Disclosing Financing in Litigation—The New Defense Tactic

What is commonly referred to as third-party litigation financing is gaining popularity among litigants, attorneys, insurers and corporations. According to a 2017 survey, the use of litigation financing in the U.S. has grown by 414% since 2013, and half of all lawyers who have not yet utilized litigation financing are expected to do so within two years.

Whether the transaction is recourse or non-recourse, involves a single case or a portfolio of cases, the litigation finance industry is exploding. However, as with all burgeoning fields, certain problems have arisen—namely the issue of disclosure.

Typically, for defendants, litigation financing utilized by the plaintiffs’ side (whether for case or personal expenses, to pay plaintiffs’ counsel, or obtained directly by plaintiffs’ counsel) is a mysterious, un-welcome entrant to the case. This is because traditionally defendants could leverage their massive resources to the detriment of plaintiffs whose law firms tended to be less well financed than defense firms. Now, third party financing serves as an equalizer in the fight.

Knowing this, some defendants have sought disclosure of the third-party financier’s identity in lawsuits, as well the nature of the financing agreement, with an eye towards using it against the plaintiffs’ side.

Whether the identity of a litigation funder should be disclosed is a question being addressed by both courts and legislators.

Proponents of disclosure argue that transparency is necessary to detect potential ethical violations and to determine the level of case participation by non-parties holding a financial stake in the outcome. 

In contrast, third-party funders and others benefiting from the arrangements claim such financing does not create ethical concerns, nor does it influence the outcome of litigation. If anything, they argue that it facilitates a fairer and timelier settlement.

With this backdrop, the battleground is staged for the legislature and courts to grapple with this issue in the years to come.

Legislation

FRCP Rule 26

In early 2017, the U.S. Chamber of Commerce proposed that Rule 26 of the Federal Rules of Civil Procedure be amended to require disclosure of “any agreement under which any person, other than an attorney permitted to charge a contingent fee representing a party, has a right to compensation that is contingent on, and sourced from, any proceeds of the civil action, by settlement, judgment or otherwise.”

The Advisory Committee on Civil Rules previously considered such a change to the rule in 2014, but decided to delay action until the third-party funding market became more developed.

Even though the industry saw large growth in the three intervening years, recently the Advisory Committee once again deferred action with respect to third-party financing disclosures until there was evidence of a meaningful change in the market that would justify its further consideration.

Despite the Advisory Committee’s decision to postpone dealing with the issue at this time, at least one state has passed a law requiring the disclosure of third-party litigation funding in civil cases and, more recently, a bill has been introduced in the Senate that would compel disclosure of such specialty funders and their financing agreements in class actions and multidistrict litigations.

Wisconsin Act 235

On April 3, 2018, Wisconsin became the first state jurisdiction in the United States to mandate the disclosure of third-party litigation funding arrangements.

Under Wisconsin Act 235, parties to a civil suit are required to provide to the other side—without a discovery request—any agreement wherein a third-party has a right to receive compensation that is contingent on, and derived from, any proceeds of the case.

While this legislation means plaintiffs’ and plaintiffs’ attorneys in Wisconsin must now disclose any financing they have received if the source of repayment is contingent upon and derived from the proceeds of a case, it is believed that it will not generally include the mandatory disclosure of more traditional attorney loans or lines of credit. Loans and lines of credit are generally recourse and are payable regardless of whether the case is won or lost; in other words, repayment is not contingent upon or derived from, the receipt of case proceeds. Under these circumstances, disclosure would not likely be required even though the maturity date of the loan might coincide with the receipt of case proceeds, provided that repayment is otherwise due even if no (or insufficient) proceeds are received from the case. 

Litigation Funding Transparency Act of 2018

The Senate Judiciary Committee Chairman Chuck Grassley (R-Iowa) and Senators Thom Tillis (R-N.C.) and John Cornyn (R-Texas) introduced the Litigation Funding Transparency Act of 2018 on May 10, 2018, which, if passed, would amend Chapter 114 and Section 1407 of title 28 of the United States Code to require disclosures related to third party litigation financing in certain large-scale disputes. 

In particular, under the proposed Act, plaintiffs’ counsel in any federal class action and any federal coordinated or consolidated proceeding (i.e. a multidistrict litigation) would be required to (1) disclose to courts and other named parties, in writing, the identity of any third party “commercial enterprise…that has a right to receive payment that is contingent upon the receipt of monetary relief in the class action [or multidistrict litigation] by settlement, judgment, or otherwise,” and (2) produce any agreement creating the contingent right, unless otherwise stipulated or ordered by the court.

Further, the bill provides that plaintiffs’ counsel must make the disclosure no later than ten days after the financing agreement is executed or at the time of service of the action.

