In the draft model, plaintiff must disclose all material information prior to the initial funding and on an on-going basis, except that information protected only by the attorney-client privilege cannot be shared without the informed, written consent of the plaintiff. That restriction is imposed notwithstanding the fact that the parties agree sharing the information among themselves would not, as a matter of law, waive the privilege, because the state of New York law on point is unsettled. In addition, the plaintiff represents the disclosure has been complete and accurate, and has the anti-fraud provisions of the securities laws in the background if they do not.

In the Dugal contract, the plaintiff makes no representations about the information disclosed to date, nor does it make very detailed commitments about the information to be shared over time. The full obligation to share information with the funder is in 3.1:

“Plaintiffs irrevocably direct the Lawyers to advise the Funder with regard to any significant issue in the Proceeding such as prospects, strategy, quantum, proof and any material change thereof. The Plaintiffs also irrevocably direct the Lawyers to promptly respond to any reasonable request by the Funder for information relating to the Proceeding.”

It is possible that material information would neither fit within “prospects, strategy, quantum, proof and any material change thereof”, and that the funder might not think to request it. If so, the draft model requires greater disclosure. However, as mentioned, the draft model does not require disclosure of information protected solely by attorney client privilege. The Canadian contract contemplates that such information will be shared.

First, in 3.3 of the Canadian contract the plaintiffs agree that all information shared with funder is subject to privilege, where privilege is defined to include “solicitor-client privilege, litigation privilege and settlement communication privilege”. Then in 5.1, under “Privilege and Confidentiality” the Canadian contract says that to preserve privilege, funder shall protect the confidentiality of the information and give access to it only to the “Funder’s directors, officers and/or employees who are engaged in functions connected to the implementation of this Agreement”, a limitation that would be protective of American attorney-client privilege but not needed for American work product protection.

Beyond these terms dealing with information about the substance of the claim, the Canadian contract, like the draft model, requires additional disclosure, namely about impairment/encumbrance of the claim. The fact that in section 9 the plaintiffs warrant that the Net Resolution Sum is not encumbered and they will not encumber it without prior written consent of the Funder simply highlights the fact that the contract does not otherwise require the plaintiff to warranty its disclosures.

Presumably the relatively limited nature of the Funders’ financial commitment–Cdn$50,000 plus bearing the risk of adverse cost orders–underlies this approach to information sharing. That is, when being paid to bear the risk of adverse cost orders, a Funder needs sufficient information to assess that risk, both up front and on an on-going basis. However that information is possibly significantly less information than a funder financing the conduct of the claim itself would need to evaluate whether or not it wanted to continue financing.

By reading Dugal’s recitals and provisions 4.1 and 4.2, we see that the funder is only directly investing $50,000, which is for “out of pocket expenses incurred by the Plaintiffs in the proceeding”. The funder is not financing the conduct of the claim itself, in contrast to the terms of the draft model contract. However the funder is bearing the risk of adverse cost orders throughout the conduct of the claim. Notably, that risk is not absolute; it is mitigated to the extent that the plaintiff receives any beneficial cost orders during the conduct of the claim. That is, the funder only owes an adverse costs order sum net of beneficial cost orders received prior to the adverse cost order.

The Dugal definitions section includes three noteworthy funding terms. The funder is entitled to a “Commission”, which is 7% of the “Net Resolution Sum”, up to a maximum cap. This structure differs in three ways from the draft model. First, the percentage is fixed, whereas the model allows a plaintiff to sell more or less; second, the model imposes no cap outside of the plaintiff’s minimum; and third, the amount the funder invests is in no way connected to the amount it ultimately receives. Indeed, it is possible the funder will pay only Cdn $50,000 to receive Cdn $10,000,000; or pay much more and receive Cdn $5,000,000. (Those payouts are the commission caps depending on whether the case advances past the plainiffs’ pre-trial conference brief or not.) The draft model, in contrast, relates upside potential to investment size through the sale of Litigation Proceed Rights. (Of course, the funder can pay the Cdn$50,000 plus adverse cost order(s) and receive nothing, just as Litigation Proceed Rights may prove worthless.)

