Last month, this blog provided an overview of litigation funding, and identified a number of issues which we planned to cover over the next several months. This month’s installment focuses on the legality of litigation funding.
A Refresher on Litigation Finance
Although the terms will differ depending on the lender and the circumstances, generally speaking a litigation funder provides a non-recourse loan to a law firm or client in exchange for an interest in the outcome of the case.
Are Litigation Finance Agreements Legal?
It depends on the jurisdiction. Some states recognize a doctrine called champerty, which prohibits a third party from financially backing a party in litigation against another party. Other states, including Texas, have never recognized the doctrine. Other states recognize the doctrine of champerty, but have found litigation finance agreements enforceable. And still others, such as Ohio, have legislatively regulated litigation financing transactions. On the other end of the spectrum, litigation financing agreements have been invalidated in Kentucky and Pennsylvania.
These laws are pretty clear cut when it comes to a client seeking litigation funding for a case in its own jurisdiction. But what happens when a client who is located in a state where litigation finance is legal (such as New York) needs funding to bring a lawsuit in Pennsylvania? That apparently remains an interesting open question. Litigation finance companies will likely argue that the legality of the transaction should be determined based on the governing law of the agreement, or by where the parties are located and where the funder’s performance under the contract took place. Those arguments make more sense than exposing clients (or attorneys) and funders to the possibility that a litigation finance agreement will be voided if the case is litigated in a state prohibiting such agreements, especially if the case is transferred into that prohibited jurisdiction after filing. Under that analysis, the opposite corollary would also apply: litigation funders should not be able to fund a client based in a state that prohibits litigation finance (such as Alabama) for a lawsuit that will be brought in a state where litigation finance is legal (such as Florida).
Tilting the Scales in Your Favor
Reputable litigation finance companies are well aware of each state’s regulation. One of the first questions they likely will ask you is where are you or your client located. But, in case they do not, it is best to confirm whether any litigation finance agreement is legal in your jurisdiction before spending the time seeking funding.
Next month, we will discuss potential ethical concerns for lawyers that arise from litigation funding, and whether those concerns have any validity.