Alternative litigation financing (ALF), also known as third-party litigation financing, is the practice of making cash advances, most typically to a party in a lawsuit, to be repaid from the proceeds from the litigation. Broadly stated, ALFs are funding mechanisms that differ from other funding, such as paying litigation expenses from the client’s or counsel’s lines of credit or operating budgets. The hallmark of ALF providers, as distinguished from settlement factoring companies, is that the financing contracts are executed before there is a settlement or judgment corpus, making ALF a way to spread the risk of uncertain litigation outcomes. The issue is not without controversy, and it has received increased attention from lawmakers, legal commentators, and ethics committees.
Generally speaking, there are two categories of ALF: consumer and commercial. The consumer ALF industry extends cash advances to plaintiffs to meet their financial needs while their actions are pending. Most occur in automobile cases, with an average advance of approximately $1,700. Commercial ALF involves far greater sums, potentially in the millions, for lawyers’ fees and litigation expenses. Commercial ALF advances can be made in exchange for a percentage of the recovery. In some instances, this financing is done in stages.
Consumer ALF. This form of financing involves lenders that offer “lawsuit loans” by advancing funds in exchange for an agreement to repay the advance plus fees. The practice is also referred to as consumer legal funding. These cash advances can provide needed living expenses and are without recourse—repayment may only come out of the litigation recovery. Nonetheless, some view the industry with a certain amount of skepticism. Rand Corp., for example, issued a report on ALF suppliers that noted concerns that have been raised about the level of fees and whether parties understand them.1
Consumer ALF lenders generally require that a consumer have an attorney who has agreed to pursue the claim. Typically, these clients are represented on a contingency basis and most involve auto accidents, although some relate to employment liability claims.2 According to the Rand report, if expressed as a monthly percentage of the advance, financing fees can significantly exceed interest rates on credit card balances or consumer bank loans.3 The report, as well as commentators at George Washington University’s (GW) ALF conference in May 2012, observed the average advance ranges from less than 10 to 15 percent of the suit’s predicted value to the plaintiff.4 These financing transactions may charge monthly interest with frequent compounding or may apply multipliers (fractions) that increase as litigation continues.5
With small sums at stake, a typical consumer ALF lender will not conduct a lengthy investigation of the case’s merits or become involved in the management of the litigation itself.6 Thus, in the typical consumer ALF transaction, the only two contact points between the lender and the plaintiff are the advance payment and the repayment.
Commercial ALF. Commercial ALF is a more sophisticated and complicated funding mechanism. Some commercial ALF lenders loan money to plaintiff firms at rates of interest, using the firms’ assets as collateral. Thus, these loans provide recourse.7 The Rand report concludes that “the major motives of ALF-applicant law firms are maintaining solvency or alleviating cash-flow problems” and that “presumably, plaintiffs’ law firms that demand this form of ALF are unable to borrow from traditional lenders.”8
Another segment of the ALF industry is investors willing to provide capital directly to businesses or their outside counsel to finance costs of pending plaintiff commercial cases. Two of these ALF companies are public, and as such, they report to shareholders. The most commonly financed actions are antitrust, intellectual property, and contract disputes.9 The two public companies in this industry primarily invest in claims by corporate litigants represented by major law firms with investments ranging from $500,000 to $15 million.10
Plaintiffs in commercial litigation may decide to give investors the opportunity to recoup a share of case recovery for several reasons. For example, a business plaintiff simply may prefer to use less of its own capital to pay outside counsel.11 The advantage of commercial ALF in this context is that the business can keep its transactional law firm—even when the firm will not take the case on a contingency basis and the client is unwilling or unable to pay the firm’s regular billing rate. Another basis for inviting investors to participate is to obtain their independent assessment of the case’s value. The Rand report cited, as another possible motive, a belief that the presence of such investors, once disclosed in the litigation, will demonstrate confidence to outside financiers that the plaintiff’s commercial case is considered meritorious.12
As a rule, the terms of commercial ALF contracts are not available for public view, but some have been revealed in litigation and media. One such case is the arrangement between a network security company called Deep Nines and a third-party litigation finance provider that had backed Deep Nines’ patent litigation with an $8 million advance.13 The case settled for $25 million, but after interest, attorney fees, and other expenses, the company received only $800,000. The financing company was dissatisfied with its share and sued Deep Nines in New York state court for more money; the case settled on undisclosed terms. The Deep Nines action has been discussed as a cautionary tale illustrative of the potential downside to commercial ALFs.14
Another caution advanced by detractors of the ALF industry involves an environmental case against Chevron Corp. in Ecuador. Roger Parloff’s 2011 article in Fortune magazine criticized the terms of the ALF arrangement because the lawyer had ties to the investment company.15 Parloff also referred to “speculating in court cases” as “a troubling new business.” As further fuel for such criticism, the funding agreement provided a disincentive to settle by inflating the ALF supplier’s recovery in the event plaintiffs settled for less than $1 billion.16
The Ecuador case also raises another potential pitfall—outside investors’ power to demand disclosure of attorney-client and work product protected documents. The lawyer who had ties to the investment company in the Ecuador case was given authority to decide “the delicate, risky question of whether attorney-client privileged materials must be disclosed” to the commercial ALF supplier.17 In commercial ALF, with large sums at stake, it should be no surprise that the investor often demands disclosure of information relevant to the investment. While an analogous situation occurs in the context of insurance, where disclosure of work product has been allowed without waiver or privilege, the degree to which disclosure to an ALF provider waives privilege may be an open issue in many jurisdictions. A similar concern raised in commercial ALF is whether the ALF provider is granted any control over the case (such as the identity of lawyers pursuing claims and the litigation strategy to be used), since this can be a professional responsibility issue, as discussed below.