Another difference is the concept of “Net Resolution Sum” versus the model’s “Proceeds.” Because the Dugal funding does not finance the conduct of the claim, when the proceeds come in they first pay fees, disbursements, taxes, and administrative expenses. Only amounts net of that total are available to be disbursed to the Plaintiff and funder. Under the draft model contract, all such sums are paid for by the Funder (and probably litigation counsel) through their purchase of Litigation Proceed Rights. Thus when the proceeds come in, the only amount that remains to “net” against them are taxes. By selling shares in the proceeds, the model puts the burden of taxes on the plaintiff, which we believe incentivizes the plaintiff to structure settlements in tax-optimal ways.

Another way the Dugal funding contract’s money terms differs from the draft model’s relates to how the total proceeds are calculated. Seeking to minimize claim commodification, the draft model explicitly excludes the monetary value of remedies not intended to be convertible to cash, such as injunctive relief. Although the Dugal case was a securities fraud claim brought by investors, making the likelihood of non-cash remedies relatively small, the contract included provision 7.3 which said “If the Resolution Sum is not money, the monetary value of the Resolution Sum received will be calculated by reference to the reasonable market value of the Resolution Sum. The Resolution Sum shall then be distributed, and any Commission paid, in proportion to its equivalent monetary value.” The underlying definition of “Resolution Sum” includes “the gross amount or amounts, or the value of any goods or services, for which the Claim or part of the Claim” is resolved in favor of the Plaintiffs. On our read of the Dugal contract, in the unlikely scenario where there was some remedy that was non-cash–perhaps additional disclosures, or corporate governance reforms–the contract would require its pricing and inclusion in the disbursement to funder. As a practical matter that might simply prevent the plaintiffs from pursuing such remedies.

Finally, the last parallel in the funding terms is staged funding. That is, the Dugal contract allows the funder to opt out of financing appeals, whether offensive or defensive. If the funder opts out, they give up any share of any proceeds that result from the appeals they otherwise would have been entitled to.

Without further ado, here’s the contract:

Canadian Class Action Litigation Funding Agreement_(executed)

Over a decade later, individual syndicates gave way to commercial funding firms and thus the funding of class actions as a viable industry emerged.  Whether commercial funding of class actions occurred prior to this time without defendants or the court being aware of it is impossible to determine.  Beginning in 2009, however, plaintiffs have disclosed the existence of a proposed funding arrangement to the judge supervising the class action, and judges have accepted that they have the jurisdiction to approve or reject the agreement based on the best interests of the class.  Although two funding agreements were judicially approved on an ex parte basis in Alberta[1] and Nova Scotia,[2] class counsel in Ontario sought court approval of an indemnity[3] agreement with an Irish funder, and did so on notice to the defendant in order to increase the probability that the judge would be comfortable approving the contract.  In this case, the judge rejected the funding contract on the basis that it may potentially overcompensate the funder and therefore be champertous.

Lawyers interviewed for a study of commercial litigation funding in 2012 were unanimously of the view that, unlike a law firm’s other banking arrangements, the involvement of a third party funder, and its contractual relationship with the representative plaintiff, must be disclosed to and approved by the class action judge.

The class action bar is starkly divided, however, on the question of the scope and timing of the approval motion.  In the same study, most lawyers maintained that the agreement should be submitted to the judge for approval early in the action.  One lawyer argued that it would be more appropriate to disclose the agreement at the end of the litigation, concurrently with class counsel’s fee.  The role of the defendant in the approval hearing is even more controversial.  The majority of the lawyers interviewed claimed that divulging any details of the funding agreement to the defendant undermines the plaintiff’s strategic advantage in obtaining such support.

Whatever the views of counsel, a recent decision of the Ontario Superior Court of Justice has (for the time being) settled the procedural question.  In Fehr v. Sun Life, the plaintiffs moved for directions regarding the procedure for approval of a funding arrangement.  The plaintiffs argued that the hearing of the motion should be closed to the public, argued without notice to the defendant, and that all documents for the motion be sealed, all on the basis that the funding agreement disclosed elements of their litigation strategy and was therefore subject to solicitor-client and litigation privilege.

