effective consultation between the client and the lawyer which the privilege is designed to permit”64

b. Some litigation finance companies have taken the aggressive position that the Second Circuit’s decision to extend attorney client privilege to include conversations between the client’s attorney and accountant means that conversations between a client’s attorney and third party litigation financers will also be protected by privilege65

3. Until a final decision is reached on whether or not attorney client or work product privilege applies to conversations involving third party litigation financers, prudent plaintiffs’ lawyers would be wise to do business with a company who plays it safe and limits their due diligence to non-‐confidential

62 Devon IT Inc., et al, v. IBM Corp. et al., 2012 WL 4748160 (E.D. Pa. 2012). 63 United States v. Kovel, 296 F.2d 918, 922 (2d Cir. 1961). 64 Id. at 922. 65 Bray & Gillespie Management LLC. v. Lexinton Insurance Company, 2008 U.S. Dist. Lexis 112380 (M.D. Fla. 2008).

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public documents or documents where confidential information has been completely redacted

4. Under HIPPA, professionals in possession of confidential information should be careful not to disclose confidential client information. a. Protected Health Information: The Privacy Rule protects all "individually

identifiable health information" held or transmitted by a covered entity or its business associate, in any form or media, whether electronic, paper, or oral66

b. One way to comply with this rule while still giving the third party litigation financer enough information to value your collateral is to redact confidential information.

i. There are no restrictions on the use or disclosure of de-‐identified health information67

ii. Information shared should not include any of the following: 1. Address & telephone number of the plaintiff 2. Social Security Number 3. Identity of Plaintiff’s employer 4. Medical information unrelated to the case at hand

c. Non-‐Recourse Financing

i. Pre Settlement Plaintiff Financing 1. Attorneys are typically asked to submit information about a specific case, such

as insurance coverage, policy limits, liability, and contributory or comparative negligence issues a. In order to protect yourself from a legal malpractice claim make sure to

share only non-‐confidential information of already filed cases 2. Caution! Some clients will ask for more funding than actually necessary

a. Be careful that the client doesn’t obtain so much funding that he/she loses interest in the case

b. Confidentiality still must be maintained – one way to do this is to have the client deal directly with the third party financer or sign a retainer agreement which acknowledges that confidential information may be shared with third parties

ii. Post-‐Settlement Attorney Financing 1. Options exist to provide liquidity for attorneys with settled or resolved

contingent fee cases that have not yet been funded. 2. To avoid disclosing confidential or privileged information attorneys should

only seek financing for cases in which the settlement or verdict is public knowledge a. Confidential settlements are generally not be eligible for this type of

funding 66 45 C.F.R. § 160.103. 67 45 C.F.R. §§ 164.502(d)(2), 164.514(a) and (b).

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5. Usury Considerations for Non-‐Recourse Financing

a. Usury, Generally i. Litigation financing agreements are frequently met with challenges under usury laws

1. Usury is “the exacting, taking, or receiving of a greater rate of interest than is allowed by law for the use or loan of money68

ii. “Usury law” is generally set by each state legislature 1. New York

a. The maximum interest rate on most loans is 16% per annum, with the exception of certain loans of $250,000 or more, in which case the maximum allowable interest rate is 25% per annum, except that there is no limit on the interest that can be charged on loans of $2,500,000 or more69

2. California a. The maximum interest rate allowable on personal consumer loans is

10%; for non-‐consumer loans the maximum interest rate is 5% plus the prevailing rate for interbank loans established by the Federal Reserve Bank of San Francisco70

3. Florida a. The maximum interest rate allowable on loans not greater than

$500,000.00 is 18% per annum.71 For loans greater than $500,000.00, the maximum rate of interest allowable is 25%, which is Florida’s criminal usury threshold72

iii. Attorneys should consider the effect of the usury laws of the state in their state, as well as the state where the funding company is located

b. Elements of Usury in most states are:

i. Agreement to lend money 1. In determining whether a transaction constitutes a loan or forbearance, the

court looks to the substance rather than the form of the transaction. In all such cases the issue is whether or not the bargain of the parties, assessed in light of all the circumstances and with a view to substance rather than form, has as its true object the hire of money at an excessive rate of interest73

ii. Borrower’s absolute obligation to repay with repayment not contingent on any other event or circumstance74

iii. A greater compensation for making the loan than is allowed under a usury statute or the State Constitution

