Litigation Finance: What Do Judges Need to Know?

Article excerpt

In any future case in this district such an agreement must be revealed to the court and members of the class as soon as possible. A "sunshine" rule is essential to protect the interests of the public, the class, and the honor of the legal profession.1

In our classic image of an American lawsuit, including class actions, the plaintiffs lawyer pays the upfront costs and then hopes to recoup them from a share of the winnings. But today, this picture is incomplete. It is no longer only the law firm's own war chest that finances a case - so can outside investors and lenders.2 As Judge Hellerstein has just reminded us, the 9/11 cases he presided over involved such third-party financing.3 The Ecuadorian plaintiffs' environmental case against Chevron, now pending in the Southern District of New York, is another prominent example in the news.4

Although such investments are usually confidential, the use of "alternative litigation financing" or "third-party litigation funding" in the United States appears to be growing.5 Specialty firms are multiplying.6 Hedge funds and major banks are also getting involved.7 Credit Suisse, for instance, recently spun off its "litigation risk strategies" division into a standalone litigation financing firm.8 And Citigroup backed Counsel Financial, the lender in Judge Hellerstein's 9/11 cases.9 The structure of the financing is also becoming more creative; ideas are crossing over from Great Britain and Australia, where third-party litigation funding has a longer history.10 A variety of schemes, including some so-called "loans" that are in effect equity stakes in the outcomes of the case, are already in use.

How might such outside financing affect the governance of mass litigation? Consider the familiar worry about potential conflicts of interest between plaintiffs and their attorneys, under typical contingency fee arrangements. To this already difficult problem of ethics and incentives, third-party litigation financing adds a further dimension: it adds (yes) a third party.11 In academic parlance, it complicates the principal-agent problem by adding a new principal.12 Most obviously, if banks and hedge funds have interests at stake, they may well want some say in how the litigation is run, or in how and when it ends. And it is easy to imagine other distortions in litigation governance, perhaps affecting the selection of counsel or the choice to bring suit in the first place.

One premise of today's dialogue (as Judge Weinstein's remarks emphasize) is that judges can and should take measures to reduce such distortions or even to resolve the conflicts of interest creating them. This is an especially sensible and widely accepted premise in class actions. Judges are given a formal set of useful tools - and obligations - for addressing conflicting interests in class actions, at least under the federal rules: not only must judges assess the adequacy of representation in deciding whether to certify a class, under Rule 23(a); but they are also tasked with selecting class counsel under Rule 23(g). Moreover, class wide settlements must meet judicial approval, under Rule 23(e), and the terms to be approved include those allocating costs and attorneys' fees. Sharp observers have started to warn that "nontraditional third-party funding for class actions . . . might raise new issues pertaining to adequacy of representation, appointment of class counsel, settlements, and legal fees."13 In light of Rule 23, such an observation not only points to potential concerns but also reminds us of the safeguards already at hand.

To use such tools most effectively, judges will need to understand how outside financing might press against (or in favor of) the plaintiffs' interests in any given case. And the earlier the financing structure is understood, the better; as the Second Circuit observed, in disapproving the co-counsel financing scheme in the Agent Orange cases:

[I]n all future class actions counsel must inform the court of the existence of a fee sharing agreement at the time it is formulated. …