The motions judge disagreed.  Justice Perell found that in the context of class actions, the terms of both counsel’s retainer agreement and the associated third party funding agreement are not privileged and must be promptly disclosed to the court. The agreement has no effect if not judicially approved.  He further held that in the context of an adversarial system of justice, the defendant’s views about the agreement provide the Court with useful information.  Justice Perell’s rationale is clearly stated (at para. 89):  “Third party funding of a class proceeding must be transparent and it must be reviewed in order to ensure that there are no abuses or interference with the administration of justice.”

The potential abuses referred to in Fehr were previously discussed in another Ontario case, Dugal v. Manulife.  In this case, Justice Strathy (now a Court of Appeal judge) discussed concerns about the incitement of litigation by a funder; officious intermeddling in the conduct of the litigation by the funder; financial exploitation of the class members; the sufficiency of assets on the part of the funder; and controls over the disclosure of the defendant’s proprietary information to the commercial funder.  Justice Strathy was comfortable approving the contract in Dugal because of provisions in the contract, among others, which safeguarded the representative plaintiff’s ability to instruct counsel without interference from the funder. Justice Strathy, like Justice Perell after him, both grounded the court’s jurisdiction to approve and then continue to monitor the funding arrangement in class proceedings legislation. In effect, the judges act as proxies for the class members in approving the contract between the funder and the representative plaintiff.

In determining that the funding agreement was subject to court approval, Ontario judges have also confronted the question of disclosure.  Justice Perell rejected the plaintiff’s argument that the agreement was privileged.  Consequently, “because there is no privilege in the third party funding agreement, then as a matter of best practices, an applicant for third party funding should not include extraneous and otherwise privileged information in a third party funding agreement” (para. 142).  Justice Perell also rejected the submission that the approval motion ought to be conduct in camera and ex parte, finding that the interests involved were insufficient to depart from the open court principle.  In a curt response to the plaintiff’s complaint that disclosure of the agreement would dampen commercial litigation funding of class actions and thus inhibit access to justice, Justice Perell stated: “As for Bridgepoint [the funder], if it does not wish to disclose its pecuniary interest in the litigation, then Bridgepoint should do its business in another less transparent or more disinterested forum” (at para.155).

The U.S. appears to be one such “less transparent” forum, at least for the time being.  Conversely, Australian funders have opted for full public disclosure of their agreements.  Such transparency is generally welcome by the Canadian bar and commentators alike, even if the obligation to disclose the contract to the defendant is significantly less popular.  In the absence of regulatory oversight by securities commissions, insurance regulators or consumer protection statutes, judicial oversight is perceived to be a necessary safety measure in a steadily burgeoning industry.

Consequences of Plaintiff’s Material Breach

As we noted in our post about a funder’s right to terminate for cause, a plaintiff’s failure to disclose material information prior to the sale of Litigation Proceed Rights could be grounds for a securities fraud claim. However, for that claim to stick, the Claim likely must be concluded; the Litigation Proceed Rights have no value otherwise. It is hard to see how damages can be calculated simply because the Funder’s Expected Value is diminished. Even in a common law fraud claim, calculating damages prior to the Proceeds realization is tricky unless the only measure of the damages is the money invested in reliance on the fraud.

To strengthen Plaintiff’s incentive to avoid a material breach, the draft model contract imposes a dire consequence, namely de-funding:

[7.1.4 Consequences of Material Breach by Plaintiff: If the Plaintiff commits an incurable material breach under 7.1.1 or 7.1.2 or fails to timely cure material breach as defined therein, Funder is entitled to an immediate refund of all of its Investment remaining in the Litigation Account and is entitled to keep its Litigation Proceed Rights. Funder shall have no further obligations under this Agreement other than the provisions that explicitly survive the termination of this Agreement. This provision shall not limit Funder's other remedies at law or equity.

 7.1.4.1 If the existence of a material breach is disputed by the Plaintiff the Disputed Refund provisions of the Escrow Agreement governing the Litigation Account shall apply.]

Alternate:

[7.1.4 Consequences of Material Breach by Plaintiff: If the Plaintiff commits an incurable material breach under 7.1.1 or 7.1.2 or fails to timely cure material breach as defined therein, Funder may seek damages from said breach at law or equity.]