Rules of Professional Conduct. The American Bar Association Commission on Ethics 20/20 issued a draft white paper on the duties of lawyers representing clients who are considering or have obtained funding from ALF suppliers.18 The white paper emphasizes the difference between consumer and commercial ALF, explaining that regulations appropriate for one sector of the market may be inappropriate for the other. The ethical considerations include an attorney’s duty to exercise independent professional judgment on behalf of a client without influence or interference, to vigilantly safeguard client confidences, and to fully and adequately communicate the terms of the funding transactions to clients.19
The white paper generally concluded that ALF is not unique with regard to confidentiality challenges and suggested that the issues of privilege and confidentiality may be handled the same way as these matters are addressed in the context of liability insurance and other analogous situations.20 ALF defenders also have voiced the opinion that ALF control over litigation is a “red herring,” and that litigation insurers could wield more control over settlements than any financier.21
ABA Model Rule 1.8 has received significant attention in this context.22 Rule 1.8(a) prohibits a lawyer from entering into a business transaction with a client or knowingly acquiring a pecuniary interest adverse to the client unless the terms are fair, reasonable, and fully disclosed in a manner reasonably understood by the client; the client is advised in writing of the desirability of seeking and is given a chance to seek independent advice; and the client consents in writing.23 Rule 1.8(f) applies where the lawyer accepts compensation other than from the client, and requires the client’s informed consent, maintenance of the lawyer’s independent judgment, and protection of client confidences.24
Model Rule 1.8(e) is very restrictive in terms of financial assistance that may be extended to clients in connection with litigation.25 The white paper identified only two jurisdictions, the District of Columbia and Texas, that allow limited financial assistance by lawyers to clients.26
One example of how states have dealt with ALFs is Louisiana, which specifies limits on the use of such funding arrangements. Rule 1.8(e)(5) of the Louisiana Rules of Professional Conduct allows counsel to provide for financing under defined circumstances. Such financing may have advantages for the client, and the rule sets forth specific procedures adequate to protect clients’ interests. This subsection of the conflict of interest rule requires the client’s written consent to the terms and conditions under which any financial assistance is made.27
The Louisiana rule also forbids counsel from charging interest where financial assistance is provided out of the lawyer’s own funds.28 If the lawyer uses a line of credit or loans from an approved financial institution to provide assistance, such as for court costs, expenses, or necessitous circumstances, “the lawyer shall not pass on to the client interest charges, including any fees or other charges attendant to such loans, in an amount exceeding the actual charge by the third-party lender, or 10 percentage points above the bank prime loan rate of interest as reported by the Federal Reserve Board on January 15th of each year in which the loan is outstanding, whichever is less.”29 Moreover, if a lawyer provides a guarantee or security on a loan made in favor of a client, the lawyer’s guarantee or security cannot apply to the extent that interest, fees, and charges exceed 10 percentage points above prime.30
Regulation of ALFs. Because of the sophistication of the parties, it is generally agreed that a commercial ALF, unlike a consumer ALF, does not require regulatory oversight. As to consumer ALFs, only three states (Maine, Nebraska, and Ohio) have statutes regulating this financing.31
Some commentators have raised the issue of whether the Consumer Financial Protection Bureau or Federal Trade Commission should step in to regulate ALFs. Others have suggested that a better alternative would be the establishment of a uniform model code. Professor Arthur Wilmarth of GW’s School of Law in Washington, D.C., explained that ALF providers are well advised to encourage the establishment of a uniform federal-state regulatory regime similar to the system created by a 2008 federal statute for mortgage loan originators.32 One consumer lender that participated in a recent conference on ALF at GW advocated for the nationwide regulation of the industry on a state rather than federal level.33
