9 Law Review Articles on Litigation Financing.pdf

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2. 47 Ariz. St. L.J. 919 Client/Matter: -NoneSearch Terms: litigation w/3 financ! Search Type: Terms and Connectors Narrowed by: Content Type Secondary Materials

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3. 63 DePaul L. Rev. 195 Client/Matter: -NoneSearch Terms: litigation w/3 financ! Search Type: Terms and Connectors Narrowed by: Content Type Secondary Materials

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4. 2005 Utah L. Rev. 863 Client/Matter: -NoneSearch Terms: litigation w/3 financ! Search Type: Terms and Connectors Narrowed by: Content Type Secondary Materials

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5. 47 Wake Forest L. Rev. 1083 Client/Matter: -NoneSearch Terms: litigation w/3 financ! Search Type: Terms and Connectors Narrowed by: Content Type Secondary Materials

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6. 54 Wm. & Mary L. Rev. 455

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8. 54 Brooklyn L. Rev. 539 Client/Matter: -NoneSearch Terms: litigation w/3 financ! Search Type: Terms and Connectors Narrowed by: Content Type Secondary Materials

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NOTE: Financing the Class: Strengthening the Class Action Through ThirdParty Investment November, 2015 Reporter 125 Yale L.J. 484

Length: 20441 words Author: TYLER W. HILL * AUTHOR. Yale Law School, J.D. expected 2016. My thanks are due to the many scholars - friends and mentors that have interrogated these ideas and encouraged me to move them forward. I am grateful to Kristin Collins for encouraging this project from its infancy and providing her indispensible mentorship and support through many drafts. Thanks also to Jonathan Macey, Ian Ayres, Howard Langer, Brian Fitzpatrick, Yair Listokin, and Keith Hylton for their feedback; to the participants of the Advanced Topics in Civil Procedure seminar in Spring 2014 for their helpful comments; and to Jane Ostrager, Rebecca Lee, and the Yale Law Journal Notes Committee for their outstanding editorial assistance.

Highlight ABSTRACT. Class action lawsuits compensate harmed individuals and enforce public norms. Their success depends largely on the ability of a private bar of entrepreneurial, fee-seeking attorneys to finance lawsuits through contingency fee representation. But the current method of awarding fees and restrictions on non-lawyer investment in lawsuits distort the set of class actions that make it into court and potentially inflate attorney fees. This Note proposes a novel method of financing class actions and setting attorney fees. Instead of relying on judges to award fees once the suit is over, this method would sell equity in a prospective class action award or settlement to financial investors before the case begins. Realigning the economics of the class action lawsuit in this way would enhance the ability of aggregate litigation to benefit plaintiffs and society. [*485]

[*486]

Text [*487]

INTRODUCTION The class action lawsuit, a mechanism of civil procedure that facilitates collective action where individual action would be financially or administratively infeasible, is a critical component of the American regulatory state. It provides at least two services to society. First, the class action enhances the ability of plaintiffs with legally cognizable harms to secure the remedy due to them under the law. Second, it promotes the rule of law, complementing the government's enforcement powers by enabling private parties to deter deep-pocketed defendants from malfeasance. But the system we have does not do as well as it could. The viability of class action lawsuits depends on an industry of fee-seeking attorneys to discover, orchestrate, and finance lawsuits. Deficiencies in how these suits are financed and attorneys are paid distort the economics of this industry, undermining its ability to deliver on its potential. The first deficiency involves financing class action lawsuits. Class actions are often expensive to litigate. Antiquated laws and rules prohibit non-lawyers from taking financial interests in lawsuits, so funding typically comes from the plaintiffs' lawyers themselves. Class action attorneys agree to front litigation costs through contingency fee arrangements in which they receive a portion of the funds awarded to the plaintiffs. This makes the financial viability of the lawsuit entirely dependent on the financial means and risk appetite of the plaintiffs' lawyers. It also raises the

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Page 2 of 31 125 Yale L.J. 484, *487 cost of capital - the financial return on their investment that the lawyers must achieve in order for the enterprise to be profitable. The second deficiency is the method courts use to set attorney fees. When they front the litigation costs, the lawyers take on the risk that the lawsuit will not prevail - a risk they can only properly appraise before the case commences. However, the fee, which partially compensates the lawyers for taking on this risk, is only set by the judge at the end of the case. Moreover, while the price of risk taking and the price of providing legal services are dictated by markets, class action attorney fees - set by judges - are generally not tested by any competitive market. As a result, even independent of the restrictions on outside financing, attorney fees often do not reflect the going market rate of legal services or the price of the risk of an individual lawsuit. This financing and fee regime undermines the class action's effectiveness. A failure to adequately differentiate lawsuits with differing levels of risk distorts the set of commercially viable lawsuits. It potentially suffocates some meritorious suits, and it privileges less socially beneficial suits that ride the coattails of government regulatory action over more beneficial suits based on novel claims. Moreover, the current system can raise the overall level of fees awarded to class counsel at the expense of plaintiffs. Finally, it can encourage - or even force - the plaintiffs' attorneys to settle for less than a claim is worth [*488] because the lawyers cannot or will not bear the responsibility of financing additional litigation, even where the risk-adjusted marginal benefit to the plaintiffs would exceed the marginal costs. As a result, plaintiffs with sound claims go without compensation and wrongdoers are not held accountable. This Note proposes a novel financing and fee-setting mechanism for a wide range of common fund class action lawsuits that would couple third-party funding with competitive price-setting. 1 Under this proposal, the plaintiffs' attorney auctions off an interest in his potential fee award to financiers, other attorneys, or even the plaintiffs themselves to fund all or part of the litigation. The auction would draw capital, allowing the lawsuit to proceed independently of the lawyer's ability or appetite to finance it. The auction would also set the plaintiffs' attorney's fee at a level determined by a competitive bidding process, driving down the price and maximizing the plaintiffs' share of the compensation for their injuries. Three other mechanisms for giving attorneys and plaintiffs financial flexibility could complement this "equity auction" procedure. First, courts could allow financial investors to purchase the claims of individual plaintiffs at the price set by the initial financing auction, giving plaintiffs the opportunity to sell their claims - in other words, to cash out, rather than opt out. This would allow plaintiffs to divest themselves of the risk of an adverse judgment and to benefit from cash payment before the completion of the lawsuit. Second, the equity auction could be accompanied by settlement bonding - an arrangement whereby a third party foils a defendant's settlement offer by indemnifying the plaintiffs and attorneys against the risks of rejecting the settlement and financing continued litigation. 2 This could reduce the impact of the plaintiffs' attorneys' incentive to settle prematurely. Finally, the winning bidder in the initial auction could syndicate her financial interest in the suit, bringing a wider panel of financiers to the table to share the risk. This could enhance many of the benefits of opening lawsuit financing to wider financial markets. Deficiencies in how class action plaintiffs' attorneys are compensated have long been a topic of academic and political debate. While this Note is not the first attempt at a solution, it offers a fresh approach. The analysis provides an account of the economic distortions inherent in the current class action financing and fee system, drawing on well-developed critiques of agency costs, 3 [*489] asymmetry in the plaintiffs' and defendants' stakes,

1

A "common fund" class action is one in which the plaintiffs are jointly awarded a sum of money. See William B. Rubenstein, Newberg on Class Actions § 15:56 (5th ed. 2011).

2

This add-on follows a proposal of Jay Tidmarsh. See Jay Tidmarsh, Auctioning Class Settlements, 56 Wm. & Mary L. Rev. 227 (2014). 3

For example, John Coffee has long criticized how class action plaintiffs' attorneys are compensated. See John C. Coffee, Jr., Rethinking the Class Action: A Policy Primer on Reform, 62 Ind. L.J. 625, 626 (1987) (noting that recent class action proposals lacked "any sustained focus on the incentive effects on the plaintiff's attorney" that the proposed procedural changes would

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Page 3 of 31 125 Yale L.J. 484, *489 4

and the futility of setting fees by judicial fiat after the lawsuit is complete. 5 The proposal draws on recent literature about the benefits of third-party litigation financing. 6 While the equity auction builds on and incorporates features of several attempted and proposed auction procedures, it is the first to incorporate improvements based on fee-setting procedures and external financing for a broad range of suits for damages and in a way that allows plaintiffs to retain ownership of their claims. Part I of this Note defends the normative foundation of this project, arguing that compensating plaintiffs and enforcing the law are worthwhile goals of the class action. Part I also addresses objections that converting the role of the plaintiffs' lawyer into a commercial enterprise is inappropriate. It replies that commodification of the class action is a natural result of reliance on the private bar to finance aggregate litigation and an essential corollary of our regime of public regulation through private rights of action. Part II demonstrates that the class action has fallen short of its potential due to restrictions on outside financing and irrational procedures for setting attorney fees. Part III provides an overview of the equity auction procedure, and elaborates on its advantages over the current system and other alternatives. [*490] Finally, Part IV responds to counterarguments that allowing third-party financing would increase agency costs and further enable socially undesirable negative-value lawsuits. Rather than making these problems worse, an open market in lawsuit financing could reduce agency costs and make it more difficult for unscrupulous lawyers to use the class action to extort unjustified damages from defendants. I. THE VIRTUES OF THE PRIVATE BAR This Note proposes a novel way to improve the contingency fee class action, but it must begin by laying the normative antecedent that the privately prosecuted, contingency fee class action is something worth keeping and improving. We should encourage private, fee-seeking attorneys to prosecute class action lawsuits to enforce the law on behalf of society and compensate plaintiffs for harm they have sustained. Moreover, we should reject normative counterarguments premised on squeamishness at commercializing the lawsuit. Such arguments deny the critical role that money already plays in American civil justice. A. Plaintiffs' Lawyers Provide a Valuable Service

have). Coffee's observations arose in the midst of a broader campaign to undermine the class action. See Deborah R. Hensler et al., Class Action Dilemmas: Pursuing Public Goals for Private Gain 15-22 (2000) (providing a concise history of the "holy war" against class actions in the press and academia during the 1960s and 1970s). While many of these contemporary critiques challenged the inherent viability of the class action, Coffee argued that "many of the deficiencies … are the judicially self-inflicted consequence of legal rules that establish serious misincentives." John C. Coffee, Jr., Understanding the Plaintiff's Attorney: The Implications of Economic Theory for Private Enforcement of Law Through Class and Derivative Actions, 86 Colum. L. Rev. 669, 671 (1986). 4

See, e.g., In re Rhone-Poulenc Rorer, Inc., 51 F.3d 1293, 1298 (7th Cir. 1995) (pointing to the potential for, in the words of Judge Henry Friendly, "blackmail settlements" in class actions where there is "a small probability of an immense judgment" (quoting Henry J. Friendly, Federal Jurisdiction: A General View 120 (1973))). 5

See, e.g., Andrew K. Niebler, In Search of Bargained-For Fees for Class Action Plaintiffs' Lawyers: The Promise and Pitfalls of Auctioning the Position of Lead Counsel, 54 Bus. Law. 763, 767-68 (1999) (noting that "the process which leads to an award of attorneys' fees often makes judges feel uneasy" because of the lack of arm's-length negotiation); see also Vaughn R. Walker & Ben Horwich, The Ethical Imperative of a Lodestar Cross-Check: Judicial Misgivings About "Reasonable Percentage" Fees in Common Fund Cases, 18 Geo. J. Legal Ethics 1453, 1464-68 (2005) (finding support for the "judicial intuition" that percentage of fund awards "may be over-compensating the lawyer (as an award from a common fund represents a zero-sum exercise) and thus under-compensating the plaintiff class"). 6

See, e.g., Deborah R. Hensler, Third-Party Financing of Class Action Litigation in the United States: Will the Sky Fall?, 63 DePaul L. Rev. 499, 504 (2014); Jonathan T. Molot, Litigation Finance: A Market Solution to a Procedural Problem, 99 Geo. L.J. 65 (2010).

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Page 4 of 31 125 Yale L.J. 484, *490 For the rule of law to obtain, the law must be enforced. 7 Enforcement is not free; the resources required to prosecute a claim must come from somewhere. Who should provide this service? We often turn to the government to enforce the law for us, with resources drawn from the public fisc. But there is an alternative: we can empower private citizens to enforce the law on behalf of themselves, others, and society at large. The American system of civil law enforcement is a mixture of both public and private efforts. 8 We often rely on private individuals to enforce the law through private rights of action, supplementing or replacing public bodies without the resources or mandate to enforce a particular claim. The private enforcer provides a critical public service: he is, in the now-famous words of Judge Jerome Frank, a "private [*491] Attorney General," 9 leveraging the collective claims of a class of plaintiffs to seek justice on their behalf and enforce the norms embodied in the law. While there are certainly alternative methods of public norm enforcement - for example, a model favored in Western Europe that relies more heavily on public bureaucracy for enforcement 10 - the United States has decisively chosen to place many important enforcement responsibilities in private hands. 11 Indeed, this choice, besides its consonance with a particularly American zeal for private enterprise over public provision, 12 reflects an inveterate conflict between the legislative and executive branches of government. As Stephen Burbank and Sean Farhang have observed, Congress's enablement of private enforcement through statutory private rights of action and fee shifting is "a form of insurance against the President's failure to use the bureaucracy to carry out Congress's will." 13 It is no coincidence that private enforcement took off in the 1960s, "when divided party control of the legislative and executive branches became the norm and relations between Congress and the President became more antagonistic." 14 Of course, the notion that the class action is responsible for enforcing the law over and apart from any duty to compensate plaintiffs is not without its critics. One prominent such critic is Martin Redish, who argues that class action plaintiffs' attorneys are "bounty hunters" that have "transformed the essence of [the] substantive law" in a way that "undermines fundamental notions of democratic theory." 15 Congress, Redish argues, did not intend for private causes of action to enable lawyer-driven suits whose primary focus is to [*492] enforce norms (and, through 7

See, e.g., Thomas Hobbes, Leviathan or the Matter, Forme and Power of a Common-wealth Ecclesiasticall and Civil 85 (1651) ("For the Lawes of Nature … of themselves, without the terror of some Power, to cause them to be observed, are contrary to our naturall Passions … . And Covenants, without the Sword, are but Words, and of no strength to secure a man at all.").

8

William B. Rubenstein, On What a "Private Attorney General" Is - And Why it Matters, 57 Vand. L. Rev. 2129, 2132 (2004) ("Lawyering … is like sex. There are not just two pure forms - the private attorney on the one hand and the government attorney on the other - but rather an array of mixes of the public and private."). 9

Associated Indus. of N.Y. State, Inc. v. Ickes, 134 F.2d 694, 704 (2d Cir. 1943). For a concise history of the private Attorney General concept, see Rubenstein, supra note 8, at 2133-37. 10

See Robert A. Kagan, Adversarial Legalism: The American Way of Law 6-14 (2001) (describing the "unique legal "style'" of the United States in compensating the injured and enforcing regulations). 11

Private rights of action support the enforcement of the law in a wide variety of areas. See, e.g., 15 U.S.C. § 15 (2012) (antitrust); 15 U.S.C. § 77k(a) (2012) (securities); 29 U.S.C. § 216(b) (2012) (labor standards); 42 U.S.C. § 1983 (2012) (civil rights). 12

Cf. Paul Starr, The Meaning of Privatization, 6 Yale L. & Pol'y Rev. 6, 37 (1988) ("The United States, which has never nationalized industry in the first place, stands in a position fundamentally different from the Western European countries with extensive public enterprise sectors… . The relations between the public sector and political leadership are drastically different in the United States from those prevailing in Latin America, the Soviet bloc, and even many Western European countries.").

13

Stephen B. Burbank & Sean Farhang, Litigation Reform: An Institutional Approach, 162 U. Pa. L. Rev. 1543, 1549 (2014).

14

Id.

15

Martin H. Redish, Class Actions and the Democratic Difficulty: Rethinking the Intersection of Private Litigation and Public Goals, 2003 U. Chi. Legal F. 71, 108.

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Page 5 of 31 125 Yale L.J. 484, *492 the bounty, enrich lawyers) rather than to provide actual plaintiffs with a meaningful remedy. 16 Redish suggests that the only acceptable class action lawsuits seeking primarily monetary (rather than injunctive) relief are those in which all members of the class have expressly chosen to participate in the lawsuit and would, if successful, receive meaningful compensation for their harm. 17 Any public interest accruing to society at large should be merely "incidental" to the private plaintiffs' compensation. 18 This argument incorrectly characterizes the content of the substantive laws that create private rights of action. These substantive laws exist to proscribe actors from undertaking certain kinds of undesirable activities; the private right of action granting the individual a right to recover against the lawbreaker is incidental to the prohibition of the offending activity. When viewed this way, it is the substantive norm embodied in the law, rather than the procedural right belonging to the individual, that bears emphasis. The attachment of a private right of action to a substantive law is a ticket into court - a legislative provision of an alternative enforcement mechanism designed to ensure the fulfillment of democratically endorsed norms. The class action is one of the procedural mechanisms to which the private cause of action grants private citizens access. Far from impinging on the democratic prerogative, private class action enforcement leverages an accepted procedural paradigm to deliver on democratic mandates. As Burbank and Farhang show, this arrangement is a compromise resulting from the interaction of the political institutions of Congress and the presidency. In sum, two goals drive the value of class action lawsuits: general enforcement, as I have argued above, and compensating individual plaintiffs. Martin Redish would emphasize this latter value to the exclusion of the former. Meanwhile, Myriam Gilles and Gary Friedman occupy the opposite extreme, arguing that "the reflexive inclination to service both objectives … is unprincipled and often counterproductive," and that enforcement of public norms is all that matters. 19 I insist that both values are important: while [*493] deterrence is a legitimate aim of the class action, the fact that it supervenes on rights belonging to individual plaintiffs is not a mere formality, and should not be cavalierly dismissed. 20 B. The Profit Motive Does Not Debase the Class Action The profit motive is an essential corollary of the private right of action, and we should harness its power to promote the class action's normative ends. Some lawyers may take offense at such commoditization, viewing it as antithetical to the mission of an important social actor with an awesome, ethically significant responsibility as "a representative of clients, an officer of the legal system and a public citizen having special responsibility for the quality of justice." 21 Such ethical significance is magnified in the context of the class action lawsuit, where the

16

See id. at 75-84 ("[A] procedural device that has been designed to do nothing more than facilitate the enforcement of substantive law's authorization of private damage suits transforms that private remedial model into a qualitatively different form of remedy that was never part of that substantive law."). 17

Id. at 129-37.

18

Id. at 76.

19

Myriam Gilles & Gary B. Friedman, Exploding the Class Action Agency Costs Myth: The Social Utility of Entrepreneurial Lawyers, 155 U. Pa. L. Rev. 103, 107 (2006). See generally Brian T. Fitzpatrick, Do Class Action Lawyers Make Too Little?, 158 U. Pa. L. Rev. 2043 (2010) (arguing that plaintiffs' lawyers are often underpaid, especially where the financial interests of individual plaintiffs are small). 20

See Tidmarsh, supra note 2, at 237 n.39. This Note remains agnostic as to which of these values should prevail when they compete, as they inevitably will in some cases. However, these values will only compete at an efficient horizon that the class action, due to its shortcomings, does not yet reach. The aim of this Note is to propose a system that would simultaneously advance both general public and individual private ends, without prejudicing either.

21

Model Rules of Prof'l Conduct pmbl., para. 1 (Am. Bar Ass'n 2013).

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Page 6 of 31 125 Yale L.J. 484, *493 lawyer often takes on the mantle of the public norm enforcer, simultaneously vindicating the rights of her client and serving society at large. 22 But the sentiment that the legal profession "must be insulated from the more vulgar mores of the marketplace" limits the potential of the class action device. 23 Such discomfort with profiting and risk-taking in litigation is a relic of the past that is blind to reality. We must not allow this ill-conceived reluctance to mix law with market forces to handicap an enforcement mechanism that plays such an important role in our regulatory state. Antipathy toward taking a financial interest in lawsuits has varied bases. Historical objections took on a religious tone. 24 Today, political philosopher Michael Sandel argues that the "corrosive tendency of markets" can corrupt things on which we place non-monetary value. 25 Meanwhile, others argue that [*494] disassociating a claim from the person with whom it originated offends Aristotelian notions of corrective justice, which posit that holding a legal claim helps repair the injustice inflicted on its bearer. 26 Other objections to claim commodification include concerns that it corrodes the attorney-client relationship, and that it undermines the public perception of the legal system because people find it offensive. 27 These objections are philosophically engaging, but they deny the realities of contemporary American civil justice. Access to our courts is expensive - prohibitively so for the vast majority of class action plaintiffs, who would never be compensated but for the efforts of attorneys motivated by profit. Moreover, we rely on members of a private bar to use their own private resources, taking on tremendous risk and committing immense resources to secure public ends. If we value these ends, and if commodification is necessary to achieve them, it would be irresponsible to plug our ears to pragmatic discussions on how to build an appropriate incentive structure in an attempt to stand on principle. We must either embrace and utilize market forces, or undermine the class action's normative aspirations. In such a contest, the former must win. 28 Whether we like it or not, we have left an important public role in the hands of a private market, which must marshal its own resources in furtherance of the public good. The private market will not provide the resources necessary to realize the good unless the investment draws rent. The legacy of antipathy toward commodification of the lawsuit still hobbles the class action, preventing it from delivering on its potential. Specifically, restrictions preventing third parties from financing litigation have isolated class action lawsuits from the capital markets. The result is higher capital costs, fewer worthwhile suits brought to court, and a plaintiffs' bar that focuses on lower-value lawsuits. The next Part examines how the restrictions on third-party financing and an irrational compensation mechanism hinder the ability of the class action to be an effective tool for plaintiffs and for society.

22

See Sean Farhang, The Litigation State: Public Regulation and Private Lawsuits in the U.S. (2010) for a historical account of the development of the private right of action and the class action device as a means of furthering public regulatory ends.

23

Richard A. Epstein, One Stop Law Shop: The Land of Solicitors and Barristers Teaches America How a Freer Market Could Deliver Better Legal Services, Legal Aff., Mar.-Apr. 2006, http://www.legalaffairs.org/issues/March-April2006/feature_epstein_marapr06.msp [http://perma.cc/FC6G-CVY2]. 24

See infra note 40.

25

Michael J. Sandel, What Money Can't Buy: The Moral Limits of Markets 9 (2012).

26

See Michael Abramowicz, On the Alienability of Legal Claims, 114 Yale L.J. 697, 712-17 (2005); cf. Jules L. Coleman, The Practice of Corrective Justice, 37 Ariz. L. Rev. 15, 30 (1995) ("Corrective justice is, in my view, the principle that one has a duty to repair the wrongful losses for which one is responsible."). 27

For an enlightening discussion of (and response to) all off these complaints, see Abramowicz, supra note 26; and Anthony J. Sebok, The Inauthentic Claim, 64 Vand. L. Rev. 61, 135 (2011). 28

Removing the profit motive does not remove the need to assess the (financial) costs and (financial) benefits of bringing a particular regulatory action. In a world of constrained resources, even government enforcers will have to undertake some form of calculus. See infra note 56.

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Page 7 of 31 125 Yale L.J. 484, *494 [*495]

II. THE DEFECTIVE ECONOMICS OF THE CLASS ACTION LAWSUIT The economics of the class action are defective for two reasons. First, plaintiffs' lawyers are generally prohibited from seeking financing from outside sources. Second, attorney fees in contingency fee cases are set by the judge after the services have been provided, on the recommendation of those to be compensated, without the benefit of any competitive bidding or arms-length negotiation. 29 As a result of these two characteristics, the set of lawsuits that are financially attractive to the plaintiffs' bar is both under-and over-inclusive, and fees are potentially higher than they need to be. This Part describes the current regime for setting fees and restrictions on third-party funding and explains how these features undermine the class action's ability to enforce the law and make plaintiffs whole. A. Background: Fees and Financing 1. Ex-Post Fee Awards In successful class actions for money damages, courts typically award fees under the common fund doctrine, which allows counsel to collect compensation out of the damages due to the plaintiff. 30 The most popular way to calculate fees under the common fund doctrine - and the method this Note focuses on - is the percentage-of-fund method, in which the lawyers are paid a percentage of the overall recovery fund due the plaintiff class. 31 Under [*496] this method, upon motion of class counsel after the completion of the lawsuit, 32 the court sets the fee based on "benchmarks" established by surveys of past attorney fee awards in previous class actions. 33 Alternatively, the court may award fees under the "lodestar" method, which multiplies the number of attorney hours

29

Federal Rule of Civil Procedure 23(h) allows courts to award attorney fees on the basis of a motion. Fed. R. Civ. P. 23(h)(1). A court awarding fees is required to state its factual and legal conclusions supporting the fee award. Fed. R. Civ. P. 23(h)(3). Although Rule 23 does not explicitly require the ex post calculation of fees through the percentage of fund method, such a practice has become standard in contingency fee cases. See Manual for Complex Litigation (Fourth) § 14.121 (2004). 30

Manual for Complex Litigation (Fourth), supra note 29, § 14.11. Courts may also award fees under a fee-shifting statute, depending on the cause of action. See, e.g., 15 U.S.C. § 15(a) (2012) (allowing a prevailing plaintiff in an antitrust suit to recover "the cost of [the] suit, including a reasonable attorney's fee"); 42 U.S.C. § 1988(b) (2012) (providing that "the court, in its discretion, may allow the prevailing party … a reasonable attorney's fee" in certain civil rights suits). There are over 150 such statutes. Manual for Complex Litigation (Fourth), supra note 29, § 14.11. 31

Empirical studies have suggested that the percentage-of-fund method is the most popular mechanism for awarding fees under the common fund doctrine. See, e.g., Brian T. Fitzpatrick, An Empirical Study of Class Action Settlements and Their Fee Awards, 7 J. Empirical Legal Stud. 811, 832 (2010) (noting that, of federal class action settlements between 2006 and 2007, sixty-nine percent employed the percentage-of-fund method, twelve percent employed the lodestar method, and the remainder did not state the method used or used another method altogether to arrive at the attorney fee). For cases where attorney fees are awarded under the common fund doctrine, most circuits give district courts the discretion to use either a lodestar or a percentage-of-fund method in calculating fees. See Goldberger v. Integrated Res., Inc., 209 F.3d 43, 49 (2d Cir. 2000); see also Manual for Complex Litigation (Fourth), supra note 29, § 14.121 ("The vast majority of courts of appeals now permit or direct district courts to use the percentage-fee method in common-fund cases." (citations omitted)). Where a statute authorizes fee shifting, the lodestar method is usually required. See Perdue v. Kenny A. ex rel. Winn, 559 U.S. 542, 550-53 (2010); Manual for Complex Litigation (Fourth), supra, § 14.63. 32

See Fed. R. Civ. P. 23(h)(1).

33

These so-called benchmarks sometimes take the crude form of a round figure around twenty-five percent of the overall fund. See, e.g., Torrisi v. Tucson Elec. Power Co., 8 F.3d 1370, 1376 (9th Cir. 1993) (establishing a general common fund benchmark of twenty-five percent). Other courts take a more nuanced approach, setting benchmarks based on the size of the fund. See, e.g., In re Prudential Ins. Co. of Am. Sales Practice Litig. Agent Actions, 148 F.3d 283, 339 (3d Cir. 1998).

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Page 8 of 31 125 Yale L.J. 484, *496 spent on the case by those attorneys' hourly fees. 34 Even where the percentage-of-fund method is used, courts use the lodestar as a "cross-check" to ensure the fees are not excessive. 35 Provided the absent class members do not object, the inquiry ends there. 36 2. Financing Restrictions Third-party investment in class action lawsuits is prohibited. Plaintiff classes must therefore depend entirely on class counsel to cover litigation [*497] expenses. In exchange for this commitment, the lawyers receive a fee at the end of the case. While attorneys hoping to represent the class are allowed to solicit funds from - and thus spread the risk among - other lawyers and law firms, 37 non-lawyers cannot contribute. Although these restrictions are not limited to class actions, they have a particularly significant effect on lawsuits that, like class actions, require largescale strategic investment. Restrictions on third party financing derive from ancient prohibitions on "maintenance" and "champerty," which still haunt the common law of many states. Maintenance, defined as "maintaining, supporting or promoting the litigation of another," 38 and champerty, which involves "a bargain to divide the proceeds of litigation between the owner of the litigated claim and the party supporting or enforcing the litigation," 39 have existed since at least medieval times. 40 In addition to impeding the formation of contracts, some state laws on maintenance and champerty even

34

See Manual for Complex Litigation, (Fourth), supra note 29, § 14.122. Sometimes, the lodestar award will be augmented with a multiplier to compensate attorneys for the zeal and skill of their representation, the complexity of the litigation, and other specific factors. Id. ("The lodestar figure may be adjusted, either upward or downward, to account for … inter alia, the quality of the representation, the benefit obtained for the class, the complexity and novelty of the issues presented, the risk of nonpayment, and any delay in payment." (citations omitted)). But see Perdue, 559 U.S. at 553-55 (holding that such enhancements are only appropriate in "rare circumstances"). 35

Id. § 14.121 ("A number of courts favor the lodestar as a backup or cross-check on the percentage method when fees might be excessive.").