68 Black’s Law Dictionary (9th ed. 2009). 69 N.Y. Gen. Oblig. §§ 5-‐501 through 5-‐531 (2012); N.Y. Banking Law § 14-‐a (2012); N.Y. Penal Law §§ 190.40 and 190.42 (2012). 70 Cal. Const., Art. XV § 1 (2012) 71 Fla. Stat. § 687.02 (2012). 72 Fla. Stat. § 687.071 (2012). 73 Southwest Concrete Products v. Gosh Construction Corp. (1990) 51 Cal. 3d 701, 274. 74 See Kelly, Grossman & Flanagan, LLP. v. Quick Cash, Inc., 35 Misc. 3d 1205A, *11, 2012 N.Y. Misc. LEXIS 1460 (N.Y. Supp. Ct. 2012)(unpublished), citing Sumner v. People, 29 N.Y. 337 (N.Y. 1864).

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1. For instance, New York applies the “traditional method” of computing interest a. Under the traditional method, “when calculating the interest rate, the

amount of the loan is deemed not the original principal amount, but only the net principal amount actually received by the borrower after deducting points and other fees considered interest and paid from the loan proceeds”75

2. Watch out for lenders who charge extra fees; some fees may be includable in the interest calculation for usury purposes if they are “solely a ruse to collect additional interest above what would be allowed by the usury law”76

3. However, lenders may charge back to the borrower reasonable expenses incurred in connection with the loan. “There is no question that a lender, by agreement with the borrower, has a right to deduct from the amount to be paid by him on actual loan expenses incurred in making the loan and such sums as will meet future expenses in connection therewith reasonably and honestly to be anticipated”77 a. Some fees which lenders may charge back to the borrower include

processing fees, commitment fees, or fees related to “periodic inspections related to advances to be made under the loan agreement”78

iv. An intention to make more for the loan of the money than the law allows 1. “The voluntary and conscious taking of greater interest for a loan of money

than that allowed by law is per se usurious. The prerequisite intention essential to usury is simply the intention to take more than the legal rate of interest”79

c. Non-‐Recourse Financing

i. Interest rates for funding directly to clients tend to be high because they are non-‐recourse investments, not loans

1. Some states have been touchy about this issue80 a. The Ohio Supreme Court held the risk of a client’s non-‐payment to the

lending company was so small that the transaction was actually a “loan” because the transaction lacked the necessary element of risk sufficient to deem it a “non-‐recourse investment”81

75 Bernard v DeGraffe, 27 Misc.3d 1216A, 910 N.Y.S.2d 760 (N.Y. Sup. Ct. 2010)(unpublished) citing Hammelburger v. Foursome Inn Corp., 76 A.D.2d 646, 648, 437 N.Y.S.2d 356 (N.Y. 1980); See Band Realty Co. v. North Brewster, Inc., 37 N.Y.2d 460, 462, 335 N.E.2d 316, 317 (N.Y. 1975) (to determine the annual rate, the total interest paid is to be divided by the total years); See also In the Matter of: Carla Leather, Inc., 44 B.R. 457 (S.D.N.Y. 1984)(The usury statute “clearly speaks of an annual interest rate”, and therefore, the so-‐called ‘true interest rate’, “is the total interest called for in a given transaction compared to the total principal actually received.”). 76 Banking Department, Legal Op. (5/5/10) citing Freitas v. Geddes Savings and Loan Ass'n, 63 N.Y.2d 254, 481 N.Y.S.2d 437 (N.Y. 1984), London Realty Co., 207 N.Y. 264, 100 N.E. 800 (N.Y. 1913). 77 Brown v. Robinson, 224 N.Y. 301, 314, 1320 N.E. 694, 698 (N.Y. 1918). 78 Freitas, 63 N.Y.2d at 265. 79 National Equipment Rental, Ltd. v. Stanley, 177 F. Supp. 583, 586 (E.D.N.Y. 1959) citing; Fiedler v. Darrin, 1872, 50 N.Y. 437, 443-‐444. 80 See e.g. Rancman v. Interim Settlement Funding Corp., 2001 Ohio 1669 (Ohio Ct. App. 9th Dist. 2001). 81 Id. at 5.

