Conflicts Created By The Funding Terms in the Model Contract

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We begin this blog post with a few suggestions on nomenclature.  For purposes of this post, we introduce the use of the terms “triad” and “dyad” to discuss and differentiate the possible combinations and permutations of conflicts inherent in any discussion of litigation finance.  While the Model Litigation Finance Contract (the “Model Contract”) is entered into by and between Plaintiff and Funder; the Plaintiff’s Litigation Counsel forms an integral part of  the essential relationships which exist and which will give rise to conflicts, both those of the legal ‘conflict of interest’ variety, as well as those represented by misaligned or diverging interests.

The “triad” of conflicts arises due to the presence of at least three parties to any litigation finance transaction:  Plaintiff, the Funder and Plaintiff’s Litigation Counsel.  The “dyads” arise out of the various relationships between: (1) Funder and Plaintiff; (2) Plaintiff and Plaintiff Litigation Counsel; and (3) Plaintiff Litigation Counsel and Funder.

Whenever there is a perceived or actual need for additional funding, an event defined as either a Supplemental Investment Event or Accelerated Investment Event, we have found in our experience representing Funders for many years, it is generally a symptom of some other event which is occurring in the Claim’s litigation.  For example, it could be a symptom of any of the following list, which is not meant to be comprehensive: (i) a less than properly analyzed Claim by the Plaintiff’s Litigation Counsel which Claim has emerged more hydra-like than initially thought; (ii) an inadequately prepared Claim litigation budget, which has required more capital than initially planned; (iii) an under-estimation of the defendant’s likely response to the Claim’s litigation or the defendant’s counsel’s litigation tactics or strategy, which has resulted in significant additional expense for which additional capital is being sought; and/or (iv) occurrences during the discovery or law and motion phases of the Claim which could not have been anticipated, regardless of how prescient Plaintiff’s Litigation Counsel had been.

Earlier discussions analyzed how to prevent the disruption or destabilization caused when the funds provided by the Funder have been used up and the Funder is ready to walk away from his investment.  What emerged from those discussions was a clause of the Model Contract, section 5.5, which requires the Funder to finance through to the next Milestone Event, unless the Funder and Plaintiff find that the need for the Supplemental Investment was created by “Attorney Waste” as defined in a retainer agreement between the Plaintiff and Litigation Counsel, which definition was left to be written by the parties.   We believe that this clause, which may have been a solution to one perceived problem, creates a multitude of problematic conflicts of interest among the various dyads involved in the transaction.

Depending on her compensation scheme, Litigation Counsel is incentivized to spend as much as possible without wasting.  The Plaintiff is incentivized to align itself with the Funder against her own attorney to find that Litigation Counsel wasted funds in order to avoid having to give the Funder any more Proceed Rights.  The Funder is incentivized to only enter contracts in cases where Litigation Counsel is a repeat player because the Funder will have more influence on the attorney’s strategic choices, which is the only way the Funder can minimize the risk that he will be caught in a runaway train of a case where getting to the Discovery Completion Milestone takes years longer than expected.

One of the goals of the Model Contract is to write a contract that aligns the incentives among the triad to achieve the “best” result for the Plaintiff.  And that must be the goal because Litigation Counsel is ethically bound to always have the Plaintiff’s best interests at heart.  However, the best result for the Plaintiff, particularly a sophisticated business entity (as assumed by the Model Contract), is not necessarily reaching the next Milestone Event.  If the proper balance between each party’s Proceed Rights is achieved, then when the triad runs out of money to fund the Claim, they will each be equally incentivized to make an appropriate decision about whether to invest more funds in the Claim and how much.

If more money is needed, then something unexpected happened that deserves a more in depth look. Sometimes, the best thing that can happen to a Plaintiff is to have the impetus to sit down, regroup, analyze what is working and what is not working, re-evaluate the value of their Claim, and move forward.  Therefore, our suggestion, rather than require Supplemental Investment, is to require a good faith negotiation because it more accurately captures what occurred that resulted in running low on funds in the litigation account.  We believe this more strategically aligns the triad towards achieving the best result in the most cost and time efficient manner.  Perhaps, it is only when the parties are unable to resolve this capital deficiency through good faith negotiation, that some sort of default provision which is more appropriately tailored to the specifics of the individual Claim transaction can be contemplated.

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