Fact Pattern and Assumptions
A broad range of funding scenarios, with different types of funders, claimants, claims and jurisdictions, are emerging in the global market place. Given that diversity, drafting an universal model contract is impossible. We must make certain assumptions about the nature of the claim, the characteristics of the funder and the claimant, and the governing law of the contract. That said, our goal is to suggest contractual arrangements that are as broadly applicable as possible.
The cases and funding contracts upon which we rely for our analysis are on file with the authors.
We assume the funder is a specialized litigation finance company.
We are not contemplating other types of financiers, such as a wealthy individual (“angel investor;” in venture capital parlance), hedge funds or similar entities that do not specialize in litigation finance but may occasionally invest in it, or a self-financing contingency law firm. As such, our funder is a “repeat player,” which will often times have greater bargaining power and sophistication, as it relates to litigation and its funding, than will claimant. This also means that the funder may have a strategic interest in the outcome of a case beyond its interest in winning the case at hand. In addition, our funder is susceptible to the pressures of a reputational market, should one develop.
Finally and most important, our funder, while usually founded and managed by attorneys, is not subject to the legal rules of Professional Responsibility. This means it can place itself in conflict with the claimant, for example by investing in both sides of a litigation or by striving to set a legal precedent that would benefit its other investments.
We assume the claimant is a corporation or an otherwise sophisticated business party or a wealthy, sophisticated individual seeking to bring a commercial claim.
We are not considering personal injury or other tort cases, divorce cases and the like. While some of the contract issues are similar, other important aspects, such as public policy, are not. For example, we do not see a funder’s capturing a very large portion of the proceeds of a sophisticated party’s financed commercial claim as offensive to public policy or usurious, but an identical rate of return could look quite different if a judgment or settlement is supposed to compensate for a personal injury, human life or environmental devastation.
Another complicating difference is the potential divergence of remedies; money generally resolves commercial claims, but tort compensation can involve elements that while costly, are not monetary in nature. Examples include medical treatment and monitoring, and environmental cleanup. Litigation funding’s potential to monetize such remedies and eschew them for straight damages, commodifying claims, is less problematic in the commercial context.
Just as we hew to commercial claims over torts, we focus on plaintiffs over defendants. First, considering both simultaneously is needlessly complex as the issues and public policy considerations are different; second, litigation finance is currently concentrated almost exclusively in the plaintiffs’ market; and last, defense funding is so similar to insurance that the scholarly gap is much narrower in that context.
Many key issues relating to litigation financing are subject to state law, especially those relating to whether the financing contract will be upheld by courts if challenged in a dispute between funder and claimant. Such issues include the champerty doctrine, the prohibition on usury, and the scope of the attorney-client privilege. These are all (in the United States) creatures of state law and vary widely from jurisdiction to jurisdiction.
Needing, therefore, to relate the contractual provisions to state law, we picked the law of the State of New York. We chose New York because its doctrines are generally accommodating of litigation finance, it is a premier commercial center, and its courts are well-regarded.
One should note that, although litigation finance contracts can and do invoke English or other foreign law, and current contracting practice often involves selection of international arbitration as a dispute resolution mechanism, these selections are not always the optimal arrangements for a given contract. Most notably, such choices may structurally disadvantage the plaintiff relative to the funder, or vice-versa.
The Analytic Framework
For the reasons presented in a separate essay, we believe the contracting issues in litigation finance closely mirror those posed by venture capital. As a result, our model is patterned on venture capital contracts in key respects.
There is an alternative structure that may have many benefits and solve some of the problems inherent in litigation finance arrangements, such as sharing information and retaining attorney-client privilege. That would include transferring the claim into a separate legal entity (corporation or a trust, as appropriate) created for the purpose of owning and litigating the claim. The plaintiff and corporation would co-own the entity, splitting the shares as negotiated amongst them. This approach would invoke general principles of corporate governance which have evolved to deal with agency problems and other economic issues (such as economies of scale and scope). However this structure may be champertous under New York law.