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ii. In New York, although some lower courts have indicated otherwise, generally non-‐recourse agreements to plaintiffs have been upheld

1. Usury laws do not apply to investments82 2. Where a transaction involves interest to be paid based upon a contingency

which is in the control of the debtor, usury will not apply83

6. Tax Considerations

a. Deductibility of interest, fees & other costs i. Attorneys should talk to their personal accountant regarding their state’s laws

concerning deductibility of interest payments to a lender 1. Under the Federal Tax Code, “[t]here shall be allowed as a deduction all

interest paid or accrued within the taxable year on indebtedness”84 a. Interest paid on a note executed in consideration of cash loan is

deductible85 ii. Generally the costs and fees associated with case financing are a necessary part of

operating the law firm and hence, deductible under the Internal Revenue Code. 1. The Federal Tax Code states generally, “[t]here shall be allowed as a deduction

all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business”86 a. A loan commitment or standby fee paid in connection with securing a

loan for taxpayer’s business is deductible as an ordinary and necessary business expense87

b. Disbursements i. Generally not deductible unless and until the attorney loses the case. ii. Within the 9th Circuit attorneys may deduct client costs related to litigation as ordinary

and necessary business expenses under 26 USC §162, so long as a gross fee contract is used88

1. In a gross fee contract the plaintiff’s law firm pays all litigation costs up-‐front and recovers a fixed percentage contingency fee if successful. By contrast, in a net fee contract the plaintiff’s law firm pays all litigation costs up front and litigation costs are taken out of any recovery before the lawyer’s contingent fee is calculated

iii. Following Boccardo, the IRS issued a Field Service Announcement proclaiming that they would not follow Boccardo outside of the 9th Circuit; it would continue to argue that the gross fee exception should not affect whether advanced expenses are treated as loans, and thus not deductible as ordinary and necessary business expenses89

82 N.Y. Gen. Oblig. L. § 5-‐501[2]. 83 Kelly, Grossman & Flanagan, LLP, supra, 35 Misc. 3d 1205A, *11. 84 I.R.C. § 163(a) 85 Woodward v United States 106 F. Supp. 14(ND Iowa 1952) aff’d 208 F.2d 893 (8th Cir. 1953). 86 I.R.C. § 162(a) 87 Duffy v. The United States, 231 Ct. Cl. 679 (Fed. Cl. 1982). 88 Boccardo v. Comm’r, 56 F.3d 1016 (9th Cir. 1999). 89 IRS Field Service Memo, supra, 1997 FSA LEXIS 442.

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iv. Subsequent decisions by the tax court have distinguished Boccardo, suggesting that the tax court may now be in line with the 9th Circuit90

v. In response to the confusion surrounding the deductibility of litigation costs, Senator Grassley of the Committee on Finance wrote to the Department of Treasury asking it to change its position in contingent gross fee cases, or in the alternative, issue guidance on the deductibility of litigation costs in contingent gross fee cases

1. A response was issued from the IRS on August 30, 2010 explaining that they have not determined whether additional guidance is appropriate at this time91

vi. Until the IRS’s position is clarified, plaintiffs’ lawyers (outside of the 9th Circuit) would be wise to treat client expenses as loans to be paid out of the eventual recovery, rather than ordinary and necessary business expenses

c. Funds from Personal Accounts i. Generally, the use of funds derived from lawyers personal accounts or credit cards are

not tax-‐deductible

7. Champerty & Maintenance

a. Overview i. A frequently cited criticism of third party litigation funding is that such agreements

violate the common law doctrines of maintenance and champerty92 1. Maintenance – any agreement by which one person, that is not a party to the

lawsuit, helps or assists another (through financing or otherwise) to prosecute or defend a lawsuit93

2. Champerty -‐ a form of maintenance and involves the situation wherein one party who has no subject-‐matter interest in a lawsuit agrees to support another in bringing a legal action in exchange for a part of the proceeds of the litigation94