A uniform regulatory regime could also offer a number of potential ways to protect consumers. One would be to mandate adequate disclosure along the lines of the “Schumer Box,” requiring a summary of costs and clear disclosure of fees and rates.34 Another beneficial restriction would require that plaintiff counsel be given notice of, or that counsel affirmatively consent to, any consumer ALF arrangement entered into by a client. Other possibilities include registration of ALF lenders and rate limits similar to those used to protect consumers from usury.35
Limitations in class actions. Third-party litigation financing has worked in class action cases in Australia,36 but class actions are generally not viewed as conducive to ALFs because of the small recovery for individual plaintiffs and the inability of named class members to bind the class as a whole to an ALF transaction without prior court approval.37 In his paper on the subject, GW law professor William Rubenstein argues that ALF is unlikely to impact class action practice significantly because the two biggest recoveries available—the whole class recovery and multiplied attorney fee—are generally unavailable. Sean Coffee, managing partner of BlackRobe capital Partners explains that it is theoretically possible for a law firm serving as lead counsel in a class action to use ALF, but outlines the risks and potential complications that make the appearance of ALF in class action cases unlikely.38
Finally, some commentators have argued that ALF could have the effect of providing funding for frivolous litigation. To date, there has been no showing that the participation of third parties in funding promotes frivolous litigation, as financiers have no motive for making a bad investment.
Professor Susan L. Martin of Hofstra University at GW’s recent conference on the pros and cons of ALF put the issue in perspective for plaintiff lawyers:
The defendants in the underlying lawsuits and their insurance companies may do much greater harm to plaintiffs/borrowers who do not have access to litigation funding. Defendants and their insurers may deliberately delay, causing plaintiffs without resources to accept unreasonably low settlement offers. Furthermore, plaintiffs may be disadvantaged by the money defendants and their insurers can expend on experts and other legal support. For example, one estimate has the tobacco industry spending $600 million in attorneys fees in 1996 alone to defend itself in lawsuits, but there is no judicial or legislative outrage about the fairness of this expense or the right of defense attorneys to earn that much money.39
ALF arrangements raise issues of concern to the bar, including the notions that plaintiffs in consumer ALFs should be fully informed and fairly treated, and that counsel in commercial ALFs will protect their independence of judgment and their client’s confidences. Discussion of these issues is worthwhile, but opponents of ALF have not demonstrated insurmountable obstacles to third-party financing, that regulatory safeguards are not feasible, or that their concerns outweigh the interests of plaintiffs who seek their day in court.
J. Burton LeBlanc is a shareholder with Baron & Budd in Baton Rouge, La., and is president-elect of AAJ. He can be reached at firstname.lastname@example.org. S. Ann Saucer is of counsel to the firm. She can be reached at email@example.com.
- Steven Garber, Alternative Litigation Financing in the United States: Issues, Knowns, and Unknowns 23 (Rand Corp. 2010), www.rand.org/pubs/occasional_papers/2010/RAND_OP306.pdf.
- Garber, supra n. 1, at 9, 10.
- Id. at 10.
- Id. at 12 (advances average less than 10 percent of conservatively estimated values of the underlying legal claim); see also Tatyana Taubman, Alternative Litigation Financing Conference Summary 1 (May 17, 2012), www.law.gwu.edu/News/20112012events/Documents/Conference%20Summary%20-%205-17-12.pdf (advance estimated at 10–15 percent of predicted value to consumer) (Alternative Litigation Funding: A Roundtable Discussion Among Experts, George Washington U., May 2, 2012).
- See Taubman, supra n. 4, at 2.
- Id. at 1–2.
- See Garber, supra n. 1, at 13.
- Id. & 15 tbl. 3. The two public companies are Juridica Investments and Burford Capital.
- Working Group on Alt. Litig. Fin., ABA Commn. on Ethics 20/20, White Paper on Alternative Litigation Finance (Draft) 9 (Sept. 2011), www.americanbar.org/content/dam/aba/administrative/ethics_2020/
- See Garber, supra n. 1, at 15.
- Altitude Nines, LLC v. Deep Nines, Inc., No. 603268-2008E (N.Y. Sup. July 22, 2011).
- See Gary A. Rubin, The Trouble with TPLF, at 4 & n. 7 (paper presented at George Washington U. Alternative Litigation Financing Conference (May 2, 2012)), www.law.gwu.edu/News/20112012events/Documents/ALF%20Event%20Submissions/Rubin%20ALF%20Submission.pdf; see also Joe Mullin, Patent Litigation Weekly: How to Win $25 Million in a Patent Suit—and End up with a Whole Lot Less (Nov. 2, 2009), http://thepriorart.typepad.com/the_prior_art/2009/11/altitude-capital-partners-altitude-nines-v-deep-nines.html.