Consequences of Funder’s Material Breach

Plaintiff can be jeopardized by Funder’s material breach in ways that go beyond the value of the Claim. For example, if the Funder shares Proprietary Information with competitor (or with an investor weighing whether to invest in Plaintiff or a competitor) the resulting damage to Plaintiff could be wholly unrelated to the Claim, even though traceable to the Funder’s investment in the Claim. Similarly if the Funder’s disclosure of privileged information results in waiver, then the damage to Plaintiff may exceed the four corners of the Claim; it depends on what information is discovered as a result. Last, if the Funder is unable to invest when required (a situation that cannot arise if Accelerated and Supplemental Investments are not used, unless the Funder fails to give timely and effective notice of termination at a Milestone) the Claim will not be jeopardized if the Plaintiff can find alternative financing quickly enough. However the terms of that financing may be damaging, in that they could be significantly more expensive than would have been available to Plaintiff if the Funder had been able to honor its commitments.

For these reasons, and the general difficulty in quantifying the damages resulting from the material breaches, the draft model contract requires the Funder to take a total loss, in addition to facing whatever remedies may be otherwise available at law or equity:

[7.2.4 Consequences of Material Breach by Funder: If Funder commits an incurable material breach under 7.2.1 or 7.2.2 or fails to timely cure a material breach as defined therein, Funder’s Litigation Proceed Rights are cancelled and Funder must promptly return its Litigation Proceed Right Certificates. This provision shall not limit any other remedies Plaintiff may have in law or equity.

7.2.4.1 If Funder disputes the existence of a material breach the Disputed Rights provisions of the Escrow Agreement governing the Proceeds Account shall apply.]

Alternate:

 [7.2.4 Consequences of Material Breach by Funder: If Funder commits an incurable breach under 7.2.1 or 7.2.2 or fails to timely cure a material breach as defined therein, Plaintiff may seek damages at law or equity.]

7.2 Material Breach by Funder

7.2.1 Material Provisions: Funder recognizes that its representations regarding its ability to honor its capital commitments and its commitments to protect Plaintiff’s privileged [and Proprietary] Information are of the essence of this agreement. For the avoidance of doubt, these are the material provisions 2.2.2 (funds), 2.2.5 and 4.1 (privilege) [and 4.3 Proprietary Information]. A material breach of 2.2.2 occurs if the Funder is unable to invest Committed Capital when required. A material breach of 2.2.5 or 4.1 occurs if the disclosure could result in waiver of the privilege if any other party to the litigation learned of the disclosure, regardless of how the other party to the litigation learned of the disclosure. [A material breach of 4.3 Proprietary Information occurs if the breach results, by any method, in the Proprietary Information being received by any person or entity that could use it to its commercial advantage or to commercially disadvantage the Plaintiff.]

Unlike the Material Provisions relevant to Plaintiff breach, these breaches do not necessarily impact the value of the Litigation Proceed Rights, although they could damage the Plaintiff in other ways. Instead of setting them up as presumptively but rebuttably material, the language is intended to create bright lines that incentivize compliance with the terms.

The other two provisions are similar to their counterparts for the Plaintiff:

7.2.2 Material Breach of Other Provisions: The breach by Funder of any other provision is material if it, by itself, reduces the potential value of the Award or Proceeds by more than [10%] as measured against the Initial Claim Value.

7.2.3 Notice of Material Breach by Funder: If Plaintiff believes Funder has materially breached this contract it shall promptly serve notice on Funder. If the breach can be cured Funder then has [30] days to do so.

7.1 Plaintiff Breach

7.1.1 Material Provisions: The provisions of this contract relating to complete and accurate disclosure of material information about the claim; to cooperation in conducting the claim; and of non-impairment of the claim, the potential award and any proceeds thereof, are the very essence of this agreement and any breach by Plaintiff of those provisions is presumptively material. For the avoidance of doubt, the material provisions are: 2.1.3 and 3.1.3 (relating to disclosures), 2.1.6 (no impairment), and 3.1.2 (cooperation). The presumption of materiality can be rebutted by Plaintiff by showing that such breach did not reduce the potential value of the funder’s Litigation Proceed Rights by more than [10%] compared to the Expected Value of those Litigation Proceed Rights.