36

The absence of objectors is commonly cited as a factor in support of accepting a fee request. See, e.g., Gunter v. Ridgewood Energy Corp., 223 F.3d 190, 195 n.1 (3d Cir. 2000) (noting that "the presence or absence of substantial objections by members of the class to the settlement terms and/or fees requested by counsel" is a factor to be considered by district courts in setting fee awards). 37

Given the complexity, riskiness, and expense of major class action litigation, a plaintiffs' firm will often not take on the role of class counsel alone. Instead, upon the filing of an action (or, as is often the case, multiple duplicative actions) various firms will agglomerate through a private ordering process into a "pyramid-shaped" coalition to prosecute the lawsuit. Gilles & Friedman, supra note 19, at 148. Allowing counsel to arrange themselves before applying to be class counsel is "by far the most common" approach. Manual for Complex Litigation (Fourth), supra note 29, § 21.272. At the top of the pyramid will sit one or a handful of firms serving as lead counsel, in charge of providing direction and cohesion and liaising with the court and counsel for other parties. Other roles, such as a place on a steering committee or lead responsibility for some aspect of discovery, will also be handed out. Some attorneys may even join the coalition purely as financial investors. Hensler, supra note 6, at 504.

38

7 Samuel Williston & Richard A. Lord, A Treatise on the Law of Contracts § 15:1 (4th ed. 2010).

39

Id.

40

Some may even argue it goes back to the Roman Empire. See Max Radin, Maintenance by Champerty, 24 Cal. L. Rev. 48, 48 (1935) (providing a historical account of the development of the concepts of maintenance and champerty from "the legal development of the ancient Greek communities," through "earlier stages of Roman law," and, finally, "the medieval law of Western Europe, especially in England"). These prohibitions may have had some basis in a pragmatic rationale to discourage abusive litigation. See, for example, economics-based arguments presented in Abramowicz, supra note 26, at 727-55. Disapproval of such practices, however, also had a moral element arising from a general disapproval of litigation. Litigation, on this view, bordered on usury and displayed an un-Christian tendency toward "vexatiousness." Radin, supra, at 58.

Theresa Coetzee

Page 9 of 31 125 Yale L.J. 484, *497 provide defendants in funded litigation with a cause of action in tort. 41 While the law of champerty and maintenance has been in a state of flux for more than a century, these prohibitions nevertheless [*498] remain widely in force. 42 These antiquated common law doctrines are reinforced by state bar ethical rules, which prohibit lawyers from sharing fees with non-lawyers in each of the fifty states in accordance with the ABA's Model Rules of Professional Conduct. 43 Notwithstanding these prohibitions - and the resistance that has kept them firmly in place - opening lawsuits to outside financing has myriad benefits. Perhaps the greatest of these is the most obvious: access to wider financial markets lowers the cost of capital. 44 Financial investors agree to take on a given amount of risk for a given return on their capital. The ability to participate in financial markets therefore allows those seeking to secure capital for a lawsuit to sell the risk associated with the lawsuit's failure to the party willing to buy it for the lowest return. A lower cost of capital means that less of the contingency fee goes to financing costs. 45 A second important advantage of open lawsuit financing is its ability to allow lawyers and plaintiffs with risks tied to the success of the litigation to offload some of that risk by selling investors a stake in the contingency fee. The ability to divest risk is a key tool for any business or individual making an investment or undertaking financial planning; lawsuit risk can significantly constrain the decision-making of a plaintiff or contingency fee lawyer in [*499] deciding whether to bring or maintain a lawsuit. An asymmetry of ability to bear (or hedge) risk between the defendant and the plaintiff in a lawsuit can lead to a settlement that does not accurately reflect the merits of the case. 46 This could play out adversely to the interests of a plaintiff class: large corporations that are the frequent subject to litigation are often more able to bear the risk of loss than plaintiffs or their lawyers. 47

41

Cf., e.g., Feld Entm't, Inc. v. Am. Soc'y for the Prevention of Cruelty to Animals, 873 F. Supp. 2d 288, 332-33 (D.D.C. 2012) (denying a motion to dismiss an action for the tort of maintenance under D.C. law). 42

For example, as far back as 1928, the Supreme Court of Arizona declared that champerty had been "practically discarded both in England, the country of its origin, and in the United States." Strahan v. Haynes, 262 P. 995, 997 (Ariz. 1928). Nearly extinct as it may have been ninety-four years ago, it continues to be illegal in many states. See Ari Dobner, Comment, Litigation for Sale, 144 U. Pa. L. Rev. 1529, 1545 (1996). 43

Model Rules of Prof'l Conduct, supra note 21, r. 5.4. The Model Rules provide for limited exceptions that allow for attorney estate planning, compensating firm employees, and sharing fees with non-profit firms that assist in litigation. Id. Only the bar of the District of Columbia offers a meaningful exception: it allows those offering certain other types of professional services to hold equity in law firms. District of Columbia Rules of Prof'l Conduct r. 5.4(b) (2015); Molot, supra note 6, at 98. The bar of Washington also allows lawyers to share fees with a novel class of professionals called Limited License Legal Technicians (LLLTs). Washington State Rules of Prof'l Conduct r. 5.9 (2015).

44

It is generally accepted that market segmentation raises the cost of capital. See, e.g., Shannon P. Pratt & Roger J. Grabowski, Cost of Capital: Applications and Examples 57 (4th ed. 2010); see also infra note 55 and accompanying text.

45

This may not result in a net decrease in absolute litigation costs. Indeed, by lowering the marginal cost of maintaining litigation, it could lead to an absolute increase in net litigation costs. See Steven Garber, Alternative Litigation Financing in the United States: Issues, Knowns, and Unknowns, RAND Corp. 34-36 (2010), http://www.rand.org/content/dam/rand/pubs/occasional_papers/2010/RAND_OP306.pdf [http://perma.cc/4L5S-35QT]. However, litigation costs as a share of total recoveries would remain less than or equal to current levels, as it would remain irrational to incur the marginal cost without the promise of the same or greater marginal benefit. 46

As Jonathan Molot points out, a plaintiff (or contingency fee attorney) with a strong case could be pushed to settle if there is even a small outlier chance of an adverse judgment for which he has a low tolerance. In such a case, the party in the worse risk position would settle toward the median judgment, rather than the mean, even if the median is significantly lower than the mean. See Molot, supra note 6, at 83-90. 47

Corporations with large litigation portfolios are able to manage lawsuit risk more effectively than individuals or entities with less lawsuit exposure. The larger the portfolio of lawsuits, the more likely it is that its actual value will converge to the portfolio's expected value.

Theresa Coetzee

Page 10 of 31 125 Yale L.J. 484, *499 Despite general restrictions on lawsuit financing that prohibit direct third party investment in lawsuits, a nascent litigation financing industry has developed in the United States. Much of this industry serves businesses, which can circumnavigate the prohibitions by structuring the financing as investments in special corporate entities. 48 Other segments of the industry provide indirect support to lawsuits in the form of nonrecourse loans to individual plaintiffs in tort suits and law firms conducting litigation. Investors in such financing schemes include wealthy individuals, hedge funds, institutional investors, and even law firms. These investors seek returns that are not correlated with macroeconomic conditions, allowing them to disaggregate the risk of their investment strategies. 49 They offer their capital either directly, or through a company specializing in such investments. 50 Meanwhile, litigation financing has a more significant presence in some non-U.S. common law jurisdictions, including Canada, the United Kingdom, and Australia. In Canada and Australia, third-party finance even plays a role in aggregate litigation. 51 [*500]

B. Valid Claims Suffocate Due to Lack of Financing Economic incentives regulating the plaintiffs' bar smother some potentially meritorious claims in their infancy because lawyers are unable or unwilling to front the costs required to pursue them in court. Other claims suffocate during the course of litigation, with attorneys accepting low-ball settlement offers because they are unable or unwilling to finance continued litigation. As a result, plaintiffs do not receive full compensation for their injuries, while rule violators are let off the hook entirely, or get off easier than the law prescribes. These outcomes are the result of financing restrictions that both increase the cost of capital 52 and make it more difficult for attorneys to offload risks associated with a lawsuit. Taken together, these defects skew the fundamental risk-reward calculus that any rational profit-seeking plaintiffs' attorney, like any rational business owner, will undertake to determine the attractiveness of an investment. The risk-reward calculus is reducible to a basic economic model, taking into consideration the potential fee payout, discounted for risk and the cost of capital, and the estimated costs associated with litigating, including attorney time and outlays for experts and administrative expenses such as notice. 53 Specifically, the lawyer evaluates the basic economics and logistics of the lawsuit, including its potential payout (based on the number of plaintiffs and the estimated value of their claims), and the cost of litigation (based on a litigation plan, including a rough timeline, the number of attorney and staff hours required, and the cost of experts). The lawyer also estimates the likelihood of success. This estimate may be based on the strength of the case, how other suits with similar claims have fared, and even an assessment of the likely venue and the temperament of its judges. On the basis of this information, the lawyer decides either that the case is a worthwhile investment or that his resources would more profitably be spent elsewhere. This process can take place with more or less formality and rigor depending on the size of the investment and the disposition of the lawyers involved. It may be especially abbreviated if the promised payout is

48

See Molot, supra note 6, at 97.

49

Id. at 96.

50

Id. at 95-96.

51

See generally Jasminka Kalajdzic et al., Justice for Profit: A Comparative Analysis of Australian, Canadian and U.S. Third Party Litigation Funding, 61 Am. J. Comp. L. 93 (2013). In Australia, class action lawsuits are frequently funded with the help of outside investors. Id. at 96-113. Under Australian class action law, plaintiffs must cover defense expenses if the lawsuit fails. Id. at 97-98. Investors are therefore needed to cover this potential liability. 52

See infra note 55 and accompanying text.

53

See, e.g., William J. Lynk, The Courts and the Market: An Economic Analysis of Contingent Fees in Class-Action Litigation, 19 J. Legal Stud. 247, 250 (1990) (seeking to "develop an economic model of the competitive determination of private contingent fee percentages and show how those percentages are governed by the inherent difficulty of winning the case, the dollar amount at stake, and the cost of legal services").

Theresa Coetzee

Page 11 of 31 125 Yale L.J. 484, *500 large and the risks are low. 54 In any [*501] event, the decisional calculus will take the same basic shape. Consider the following inequality: [SEE EQUATION IN ORIGINAL] where EV is an expected value function based on the probability density of potential outcomes; c = share of the recovery the attorneys will collect as a fee; R = total potential plaintiff recovery; E = total reimbursement for non-attorney expenses; i = lawyer's cost of capital; 55 T = total number of time periods between the initial investment and the recovery; H = total number of attorney hours not spent on other cases in time period t; f = attorneys' market rate hourly fee; and k = total out-of-pocket outlay for non-attorney expenses in time period t. The left side of this inequality expresses the expected present value of an award of fees and costs. The right side expresses the present value of the fees the lawyer would earn working at the hourly rate (H * f) plus all additional expenses required over the course of the litigation (k). Conceptually, we can see why this inequality must hold in the long run. While the law firm may miscalculate in the odd case, the firm that consistently fails to achieve this inequality will ultimately lose all of its lawyers, who will leave the firm to earn the market rate for their services. If we understand the left side of the inequality as actual revenues and cash reimbursements, and the right side as [*502] achievable revenue and cash, we see that the inequality fails only when a firm is underperforming its manifest potential. While the inequality captures the basic idea of the viability of the lawsuit as a business investment, there are two additional important constraints on the lawyer's decision as to whether to take the case. The first constraint is risk appetite: how prepared is the lawyer for an eventuality in which he recovers little or nothing at the end of the lawsuit? If his firm's financial exposure to the lawsuit is significant enough, he and his partners may be uncomfortable with even a small likelihood of failure, as that failure could put the firm out of business. The second constraint is cash flow: between the time the suit is initiated and the fee is awarded, will the firm have difficulty meeting payroll obligations and paying experts? The firm's level of financial exposure to the potential lawsuit will

54

This is often the case with lawsuits "piggybacking" on government regulatory actions, where the likelihood of a large payout is very high. See, e.g., John H. Beisner et al., Class Action "Cops": Public Servants or Private Entrepreneurs?, 57 Stan. L. Rev. 1441, 1453 (2005) (commenting disapprovingly on the phenomenon). 55

Theoretically, in a truly open market for financing lawsuits and law firms, this cost of capital should approach the return on risk-free securities. Most of the risk associated with the law firm is not correlated with macroeconomic trends. See supra note 49 and accompanying text. Rather, the risks are specific to the circumstances of individual law firms and the legal industry in general. If restrictions on third party finance were relaxed, such specific risk could be eliminated through diversification: investors would be able to hold the equity of many law firms in a well-rounded portfolio in which the specific risks cancel each other out. Where the risk is diversifiable, it should not impact the cost of capital. See Richard A. Brealey et al., Principles of Corporate Finance 156-78, 224 (10th ed. 2011) (providing a background description of financial risk and its relationship to the cost of capital).

Theresa Coetzee

Page 12 of 31 125 Yale L.J. 484, *502 again be relevant in this determination, as will the time horizon of the litigation and the likelihood that it will go on longer than anticipated. 56 To see how the increased cost of capital distorts this calculus, note that the lefthand side of Figure 1 varies inversely with the cost of capital (i): the higher the cost of capital, the lower the expected present value of the potential payout. 57 This means that a higher cost of capital requires a higher expected fee award for a case to be an attractive investment. By raising the cost of capital, funding restrictions create a vicious cycle, simultaneously inflating class action fees and preventing lawyers from taking potentially meritorious cases that would have been viable if the cost of capital were lower. Because of the increased capital costs, lawyers will only take higher-fee cases. Over time, this tendency inflates the fees in the pool of past cases judges refer to in determining fees in the cases before them (recall that judges set fees based on "benchmarks" established by surveys of past fee awards in previous class actions). Ultimately, the higher level of fees impacts the market price of the [*503] lawyer's services. This drives up the lodestar itself (H [in'*'] f), inflating the right hand side of the inequality, thereby further raising the threshold for bringing a case. The result of this cycle is that fewer claims meet the threshold required to make them attractive investments for contingency fee lawyers. This effect is exacerbated by the inability of the attorney to offload the risk of a lawsuit; even where the lawsuit has an acceptable present expected value, its particular risk profile may be unattractive to the lawyers. Such distortions may also encourage premature settlement. 58 When capital costs are higher, the marginal costs associated with prolonging litigation are higher. The attorney's cash flow constraints and risk aversion can amplify the settlement incentive. Without access to outside funding, class counsel will pursue the class's claims only as long as the attorneys are able to maintain working capital and manage their financial exposure. If, during the course of litigation, class counsel's working capital is depleted, or the partners determine they can no longer sustain their exposure to the risk, they will have an incentive to settle early. While loans from banks or investment funds may be available, such financing is expensive 59 and would be an unattractive and risky alternative to a settlement offer.

56

This type of decision-making is not limited to firms that seek to maximize profits. Even a public interest firm will have to engage in some form of cost-benefit analysis. Unless a firm has unlimited resources, it will have to weigh the opportunity costs of bringing a particular claim against the potential benefits. The financial viability of claims, risk appetite, and cash flow constraints loom especially large when attorney fees are the firm's only source of income. Non-monetary concerns may factor into one side of the inequality or the other, but the decision will always have a financial core: will the lawsuit be an outsized burden on the organization's resources, preventing it from undertaking other socially useful projects? (If we wanted to be truly rigorous about it, we could add coefficients U and U to each side of the inequality, where U/U expresses the comparative social utility of the action under consideration with that of the organization's next-best alternative.) 57

The higher cost of capital will affect the right-hand side of the inequality as well; however, the increase in i will have a relatively higher impact on the left-hand side, as cash flows on the left are concentrated in the terminal time period T.

58

The Federal Rules of Civil Procedure do contain safeguards intended to protect the integrity of class action settlements; however, these safeguards are not an effective bar to early settlement. In theory, settlements in class action suits in federal court are subject to review under Rule 23(e), which requires the court to find that the settlement "is fair, reasonable, and adequate" before approving it. Fed. R. Civ. P. 23(e)(2). As with a Rule 23(h) fairness review of attorney fees, a class member, having received notice of the settlement, may object to its terms. Fed. R. Civ. P. 23(e)(5). But, as with review under 23(h), we cannot expect judges to adequately evaluate the economics of a settlement offer under 23(e) review. See Tidmarsh, supra note 2, at 235-38 ("Courts' lack of knowledge about the strength of the claims, as well as many courts' desire to move big cases off their dockets, renders the "fair, reasonable, and adequate' check on settlements an imperfect mechanism to avoid agency costs."). Indeed, while courts may be on the lookout for egregious unfairness such as collusion between the defense and plaintiffs' counsel, they afford significant deference to settlement offers. See, e.g., In re Prudential Ins. Co. of Am. Sales Practices Litig., 962 F. Supp. 450, 534-35 (D.N.J. 1997) ("The Court should be careful not to substitute its image of an ideal settlement for the compromising parties' views … . The issue is whether the settlement is adequate and reasonable, not whether one could conceive of a better settlement."). 59

See Molot, supra note 6, at 99-100.

Theresa Coetzee

Page 13 of 31 125 Yale L.J. 484, *503 The cost of capital and risk considerations are not the only causes of early settlement. Even absent any consideration of the source of their financing, class action attorneys will have an incentive to settle at the point where the marginal cost of litigating is equal to the expected marginal fee that will be generated [*504] from the effort. 60 This results from the fact that the contingency fee theoretically reflects more than just the hourly cost of their labor. Even where plaintiffs may get a significantly bigger award, class counsel - who have all the information and call the shots - will settle at the point that maximizes their expected value. This problem may be especially pressing in cases where the plaintiffs are also seeking some form of non-monetary relief in which the contingency fee attorney generally has no fee interest. 61 In such cases, class counsel have the incentive "to settle … on the eve of trial, knowing that in so doing they obtain most of the benefits they can expect from the litigation while eliminating their downside risk." 62 While restrictions on outside financing do not cause this problem, they do preclude arrangements that could alleviate the problem, such as allowing investors to buy out the settlement and continue litigating. 63 C. Incentives Favor Claims with Less Social Utility Because fees are set through a noncompetitive process at the end of the lawsuit, and because only lawyers are allowed to provide financing, the fee awarded to class action attorneys does not accurately account for risk. As a result, there is little price differentiation between lower-risk suits, such as those piggybacking on regulatory action, and higher-risk suits involving more complex or novel claims. Given a choice between a lower-risk suit and a higher-risk suit that otherwise yields a similar return on investment, rational attorneys will focus on the lower-risk suit. These lower-risk suits, which are often duplicative of government regulatory action, have less deterrence value than higher-risk alternatives that pursue novel or complex claims. While it is possible to accurately value an attorney's legal services after those services have been rendered - after all, a competitive and transparent [*505] market for legal services priced in hours already exists 64 - it is not plausible to set a correct price for financing a lawsuit in isolation after the lawsuit is over. 65 The price of financing should track information about the risks and rewards of a particular lawsuit before that lawsuit commences. While this information will never be perfect - the variables involved in making the risk-reward assessment are many and subjective - a fair market price is the result of many different potential investors independently making their own ex ante assessments based on the information they are able to obtain through due diligence. Without any reason to believe that they will receive a higher premium on their effort for a riskier lawsuit, rational lawyers will choose to pursue less-risky suits. But these less risky suits often correspond to diminished enforcement

60

See, e.g., Gilles & Friedman, supra note 19, at 140-42. Though Gilles and Friedman present the problem as it exists with respect to the lodestar method, a percentage-of-fund calculation can also encourage the settlement problem. 61

While it is generally the case that injunctive relief does not contribute toward the common fund, which serves as the denominator of percentage of fee calculations, some courts have entertained the idea of adding the value of injunctive relief to the common fund where the value of the injunctive relief is measurable. See, e.g., Staton v. Boeing Co., 327 F.3d 938, 973-74 (9th Cir. 2003). 62

Jonathan R. Macey & Geoffrey P. Miller, The Plaintiffs' Attorney's Role in Class Action and Derivative Litigation: Economic Analysis and Recommendations for Reform, 58 U. Chi. L. Rev. 1, 22 (1991).

63

See infra Part III.A.2.

64

This is not an endorsement of the billable hour model of attorney compensation, which is not without its own problems. See infra note 76. 65

This deficiency has been well rehearsed, and has inspired a push to reform through innovations like the lead counsel auction. See Niebler, supra note 5, at 766; see also In re Oracle Sec. Litig., 131 F.R.D. 688, 692 (N.D. Cal. 1990) ("Hindsight will invariably alter the perceived fairness of class counsel's compensation arrangements … . Moreover, it is inherently illogical for lawyers to undertake litigation on the basis of the risks and rewards they perceive at the beginning, yet be compensated on the basis of the risks and rewards the court perceives at the end of the litigation.").

Theresa Coetzee

Page 14 of 31 125 Yale L.J. 484, *505 benefits relative to suits that involve more risk. Ideally, class action plaintiffs' lawyers should supplement government regulators by marshaling private resources to discover and develop viable class action claims on their own initiative. 66 But many class action suits ride the coattails of government regulatory action in a practice known as "piggybacking." 67 Because these suits are easier to discover and the government has done most of the work developing the claims and determining their viability, piggybacking suits are low-risk for lawyers but offer only modest marginal enforcement benefits for the public. In contrast, higher-risk suits can do more to serve the class action's unique and valuable role in enforcing public norms. Consider In re NASDAQ, an antitrust case that settled for more than one billion dollars. 68 Private attorneys brought the case against NASDAQ market [*506] makers after an academic article pointed out peculiarities in NASDAQ quotations that suggested the spreads on listed securities were being rounded up. 69 The private attorneys aggressively investigated the claims for nearly a year before filing a case, in the face of dogged resistance from the securities industry, by retaining expert economists and even conferring with non-defendant market makers to try to influence the spreads on certain securities to test the plaintiffs' hypothesis. 70 The effort was risky, but it paid off. The suit yielded the largest antitrust recovery in history, and resulted in significant reductions in trading costs. 71 As the judge noted in approving the settlement, the case was the antithesis of a piggybacking suit, 72 as the filing of the claim by intrepid private attorneys ultimately spurred the government into action. 73 Blockbuster cases like In re NASDAQ may provide some incentive for intrepid lawyers to seek out meaningful cases, but they are not the norm. Difficult lawsuits that require creativity and persistence will always be at a disadvantage where there is no reliable way to ensure that the fee accurately reflects the lawsuit's risk. Plaintiffs' lawyers should be rewarded for bringing novel cases rather than finding the quickest route to the courthouse. D. Fees Are Inflated Due to Lack of Competition The attorneys' share of the class action award or settlement can sometimes be excessive, benefitting class action attorneys at the expense of the plaintiffs. There are at least four reasons for this phenomenon. The first is the vicious cycle generated by the increased cost of capital that results from financing restrictions described supra. Second, restrictions on outside financing create barriers to competition from potentially skilled practitioners that may not have the capital or risk appetite to offer a contingency fee service. 74 Third, the way judges award fees typically

66

Innovation and creativity in finding claims has led to novel areas of class action practice, such as consumer privacy lawsuits against technology companies. See Conor Dougherty, Jay Edelson, the Class-Action Lawyer Who May Be Tech's Least Friended Man, N.Y. Times, April 4, 2015, http://www.nytimes.com/2015/04/05/technology/unpopular-in-silicon-valley.html [http://perma.cc/8GRX-5F2N]. 67

See Beisner et al., supra note 54, at 1453.

68

In re NASDAQ Market-Makers Antitrust Litig., 187 F.R.D. 465, 465 (S.D.N.Y. 1998); see also Arthur M. Kaplan, Antitrust as a Public-Private Partnership: A Case Study of the NASDAQ Litigation, 52 Case W. Res. L. Rev. 111 (2001). 69

Kaplan, supra note 68, at 114-16.

70

Id.

71

Id. at 111.

72 73

In re NASDAQ, 187 F.R.D. at 488 n.23. Kaplan, supra note 68, at 112-13.

74

Allowing litigants to secure the services of attorneys not willing to work on a contingency fee is a selling point of litigation financiers. See, e.g., The New Economics of Litigation, Burford Cap. 7 (2015), http://www.burfordcapital.com/wpcontent/uploads/2015/01/3_Burford_Business_US.pdf [http://perma.cc/Z7KR-YB5T]; cf. Hensler, supra note 6, at 508

Theresa Coetzee

Page 15 of 31 125 Yale L.J. 484, *506 prevents the possibility of price competition [*507] between attorneys. 75 Finally, attorneys can manipulate judicial fee determinations through churning - undertaking non-value-adding activities for the purpose of padding the number of hours spent on the case. 76 Such churning impacts the lodestar, which serves as a benchmark even where the fee is calculated as a percentage of the common fund. 77 The rudimentary checks and corrections judges perform under Federal Rule of Civil Procedure 23(h), which requires them to review fee awards for fairness, 78 do not eliminate the problem of inflated fees. The standard techniques for reviewing fairness, most notably comparing a percentage-of-fund fee with benchmarks based on previous class actions, often perpetuate the faulty fee-setting of previous lawsuits, and do nothing to calibrate the fee to the particular circumstances of the suit at bar. 79 The lodestar "cross-check" attempts to take into account the particular circumstances of the lawsuit, but it can only calibrate for the legal services of class counsel and not for the financing. Finally, the judge's reliance on the fact that no objectors have come forward can hardly inspire confidence in the outcome when absent class members will often lack the sophistication or the inclination to scrutinize the fees, and any benefit of objecting, spread across the class as a whole, will not justify the individual's effort. III. THE SOLUTION: AUCTIONING EQUITY IN THE CLASS ACTION TO FINANCIAL INVESTORS Auctioning shares of the potential recovery in a class action lawsuit, and using the proceeds to cover litigation expenses, could improve the class action's ability to secure compensation for plaintiffs and enforce the law. This method of financing lawsuits and awarding fees to attorneys combines the competitive market advantages of a feesetting auction with those of third-party financing. [*508] Lawyers seeking appointment as class counsel could conduct an auction, offering financial investors (both lawyers and non-lawyers) equity in the potential recovery in exchange for the capital required to prosecute the case. This process would set an attorney fee based on prevailing market capital costs and ex ante assessments of the lawsuit's riskiness, and would liberate class action litigation from the financial circumstances of class counsel. This proposal would depend on opening the financing of class action lawsuits to third-party, non-lawyer investors with no underlying interest in the claim, a practice which is largely prohibited by common law doctrine and state bar ethical rules. 80 Supposing that legal restrictions on alternative financing could be lifted, adopting the equity auction would require no changes to Rule 23 or its application. A. The Equity Auction Proposal Imagine a class action universe in which lawyers are allowed - indeed, encouraged - to seek outside financing, and there exists a well-developed market of sophisticated investors willing to put capital into such lawsuits. Once a

("Commercial litigation financing might be attractive to new entrants to the market or as a means of allowing an established firm to penetrate or develop a new segment of the class action market while limiting its risk."). 75

See, e.g., Niebler, supra note 5, at 768 ("Attorneys' fees set by judicial fiat are generally poor substitutes for arms-length, negotiated fee arrangements agreed to in the open market by a willing buyer and a willing seller.").

76

Indeed, this practice is not limited to class actions. See, e.g., Peter Lattman, Suit Offers a Peek at the Practice of Inflating a Legal Bill, N.Y. Times: DealBook, Mar. 25, 2013, http://dealbook.nytimes.com/2013/03/25/suit-offers-a-peek-at-the-practice-ofpadding-a-legal-bill [http://perma.cc/WE2D-T4H5]. 77

78

See supra note 35 and accompanying text. Fed. R. Civ. P. 23(h); see also supra note 29.

79

See Fitzpatrick, supra note 19, at 2054-56; Third Circuit Task Force on Selection of Class Counsel, U.S. Court of Appeals for the Third Circuit, Third Circuit Task Force Report on Selection of Class Counsel, 74 Temp. L. Rev. 689, 722 n.110 (2001) [hereinafter Third Circuit Task Force Report]. 80

See supra Part II.A.2.

