One of the important factors behind the recent rise of third-party litigation financing has been the view in many jurisdictions that litigation finance does not violate ancient prohibitions against “champerty” – that is, the investment by an uninvolved third-party in a lawsuit with the intent of sharing in any recovery. As I discussed in a recent post, the general view is that litigation funding arrangements are not champertous as long as the plaintiff continues to control the litigation.
However, in a recent decision, the New York Court of Appeals (the state’s highest court) held that a financial transaction in which the plaintiff had purchased securities for the purpose of filing suit violated New York’s champerty statute. The Court also ruled that the transaction did not come within the statutory safe harbor for larger financial transactions. The appellate court’s ruling on the champerty issue is interesting, but its discussion of the safe harbor provisions – which likely would protect most conventional litigation finance arrangements – may be the more significant part of the court’s decision.
The New York Court of Appeals’ October 27, 2016 opinion in Justinian Capital SPC v. WestLB AG can be found here. Alison Frankel’s October 28, 2016 Reuters article about the decision can be found here.
In 2003, nonparty DPAG purchased securities from two special purpose entities sponsored and managed by WestLB. By 2008, the securities had lost most of their value. DPAG considered suing WestLB, but for various reasons concluded it could not do so in its own name. DPAG sold the notes to Justinian in an agreement that stated that Justinian would pay DPAG $1 million; however, Justinian did not pay the $1 million. Rather the understanding is that Justinian would pay the $ 1 million (and other consideration) out of any recovery in the lawsuit.
Days after acquiring the Notes, Justinian sued WestLB. WestLB filed a motion for summary judgment, arguing that Justinian’s purchase of the securities violated New York’s statutory provisions prohibiting champerty. WestLB also argued that the transaction did not come within the statute’s safe harbor for larger transactions because Justinian had not actually paid the $1 million purchase price. The trial court granted WestLB’s summary judgment motion, and an intermediate appellate court affirmed the ruling. Justinan appealed.
New York’s champerty doctrine is codified in Judiciary Law Section 489, which restricts individuals and companies from purchasing or taking an assignment of notes or other securities “with the intent and for the purpose of bringing an action or proceeding thereon.”
Subsection 2 of the statute provides a safe harbor, which exempts the purchase or assignment of notes or other securities from the restrictions of Section 489 when the notes or other securities “have an aggregate purchase price of at least five hundred thousand dollars.”
The October 27, 2016 Opinion
In an October 27, 2016 opinion written by Chief Judge Janet DiFiore for a 5-2 majority, the Court of Appeals affirmed the lower courts’ rulings, holding that Justinian’s purchase of the securities violated New York’s statutory prohibition on champerty, and that the transaction did not come within the statute’s safe harbor provisions.
In concluding that the transaction violated the statutory prohibition, the court noted that there was no evidence that Justinian’s acquisition of the securities was for any purpose other than the lawsuit it commenced shortly after acquiring the securities. The lawsuit, the court said, “was not merely an incidental or secondary purpose of the assignment, but its very essence.” Because Justinian’s sole purpose in acquiring the notes was to bring the lawsuit, “its acquisition was champertous.”
In concluding that the transaction did not come within the safe harbor for transactions having an “aggregate purchase price” over $500,000, the court said that because the $1 million purchase price listed in the transaction documents “was not a binding and bona fide obligation to pay the purchase price other than from the proceeds of the lawsuit,” Justinian’s acquisition of the securities satisfy the safe harbor’s requirements.
The majority opinion’s discussion of the safe harbor issues includes a lengthy discussion of the statute’s legislative history and of the purposes of the safe harbor provision. The court noted that New York has long been “a leading commercial center,” and that the state’s statutes and jurisprudence have “greatly enhanced New York’s leadership as the center of commercial litigation.” The safe harbor, the majority opinion states , “was enacted to exempt large-scale commercial transactions in New York’s debt-trading markets from the champerty statute in order to facilitate the fluidity of transactions in these markets.”
The court went on to note that in setting the $500,000 purchase price requirement for the safe harbor, the legislature “took comfort that buyers of claims would not invest large sums of money to pursue litigation unless the buyers believed in the value of their investments.” This comfort is lost if payment is contingent on the outcome of a lawsuit, as that would permit purchasers “to receive the protection of the safe harbor without bearing any risk or having any ‘skin in the game,’ as the legislature intended.”
Two justices dissented, arguing that the majority’s reasoning depending on reaching conclusions about the intent and motivation of the parties to the underlying transaction, which, the dissent said, are not issues that appropriately can be decided at the summary judgment stage.
As Alison Frankel noted in her Reuters article, the Court’s reading of the champerty statute and its conclusion that the transaction at issue was champertous certainly “sounds ominous” for litigation funders and distressed debt investors.
However, the New York’s court’s ruling, consistent with the provisions of the statute, is of greatest significance with respect to smaller financial transactions. As long as the transaction meets the safe harbor dollar value threshold, and the transaction involves a bona fide commitment to pay the purchase price, the transaction will not violate the statutory prohibitions on champerty.
So while the court’s ruled that the transaction at issue in this case violated the statute, the court’s decision, and in particular its discussion of the statutory safe harbor provision, are likely of some comfort to, or at least not troublesome to, larger, more-conventional third-party litigation funding firms.
Indeed, in an October 28, 2016 blog post on his company’s website (here), Chris Bogart, the CEO of the Burford Capital litigation funding firm, said that the case stands for the proposition that the doctrine of champerty “has no application whatsoever in New York when a payment or investment exceeds $500,000” – as, Bogart noted, “is the case with all of Burford’s investments.”
In her Reuters article about the case, Frankel quotes West LB’s lawyer as saying that the court’s ruling reflected the judges’ skepticism about this particular deal and won’t affect well-capitalized litigation funders who qualify for the safe harbor. The lawyer went on to note that if the decision affects litigation finance at all, it will be the smaller players that can’t commit $500,000 that will be affected.
Bogart also noted in his blog post that the transaction at issue in this case was far different than what is typically involved in conventional litigation finance. Justinian didn’t just finance the litigation, but it took over the claims and filed the lawsuit in its own name. Even that, Bogart noted, would have been O.K. under the statute, if Justinian had actually paid the purchase price.
Bogart said that the Court, in its comments about the legislature wanting investors to have “skin in the game,” recognized that “commercial funders are not interested in bringing frivolous litigation.” The decision, Bogart said, “reaffirms New York’s support of significant litigation finance.” He added that the dissent had gone even further and had lauded litigation financiers as “fostering accountability in commercial dealings.” He also said that Burford, which had appeared in the case as amicus curiae, was “pleased” with the court’s “reaffirmation of New York as a leading jurisdiction for litigation finance transactions.”
(How about that, in response to a court ruling in which the transaction at issue was found to be champertous?)
For a recent post in which I discuss a decision earlier this month by a Pennsylvania court, applying Pennsylvania law and holding an unusual litigation funding arrangement to be champertous, refer here.
My August 2016 interview of Chris Bogart of Burford Capital can be found here.