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FMG Law Blog Line

Archive for November, 2016

Third-Party Lending May be Bad Investment for Attorneys: Litigation Finance and Champerty Affect Validity of Fee Agreements and Ethical Duties

Posted on: November 1st, 2016

By: Meaghan Londergan

Once universally disfavored, litigation finance (funding of lawsuits through third-party lending) is now commonly used to pursue litigation against well-funded defendants. However, the longstanding doctrine of “champerty” in many states provides the defense bar with a mechanism to prevent the buying and selling of lawsuits by third parties. While many jurisdictions have repealed the champerty defense, where applicable, it can result in invalid fee agreements, ethical violations and potential malpractice actions.

            Relying on the “doctrine of “champerty,” the Superior Court of Pennsylvania recently held invalid a contingency fee agreement between Bruce McKissock—an attorney at Marshall, Dehenney, Coggin & Werner—and Polymer Dynamics, Inc. (“PDI”). In 1999, McKissock—then of McKissock & Hoffman—represented PDI in a suit against Bayer Corporation in the Eastern District Court of Pennsylvania. The jury returned a verdict of $12.5 million against Bayer. In 2008, PDI and McKissock entered into a new fee agreement increasing his contingency fee to 33% and appealed to the Third Circuit. Because PDI could not afford to appeal, a third party, Litigation Fund Investors, funded the litigation in exchange for principal paid out of McKissock’s 33% contingency fee. The Third Circuit affirmed the lower court’s verdict.

            After Investors were paid out of McKissock’s fee, insufficient funds were left to pay McKissock. McKissock filed claims against the Investors in the Superior Court of Pennsylvania alleging he had a lien on the recovery funds pursuant to the fee agreement. The Court denied his claims, holding the 2008 Fee Agreement was champertous and unenforceable. In Pennsylvania, a fee agreement is invalid if: (1) an investor has no legitimate interest in a suit; (2) the investor gives money to carry out the suit; and (3) the investor is entitled to a share of the proceeds. A loan is valid if an investor has no expectation of benefiting from the litigation proceeds. Unlawful litigation finance agreements have financial and ethical implications for attorneys.

            How a state applies the champerty defense determines what agreements are enforceable and what ethical implications exist. While investors want to be informed about the lawsuit, attorneys must not waive attorney/client privilege without informed consent. Some states require an attorney to disclose this risk before entering into a litigation finance agreement. Further, litigation finance must not affect the duty owed to a client or influence a lawyer’s professional judgment.

            The Superior Court’s recent decision shows that regulation of litigation finance is alive and well in Pennsylvania. Fee agreements that involve champerty may be deemed invalid, and attorneys must always recognize privilege and duty concerns when addressing third-party financing.