In support of the legislation, Senator Grassley stated, “transparency brings accountability…. The courts and opposing parties should know whether there are undue pressures and secret agreements at play that could unnecessarily drag out litigation or harm the interest of claimants themselves.” However, noticeably absent from the proposed Act are any disclosure requirements of the defense counsel’s financing sources, which arguably, could also drag out litigation and are more likely to harm the interest of claimants.

Similar to the Wisconsin Act, it is believed that this bill will not mandate the disclosure of more traditional attorney loans or lines of credit because typically payment under those types of financing arrangements is not a contingent right. Additionally, the bill, as drafted, only applies to commercial funders—not litigation financing provided by individuals.

Court Rules and Rulings

Given that there are no definitive rules governing third-party funding disclosure in most jurisdictions, the courts are left to deal with the issue on a case-by-case basis.

Northern District of California 

With respect to attorney funding (as opposed to plaintiff financing), in 2016 the U.S. District Court for the Northern District of California adopted its own disclosure requirement through a Standing Order.[1] The Court later added to its Order a provision requiring that in any proposed class action, all judges must mandate the disclosure of the identity of third-party lenders that have funded any claim or counterclaim if the lender has a contingent interest in the proceeds derived from the case.[2] The application of the rule was intentionally limited to class actions.

In August 2016, a Northern District of California court took up the disclosure issue in the case, Gbarabe v. Chevron Corp.[3] In that case, the defense moved for disclosure of third party funding source to determine the plaintiffs’ counsel’s “adequacy” to represent the class members.[4] The plaintiffs’ counsel did not resist on privilege, work product or “common interest” grounds, but rather, asserted a contractual obligation not to disclose the funder’s identity.[5] Ultimately, the court granted defendant’s motion to compel disclosure of the funding agreement, finding it relevant to the adequacy determination.[6]

Northern District of Ohio

Recently, on May 7, 2018, a multidistrict litigation court for the first time held in favor of disclosing third-party attorney funding arrangements.[7] Specifically, the court ordered that any attorney who obtained third-party contingent litigation financing must: (1) share a copy of the judge’s order with any lender or potential lender; and (2) submit ex parte, for in camera review (a) a letter identifying and briefly describing the third-party financing, and (b) a sworn affirmation from each of counsel and the lender that the third-party contingent litigation financing does not: (i) create any conflict of interest for counsel; (ii) undermine counsel’s obligation of vigorous advocacy; (iii) affect counsel’s independent professional judgment; (iv) give to the lender any control over litigation strategy or settlement decisions; or (v) affect party control of settlement.[8] Similar to Wisconsin Act 235, third-party contingent litigation financing was defined by the court as “any agreement under which any person, other than an attorney permitted to charge a contingent fee representing a party, has a right to receive compensation that is contingent on and sourced from any proceeds of an MDL Case, by settlement, judgment, or otherwise.”[9]

The Court in the Opioid MDL further stipulated that absent extraordinary circumstances, the Court will not allow discovery into third-party contingent litigation financing.

The issue of whether a party is required to disclose a lender’s identity and/or the terms of a funding agreement will be greatly litigated in the years to come. Although a recipient of funding is not obligated to disclose this information in the normal course of discovery, at this point, the rules will develop on a jurisdictional basis until legislation is enacted.

In the meantime, plaintiffs and plaintiffs’ attorneys utilizing third party funding should be aware of rules, regulations and court decisions controlling their cases when deciding whether (1) they should disclose their funder’s information or (2) what type of financing to secure. Currently, financing transactions that are structured as recourse loans or credit lines are immune from any disclosure requirements. Conceptually, any new attempt to prompt disclosure of plaintiff law firm loans or lines or credit could well result in an equivocal request to the defense bar, which often utilize traditional bank lines as well.

[1] See Notice Regarding Civil L.R. 3-15 and Standing Order for All Judges of the Northern District of California (Jan. 2017).

[2] Id.

[3] Order Granting in Party Defendant’s Motion to Compel, Denying Plaintiff’s Administrative Motions to File Under Seal and Denying Plaintiff’s Motion for Sanctions, Gbarabe v. Chevron Corp., No. 3:14-cv-00173 (N.D. Cal. Aug. 5, 2016) (Doc. 159).

[4] Id. at 2.

[5] Id. at 3.

[6] Id. at 4.

[7] Order Regarding Third-Party Contingent Litigation Financing, In Re: National Prescription Opiate Litigation, Case No.: 1:17-md-2804 (N.D. Ohio May 7, 2018) (Doc. 383).

[8] Id. at 1-2.

[9] Id. at 1.