3. Barratry -‐ repeated champerty and maintenance ii. Simply summarized, “maintenance is helping another prosecute a suit; champerty is

maintaining a suit in return for a financial interest in the outcome; and barratry is a continuing practice of maintenance or champerty”95

iii. The overarching principle is that champerty and maintenance require the presence of “officious intermeddlers” or disinterested people dedicated to “stirring up strife”96

b. History of the Doctrines

90 See Pelton & Gunther v. Commissioner, 78 T.C.M. 578, T.C. Memo. 1999-‐339 (U.S.T.C., 1999) Doc 1999-‐ 32749 or 1999 TNT 196-‐58. 91 I.R.S. Priv. Ltr. Rul. 2010-‐0218 (Aug. 30, 2010), http://www.irs.gov/pub/irs-‐wd/10-‐0218.pdf. 92 See Jason Lyon, Revolution in Progress: Third-‐Party Funding of American Litigation, 58 UCLA L. Rev. 571 (2010). 93 14 Am. Jur. 2d. Champerty, Maintenance, and Barratry § 1 (2000). 94 Black's Law Dictionary (6th ed. 1990); Coleman Powermate, Inc. v. Rheem Mfg. Co., 880 So. 2d 329, 334 (Miss. 2004). 95 In re Primus, 436 U.S. 412, 424 n.15 (1978). 96 Douglas R. Richmond, “Other People’s Money: The Ethics of Litigation Funding”, 56 Mercer L. Rev. 649 (2005).

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i. The doctrines of maintenance and champerty arose from causes unique to English life, in part due to the conflict between the crown and feudal lords, and indeed, feudalism itself

1. “When the doctrine was established, lords and other large landholders were accustomed to buy up contested claims against each other, or against commoners with whom they were at variance, in order to harass and oppose those in possession. On the other hand, commoners, by way of self-‐defense, thinking that they had title to lands, would convey part of their interest to some powerful lord, in order, through his influence, to secure their pretended right. The power of the nobles became mighty in corrupting the fountains of justice. To remedy these evils, the law against both maintenance and champerty was introduced”97

ii. Maintenance and champerty found their way into American jurisprudence via common law98

1. In particular, champerty and maintenance evolved out of a fear that purchasing an interest in another’s lawsuit would encourage frivolous lawsuits, discourage settlements, and increase damages99

c. Treatment of Champerty & Maintenance

i. Champerty and maintenance have been described as dated, ancient, and rare100 1. The reason that the doctrines have become outdated is because the principal

behind the common law doctrines was to thwart the presence of “officious intermeddlers” or disinterested people from “stirring up strife” in lawsuits101 a. Formerly, the doctrines were directed to "keep alive strife and

contention, and pervert the remedial process of the law into an engine of oppression" and are now "obsolete doctrines"102

ii. States vary in their interpretations, definitions, and approaches to champerty and maintenance103

1. Many states such as Maryland have held that the broad scope of common law champerty and maintenance did not survive beyond the mid-‐19th Century.104 a. 28 states have explicitly taken the position of permitting champerty and

maintenance (although many with limitation)105

97 Croco v. Oregon, 18 Utah 311 (Utah 1898); Maya Steinitz, Whose Claim is this Anyway? Third-‐party Litigation Funding, 95 Minn. L. Rev. 1268 (2011) citing Thallhimer v. Brinckerhoff, 3 Cow. 623 (N.Y. Sup. Ct. 1824) 98 Jason Lyon, Revolution in Progress: Third-‐Party Funding of American Litigation, 58 UCLA L. Rev. 571 (2010). 99 Courtney Barksdale, All That Glitters Isn’t Gold: Analyzing the Costs and Benefits of Litigation Finance, 26 Rev. Litig. 707, 716 (2007); quoting Ari Dobner, Litigation for Sale, 144 U. Pa. L. Rev 1529, 1544-‐1547 (1996). 100 Paul Bond, “Making Champerty Work: An Invitation to State”, 150 U. Pa. L. Rev. 1297, 1301 (2002). 101 Douglas R. Richmond, “Other People’s Money: The Ethics of Litigation Funding”, 56 Mercer L. Rev. 649, 654 (2005). 102 Home Fire Ins. Co. v. Barber, 1903 Neb. LEXIS 454 (Neb. 1903). 103 Mariel Rodak, “It’s About Time: A Systems Thinking Analysis of the Litigation Finance Industry and It’s Effect on Settlement”, 155 U. Pa. L. Rev. 503 (2006) 104 Schaferman v. O'Brien, 28 Md. 565, 574 (1868) A treatise On The Pleas of the Crown by William Hawkins (1824)(Maryland law is “confined to cases where a man improperly, and for the purpose of stirring up litigation and strife, encourages others either to bring actions, or to make defenses which they have no right to make.").

