Cold Water Thrown on Certain Litigation Funding

Not All Litigation Funding Is Prohibited   

In the litigation funding industry, funders extend financing to litigators or their clients, and repayment of the financing is contingent upon the outcome of the litigation. 

Under typical funding arrangements, the funder agrees directly with the lawyer’s client to provide funding for a specific case, and the client agrees to make future payments if the client prevails. When the client is the plaintiff in a civil matter, the amount the funder receives may depend upon the amount the plaintiff recovers.

According to the New York City Bar’s ethics committee, client-funder arrangements of this nature do not violate Rule 5.4(a) which provides, in part, that “[a] lawyer or law firm shall not share legal fees with a nonlawyer.” The committee explained that these types of client-funder arrangements do not implicate Rule 5.4 because the lawyer is not a party to the arrangement, payments are made by the client from the client’s recovery, and the payments do not affect the amount of the lawyer’s fee.

Some Funding Arrangements Trigger Fee-Sharing Prohibition

The committee’s opinion focused on funding arrangements between a funder and a lawyer or a lawyer’s firm. There are different types of lawyer-funder arrangements. For example, Rule 5.4 does not forbid a traditional loan, secured by collateral or otherwise, that requires a lawyer to repay the loan at a fixed rate of interest regardless of the matter’s outcome or the amount of the lawyer’s fees. However, the ethics committee concluded there are two types of lawyer-funder arrangements that do violate Rule 5.4: (1) funding arrangements where the loan is secured by the attorney’s fee in one or more lawsuits and the attorney will have to pay the funder only if the attorney receives legal fees from those lawsuits; and (2) funding arrangements where the funder and the attorney agree that the amount the attorney will repay will depend on the total amount of attorney’s fees received.

The committee explained Rule 5.4 is not implicated simply because a funder is repaid by a lawyer from funds derived from legal fees, but that the Rule does prohibit financing arrangements where payments to the funder are tied to the lawyer’s receipt or amount of legal fees. The committee stated that Rule 5.4(a) “has long been understood to apply to business arrangements in which lawyers’ payments to nonlawyers are tied to legal fees in these types of ways.”

For instance, the committee pointed to a 2013 ethics opinion, where the New York State Bar Association Committee on Professional Ethics concluded that a lawyer could not compensate a business owner for marketing services based on a percentage of fees from a particular matter because this was tantamount to fee sharing. The committee explained that no “meaningful difference” exists between payment for litigation funding arrangements and payments for goods and services that would call for diverging interpretations of fee sharing. “Rightly or wrongly,” the committee wrote, “the rule presupposes that when nonlawyers have a stake in the legal fees from particular matters, they have an incentive or ability to improperly influence the lawyer.”

Ethics Committee Gets It Right

Several ABA Section of Litigation leaders agree that the committee’s opinion is sound and well-reasoned. “The purpose of the fee-sharing provision is to the protect the lawyer’s independence of judgment. There are ‘good’ funders and ‘not-so-good’ funders,” explains John M. Barkett, Miami, FL, cochair of the Section of Litigation’s Ethics & Professionalism Committee. “Good funders never interfere with the independence of a lawyer’s judgment. The question is whether there are ‘not-so-good’ funders who may attempt to interfere. Presumably, that was a motivating factor in the outcome of the opinion,” states Barkett.

Even though the committee concluded certain lawyer-funder arrangements implicated Rule 5.4, litigation funding generally is still permitted. “The ruling by the New York City Bar strikes the proper chord and does not completely prohibit attorneys from seeking outside funding to support litigation,” observes Alexander C. Wharton, Memphis, TN, cochair of the Section’s Minority Trial Lawyer Committee. “But anything that interrupts the sanctity or confidentiality of the attorney-client relationship, especially when it comes to money, should not be allowed,” advises Wharton.

Some litigation leaders wonder whether additional guidance is needed regarding client involvement in funding deals. “The opinion does not delve into the issues of informed client consent to lawyer-funder arrangements, including whether a funder’s dealing with the law firm directly rather than the client may be more beneficial to the client,” states Thomas G. Wilkinson Jr., Philadelphia, PA, member of the ABA Standing Committee on Professionalism.

Onika K. Williams is an associate editor for Litigation News.

Hashtags: #litigation, #finance, #ethics, #independence

Related Resources

• ABA Model Rules of Professional Responsibility, Rule 5.4: Professional Independence of a Lawyer.
• Jamie Hwang, “Wisconsin Law Requires All Litigation Funding Arrangements to be Disclosed,” ABA J. (Apr. 10, 2018).

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