Canada’s ‘Model’ Litigation Finance Contract

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Litigation finance (or third party litigation funding, as it is most often called in Canadian jurisprudence), has only recently become the subject of public scrutiny, thanks to the development of a class action funding industry.  The issue first gained prominence when a 2009 Ontario court refused to approve a funding arrangement in a securities class action on the basis of champerty and maintenance rules. Since then, several other class action funding agreements have been approved. In doing so, and in the absence of any legislation to guide them, judges have fashioned a ‘model’ litigation finance contract for class actions.  In three fundamental ways, this de facto standard contract converges with Prof. Steinitz’ draft Model Litigation Finance Contract (MLFC). On two crucial points, however, the draft MLFC would meet with resistance north of the border.

Instigation, Exploitation & Control. Like many U.S. states, Canada has long-standing rules against champerty and maintenance.  In the 2011 Dugal decision, Justice Strathy interpreted those common law prohibitions in a manner that did not preclude third party litigation funding per se.  His reasons will sound familiar to those who have read other commentaries on this site.

Canadian case law regularly identifies three principal mischiefs that champerty rules aim to cure: the promotion of unnecessary litigation by a non-party; the over-compensation of the financier; and intermeddling in the conduct of the litigation.  By confirming that a valid claim was initiated before the involvement of the funder, concerns about spurring litigation are resolved.  As in New York, the evil to be avoided in Canada is the instigation of a claim by a funder that would not otherwise have been filed.  Ontario’s Chief Justice put it bluntly when he stated that the purpose of class action legislation is “to facilitate the litigation of causes of action and not to generate them for financial gain.”

Concerns about over-compensation were also expressed in Dugal.  A previous attempt to obtain judicial approval of a finance agreement in a class action failed on the basis that the contracted rate of return – 7% of any “resolution amount” – bore no relationship to the amount of money invested by the funder, the period of time during which those monies were outstanding, the degree of risk assumed by the funder, or the extent of its exposure to costs. (Ontario is a cost-shifting regime, and funders’ most important contribution to the representative plaintiff, therefore, is an indemnity against adverse costs). In Dugal, however, the funder’s 7% rate of return was capped at $5 million if the case settled before trial, and $10 million if resolved thereafter.  Although quite different from the Litigation Proceed Rights structure in the draft MLFC, the rate of return and cap in Dugal and §5.7 of the draft MLFC reflect a common desire to secure a minimum share of proceeds for the plaintiffs.  While Justice Strathy accepted that litigation funding involved the commodification of litigation, he also recognized that some parameters were necessary to prevent the exploitation of absent class members.

Finally, Justice Strathy also addressed the critical issue of control.  The agreement contained a provision that power to instruct counsel rested solely with the representative plaintiff; the funder was entitled only to “appropriate information about the progress of the litigation”.  Unlike their Australian counterparts, Canadian courts have been firm in their rejection of a funder’s contractual right to exercise any control over the conduct of the litigation.  The agreement in Dugal, however, went further than §3.1.4 of the draft MLFC, in that the plaintiff’s termination of the original litigation counsel’s retainer triggered the funder’s right to terminate the funding agreement.  I have expressed elsewhere a concern that, given the plaintiff’s reduced leverage in a commercially funded class action, this term may differ only in degree from a provision permitting the funder to select counsel.  Courts have yet to grapple with many of the ethical dimensions of the funder-client-lawyer relationship confronted in the draft MLFC.

Rights of Termination & Participation.  Two provisions in the draft MLFC would be of some concern to Canadian judges.  First, §3.1.5 gives the funder the right to participate in settlement decisionmaking.  Although the plaintiff is obligated only to give good faith consideration to the Funder’s analysis of the offer, Ontario judges have expressed (here, at para. 361) that “they are particularly concerned to know the details of the arrangement with the third party [funder] to ensure that the representative plaintiff, and not the third party, is actually calling the shots.”  The only contractual right of participation approved to date has been the right to be provided with “appropriate” information about the progress of the litigation. No reciprocal duty to consider the funder’s views has been identified.

Second, §6.0 provides that the funder may terminate the investment without cause.  Even if such termination occurs without a right to repayment of the initial investment, termination without cause is unlikely to be accepted in Ontario.  Recall that litigants are subject to cost-shifting; the funder’s most important function in the class action context is to indemnify the plaintiff against costs.  Cash investments to date have been very modest.  The power to revoke the indemnity midway through the litigation would give the funder de facto control over the lawsuit.  For this reason alone, termination without cause would not be countenanced.  Termination with cause is limited to a breach of the narrow information-sharing obligation and replacement of litigation counsel, as referred to above.

Unlike the ABA and state bar associations, Canadian regulators have not considered the ethical issues surrounding third party litigation funding, leaving judges with the task to create rules and standards on a piecemeal basis, and this only in the context of class actions where judicial oversight is a legislative requirement.  Non-representative proceedings, specifically personal injury litigation, complex commercial litigation and international arbitration, where third party funding also exists, are not subject to these judicial controls.  The transparency engendered by a model contract would be a welcome development.

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