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By Gabriel Canto and Sharlynne M. Mate
Third-party litigation financing is the practice of obtaining litigation financing through a third-party financial institution (i.e. “the financier”). Although there is no universally accepted definition of third-party litigation finance, such agreements share several common traits: (1) a cash advance; (2) made by a non-party; (3) in exchange for a share of the litigation or arbitration proceeds; (4) whether in settlement or judgment or award; and (5) payable at the time of recovery if, and only if, such recovery takes place.1
It is most utilized by the plaintiff’s bar to prevent a plaintiff’s firm from incurring and maintaining significant litigation costs, which would normally be recovered by the firm after a case is settled or upon obtaining a successful verdict and recovery. If there is no recovery, the firm would not recover those case expenses. Looking to limit their exposure, many plaintiff’s firms have instead moved to a model where a third-party financial institution finances the litigation expenses. The financier loans the money to the litigant for the life of the lawsuit at an agreed rate of interest. If the case is successful, the financier recovers its contribution with interest. If the case is not successful, the financier typically foregoes any recovery. The practice is essentially a risk mitigation tool for plaintiff’s firms to spread the risk of no recovery to their clients who receive financing at the price of interest.
The arrangement between the financier, plaintiff, and counsel is wrought with ethical pitfalls. For example, the financier may seek a right to make decisions on the claim such as whether or not to accept a settlement, implicating Model Rule of Professional Conduct Rule 5.4: Professional Independence of a Lawyer.2 The financier may require counsel to stipulate to the merits of the claim, which resembles the type of guarantee of outcome barred by Rule 7.1.3
At common-law, third-party litigation financing was barred by the doctrines of maintenance, champerty, and barratry. Most jurisdictions have relaxed these prohibitions, and a few have created regulatory schemes to monitor the practice on the theory that third-party financing gives more individuals access to the courthouse. The most common measure to ensure accountability on the third-party financing practice is the requirement that financing arrangement be disclosed. There is a clear judicial trend towards automatic disclosure of third-party litigation financiers.
Disclosure of third-party litigation financiers is not required under the Federal Rules of Civil Procedure nor in the Rules of all but two states. However, many federal districts and state courts have incorporated the automatic disclosure of third-party litigation financiers by standing order or local rules.
For example, the Northern District of Texas Local Rule 3.1(c) requires that a plaintiff’s electronically filed complaint must be accompanied by a “signed certificate of interested persons… that contains… a complete list of all persons, associations of persons, firms, partnerships, corporations, guarantors, insurers, affiliates, parent or subsidiary corporations, or other legal entities that are financially interested in the outcome of the case.” The “financially interested in the outcome of the case” language encompasses third-party litigation financiers. Note this is an automatic disclosure requirement without the need of a request from the opposing party.
Another example would be the Central District of California Local Rule 7.1-1, which requires that “[a]ll non-governmental parties shall file with their first appearance a Notice of Interested Parties, which shall list all persons, associations of persons, firms, partnerships, and corporations . . . that may have a pecuniary interest in the outcome of the case . . .” This, too, is a required disclosure that does not require a request from another party.
As of April 1, 2023, the following federal districts had similar local rules: Delaware, New Jersey, Arizona, Northern District of California, Middle District of Florida, Northern District of Georgia, Southern District of Georgia, Northern District of Iowa, Southern District of Iowa, Maryland, Eastern District of Michigan, Western District of Michigan, Nebraska, Nevada, Eastern District of North Carolina, Middle District of North Carolina, Western District of North Carolina, Eastern District of Oklahoma, Northern District of Oklahoma, Western District of Oklahoma, Middle District of Tennessee, Western District of Texas, Western District of Virginia, and Western District of Wisconsin. It’s fair to assume that a growing number of federal districts will expand their own local rules to require automatic disclosure.
At the Circuit level, the Third, Fourth, Fifth, Tenth, and Eleventh Circuits also have disclosure rules of their own for parties to an appeal.
Two states have issued similar rules for their state courts: West Virginia and Wisconsin.4 A few more states have devised regulatory schemes for third-party litigation funding: Maine, Utah, and Oklahoma.5
As automatic disclosure is also likely to expand, practitioners in each state would be prudent to revisit the local requirements in their jurisdictions.
Lastly, practitioners in some states may obtain discovery on the financiers (beyond their mere involvement in a case). For example, District Courts in the Northern District of Ohio and Southern District of Florida have issued recent opinions requiring disclosure of financiers in multidistrict litigation cases based on unique facts presented in those matters.6
Defense counsel should monitor changes in disclosure requirements and, where applicable, evaluate whether requesting additional discovery on third-party litigation financing agreements would serve their clients.
1 See Bernardo M. Cremades Roman Jr., Usury an Other Defenses in U.S. Litigation Finance, (2014) 23 Kan. J.L. & Pub. Poly 151, 152.
2 Model Rule of Professional Conduct Rule 5.4: Professional Independence of a Lawyer states, in pertinent part: . . .(b) A lawyer shall not form a partnership with a nonlawyer if any of the activities of the partnership consist the practice of law. (c) A lawyer shall not permit a person who recommends, employs, or pays the lawyer to render legal services for another to direct or regulate a lawyer’s professional judgment in rendering such legal services. . .
3 “A lawyer shall not make a false or misleading communication about the lawyer or the lawyer’s services. A communication is false or misleading if it contains a material misrepresentation of fact or law, or omits a fact necessary to make the statement considered as a whole not materially misleading.”
4 W. Va. Code Ann. § 46A-6N-6 (2019); Wis. Code § 804.01(2)(bg) (2018).
5 See Me. Rev. Stat. Ann, tit, 9-A, §§ 12-101 et seq. (2021); Utah Code Ann. §§ 13-57-101 et seq. (2020) 14A Okla. Stat. §§ 3-801 et seq. (2014).
6 In re Nat’l Prescription Opiate Litig., 2018 WL 2127807 at *1 (N.D. Ohio May 7, 2018); In re Zantac (Ranitidine) Prods. Liab. Litig., 2020 WL 1669444, at *5-6 (S.D. Fla. Apr. 3, 2020).
For more information, please contact Texas attorney Gabriel Canto at [email protected], California attorney Sharlynne M. Mate at [email protected], or your local FMG attorney.