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ABA's new guidance on litigation funding misses the mark

  • Andrew Cohen
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Andrew Cohen

Andrew Cohen


Former Litigator, Debevoise & Plimpton

At its annual meeting on Monday, the American Bar Association's House of Delegates voted to approve the ABA's best practices for third-party litigation funding.1

The ABA is right to educate lawyers about the use of third-party litigation funding, and has sought to provide best practices in the past. In 2012, my firm welcomed the opportunity to share our comments ahead of the publication of the ABA's Commission on Ethics 20/20 report on what was then called alternative litigation finance.

Unfortunately, the ABA's new best practices were drafted without a similar opportunity for comment and with the glaring omission of commercial legal finance providers. Not surprisingly, the resulting best practices do not reflect how legal finance actually works and could create confusion among lawyers considering it—the opposite of what was intended.

The ABA should take additional time to allow for public comment on and revision of the best practices. Although the best practices recommendations are not intended as the basis for discipline, it is important that they not to misinform or confuse lawyers in the ABA's name.

Specifically, the best practices should be revised to address the following:

1. Provide important context.

The best practices should make two important points that would help the ABA's members understand legal finance.

First, legal finance has been permitted and endorsed in many American states since they separated from England. Rulings in various state and federal courts suggest that laws concerning champerty, maintenance and barratry are outmoded. Barriers to consumer legal finance recently imposed by a limited number of states do not apply to commercial legal finance. Most other states either never adopted champerty prohibitions or have explicitly abolished their champerty rules.

Second, liability insurers' control of their insureds' defense counsel raises issues applicable to—and more severe than—those dealt with in the best practices. Liability insurers' policies permit them to take complete control of litigation—hiring and directing the conduct of attorneys. The success by the bar and the courts in responding to those issues is important to acknowledge.

2. Deal with two different industries separately.

The ABA attempts to provide a single set of best practices for the funding of disputes between commercial entities and consumer litigation funding, in which funding companies provide individual lawsuit loans to people with personal injury or other individual claims. These are entirely different practices.

Commercial legal finance companies provide multimillion-dollar nonrecourse investments to companies and law firms represented by world-class counsel. Consumer litigation funders make small-dollar cash provisions to individuals in economic distress who may not be experienced in or savvy about negotiating legal transactions. It is as illogical to treat them in the same document as it would be to offer a single set of best practices to cover both investment banking and payday lending.

For example, commercial litigation funders work with clients who typically have internal or external corporate counsel. Consumer litigation funders' clients do not, and as a result, may ask their litigation attorneys for advice on obtaining litigation funding, or on particular contract terms. The ABA best practices should address in what circumstances, if any, it is appropriate for the individual's lawyer to give such advice.

Another example of differentiation is in case management and strategic decision making. While neither consumer nor commercial litigation funders take control of litigation, sophisticated clients accessing commercial litigation funding are far more likely to welcome active monitoring by funders. Consumer litigation funders will seldom, if ever, give an opinion about a strategic decision to be made in the litigation.

In turn, the appropriate attitude lawyers should take to funder contact will depend on whether it is commercial or consumer funding. The ABA best practices do not address this nuance, including how litigation attorneys should deal with strategic input coming from their client, informed by a commercial litigation funder.

3. Clarify client-directed versus lawyer-directed funding.

Section III of the ABA best practices divides legal finance into client-directed and lawyer-directed funding arrangements, but by placing lawyer-directed arrangements first, misrepresents the relative significance of these funding scenarios. Client-directed arrangements have been the clear focus of legal opinions, ethics opinions and capital in connection to legal finance over the past two decades.

Further, while Section III starts off by dividing the world into lawyer-directed and client-directed funding arrangements, the subdivisions within those sections do not follow logically. For example, single-case commercial litigation finance can be done directly with the claimant or with the lawyer. Portfolio funding, too, can be done with a single client or with a law firm. And of course, law firms that practice international arbitration can take funding.

The ABA's mischaracterization of these types of funding as exclusively client-directed is confusing, and the resulting guidance does not appropriately address the situations that arise in lawyer-directed funding. By way of example, a law firm seeking financing across a portfolio of representations must consider what level of client notice is required, if any, and whether advance waivers in standard engagement agreements describing the nature of disclosures to potential creditors suffice to provide that notice.

4. Remove or revise references to a much-criticized 2018 nonbinding advisory opinion by the New York City Bar Association.