Theresa Coetzee

Page 16 of 31 125 Yale L.J. 484, *508 plaintiffs' lawyer has decided to file an action, he raises capital by auctioning equity stakes in the final judgment. Financial investors bid on the responsibility to provide a fixed share of the litigation expenses. Their bids are denominated as a percentage of the potential final judgment due to the plaintiffs. The lowest bid specifies the percentage of the judgment damages that will constitute the percentage-of-fund fee awarded if the lawsuit succeeds. The equity sale process, of which the auction is a part, is analogous to procedures followed in auction-based mergers and acquisitions. 81 Following is a step-by-step outline of how the sale process might unfold, as well as potential ways of enhancing or supplementing the equity sale by (1) allowing plaintiffs to sell their shares in the award, (2) allowing investors to buy out a settlement proposal, and (3) syndicating investors' equity stakes to increase liquidity. Finally, this subpart untangles some of the technical challenges that might arise when lawyers' and financiers' pre-sale estimates of litigation expenses, time horizon, and fee award are inaccurate. [*509]

1. The Equity Sale Procedure a. Step One: Pre-Offer Preparation 82 Before initiating a bidding process, the lawyers decide how much of the liability for litigation expenses they wish to transfer to investors. They could transfer all of it, accepting an obligation from investors to cover cash expenses and compensate the attorneys on an hourly basis for the time required to find and develop the claim 83 and the time they estimate will be required to pursue the lawsuit to the end. This would allow them to divest all of the risk that the lawsuit will not succeed; they would get paid as any other lawyer working by the hour. Another option would be to transfer liability for some of their expenses, allowing the attorneys to offload some of the risk and recoup some of their initial investment in the case while retaining some interest in the final award. 84 After determining how much capital to raise, the lawyers then draw up an in-depth offering memorandum containing all the basic economic and logistical information any third-party financier would want to consider before deciding whether to invest. This memorandum would include a theory of the case; estimates of the size and shape of the plaintiff class; an estimate of the potential award; an outline of litigation expenses; and an explanation of the financier's expected economic involvement in the case (such as a schedule for cash disbursements and an outline of any other expected financial obligations). In presenting estimates of award sizes and litigation expenses, the memorandum would provide figures under a range of possible scenarios, and would rely on benchmarks from previous cases. b. Step Two: Solicitation of Bids and Due Diligence The lawyers send notification of their intention to auction equity in the case to a group of potential investors, whom they provide with a summary prospectus outlining the highlights of their offer memorandum. Interested recipients sign a confidentiality agreement and receive the offer memorandum.

81

For general descriptions of the processes used in auction-based sales of controlling equity stakes in corporations, see Christina M. Sautter, Auction Theory and Standstills: Dealing with Friends and Foes in a Sale of Corporate Control, 64 Case W. Res. L. Rev. 521, 539-44 (2013); and see generally Robert G. Hansen, Auctions of Companies, 39 Econ. Inquiry 30 (2001). 82

We can think of the entrepreneurial function of claim discovery, discussed supra Part II, and the formation of a prospective class counsel coalition, discussed supra note 37, as step zero.

83

Compensating attorneys for the time and initiative they have already invested in the claim is important, as it preserves the incentive to pursue and develop novel claims. 84

Judges and financiers may also look upon partial, as opposed to full, divestment favorably, as fees at risk give class counsel a performance incentive.

Theresa Coetzee

Page 17 of 31 125 Yale L.J. 484, *509 [*510] The bidders then begin their due diligence, consulting with their own lawyers and experts and devising their bidding strategy. During their diligence, they make their own estimates of the amount of time it will take to realize a recovery, the level of risk associated with the lawsuit, and the yield they demand for that level of risk. These estimates may be guided by the bidders' views on the strength of the claim; their assessments of the lawyers' theories and strategies; their evaluations of the lawyers' skill and track record; and their reading of the court's tendencies.

c. Step Three: The Auction The auction commences. The bidders deliver sealed bids, denominated as a percentage of the final judgment that they are willing to take in exchange for the financing obligations outlined in the offer memo. The bid with the lowest percentage wins. With funding secured, the lawyers are now prepared to apply to the court for appointment as interim class counsel. As part of their application, they can present the court with the details of their financing arrangement and documentation of the robustness of the auction procedure. Critically, the attorneys are able to present the court with the percentage of the potential plaintiff fund that will go toward compensating the investors and attorneys - the auction has effectively set the contingency fee percentage. To calculate the percentage of the fund that will go toward fees, the lawyers will scale the equity share purchased by the investors according to the proportion of the total financing commitment the investors have made. For example, if the investors agreed to take half of the financial responsibility in exchange for a bid of ten percent of the final fee award, the overall fee level would amount to twenty percent of the final fee award. The financiers, covering half of the expenses, take ten percent of the final award; the lawyers, who have retained responsibility for the other half of the expenses, also take ten percent. The plaintiffs receive the remainder. This equity auction procedure may be more feasible in cases involving primarily money damages rather than injunctive relief, as the percentage-of-fund method of calculating fees is generally not available where there is no monetary common fund out of which fees can be awarded. 85 This proposal would therefore be inappropriate in a case such as a civil rights suit seeking [*511] injunctive relief. 86 Moreover, to set an accurate price at the beginning of the lawsuit, litigation costs and the potential recovery will have to be at least somewhat estimable on the basis of pre-filing research into the claims. The hypothetical case of In re Widget, an antitrust suit based on a claim of horizontal price-fixing against defendants X, Y, and Z, illustrates the ideal conditions for equity auction treatment. Fees in antitrust class actions, which almost always seek monetary damages, are frequently awarded under the common fund doctrine. 87

85

Fees in such cases, which may be awardable under an applicable fee-shifting statute, must be calculated by the lodestar method. See Perdue v. Kenny A. ex rel. Winn, 559 U.S. 542, 550-51 (2010) (describing the virtues of the lodestar method and finding it appropriate for cases seeking injunctive and declaratory relief); Manual for Complex Litigation (Fourth), supra note 29, § 14.11. However, some courts have considered putting a value on injunctive relief and adding that value to the common fund. See supra note 61. 86

Perdue, a recent case involving the calculation of fees under a fee-shifting statute, is an example of a class action that would be inappropriate for the auction method I propose. Plaintiff Kenny A. sought a structural injunction under 42 U.S.C. § 1983 against the state of Georgia to improve foster child services. See Kenny A. ex rel. Winn v. Perdue, 454 F. Supp. 2d 1260 (N.D. Ga. 2006), aff'd, 532 F.3d 1209 (11th Cir. 2008), rev'd, 559 U.S. 542 (2010). Despite class counsel's Rule 23(h) motion for a common fund fee award, the district court held that "the common fund doctrine is inapplicable because no fund was created by the parties' settlement. Instead, the settlement is one in which State Defendants have agreed to undertake certain actions to benefit foster children." Id. at 1271. 87

See, e.g., In re Coordinated Pretrial Proceedings in Petroleum Prods. Antitrust Litig., 109 F.3d 602, 607 (9th Cir. 1997); In re Cardizem CD Antitrust Litig., 218 F.R.D. 508, 531-32 (E.D. Mich. 2003); In re NASDAQ Market-Makers Antitrust Litig., 187 F.R.D. 465 (S.D.N.Y. 1998). While the Clayton Act, which provides a private right of action under the federal antitrust laws, does provide for fee shifting, see 15 U.S.C. § 15(a) (2012), the common fund doctrine applies universally to class actions that establish a settlement common fund, see infra text accompanying notes 100-118. Furthermore, in some circuits, the common

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Page 18 of 31 125 Yale L.J. 484, *511 Predicting potential economic damages will be relatively straightforward: one need only estimate the difference between the prices the direct purchasers paid for widgets and the market price absent X, Y, and Z's collusion, scaled according to the size of the overall market over the period of alleged collusion. 88 Suppose Lawyer A, lead counsel in In re Widget, estimates that going forward with the lawsuit will cost $ 4 million. He has derived this figure by taking the present value of the total number of attorney hours that he estimates will be required multiplied by the hourly rate he [*512] charges his non-contingency-fee clients plus out-of-pocket expenses. 89 If we recall Figure 1, this sum is equal to [see org]. Lawyer A has decided to seek $ 2 million in outside capital. He conducts the equity procedure as described above. At auction, Financier B and her partners submit the winning bid. After a full assessment of the potential payout and the risks associated with the case, Financier B estimates a recovery of around $ 30 million and a litigation timeframe of about two years. Based on the level of risk she has assessed, she requires a return on her capital of 12%. This means that, if she commits to providing $ 2 million today, she must expect to recover her $ 2 million plus two years of compound interest - a total of $ 2.5 million. This $ 2.5 million amounts to 8.4% of the $ 30 million expected award. She will therefore bid 8.4%. 90 Assuming the bidding process was sufficiently competitive and the bidders each based their submissions on the best available information, the auction has set the percentage of fund award at an efficient minimum. Financier B and her competitors submitted bids that amounted to the lowest share of the recovery they would be willing to take given their assessment of the merits and risks of the lawsuit. B won because of a combination of her optimism about the risks of the case relative to the other bidders and the competitive price of her funding given her assessed level of risk. B's stake suggests an overall fee award of 16.8% of the final recovery due to the plaintiffs. 2. Extensions of the Equity Sale Procedure Three potential extensions to the equity sale procedure could further strengthen the class action: (1) allowing plaintiffs to sell their equity stakes to financiers, (2) allowing objectors to a settlement offer to buy out non-objectors at the settlement price with the assistance of third-party financiers, and (3) syndicating financiers' equity investment. Allowing plaintiffs to sell equity would give them the opportunity to realize for certain the risk-discounted [*513] value of their claims - to recover some compensation for their harms regardless of litigation risk. Settlement buyouts could prevent lawsuits from ending with settlements below the true value of the claim, benefitting plaintiffs and enhancing the deterrence value of lawsuits. Finally, syndication would make the financier's equity investment in the lawsuit more liquid, potentially further reducing the cost of capital. a. Extension One: Sale of Plaintiffs' Equity

fund doctrine can apply in hybrid cases implicating both a fee-shifting statute and a common fund. See, e.g., Staton v. Boeing Co., 327 F.3d 938, 945 (9th Cir. 2003); Brytus v. Spang & Co., 203 F.3d 238, 247 (3d Cir. 2000) (holding that the common fund doctrine applies in hybrid cases "when the defendant responsible for the statutory fee has … insufficient funds" or "when there has been a showing that competent counsel could not have been obtained for that case or that line of cases"); see also Martha Pacold, Comment, Attorneys' Fees in Class Actions Governed by Fee-Shifting Statutes, 68 U. Chi. L. Rev. 1007, 1026-29 (2001). 88

See ABA Section of Antitrust Law, Antitrust Class Actions Handbook 55 (2010) (describing the factors to be considered in calculating damages in price fixing cases).

89

This may be a somewhat simplified picture, as the lawyer and the financier may assume different discount rates. Instead of (or in addition to) calculating the present value, the lawyer can present bidders with a schedule that details when they expect the investors will be responsible for cash payments to cover expenses. The bidders can then use their own discount rate to determine a present value. 90

Her bid will be equal to $ 2,000,000 [in''] (1 + 12%)2 $ 30,000,000.

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Page 19 of 31 125 Yale L.J. 484, *513 This enhancement, which has the signature of the equity auction proposal advanced by Macey and Miller, 91 would bring plaintiffs into the equity sale process by allowing financiers to buy plaintiffs' claims at the price determined by the initial equity auction. Class members are already entitled to opt out of Rule 23(b)(3) classes and thus preserve their independent claims against the defendants. 92 Under this proposal, instead of opting out, they could also cash out: they could take an upfront cash payment in exchange for their interest in the claim, perhaps before the class is even certified. This would allow plaintiffs to divest themselves of the risk of an adverse judgment. It would also allow them to receive a payout before the case is resolved and a payout fund is established, which often takes years. Plaintiffs' shares would be priced by reference to the original equity auction, which puts a present dollar value on each percentage point of equity in the final judgment. Let P represent the present dollar value of the investor's equity share and E represent the percentage of equity purchased by the investor at the auction. 93 The present dollar value of every percentage point of equity in the final judgment will equal [SEE EQUATION IN ORIGINAL]. [*514] Multiplying this by the number of percentage points of equity held by the plaintiff (that is, the plaintiff's equity share, E, multiplied by 100) will give the present dollar value of the plaintiff's equity. 94 Investors can therefore purchase the plaintiff's equity share for a sum equal to . We can see how this might play out in the context of In re Widget. Imagine that Plaintiff P owns a small business that is a direct purchaser of widgets. She reads about the lawsuit in Widgets Today, a trade publication in which class counsel and Financier B have advertised the lawsuit and the early cash out offer. She determines that if class counsel's economic predictions are correct, her damages from overpaying for widgets amount to a total of $ 15,000. The equity auction has already established a fair, competitive price for P's claim: in this scenario, P = $ 2,000,000, E = 8.4%, and [SEE EQUATION IN ORIGINAL] = 0.04%. Based on Financier B's winning bid, the present value of one percentage point of equity in the final judgment is [SEE FORMULA IN ORIGINAL] = $ 240,000. As Plaintiff P's claim amounts to 0.04 percentage points of equity, her stake is worth about $ 9,500 in cash today. Financier B offers her this sum, payable immediately. P believes this cash will give her the opportunity to make a significant profitable investment in her business, so she takes the offer. In exchange, Financier B gets an additional 0.04% share in the eventual judgment. b. Extension Two: Settlement Bonding Another potential extension of the equity auction procedure has been suggested as a standalone proposal by Jay Tidmarsh. 95 This proposal would enable class members that object to a settlement proposal to pursue their objections without undermining the interests of class members that may be better served by accepting the settlement. Imagine, for example, that an objector believes the settlement leaves money on the table, but continuing litigation would be risky and could delay recovery for the class. Such an objector could bring in third-party investors to pay off class counsel and create a recovery fund for the class. This would allow him to pursue a larger payout for

91

The Macey and Miller proposal would divest plaintiffs of their equity in the claim as a default. See Macey & Miller, supra note 62, at 105-16. Having bought the claim, the claim purchaser would then prosecute the lawsuit on her own behalf. Id. In contrast, under my proposal, plaintiffs would retain their equity as a default rule and would themselves have to take the initiative to divest. The mandatory opt-out nature of Macey and Miller's proposal may not be problematic in suits in which individual claims are not worth very much, but it may substantially prejudice the interest of plaintiffs whose claims are valuable to them. In contrast, under the procedure I propose, plaintiffs would only be separated from their claims if they so choose. 92 93

Fed. R. Civ. P. 23(c)(2)(B)(v). P is equal to the present value of the financier's expected cash contribution.

94

[see org], where D is the expected damages award for the class as a whole, D is the plaintiff's individual damages, and E and E are the equity percentages of the financiers and the lawyers, respectively.

95

See Tidmarsh, supra note 2.

Theresa Coetzee

Page 20 of 31 125 Yale L.J. 484, *514 himself and for the class while protecting his fellow plaintiffs against any recovery less favorable than the terms of the settlement. A recent derivative suit in the Delaware Court of Chancery shows that Burford Capital, a British litigation financier that touts itself as "the world's [*515] largest provider of investment capital and risk solutions for litigation," 96 is trying to open the door to such practices in the United States. 97 In that case, objectors offered to engage Burford to secure the settlement terms for the rest of the class while continuing to pursue litigation. 98 Although the court seriously entertained the proposal - and acknowledged that the deal would make the class better off - the court ultimately turned down the objectors on the grounds that no market auction had taken place to establish the reasonableness of Burford's expected returns. 99 Conducting a second auction could solve this problem. Interested investors (perhaps including the original investor) would bid on the opportunity to take a percentage of the upside of continuing litigation in exchange for providing a recovery fund for the plaintiffs and funding the marginal effort. Their bids would be priced as a percentage of the marginal amount of the final judgment above the settlement offer. 100 Such a procedure would allow for settlements to be tested by the market for their sufficiency without putting plaintiffs at risk. c. Extension Three: Syndication Syndication allows financial investors to divvy up a large investment in order to pool the risks and rewards. In particularly resource-intensive class action suits requiring large amounts of capital, syndicating the financiers' equity investment could enhance the benefits of the equity sale by increasing the amount of capital available and facilitating the liquidity of the investment. This would further lower the cost of capital and enhance the equity sale's risk-sharing potential. Syndication could be executed by allowing individual financial firms to compete in the auction and then sell portions of their equity stake to other [*516] investors in secondary transactions. Alternatively, groups of investors could enter the bidding together as a unit. Under a third method, prospective class counsel could slice the present value of the expected cash financing into nominal units and sell off those nominal units to interested investors in a Dutch auction. 101 (This option, however, may have more limited liquidity benefits as these shares may not be as easily transferable.) Whichever method is used, syndication has the potential to increase the liquidity of the investment and enhance the spreading of risk, thereby attracting more investors. These benefits could enlarge the pool of capital available to class action lawsuits, further lowering the cost of capital. 3. What Happens When Investors' Cost Predictions Are Wrong?

96

Burford Capital Continues Strong Performance, Burford Cap. (Jan. 13, 2015), http://www.burfordcapital.com/wpcontent/uploads/2015/01/Burford-Capital-Trading-Update-FINAL-13-January-2015.pdf [http://perma.cc/H5TM-ZUTU]. 97

Forsythe v. ESC Fund Mgmt. Co., C.A. No. 1091-VCL, 2013 WL 458373 (Del. Ch. Feb. 6, 2013). In a letter introducing itself to the court, Burford noted that it agreed to assist the objectors in their offer because of its "broader interest in supporting and developing the litigation risk transfer market … ." Letter from Gregory P. Williams on Behalf of Burford Capital at 3, Forsythe v. ESC Fund Mgmt. Co., No. 1091-VCL (Del. Ch. Feb. 6, 2013), 2013 WL 458373. 98

See Forsythe, 2013 WL 458373 at 1.

99

Id. at 4 (ruling that Burford and the objectors had not established that "the percentage of the upside extracted by [Burford] is a market rate that falls within a range of reasonableness").

100

If A is the final award and S is the settlement offer currently on the table, the bid would be priced as a percentage of (A - S).

101

In a Dutch auction, the price is set at the highest price at which there are investors willing to accept all of the shares on offer. See James Bergin, Microeconomic Theory: A Concise Course 101 (2005) (ebook). In the case of an equity sale of a class action lawsuit, a Dutch auction would set the lowest percentage per nominal financing share the investors participating in the auction would be willing to accept in exchange for the financing commitment associated with that share.

Theresa Coetzee

Page 21 of 31 125 Yale L.J. 484, *516 The initial estimate of the cost of the lawsuit is unlikely to be exactly accurate. It is therefore essential that the terms of the equity investment agreement leave room for eventualities in which litigation costs depart significantly from initial estimates. Where litigation costs significantly undershoot actual expenditures - perhaps because defendants, knowing that class counsel was well-funded and unlikely to back down, capitulated more quickly than anticipated - investors should be awarded the same percentage of fund rate set at the auction stage, and the remainder of the unspent capital should go to the plaintiffs' share of the recovery (or, put another way, the total unspent costs should be deducted from the fee awarded). More difficult is a scenario in which class counsel have significantly underestimated the amount of capital needed to prosecute the lawsuit. Adequate provision for such circumstances should be among the key terms of the financing agreement, and an important factor for judicial scrutiny when the lawyers present the funding agreement as part of their application for appointment as class counsel. Such provisions may require financiers to contribute additional capital up to a certain threshold above which they can continue to provide capital at their discretion. Additional capital could come directly out of class counsel's pockets, or they could jointly arrange terms with a second string of investors, offering those investors a share of the fee they established at auction. The risk that the investors will have to cover the additional capital will be reflected in their auction bids. What if even this [*517] threshold is exceeded, and the financiers are not willing to provide more capital? If there are no other investors willing to buy out the equity of the financiers and contribute more capital, the situation is ripe for settlement bonding. 102 B. Rule 23 and the Role of the Judge The auction procedure does not require a change in the judge's responsibilities or authority under Rule 23 with respect to appointing class counsel 103 and awarding attorney fees and costs 104 under the common fund doctrine. Moreover, the equity sale would not change the procedure for the appointment of class counsel, who would still be appointed by the judge according to their qualifications. The judge would retain extensive supervisory responsibilities under the equity auction procedure, so we should not expect the equity auction to significantly reduce the amount of judicial resources that go into litigating attorney fees. 105 Under the auction procedure, the judge retains her role as the critical guarantor of the fairness of fee arrangements. She will need to vet the auction and the resulting fee arrangement for fairness at two points: when she appoints class counsel and when she enters a final judgment or approves a settlement. In vetting the auction procedure at the appointment stage, she will require class counsel to show that the auction was conducted fairly and at arm's length, without collusion or foul play on the part of the financiers or attorneys, and that the bids were based on reasonable projections and assumptions about the conduct of the lawsuit. Having established at the outset that the fee set through the equity auction was fair, this presumption should have a heavy weight in any ex post review of the fee award. A judge might reduce an award on an ex post review where, for example, she finds that class counsel were incompetent or did not act in the best interests of the class, or that the investors exerted undue influence on class counsel during the course of the litigation. A judge may also reduce an award where some unforeseen eventuality results in a significant deviation from [*518] initial projections. 106 Financiers and class counsel may want to stipulate terms around such an eventuality during the bidding process.

102

See supra notes 95-100 and accompanying text.

103

Fed. R. Civ. P. 23(g).

104

Fed. R. Civ. P. 23(h).

105

It is no secret that Rule 23(h) is already the source of extensive litigation, as fee applications are subject to "thorough judicial review" by the district court, and are also closely reviewed on appeal. See In re Rite Aid Corp. Sec. Litig., 396 F.3d 294, 299-300 (3d Cir. 2005) (quoting In re Prudential Ins. Co. of Am. Sales Practice Litig. Agent Actions, 148 F.3d 283, 333 (3d Cir. 1998)). 106

This is in line with ex post judicial review of ex ante fee arrangements between lead plaintiffs and attorneys in securities litigation subject to the Private Securities Litigation Reform Act (PSLRA). See, e.g., In re Cedant Corp. Litig., 264 F.3d 201, 282-

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Page 22 of 31 125 Yale L.J. 484, *518 C. Required Changes in the Law In order for the equity auction to be viable, two sets of legal roadblocks must be overcome. First, state legislatures, courts, and bars would have to roll back restrictions on third-party lawsuit financing. 107 Second, courts may need to modify attorney-client privilege doctrine. Prospective funders may need access to privileged attorney-client communications in cases like mass torts that require plaintiff-specific discovery and verification. 108 Such a modification could take the form of an expansion of the common interest exception, under which communications between multiple parties and an attorney are jointly privileged where the parties share a common interest. 109 No change in work-product doctrine would be required. 110 These roadblocks to third-party financing arrangements notwithstanding, district court judges in most federal circuits would possess the authority to allow a fee to be set through an equity auction procedure in common fund cases. Awarding attorney fees under the common fund doctrine (rather than [*519] under a fee-shifting statute) is an exercise of equity power. 111 As such, district courts generally have "significant flexibility in setting attorneys' fees" 112 subject only to review on an abuse of discretion standard. 113 For example, as discussed below, some judges have experimented with appointing lead counsel through an auction based in part on bids to accept the lowest percentage of the recovery as a fee award. 114 The authority that empowers judges to conduct these "lead counsel auctions" would authorize judges to allow equity auctions. However, while federal district court judges maintain the discretion to institute an auction procedure to set a reasonable attorney fee ex ante, some exceptions may apply. The Third Circuit, for example, has held that fees set through lead counsel auctions must undergo a searching ex post review looking at the same factors that govern review of common fund awards in the absence of a bidding process, including the size of the fund, the presence of objectors, the lodestar, and benchmarks from similar cases. 115 Such a searching review at least partially

84 (3d Cir. 2001) (holding that while a presumption of reasonableness attaches to fee arrangements between lead plaintiffs and class counsel under the PSLRA, this presumption can be rebutted by a change in circumstances during the course of litigation). 107

See supra notes 40-43 and accompanying text.

108

See Comm'n on Ethics 20/20, White Paper on Alternative Litigation Finance, Am. Bar Ass'n 34-37 (Oct. 2011), http://www.americanbar.org/content/dam/aba/administrative/ethics_2020/20111019_draft_alf_white_paper_posting.authcheckda m.pdf [http://perma.cc/TE9K-R9MJ]. 109

See Maya Steinitz, Whose Claim Is This Anyway? Third-Party Litigation Funding, 95 Minn. L. Rev. 1268, 1328 (2011); see also Cavallaro v. United States, 284 F.3d 236, 249-50 (1st Cir. 2002) (providing a definition of the common interest exception). 110

In sharing such documents with third-party financiers under a strict seal of confidence, class counsel would not be waiving protection under the work-product doctrine. See Blanchard v. EdgeMark Fin. Corp., 192 F.R.D. 233, 237 (N.D. Ill. 2000) (holding that the protection of work product is waived by a disclosure to a third party only where "the particular disclosure was of such a nature as to enable an adversary to gain access to the information"); 8 Charles Alan Wright et al., Federal Practice & Procedure § 2024 (3d ed. 2015) ("Disclosure of a document to third persons does not waive the work product immunity unless it has substantially increased the opportunities for potential adversaries to obtain the information."). 111

Boeing Co. v. Van Gemert, 444 U.S. 472, 478 (1980).

112

In re Cendant Corp. Sec. Litig., 404 F.3d 173, 187 (3d Cir. 2005).

113

Id. at 186.

114

See infra notes 125-132 and accompanying text.

115

In In re Cendant Corp. PRIDES Litigation, the Third Circuit vacated a fee award set through a lead counsel auction because the judge's ex post review of the award was "too cursory for [the court] to "have a sufficient basis to review for abuse of discretion.'" 243 F.3d 722, 733 (3rd Cir. 2001) (quoting Gunter v. Ridgewood Energy Corp., 223 F.3d 190, 196 (3d Cir. 2000)).

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Page 23 of 31 125 Yale L.J. 484, *519 undermines the advantages of an ex ante bidding procedure. 116 The Third Circuit has also held that the lead counsel provision of the Private Securities Litigation Reform Act (PSLRA) preempts the judge's discretion to institute a competitive bidding procedure in securities cases where a viable lead plaintiff exists. 117 While judges do have the power to implement novel market-based procedures for setting attorney fees in most common fund cases, the law puts more restrictions on judges' ability to award fees under fee-shifting statutes. Awards made pursuant to statutory fee shifting are governed exclusively by the lodestar method, and there is a strong presumption against enhancements to or [*520] modifications of that method. 118 The lodestar method is only intended to compensate an attorney with "an award that roughly approximates the fee that the prevailing attorney would have received if he or she had been representing a paying client who was billed by the hour in a comparable case." 119 Absent unusual or unforeseen circumstances, fee awards must be equal to the number of hours class counsel spent on the case multiplied by the prevailing market rate. While there may be some flexibility in cases where there has been an "extraordinary outlay of expenses and the litigation is exceptionally protracted," or where payout of the fee has been significantly delayed, fee enhancements in such circumstances are limited to a strict, objective application of a "standard" rate of interest. 120 Indeed, the Supreme Court has explicitly forbidden accounting for risk in the lodestar method applied in a fee-shifting case. 121 Unless the law changes, no competitive method of setting fees can apply in fee-shifting cases. D. Distinguishing the Equity Auction The equity auction approach offers advantages over two other notable auction-based proposals: the lead counsel auction introduced into practice in 1990 by Judge Walker of the Northern District of California and the auction procedure proposed by Macey and Miller. The former does not enjoy the benefits of third-party investment. The latter, which forcibly separates individual class action plaintiffs from their claims, is intended only for "large-scale, small-claim" suits, and would offend basic notions of the rights of plaintiffs if extended to cases where class members may have meaningful interests in the case. 122 1. The Lead Counsel Auction While the lead counsel auction has substantial potential to reduce attorney fees by introducing a competitive bidding process, it has several defects. The [*521] auction procedure begins with law firms submitting bids "specifying the percentage of any recovery such firm will charge as fees and costs in the event that a recovery for

The Third Circuit held that the court must evaluate the fee award against at least seven specific factors governing all ex post fee determinations in common fund cases. Id. 116

See Laural L. Hooper & Marie Leary, Auctioning the Role of Class Counsel in Class Action Cases: A Descriptive Study, 209 F.R.D. 519, 610-11 (2001) (discussing the concerns voiced by Judge Shadur in In re Bank One Shareholders Class Actions, 96 F. Supp. 2d 780 (N.D. Ill. 2000), and In re Comdisco Sec. Litig., 141 F. Supp. 2d 951 (N.D. Ill. 2001)). 117

See In re Cendant Corp. Sec. Litig., 404 F.3d at 192-93 (holding that a lead counsel auction is authorized "only in the unusual situation in which no sophisticated lead plaintiff can be trusted to fulfill its duties to the class under the PSLRA"). 118

Perdue v. Kenny A. ex rel. Winn, 559 U.S. 542, 552-53 (2010); see also Pennsylvania v. Del. Valley Citizens' Council for Clean Air, 478 U.S. 546, 565 (1986) ("A strong presumption that the lodestar figure … represents a "reasonable' fee is wholly consistent with the rationale behind the usual fee-shifting statute … ."). 119

Perdue, 559 U.S. at 551.

120

Id. at 555-56.

121

City of Burlington v. Dague, 505 U.S. 557, 561, 567 (1992) (holding that fees calculated under the lodestar method in statutory fee shifting cases cannot be enhanced for the "contingent risk of nonpayment"). 122

Macey & Miller, supra note 62, at 105-06.

