August 2018 | Earn one hour of MCLE Credit in Legal Ethics
By Amy Bomse
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Seeking to vindicate one’s rights through litigation, particularly modern-day, discovery-heavy litigation, requires resources. Traditionally, a party with a claim has had two main options: (a) pay the fees out of pocket, either personally or with help from a related party (e.g., a relative or indemnitor); or (b) enter into a contingency fee arrangement with one’s lawyer whereby the lawyer is entitled to a portion of any recovery.
In the last couple of decades, however, another option has emerged in the United States—a contract with a third party litigation funding company.
A litigation funder provides funds to a litigant in exchange for which the claimant agrees that the funder will be entitled a percentage of future proceeds from the litigation, if any. (There are other models of litigation funding including portfolio funding in which a litigation funder provides funds to a law firm to finance a portfolio of cases.) The financing is typically non-recourse, which means that if the funded party does not recover in the litigation, the client has no obligation to repay the funder from other sources.
The litigant may use the funds to pay litigation expenses or for non-litigation purposes, including personal or business expenses. This flexibility is an advantage litigation funding offers over a traditional contingent fee arrangement. A lawyer is generally prohibited from agreeing to pay non-litigation expenses of a prospective client or existing client, although a lawyer may loan money to an existing client upon written agreement to repay the loan. California Rules of Professional Conduct (“Rules”), Rule 4-210
Many legal ethics committees and other bodies have published opinions that consider various ethical implications of the introduction of a litigation funding agreement into the mix of litigation and the attorney-client relationship. Broadly speaking, these authorities agree that there is no categorical ethical prohibition on a lawyer representing a client that has entered into a legal funding agreement.
However such funding arrangements pose risks that the attorney-client relationship or the representation may be compromised in ways that can implicate ethical rules. This article flags some of the key risks to assist practitioners in avoiding them. It should be noted that in addition to legal ethics issues, there may be separate questions about the cost of these funds and fees associated with obtaining such funding; such considerations are not addressed in this article.
Is it legal? California lawyers must uphold the laws of California and the United States. Accordingly, one of the first questions a lawyer would need to consider is whether a litigation funding arrangement runs afoul of any California or federal law. There are states that still recognize prohibitions on champerty and maintenance, legal doctrines dating from the Medieval England that developed to prevent feudal lords from financing other individuals’ legal claims against the wealthy financer’s political or personal enemies. See Charge Injection Tech. v. DuPont, 2016 WL 937400 *4 (Del. Sup. Ct.) (“CIT”) (denying motion to dismiss plaintiffs claim on the basis that funder was actually litigating the case in violation of Delaware’s common law anti-champerty rule). California, however, has never recognized or adopted prohibitions on champerty. See In re Cohen’s Estate 66 Cal.App.2d 450, 458 (1944) (“those doctrines have their origin in statutes enacted in England in early times, but which afterwards became nearly obsolete because…the evils those doctrines were designed to prevent had ceased”).
Professional Independence and Funder Control: A lawyer has an ethical obligation both as an advocate and licensed attorney to exercise independent judgment in representing their client. The ABA Model Rules require that a lawyer “exercise independent professional judgment and render candid advice.” Model Rule 2.1. There is no parallel rule in the California ethics rules; however the concept is present in California law.
For example, the Rules of Professional Conduct forbid a lawyer from accepting compensation for representing a client from one other than the client unless there is no interference with the attorney’s independent professional judgment, the client gives informed written consent to the arrangement and confidential information is protected. Rule 3-310(F).
Typically a litigation funder pays the client who may use those funds or some of them to pay the lawyer. In such an arrangement, Rule 3-310(F) would not appear to apply because the funder is not directly paying the lawyer’s fees any more than a bank that loans a client money to pay the client’s legal fees can be said to be paying the lawyer’s fees.
Nonetheless, the ethical imperative to exercise independent judgment requires a lawyer to ensure that their professional judgment is not clouded by the interests of a third party funder.
A related concern is that the funder may seek control over aspects of the litigation. For example, a funding contract might put limits on the client’s right to change counsel. See e.g. Charge Injection Tech. v. DuPont, 2016 WL 937400 *4 (Del. Sup. Ct.) (“CIT”) (funding agreement disclaimed control but funder retained right to approve any proposed changes in counsel). Some ethics committees have concluded that a client may ethically cede certain control as long as the client does so in a free and informed manner. NYC Bar Assoc. Formal Op 2011-02 (concluding that with the appropriate consent, a client may “agree to permit a financing company to direct strategy or other aspects of a lawsuit”).
The contractual obligations of the client to the funder, however, do not alter the lawyer’s ethical obligation to independently advise the client. Rather, the terms of funding agreement become another aspect of the case that the lawyer must take into account in advising the client. See ABA Formal Op. 96-403 (lawyer may not accept settlement agreement against wishes of client even if client’s contract with its insurer gives insurer right to settle within policy limits).
A more difficult question is whether a funding agreement contains terms that may curtail the individual lawyer’s judgment about how to run the case and the ethical implications of such terms.
The ABA has recognized a litigation funding contract “may create such a limitation on the attorney’s professional judgment that a reasonable lawyer might conclude that it is impossible to provide competent representation.” ABA’s Commission on Ethics 20/20, Informational Report to the House of Delegates at 23.