Several paragraphs in the ABA best practices are devoted to a nonbinding advisory opinion issued by the New York City Bar Association's Committee on Professional Ethics in 2018 that argued that legal finance provided to law firms constitutes fee-splitting. When that opinion was released in August 2018, it immediately drew criticism from legal scholars and practitioners for its failure to properly account for New York case law and its lack of engagement with overwhelming judicial rejection of its basic premise. The opinion was also criticized for the failure of the committee either to take public comment or enlist participation by users or providers of legal finance. 

Acknowledging as much, following the publication of the nonbinding opinion in the summer of 2018 and the resulting public criticism, the New York City Bar Association formed a working group on litigation funding involving in-house and law firm lawyers, academics and legal finance providers, which spent some 18 months preparing a report to which it invited public comment before ultimately walking back the controversial nonbinding opinion.

While acknowledging that the 2018 opinion drew criticism, the ABA's new best practices create the impression that fee-splitting is an open issue for lawyers considering using legal finance and does not sufficiently emphasize that the nonbinding opinion carries negligible weight, even in New York.

As noted, the 2018 opinion broke from substantial case law precedent and the overwhelming opinion of legal scholars and ethicists. Legal ethics scholars rejected the New York City Bar Association's argument, noting that the reasoning of the nonbinding opinion would restrict not only nonrecourse legal finance but also traditional recourse loans provided to law firms by financial institutions, which give creditors broad control over law firms' legal budgets, and on which many law firms rely.

Notably, the New York City Bar Association acknowledged that the 2018 opinion had taken an opposing view to the New York courts, which have uniformly accepted and enforced precisely the kinds of nonrecourse financing arrangements that the opinion addresses. For these reasons, we would leave the nonbinding advisory opinion out of the ABA best practices entirely, or at least provide a more accurate rendering of that opinion. 

5. Provide an accurate picture of privilege and work product.

The section of the ABA best practices that addresses privilege and work product is based on the International Council for Commercial Arbitration-Queen Mary task force report on third-party funding in international arbitration that has limited applicability to U.S. litigation. 

In particular, the description of work-product protection is woefully inadequate and suggests that it is just as waivable as attorney-client privilege. In fact, materials created for and provided to a potential financier as a consequence of litigation are generally protected under the work-product doctrine in the U.S., particularly when there is an existing confidentiality obligation, such as a nondisclosure agreement, in place. 

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.

6. Refine or remove recommendations that do not serve lawyers or clients well.

While some of the ABA's high-level best practice recommendations are appropriate and already practiced by many providers of legal finance—including the need for written agreements and for assurance that the client remains in control of the case—others require some refining or do not serve lawyers or clients well as a practical matter. Consider the following four examples:

First, the ABA is right to recommend that written agreements should address what happens to the funding arrangement if, down the road, the client and the funder disagree on litigation strategy or goals—but its recommendations as to termination do not apply to monetization arrangements, in which the funder advances cash ahead of a claim resolution, as distinct from traditional fees and expenses funding, in which the funder pays the costs of the litigation as they are incurred. This distinction merits clarification. 

Second, the ABA best practices incorrectly assert that lawyers and clients seeking funding should make no representations, and that funders should disclaim reliance on any such representations; instead, the best practice is to limit funders' reliance on opinions provided by counsel but still have clients represent to the accuracy of documents and information provided.

Third, the ABA best practices wrongly imply that a funder's ability to have oversight of litigation expenses is part and parcel of controlling litigation decision making or unduly influencing case management and "can be problematic." In fact, lawyers should be highly suspicious of any funder willing to provide capital on a nonrecourse basis that does not require regular reporting on budgets and case developments. Funders providing litigation fees and expenses work with their clients to monitor ongoing expenses against budgets, to ensure that there continues to be enough available financing to see the litigation through,
especially when unexpected costs arise in the litigation. 

Fourth, there is insufficient consideration of issues relating to a lawyer's professional responsibility, with only two pages dedicated to the topic. These issues should either be examined in greater detail and with more context to the reader or left out so as not to create undue concern. By way of comparison, the report of the New York City Bar Association's working group on litigation funding spent 10 pages on guidelines for New York lawyers, covering many ethical issues.

Make no mistake: The ABA is right to devote its expertise to developing and publishing best practices for legal finance—especially now, given the economic pressures that all businesses and their law firms face. But true best practices require the participation of experts—and we urge the ABA to invite providers and users of legal finance to weigh in.

[1] https://www.americanbar.org/content/dam/aba/administrative/news/2020/08/2020-am-resolutions/111a.pdf.


This article was originally published in Law360 and can be read here.