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Page 24 of 31 125 Yale L.J. 484, *521 the class is achieved," as well as details related to counsel's qualifications. class counsel on the basis of both estimated price and qualifications. 124

123

The judge will award the role of

This procedure does not produce any of the benefits of opening the class action to third-party financing. The lack of an open and competitive market for capital financing has its own effects on attorney fee levels and whether certain lawsuits are brought or maintained through inadequate settlement offers. Without allowing support from outside financiers, the lead counsel auction can only partially address the issues that result from inefficient financing. It is true that the auction does put the better-financed lawyer at an advantage: that attorney will be able to make a lower bid, and the judge will be able to take into consideration the health of his firm's balance sheet when evaluating offers. Major problems, however, are left unaddressed. Better-financed attorneys aren't necessarily better attorneys. Moreover, without the option of outside investment, financing will ultimately remain cordoned off from broader capital markets, raising the cost of capital and leaving attorneys limited in their decision-making by their ability to bear risk and manage cash flow. The lead counsel auction has other shortcomings not directly connected to the lack of third-party financing. Just over a decade after Judge Walker first introduced the method, a Third Circuit Task Force Report pointed out several such defects in a comprehensive evaluation of lead counsel auctions, relying on empirical studies and extensive testimony from academics, judges, and lawyers. 125 Despite initial indications that the method successfully reduces attorney fees, the task force pointed out several potential problems, including whether the class is best served by selecting the counsel who offers the lowest bid (even if the court includes qualitative factors in its determination); whether a court can replicate a client's choice without becoming unduly involved in the selection and negotiation process; and whether a meaningful fee agreement can be reached in advance of the [*522] case, when the judge remains bound under Rule 23 to review the fee at the end of the case. 126

Additional problems include the potential for an auction to misprice the attorneys' fees in actions with an uncertain outcome, as well as the potentially damaging systemic effects of undercompensating, and therefore underincentivizing, the work firms do before filing to find viable claims to bring to court in the first place. 127 The task force ultimately recommended that private ordering should remain the favored class counsel selection method, and that courts should conduct lead counsel auctions only in exceptional situations. 128 The taskforce concluded that "traditional criteria for appointing class counsel are preferable, in most cases, to the use of an auction" despite the fact that the potential downsides of auctions could be minimized in certain kinds of cases (for example, those where liability and damages are clear cut, the litigation will be relatively straightforward, and no particular attorney has undertaken extensive pre-filing investigatory work). 129 Perhaps as a result of the task force's cautious evaluation, lead counsel auctions remain rare. 130

123

In re Oracle Sec. Litig., 131 F.R.D. 688, 697 (N.D. Cal. 1990); see also Third Circuit Task Force Report, supra note 79, at 708 & n.44. 124

Though commonly referred to as an "auction," the term may be a misnomer. Judges assessing bids for lead counsel generally have not made such determinations solely on the price of the bid - like Judge Walker, they also take counsel's qualifications into consideration. As such, the procedure is not an auction in the technical sense of the term. See In re Synthroid Mktg. Litig., 264 F.3d 712, 720 (7th Cir. 2001). 125

Third Circuit Task Force Report, supra note 79.

126

Id. at 708.

127

Id. at 741-45.

128

Id. at 740-41.

129

Id. at 740-45.

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Page 25 of 31 125 Yale L.J. 484, *522 Whether or not the task force's cautiousness is justified, the equity auction procedure proposed in this Note reduces or eliminates most of these purported disadvantages. Under the equity auction procedure, the judge's choice of class counsel is independent of the market forces that set the attorney fee. The procedure therefore does not increase the likelihood that less qualified counsel will be appointed - indeed, quite the opposite. Investors will only contribute their capital where they have confidence in the attorneys involved in the lawsuit. Moreover, the procedure does not require judges to "unduly" involve themselves in the counsel selection or financing process. Although they must scrutinize the auction process for fairness, they do not conduct the process. Equity auctions also preserve, and even enhance, the incentive for attorneys to do the entrepreneurial pre-filing legwork required to bring class action claims to court: attorneys who may be uncomfortable with bearing the full risk of bringing the action to completion can extract compensation at the auction stage. The procedure could therefore lead to an even more robust industry of entrepreneurial claim seekers. [*523] An additional concern about the lead counsel auction is that, by pushing down attorney compensation, it decreases the incentives for counsel to litigate the class action robustly. This is a particular concern in the class action context, as class counsel's efforts are typically not closely supervised by any member of the plaintiff class. The equity auction does not suffer from this problem because, unlike in the case of the lead counsel auction, competence and reputation at bar will be critical components of the financier's decision to invest in the case in the first place. While courts rarely question class counsel's competence in their determinations of class counsel's adequacy under Rule 23(g), 131 part of any financier's due diligence will involve assessing the attorney's track record. 132 Attorneys that are repeat players will therefore have every incentive to preserve their reputation by litigating zealously and competently. Moreover, to the extent that counsel retain some equity in the fee award, their compensation will remain directly tied to their efforts.

2. Macey and Miller's Auction The auction Macey and Miller propose, which would allow judges to auction certain claims in their entirety to third parties to litigate, is a compelling alternative for class actions involving large volumes of small claims. Under their proposal, the judge would make an initial determination as to whether the case warrants auction treatment by considering, among other factors, whether the case falls into the "large-scale, small-claim" category and whether the claims are definite enough to make a reasonable estimation of the damages. 133 If the case fits the criteria, the judge directs notice to class members allowing individuals to opt out; subject to this opt out, the court auctions the bundle of claims to the highest bidder and disburses the proceeds to the plaintiffs. 134 Notably, defendants themselves are entitled to participate in the auction, essentially allowing them to settle the lawsuit at a competitive price without any litigation. 135 [*524] The administrative simplicity of Macey and Miller's proposal makes it an attractive alternative to the equity auction in many consumer and shareholder class actions (or derivative suits) where it is unlikely that individual plaintiffs would be able to collect more than a few dollars or a coupon. However, as Macey and Miller themselves note, their approach is not appropriate for cases where the plaintiffs' claims are not "small." 136 Where plaintiffs'

130

Rubenstein, supra note 1, at § 10:14.

131

See Hubler Chevrolet, Inc. v. Gen. Motors Corp., 193 F.R.D. 574, 578 (S.D. Ind. 2000) ("Courts generally presume competency of class counsel at the outset of the litigation in the absence of specific proof to the contrary by the defendant."). 132

For example, Burford Capital makes clear on its website that it "seeks to insure that the highest quality counsel is involved in [its] cases." Working with Burford, Burford Cap. (2014), http://www.burfordcapital.com/how-we-help-uk/working-with-burford [http://perma.cc/43G5-8RU5]. 133

See Macey & Miller, supra note 62, at 106.

134

See id. at 107-08.

135

See id. at 108.

136

Cf. id. at 106 (mentioning that suitability for auction turns, in part, on the smallness of the claims).

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Page 26 of 31 125 Yale L.J. 484, *524 claims are meaningful, either in their monetary value or in their qualitative value to plaintiffs, alienating plaintiffs from their claims would violate the fundamental duty of the class action to make plaintiffs whole. 137 The proposal would preserve plaintiffs' right to opt out; however, they may not receive notice in time. And even if they do, the auction deprives them of the ability to participate in the class action, forcing them to choose between litigating alone - which could be prohibitively expensive - and forfeiting any potential to collect more than the auction participants estimated their claims were worth before litigation. The equity auction is therefore more appropriate for cases in which the meaningful interest of the plaintiffs in the litigation must be preserved. IV. ASSESSING THE RESTRICTIONS ON OUTSIDE FINANCING Restrictions on outside financing pose the largest obstacle to the equity auction proposal. These restrictions are sustained by concerted opposition from large corporations 138 - many of which are able to use their balance sheets to enjoy the very benefits they oppose giving to plaintiffs. 139 The opposition has been vociferous, and is especially shrill when mentioned in the same breath as the class action. 140 Critics resolutely resist enabling litigation financing on the grounds that it will provide overly litigious plaintiffs' lawyers with yet another unfair tactic with which to harass corporate defendants. 141 It is perhaps [*525] of little surprise, then, that ancient laws and professional standards barring many financing practices remain largely intact despite enthusiasm within the academy and successes abroad. This opposition has attached a social stigma to the practice, relegating it "to the dark corners of the capital markets and the legal profession." 142 Perhaps as a result, reputable lawyers are reluctant to push the law in a more sympathetic direction. 143 Meanwhile, litigation financiers are content, at least in public, to disavow any interest in class actions and focus their attention on corporate clients. 144 Will the adoption of litigation financing in the class action arena have undesirable effects on the efficient and fair administration of civil justice? Opponents of financing cite two classes of negative consequences of its widespread adoption. The first relates to agency costs. The argument is that investors may interpose their interests, which could be adverse to those of the plaintiffs. 145 The second, weightier objection relates to a perennial class action

137

Cf. id. at 30 (noting that the Supreme Court has generally required actual notice as a matter of due process in cases where the property right at issue is "substantial in size or importance" to the claimant). 138

See Hensler, supra note 6, at 499-500 (noting the "strident" advocacy of "corporate interest groups" against litigation financing). 139

See supra note 48 and accompanying text.

140

In the words of Deborah Hensler, "No area of legal practice has been more clearly targeted for prohibition of [third-party] financing than class action litigation." Hensler, supra note 6, at 500.

141

The U.S. Chamber of Commerce, for example, features a website, updated on a near-weekly basis, dedicated to advancing the cause against litigation financing. U.S. Chamber Inst. for Legal Reform, Third Party Litigation Funding, U.S. Chamber of Com., http://www.instituteforlegalreform.com/issues/third-party-litigation-funding [http://perma.cc/73SH-UCVK]. The rhetoric could perhaps fairly be characterized as shrill. A particularly ear-splitting example of the genre refers breathlessly to litigation financing as "a clear and present danger to the impartial and efficient administration of civil justice in the United States." John H. Beisner & Gary A. Rubin, Stopping the Sale on Lawsuits: A Proposal to Regulate Third-Party Investments in Litigation, U.S. Chamber Inst. for Legal Reform 1 (2012), http://www.instituteforlegalreform.com/uploads/sites/1/TPLF_Solutions.pdf [http://perma.cc/J8JW-ESJ9]. 142

Molot, supra note 6, at 102.

143

Id.

144

See Hensler, supra note 6, at 507-08 (parsing public statements of litigation financiers Burford and Juridica and concluding that "it is difficult to avoid the inference that litigation investors who see their market as comprising large corporations believe that it is politic to give class actions a wide berth"). 145

See Hensler, supra note 6, at 515-16.

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Page 27 of 31 125 Yale L.J. 484, *525 bogeyman: the negative-value lawsuit, which costs more to litigate than the underlying claim is worth. 146 The fear is that, with more cash to spare, unscrupulous financiers and lawyers could be emboldened to go after deeppocketed defendants in such cases with the goal of terrorizing them into an unfair settlement. This Part addresses each argument in turn. A. Agency Costs Arguments Litigation financing gives a third party without an independent interest in a lawsuit a direct financial stake in its outcome. This could be problematic where the financier's interest conflicts with the interests of the plaintiff. Would the financier push the lawyer to advance the financier's own best interests over [*526] those of the plaintiff? This could be particularly dangerous in the class action context, where plaintiffs are not present to call the shots and supervise the financier-attorney relationship. 147 A judge-enforced requirement that investors remain on the sidelines would not be sufficient. After all, class counsel, repeat players in the market for financing, could feel compelled to tacitly acquiesce to the financier's interests. It would be difficult for any court to completely enforce the independence of class counsel from the financier. The danger that financiers will push to settle early is a real one - but not one created by the existence of the thirdparty financier. The underlying financial interests of investors are indistinguishable from the basic interests of the lawyers under the current regime. There is no reason to think that judicial oversight would be sufficient to ameliorate existing class action agency problems but would somehow fail to protect against agency conflicts with financiers. Indeed, opening the financing market could reduce the risk that the interests of a particular investor will be realized at the expense of the plaintiff class. Equity holders in an open financing market can divest themselves of their equity without affecting the conduct of the lawsuit. As long as litigating remains financially viable, someone else will have the incentive to step in and allow the antsy investor to exit. Another advantage of an open financing market is alleviating conflicts of interest, both between attorneys-cum-financiers and within the plaintiff class itself. Alternative financing arrangements can allow objectors who would be better served by continuing litigation despite an attractive settlement offer to do so without harming the interests of the rest of the class. They also allow plaintiffs who would be better served by cashing out at a point earlier than final judgment or settlement to do so on transparent and market-priced terms. And what of potential agency problems arising from the tension between monetary and non-monetary forms of relief? The plaintiff class may desire to benefit from some measure of declaratory or injunctive relief in addition to its monetary claims. While it may be in the plaintiffs' interest to sacrifice some of the latter to achieve the former, the financier would likely not be interested in doing so - especially if it required delaying settlement or putting more capital [*527] at risk. This potential for conflict exists in the normal contingency fee context, but to a lesser extent. Where class counsel are financing the lawsuit, any work they undertake to pursue declaratory or injunctive relief would at least be reflected in the lodestar calculation the judge ultimately uses to set or crosscheck the fee. Agency problems relating to non-monetary relief either will not arise at all because such lawsuits won't be amenable to treatment under the equity auction procedure, or else can be mostly addressed through judicial oversight. Attorney fees in a class action seeking significant declaratory or injunctive relief - which will likely be certified under Rule 23(b)(2) - will generally be calculated using the lodestar method, which, as I have noted, is incompatible with the approach I have proposed. For those class actions certified under Rule 23(b)(3) where declaratory or injunctive relief are at issue to some degree, the agency problem can be remedied through judicial supervision. Judges will have to ensure that the non-monetary issues are given adequate attention. In some circumstances, judges may

146

Id. at 510-15; see also infra notes 150-151 and accompanying text.

147

Examples of situations where financiers' and plaintiffs' interests compete include cases where the financier wants to settle early for a smaller sum in order to alleviate risk or cash flow concerns; where the plaintiff class would be better served by collecting immediately, but the financier wants to continue litigation; where there is some tension between expending resources and achieving some non-monetary remedy important to the plaintiffs; or where the funder has an independent agenda unrelated to the size of recovery (for example, establishing a rule that could benefit recovery in other cases in the financier's portfolio).

Theresa Coetzee

Page 28 of 31 125 Yale L.J. 484, *527 even be able to incorporate the value of the injunctive relief into the common fund. 148 Class counsel and financiers should make sure they take the non-monetary issues into consideration when estimating how much the litigation will cost. B. Lawsuit Abuse Arguments In medieval times, individuals with grievances enlisted the help of the powerful, who used their resources and influence to manipulate the outcome of a case in exchange for some of the proceeds, usually in the form of land. 149 According to litigation financing critics, the modern version of this practice involves bringing shaky claims against a defendant who is forced to settle due to the uneconomical (or potentially ruinous) costs of putting on a defense. 150 Alternative litigation finance is not the root cause of this issue: critics claim that such abuse already takes place, enabled by the pocketbooks of plaintiffs themselves or perfidious contingency fee attorneys. 151 (Other scholars refute [*528] that such negative value suits take place. 152) Opponents of alternative litigation finance claim that an open financing market would aggravate this supposed problem by enabling deep-pocketed outsiders to engage in abusive litigation. 153 They point to one notorious example, a corruption-riddled Ecuadorian class action against Chevron partially funded by Burford, 154 to highlight the dangers of the potentially noxious combination of thirdparty finance and class action lawsuits. How justifiable are their fears? 1. The Theoretical Possibility of Negative Value Suits A theoretical possibility of negative value suits - meritless suits brought to cow defendants into settlement - does exist. The Chevron case, which involved a foreign venue, is perhaps not a persuasive example for critics of thirdparty financing to class actions litigated in American courts; however, many supporters of alternative litigation finance have perhaps too summarily dismissed the possibility that the practice could enable negative value suits. One standard response is that it would be unacceptably risky, and therefore a poor business decision, for a financier to back a lawsuit that would not hold up on the merits. 155 While this may be true to an extent, it is not

148

See supra note 61.

149

See Steinitz, supra note 109, at 1286-87.

150

See U.S. Chamber Inst. for Legal Reform, Class Actions, U.S. Chamber of Com., http://www.instituteforlegalreform.com/issues/class-actions [http://perma.cc/ALA2-G62P] ("The large size of some classes, and the resulting large potential payouts, make these cases very risky for businesses. As a result, most business defendants seek to settle class actions before going to trial."). 151

See, e.g., Victor E. Schwartz & Cary Silverman, The New Lawsuit Ecosystem: Trends, Targets and Players, U.S. Chamber Inst. for Legal Reform 1 (Oct. 2013) http://www.instituteforlegalreform.com/uploads/sites/1/web-The_New-Lawsuit-EcosystemReport-Oct2013_2.pdf [http://perma.cc/KSL8-6RUN] (decrying "the litigious culture that sustains big ticket litigation, the players that drive it, and how those players try to manipulate or change the law to their favor"). 152

Macey & Miller, supra note 62, at 77-78.

153

See, e.g., Beisner & Rubin, supra note 141, at 4.

154

Roger Parloff, Have You Got a Piece of This Lawsuit?, Fortune, June 28, 2011, http://fortune.com/2011/06/28/have-you-gota-piece-of-this-lawsuit-2 [http://perma.cc/7K8W-S4DY]. 155

See Steinitz, supra note 109, at 1327 ("A commercial funder needs to make a rational economic decision to invest in a claim. It would not do so if the claim does not have merit and is unlikely to succeed."); see also Hensler, supra note 6, at 513 ("At worst, bringing a frivolous claim would result in an expensive pretrial battle and a defense victory, with a financial loss for class counsel, who will neither recover expenses nor win fees for time spent on the case."); Molot, supra note 6, at 106 ("Why an investor would purposely invest money in a case that is weak on the merits and likely to lose is hard to understand."). In addition to these theoretical arguments, Hensler in particular has also pointed to the fact that the sky has not fallen in Australia, where third-party financing of class action suits has developed into an essential component of that country's Rule 23(b)(3)-inspired

Theresa Coetzee

Page 29 of 31 125 Yale L.J. 484, *528 hard to imagine [*529] financiers with capital at their fingertips, few scruples, and a high risk tolerance. Moreover, at least theoretically speaking, it is possible that such a strategy could be profitable. To see how this could occur, consider a hypothetical in which Lawyer A's unscrupulous doppelganger, Lawyer E, enlists the help of outside financiers and brings a widget price fixing suit against defendants X, Y, and Z even though he believes that such claims would likely prove to be meritless after extensive discovery. Lawyer E estimates that a full-throated prosecution of his claims would cost about $ 5 million; however, given the dubiousness of the claims he is bringing, the expected value of the plaintiff award is low - also about $ 5 million, with an expected fee award of around $ 1.5 million. If Lawyer E brings suit, and the suit is fully litigated, he can expect to lose around $ 3.5 million. Assuming that the defendants will fight to the end, it makes little sense for Lawyer E to bring suit; he and his financiers will, after all, probably lose a great deal of money. But what if he can be relatively confident that the defendants will not put up a vigorous defense? Consider the position of X, Y, and Z. It will cost them collectively about $ 5 million to defend the case vigorously. And even after putting on a full defense, they could lose: the expected value of their payout is, as mentioned above, $ 5 million. Therefore the overall expected value of the lawsuit for them, if they litigate to the fullest extent, is a loss of $ 10 million. Does it make sense for them to capitulate and settle for some sum less than $ 10 million, or should X, Y, and Z put on a defense? The answer to this question depends on an iterative, step-by-step dance between the parties as they alternately litigate and negotiate. 156 We can see how this might unfold by considering a simplified world in which parties have only two choices: settle at the outset, or litigate through to a final judgment. In this situation, both parties lose if they litigate to completion. It is rational for Lawyer E to accept any settlement amount whatsoever. Meanwhile, it is rational for X, Y, and Z to accept any settlement under $ 10 million. Assuming that the outcome of their negotiations will not have consequences for future lawsuits, their interaction will resemble an ultimatum game, and the parties will likely reach some sort of settlement. 157 Adversaries' knowledge about the merits of the case and the costs that the opposing party would incur if they rejected settlement and insisted on litigating will influence the outcome. [*530] The scenario above makes two strong assumptions that are often false in the real world. When we consider each of these assumptions, it becomes clear that the availability of a litigation finance market can give the plaintiffs' lawyer a significant advantage in settlement negotiations in a lawsuit with a low chance of success. The first of these assumptions is that both parties will be playing toward the expected value, which is calculated by taking the probability-weighted mean of all potential outcomes, instead of playing toward a median value that more accurately reflects their risk preferences. 158 Consider the following two scenarios, as assessed from an ex ante perspective. In Scenario One, if the lawsuit goes to judgment at trial, X, Y, and Z will be liable for $ 30 million in damages; however, the lawsuit only has a 17% chance of success. In Scenario Two, if the lawsuit goes to judgment at trial, X, Y, and Z will be liable for $ 10 million, and the lawsuit has a 50% chance of success.

For the defendants, each of these scenarios has an expected negative value of about $ 5 million dollars. Yet the defendants' attitudes toward each scenario may be very different. Suppose that X, Y, and Z would essentially be put out of business if assessed a $ 30 million judgment (on top of the costs of their defense), but would be able to afford a judgment of up to $ 10 million plus $ 5 million in legal fees. Scenario One puts them in a worse bargaining position than Scenario Two, as in the former scenario they cannot risk going to trial and losing. Therefore, in class action procedure. Hensler, supra note 6, at 517-18, 524. But the Australian example is not quite apropos, as fees are assessed against the plaintiffs if the case loses, providing defendants with additional protection. See id. at 518-19. As a result of this fee shifting, the involvement of financiers, and other aspects of the legal fee regime, the Australian procedure now resembles more of a glorified joinder device than a true Rule 23(b)(3) class action. See id. at 519 ("The result in Australia has been that the formal opt-out regime has become, in practice, an opt-in regime."). 156

See generally Molot, supra note 6, at 106 n.130 (describing scholarship on both sides of this debate).

157

See generally Werner Guth et al., An Experimental Analysis of Ultimatum Bargaining, 3 J. Econ. Behav. & Org. 367 (1982), for background on the ultimatum game.

158

For a full discussion of playing toward the mean versus playing toward the median, see Molot, supra note 6, at 83-90.

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Page 30 of 31 125 Yale L.J. 484, *530 Scenario One, the defendants' strategy requires settlement, whereas in Scenario Two they may be willing to put up a fight. Scenario One may not present the defendants with a disadvantage if Lawyer E is similarly risk constrained. In Scenario One, he has an 83% chance of losing $ 5 million with a litigation strategy, odds that could be unacceptable to him. But if Lawyer E has the backing of a financier that can hedge the risk, he would be comfortable with the risk of a litigation strategy in Scenario One; Lawyer E and his financier have a good chance of at least breaking even if they spread their risk over five other lawsuits with similar odds. Especially if he knows that the defendants are in the weaker position, Lawyer E has the ability to drive a hard bargain, potentially extracting an unmerited settlement up to the defendants' ability to pay - in this case, $ 15 million. That leaves Lawyer E with a windfall far above his expected value, and the defendants with a loss far below theirs. The second assumption is that the litigation takes place in a vacuum: that settlement negotiations will not be influenced by the implications of each [*531] party's behavior on future lawsuits. This assumption often will not hold. In deciding on a settlement threshold, defendants must consider the implications of settlement on future lawsuits. Entering into a settlement could, for example, embolden future plaintiffs by signaling a willingness to capitulate to less-than-clearly-meritorious lawsuits. The plaintiffs' lawyer may make similar calculations: settlement under a certain amount may give him a reputation as weak, and therefore harm him in future negotiations. It is very clear, though, that a well-capitalized financier's backing could put Lawyer E at a tremendous advantage by inoculating him against the risks of an aggressive litigation strategy. The financier would happily enable him to do that in order to signal to future defendants that her involvement means plaintiffs' counsel will be aggressive. The financier would rather Lawyer E litigate, and thereby burnish the credibility of future lawyers she backs, than compromise her credibility by accepting a less-than-attractive settlement. 2. Litigation Finance Solves Its Own Problem As we have seen, the fairness of a settlement can be skewed by an asymmetry in the parties' abilities to distribute litigation risk. Litigation financing has the potential to introduce or exacerbate these asymmetries, putting the plaintiffs' lawyer at an advantage in negotiating settlements in lawsuits of dubious merit. Does this present a fatal blow to litigation financing? Far from it. Litigation financing only presents this danger if there is an asymmetry of access to it. If both parties have the ability to insure their litigation risk, the asymmetry vanishes. A truly robust litigation financing market would make available resources to spread litigation risk equally to plaintiffs and defendants. 159 Consider our discussion of how a defendant's expectations of future lawsuits will bear on his settlement behaviors. Clever lawyers and financiers will prey on the weak defendants that have shown they would rather settle than litigate a full defense, either because they are not repeat defendants, or because they are otherwise unable to protect themselves against litigation risk. But any corporation that can manage its litigation risk will not be a weak defendant. On the contrary, like Lawyer E and his financier, the defendant will be able to pursue an aggressive strategy that signals the ability to manage the risks of making a full defense rather than capitulating. [*532]

CONCLUSION Over the last few decades, the class action lawsuit has been on its back foot. Legislative interventions like the Class Action Fairness Act of 2005 160 and the Private Securities Litigation Reform Act 161 have made it easier to

159

For a broader discussion of how litigation financing allows corporate defendants to manage their litigation risk, see Jonathan T. Molot, A Market in Litigation Risk, 76 U. Chi. L. Rev. 367 (2009). 160

Class Action Fairness Act of 2005, Pub. L. No. 109-2, 119 Stat. 4 (codified in scattered sections of 28 U.S.C.).

161

Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (codified as amended in scattered sections of 15 U.S.C.).

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Page 31 of 31 125 Yale L.J. 484, *532 remove class actions to federal court and raised pleading requirements in securities litigation. Meanwhile, in cases like Wal-Mart Stores, Inc. v. Dukes 162 and Comcast Corp. v. Behrend, 163 the Supreme Court has made it increasingly difficult for plaintiff classes to obtain certification. Given this clear trend, a proposal to liberalize financing restrictions and change the way class action contingency fees are set may face headwinds. But, as discussed above, the current financing and fee regime undermines the class action's goals. As a result, the class action device simply does not work as well as it could. We can do better. The equity sale method, a competitive auction open to non-lawyer financiers, would enhance the welfare of plaintiffs and further the enforcement function of the class action. The proposal would comply with Rule 23 and current doctrine on attorney fee awards. It would, however, require us to become comfortable with the prospect of non-lawyers financing lawsuits. The dialogue must begin with a full acknowledgement of the critical role that profit, capital, and risk already play in setting the terms of justice. But as long as the class action remains a tool of American civil procedure, we would do well to focus on maximizing its ability to deliver on its mandate to facilitate justice for certain plaintiffs and to promote public welfare through private rights of action. Yale Law Journal Copyright (c) 2015 The Yale Law Journal Company, Inc. The Yale Law Journal

End of Document

162

131 S. Ct. 2541 (2011).

163

133 S. Ct. 1426 (2013).

Theresa Coetzee

ARTICLE: Economic Conundrums in Search of a Solution: The Functions of Third-Party Litigation Finance Fall, 2015 Reporter 47 Ariz. St. L.J. 919

Length: 18936 words Author: Joanna M. Shepherd*** * Professor of Law, Emory University School of Law. ** Law Clerk, Hon. Antonin Scalia, Associate Justice, Supreme Court of the United States. We are grateful to Richard Fields, Chris Klimmek, Bill Rinner, and Derek Ho, for thoughtful comments and feedback on earlier drafts, and Sarah Donohue, Elise Nelson, and Vincent Wagner for valuable research assistance. The views expressed in this article are the authors' alone.

Highlight [*919]

Abstract Despite a rapid increase in economic significance and substantial increase in international use, third-party litigation financing remains poorly understood. No academic consensus takes account of the multiple economic conundrums that third-party litigation financing arises to solve, nor do legal scholars adequately consider obvious public and private substitutes for litigation financing that society rightfully recognizes as innocuous or outright beneficial. In this Article, we explore the economic challenges driving both business plaintiffs and sophisticated law firms to seek external litigation financing. We examine closely the key elements of the litigation financing arrangement itself, focusing on eligible cases and clients, devices financiers employ to ensure repayment without meaningful control over the litigation, and theorize conditions under which third-party litigation financing will be attractive to companies and firms. We then address several concerns regarding third-party litigation financing, ultimately finding them either unpersuasive in theory or undemonstrated in fact. We conclude by noting the variety of similar arrangements already safely beyond the scope of these concerns. Ultimately, litigation financing encourages both businesses and firms to make more efficient uses of capital. Any attempt to regulate or dissuade litigation financing must begin with an economically and legally sound appreciation for how the industry actually functions.