These provisions go to the heart of the funder’s risk/reward calculus. Breaches of these provisions most plausibly support claims that the funder would not have invested, or re-invested but for the omission (for disclosure/impairment breaches) or for the unfulfilled promise of future action (cooperation.) The 10% threshold for defining materiality is intended to prevent the funder from claiming a disclosure failure or cooperation failure was material when in fact it was not. That is, if significant damages cannot be traced to the breach, the Funder should not be able to assert the breach was material. Because of the difficulty of proving the connection, however, and to ensure the incentive not to breach is created, it is up to the Plaintiff to prove the breach’s consequences were de minimis.

Whether 10% is the correct threshold is not obvious; arguably it is too high. Securities fraud claims do not require a demonstration of a certain percentage of loss though they do require the security holder to prove the misrepresentation caused the claimed loss. Because the Model Contract is structured as a sale of securities, i.e., securities fraud rules are applicable, the correct percentage should be set with a securities fraud claim in mind. That is, the funder should be able to say, well, if plaintiff’s breach cost me $xxx, that would be a big enough loss that I would seriously consider suing for securities fraud. The termination for cause percentage could then be set as equal to or even smaller than that number, so that breach could give the funder access to remedies without having to pursue a securities fraud claim.

One kind of breach of the material provisions would not ever justify a securities fraud claim and thus should similarly not justify termination for cause: the failure to disclose material, favorable information. The only parties harmed by such failure are the plaintiff, whose pricing is worse than it otherwise would have been, and the investors who did not participate because they did not realize how good the opportunity was. To foreclose the possibility that a Funder would seek to terminate for cause when the plaintiff failed to disclose favorable material information, the contract includes the following:

7.1.1.1 Notwithstanding 7.1.1, failure to disclose material information about the claim that supports the claim, strengthens the claim, or otherwise cannot reasonably be believed to have influenced funder to avoid investing or re-investing in the claim had it been disclosed when required is not a material breach of the disclosure provisions.

Without trying to anticipate all the factual situations under which the breach by the plaintiff of other provisions would damage the value of the claim significantly, this provision is intended to capture them:

7.1.2 Material Breach of Other Provisions: The breach by Plaintiff of any other provision is material if it, by itself, reduces the potential value of the funder’s Litigation Proceed Rights by more than [33%], compared to the Expected Value of those Litigation Proceed Rights.

Finally, some material breaches are inadvertent and can be cured if the Plaintiff is made aware of them. For example, if the Plaintiff failed to authorize the finance transaction properly, such failure may be curable. As a result, the contract contains a notice and opportunity to cure provision[MS4] , while recognizing that some breaches simply cannot be fixed:

7.1.3 Notice of Material Breach by Plaintiff: If Funder believes Plaintiff has materially breached this contract it shall promptly serve notice on Plaintiff. If the breach can be cured Plaintiff then has [30] days to do so. Breaches of the following provisions cannot be cured: the failure to disclose material information covered by 7.1.1.1  at the time of contract execution not and the failure to disclose existing claim impairment at contract execution.

The next post will cover the parallel provisions giving the Plaintiff the right to terminate for cause.

Reviewing the Context

The draft model contract is intended for a very specific type of case: a corporate or other sophisticated plaintiff bringing a commercial claim. That does not mean the contract has limited utility; the universe of such potential claims is vast. Indeed, corporate finance and accounting concerns inhibit many companies from bringing meritorious albeit smaller cases, and litigation finance can address those concerns. A recently formed fund emphasized that opportunity when announcing itself. But the sophistication of the players–unlike consumers or injured victims–and the type of harm sued over are important background when analyzing the issues raise by the funding terms of the model contract.

The premise of the model contract’s adoption of venture capital is that a funder can–and should–be able to refuse to further fund a claim at predetermined decision points called “milestones.” As we’ve explained, good milestones are points in time at which the information about the value of the claim has fundamentally changed, such as at the close of discovery, or the entry of a judgment that may yet be (or will certainly be) appealed. We can justify, as a normative matter, a funder’s decision to essentially abandon this type of plaintiff during this type of claim if the decision reflects new information demonstrating the claim is much less meritorious, or much less valuable, than previously known.

If the funder is being used purely for corporate finance reasons, the plaintiff has the opportunity to continue to fund the case itself rather than settle. If the funder is genuinely providing access to justice, and the plaintiff is thus forced to either give up its case or settle on adverse terms because of the decision not to further fund, that result is not per se bad so long as the decision not to further fund reflects new, adverse information.

