Why Alternative Litigation Financing Is Poised to Disrupt Litigation

In April 2016, an independent state university school newspaper, the Kentucky Kernel, made an Open Records Act demand on the University of Kentucky, seeking documents related to allegations of sexual harassment by a tenured faculty member. The university denied most of the request, but the Kernel sought and obtained a state attorney general opinion that vindicated its position and opined that the university should turn over the requested records. The university then promptly sued the Kernel, seeking a ruling that the AG was wrong.

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The Kernel, as an independent student-run newspaper, had no readily available financial means to pay a lawyer to defend the lawsuit and assert its position that that records were covered by the state Open Records Act. In days past, this would mean it could not continue defending the suit and an important public issue would be resolved by default, leaving the university unchallenged. (Somewhat ironically, the Kernel, shortly after the AG reached his decision, obtained the records from a “confidential source”).

But the Kernel raised funds via GoFundMe to allow it to hire and pay a lawyer. So the playing field between a well-heeled party and one with few resources was, if not leveled, at least tilted more toward plumb. And an important public issue—whether the public interest in the underlying issues overshadows privacy interests—could be decided by the judiciary rather than by financial constraints on one of the interested parties.

Another perhaps better-known example of alternative litigation funding was the bankrolling by Peter Thiel of the litigation by the ex-pro wrestler Hulk Hogan against Gawker. Of course, a key difference with Hulk’s situation was that Thiel presumably received a financial return on his investment while the participants in the GoFundMe Kernel project did not.

But in both examples, the result was the ability of claimant to pursue litigation through alternative litigation funding (ALF), when otherwise they might have not have been able to do so. And given the ability to leverage a charitable interest in the Kentucky Kernel case and a pecuniary interest in the Hulk Hogan lawsuit, use of litigation funding devices will continue to grow, increasing the access to justice.

How It Works

Here’s how alternative litigation funding works: A fund is created and donations or investments are sought to advance money to a law firm or party in return for some agreed-to percentage of return via verdict or settlement or, in the case of charitable donations, to achieve some social-justice-related cause. By using the internet and social media, information about the case and the players, the forum and the judiciary can be easily obtained, informed decisions about the cause or potential return can be made, and funding often relatively easily achieved.

In years past, ALF was referred to as champerty, and was not allowed or at least disfavored. See the Wikipedia entry for “Champerty and Maintenance.” In more recent times, however, this disfavor has itself become disfavored. NAACP v. Button, for example, held in 1963 that the concepts could not be used to chill rights of free speech. More recently, a federal court in Miller UK Ltd. et al v. Caterpillar, Inc., No 1:2010cv03770-Document 470 (N.D. Ill. 2014) held “…there was no intermeddling by the funder in the sense contemplated by the [Illinois champerty} statute. The funder was sought out by a cash-starved litigant embroiled in bitterly contested litigation.” The result was that UK Ltd. ultimately obtained a jury verdict of $73.6 million against Caterpillar for its alleged trade secrets violations, a result unlikely but for the ALF.

The ABA has also weighed in on the erosion of concepts designed to discourage litigation funding. In its Commission on Ethics 20/20 White Paper in February 2012, the ABA opined that “shifts away from older legal doctrines such as champerty, and society’s embracing of credit as a financial tool have paved the way for a litigation financing industry that appears poised to continue to grow…”

Now, with the rise of the internet and apps, finding and putting together ALF deals is easier and the participants more diverse. ALF is exploding. Buford Capitol, a leading litigation financing firm, has estimated that 28% of law firms used ALF in 2015 versus 13% in 2013, a four-fold increase. Startups and even some not-so-startups are also rushing into the field:

  • Mighty (funded over $5.25 million last year)
  • LexShares (devotes blog to the practice)
  • Grecian Keller (claims to be world’s largest provider)
  • Legalist (claims to have created algorithm to predict outcome).