Text [*920]

I. Introduction An international proliferation in third-party litigation financing - a nominally novel but economically familiar arrangement - has attracted relatively little academic attention. Despite modest journalistic coverage and regulatory interest, no scholarly consensus has emerged describing how, or theorizing why, litigation financing occurs. 1

1

For one earlier treatment of the topic, see Joanna M. Shepherd, Ideal Versus Reality in Third-Party Litigation Financing, 8 J.L. Econ. & Pol'y 593 (2012); see also Elizabeth Chamblee Burch, Financiers as Monitors in Aggregate Litigation, 87 N.Y.U. L.

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Page 2 of 28 47 Ariz. St. L.J. 919, *920 The full economic origins and implications undergirding third-party litigation financing remain equally unclear. But where legal academia has largely overlooked litigation financing, businessmen have not: third-party litigation financing has rapidly blossomed both domestically and internationally as several new litigation-finance corporations have emerged. 2 Juridica Investments, the first publicly traded litigation firm, was founded in just 2007; now multiple public and private corporations, investment banks, hedge funds, and even individuals have billions invested in commercial lawsuits. 3 And by at least several accounts, litigation financing remains in its inchoate stages in the United States; these figures understate - possibly drastically - the practice's full economic impact. 4 Rarely in the academy can such a momentous development escape scrutiny for long. This Article explores why commercial third-party litigation finance arises in the United States, focusing on multiple separate economic incentives leading business plaintiffs and sophisticated law firms to seek out external litigation financing. Businesses generally shy away from expensive litigation with questionable future returns in favor of more efficient uses of capital, and large law firms are hesitant to carry expenses from protracted business [*921] suits - even when profitable. Third-party litigation financing arises to resolve an otherwise adverse economic relationship between capital-constrained attorneys and litigation-cost-averse clients. Any critique or regulation of commercial third-party litigation financing must begin by understanding the economic forces that make these funding arrangements desirable to both law firms and business clients. The dearth in understanding of third-party litigation financing is surprising considering the field's ancestry. Notions of champerty, third-party lawsuit support contingent on shared recovery with the outsider, and maintenance, simple external support of another's lawsuit, 5 date back centuries and across countries rooted in English law. 6 Champerty and maintenance were each both crimes and torts. 7 Both criminal and tort prohibitions against each practice have long been virtually abolished in the United States; 8 instead, various forms of litigation financing have crept into practice since at least the 1980s. 9 Cash-advance lenders offer small loans to personal injury

Rev. 1273 (2012); Jonathan T. Molot, The Feasibility of Litigation Markets, 89 Ind. L.J. 171 (2014). 2

William Alden, Litigation Finance Firm Raises $ 260 Million for New Fund, N.Y. Times Dealbook (Jan. 12, 2014, 10:33 PM), http://dealbook.nytimes.com/2014/01/12/litigation-finance-firm-raises-260-million-for-new-fund/; Investing in Litigation: Secondhand Suits, The Economist (Apr. 4, 2013, 3:09 PM), http://www.economist.com/news/finance-and-economics/21575805-fatreturns-those-who-help-companies- take-legal-action-second-hand-suits. 3

Binyamin Appelbaum, Investors Put Money on Lawsuits to Get Payouts, N.Y. Times, Nov. 15, 2010, at A1. Other litigation finance corporations include Burford Capital, Gerchen Keller Capital, Parabellum Capital, ARCA Capital, Calunius Capital, Juris Capital, IMF Ltd., and recenlty closed BlackRobe Capital Partners. See also Alden, supra note 2; Steven Garber, Alternative Litigation Financing in the United States: Issues, Knowns, and Unknowns, 14-16 (2010), http://www.rand.org/pubs/occasional_papers/OP306.html. 4

Investing in Litigation: Second-hand Suits, supra note 2; see also Interview with Richard A. Fields, CEO, Juridica Investments Ltd., in N.Y.C., N.Y. (Jan. 9, 2014) (notes on file with authors) [hereinafter Richard Fields Interview].

5

See generally 14 Am. Jur. 2d Champerty and Maintenance, Etc.§§1-18 (2015).

6

Sarah Northway, Non-Traditional Class Action Financing and Traditional Rules of Ethics: Time for a Compromise, 14 Geo. J. Legal Ethics 241, 243 (2000). 7

Id.

8

See, e.g., Facts About ALFA, Am. Legal Fin. Ass'n, http://www.americanlegalfin.com/FactsAboutALFA.asp (last visited Nov. 16, 2015) (discussing successful efforts to overturn Ohio champerty law). 9

See generally Jason Lyon, Comment, Revolution in Progress: Third-Party Funding of American Litigation, 58 UCLA L. Rev. 571, 574 (2010).

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Page 3 of 28 47 Ariz. St. L.J. 919, *921 victims to fund pending lawsuits. 10 Some larger-claim plaintiffs directly solicit individual lenders, syndicating costs and allocating potential recovery accordingly. 11 Federal courts have considered a potential class representative's financial ability to prosecute a class action as integral to whether that proposed party can adequately represent the class; 12 courts have gone so far as to even consider whether the class attorney was willing to partially or fully fund the class litigation. 13 While each of these arrangements could be fairly described generically as "third-party litigation financing," this Article instead explores the new breed of litigation financing that has emerged in the past decade: the investment of millions of dollars by outside financiers in large commercial cases. [*922] This Article proceeds in five parts. In Part II, we argue that third-party commercial litigation has arisen to solve several interrelated economic problems arising between lawyers, law firms, and business plaintiffs. Business plaintiffs retain both institutional prejudices against acting as plaintiffs as well as a justifiable age-old mistrust of lawyers, whose services are notoriously opaque, difficult to value, and billed on a metric necessarily rivalrous against the company's interests. Large law firms, by contrast, may prove willing to partially align incentives with business plaintiffs through contingent-fee and similar arrangements, but ethical rules rooted in history and tradition effectively prohibit firms from raising capital through some of the most obvious channels. 14 Further, competently prosecuting many commercial cases requires a substantial capital commitment, potentially exceeding millions of dollars. This amount is often difficult to predict ex ante, adding an unwelcome uncertainty dimension to a risky financial proposition. 15 Rather than a novel - or dangerous! - practice, third-party litigation is a simple financial solution to an old and familiar incentives problem between business plaintiffs and law firms, between clients and lawyers. In fact, third-party litigation financing is so common - in both the legal and economic senses - that obvious substitutes inexplicably escape notice. Third-party litigation financing is far from new.

In Part III, we analyze the concerns and constraints confronting the litigation financier. The financier's need to ensure a safe return on investment without a direct method for compelling litigation settlement (or non-settlement) puts him in an economically vulnerable position. Sophisticated financiers therefore include various ex ante and ex post devices in the third-party litigation financing agreement itself to mitigate this risk. The financier's choice of clients, and the collateral or conditions the financier may require, protect the financier from this risk in light of his fundamental and nearly irreconcilable alienation from the attorney/client relationship. Part IV addresses the potential benefits and concerns regarding this burgeoning industry. Litigation financiers provide the initial or ongoing investment necessary to operate a lawsuit, obviating the need for the business plaintiff to divert capital from business lines and reducing various agency problems. Litigation financiers also align law firms' incentives by requiring law firms to take on some portion of risk in the form of future, contingent payment. Financiers also monitor firm billing against the financier's guaranteed funding, reducing the business plaintiff's monitoring costs. Yet as with many poorly understood practices, third-party litigation financing [*923] inspires a variety of criticisms. Of greatest concern among these is that third-party litigation financing either directly encourages additional litigation, frivolous litigation, or ethical compromises in the attorney-client relationship. As we explain, these concerns are unfounded: the frivolous-litigation complaints fail in theory, the ethical questions in practice. This is especially true when one considers that the billions of dollars in what we now call third-party litigation financing represent a mere fraction of the larger swath of economically and legally similar litigationfinancing arrangements.

10

Garber, supra note 3, at 12 ("two industry leaders estimate the average sizes of their cash advances to be $ 1,750 and $ 4,500").

11

Daniel C. Cox, Lawsuit Syndication: An Investment Opportunity in Legal Grievances, 35 St. Louis U. L.J. 153, 154-59 (1990); Susan Lorde Martin, Syndicated Lawsuits: Illegal Champerty or New Business Opportunity?, 30 Am. Bus. L.J. 485, 498 (1992). 12

See 7A Charles Alan Wright et al., Federal Practice & Procedure § 1767 (3d. ed. 2015).

13

See generally id.

14

See generally infra Section II.B.

15

See generally infra Section II.A. and accompanying notes.

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Page 4 of 28 47 Ariz. St. L.J. 919, *923 Part V concludes. Ultimately, we argue that third party investment in commercial cases allows both business plaintiffs and law firms to make more efficient use of their limited capital. In the process, litigation finance solves a host of other agency and information problems. Any regulation of this burgeoning industry must fully appreciate the benefits of third-party litigation financing to both law firms and business plaintiffs: illiquid lawyers and cost-averse businesses will seek a solution to their economic problems. II. Two Economic Problems in Search of a Solution Most third-party litigation financing arrangements rely on a familiar cast of characters: an operating company, a law firm, lawyers, and a financier. Each has an equally familiar incentive; these incentives provide both the opportunity for and the contours of the third-party financing relationship. The prototypical operating company has limited and scarce liquid capital and wants to maximize profits across a line of businesses, typically sensitive to insider and shareholder perceptions of company decisions. Business plaintiffs are skeptical to invest scarce capital in unfamiliar ways, especially in lawsuits. The prototypical law firm carries substantial overhead, is broadly illiquid for its size, and is risk-averse vis-a-vis future income streams. The prototypical litigation financier wants a competitive return on his investment and, accordingly, to hedge various losses as much as possible: in bad cases, stubborn clients, unnecessarily sanguine clients, ineffective attorneys, and so on. In this section, we discuss the cast of characters in a third-party litigation financing agreement, focusing on each party's unmet economic needs giving rise to need for the financing. A. Business Plaintiffs Every third-party litigation arrangement begins with a business with both a valuable commercial claim and a host of reasons not to prosecute that claim through judgment and appeals. These clients, typically sophisticated business entities, share four salient features. We may group these into two general [*924] categories: business plaintiffs are both institutionally limited in terms of relevant litigation experience, and they are risk sensitive to a lost investment in litigation. By institutionally limited, we mean that most corporations with sufficiently large unprosecuted claims to require financing - generally multiple millions of dollars in potential recovery - are typically inexperienced in relevant ways in the potential litigation. 16 This inexperience extends to both the company's posture as a plaintiff in business litigation as well as its comparatively narrow substantive legal expertise. 17 By risk sensitive, we mean that multiple predictable economic forces both inside and outside the operating company render the company sensitive to value or investment metrics as well as to manipulation by agents with divergent incentives from shareholders or other

16

See, e.g., Steven L. Schwarcz, To Make or to Buy: In-House Lawyering and Value Creation, 33 J. Corp. L. 497, 506-07 (2008) (noting how in-house counsel can perform even complex tasks as long as they are familiar or repetitive to the firm, but that companies typically turn to outside counsel in part due to economies of scale and specialization, and that outside counsel can offer experience and expertise to the business). 17

See generally Elizabeth Chambliss, New Sources of Managerial Authority in Large Law Firms, 22 Geo. J. Legal Ethics 63, 7274 (2009) (describing distinct skill set of general counsel as different from large law firm partners, and trend towards intra-firm specialization through use of assistant general counsel); Janet Stidman Eveleth, Life as Corporate Counsel, 37 Md. B.J. 16, 20 (Jan.-Feb. 2004) ("Whether large or small, all corporate legal departments draw on the expertise of outside counsel… . most companies go outside for technical expertise, litigation, issues that are not routine[,] and big projects."); David Engstrom, Harnessing the Private Attorney General: Evidence From Qui Tam Litigation, 112 Colum. L. Rev. 1244, 1288-98 (2012) (describing specialization within law firms and greater recovery rates and discovering larger False Claims Act frauds by qui tam specialists); Richard S. Gruner, General Counsel in an Era of Compliance Programs and Corporate Self-Policing, 46 Emory L.J. 1113, 1146-51 (1997) (describing specialization of general counsel for businesses and how in-house attorneys have to develop various kinds of specialization on industry that outside counsel likely will not possess, but that often in-house counsel lack expertise in specific areas, requiring outside counsel for assistance).

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Page 5 of 28 47 Ariz. St. L.J. 919, *924 relevant stakeholders. 18 These two traits - institutional limitation and risk sensitivity - define the typical business plaintiff's resistance to bringing litigation. Businesses beyond a minimal size typically accrue some institutional knowledge as litigants, but much of this knowledge, typically concentrated in the business's legal department, is in defending cases, not prosecuting them. Moreover, in-house corporate legal departments typically comprise attorneys whose background prior to their corporate experience focused on [*925] defending corporate litigation. 19 Companies' in-house legal experience, risk tolerance in litigation outcomes, settlement expectations, and litigation budgets all derive at least in part from this institutional bias towards defending, rather than prosecuting, lawsuits. 20 Prosecuting a lawsuit requires different expertise from defending one, however, and sometimes even different skill sets; certainly often different outside counsel. 21 Readily accessible insurance further reduces these incentives; to the extent businesses are often insured for the claims in which they are defendants, the insurers' lawyers, and not the company's lawyers, generally accrue substantive knowledge. 22 Companies used to defending lawsuits (or negotiating compliance with regulators) - but not prosecuting cases - therefore face comparatively higher information, agency, and monitoring costs as they must make sometimes substantial initial investments in the art of bringing a lawsuit as a plaintiff. 23 A business's litigation expertise, already narrowed by disproportionate experience as defendants, must also be limited in substantive scope. Most businesses develop related product lines, or at least related portfolios of substantive legal expertise. Businesses in regulated industries may develop knowledge of administrative law and their applicable regulations. 24 Many [*926] businesses will be familiar with labor and employment law; those in

18

This is not, by contrast, to discuss - or even evaluate in this context - the general assumption that firms are risk-neutral. In this sense, our observations regarding third-party litigation financing in part reflect that risk-neutral corporations may opt to partially finance litigation in lieu of accepting risk above a given threshold. We leave further implications regarding risk tolerance and risk neutrality in the litigation-finance context to another paper. 19

See Tanina Rostain, General Counsel in the Age of Compliance: Preliminary Findings And New Research Questions, 21 Geo. J. Legal Ethics 465, 465 (2008) (noting that corporations generally attract "well-known partners from elite corporate firms" to general counsel and high-ranking positions in-house). 20

Id. at 474 (describing a large firm's business departments as the company's "offense" with the legal department as the company's "defense"). 21

See generally Rostain, supra note 19, at 472 (citing Robert L. Nelson & Laura Beth Nielsen, Cops, Counsel, & Entrepreneurs: Constructing the Role of Inside Counsel in Large Corporations, 34 Law & Soc'y Rev. 457, 470-73 (2000) (listing three major roles for in-house counsel: (1) "cops" that police clients' conduct; (2) "counselors" who combine legal and business expertise; and (3) "entrepreneurs" who functioned as "gate-keepers" on proposed risks for various courses of action for primarily business advice); Mitchell J. Frank & Osvaldo F. Morera, Professionalism & Advocacy at Trial - Real Jurors Speak in Detail About the Performance of Their Advocates, 64 Baylor L. Rev. 1, 23-25 (2012) (discussing similarities and differences in juror perceptions of prosecutors/plaintiffs' attorneys and defense attorneys and how jurors perceive similar qualities between plaintiffs' and defense bars differently, or to different degrees). 22

Insurance's inherent uncertainty-mitigation functions may also encourage the prophylactic purchase of insurance and the general aversion to litigation. For many companies, and especially those that can effectively self-insure but choose not to, insurance is a partial substitute for litigation expertise (and for litigation more generally), and we discuss in greater detail below the economic similarity between insurance subrogation and third-party litigation financing arrangements. See generally infra Part IV. 23

Rostain, supra note 19, at 474, 469 n.27, 472 n.43.

24

See, e.g., Schwarcz, supra note 16, at 499 ("Companies have legal departments numbering in the hundreds," a result of "the shift from outside to in-house "transactional lawyering,'" where the repetitive legal activities related to the regular business duties of the company, such as "the structuring, negotiating, contract drafting, advisory and opinion-giving process leading to "closing' a commercial, financing, or other business transaction" are performed).

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Page 6 of 28 47 Ariz. St. L.J. 919, *926 unionized industries even more than others. 25 High-technology firms will grow familiar with intellectual property law, especially patent law. 26 But these firms have little to no reason to develop cross-topical specialization. When companies with comparatively small patent portfolios find themselves enmeshed in patent lawsuits, or companies with no reason to fear international competition law suddenly discover they are the efficient enforcers for viable antitrust claims, these companies likely will not know how to proceed. 27 This institutional limitation in substantive legal knowledge, like the limitation in experience with prosecuting claims, raises the costs of: detecting and evaluating viable claims, valuing potential cases, and analyzing collateral consequences; thus increasing the uncertainty to business plaintiffs in prosecuting viable claims. Businesses, like most people and organizations, shy away from the unfamiliar. 28 Essentially all prospective litigation as a plaintiff firm implicates business plaintiffs' risk sensitivity. Prosecuting litigation necessarily requires an immediate substantial capital investment for a remote future reward. 29 This entails another predictable problem: plaintiff-side litigation requires an immediate substantial investment for a future reward. Most companies with sufficient business ventures to engender valuable business litigation have lucrative substitutes for the capital required to prosecute a complex commercial case, including developing new product lines, recruiting scarce or expensive talent, or expanding current manufacturing or distribution channels. 30 Companies with outside investors are also hesitant to incur voluntary expenses with uncertain prospective payoffs because they must justify these expenses both directly to investors and through publicly available reports and metrics. 31 Even a comparatively small additional expense may be received unfavorably in market reports, [*927]

25

See generally Stephen M. Bainbridge, Privately Ordered Participatory Management: An Organizational Failures Analysis, 23 Del. J. Corp. L. 979, 1061-62 (1998) (describing, in part, several differences demonstrated through experiences interacting with unions that unionized firms, or firms in unionized industries). 26

See, e.g., Mark A. Lemley & A. Douglas Melamed, Missing the Forest for the Trolls, 113 Colum. L. Rev. 2117, 2161-62 (2013); Craig Allen Nard & John F. Duffy, Rethinking Patent Law's Uniformity Principle, 101 Nw. U. L. Rev. 1619, 1648 n.101 (2007). 27

See Peter J. Gardner, A Role for the Business Attorney in the Twenty-First Century: Adding Value to the Client's Enterprise in the Knowledge Economy, 7 Marq. Intell. Prop. L. Rev. 17, 20-21 (2003) ("The rise of in-house counsel … will force outside firms to provide still further "specialized services on a … transaction-by-transaction basis' in areas such as "litigation and quick, intense transactions,' "rapidly changing and complex areas of law,' and areas where specific expertise is required to accomplish a particular task.") (citing Nelson & Nielsen, supra note 21, at 458); Abram Chayes & Antonia H. Chayes, Corporate Counsel and the Elite Law Firm, 37 Stan. L. Rev. 277, 293 (1985) (observing that outside lawyers are chosen for a particular job, case, or role); S.S. Samuelson & L. Fahey, Strategic Planning for Law Firms: The Application of Management Theory, 52 U. Pitt. L. Rev. 435, 453 (1991); Michael S. Harris et al., Local and Specialized Outside Counsel, in Successful Partnering Between Inside and Outside Counsel 20:1 (Robert L. Haig ed., 2000). 28

See generally Jeffrey Pfeffer & Gerald R. Salancik, The External Control of Organizations: A Resource Dependence Perspective (1978) (finding resource dependency theory to suggest organizations base their external relationships on the uncertainty resulting from their environment); Oliver E. Williamson, Markets and Hierarchies, Analysis and Antitrust Implications: A Study in the Economics of Internal Organization (Free Press 1975) (discussing how transaction cost theory focuses on how uncertainty influences decisions of the firm, specifically when deciding to vertically integrate). 29

See Marco de Morpurgo, A Comparative Legal and Economic Approach to Third-Party Litigation Funding, 19 Cardozo J. Int'l & Comp. L. 343, 347 (2011) ("Among the most innovative systems for financing civil litigation is the after-the-event third-party investment in litigation, a practice that contemplates third parties … investing in claimholder's litigation, covering all his litigation costs in exchange for a share of any proceeds if the suit is successful, or, in the alternative, nothing if the case is lost."). We discuss contingency-fee arrangements generally infra Section II.B, Part IV. 30

See, e.g., Binyamin Appelbaum, Investors Put Money on Lawsuits to Get Payouts, N.Y. Times, (Nov. 14, 2010), http://www.nytimes.com/2010/11/15/business/15lawsuit.html?pa gewanted=all. 31

See Steven T. Taylor, CEO of a New Company Embraces a New Concept: Outside Investing in B2B Litigation, 27 Of Counsel 24, Nov. 2008, at 16, 18; see also Garber, supra note 3, at 15.

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Page 7 of 28 47 Ariz. St. L.J. 919, *927 mandatory corporate disclosures, or in share prices. 32 Even sophisticated managers with incentives aligned with the company understandably hesitate to assume these costs for temporally distant and financially varying future payoffs. And where these incentives diverge, principal-agent problems within the firm further exacerbate a company's justified aversion to financing litigation. Myriad plausible self-interested alternatives abound. Agents may prefer to divert company resources to themselves through higher salaries or perquisites. 33 More covertly, agents may instead prefer to divert resources to [*928] preferred departments and subordinates rather than to an abstract legal conflict. 34 Agents may avoid prosecuting lawsuits fully because business cases involve extensive investigations of past firm and managerial conduct, and individually risk-averse agents may assume this investigation poses some risk to their positions. 35 And, of course, agents prefer not to incur present-tense costs on their charge in order to secure large gains for some future agent. For example, a company's general counsel typically holds significant reputational capital with other firms in the industry, with upstream vendors, and with downstream clients. Though it may be in the firm's best interest to sue one of these entities, prosecuting lawsuits against these entities may dissipate some of his portable and personal reputational capital. This aversion sharpens under many circumstances where traditional principal/agent problems increase, including an agent possessing desirable outside options or the credible possibility the agent will be fired. 36 Even the rare business with substantial plaintiffs' experience, a legal department with substantial plaintiffs' experience, broad litigation knowledge (or a diverse set of business lines/models to defend), sufficient market capitalization, and broadly faithful agents sometimes abjures litigation simply due to mistrusting lawyers' incentives. Businesses want contentious litigation concluded quickly, efficiently, and at low cost. Businesses realize that law firms billing by the hour ordinarily want none of these. This risk would be sufficient if a business plaintiff bringing a suit had to contend with merely one law firm's adverse incentives; however, any substantial commercial litigation requires at least two firms - one for each [*929] side - and, quite commonly, many more. 37 A business plaintiff

32

See generally Nicholas Bloom, The Impact of Uncertainty Shocks, The Nat'l Bureau of Econ. Res. (Sept. 2007), http://www.nber.org/papers/w13385.pdf (suggesting "that changes in stock-price volatility are … linked with real and financial shocks" and that firm-level shocks affect stock prices in general). 33

See Chris Giles, Curbs on Covetousness: Envy Can Make Capitalism More Efficient and Help to Restrain Executive Pay, Financial Times (Feb. 2002), http://www.law.harvard.edu/faculty/bebchuk/pdfs/FT.Curbs.on. Covetousness.pdf ("The pay and perks pacakges of CEOs better resemble "rent extraction' than optimal contracting," and these compensation packages are the manifestation of the principal-agent problem between shareholders and managers). See generally Lucian Ayre Bebchuk, Jesse M. Fried & David I. Walker, Executive Compensation in America: Optimal Contracting or Extraction of Rents?, The Nat'l Bureau of Econ. Res. (Dec. 2001), http://www.nber.org/papers/w8661.pdf. 34

This is an expansion of the general principal-agent problem. See Sean Gailmard, Accountability and Principal-Agent Models, in Oxford Handbook of Public Accountability 90, 91-93 (Mark Bovens, Robert E. Goodin & Thomas Schillemans eds., 2014), http://www.law.berkeley.edu/files/csls/Gailmard_-_Accountability_and_Principal- Agent_Models(2).pdf (explaining that where the agent and principal have different preferences over the agent's possible actions, but the principal cannot directly control the agent's decision and there is no incentive for the agent to act in the principal's preferred manner, the agent will act per his own preferences). 35

See, e.g., Christine Hurt, The Undercivilization of Corporate Law, 33 J. Corp. L. 361, 413 (2008) (stating that a principal, i.e., a shareholder, may file suit against an agent, i.e., a CEO, who may be found guilty of securities fraud if he should have known or was in a position to have known - of prior corporate fraud, even if the individual did not himself commit the fraud).

36

See generally Robert Flannigan, The Economics of Fiduciary Accountability, 32 Del. J. Corp. L. 393, 408-27 (2007) (surveying economics and law & economics literature on principal/agent problems and factors aggravating and mitigating this classic problem). 37

Robert Rubinson, A Theory of Access to Justice, 29 J. Legal Prof. 89, 107 (2004-2005) (finding that the resulting legal team of cases involving large business organizations are generally made up of numerous lawyers from multiple firms and their personnel

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Page 8 of 28 47 Ariz. St. L.J. 919, *929 therefore faces an unusual and difficult-to-monitor problem: hourly billing firms individually hesitate to hasten cases along, and it takes only one party's or firm's intransigence to increase costs on all parties. 38 This necessarily leads to substantial uncertainty in the ultimate costs in bringing even valuable and meritorious commercial litigation, and this uncertainty deters many potential plaintiffs. Businesses would prefer something closer to a free option with partial recovery, even with a lower expected value, than to front litigation costs. Such an option would avoid both the risk and uncertainty of expensive litigation costs and the corresponding aversion to accounting for those costs to stakeholders. It would alleviate faithful agents' need to justify litigation expenses vis-a-vis immediately productive alternative investments, and discourage faithless agents' diverting litigation resources elsewhere. It would prevent the single most significant asymmetry in the lawyer/client relationship: the business's justified expectation that hourly billing discourages hasty dispute resolution. In exchange, the business could enjoy a partial future recovery of an already-sunk cost - the harm suffered from the underlying business tort - which it might have foregone altogether for fear of litigation expenses. A contingency-fee arrangement could obviously solve many of these problems; however, as we explain next, this incomplete solution is undesirable to most law firms. B. Law Firms Though contingency-fee billing broadly accommodates business plaintiffs' concerns, law firms sufficiently sophisticated to handle major business litigation rarely will, or even can, accept contingency-fee cases. Law firms are notoriously illiquid and leveraged business entities. 39 Major law firm principals draw their income proportionally from the firm's yearly [*930] profits; law firm partners are therefore more attuned to a firm's income - and income stream - than almost any other business's officers. 40 Large law firm associates also represent substantial, consistent overhead for which firms must either earn predictable income streams or absorb costs. 41 A law firm solvent by an expected valuation of a contingency-fee case may find itself insolvent overnight if the case suffers an unexpected setback or adverse ruling. 42 Hourly-fee arrangements, by contrast, provide highly leveraged firms with predictability and smooth out income relative to contingency-fee arrangements. 43 In short, contingency-fee cases simply require leveraged and illiquid law firms to forego tantalizing income streams in favor of risky future payoffs. Law firms' illiquidity and leverage derive from legal ethics rules strictly constraining firms' ownership, operation, and capitalization. The American Bar Association's Model Rules of Professional Conduct exemplify these constraints. First, the Rules essentially forbid law firms from hedging risk by diversifying business lines. Model Rule 5.4(a) forbids lawyers and firms from sharing fees with non-lawyers except in very limited circumstances. 44 Rule 5.4(b)

support); see also Richard H. Sander & E. Douglass Williams, Why Are There So Many Lawyers? Perspectives on a Turbulent Market, 14 Law & Soc. Inquiry 431, 471 (1989). 38

Rubinson, supra note 37, at 113 (juxtaposing the hourly billing practice of lawyers at elite firms in the arguably slowly advancing commercial disputes to the lucrative, quick settlements that occur in personal injury cases where lawyers must take on numerous cases in order to generate significant returns).

39

Jeremy Kidd, To Fund or Not to Fund: The Need for Second-Best Solutions to the Litigation Finance Dilemma, 8 J.L. Econ. & Pol'y 613, 617 n.21 (2012). 40

See Larry E. Ribstein, The Death of Big Law, 2010 Wis. L. Rev. 749, 755-56 (2010).

41

See id. at 761-63.

42

See Jonathan T. Molot, Litigation Finance: A Market Solution to a Procedural Problem, 99 Geo. L.J. 65, 105 (2010).

43

See id.

