Lisa Baker Morgan
What do the Hulk Hogan/Gawker Media and Underwood /Huy Fong (Sriracha Hot Sauce) litigations have in common? Both received financing from a third party funder (TPF). In the former, it was PayPal cofounder and early Facebook-backer Peter Thiel; in the latter, it was Burford. Third party litigation financing (TPLF) is becoming more and more commonplace. It is estimated that there are $15.2 billion in commercial litigation investments in the United States alone. See U.S. Chamber of Commerce Institute for Legal Reform "What You Need to Know about Third Party Litigation Funding" (June 7, 2024) (https://instituteforlegalreform.com/what-you-need-to-know-about-third-party-litigation-funding/). In 2023, Burford committed $1.2 billion to finance the legal industry and its portfolio includes over 1,000 litigation and arbitration matters. (https://www.burfordcapital.com/eu/about-us/)
TPLF generates both curiosity and criticism. Little has been written on the topic of TPLF and mediation. Then the Burford /Sysco Arbitration happened. While TPFs often represent that the litigation/settlement remains with the client (https://www.burfordcapital.com/eu/insights-news-events/insights-research/video-why-burford/), the dispute between Sysco and Burford demonstrates that a TPF's level of involvement in mediation may extend beyond an advisory role. First, some background on TPLF and litigation funding agreements (LFAs).
What is TPLF?
TPLF is non-recourse funding by a TPF contingent upon the outcome of the case. If the party does not prevail, they do not pay. Because the financing is an investment, not a loan, lending laws do not apply. Hedge funds are the largest private source of capital. Other funders include listed companies, closed single funds, operating companies with investors who reinvest profit and pay dividends to investors, and family offices as part of their diversification. While some parties seek TPLF out of financial need; for others, it is strategic - to mitigate risk, retain cash for other projects, or monetize their claim by realizing its value up front instead of years down the road. TPLF is an attractive investment because litigation does not fluctuate like the stock market and TPLF is a way to diversify an investor's portfolio.
There are two types of funding: consumer funding which provides personal funds to plaintiffs bringing personal injury claims (which do not fund the litigation); and commercial litigation funding - TPLF or alternative litigation funding (ALF) - where a TPF invests in the litigation or arbitration by funding the legal fees and costs. This article concerns the latter. There is single case funding and portfolio funding which permits a TPF to finance multiple cases belonging to a law firm (or a company) with a return on invested capital from the settlement or judgment/award of any individual or group of cases. In the U.S., law firms are financing their growth through legal finance.
TPLF began in Australia in the 1990s. About ten years later it expanded to the U.S. and Europe. In common law jurisdictions, TPLF was previously not permitted due to champerty and maintenance laws which forbid third parties from providing financial assistance to a party for a financial interest in the outcome or meddling in another's lawsuit. In the U.S., champerty is a state issue. California does not recognize prohibitions against champerty or its variants. See In re Cohen's Estate (1944) 66 Cal.App.2d 450.
The TPLF industry is largely unregulated. Last year 60 Minutes' Leslie Stahl did a piece on the lack of legislation or rules pertaining to TPLF. There remains no legislation in California governing TPLF. Senate Bill 581 - which attempted to regulate the industry and originally required parties to disclose the existence of TPLF - died in February 2024. It should come as no surprise that within the last five years, California has seen an influx of TPFs coming to the state or opening branch offices.
A TPF's decision to invest in litigation or arbitration occurs only after months of due diligence. This analysis includes the claims, defenses, attorneys involved, venue, anticipated fees/costs to take the matter to trial or arbitration, the expected return, and the likelihood of success. Issues of appeal, the liquidity of the potentially liable party and costs of enforcement (including possible annulment and set-aside procedures) are also included in the analysis. Anticipated recovery is also discounted. International arbitration matters carry a greater risk because there is no stare decisis. Prior to due diligence, the potential funded party (and their counsel) and the TPF will execute an NDA to permit the honest exchange of information.
LFAs may be underwritten in a variety of ways, for example: (1) if the party is successful, the TPF will recover a multiple of the money invested (i.e., Underwood Farms' paid Burford 2x the investment amount); (2) the TPF could obtain a percentage (i.e., 30-40%) of a settlement or judgment/award; or (3) there could be a sliding pay scale (i.e., the TPF receives a larger percentage the further along the process has gone). It could be a combination of these using whichever is greater. Whether or not a matter will be funded typically is based upon the ratio used, for example, 1 to 10; 1 being the amount of budget (how much investment will realistically be needed) and 10 being the recoverable damages. Most matters are not funded.