A Google search of litigation funding and GoFundMe reveals numerous instances of pure charitable crowdfunding being used as a vehicle to fund litigation, particularly where important public interests are at stake.

Litigation Disruption

Why is this important and so potentially disruptive? Historically, well-heeled parties had certain and inevitable advantages in litigation. They could hire the best lawyers and experts, and then grind the less well-off party into submission both because of a lack of resources and cash flow issues.

Granted, in certain catastrophic or high-value cases, particularly in the personal injury context, there were and are plaintiff law firms with the financial wherewithal to go toe-to-toe with richer defendants and wait it out. But in less-glamorous cases and in claims involving small businesses, this litigation dynamic would either force a settlement that was perhaps less than what it could be otherwise, or result in the claim not being brought at all.

But as the Hulk Hogan, UK Ltd. and even Kentucky Kernel litigation shows, the internet and ALF has enabled this advantage to be successfully overcome. The result will be increased litigation and better access to justice by those who have historically been frozen out.

But criticisms certainly exist. Unlike plaintiffs’ lawyers who take a percentage of recovery as fees, the litigation investors and funders are not regulated, and unlike the lawyer, owe no fiduciary duty to the client. Often, a client has other interests than purely immediate financial gain. Plus, the ultimate payment to plaintiff will be reduced even further by the return owed the funder. And while nothing per se is unfair about that, it could result in unscrupulous lawyers bringing claims that might not otherwise be brought, and in claimants demanding more in return to be “made whole” than otherwise (some funders seek up to 50% of the final judgment or settlement. When combined with a lawyer’s contingency fee of one-third of the recovery, that leaves precious little for the victim). It was these concerns that in part led to the practice being outlawed to begin with.

The funding side has concerns as well. Where funders donate without the expectation of return, there is less risk for the litigating party but much more risk for the contributor. Contributors have no control over where and how the funds are spent or the lawyers doing the work, leaving an arena ripe for taking advantage.

But lawyers have been managing through these concerns on the defense side for years. Insurance companies often pay defense costs, but may have different financial interests than their insureds. Claims are policed not so much by the carrier or regulation, but by the lawyer with the duty to look out for the best interests of his client, not the carrier. Insurance defense lawyers often walk the tightrope between the competing interests of those that fund the litigation and those that are actively involved in it. While that relationship is not without its bumps, it by and large works effectively. So can ALF.

Lawyer Responsibility

As the ABA Commission realized in its 20/20 White Paper,”[this]Report should not be interpreted as suggesting alternative litigation finance raises novel professional responsibilities, since many of the same issues…arise whenever a third party has a financial interest in the outcome of the client’s litigation. A lawyer must always exercise independent professional judgment on behalf of a client… “

The bar will continue to play a significant role here, in policing lawyer conduct. At the end of the day, it is the lawyer who is ultimately responsible for abuses. It is the lawyer that owes the fiduciary duty to the client to be responsible and represent the client’s—not the investor’s or contributor’s—interests. That’s is the lawyer’s ultimate duty.

This is not to advocate the superiority of lawyers over other professionals. ALF funders and investors, like many other legal service providers, play a key role. But efforts to force regulation on them is wrongly directed, and may even be irresponsible for the legal profession. It is the lawyer with the client relationship, and the lawyer who must look out for the client.

Balanced against the risks is the upside. In a world where over 60% of small businesses who experienced a legal event in the past two years report not hiring a lawyer (LegalShield Survey Report ), where 80% of the legal needs of the poor and middle class go unmet (See Legal Service Report)and where some 40% of law school graduates can’t find full time jobs (ABA 2015 Report) anything that tears down barriers to justice and allows an underserved population to be served may be worth the risk.

And like many technological enabled disruptions, this one is here to stay.

About the Author

EmbryStephen E. Embry is a member of Frost Brown Todd LLC, and is a member of the Law Practice Today Editorial Board.

 

 

 

(Feature Image Credit: ShutterStock)

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