44

For example, the Rules permit fee-sharing for the benefit of nonprofit entities in response to court-awarded legal fees when the entity referred the fee-generating lawyer. Model Rules of Prof'l Conduct r. 5.4(a)(4) (Am. Bar Ass'n 2013) [hereinafter Model

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Page 9 of 28 47 Ariz. St. L.J. 919, *930 backstops this prohibition by forbidding lawyers from forming partnerships that practice law with non-lawyers. 45 These restrictions segregate the for-profit practice of law from other professional services and other businesses; this restriction leaves law firms more vulnerable to market downturns. 46 The Rules then confine law firms to debt, rather than equity, to raise capital. Rule 5.4(d) prohibits lawyers from the for-profit practice of law within a corporation that conveys any interest - including any equity interest, down to common stock - on non-lawyers. 47 And Rule 5.4(d) then prohibits lawyers from practicing for corporations which contain non-lawyers as [*931] corporate board members or officers, or which enable non-lawyers to direct lawyers' professional judgment. 48 Collectively, Rule 5.4's restrictions lock sophisticated law firms into the partner/associate model, its inherent illiquidity, its current undercapitalization, and its reliance on billing structures which avoid, rather than accept, economic risks. Contingency-fee cases simply prove too expensive and too risky for many of these firms. This undercapitalization fundamentally aggravates the underlying misalignment between lawyers' and clients' incentives. A client matter extending in length guarantees future revenues but necessarily delays resolving or settling a dispute or consummating a transaction. Speedy and effective representations may guarantee future business, but a need for future legal services is highly unpredictable in the specific and broadly avoided in general. Lawyers and clients alike know that it is difficult for clients to monitor their attorneys' performance, and the Model Rules bar most of the time-honored and familiar methods for resolving this law firm undercapitalization problem in a way that also solves the attorney/client incentives problem. 49 Law firms and clients develop novel business arrangements to circumvent Model Rule 5.4's antiquated and comprehensive business restrictions. Law firms understand the precarious economic position the Model Rules place the traditional law firm in; they also recognize their clients' view of the underlying adverse incentives between lawyer and client. Multiple arrangements have evolved to satisfy these problems. Some law firms adopt a contingency fee business model, operating with a larger capital cushion than rivals to absorb the periodic shocks from waiting on payoffs. 50 Large law firms' hiring practices post-crash is another response to this [*932] undercapitalization problem, decreasing reliance on expensive partner-track associates in favor of contract and staff attorneys with lower salaries and fewer expectations of job security. 51 These lower-paid attorneys may Rules]. Another exception permits fee-sharing as part of a profit-sharing or retirement plan with non-lawyers. Id. r. 5.4(a)(3). It suffices to say that none of the limited exceptions permit fee-sharing with a for-profit non-lawyer/non-law-firm corporate entity. See id. r. 5.4(a). 45

Id. r. 5.4(b).

46

See Thomas Markle, Comment, A Call to Partner with Outside Capital: The Non-Lawyer Investment Approach Must Be Updated, 45 Ariz. St. L.J. 1251, 1252-54 (2013); Ribstein, supra note 40, at 751-52.

47

Model Rules, supra note 44, r. 5.4(d)(1).

48

Id. r. 5.4(d)(2)-(3).

49

Indeed, in-house legal departments are one of the only methods Model Rule 5.4 allows for companies to align generally a legal team's incentives with the firm's through long-term compensation arrangements and similar contracts.

50

See, e.g., Saucier v. Hayes Dairy Prods., Inc., 373 So. 2d 102, 105 (La. 1978) ("Such contracts promote the distribution of needed legal services by reducing the risk of financial loss to clients and making legal services available to those without means."); Alexander v. Inman, 903 S.W.2d 686, 696 (Tenn. Ct. App. 1995) ("Contingent fee arrangements serve a two-fold purpose. First, they enable clients who are unable to pay a reasonable fixed fee to obtain competent representation. Second, they provide a risk-shifting mechanism not present with traditional hourly billing that requires the attorney to bear all or part of the risk that the client's claim will be unsuccessful."); Neil F.X. Kelly & Fidelma L. Fitzpatrick, Access to Justice: The Use of Contingent Fee Arrangements by Public Officials to Vindicate Public Rights, 13 Cardozo J.L. & Gender 759, 768 (2008) (citing Landis v. Grange Mut. Ins. Co., 82 Ohio St. 3d 339, 342 (1998) (stating contingency fee agreements "permit persons of ordinary means access to a legal system which can sometimes demand extraordinary expense."); Markle, supra note 46, at 1263-64. 51

See, e.g., Bernard A. Burk & David McGowan, Big but Brittle: Economic Perspectives on the Future of the Law Firm in the New Economy, 2011 Colum. Bus. L. Rev. 1, 95-97 (2011); Vanessa O'Connell, The Rise of the Temp Lawyer, Wall St. J. (Jun. 15, 2011, 12:18 PM), http://blogs.wsj.com/law/2011/06/15/the-rise-of-the-temp-lawyer/; Anna Stolley Persky, Under Contract:

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Page 10 of 28 47 Ariz. St. L.J. 919, *932 correspondingly be hired and fired to match expected work levels without firms suffering reputational costs. 52 And law firms operating outside the United States are not confined to American Bar Association restrictions - these firms may operate American offices or affiliates and nonetheless take advantage of many of the traditional benefits inherent in the corporate form, including capital-raising benefits. 53 Third-party litigation finance offers law firms one more method to raise capital and smooth revenue streams despite an ethical framework apparently designed to inhibit both needs. But third-party litigation finance requires third-party litigation financiers; financiers with distinct motivations and concerns, separate from either lawyer or client. We next discuss where litigation financiers fit between litigation-cost-averse businesses and undercapitalized law firms. C. Third-Party Financiers Third-party litigation financiers are, first and foremost, investors. In general, investors all share a common want: the maximum possible risk-adjusted return on investment. Investors trade the time value of money and risk of loss in the underlying asset - the risk of an adverse decision in a case [*933] for litigation financiers - for a return. 54 Third-party litigation financiers employ relationships within the legal sector, knowledge of specific law firms (and even specific lawyers), and knowledge of legal positions to evaluate cases. 55 This evaluation allows financiers to identify undervalued assets - namely meritorious cases which business plaintiffs hesitate to prosecute or to continue prosecuting - and to offer both business clients and law firms a partial solution to their respective problems. Third-party litigation financiers are therefore simply an additional type of investor in a specialized two-sided market. Financiers understand businesses' hesitation to divert scarce company resources away from primary business lines to pursue even an obviously meritorious claim, and offer to assume these costs from companies (partially or wholly). Financiers also know that many sophisticated law firms cannot afford to carry protracted litigation costs, and that these dual economic issues aggravate an underlying incentives misalignment between law firms and clients. Substitutes to bringing or maintaining a case exist for business plaintiffs, including investing in other product lines, settling at a deep discount, insuring valuable interests (and thereafter subrogating claims), or Temporary Attorneys Encounter No-Frills Assignments, Workspaces, Washington Law. (Jan. 2014), http://www.dcbar.org/barresources/publications/washington-lawyer/articles/january-2014-contract-lawyers.cfm. 52

See Burk & McGowan, supra note 51, at 95-97.

53

See generally Ashish Prasad & Ajay Mago, Legal Process Outsourcing: A Guide to Important Considerations, Risk Mitigations & Achieving Success, in Doing Business in India 2008: Critical Legal Issues for U.S. Companies (Practicing Law Institute, 2008); Kath Hall, Educating Global Lawyers, 5 Drexel L. Rev. 391, 393 (2013) ("From 2011 to 2012, the largest global law firms employed at least half of their lawyers in countries around the world. These firms also increased both the percentage of their lawyers working overseas and the countries in which they have operations. For example, … DLA Piper increased the number of lawyers working in thirty-two countries (expanding to three more countries) to 66%.") (citations omitted); Offshoring Your Lawyer, Economist (Dec. 16, 2010, 11:04 AM), http://www.economist.com/node/17733545. 54

See generally Franco Modigliani & Merton H. Miller, The Cost of Capital, Corporation Finance and The Theory of Investment, Am. Econ. Rev. 261, 262 (Jun. 1958) http://www.aeaweb.org/aer/top20/48.3.261-297.pdf ("According to the first criterion [profit maximization], a physical asset is worth acquiring if it will increase the net profit of the owners of the firm. But net profit will increase only if the expected rate of return, or yield, of the asset exceeds the rate of interest… . Investment decisions are then supposed to be based on a comparison of this "risk adjusted' or "certainty equivalent' yield with the market rate of interest."). 55

Am. Bar Ass'n Commission on Ethics 20/20: Informational Report to the House of Delegates 22 (2011), http://www.americanbar.org/content/dam/aba/administrative/et hics_2020/20111212_ethics_20_20_ alf_white_paper_final_hod _informational_report.authcheckdam.pdf ("In order to protect their investments and to maximize the expected value of claims, suppliers may seek to exercise some measure of control over the litigation, including the identity of lawyers pursuing the claims, litigation strategy to be employed, and whether to accept a settlement offer or refuse it and continue to trial.").

Theresa Coetzee

Page 11 of 28 47 Ariz. St. L.J. 919, *933 reluctantly licensing or selling infringed or converted property. Likewise, law firms have several substitutes for carrying debt associated with covering the costs of a lawsuit, including contingency-fee agreements, alternative foreign business structures, and hiring fewer partnership-track associates. Third-party litigation financiers offer a service familiar to each side of the lawyer/client relationship, for which adequate substitutes exist on both sides, but for which no single device adequately resolves both parties' problems. As we discuss next, third-party litigation financiers approach this conundrum familiar with the capitalization problems and incentives problems large law firms face, as well as the reasons for business plaintiffs' hesitation [*934] to maintain expensive lawsuits. Financiers possess the sophistication to find and value appropriate business litigation cases and to manage and monitor law firms. They are not cost-sensitive - at least not in the same way that business plaintiffs are. Nor are they illiquid or leveraged like law firms, and they, like any investor, come to any case willing to invest much-needed capital. But financiers come to the attorney/client relationship as a stranger, albeit an interested stranger; they lack the authority to settle the case, or even the standing to intercede in the attorney/client relationship. This fundamental asymmetry - that financiers depend on the outcome of cases for their returns, but ultimately possess no formal controls over those cases' prosecution or settlement - shapes the entire third-party litigation finance contract. As we discuss next, third-party litigation financiers select clients, cases, law firms, and contractual terms to ensure repayment without violating the attorney/client relationship's boundaries. Overcoming this challenge while still addressing business plaintiffs' and law firms' unique economic needs defines the litigation financier's role. III. A Third-Party Litigation Finance Agreement Litigation financiers approach potential cases with the above-discussed economic problems in mind. The case requires both a cost-averse business plaintiff and a law firm equally unwilling or unable to shoulder the risks and costs of business litigation going forward. Further, litigation financiers must structure agreements to ensure recovery despite a lack of formal controls over settlement and litigation. We next discuss how these elements shape what cases litigation financiers approach for investment, how litigation financiers structure relationships and contracts, and how various mechanisms protect financiers' interests without impermissibly intermeddling in the attorney/client relationship. Business plaintiffs' incentives partially shape which cases third-party litigation financiers find attractive. For a case to have any surplus for a litigation financier to share, it must be prohibitively expensive for the business company to pursue, yet valuable for an outside party. If litigation financiers bring external expertise and capital to litigation, the most valuable cases will be ones in which business plaintiffs most suffer from a lack of expertise in the relevant area and for which defendants enjoy the greatest potential premiums in settlement terms for having disproportionate litigation resources. "Non-core" business cases - cases in which business plaintiffs have no reason to be familiar with the substantive area of law at hand - provide the best opportunities for litigation financiers to add value by adding [*935] expertise. 56 Business plaintiffs are, in turn, less likely to view these non-core cases as essential to their business, either retrospectively or prospectively. In retrospect, non-core business cases are less likely to involve long-term business relationships, repeat occurrences or transactions, or incidents which arose from the firm's long-term strategic decisions. They therefore implicate fewer prospective concerns about the ongoing relationships and business decisions which drive the business plaintiff's central business lines and ongoing enterprises.

56

Anthony J. Sebok & W. Bradley Wendel, Duty in the Litigation-Investment Agreement: The Choice Between Tort & Contract Norms When the Deal Breaks Down, 66 Vand. L. Rev. 1831, 1833 (2013), http://scholarship.law.cornell.edu/facpub/670 (noting that "litigation investment is a way to manage the risk associated with litigation while bringing to bear the particular subject matter expertise of a risk-neutral institutional actor").

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Page 12 of 28 47 Ariz. St. L.J. 919, *935 Cases in areas of law with exceedingly favorable remedial schemes, such as antitrust and patent claims, also present desirable investment opportunities. 57 These areas commonly feature defendants that are highly averse to actually trying a case to judgment, but that are prepared to use an advantageous asymmetrical financial position to bargain down settlement prices. 58 In these regimes, the defendant's knowledge that the plaintiff has obtained additional capital to litigate drives up a given case's settlement value. 59 Conversely, legal areas with favorable remedial schemes typically create costs and risk imbalances that favor plaintiffs, especially sophisticated or experienced plaintiffs. 60 Patent, antitrust, and similar cases offer potent tools for enthusiastic plaintiffs: preliminary injunctions, permanent injunctions, attorneys' fees, treble damages, and highly variable punitive damages awards. 61 Where business plaintiffs may have a natural aversion to engaging in these cases due to their complexity and expense - at least when they can reasonably avoid it as a business decision - these substantive legal areas present ripe opportunities for the basic trade for any litigation financier: [*936] litigation risk for profit. A third-party litigation financier therefore prefers cases in these potent legal regimes precisely because a risk-accepting plaintiff enjoys a wider and more indulgent panoply of remedies that can be traded for better settlement terms or a larger judgment. 62 Sophisticated law firms' undercapitalization also contributes another narrowing criterion for litigation financiers: cases must typically be prohibitively expensive or have a payoff too temporally remote for law firms to carry these potentially profitable suits themselves. Business plaintiffs can, and likely will, bear relatively inexpensive cases with sufficiently certain and temporally proximate payoffs. Law firms may assume some of the litigation risk through a contingency-fee arrangement where a favorable settlement is both likely and proximate, assuming the firm has some information advantage over the business plaintiff on the outcome of the litigation and the costs are sufficiently low. But law firms cannot or will not carry the risk of many commercial cases, at least not without making contingency fee litigation their primary business model. 63 Investment-grade cases are therefore typically

57

As a previous paper noted, these investment opportunities are desirable precisely in part because the remedial opportunities for these business wrongs often largely outstrip any economic harms they present. See generally Shepherd, supra note 1. 58

Id. at 594 (stating that third-party financing can reduce any barriers to justice may result from financially constrained plaintiffs bringing suit against well-financed defendants). 59

Id. at 595. Note, again, that this additional settlement value need not correlate to any additional social welfare presented by the potential case.

60

Id.

61

See, e.g., 2008 Annual Report & Accounts, Juridica Invs. Ltd. 9 (2008), http://www.juridicainvestments.com//media/Files/J/Juri dica/pdfs/2008_Annual_Report.pdf (noting that antitrust litigation under the Sherman Act or Clayton Aact allow for the possibility of statutory treble damages); Shepherd, supra note 1, at 595 (noting patent infringement cases allow for the possibility of preliminary injunctions & treble damages, attorneys' fees, and permanent injunctions). 62

See The Fund, Juridica Invs. Ltd., http://www.juridicainvestments.com/about-juridica/the-fund.aspx (last visited Oct. 10, 2015); Jason Douglas, UPDATE: Burford Capital Raises GBP80 Million In 5th AIM Float of "09, Dow Jones Newswires (Oct. 16, 2009, 6:23 AM), http://www.advfn.com/news_UPDATE-Burford-Capital-Raises-GBP80-Million-In-5th-AIM-Float-OF- 09_39926053.html (reporting that Burford's CEO has stated their focus is on cases with big rewards such as "patent thefts, antitrust proceedings or corporate torts"). In this sense, third-party litigation financing, strictly speaking, encourages some additional litigation: it reduces risk to business plaintiffs to bring highly technical cases in non-core businesses for meritorious claims in remedy-rich legal areas. This is, of course, a far cry from the comparatively unsophisticated claim that third-party litigation financing encourages "frivolous litigation," a claim that, as we demonstrate below, necessarily contradicts the essence of the litigation financier's business model. But this somewhat subtler claim presents a different question of social benefits and social costs, and we discuss this below. See infra Part IV; see also Shepherd, supra note 1, at 610 ("An increase in litigation among the types of cases where cost and risk imbalances lead to inefficient case outcomes will magnify [some] inefficiencies."). 63

See, e.g., John S. Dzienkowski & Robert J. Peroni, The Decline in Lawyer Independence: Lawyer Equity Investments in Clients, 81 Tex. L. Rev. 405, 546 (2002); see generally A. Barry Cappello, A Contingency Fee Business Litigation Practice, 23 Am. J. Trial Advoc. 189 (1999).

Theresa Coetzee

Page 13 of 28 47 Ariz. St. L.J. 919, *936 expensive either through expected or already realized litigation costs. These cases are lengthy, or at least potentially lengthy - in the most threatening remedial regimes, dilatory tactics are common - and with distant or variant future payoffs. 64 [*937] The fundamental trade in a third-party litigation financing arrangement is, like virtually all investments, immediate capital for future returns: the financier provides immediate capital to prosecute the case in exchange for a percentage of the future recovery. Of course, the most direct way to guarantee some return in a litigation investment is to settle a case, preferably after a favorable ruling on a potentially dispositive motion. 65 This introduces a new economic problem: the financier is not the client. 66 The client - the business plaintiff - retains the essential tools to direct the course of the litigation, and therefore, to choose between the essential paths at the various decision nodes that every case may encounter. 67 Whether to settle a case is the most substantial tool in directing a case's potential payout. 68 But the business plaintiff also retains the powers any client retains over counsel: to hire local or outside counsel, to pursue (or waive) various procedural or forum-selection tactics, such as changes of venue, arbitration, or administrative adjudication, to pursue various theories of the case, to retain one or more experts, to fire counsel, or to dismiss the case altogether (in this circumstance, to file another time). 69 These decisions, each deriving from the power to direct [*938] the litigation, can, and probably will, affect a case's expected value. The financier controls - may ethically control - exactly none of these. 70

64

See generally John H. Beisner, Discovering a Better Way: The Need for Effective Civil Litigation Reform, 60 Duke L.J. 547, 549 (2010) (describing how "discovery abuse … represents one of the principal causes of delay and congestion in the judicial system"); Jeanne L. Schroeder, The Midas Touch: The Lethal Effect of Wealth Maximization, 1999 Wis. L. Rev. 687, 689 (1999) (describing how wealth - or value - is made up of money and time, and generally individuals and corporations are wealth maximizers). 65

See generally Bruce A. Ericson, Business & Commmercial Litiation in Federal Courts § 33:24 (2013) (describing that, for cases with an uncertain legal theory, a motion testing legal theory of case can reduce uncertainty and encourage settlement); Michael Greenberg, The Forum Non Conveniens Motion & the Death of the Moth: A Defense Perspective in the Post-Sinochem Era, 72 Alb. L. Rev. 319, 331-42, 332 n.65 (2009) (describing the "death knell" effect of a successful forum non conveniens motion on a potential case and potential settlement effects). 66

See generally U.S. Chamber Inst. for Legal Reform, Selling Lawsuits, Buying Trouble Third-Party Litigation Funding in the United States 1 (2009), http://legaltimes.typepad.com/files/thirdpartylitigationfina ncing.pdf.

67

See generally Andrew F. Daughety & Jennifer F. Reinganum, The Effect of Third-Party Funding of Plaintiffs on Settlement 5 (Vand. U. Cent. for the Study of Democratic Insts., Working paper No. 01-2013, 2013), http://www.vanderbilt.edu/csdi/research/CSDI_WP_ 01-2013.pdf (finding under game-theoretic model that plaintiff necessarily maintains control over the suit due to her private information as to the suit, and that she makes the decisions about settlement bargaining and trial). 68

See Sebok & Wendel, supra note 56, at 1839 (suggesting that a plaintiff might have accepted a settlement in the absence of a third-party funder, however may re-think that decision as it is disadvantageous to the investor); Daughety & Reinganum, supra note 67, at 1 (emphasizing that "optimal loans" from third parties "induces full settlement" of a case) (emphasis added). 69

Symposium, Third-Party Litigation Financing, 8 J.L. Econ & Pol'y 257, 262 (2011) [hereinafter Third-Party Litigation] (quoting Paul Sullivan, a Senior Vice President at Juridica Capital Management, a firm that provides a form of litigation financing, stating that his company does "not have control over litigation strategy or settlement decisions. Because litigation strategy and settlement decisions remain in the control of the plaintiff or defendant, Juridica needs to make sure that the plaintiff or defendant is incentivized to make decisions that, although they are self-interested, benefit us as well because of our alignment"). 70

See Burch, supra note 1, at 1320 (citing Model Rules of Prof'l Conduct r. 1.2(a) (Am. Bar Ass'n 2011) (requiring a lawyer to "abide by a client's decisions concerning the objectives of representation" and to "consult with the client as to the means [for pursuing those objectives]")) (stating that funders are currently prohibited "from interfering with or controlling litigation"). This is not to say that a litigation financier does not assert some influence over these decisions through the litigation contract; of course he does. But litigation finance contracts do not disturb formal mechanisms of control over any of these decisions; at

Theresa Coetzee

Page 14 of 28 47 Ariz. St. L.J. 919, *938 Instead, financiers exert all the influence they can, and, indeed, all the influence they will ever have in the contractformation stage of the investment. Financiers typically enter cases in one of two postures: at the outset, when contractual incentives will apply to the most future decisions, or in the shadow of a case's insolvency, when more investment-adverse decisions have been made, but the client, firm, or both strongly desire the financier's intervention and will consent to more stringent terms. 71 But the financier must secure his investment in the formation of the contract as much as he can, because he can never formally affect the litigation's outcome, and can, at most, informally affect the client's decisions only lightly, and at the client's request. Depending on the posture, the case, and individual negotiations, financiers design the investment contract including ex ante and ex post incentives - relative to the investment contract - to ensure both business clients and law firms secure the financier's returns. Ex ante protections broadly include all screening choices the financier can make prior to the contract's formation. These predominantly include choosing parties in the relationship: there are many more avenues seeking investment money, even litigation investments, than financier dollars. 72 Litigation financiers thoroughly screen clients for business sophistication, solvency, and realistic expectations. Financiers will occasionally outright purchase a claim from an undesirable client when the case seems especially [*939] meritorious and the law firm especially competent; in this sense, the amount of the financier's investment (as a fraction of the expected recovery) may be viewed as an ex ante protection. Financiers may also condition investment in the case on retaining preferred counsel, local counsel, or terminating current counsel. 73 While this could present serious ethical problems from within the attorney-client relationship, it seems both wholly defensible and similar to other business arrangements surrounding the attorney-client relationship as a condition for extrinsic funding. 74 Financiers will also examine the solvency and history of the law firm to ensure the lawyers on the case are prepared to partially assume the risk of the case - a necessary incentives-aligning function of any finance arrangement. 75 Financiers also stringently investigate cases' expected value aside from the plaintiff and firm prosecuting the case. This involves two dimensions: investigating the merits of the case and examining the profitability of the attendant legal regime. 76 Financiers independently review a case's legal theories and evidence, retaining or examining

most, litigation financiers insist on retention of or termination of, for example, a given law firm prior to executing a finance agreement. This is one of multiple ex ante screens, discussed above, that helps align an financier's and a business plaintiff's incentives in maximizing recovery in light of litigation risk and time preferences. 71

See Shepherd, supra note 1, at 598-99 (stating that in situations where contingency fee arrangements don't provide justice for risk-averse individuals facing large financial barriers, financiers can provide the financing for meritorious suits that would otherwise not be filed).

72

According to Richard Fields, an article in a major national newspaper in which Juridica Investments indicated it sought cases in which to invest yielded over 12,000 responses soliciting an investment, a consultation, or further investigation. See generally Richard Fields Interview, supra note 4. Of these, Juridica made four investments. Id. 73

See Third-Party Litigation, supra note 69, at 261 (Paul Sullivan stating that his company, Juridica, is "unlikely to invest in cases with a misalignment of interests between the client and counsel … . Actually, we spent a lot of time vetting the lawyers and evaluating the lawyers as a part of our due diligence process.").

74

See id. Contrast this perspective with Model Rule of Professional Conduct 1.16's official comments, which provide that a lawyer has an option to withdraw only for misuse of services (or similar, for-cause grounds), if withdrawal will not impose a "material adverse effect on the client's interests," or if the client fails to adhere to an already-made agreement regarding the representation, such as regarding fees. Model Rules of Prof'l Conduct r. 1.16 (Am. Bar Ass'n 2011). By implication, the necessity of a failure to abide an agreement presupposes an agreement to be broken; in other words, that an attorney may not withdraw simply because a client has failed to agree with the attorney regarding outside counsel to employ or methods to use in prosecuting the case. In fact, Model Rule 1.2(a) assigns these responsibilities expressly to the client. Id. r. 1.2(a); see Model Rules, supra note 44, r. 1.16(b)(1), cmt. 7, r. 1.2. But these duties attach, by definition, to lawyers, and not to outside investors. 75

See generally Third-Party Litigation, supra note 69, at 261; see also Richard Fields Interview, supra note 4.

76

See generally Third-Party Litigation, supra note 69, at 260.

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Page 15 of 28 47 Ariz. St. L.J. 919, *939 experts when necessary to externally evaluate the business plaintiff's probability of success on the merits. 77 Financiers also adjust these expectations where necessary by taking account of the judge and venue. Some forums systematically skew towards [*940] plaintiffs or towards defendants, of course. But some forums skew towards lengthier case durations where others are famously, even notoriously, efficient. 78 Still other forums famously prefer motion practice, while others resolve as many issues as possible in front of juries. 79 Finally, financiers evaluate the remedial scheme in the legal regime surrounding the case. Cases with more generous remedial systems, including punitive damages and attorneys' fees, enjoy several positive effects for a financier. Generous remedial regimes encourage defendant settlement, drive up the price of settlement, and increase the probable recovery in a jury trial. 80 These factors each inform a financier's evaluation of a case's investment quality; financiers prefer speedy, predictable case resolution, with forums favoring plaintiffs, under generous remedial regimes. The financier's ex ante filters rely on information advantages and generate positive externalities by signaling this information to other players in the case and surrounding legal world. Financiers act as legal arbitrageurs in one sense, purchasing or investing in undervalued cases that business plaintiffs might otherwise abandon, and thereby transmitting signals to other participants about what makes a case valuable. 81 Financiers send signals to defendants as to the strength of plaintiffs' cases, and to judges and legislatures as to which venues and legal regimes offer comparatively promising payoffs. 82 Fair [*941] arguments can be made against a system where information signals on any of these points are possible: after all, the value of a signal regarding the desirability of a given court takes as an assumption that courts are not all alike, which is to say that legal outcomes result from more inputs than simply the law. 83 These arguments are lost on the litigation financier; and, considered carefully, should never have been directed to him in the first place. Litigation financiers do not create a system where

77

Id. (Paul Sullivan states that "Third-party capital tries to identify good cases in which to make an investment - similar to a portfolio manager identifying a good stock, or a contingency fee lawyer deciding on which cases to invest his or her time. [Alternative litigation financing], therefore, looks for efficiency, predictability, transparency, and timely returns to drive results. We look for cases that can be completed efficiently and in a timely manner, and for cases where the lawyers and the clients are trying to drive cost out of the process and reduce risk because we are usually being asked to finance those costs."). 78

See, e.g., Mark A. Lemley, Where to File Your Patent Case, 38 Aipla Q.J. 401, 415-18 tbl.5 (finding that there are "rocket docket" districts, such as the Western District of Wisconsin and Eastern District of Virginia that resolve the average patent case in just over six months, and that some of the slowest jurisdictions include the Eastern District of Texas, Northern District of California and the Eastern District of Pennsylvania, where the average time to disposition is about 15-16 months). 79

See, e.g., Timothy C. Meecee, Litigation in East Texas After the Federal Circuit's Decision in TS Tech, Banner & Witcoff: Intell. Prop. Update, Spring 2009, at 1, http://www.bannerwitcoff.com/_docs/library/articles/0 5.09%20Meece%20Client%20Newsletter.pdf (stating that 93% of East Texas jurors favor protecting inventions with patents). 80

See Shepherd, supra note 1, at 594 (describing how in patent and price-fixing cases defendants face numerous potential losses at trial, including treble damages and large attorneys' fee awards, and discussing how these costs weaken defendants' bargaining positions and lead to systematically larger than expected trial outcomes and settlements).

