One of the most interesting and important recent litigation-related developments has been the rise of third-party litigation funding. An important part of this development has been the more or less general view that there is nothing improper about these kinds of arrangements and, in particular, that litigation funding does not represent improper champerty or maintenance, as long as the actual plaintiff continues to control the case. However, a recent decision from a Pennsylvania appellate court suggests that the somewhat unusual litigation funding arrangement involved in an attorney fee dispute was “champertous” and therefore invalid. This decision and another recent decision from Delaware (also discussed below) nullified the specific funding arrangements presented to the courts in those cases; the question is what these decisions may say about litigation funding in general.
The factual background and procedural history leading up to the recent Pennsylvania decision is as Alison Frankel notes in her October 5, 2016 post about the decision on her On the Case blog (here) “unbelievably complicated.” Suffice it to say that the dispute about the litigation funding arrangement arises out of an underlying lawsuit in which PDI sued Beyer. PDI hoped to recover over $100 million in the litigation, but they jury awarded only $12.5 million.
PDI wanted to appeal the jury verdict, but lacked funds, so it solicited and obtained litigation funding from third parties, in order to pursue the appeal. In the funding agreement, PDI increased the contingency fee of its lawyer (McKissock) from seven percent to one-third, with the further proviso that the litigation funders were to be repaid out of McKissock’s fee. The appellate court affirmed the trial court verdict and Beyer paid PDI a total of $14.4 million (representing the amount of the verdict plus interest).
PDI repaid the litigation funders out of the judgment fund, leaving insufficient funds to pay McKissock. McKissock sued the litigation investors to recover his fee. McKissock argued that his fee should have been considered a lien against the judgment fund so that he should have been paid first out of the funds, before the investors.
In a September 13, 2016 opinion by Judge John Bender for a unanimous three-judge panel of the Superior Court of Pennsylvania, the appellate court, in assessing the question of whether or not McKissock’s fee created a lien on the fund, concluded that the litigation funding agreement itself was “champertous” and therefore void and unenforceable by anyone.
The court noted first that “the common law doctrine of champerty remains a viable defense in Pennsylvania.” (“Champerty” occurs where an unconnected person seeks a share of the proceeds of litigation in exchange for funding that litigation.)
The defense of champerty in Pennsylvania has three elements: the party involved must be one who has no legitimate interest in the suit; the party must expend its own money in prosecuting the suit; and the party must be entitled by the bargain to share the proceeds of the suit.
The appellate court said, in consideration of the litigation funding arrangement on which McKissock relied to assert his lien on and priority rights in the judgment fund, said that “the requisite elements of champerty have all clearly been met.”
The litigation funders, the court said, are “completely unrelated parties who had no legitimate interest in” the underlying litigation. Instead, the litigation funders “loaned their own money simply to aid in the cost of the litigation, and in return, were promised to be paid ‘principal, interest, and incentive’ out of the proceeds of the litigation.” Accordingly, the court said, “we are constrained to conclude that the [funding agreement] is invalid.”
So what does the court’s holding mean for litigation funding in Pennsylvania? Does the court’s ruling, as Alison Frankel suggests in her blog post, “breathe some life into champerty law as it applies to litigation funding deals” in Pennsylvania?
On the one hand, the funding arrangement at issue in this case was both unusual and unusually complicated. The funding arrangement in this case was, as Frankel notes, “more complicated than ordinary litigation funding arrangements.”
On the other hand, the court’s finding here that the litigation funders are “unrelated parties who had no legitimate interest” in the litigation that they were funding is, as the Drug & Device Law Blog notes, “quite broad.”
The Pennsylvania Court is not the first court in recent times to consider a litigation funding agreement to be invalid. As noted here, in April 2016, the Irish High Court concluded that professional third party litigation funding arrangements give rise to impropriety which offend the maintenance and champerty rules.
As for whether litigation funders should be worried about this decision, Frankel quotes the counsel for one of the litigation investors involved in this case as saying the effect of this case “remains to be seen,” adding that there is not much precedent in Pennsylvania on champerty and litigation funding as it is practiced these days. So it is hard to tell what might happen next, but there could be more of this story yet to be told.
Delaware Chancery Court Rejects Litigation Funder’s Fee Application: Just days after the Pennsylvania court entered its opinion in the case noted above, Delaware Vice Chancellor Travis Laster entered an opinion denying the fee application of a litigation funder in yet another long-running legal battle. Laster’s September 19, 2016 opinion in Judy v. Preferred Communications Systems, Inc. can be found here.
