The Dugal litigation finance contract, which provides insurance against adverse cost orders in a Canadian shareholder class action, allows the Funder and Plaintiff to terminate for cause, and allows the Funder to terminate by refusing to insure the adverse cost order risk during appeals. This structure closely parallels that of the draft model, which allows each to terminate for cause, and which allows the funder to terminate by refusing to make additional investments.
One key difference, however, relates to what is considered “cause.” Section 11 of the Dugal contract lays out the conditions which give the funder termination rights and what the consequences of such termination are. Subsection 11.1 describes the actions of the plaintiff that give the funder the right to terminate, which we are considering “for cause” although subsections in the Dugal contract do not have titles. 11.1 says:
“11.1 If the Plaintiffs,
(a) do not fulfill their obligations as stipulated in clause 3 above; or
(b) appoint different Lawyers to replace the present Lawyers;
the funder may elect to terminate this Agreement by serving a Termination Notice upon the Plaintiffs. Termination shall become effective as of the seventh day after service of the Termination Notice.”
“Clause 3″ contains a range of provisions, most of which the model also treats as so necessary that violation of them triggers termination rights (or would if the American system imposed process requirements that the Canadian system does), and one which we think is improper for triggering termination, or at least deserves close scrutiny by plaintiffs. Specifically, the information sharing and protecting duties of 3.1, 3.3, 3.4 and 3.5 are unsurprisingly important enough to trigger termination rights. Similarly the process/good faith commitments of 3.2 (b), 3.2(c) and 3.6 are essential to the agreement. However this language from 3.2 (a) is problematic:
3.2 The Plaintiffs must:
(a) conduct the Proceeding in a manner that avoids unnecessary cost and delay;
While making such a commitment in and of itself is not problematic, enabling the funder to terminate on this basis is. That’s because it makes the funder the party to judge what “unnecessary cost and delay” is, indirectly giving the funder significant influence over trial strategy. Nonetheless the funder has little incentive to abusively terminate the contract, because the consequences of such termination are costly: the funder loses any payout it would otherwise receive from moneys awarded plaintiff post-termination, and the funder remains liable for adverse cost orders tied to conduct during the term of the contract. Indeed, it is hard to imagine the funder terminating on this basis if it continued to perceive the case as a winner, and thus the provision functions as a risk hedging exit opportunity. As is clear from the model, we do not find such risk management categorically problematic. However, the indirect way the funder gains the right to manage the risk–by declaring the case conduct unnecessarily costly or delayed–gives the funder a kind of strategic influence not granted by the model. This hidden control is also seen in subsection 10.3 as discussed earlier.
In the model the funder gains this type of risk management termination ability directly, by being able to refuse further funding at milestones or to refuse bridge financing in between milestones. Under the model the consequences for termination vary and are designed to limit the plaintiff’s risk that the funder will leave it without financing. For example, the funder can terminate without any penalty if it lines up replacement funding. Terminating at other times triggers penalties of varying severity depending on whether the termination is at a milestone or in between. Because the funder in the model contract has made a significant direct investment as opposed to simply insuring a risk, the penalties tied to termination without replacement funding are more punative than the termination consequences in Dugal.
The funder’s right to terminate created by 11.1(b) is more problematic and perhaps illegal in the American system. American legal ethics require a client be able to fire her counsel at will. That is why the model allows a funder to opine on a plaintiff’s choice of replacement counsel and requires the plaintiff to hear the funder out in good faith, but doesn’t give the funder any kind of veto over the plaintiff’s choice. The Dugal contract provision allowing the funder to terminate if the plaintiff changes lawyers is a kind of veto. In practice it means “if you pick a lawyer you like but we don’t we’ll stop insuring you.”
While it is true that in the American system insurers can control the choice of counsel for their insured to a large extent, we believe the differences between the insurer-insured relationship and that of the plaintiff and funder in Dugal are too great to justify the control given the Dugal funder on that analogy. As a result, we believe 11.1(a) is problematic in the American system. Nonetheless we recognize why funders would negotiate for it: who the lawyers are goes directly to the risk of adverse cost orders, just as it does to the risk of whether or not the claim will be successful.
Under the Dugal contract, the Plaintiff’s termination rights are very straightforward: if the funder refuses to pay or doesn’t protect information appropriately, Plaintiff can terminate. In such case, the funder gets no payment and is still on the hook for adverse cost orders arising from conduct prior to the termination. The termination for cause rights are a little more complex in the draft model, but the consequences are essentially the same; the funder loses the benefit of its bargain.