81

Maya Steinitz, Whose Claim Is This Anyway? Third-Party Litigation Funding, 95 Minn. L. Rev. 1268, 1305 (2011) [hereinafter Steinitz, Whose Claim Is This Anyway?] (citing Robert H. Mnookin & Lewis Kornhauser, Bargaining in the Shadow of the Law: The Case of Divorce, 88 Yale L.J. 950, 972-73 (1979) (explaining the ways in which information is transferred in litigation and negotiation)) (describing how "an institutional commercial funder's willingness to fund a law suit, if known to the opposing party, may itself function as a signal to the opposing party regarding the strength of the claim"). 82

Id.; Third-Party Litigation Financing, supra note 69, at 277 (Professor Michelle Boardman stating that in insurance cases, an "insurance defense payment for the defendant creates an imbalance for the plaintiff" and that this related claim that is made, "which is that the insurer providing the defense is like an imperator, it is like a signal to the other party and to the court that the defendant has a good case. And, if you allow a third-party funder to come in, that is a counter-billing signal, and the funder thinks that the plaintiff has a good case."). 83

See, e.g., Lee Epstein et al., The Behavior of Federal Judges: A Theoretical and Empirical Study of Rational Choice (2013); Joanna M. Shepherd, Money, Politics, and Impartial Justice, 58 Duke L.J. 623, 670-72, tbls. 7, 8 (2009).

Theresa Coetzee

Page 16 of 28 47 Ariz. St. L.J. 919, *941 navigating different forums can affect the potential payout of a case - they merely acknowledge and overtly monetize it. The financier's ex post filters rely on contractual terms that align the client's and law firm's potential decisions with the financier's payment. The financier is one part of a triangular relationship: he must influence both the business plaintiff and the law firm, and in somewhat different ways. The financier must ensure the business plaintiff pursues the highest time-justified payout possible from the litigation. Reasonable trade-offs may exist between a quick settlement for 50% of a claim's value, a slow settlement for 80% of a claim's value, and going to verdict for potentially more than a claim's expected value, but the financier must ensure the business plaintiff neither dithers to accept a reasonable settlement nor hastens to accept a mediocre one. The financier must also ensure the law firm efficiently and effectively prosecutes the litigation to the maximum cost-justified payout: neither allowing a case to develop slowly as a long-run revenue stream to the law firm nor over-staffing it to justify expensive and new associates. Devices familiar to both finance and the principal-agent literature abound for each of these problems. The financier influences the business plaintiff's behavior going forward principally by structuring the investment contract to mandate the financier's repayment first. The simplest device is the most common: financiers require repayment of at least their initial investment, usually with a minimum acceptable return, before any other constituency is paid. 84 This "first money out" policy disproportionately front-loads the financier's expected fraction of [*942] payment in the case both to discourage the business client from settling for too little as well as to ensure the business plaintiff retains some incentive to maximize the total recovery. This first money out policy sometimes accompanies a "waterfall" payment structure, where the financier receives a decreasing marginal rate of money across tranches of payments. 85 For example, the financier might receive 100% of the first $ 2M in any settlement or verdict, but 75% of the next $ 2M, 50% of the next $ 2M, and a quarter of everything beyond $ 6M the case yields. This decreasing marginal return again encourages the business plaintiff to maximize total recovery. As a backstop to both of these tactics, and a partial substitute to the former, the financier may take collateral in a tangible asset, contingent on recovery: this turns the investment into effectively a secured loan, and is a tolerable substitute - but better complement - for guaranteeing repayment. 86 The financier controls the law firm principally by converting an hourly-fee arrangement into a hybrid billing structure. Rather than requiring the law firm assume the risk of the case completely, as in a contingency fee arrangement, the financier provides a fixed amount of money for going-forward litigation costs, to be earned hourly, combined with a contingency fee. This contingency fee may be a percentage of the total recovery or a fixed sum, but is always paid after the financier receives his initial investment and base return - and either on equal step with, or before, the business plaintiff, depending on the agreement. 87 The financier advances an amount of money significantly less than the expected litigation costs, including any arrears the business plaintiff may owe the law firm. This deficit

84

See, e.g., Maya Steinitz, The Litigation Finance Contract, 54 Wm. & Mary L. Rev. 455, 467-71 (2012) [hereinafter Steinitz, Finance Contracts] (describing Burford Capital's payment arrangements in Chevron/Ecuador); Steinitz, Whose Claim Is This Anyway?, supra note 81, at 1276-78; see also Richard Fields Interview, supra note 4. 85

See generally Maya Steinitz & Abigail C. Field, A Model Litigation Finance Contract, 99 Iowa L. Rev. 711, 713, 745-48 (2014); Steinitz, Finance Contracts, supra note 84, at 467-68; Steinitz, Whose Claim Is This Anyway?, supra note 81, at 127678; Richard Fields Interview, supra note 4; Roger Parloff, Have You Got a Piece of This Lawsuit?, Fortune (June 28, 2011, 6:06 PM), http://features.blogs.fortune.cnn.com/2011/06/28/have-you-got-a-piece-of-this-lawsuit-2. 86

Our discussions suggest this is comparatively rare, and some of the scholarship in this area discusses third-party litigation finance arrangements as nonrecourse debt, whereby the financier's only security for his loan is the underlying case. See, e.g., Steinitz & Field, supra note 85, at 720 (describing traditional structure as nonrecourse). We believe this is not true, though we acknowledge that litigation finance agreements are notoriously confidential, and that the industry is notoriously "opaque." See id. at 719 (noting opacity of industry). 87

See, e.g., Garber, supra note 3, at 25-28; Steinitz, Finance Contracts, supra note 84, at 467-71 (describing Burford Capital's payment arrangements in Chevron/Ecuador); Steinitz, Whose Claim Is This Anyway?, supra note 81, at 1276-78; see also Richard Fields Interview, supra note 4.

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Page 17 of 28 47 Ariz. St. L.J. 919, *942 ensures the law firm retains a meaningful incentive to recover more than the financier's initial investment; the first money out policy means that the law firm must ensure the financier is paid in full before it receives essentially the balance of its [*943] expected fees. More aggressive firms may prefer a percentage recovery past the financier's recoup amount to a fixed dollar recovery; this depends entirely on the individual contract. The financier also monitors the hours earned and accrued, essentially allowing or disallowing billed hours akin to a sophisticated client - and by default pushing law firms to generally more productive and cost-effective litigation strategies. Ex post screens broadly generate welfare and positive externalities by reducing agency costs. Business plaintiffs no longer suffer adverse incentives between internal principals and the firm or between the firm and shareholders by resisting profitable litigation out of concern for justifying litigation expenditures. Potentially faithless agents no longer struggle to divert litigation expenditures back to themselves or preferred firm constituencies. Law firms' adverse incentives to extend cases into the future are quelled two ways. First, law firms know with certainty the fixed pool of hourly fees they can generate from the case, and second, law firms enjoy some incentive to bring a case to its conclusion to receive the contingent portion of their fee. This new fee structure, combined with the financier's monitoring of billed hours, reduces the business plaintiff's agency costs vis-a-vis the law firm. Note that each of these ex post screens responds to business plaintiffs' and law firms' core economic concerns. The ex post screens financiers apply to business plaintiffs guarantee that the business plaintiff need spend little to no additional future money on the litigation, and retains a large portion of a substantial future return. Yet the financier structures both his finance arrangement and his prospective return to ensure that the business plaintiff, effectively a stranger, makes litigation and settlement decisions which will maximize the time-and risk-adjusted payoff for both the financier and the business. The ex post screens to law firms guarantee a known and fixed revenue stream for a known future and require only a manageable amount of risk exposure to an otherwise financially exposed firm. Yet the financier monitors the law firm's activities and billed hours more stringently than most business plaintiffs could, and only partially finances future litigation expenses, requiring law firms to earn their keep in the ultimate settlement or verdict. Litigation financiers reinforce these ex ante and ex post screens by hedging risk outside of individual cases as well. Like any investor, litigation financiers first hedge against risk by buying stakes in large pools of litigation, purchasing portions of many cases rather than a few cases in entirety. This partially explains most litigation financiers' ideal case value - from several million to $ 25M in expected payout - as the major litigation finance firms currently can afford a tranche of diverse cases at this rate, but only a handful [*944] of much larger cases. 88 Litigation financiers may also insure their judgments: for example, through appeal gap insurance, which protects against a favorable judgment being overturned on appeal. 89 Multiple similar forms of insurance against the disturbance of a favorable judgment are available. Viewed broadly, third-party litigation financiers occupy an economically and legally familiar position. To the extent that financiers purchase stakes in cases that they fundamentally do not own, they merely take a position familiar to finance and corporate law: that of a claimant not entitled to control over an asset. 90 To the extent that financiers assume a business plaintiff's downside risk and cost from potential litigation, they merely take the place of any

88

Richard Fields Interview, supra note 4; see also Burford Capital, Litigation Finance: An Introduction 4 (2013), http://www.burfordcapital.com/wp-content/uploads/2013/08/Booklet-Intro-to-Litigation-FinanceFINAL-Web-2013-08-16.pdf (describing financier's investments in cases as "sometimes up to $ 15 million and beyond" while maintaining approximately $ 300 million under management). 89

Note: in some sense, this is insurance on insurance on insurance. To the extent we view litigation as a substitute for insuring non-core business assets, and that third-party litigation financing acts as a substitute for insurance, this insurance is the third vertical level in risk spreading. Doubtless one could investigate these appeal gap insurance policies' underwriters further to discover further levels, but that is beyond the scope of this paper. 90

See, e.g., Julian Velasco, Shareholder Ownership and Primacy, 2010 U. Ill. L. Rev. 897, 908 (2010) ("A corporation … does not allow the co-owners to act independently (unless they agree otherwise). Instead, shareholders act together to elect directors who are given control over the assets.").

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Page 18 of 28 47 Ariz. St. L.J. 919, *944 common insurer or risk-sharer. To the extent that financiers provide a capital cushion and liquidity while monitoring law firms' expenditures, they resemble and have similar interests to a general creditor. 91 Unfortunately, because of the relative obscurity and comparative novelty third-party litigation financiers hold in each of these three functions, litigation finance as a practice has drawn several meritless (and a few understandable) criticisms. We next evaluate several common criticisms of third-party litigation financing, explaining the practice's benefits and costs and displaying how remarkably unremarkable the practice really proves. IV. Arguments For and Against Third-Party Litigation Financing We next address both the benefits and criticisms of third-party litigation financing. To appreciate both these benefits and potential drawbacks, it is [*945] important to emphasize that many concerns critics raise to new financial devices do not apply to commercial litigation financing. First and foremost, litigation finance is a voluntary arrangement between almost exclusively sophisticated parties with recourse to multiple other options, both business plaintiffs and law firms alike. The possibility that litigation finance will somehow deprive business plaintiffs or law firms of free agency in either the attorney-client relationship or at the investment contract formation stage is deeply implausible. Note the wide distinctions between commercial third-party litigation finance and, for example, personal injury third-party litigation finance: commercial litigation parties are almost uniformly sophisticated and can deal with financiers and law firms at arm's length. To the extent we contrast business plaintiffs with individuals unable to meet basic needs due to an injury, business plaintiffs are undoubtedly more elastic regarding the cost of money than individuals, and are therefore less susceptible to coercion, overreaching, or even simple unfairness. In a civil justice system predicated on private ownership of private claims, this independence and arm's-length bargaining is worth substantial deference. But most benefits to third-party litigation financing are private, easily overlooked, and internal to parties within the system. Criticisms ignore these benefits, fail to perceive these benefits, or presume the litigation financing agreement imposes external costs on the general public. We therefore first summarize the benefits of third-party litigation financing, as we've discussed above, before turning to the most common criticisms of litigation financing. We then compare litigation financing to several more familiar business and political arrangements to illustrate that current criticisms of litigation finance are broadly misplaced. A. Benefits of Third-Party Litigation Financing The benefits to business plaintiffs are obvious: third-party litigation financing transforms an expensive and burdensome lawsuit into essentially a free option. Business plaintiffs pursuing third-party litigation financing worry about the potential downside risk to litigation: lengthy proceedings and variant expenses. As outlined above, initiating litigation unexpectedly diverts resources from within a business, introducing principal-agent problems and increasing agency costs to the business plaintiff. 92 The business plaintiff's [*946] directors and officers must justify litigation expenses to shareholders or other investors; its employees and principals will resist even profitable litigation to preserve resources for favored departments or to reduce perceived individual responsibility for any

91

See generally Stuart C. Gilson & Michael R. Vetsuypens, Creditor Control in Financially Distressed Firms: Empirical Evidence, 72 Wash. U. L.Q. 1005, 1008-13 (1994) (discussing uses of credit for firms in financial stress and also corresponding influence creditors have over these firms as a consequence, including restrictive covenants, management changes, and influence over similar business decisions). 92

See supra Section II.A. and accompanying notes; cf. Burch, supra note 1, at 1291, 1316 (discussing the agency costs that arise in aggregate litigation because of the contingent-fee attorney's dual roles as agent and investor, and suggesting third-party litigation financing as the solution to this conflict of interest).

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Page 19 of 28 47 Ariz. St. L.J. 919, *946 blameworthy conduct underlying the case. 93 Litigation also inflicts information, monitoring, transaction, and decision costs on the business plaintiff: the business plaintiff must select and retain a law firm, monitor the law firm's litigation decisions and billing, and so on. In short, litigation is deeply disruptive to all but the largest or most litigation-experienced businesses. 94 These costs and risks drive many business plaintiffs away from litigation; these business plaintiffs would otherwise settle immediately at a substantial discount, 95 forego bringing a case altogether, or drop a case that has already been filed. 96 Litigation financiers ameliorate these problems partially or completely. Litigation financiers provide the initial or ongoing investment necessary to operate a lawsuit, obviating the need for the business firm to divert capital from business lines. This in turn eliminates or reduces these myriad agency problems. Litigation financiers also align law firms' incentives by requiring law firms to take on some portion of risk in the form of future, contingent payment, and monitor firm billing against the guaranteed funding by the financier, reducing the business plaintiff's monitoring costs. 97 Third-party investment presents an enticing trade to business plaintiffs: business plaintiffs [*947] give up a large fraction of the potential gains from litigation, but almost all of the underlying risks and costs. 98 The resulting deal is a free, positive-value option, which even very conservative business plaintiffs find irresistible. Litigation financiers also reduce present and future information costs to business plaintiffs through their ex ante screening functions. Litigation financiers act as independent checks on the company's assessment of its case, its legal theories in that case, and its law firm. 99 Litigation financiers' conditions before the investment contract provide useful signals to companies. Some of these may be used regardless of whether the investment contract comes to fruition: a financier informing a business plaintiff that he will only invest in a case if the business plaintiff retains a specific firm - at the financier's cost - sends a valuable signal; a financier demanding the business plaintiff terminate current counsel sends an even more valuable signal. 100 These signals precede the investment

93

See Garber, supra note 3, at 15 ("In some instances, corporate legal departments may prefer using outside capital to requesting additional funds from corporate management to pursue litigation opportunities that were not identified in time to be considered in budgeting processes."). 94

See id. at 15-16.

95

As we discuss below, objections that litigation financing increases settlement prices raises distributional concerns between tortfeasor defendants and external litigation financiers. These concerns, while valid, have ambiguous social utility consequences at best. See generally Part IV. 96

This of course reflects the anodyne and well-accepted fact that to increase a good's cost is to reduce the amount a rational actor will consume of that good - including litigation. See generally Janet Cooper Alexander, Do the Merits Matter? A Study of Settlements in Securities Class Actions, 43 Stan. L. Rev. 497, 529-31, 575-77 (1991) (discussing costliness of litigation in securities context, transaction costs imposed on defendants and resultant unwillingness to litigate, and effects of contingencyfee arrangements on plaintiffs in securities cases); Claire A. Hill, Bargaining in the Shadow of the Lawsuit: A Social Norms Theory of Incomplete Contracts, 34 Del. J. Corp. L. 191, 208-10 (2009) (discussing the complex transacting community's strong norm against litigation and noting that "once the norms for negotiating and contracting are established, seeking additional increments of precision may signal one's propensity to litigate, which in turn may signal that one is a less desirable transacting partner"); Richard L. Schmalbeck & Gary Myers, A Policy Analysis of Fee-Shifting Rules Under the Internal Revenue Code, 1986 Duke L.J. 970, 975-76 (1986) (referencing fee-shifting statutes in tax context and discussing how potential attorneys' fees and related litigation expenses deter even potentially meritorious claims). 97

See Garber, supra note 3, at 15-16.

98

See id. at 15.

99

See id.

100

But see Am. Bar Ass'n Comm'n on Ethics 20/20, supra note 56, at 16 ("An agreement between an ALF [alternative litigation finance] supplier and a client, permitting the ALF supplier to have veto power over the selection of counsel, may limit the client's right to terminate counsel in a manner that is inconsistent with Model Rule [of Professional Conduct] 1.16(a)."); Molot, supra note 1, at 178-79 (noting that litigation financier Burford Capital is a "passive provider of financing" and does not interfere with the

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Page 20 of 28 47 Ariz. St. L.J. 919, *947 contract's formation, and therefore come at little or no cost to the business plaintiff. 101 While some information signals are case-specific, such as various theories or claims to advance, others, including counsel to retain or dismiss, potentially reduce future costs in seeking out competent and effective counsel for business plaintiffs in other matters. 102 Litigation financing also imparts to business plaintiffs another degree of sophistication that law firms often cannot (or will not): sophistication in dealing with law firms themselves. Litigation financiers will inform a [*948] business plaintiff about the business plaintiff's relative strength and realistic settlement options in a powerful signal that hourly billing attorneys do not have the correct incentives to provide. 103 Despite ethical obligations to the contrary, law firms billing by the hour have a critical incentive to vigorously prosecute even marginal cases; third-party litigation financiers must necessarily pass on even many infra-marginal cases, much less truly risky ventures. 104 Similarly, litigation financiers also sometimes condition investment agreements on working with certain firms (or not others). This signal indicates to business plaintiffs the relative trustworthiness and competence of a given law firm in a given area. Litigation financiers also serve as the business plaintiff's agent in dealing with relevant law firms. Litigation financiers monitor strictly the billed hours retained firms claim against the money the financier invests, discounting or writing off altogether some charges. 105 The financier strictly acts as the business plaintiff's agent in this function, monitoring the law firm's progress and coordinating with the business plaintiff periodically. 106 The financier effectively negotiates a discount with the law firm based on disallowed expenses, controlling costs to the case. 107 Inexperienced business plaintiffs gain some sophistication simply by monitoring the litigation financier's monitoring of the law firm; as the principal in the litigation, the business plaintiff is entitled to know the litigation financier's methods and criteria for allowing or disallowing expenses in the case. 108 And though the financier may not control the business plaintiff's settlement options, the financier, along with the law firm, gladly provides advice

traditional attorney-client relationship; instead the company's financing allows clients to retain the lawyers and firms of their choice). 101

Litigation financiers might resort to "lock-up fees" or earnest money to counteract the potentially free transmission of information here, and might even be wise to do so. We have not, however, encountered this phenomenon in our research of third-party litigation contracts. Nor would we expect to: when business plaintiffs are already highly cost-sensitive, it stands to reason that these businesses might balk at even relatively small sums demanded in advance to secure a deal. In this sense, critiques that imply litigation financiers somehow take advantage of cost-sensitive plaintiffs ignore that litigation financiers must make the first investment in investigating a case - and confer valuable benefits on prospective clients - before receiving anything in return. See Garber, supra note 3, at 24-26. 102

See Molot, supra note 1, at 179-80 ("Although Burford's capital has been used by different businesses for different purposes, as a general matter Burford's financing has enabled those businesses to retain higher-quality counsel and/or mount a more vigorous prosecution of a case than would have been possible without Burford financing.").

103

Garber, supra note 3, at 32-33.

104

See id. at 32-33; Burch, supra note 1, at 1317. It is easy to understate how risk-averse litigation financiers are in selecting cases. By one account, a litigation finance fund need only "lose" - in the sense of fail to recoup an investment - as few as a tenth to a quarter of invested cases for a fund to fail. See Richard Fields Interview, supra note 4. 105

See Burch, supra note 1, at 1316, 1336 ("As repeat players, financiers are likely to be more efficient than one-time clients at monitoring litigation costs and keeping attorneys' fees manageable."). 106

See id. at 1315 (describing litigation financiers as intermediaries that have the expertise, sophistication, and substantial capital to monitor the attorneys involved in a case). 107

See id. at 1316-17 (explaining that "a litigation-savvy financier [can] negotiate a better hourly rate and thereby prevent astronomical fees while ensuring that the case is adequately funded."). 108

See id. at 1319-20.

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Page 21 of 28 47 Ariz. St. L.J. 919, *948 on whether a defendant's settlement terms are comparatively favorable. 109 This advice provides an external check [*949] on, and confirmation of, the law firm's advice on whether to prosecute litigation further or accept a settlement offer. 110 Third-party litigation financing also benefits law firms. Financiers provide an additional option for law firms to capitalize themselves - and, by necessity, an additional business model for firms to take on additional cases. This additional model alleviates law firms' illiquidity and financial fragility. Litigation financing allows law firms to continue prosecuting expensive cases that the firms and clients would be mutually unwilling to pursue further absent the outside capital. 111 This reduces the amount of debt law firms would have to carry to successfully prosecute a case and guarantees the law firm some amount of guaranteed future income along with an incentive to vigorously prosecute the case vis-a-vis a contingency payment. 112 Litigation financing expands the pool of potential matters and clients that a law firm may accept. This expansion necessarily enables firms to diversify revenue streams: all else equal, carrying additional cases gives firms some flexibility in taking on debt in one matter while pending a settlement, judgment, or payment in another. 113 The ability to take on additional matters also offers law firms the chance to diversify practice areas and internal expertise in various types of commercial litigation, potentially opening up new pools of clients for the firm in the long run. 114 Litigation financing also opens law firms to new business clients, and, by extension, allows law firms to foster relationships with these businesses for potential future cases or matters. Of course, this additional supply naturally provides some downward pricing pressure in the market for complex legal services and legal services at large, which benefits consumers of legal services and the general public as well. 115 Finally, litigation financing also directly spreads risk across litigation constituencies, encouraging risk-neutral decision-making at key stages of the litigation. Like all economic actors, business plaintiffs and law firms have risk tolerances. 116 This level, the amount of money as an expected value of a litigation decision, that either a business plaintiff (as the owner of a claim) or law firm (on a contingency-fee contract) will tolerate losing at any given litigation decision node is finite, often shifting, and sometimes unknown ex [*950] ante. 117 Favorable rulings early on in litigation, or a relatively unfavorable initial fixed cost in starting a case, can cause business plaintiffs to forego profitable litigation and law firms to forego successful cases out of nothing more than risk aversion. Third-party litigation financiers by definition accept part of this litigation risk - and sometimes are willing to continue to accept more litigation risk in favorable circumstances. 118 This financier risk-acceptance encourages risk-neutral decisionmaking by both business plaintiffs and law firms by driving values of litigation decisions below sensitive business plaintiffs' risk tolerances. 119 Similarly, hybrid billing terms, where litigation financiers guarantee a finite sum earned hourly combined with a contingent-fee sum reduces law firms' risk exposure relative to a pure contingency fee contract. This diffusion of risk discourages either business clients from accepting, or contingency-fee law firms

109

See id. at 1317.

110

See id.

111

See, e.g., Lyon, supra note 9, at 590.

112

Garber, supra note 3, at 15.

113

See Shepherd, supra note 1, at 598-99.

114

See id.

115

See Geoffrey J. Lysaught & D. Scott Hazelgrove, Economic Implications of Third-Party Litigation Financing on the U.S. Civil Justice System, 8 J.L. Econ. & Pol'y 645, 658 n.37 (2012). 116

See Molot, supra note 42, at 76.

117

See Shepherd, supra note 1, at 597-98.

118

See id. at 599-600.

119

See id. at 595, 599.

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Page 22 of 28 47 Ariz. St. L.J. 919, *950 from encouraging, lower-valued or premature settlements in the wake of adverse business conditions or litigation setbacks. 120 B. Arguments Against Third-Party Litigation Financing Criticisms of third-party litigation financing do not deny the above-described private benefits; instead, they imply corresponding public costs, especially in the form of additional litigation. This is perhaps the most insistent and easily understandable criticism of litigation finance. It comes in two varieties: either that financing encourages frivolous litigation, or that it merely encourages additional litigation. The former claim is easy to dispatch: frivolous litigation makes for a worthless investment. Third-party litigation financiers invest only in cases with millions to tens of millions of dollars at stake and between incredibly sophisticated parties. 121 Litigation funds can afford few failed investments for an entire fund family to collapse. 122 It seems ludicrous at first blush that investment managers with a strong aversion to worthless assets would pursue an asset class - frivolous litigation - that is, by definition, worthless. Proponents of the "frivolous litigation" theory of third-party litigation finance might respond that litigation financiers effectively intimidate [*951] defendants into settlement by bankrolling otherwise frivolous claims. 123 This response overlooks the costs borne by the business plaintiff and law firm, however, as well as the implicit threat (such as it is) undergirding financial support of litigation. A substantial fraction of cases financed receive litigation funding after the case has begun: namely, after the business plaintiff has invested money in the case. 124 Litigation finance agreements also commonly require law firms to accept some risk through a partial contingencyfee arrangement. 125 These each strongly suggest that the business plaintiff and law firm alike invest expecting the case is valuable. 126 Defendants in litigation-financed cases are broadly sophisticated, able to resort to experts and attorneys that can discern worthwhile claims from worthless ones. To the extent defendants find litigation finance coercive vis-a-vis settlement, it is because financing litigation carries the threat not of a forcible settlement, which is naturally a contradiction in terms, but of a business plaintiff prepared to litigate a case to judgment. 127 This, of course, implies not only a meritorious claim, but a potentially strong claim, or at least a strong claim in light of available remedies. 128

120

See id. at 599.

121

See Lyon, supra note 9, at 593.

122

See id. at 593-94.

123

See id.

124

See Molot, supra note 1, at 178-80; see also Paul Barrett, Hedge Fund Betting on Lawsuits is Spreading, Bloomberg (Mar. 18, 2015), http://www.bloomberg.com/news/articles/2015-03-18/hedge-fund-betting-on-lawsuits-is-spreading. 125

See Burch, supra note 1, at 1318-19.

126

To the potential rejoinder that the law firm perceives value out of the litigation financier's potentially coercive settlement power, we would note that this assertion obviates the need for the financier entirely. Such a firm could simply take the case on contingency to begin with. But even if the financier served only a signaling function, one hesitates to conclude why this signaling function would work only perversely - to support meritless cases - rather than accurately, in suggesting a case's relative strength. We discuss the potential social benefits to third-party litigation finance encouraging meritorious cases immediately below. 127

This, of course, implies that the role of a third-party litigation financier ends once a case has gone to judgment. Naturally, it does not. But litigation financiers' and business plaintiffs' slightly differing incentives following a favorable judgment but preceding collection of the judgment, as opposed to preceding judgment, are beyond the scope of this paper. 128

See generally Shepherd, supra note 1, at 607-09.

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Page 23 of 28 47 Ariz. St. L.J. 919, *951 It is more difficult to evaluate the more sophisticated claim that third-party litigation financing encourages additional meritorious litigation. We are glad to concede that third-party litigation financing reduces the cost of litigation to business plaintiffs and the cost of carrying some cases to law firms, and accordingly almost certainly increases the total amount of litigation. Even if this litigation is particularly strong on the legal merits, we can envision sensible objections to enabling meritorious business tort cases. There is well-established literature on the comparative inefficiency of the tort system in [*952] transferring wealth in even the simplest of cases, and surely sophisticated business litigation is far from the simplest of cases. Several studies have found that tort plaintiffs receive between thirty-seven and fifty cents of every dollar spent by defendants. 129 And additional meritorious cases, even additional meritorious judgments, guarantee nothing in social value in and of themselves. It could be, for example, that current tort rules penalize some socially beneficial conduct that a combination of transaction costs, litigation costs, informal norms, and intra-firm constituencies prevent. 130 Third-party litigation financing under these conditions would enable business plaintiffs to vindicate legal rights at the cost of public welfare or economic efficiency. 131 As a preliminary matter, it seems to us that these potential objections instead focus on either the social benefits of the underlying rules of decision or the inefficiency of the civil justice system. These are serious and substantial problems, but neither of these problems has anything to do with third-party litigation financing. Recourse for full vindication of legal rights under current legal regimes must at least primarily lie with lawmakers broadly, in legislatures, administrative agencies, or courts. 132 Private parties seem especially poorly positioned to effect a society-wide abrogation of legal rights through legal unilateral disarmament - e.g. foregoing a meritorious claim because of theoretical benefits to outside parties if all others similarly situated also forego similar claims. 133 And any discussion of litigation financiers' impact on litigation costs must include all dimensions of financiers' involvement. It is certainly true that litigation financiers enable business plaintiffs to prosecute cases that these plaintiffs would otherwise conclude. 134 The amount of additional litigation costs incurred due to litigation finance must be offset by reductions in costs through financiers': (1) partial re-alignment between business plaintiffs' and law firms' incentives, discussed above; (2) downward cost pressure on [*953] litigation generally; (3) signals regarding case quality to defendants, encouraging settlement; and (4) general deterrence to other potential tortfeasor businesses, discussed below. The ultimate effect of third-party litigation financing on total litigation costs is quite complex and an empirical question that we do not endeavor to resolve. We merely note that it is anything but clear that litigation finance net increases litigation costs. But even with these responses, potential objections to third-party litigation as increasing litigation seem to overlook the theoretical benefits to a financier's encouraging specific additional cases. Investment-grade cases almost uniformly focus on defendants that have actually committed underlying torts. 135 As mentioned above, we can and scholars often do - dispute whether enforcing these torts, or remedying them with injunctions or punitive

129

Stephen J. Carroll et al., Rand Inst. for Civil Justice, Asbestos Litigation 104 (2005) (concluding that plaintiffs receive fortytwo cents of every dollar paid by defendants in asbestos cases); Peter W. Huber, Liability: The Legal Revolution and Its Consequences 151 (1988) (concluding that plaintiffs receive forty cents of every dollar paid by defendants in medical practice cases and forty cents of every dollar paid by defendants in products liability cases); Patricia M. Danzon, Liability for Medical Malpractice, in 1B Handbook of Health Economics 1339, 1369 (Anthony J. Culyer & Joseph P. Newhouse eds., 2000) (concluding that plaintiffs receive forty cents of every dollar paid by defendants in medical practice cases).