Duty of Loyalty and Conflicts of Interest: There is also a risk that a lawyer’s loyalty to the client may be divided by the presence of a litigation funder with its own significant interest in the matter. The duty of loyalty along with the duty of confidentiality is the bedrock of the attorney-client relationship. Flatt v. Superior Court, 9 Cal. 4th 275, 289. The duty of loyalty prohibits an attorney “from assuming any relation which would prevent him from devoting his entire energies to his client's interests.” Santa Clara County Counsel Attorneys v. Woodside, 7 Cal. 4th 525, 548 (1994).
The interests of the funder and the client will generally be aligned: both wish to obtain a favorable judgment or settlement. However, the interests could diverge. To give a simple example, a funder who has provided $1 million in funding may prefer that the plaintiff settle for any amount over $1 million, particularly if the funding contract calls for the funder to get paid first. If the lawyer is concerned to maintain a good relationship with a funder, that relationship and the funder’s interest could interfere with the lawyer’s independent judgment about whether to advise the client to settle. The lawyer’s ethical obligations both to exercise independent judgment and loyalty to the client require that they put aside the interests of the funder and advise the client based on what is in the client’s interests.
The California conflict of interest rules require a lawyer to disclose to their client any legal, business, financial, professional or personal relationship they have or had with a witness or party in the same matter or with a person or entity that the lawyer knows or reasonably should know would be “affected substantially” by resolution of the matter.
The funder, whose recovery depends on the outcome of the case, is clearly “affected substantially” by the outcome of the matter. If the lawyer has a legal, business, financial, professional or personal relationship with the funder, they would need to disclose that in writing to the client.
For example, if a funder has a history of providing funding to the lawyer’s clients or clients of the law firm, the lawyer should consider whether that the history creates a relationship with the funder that the lawyer must disclose. In addition to complying with applicable disclosure rules, as noted above, the duty of loyalty obligates the lawyer to pursue the client’s best interest even if doing so is not in the best interest of the funder.
Confidentiality: Representing a client whose case is funded by a litigation funder also implicates the lawyer’s ethical obligation to protect the confidences of the client. California law requires the lawyer to preserve the secrets of his or her client at every peril to him or herself. Business and Professions Code §6068(e). The rules make this legal obligation an ethical one as well. See Rule 3-100 (lawyer may not reveal information protected by 6068(e) without the informed consent of the client (except in very limited circumstances)).
Litigation funders are likely to ask for information about the case prior to investing in order to assess its merit. A lawyer may not disclose any client confidences without first obtaining the client’s informed consent. “Informed written consent” is defined as written agreement after disclosure to the client of the “actual and reasonably foreseeable adverse consequences to the client.” In order for the client’s consent to be informed, the lawyer must inform the client about the risks such sharing may entail, including the risk that its adversary may seek to discover communications between the funder and the client or lawyer and that a court may hold that the sharing effected a waiver of otherwise available evidentiary privileges.
Under California law, confidential communications between a lawyer and a client are privileged. Evid. C. 954. Disclosures to third parties who are reasonably necessary to the accomplishment of the lawyer’s engagement does not waive the privilege. Id. at 952. However, generally disclosing to a third party a “significant party” of a confidential communication or consenting to such disclosure will destroy the confidentiality and thus the privileged status of the communication as well. Id. §912.
Based on these principles, disclosing privileged attorney-client communications to a litigation funder creates a risk that those communications may not be deemed to be protected by the attorney-client privilege. (It is possible that the communications may be protected by some other doctrine such as work product.)
In addition to attorney-client privilege, an attorney’s work product is protected from discovery. The purpose of the work product protection is to preserve the ability of an attorney to freely prepare cases for trial without fear that their work will be discovered and used by their adversary. See Civ. Proc. C. § 2018.010. In contrast to attorney-client privileged communications, mere disclosure of work-product does not always effect a waiver. Rather the inquiry is whether the disclosure “substantially increas[es] the possibility that an opposing party will obtain the information.”) 2 Christopher B. Mueller & Laird C. Kirkpatrick, Federal Evidence § 5:38 (4th ed. 2016).
Accordingly, several courts have held that work product does not lose its work product status because an attorney or client shares that work product with a funder as long as the funder agreed to keep the information confidential. See Miller UK Ltd. v. Caterpillar, Inc., 17 F. Supp. 3d 711, 738 (N.D. Ill. 2014) (holding that sharing with funder did not waive work product because disclosure did not substantially increase the likelihood that an adversary would obtain the materials where plaintiff had oral and written confidentiality agreements with prospective and actual funders).
However, lawyers who disclose or are aware that their clients are disclosing privileged information to funders must be cognizant of the fact that the law is still developing in this area and is not uniform. See Leader Tech. Inc. v. Facebook, Inc., 719 F. Supp. 2d 373, 376-77 (D. Del. 2010) (work product protection waived by sharing with funder).
A lawyer’s ethical obligations including the duty of confidentiality require that the lawyer apprise the client of the risks of sharing confidential information with litigation funders and take appropriate steps to mitigate such risks including using confidentiality agreements. See Miller 17 F. Supp. 3d at 738 (work product waived as to documents shared without protective measures).
The law profession continues to change and change fast. Like it or not, we lawyers are compelled to keep up and figure out how to do so ethically.
Amy L. Bomse is a commercial litigation partner with Arnold & Porter who focuses her practice principally on representing lawyers and law firms. She is currently serving as the Vice Chair of the Committee on Professional Responsibility and Conduct, a standing committee member of the State Bar of California Board of Trustees focused on legal ethics.
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