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b. 9 states stay ambiguous as to the current status of the doctrines106 c. 14 states107 have overtly declared that champerty and maintenance are

unlawful108 iii. Ohio Supreme Court case, Rancman v. Interim Settlement Funding Corporation109

1. Rancman was injured in an auto accident and contacted Interim Settlement Funding Corporation (“ISF”) about an advance of funds to be secured by her pending lawsuit a. Future Settlement Funding (“FSF”), an affiliated company, advanced

$6,000 to Rancman in exchange for the first $16,800 she would recover if the case resolved in 12 months

b. Rancman settled the case for $100,000 within 12 months, but refused to honor the terms of the contract and sued to rescind her agreements with FSF and ISF

2. The Supreme Court of Ohio held the advances at issue were “void as champerty and maintenance” a. The court in Rancman considered the advances to be champertous

because FSF and ISF sought to profit from Rancman’s case i. The advances constituted maintenance because FSF and ISF

purchased shares of a lawsuit in which they did not have an independent interest and because they gave Rancman a disincentive to settle her case

iv. Despite the holding in Rancman, “the consistent trend across the country is toward limiting, not expanding, champerty's reach”110

1. For instance, in New York, a Supreme Court held that while the facts of a case were very similar to Rancman, “it is not the facts that account for the differences of opinion, but rather it is the different law of the different states which allow us to differ in our conclusions”111 a. “As mentioned above the Ohio decision is based on Ohio precedent that

the assignment of rights in a lawsuit can be void as Champerty”112 b. “Under New York law these assignments are allowed as long as the

primary purpose and intent of the assignment was for some reason other then bringing suit on that assignment”113

c. “Therefore under Ohio law, taking an assignment of a judgment for profit by itself is enough to constitute [c]hamperty, while under New York law

105 Arizona, California, Colorado, Connecticut, Florida, Hawaii, Iowa, Kansas, Maine, Maryland, Massachusetts, Michigan, Missouri, Montana, New Hampshire, New Jersey, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, South Carolina, Tennessee, Texas, Washington, and West Virginia. 106 Alaska, Arkansas, Idaho, Indiana, Nebraska, New Mexico, Utah, Vermont, and Wyoming. 107 Alabama, Delaware, District of Columbia, Georgia, Illinois, Kentucky, Minnesota, Mississippi, Nevada, Pennsylvania, Rhode Island, South Dakota, Virginia, and Wisconsin. 108 Anthony J. Sebok, The Inauthentic Claim, 64 Vand. L. Rev. 61, 98-‐99; See also Miss. Code Ann. § 97-‐9-‐11 (2010). 109 Rancman v. Interim Settlement Funding Corp., 789 N.E.2d 217, 219-‐21 (Ohio 2003)(overturned by the Ohio legislature). 110 Del Webb Communities v. Partington 652 F.3d 1145 (9th Cir. July 21, 2011). 111 Echeverria v. Estate of Lindner, 7 Misc. 3d 1019A (N.Y. Sup. Ct. 2005). 112 Id. citing Brown, 66 Ohio St. 316, 64 N.E. 123. 113 Id. citing Knobel, 432 N.Y.S.2d at 68.

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the primary purpose and intent of taking the assignment would be to profit, and not to bring suit, which would prevent this action from being [c]hamperty. Resting on the language of Judiciary Law 489, and the purpose and intent requirement, the Court is comfortable finding that the instant agreement is not [c]hamperty”114

2. Further, the Ohio legislature has subsequently overruled Rancman and permitted the transactions involved in that case

8. Conclusion Counsel Financial Services has created this publication to provide you with accurate and authoritative information concerning the subject matter covered. However, this publication was not necessarily prepared by persons licensed to practice law in a particular jurisdiction. Counsel Financial Services is not engaged in rendering legal or other professional advice, and this publication is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional. Litigation Financing in the 21st Century is a trademark filed with the U.S. Patent and Trademark Office. COPYRIGHT © 2014 Counsel Financial II LLC

114 Id.

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