The world is not so neat and tidy, however, as to guarantee that the moneys provided by funder(s) at the Initial Closing will fund the case through to the Discovery Milestone, or whatever milestone the parties negotiate. When such a gap happens in the venture capital world, the parties simply engage in good faith negotiations to see if they can work out a bridge financing deal. As Elisha Weiner and Kenneth Linzer noted, that approach might be proper in the litigation finance context as well. In that regard they voiced a similar concern to the one raised by Edward Reilly of Themis Capital. To the extent that the funder is simply providing a solution to accounting issues or corporate finance priorities, rather than access to justice, we agree that requiring good faith negotiations is a sufficient contractual provision; in that situation the plaintiff cannot be held up during the negotiations because the plaintiff does not need the money to pursue its suit.

Funding Shortfalls in Access to Justice Cases

When we drafted the model contract, we were more focused on plaintiffs who lacked the resources to sue effectively without financing, true access to justice cases (small corporations suing big ones, wealthy but not mega-rich individuals suing a much deeper pocket). In such cases, the need to negotiate bridge financing a la venture capital can leave plaintiff particularly vulnerable to being “held up”, to use the VC term. That’s in part because the plaintiff in a litigation faces far more systemic constraints and has much less control over the time frame for action than entrepreneurs in the open marketplace do. To protect against such uneven bargaining power, the draft model contract defaults to “Accelerated Investments” and “Supplemental Investments” instead of simply mandating further negotiations.

To understand “Accelerated” and “Supplemental” investments, the concept of “Committed Capital” must be kept in mind. That is, at the outset of the deal, the plaintiff and funder negotiate, based on their estimates of claim value and costs to conduct the claim, the total amount of money a funder is willing to invest to fund the entire claim–the “Committed Capital.” This amount of money is not invested all at once; rather, at the outset the deal is broken into tranches that the funder in good faith intends to invest at the various milestones, unless information developed during the conduct of the claim convinces the funder not to continue funding at such milestone.

An “Accelerated” investment occurs if it seems clear the money invested at the most recent milestone will run out before the next milestone arrives; in that situation, the funder is required to invest some of the capital it had already agreed to invest at a later date. This investment thus does not change the total amount of capital a funder has been willing to commit to a case. While it is true that accelerating some of the investment may ultimately produce a future shortfall, that result is not nearly certain because no one can gauge when settlement will happen.

Imagine, for example, that going through discovery was significantly more expensive than anticipated at the Initial Closing, so that the money invested then will run out before the close of discovery. Requiring additional investment to reach the close of discovery does not necessarily mean that insufficient funds will remain committed to conduct the rest of the case; settlement after the close of discovery is a plausible result, particularly for these types of cases. Indeed, the critical difference between Accelerated Investments and what happens in bridge financing is not that additional capital is invested; the difference is that with Accelerated Investments the price of the capital is not re-negotiated and the further investment is not optional.

(An important caveat is that the Accelerated Investment is not totally mandatory; the funder can terminate the contract at will to avoid Accelerated Investments, with various consequences depending on what the funder does. This discussion assumes the funder does not want to terminate the contract. However we will revisit this issue in Friday’s post, which returns to termination as we start discussing termination for cause.)

The bar against renegotiation is justified both by the disproportionate bargaining power issue above and by the fact that nothing has changed to justify altering the terms. Specifically, at the last profound change in information about claim value (as opposed to claim cost)–the last milestone–the funder made the decision to invest on certain terms. As the next milestone has not yet been reached, and thus the informational landscape of claim value not significantly changed, the return earned by the new purchase of Litigation Proceed Rights should have a similar–indeed, because of the time value of money, greater–return as the Rights bought at the earlier milestone.  That seems commercially reasonable.

The mandate to invest is justified both to protect the plaintiff from being held up and because our courts are a public good and are currently tremendously overburdened. If funders could walk away from a claim before reaching a point at which the information about claim value has materially changed, they could “claim shop.” That is, funders could initially invest in many claims, and then abandon many even though new information about claim merit/value has not emerged to divert resources into a subset of those investments. (According to some, this happens with some contingency law firms that invest in a large portfolio of cases).  In this scenario, the claims they would continue funding would be the ones that were moving along fastest, at lowest cost, or the ones in which plaintiffs offered the best possible deal; not necessarily those that were most meritorious or most potentially valuable to all parties. Indeed, funders would have an incentive to always under invest at the initial closing. This outcome would be less problematic in the venture capital context, but in the litigation context it is normatively undesirable. (Again, plaintiffs that are using funders for accounting reasons do not face the bargaining power problem and these concerns are not significant.)

