January 25, 2017 article

Litigation Funding: What Are the Benefits for Solo Practitioners and Small Firms?

By David Gallagher

This article covers some of the practical and ethical questions that arise in connection with litigation funding, focusing specifically on some of the ABA Model Rules of Professional Conduct that directly or indirectly implicate litigation funding. An earlier two-part version of this article appeared in a newsletter of the State Bar of California.

Opportunities and Challenges of Contingency Fees

Attorneys practicing solo or in small firms are particularly well suited to benefit from litigation funding. Litigation funding is often used in the context of contingency fee cases, and attorneys practicing solo or in small firms are more likely than those practicing in larger firms to take cases on a contingency basis. In any contingency fee cases they do take on, the individual lawyers handling the matters are also likely to enjoy more of the upside of any success and more of the downside of any failure, as compared with their big law counterparts. Litigation funding can enable attorneys practicing in small firms or as solos to take on more cases on a contingency or blended/hybrid fee basis and to share the risk of doing so with a funder.

Single-Case Funding for Clients

Among the leading commercial litigation funders, the structures of funding deals vary, but all deals have one thing in common—the funding is nonrecourse. The party or law firm taking the funding owes the funder nothing—not even its money back—unless the litigation is successful and there is a settlement or collected judgment.

A typical single-case funding model that works well for attorneys and clients starts from a blended or hybrid fee arrangement and a reasonable budget. The attorney bills the client at 50 percent of his or her normal, realized rates, putting in the other half of his or her time on a contingency fee basis. The funder provides funding to the client to pay the monthly billed half of the fees, up to an agreed-upon maximum budgeted amount. The client pays only the litigation costs. If the case is successful and there is a recovery, the largest portion typically goes to the client, after the attorney is paid his or her contingency fee, and the funder is paid its contracted return (which may be a multiple of the funded amount or a percentage of the recovery). This model is simply one among many possible variations.

Portfolio Funding for Law Firms

In addition to providing funding directly to clients in single cases, funders can provide funding to law firms on a "portfolio" basis. In a law firm portfolio deal, the funder invests a fixed dollar amount into a law firm, and the funder's return is secured by a portfolio of cases being handled by the firm on a contingency or partial contingency (a blended or hybrid) basis. The amount funded frequently represents a portion of the fee budgets or cost budgets in the same portfolio cases, but the firm can use the funding for any purpose—to hire new associates, expand a practice group by adding new partners, open a new office, advance litigation costs, etc. Again, the funder will need to determine whether the merits of the portfolio cases and the likelihood of collection will support the requested funding.

In a portfolio deal, when the firm collects its contingency fees from any one or more of the cases, it pays the funder its contracted return (usually a multiple of the funding amount). No portion of the funder's return is taken from the client. Like single-case funding, portfolio funding is nonrecourse. If the firm is unsuccessful on all the portfolio cases, it owes the funder nothing.

Ethical Issues

Fee-splitting. Model Rule 5.4 provides in part that "a lawyer or law firm shall not share legal fees with a nonlawyer." The rule against fee-splitting is not implicated in a single-case funding arrangement, in which it is the client, not the attorney, who enters into the litigation funding agreement, and in which the funder's investment return comes strictly from the client's recovery, not from the attorney's fees. No portion of the legal fees goes directly or indirectly to the funder.

In a law firm portfolio funding arrangement, however, it is the law firm (whether a solo practitioner, a small firm, or a larger firm) that enters into the funding agreement, and the funder's investment return comes from the law firm's contingency fees in the cases included in the portfolio. As a result, the rule against fee-splitting needs to be considered carefully.

Typically, the only revenue a law firm has is its legal fees. The rule against fee-splitting cannot be interpreted categorically to prohibit a law firm from using its fee revenue to pay third parties for goods or services, or no law firm would be allowed, for example, to buy furniture or rent office space. The same principle holds true with respect to the law firm paying for financial products. Clearly, a law firm is permitted to take out a line of credit with a bank and to pay down the line of credit with its legal fee revenues, notwithstanding the rule against fee-splitting. Similarly, a law firm is permitted to obtain litigation funding and later to repay the funding, along with an investment return on the funding.

Courts and scholars have concluded that litigation funding arrangements with law firms do not violate the rule against fee-splitting, provided that the arrangements do not compromise the attorneys' exercise of independent professional judgment, the protection of which is the underlying purpose of the rule. Indeed, the title of Rule 5.4 is "Professional Independence of a Lawyer."

Two key features of ethically permissible law firm funding arrangements that help to protect the attorneys' exercise of independent professional judgment are the following:

  1. an express provision that the funder has no right to control litigation strategy or settlement decisions, and
  2. the inclusion of multiple matters in the funded portfolio—typically three or more—to ensure that the funder's investment return will not be tied to any particular client matter.

Incidentally, all of the investment managers at my litigation funding firm, Bentham IMF, are attorneys, but even if this were not the case, the rule against fee-splitting with non-attorneys would not apply to Bentham's law firm funding arrangements, for the reasons explained above.

Referral fees. Model Rule 7.2(b) provides in part that "a lawyer shall not give anything of value to a person for recommending the lawyer's services." Litigation funders frequently refer cases to attorneys, but attorneys should not offer, and funders should not accept, referral fees from attorneys. A funder to whom a case is referred by a non-attorney may appropriately pay a referral fee to the non-attorney referrer.

Confidential information of a client. Model Rule 1.6 provides in part that "a lawyer shall not reveal information relating to the representation of a client unless the client gives informed consent" and further provides that "a lawyer shall make reasonable efforts to prevent the inadvertent or unauthorized disclosure of, or unauthorized access to, information relating to the representation of a client."

No attorney should disclose confidential client information to a litigation funder without client consent. In order for that consent to be informed, the attorney should advise the client of the risk that a disclosure to a funder might be deemed a waiver of the attorney-client privilege. To be sure, there is a strong argument to be made that the disclosure of attorney-client-privileged information to a litigation funder is not a waiver of the privilege, and some courts have so held. In an abundance of caution, however, the recommended course is to advise clients not to disclose attorney-client-privileged information to a funder.

In contrast, the related issue of whether the attorney work-product protection is waived by disclosure to a funder has been definitively resolved in all jurisdictions that have considered it. Disclosure of attorney work product to a funder under a confidentiality agreement is not a waiver of the work-product protection because the disclosure does not make it substantially more likely that the other party will obtain the protected material. Accordingly, an attorney and client can comfortably share work product with a funder to aid the funder's evaluation of the case, subject to an appropriate nondisclosure agreement.

Acting competently. Model Rule 1.1 provides that "[a] lawyer shall provide competent representation to a client. Competent representation requires the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation." Clients are increasingly asking their attorneys for advice about litigation funding. To advise clients competently, attorneys should acquire "the requisite knowledge and skill" on the subject, as required by the comment to the rule.

Conclusion

Partnering with a litigation funder allows a law firm to increase revenues, realization rates, and profits; grow new business; and cover operational and expansion costs, while taking on measured risk. Clients who partner directly with litigation funders are able to pursue claims they otherwise might not be able to afford, while obtaining working capital to maintain their business, hire top counsel, and avail themselves of the resources needed to bring cases against deep-pocketed defendants. As litigation funding becomes increasingly adopted, it is important for lawyers to understand how to use it as a resource without running afoul of ethics rules. Bentham offers CLE courses to firms and legal departments free of charge on both the basics of funding and the ethics of funding.

Keywords: litigation, solo practitioners, small firms, litigation funding, single case funding, portfolio funding, Model Rules of Professional Conduct

David Gallagher is an investment manager in Bentham IMF's Los Angeles, California, office.


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