The factual background and procedural history of the Delaware case is even more complicated than the Pennsylvania case. The specific issue before the court involved an application by Preferred Spectrum Investments (PSI) for a fee it claimed to have earned as a result of litigation it funded against Preferred Communication Systems Inc. (PCSI). PSI had been organized as part of an effort to take over PCSI. Among other things, PSI financed a series of legal claims against PCSI, including a books-and-records action; an action to compel a stockholders’ meeting; and an action challenging the authority of the individual then running PCSI. Eventually, PCSI’s board sold valuable telephone spectrum licenses it held for $60 million. PSI claimed that the sale was the result of the litigation it had funded and that it (PSI) was entitled to a $20 share of the $60 million proceeds.
In his September 19 opinion, Laster denied PSI’s fee application, on four grounds. First, Laster denied the application because PSI lacks standing, noting that PSI had not been the plaintiff or the plaintiff’s counsel in the underlying litigation, but rather “gratuitously financed litigation nominally being conducted by” the actual named plaintiff in the litigation. As a “volunteer financier,” PSI “cannot seek an equitable fee award.” Later referenced Delaware precedent that, Laster said, “universally assumes that only a litigant or its counsel has standing to seek a fee award.” In rejecting PSI’s contention that it should nevertheless receive a fee award on policy grounds, Laster noted that:
PSI could have entered an agreement with [the named plaintiff in the underlying litigation] that would have contemplated some form of repayment, including potentially a repayment that would be funded by a court-ordered fee award. Instead, PSI chose not to document its arrangement with [the named plaintiff] and to provide its financial backing as a gratuitous volunteer. Under the circumstances, PSI cannot now seek an equitable award of attorneys’ fees and expenses.
Laster also rejected the fee application on the grounds that PSI financed the litigation as part of an attempt to take over PCSI; Laster noted that the court has previously held that “parties cannot obtain an equitable fee award when they use litigation in support of a takeover.”
Additionally, Laster rejected the fee application because PSI cannot establish the necessary “causal connection” between its litigation financing and the value and sale of the telephone spectrum licenses. Finally, Laster rejected PSI’s contention that it was entitled to its requested fee on a quantum meruit basis.
The obvious lesson here is that if PSI hoped to secure a fee out of any eventual recovery, it should have put its fee agreement in writing. To that extent, at least, this opinion should have little impact on most litigation funding arrangements, which typically take the form of written agreements.
However, as noted in an October 5, 2016 post on the Delaware Business Litigation Report (here), the more troublesome aspect of this opinion has to do the language Laster used when considering PSI’s claim of entitlement to a percentage of telephone license sale proceeds. Among the reason Laster rejected the fee request is that PSI is “neither plaintiff nor plaintiff’s counsel.” Obviously, that is always going to be the case for a third-party litigation funder. As the blog post notes, “exactly how far that holding goes is important.”
As an example of the reasons that litigation funders might be concerned about this aspect of Laster’s opinion, the blog post references shareholder litigation, where the named plaintiff’s recovery might well be slight, while the overall recovery of the overall class of shareholders might be more substantial. If the litigation funder’s recovery is limited to the agreed-upon share of the recovery of its client – the named plaintiff – the litigation funder “will not lend in those circumstances.” Moreover, it is counsel that receives a fee award, not the client, and counsel may be prohibited by ethical considerations from splitting a fee. As the blog post notes, “The splitting of attorney fees with a nonlawyer is generally not permitted under the Rules of Professional Conduct.” Therefore, the recent Delaware decision “may effectively bar litigation funding in any case where the individual client is not going to recover his own, substantial damages.”
These two opinions present issues that arguably raise a caution for litigation funders. That said, however, it should be emphasized that each of these cases involved highly unusual circumstances. The litigation funding arrangements the courts were asked to review did not involve the more straightforward kinds of arrangements that are involved in the typical third-party funding structures that litigation funding firms put in place these days. Litigation funding firms may well conclude that because of the unusual circumstances involved these cases have little relevance for the more conventional arrangements that characterize litigation funding as it is currently put in place and carried out.
As far as Delaware goes, funding firms may well take comfort from the recent Delaware court decision (refer here) in which the court have held that more conventionally structured litigation funding agreement will not be found improper and do not violate prohibitions against champerty and maintenance.
The only question is whether some of the more open ended language that the courts used in these opinions could come into play if disputes were to arise in these jurisdictions over funding arrangements.