In sum, the concepts of Accelerated Investments and even Supplemental Investments help prevent funders from abusing the system by forcing them to honor their commitment to the plaintiff through to a point where all parties have new information that justifies reassessing going forward and/or what the terms of a fair settlement are.

Admittedly, supplemental Investments are somewhat different, in that they occur after all the Committed Capital has been spent. Nonetheless, if the funder has not already decided to exit, whether by ceasing funding at a milestone, lining up a replacement funder, or simply walking away and cutting its losses, the funder is affirming that in its view the case is meritorious and should be pursued. Because Supplemental Investments require the investment of new capital, the contract imagines the funder will want a premium, and it suggests one. The point of doing that negotiation at the outset is simply to limit the transaction costs and bargaining power disparity when the committed capital runs out; the premium has already been negotiated.

When we first unveiled the idea of Accelerated and Supplemental Investments, Edward Reilly objected based on the idea that the funder is absorbing the risk of cost overruns without itself causing the overruns. Indeed, while many reasons can drive the overruns, as partially sketched by Kenneth Linzer and Elisha Weiner, only a poorly conceived litigation budget (or a strategic decision pushed by the funder) could be even partially attributed to the funder. There are two kinds of responses to Mr. Reilly’s concern.

One, the allocation of risk is appropriate because it is on the party most able to bear it, one that (in the case of Accelerated Investments) has already indicated a willingness to invest the capital in the claim. We acknowledge, however, that Supplemental Investments are very different than Accelerated Investments, even in access to justice cases, as they involve the provision of new capital.

Finally, Weiner and Linzer also suggest that Accelerated Investments and Attorney Waste would push funders to use litigation counsel that are repeat players so that the funders can exert more influence on the Litigation Counsel. That concern seems to us to be a bit overstated, simply because funders are already heavily incentivized to work with repeat Litigation Counsel to get that influence. That is, it may be true that the terms increase that incentive but it is not clear to us that the increase is meaningful given the strength of the underlying incentive.

Here is the revised contract language:

[5.4 Funding Shortfall: If a Funding Shortfall occurs, Litigation Counsel shall so certify to [the/each] Funder and the Plaintiff. Within [30] days of receiving such certification, the parties shall negotiate in good faith to finance the Claim until the next Milestone; such negotiations may involve the sale of additional Litigation Proceed Rights or any other financing mechanism not prohibited by law.]

Alternate:

[5.4 Accelerated Investment: If an Acceleration Event occurs, Litigation Counsel shall so certify to [the/each] Funder. Within [30] days of receiving such certification, [the/each] Funder shall purchase [a pro-rata share of] [5] Litigation Proceed Rights at the Litigation Proceed Right Purchase Price used at the Closing immediately prior by depositing the Funder’s total purchase price into the Litigation Account. This Accelerated Investment shall not represent a new capital commitment; instead it is the acceleration of a portion of the capital intended for investment at the next Closing. The number of Litigation Proceed Rights sold at an Acceleration Closing shall reduce the number of Litigation Proceed Rights offered for sale at the [Discovery Closing/at the next Milestone Event Closing] by a like amount.

[5.5 Supplemental Investment: If a Supplemental Investment Event occurs, Litigation Counsel shall so certify to [the/each] Funder. Within [30] days of receiving such certification, [the/each] Funder shall purchase [a pro-rata share of] [5] Litigation Proceed Rights at [the Litigation Proceed Right Purchase Price used at the Closing immediately prior/at a price [10%] less than the price used at the Closing immediately prior] by depositing the Funder’s Supplemental Investment into the Litigation Account.]

Funding Shortfall: The balance of the Litigation Account falls below [$ ] and the Litigation Counsel in good faith reasonably believes the amount remaining in the Litigation Account is insufficient to finance the conduct of the Claim through to the Milestone Event marking the next Closing.

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.