One of the biggest challenges in litigation finance is striking the right balance of risk between litigants and funders, consistent with the norms of the legal system and the ethical duties constraining counsel. Striking the right balance increases the chances meritorious cases are funded and that plaintiffs get their due. Key to striking the balance is determining the circumstances under which the funder can refuse to invest additional money in the case. On the one hand, funders need to be able to exit in certain circumstances. On the other, plaintiffs ideally should not be left without funds mid-way through a meritorious litigation that is being reasonably and responsibly pursued. The draft model contract enables a funder to end its commitments both with and without cause.
Termination Without Cause, Recap
As discussed some months ago, and revisited in our last post, the draft model contract allows a funder to refuse to purchase more Litigation Proceed Rights at pre-determined milestones, without having to justify that decision in terms of a material breach of the funding contract. Nor must a funder wait for the next milestone to signal its intent to refuse further funding; it may terminate its obligations without cause at any time, with varying consequences depending on whether the funder lines up replacement funding at any time. Those additional termination without cause provisions were necessary to enable a funder to escape Accelerated and Supplemental Investment obligations; if those provisions are not used, those termination provisions are unnecessary.
The critical points about terminating without cause are two. 1) The model envisions the funder making the decision on what is essentially a type of cause—new information about the claim that changes the risk/reward calculus—not simply for portfolio management or other extrinsic reason; hence the milestone focus. 2) The practical consequences of refusing to further fund may not be immediate; depending on the circumstances the plaintiff may be able to continue funding the claim for some time after the funder decides to pull out. The second point reflects the fact that the investment is not an ongoing, continuous draw but rather done in tranches. Depending on how many Litigation Proceed Rights were initially sold, their price, and the burn rate of the proceeds of that sale, the Plaintiff may have plenty of cash on hand when the next milestone is reached.
Termination for Cause Overview
We will start rolling out the termination for cause provisions on next Wednesday. The basic structure is straightforward. Certain provisions are deemed material, such that any breach presumptively constitutes a material breach and grounds for termination. The presumption could be rebutted if litigation ensued, but the burden is not easy to meet simply because proving a negative is hard.
The breach of any other provision can rise to the level of materiality if it has specified impacts on the Claim’s value. Material breaches trigger the right to terminate for cause. Like rebutting the presumption of materiality when contesting breach of certain provisions, proving materiality of the breach of the other provisions is hard for the same reason. In most cases it’s very hard to prove the breach had a sufficient impact on claim value, given all the extrinsic reasons claim value can be affected.
Because of these burdens of proof, we expect that termination for cause will only happen when the facts giving rise to the claim of breach are very clear and compelling.
So what should happen when terminating for cause, since termination without cause is already possible? We offer two alternative sets of provisions. One, the terminating party can pursue damages; or, certain consequences follow, plus the party can pursue damages. Details will follow as we unveil the terms.
Termination Provisions Uniquely American?
As noted by Jasminka Kalajdzic, in Canada judges oversee funding arrangements and are unlikely to countenance termination provisions like those in the model contract, essentially nixing the idea of staged funding in Canada. The reason is that funding in Canada is primarily a form of insurance against fee shifting (under a “loser pays” rule). In that context, if a funder could terminate that obligation by terminating the contract then its biggest value to Canadian litigants would evaporate. Kalajdzic also noted that Canadian judges would only accept termination for cause in narrow circumstances, primarily limited to information sharing. As a result, Canadian judges would also likely not approve of the termination for cause provisions of the model contract. We cannot anticipate how the provisions would play in other non-U.S. jurisictions.