There is a lack of uniformity on the discoverability of TPLF in litigation. In California, the identity of a TPF may be discoverable; some courts have automatic disclosure requirements in this regard. For example, the Central District of California Local Rule 7.1-1 requires that all non-governmental parties shall file with their first appearance a Notice of Interested Parties which identifies all persons, corporations, associations, etc., "with a pecuniary interest in the outcome of the case." The Northern District of California Civil Local Rule 3-15 is similar. LFAs and communications regarding the investment or underwriting are not typically required to be disclosed. Guidance in this regard comes from patent cases, one-fourth of which are estimated to be funded by TPFs. When TPLF may be deemed relevant, attorney-client, work-product or common interest privileges/doctrines may apply. See e.g., Taction Tech., Inc. v. Apple Inc, No. 21-CV-00812-TWR-JLB 2022 WL18781396, at *5 (S.D.Cal Mar. 16, 2022) (permitted disclosure identities of the TPFs and the existence of LFAs but denied compelling the production of communications regarding TPLF or the LFAs); Finjan, Inc. v. SonicWall, Inc., 2020 WL 4192285, at *4 (N.D. Cal. July 7, 2020) (magistrate judge held common law doctrine did not apply to information shared with a third party litigation funder and Finjan waived any work-product doctrine protection by their use in another matter).
The benefits and concerns presented by TPLF
American litigation is expensive and without financial support, some would have no access to the justice system or the ability to continue in the process. TPLF can level an uneven financial playing field and align the risk tolerance between the parties. The existence of TPLF may also cause an opposing party to re-evaluate its risk analysis, providing the funded party with leverage in settlement negotiations and litigation it might otherwise not have.
There are three primary concerns surrounding TPLF: the encouragement of frivolous lawsuits or litigation abuse; compromise of the attorney-client relationship; and the impact on settlements. At the heart of these concerns lies the motivation and interference level of a third party in a lawsuit.
When it comes to frivolous lawsuits two examples are often cited: class actions (which are more vulnerable to litigation abuse because the defendant faces greater exposure); and patent cases where entities or monetizers ("patent trolls") make patent assertions. There are arguments that TPLF has been used by foreign adversaries to influence the American justice system or negatively interfere with American businesses. This argument has gained more traction recently in IP litigation, class actions, transnational commercial matters, and investor-state disputes. Inspired by these concerns, Senate Bill: "Protecting Our Courts from Foreign Manipulation Act of 2023," was introduced in Congress last year. (https://www.congress.gov/bill/118th-congress/senate-bill/2805/text). The U.S. Chamber of Commerce has emerged as the primary adversary of TPLF, and the Chamber's Institute for Legal Reform has raised alarms about the risks and potential misuse of TPLF.
TPLF raises concerns that the funded representation will be compromised in favor of the TPF. Both the ABA and the California Bar Association have addressed the topic. The California bar issued a formal opinion on a lawyer's professional responsibilities regarding TPLF. See Formal Opinion Interim No. 2020-204 State Bar of California Standing Committee on Professional Responsibility and Conduct. While the opinion does not say that "any particular degree of control of the litigation" by a TPF is per se unethical, it reiterates that an attorney has an ethical "obligation to advise the client about the impact of such limitations on the lawyer's representation." Id. at 6. The ABA's 2020 Best Practices for Third-Party Litigation Funding emphasizes the importance of transparency, informed consent from clients, and the independence of legal counsel. (https://www.americanbar.org/content/dam/aba/directories/policy/annual-2020/111a-annual-2020.pdf).
Lastly, TPLF may influence settlement negotiations in a variety of ways. First, the existence of funding may discourage a funded party from settling, making them more willing to "roll the dice." (Although this does not seem any different than matters prosecuted under a contingency fee agreement.) It should also be pointed out that TPLF may encourage settlement as the non-funded party may re-evaluate its position and that of the funded party; very few matters are funded and that fact lends credibility to the funded party's case.
Second, the terms of the LFA itself may discourage settlement. For example, if the funding agreement has a waterfall clause, requiring the TPF to be paid before anyone else, this could affect creative settlements - such as structured settlements.
Third, it is argued that there is a misalignment of timing and interests between the funded and the TPF. A funded party may also have non-financial interests - business relationships, creating or modifying contracts, its reputation, use of human resources - that, if satisfied, justify accepting a lower monetary settlement. (This should be obvious. The TPF's interest is a solid return on its investment.) As for timing, the TPF may have a timeline dedicated to the maximization of profit - which matter settles first and for how much - as it may influence other investments in which they are a part. If the LFA is written as a sliding scale or as 3x the money invested, as long as settlement covers that obligation the TPF may not care if and when settlement occurs. However, if the funding agreement is written as a percentage of the settlement/award, a TPF may want to hedge its bets and let a matter go to trial even if the funded wants out. The issue is the degree of influence a TPF has on the negotiations, directly or indirectly. No doubt, the terms of the LFA will be top of mind in any settlement negotiation. However, LFAs - and their impact on settlements - have largely eluded public examination.
That is, until now.
This guest article is part one of a three-part series exploring litigation funding. The next article will appear on Monday, Aug. 19.