- Roger Parloff, Have You Got a Piece of This Lawsuit?, Fortune (June 13, 2011), http://features.blogs.fortune.cnn.com/2011/06/28/have-you-got-a-piece-of-this-lawsuit-2/.
- Id.; see Rubin, supra n. 14, at 4.
- See Parloff, supra n. 15.
- Working Group on Alt. Litig. Fin., supra n. 10.
- See id. at 4. The white paper discusses the applicable provisions of the ABA Model Rules of Professional Conduct (2009) including: Rule 1.6(a) (protected client information); Rule 1.7(a)(2) (representation materially limited by lawyer’s responsibilities to a third party or the lawyer’s own interests); Rule 1.8(e) (with limited exceptions, lawyers may not provide financial assistance to client); Rule 1.8(f) (lawyer must not accept compensation for representation from third party without informed consent of client and unless it will not interfere with independent professional judgment); Rule 1.8(i) (lawyers may not acquire proprietary interests on subject matter of representation); Rule 2.1(attorney must exercise independent professional judgment on behalf of a client); and Rule 5.4(c) (lawyer may not permit fee payor to direct or regulate lawyer’s professional judgment).
- See Taubman, supra n. 4, at 8–9.
- Id. at 10.
- See generally ABA Model R. 1.8.
- See ABA R. 1.8(a).
- See ABA R. 1.8(f).
- See ABA R. 1.8(e).
- Working Group on Alt. Litig. Fin., ABA White Paper, supra n. 10, at 21 n. 33; see also Gary Chodes, Alternative Litigation Funding 4, www.law.gwu.edu/News/20112012events/Documents/Chodes%20Submission.pdf.
- La. R. Prof. Conduct 1.8(e)(5)(v) (2006).
- Id. at 1.8(e)(5)(i).
- Id. at 1.8(e)(5)(iii).
- Id. at 1.8(e)(5)(iv). Limited financial assistance by lawyers to clients is permitted in the District of Columbia and Texas. See D.C. R. Prof. Conduct 1.8(d)(2) (2007); Tex. Disc. R. Prof. Conduct 1.08(d)(1) (2005) (cited at Working Group on Alternative Litigation Finance, supra n. 10, at 21 n. 33).
- See Me. Rev. Stat. Ann. tit. 9-A, §§12-101 to -107 (2007); Neb. Rev. Stat. §§25-3301 to -3309 (2010); Ohio Rev. Code Ann. §1349.55 (Lexis 2008).
- See Arthur E. Wilmarth, Jr., The Desirability of a Uniform Federal-State Regulatory Regime for Alternative Litigation Funding Contracts for Consumers, www.law.gwu.edu/News/20112012events/Documents/Wilmarth%20Submission.pdf.
- See Chodes, supra n. 26, at 3–4.
- The “Schumer Box” refers to a notice named after Sen. Charles E. Schumer of New York. Senator Schumer created the Schumer Box under a provision in the federal Truth-in-Lending Act, and it requires that credit card companies present the borrower with key facts and figures about the lending agreement in a clear and conspicuous manner.
- See Working Group on Alt. Litig. Fin., supra n. 10, at 13–14 (discussing arguments for and against the application of existing usury laws to consumer ALF). Notably, ALF lenders dispute the application of existing usury laws in that they deny that they are making loans.
- See Deborah R. Hensler, Notes on (Some of) the Effects of Alternative Litigation Financing on Large-Scale Litigation (May 2, 2012), www.law.gwu.edu/News/20112012events/Documents/ALF%20Event%20Submissions/Hensler%20ALF%20Submission.pdf.
- See Sean Coffey, Comments for GWU Law Panel on Alternative Litigation Finance 3–5 (May 2, 2012), www.law.gwu.edu/News/20112012events/Documents/ALF%20Event%20Submissions/Coffey%20ALF%20Submission.pdf; William B. Rubenstein, ALF in the Class Action Context—Some Initial Thoughts 1 (May 2, 2012), www.law.gwu.edu/News/20112012events/Documents/ALF%20Event%20Submissions/Rubenstein%20ALF%20Submission.pdf.
- See generally Coffey, supra n. 37.
- Remarks of Susan L. Martin at Alternative Litigation Funding Conference 1 (May 2, 2012), www.law.gwu.edu/News/20112012events/Documents/Martin%20Submission.pdf.