130

See Huber, supra note 129, at 287.

131

See Garber, supra note 3, at 34-36.

132

See Lyon, supra note 9, at 608-09.

133

See Burch, supra note 1, at 1306-11.

134

See Garber, supra note 3, at 23.

135

See Shepherd, supra note 1, at 595-97.

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Page 24 of 28 47 Ariz. St. L.J. 919, *953 damages, generates any social welfare at a certain margin. 136 But to the extent tort law even loosely tracks prohibiting harmful conduct, investment-grade cases focus on defendants who have actually harmed business plaintiffs, and have almost certainly harmed other potential plaintiffs, either consumers or rival businesses, in the past. 137 Litigation financing therefore encourages tort suits against these defendants. These suits serve two familiar deterrence dimensions: specific deterrence, by increasing the defendant business's expected costs for committing similar harms against other businesses or consumers, and general deterrence, by increasing similarly positioned firms' estimation that victims will litigate perceived claims. 138 It suffices to say that even if one concedes that third-party litigation financing may increase meritorious litigation, it far from suffices to assert this fact as if it self-evidently condemns third-party litigation financing as a practice. It is possible that litigation financing encourages, for example, patent suits that harm social welfare. 139 In fact, it is even likely. But this is a fault of patent law more than litigation financing. By contrast, it is also likely [*954] that litigation financing encourages antitrust suits against price-fixing arrangements. 140 These suits almost certainly increase social welfare. 141 Between these two extremes lie numerous potential cases with complicated socialwelfare implications, contingent on the relative values of various public and private goods, distributional concerns, and a host of other trade-offs broadly (and properly) considered a legislature's province. 142 Third-party litigation financing's critics should first acknowledge that many of their concerns are with specific legal doctrines or business torts; barring that, these critics should at least demonstrate - rather than merely assert - that litigation financing on net harms social welfare. We believe this position is theoretically unlikely to prove true and virtually impossible to demonstrate. But to justify restricting litigation financing, the critics' model could not even stop there: at, say, attempting to compare social benefits from a class of litigation-financed cases with social costs from other potential litigationfinanced cases. That would be challenging enough. As we have established, third-party litigation financing has a complicated relationship with overall litigation levels: it causes some cases to exist that otherwise would not, and encourages some cases to settle that might otherwise go to trial. And these cases have an equally complicated relationship with social welfare: some cases are almost certainly socially beneficial, while others are probably socially harmful. But third-party litigation finance's opponents must also consider litigation finance's proximate substitutes, both public and private. The private sphere contains several obvious substitutes; insurance subrogation is clearly the nearest. The typical insurance contract includes a subrogation clause, which provides that if an insured enjoys any claim against any other party for damages the insured seeks recovery for under the policy, the insured surrenders those claims to the

136

See, e.g., Keith N. Hylton, The Economics of Third-Party Financed Litigation, 8 J.L. Econ. & Pol'y 701, 709-10 (2012) (explaining that while "the first lawsuit may be worthwhile in terms of the deterrence benefits it brings to society, … the one hundredth lawsuit may be undesirable … because of diminishing deterrence returns," and demonstrating that in many cases "the marginal social benefit from litigation (based on deterrence benefits) is just equal to its marginal social cost (based on litigation expenses)."). 137

See Lyon, supra note 9, at 593-94.

138

See Kidd, supra note 39, at 625-26.

139

See Shepherd, supra note 1, at 601-04 (noting that "many patent infringement cases are opportunistic - initiated not to protect property rights, but to bully quick settlement agreements out of defendants"). 140

See id. at 604-07.

141

But see id. (explaining that because antitrust law provides for treble damages, joint and several liability for defendants, and no right of contribution from co-conspirators, plaintiffs have so much bargaining power in settlement negotiations that there is the potential for inefficient case outcomes). 142

See id. at 611 (acknowledging that third-party litigation financing has the potential to improve access to justice, but calling upon legislatures to take steps to prevent third-party financing from threatening the compensatory and deterrent goals of the legal system).

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Page 25 of 28 47 Ariz. St. L.J. 919, *954 insurance company. 143 Subrogation actually enables the insurance company to conduct the litigation directly against the tortfeasor; the insured no longer controls the litigation, directs attorneys, or decides when or whether to settle. 144 Subrogation is therefore [*955] literally a third-party litigation financing arrangement: an insurance company advances a third party (the insured) the expected recovery and not only assumes a portion of the recovery, but assumes all of the recovery and directs the conduct of the litigation going forward. 145 Instead of charging a percentage of the recovery for a portion of the litigation expenses, insurance companies charge premiums and limit litigation expenses (in some sense, the insurance company's litigation-finance investment) per the insurance policy. 146 Other private substitutes exist as well. Patent assertion entities (PAEs) monetize litigation risk simply by purchasing patents to gain the right to sue for those patents' infringement. 147 As mentioned above, contingency-fee firms essentially bring third-party litigation financing in-house, financing litigation for business plaintiffs by carrying costs directly. 148 And small-scale litigation financing for personal injury cases has occurred for decades. 149 Third-party litigation financing merely performs the same private function as each of these decades-old (or older) arrangements. 150 Third-party litigation finance even occurs in the public sector. Nearly every politically or ideologically motivated litigation entity champions either a public right or a class of private rights by soliciting donations - sometimes from governmental entities - to prosecute or defend specific cases. 151 These entities, ranging from the Institute for Justice to the Center for Reproductive Rights, quite literally facilitate and direct litigation financed by third parties. 152 These organizations recruit clients on behalf of a given right enjoyed by some (or all) of the public to use as a named plaintiff; donors [*956] underwrite the litigation, which the ideological entity prosecutes directly. 153 To the extent that either rights or politically contentious outcomes may be reasonably considered at least partially fungible with money, the parallels to third-party litigation financing are both stark and unexpected. Donors pay for a private party to finance a case on behalf of a right the party enjoys, but only in common with others; the party continues to direct the litigation - sometimes - but the ideological organization practically steers both the individual's case and the litigation strategy in service of the donors' ideological goals. The donors' analogous return on investment is of course an injunction against whatever undesirable governmental action or law the representative plaintiff sought to

143

See Steinitz, Whose Claim Is This Anyway?, supra note 81, at 1295-96, 1295 n.95 (2011).

144

See id.

145

See id.; see also Michelle Boardman, Insurers Defend and Third Parties Fund: A Comparison of Litigation Participation, 8 J.L. Econ. & Pol'y 673, 673-75, 673 n.2, 674 n.6 (2012) (asserting that "insurers are litigation funders in the same relevant sense as that term is used to apply to third-party litigation funders"). 146

See Boardman, supra note 145, at 677 ("An insurer is more like a contingency fee lawyer in the sense that it must decide how much to spend on the litigation as the case unfolds. An insurer is dissimilar from both a litigation investment fund and a contingency fee lawyer in that the insurer's funds are on the hook for the eventual settlement or court award.").

147

See Hylton, supra note 136, at 703; Shepherd, supra note 1, at 604.

148

See Garber, supra note 3, at 30 ("Many corporate law firms, including some of the most respected ones in the country, do at least some litigation work on a contingency-fee basis for plaintiffs in commercial litigation.").

149

See Shepherd, supra note 1, at 593 ("The cash advance industry offers pre-settlement funding agreements that loan a few thousand dollars to personal injury victims while their lawsuits are pending.").

150

See id. ("Third-party litigation financing is not an entirely new phenomenon in the United States; indeed certain forms have been in practice since the 1980s."). 151

See Paul H. Rubin, Third-Party Financing of Litigation, 38 N. Ky. L. Rev. 673, 679 (2011).

152

See id.

153

See id.

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Page 26 of 28 47 Ariz. St. L.J. 919, *956 prohibit in the first place. 154 Much like with insurance subrogation, public interest entities exercise more control over an individual case than their third-party litigation financier counterparts. Other criticisms focus not on litigation finance's effect on overall litigation levels writ large, but on the practice's potential effects on the attorney-client relationship. One noteworthy version of these concerns is the potential that adding an additional party to the attorney-client relationship could adversely affect the litigation, the relationship, or both. This criticism has some theoretical justification. Attorney-client privilege is typically violated, for example, by disclosures on a case to any third party. And financiers, even with benign motives, have good reason to want to know confidential information about cases. 155 Similarly, some more-thoughtful criticisms of third-party litigation financing target the practice's potential effects not on any particular client, but on the integrity of the attorney-client relationship itself. 156 This logic is straightforward: attorneys that know of the external financing relationship are likely to make litigation decisions in response to it, or to seek the litigation financier's approval before key decisions in the litigation. 157 Litigation financiers anticipate these concerns and conspicuously attempt to avoid any direct influence over clients' actions, relying instead on the ex ante screens and ex post contractual terms to align incentives. Litigation financiers have an interest in controlling the outcome of litigation in one broad, obvious sense: in that they want to ensure their repayment and [*957] maximize the risk-adjusted return on investment. 158 But litigation financiers conspicuously avoid interfering in the day-to-day litigation decisions otherwise, deliberately advancing all potential investment in the case at the investment's outset to avoid potentially controlling either attorneys or clients afterwards. 159 Even monitoring of attorneys' billed hours takes place only at the client's behest and for the client's benefit. 160 Litigation financiers appear to construct contracts with the knowledge that informally pressuring attorneys after an investment could compromise privilege or otherwise impair the client's case. The litigation financier cannot alter or terminate the attorney/client relationship, and only has the power to discipline attorneys by virtue of providing the client information. And though litigation financiers in some sense direct the course of the litigation by contractual terms - specifically, to ensure financiers' repayment - it is worth noting that these contractual terms potentially reduce other external pressures on clients to settle claims. Pure contingency-fee arrangements, for example, can result in situations where attorneys pressure clients to accept settlements in part based on the firm's cash-flow issues or ability and willingness to carry the case's expenses. Defendants naturally pressure less-capitalized business plaintiffs with the threat of increasing litigation expenses strategically; discovery is notoriously expensive, and better-capitalized parties can obviously exploit asymmetrical financial positions through litigation expenses. 161 In fact, parties requiring litigation financing are necessarily especially sensitive to these costs: they aggravate the problem litigation financing is designed to mitigate. 162 Much as with social welfare concerns surrounding litigation finance, it is anything but clear that litigation finance's critics can establish that the financier/client relationship interferes, on net, with the litigation when one considers the potential economic forces the investment offsets.

154

See Elizabeth Chamblee Burch, Procedural Justice in Nonclass Aggregation, 44 Wake Forest L. Rev. 1, 17-19 (2009) (describing the goals of group-oriented litigation). 155

See Lyon, supra note 9, at 604-05.

156

See id. at 601-08.

157

See id. at 607-08.

158

See Garber, supra note 3, at 23-24; Shepherd, supra note 1, at 595.

159

See Molot, supra note 1, at 178-79.

160

See Burch, supra note 1, at 1315-17.

161

See Lyon, supra note 9, at 599.

162

See id.

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Page 27 of 28 47 Ariz. St. L.J. 919, *957 V. Conclusions This is, in short, the story of litigation finance: though the benefits are clear, even the claimed risks remain ambiguous on net. Considered alongside other economically and legally familiar risk-sharing mechanisms, the poor understanding of third-party litigation financing is downright mysterious. Litigation financing has existed for decades in smaller-claim format. Its most [*958] proximate substitute, insurance subrogation, is significantly older still. What little attention third-party litigation financing attracts focuses almost entirely on implausible harms to the civil justice system or the attorney-client relationship rather than on the not only plausible, but real, benefits both business plaintiffs and law firms enjoy through this alternative financing arrangement. But the economic functions of third-party commercial litigation financing explain both its origins and its benign, even productive, purposes. Commercial litigation financing neither takes advantage of vulnerable plaintiffs nor burdens the justice system. Instead, it arises almost exclusively between sophisticated business plaintiffs and law firms, in litigation targeting also-sophisticated business defendants. These business defendants have almost certainly committed torts, yet by virtue of law firms' undercapitalization and business plaintiffs' aversion to investing immediate capital for a potentially distant and uncertain payout, these businesses cannot afford to prosecute the resultant litigation on their own. Litigation financiers assume all of the business plaintiff's risk - and a substantial portion of the law firm's risk - in exchange for a portion of the prospective payoff from the lawsuit. The litigation financier shares risk with both parties, encouraging risk-neutral decision-making; he helps align incentives between law firm and business plaintiff; he quells adverse incentives within the business plaintiff by removing the need to fund a lawsuit continuously. Each of these functions is well-understood in other contexts, and it appears the litigation financier merely suffers the curse of relative, and only apparent, novelty. Hesitation regarding third-party litigation financing suffers from two unintended ironies. First, third-party litigation financing is made possible through antiquated rules that prohibit law firms from raising capital through the traditional and broadly understood equity markets. These restrictions reminisce of law firms as guilds, rather than businesses, and, rather than ensuring law firms act as guilds, they render law firms merely poorly capitalized businesses. Opponents of third-party litigation financing should consider the proximate alternatives: the consequences, for example, of parties owning common stock in law firms. Of course, litigation finance's critics do not seriously consider making equity markets available to law firms as a viable alternative; they simply prefer law firms remain relatively undercapitalized. Whatever the merits of this position as a normative preference, litigation finance's critics should first understand the business needs the financial arrangement provides law firms as well as business plaintiffs. The second irony is that third-party litigation financing is, in fact, already incredibly common; an enormous swath of American litigation already [*959] receives third-party financing. Insurance companies routinely require insured parties to file and subrogate claims against wrongdoers, and the insurers assume not only financial responsibility for the litigation, but provide representation directly. In fact, insurance companies assert exponentially more direct control over nominally third-party litigation than any litigation financier has yet aspired to accomplish. Patent assertion entities are simply third-party litigation financiers that specialize in intellectual property litigation and purchase underlying property rights entirely rather than simply one-off claims. And many of the most prominent public interest litigation boutiques exist precisely to raise funds for and prosecute litigation on behalf of whole classes of third parties. The United States has already substantially deviated from the plaintiff-versus-defendantonly model of wholly bilateral litigation. Yet two major concerns persist, and though both are understandable, neither one is a persuasive reason to curtail or prohibit third-party litigation financing. First, opponents assert that third-party litigation financing encourages frivolous litigation. This is obviously incorrect: litigation financing as an investment vehicle relies on cases with a high chance of substantial damages, which broadly necessitates a high chance of winning on the merits. But to the extent we refine this concern to that litigation financing encourages meritorious cases, the social welfare and efficiency implications for litigation financing grow ambiguous. Litigation financing encourages some additional cases, but also reduces the agency costs in many cases, and surely facilitates a speedy end to some cases Theresa Coetzee

Page 28 of 28 47 Ariz. St. L.J. 919, *959 through settlement. Litigation financing also offers some deterrent effect against third-party tortfeasors; to the extent we assume that tort law roughly tracks blameworthy or inefficient conduct, this deterrent effect must generate some social welfare to non-litigants. The second criticism, that litigation finance invades the attorney-client relationship, appears unfounded. Litigation financiers structure transactions specifically to respect the attorneyclient relationship's bounds, and neither need nor are able to assert control in that relationship to ensure repayment. These concerns are ultimately misplaced. Third-party commercial litigation financing may be viewed as, at worst, the private expansion of a recent American trend towards third-party involvement in legal disputes. More plausibly, third-party commercial litigation financiers offer an attractive substitute to both business plaintiffs and law firms from already-established options. For business plaintiffs, litigation financiers compete with pure contingency-fee law firms and insurance companies as litigation dispute resolution sources. For law firms, litigation financiers compete with other creditors and financiers, including banks and other investors. [*960] But what is certain is that third-party litigation financing is neither novel nor unfamiliar, and it will behoove both commentators and regulators to familiarize themselves with the underlying economic quandaries inevitably fueling this industry's growth. Attempts to inhibit third-party commercial litigation financing out of naive surprise or a fundamental misunderstanding as to the industry's economic functions will, at best, cause business plaintiffs and law firms to struggle to find one of a menu of alternatives to satisfy their interlocking economic problems. It is easy to understand the origins of these economic problems because they are each old and quite familiar. The only real quandary is why the practice is so poorly understood. Arizona State Law Journal Copyright (c) 2015 Arizona State Law Journal Arizona State Law Journal

End of Document

Theresa Coetzee

SYMPOSIUM: A BRAVE NEW WORLD: THE CHANGING FACE OF LITIGATION AND LAW FIRM FINANCE: ARTICLE: LITIGATION FINANCE AND THE PROBLEM OF FRIVOLOUS LITIGATION Winter, 2014 Reporter 63 DePaul L. Rev. 195

Length: 16819 words Author: Michael Abramowicz* * Professor of Law, George Washington University. I am grateful to the Searle Center on Law, Regulation, and Economic Growth for funding this research, and to participants in a Searle Center Roundtable for helpful comments.

LexisNexis Summary … This rule will encourage finance companies to lend only where a plaintiff's probability of winning is expected to be greater than 50%, although the rule can be altered to target lower probability thresholds. … If the lender expects the plaintiff to be able to achieve a quick settlement, then in effect the lender anticipates a very high probability that the plaintiff will recover something through settlement, even if there is a relatively low probability that the plaintiff would recover at trial. … Part IV elaborates on variations and extensions to the basic approach, including how it could be used in disputes over damages rather than liability, in suits in which there are one or more claims for injunctive relief, where the litigation finance company provides financing in installments, and where only some of the plaintiff's financing is to be provided by a litigation finance company. … A Model of Contingency Fees and Litigation Finance This Part offers a brief explanation of why low-probability lawsuits should be seen as problematic, and why the screening that lawyers conduct before agreeing to contingency fee cases and that litigation finance companies perform before extending nonrecourse loans still may not provide socially adequate incentives to block low-probability lawsuits. … This is equivalent to requiring the plaintiff to pay the defendant's reasonable litigation expenses, a conventional one-way fee-shifting mechanism, and requiring the litigation finance company to finance this aspect of the plaintiff's expenses if it finances other expenses.

Highlight Litigation finance companies have some incentives to screen plaintiffs applying for financing based on the strength of their claims, but a company may still have incentives to provide financing when the probability that a plaintiff would prevail at litigation is low. The result is that litigation finance may facilitate both meritorious and nonmeritorious claims. This Article argues that fee limitation rules for litigation finance companies can improve their incentives to select only relatively high probability cases, thus enhancing the normative case for states to enact legal reforms allowing litigation finance. A simple version of the rule, which will work if a case is sure to go to trial, allows a successful plaintiff to return no more than the amount borrowed and then the same amount again, plus ordinary interest. This rule will encourage finance companies to lend only where a plaintiff's probability of winning is expected to be greater than 50%, although the rule can be altered to target lower probability thresholds. The Article also describes alterations to the rule to accommodate the possibility of settlement, cases in which damages are disputed, where injunctive relief is at issue, where financing is provided in installments, and where only a portion of the plaintiff's expenses are paid by litigation finance companies. Should fee limitation rules become established in the fee limitation context, they also might be extended as a vehicle of tort reform. A requirement that plaintiffs and defendants fund some portion of their litigation costs through litigation finance can reduce frivolous suits and frivolous defenses of meritorious suits and may have advantages over other mechanisms, such as fee-shifting rules.

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Page 2 of 23 63 DePaul L. Rev. 195, *195

Text [*195] Introduction

Recently, litigation finance companies and arrangements have become more commonplace in both the United States and abroad. 1 Typically, [*196] a litigation finance company will give a plaintiff who otherwise might not be able to afford a lawsuit the funds needed to cover legal expenses. Loans are nonrecourse; if the plaintiff loses the lawsuit, the loan is forgiven. 2 Interest rates on such loans are accordingly well in excess of typical market rates, but such an arrangement may be beneficial to plaintiffs who do not have enough cash on hand to finance a lawsuit and who either cannot obtain funds through traditional loan sources or do not want to risk the possibility of facing a large debt if the lawsuit fails. The social welfare case for litigation finance is simple. Litigation finance is effectively a type of law firm finance, a means of enabling law firms to represent clients whom they otherwise might not be able to defend. Such financing enables liquidity-constrained plaintiffs to bring more cases and to prosecute cases more effectively. 3 Increased funding for litigation should thus reduce legal error and help achieve the legal system's goals, including both compensation and deterrence of negligent or wrongful acts. Litigation finance, however, at times might be used to fund nonmeritorious cases. 4 It might seem that plaintiffs have no incentive to bring cases that would likely lose, but a plaintiff might have some probability of prevailing on a nonmeritorious claim. The possibility of legal error thus suggests a need to balance the benefits of legal finance (reduction in false negatives, where meritorious claims are lost because of lack of financing) with its costs (increase in false positives, where nonmeritorious claims prevail or receive a nuisance settlement). When evaluating procedure, it is impractical to inquire as to the correctness of substantive law, and yet it would be foolish to pretend that the result actually achieved in a particular case is always the correct one. A simple yet valuable measure of a hypothetical claim's [*197] merit is the percentage of judges or juries that would find for the plaintiff on the claim. So, to evaluate litigation finance, we should assess the extent to which the new claims that it enables are claims that usually would succeed, meaning a majority of courts in the jurisdiction would find for the plaintiff, or claims that usually would fail, meaning a majority of courts would conclude that the plaintiff should not recover. It might seem that litigation finance should score well under this criterion. Because loans are nonrecourse, lenders have some incentive to screen cases. 5 If the probability of success is sufficiently low, lenders will not finance a

1

See, e.g., David S. Abrams & Daniel L. Chen, A Market for Justice: A First Empirical Look at Third Party Litigation Funding, 15 U. Pa. J. Bus. L. 1075 (2013) (documenting the recent increase in litigation finance in Australia); Susan Lorde Martin, Litigation Financing: Another Subprime Industry that Has a Place in the United States Market, 53 Vill. L. Rev. 83 (2008) (discussing litigation finance in the United States); Andrew Hill, Money for Smart Suits, Fin. Times, Jan. 5, 2007, at 18 (discussing the rise of litigation finance in the United Kingdom). For a history of the litigation finance industry in the United States, see Mariel Rodak, Comment, It's About Time: A Systems Thinking Analysis of the Litigation Finance Industry and Its Effect on Settlement, 155 U. Pa. L. Rev. 503, 505-08 (2006). 2

Courtney R. Barksdale, Note, All That Glitters Isn't Gold: Analyzing the Costs and Benefits of Litigation Finance, 26 Rev. Litig. 707, 708-09, 709 n.8 (2007) (examining the repayment provisions of typical litigation finance contracts). 3

See, e.g., Lauren J. Grous, Note, Causes of Action for Sale: The New Trend of Legal Gambling, 61 U. Miami L. Rev. 203, 204 (2006) (characterizing the litigation finance industry as an antidote for situations in which "a plaintiff with a strong cause of action may lack the finances to either pursue the claim or to pay medical bills and other living expenses during the litigation's pendency"). 4

For previous arguments to this effect, see Jeremy Kidd, To Fund or Not To Fund: The Need for Second-Best Solutions to the Litigation-Finance Dilemma, 8 J.L. Econ. & Pol'y 613, 627-29 (2012); Geoffrey J. Lysaught & D. Scott Hazelgrove, Economic Implications of Third-Party Litigation Financing on the U.S. Civil Justice System, 8 J.L. Econ. & Pol'y 645, 662-65 (2012); Rodak, supra note 1, 518-19. 5

See Abrams & Chen, supra note 1, at 1088 (noting that Australian litigation finance companies claim to take cases only "where they estimate the probability of winning a successful judgment or settlement to be large," from at least 50% to at least

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Page 3 of 23 63 DePaul L. Rev. 195, *197 case. Lenders, however, still might finance some low-probability cases if the expected recovery will be great enough to pay off the loan with a sufficient return. Because most cases settle, 6 as both sides seek to avoid legal expenses, lenders might finance even cases that would have only a small chance of succeeding if tried. Such settlements may be for relatively low dollar amounts, but nonetheless should be given some weight as false positives in the overall social calculus. Meanwhile, the universe of potential cases may include many more lowprobability cases than high-probability ones. 7 For any given level of damages, a lawyer may be able to find a large number of cases with a low probability of winning for each single case with at least a 50% chance of winning. Finally, because contingency fee arrangements already exist to help plaintiffs with limited means and serve a similar screening function, the additional cases enabled by litigation finance are those that contingency fee lawyers would not accept and may tend to be disproportionately weak. Litigation finance is a form of finance that enables law firms to take cases that they otherwise would reject, thus the relevant cases are the marginal ones that a law firm would not take on contingency. [*198] The net social welfare effects of litigation finance are indeterminate. Theory alone cannot tell us how many false positives litigation finance will enable, let alone whether the relatively small cost of settlements in many such cases outweighs the benefit of reduced false negatives. Litigation finance provides a screening function that will tend to reduce false positives relative to a hypothetical world in which all plaintiffs have sufficient liquidity to bring their own lawsuits. It would be difficult to measure empirically the overall quality of lawsuits financed by litigation finance companies, both because it is difficult to determine whether such cases would still have been brought absent litigation finance and because measuring lawsuit quality is challenging when many lawsuits settle.

It should be possible, however, to improve the incentives of litigation finance companies not to finance lowprobability suits by enacting rules that will affect their financial return. Indeed, those who are critical of litigation finance on the basis that it can spur frivolous litigation should recognize that, in fact, litigation finance presents an opportunity. Because litigation finance companies will necessarily perform some screening on the quality of lawsuits they fund, rules can be devised that will tend to improve the incentives of companies to support lawsuits they truly believe are meritorious while rejecting nonmeritorious ones. A variety of mechanisms seeking to achieve similar effects already exist and operate directly on litigants. These mechanisms include sanctions for frivolous suits 8 and fee-shifting rules. 9 However, designing such mechanisms to produce optimal incentives is not

95% depending on the firm). This quotation reveals that firms are interested in cases that will produce a successful judgment or settlement, not necessarily those cases that, if tried, would be likely to yield a judgment. 6

See generally Marc Galanter & Mia Cahill, "Most Cases Settle": Judicial Promotion and Regulation of Settlements, 46 Stan. L. Rev. 1339 (1994). 7

It is difficult to measure the distribution, but Robert Gertner offers a theoretical model showing that "litigated cases differ from the underlying distribution of disputes in that they are less likely to be successful than a randomly chosen dispute and damages are likely to be higher than in a randomly chosen dispute." Robert H. Gertner, Asymmetric Information, Uncertainty, and Selection Bias in Litigation, 1993 U. Chi. L. Sch. Roundtable 75, 90-91. This is consistent with the existence of disputes that have a small probability of producing high damages, precisely the disputes that a litigation finance mechanism might seek to exclude. 8

See, e.g., Fed. R. Civ. P. 11(b)-(c) (allowing a court to impose sanctions on an attorney, law firm, or party where "the claims, defenses, and other legal contentions are [not] warranted by existing law or by a nonfrivolous argument for extending, modifying, or reversing existing law or for establishing new law," or where "the factual contentions [do not] have evidentiary support"). 9

Analyses of fee-shifting rules include Ephraim Fischbach & William McLauchlan, Reverse-Cost-Shifting: A New Proposal for Allocating Legal Expenses, 32 J. Marshall L. Rev. 35 (1998); Gregory E. Maggs & Michael D. Weiss, Progress on Attorney's Fees: Expanding the "Loser Pays" Rule in Texas, 30 Hous. L. Rev. 1915 (1994); Walter Olson & David Bernstein, Loser-Pays: Where Next?, 55 Md. L. Rev. 1161 (1996); Thomas D. Rowe, Jr., The Legal Theory of Attorney Fee Shifting: A Critical Overview, 1982 Duke L.J. 651; Eric Talley, Liability-Based Fee-Shifting Rules and Settlement Mechanisms Under Incomplete Information, 71 Chi.-Kent L. Rev. 461 (1995); Matthew J. Wilson, Failed Attempt to Undermine the Third Wave: Attorney Fee Shifting Movement in Japan, 19 Emory Int'l L. Rev. 1457 (2005).

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Page 4 of 23 63 DePaul L. Rev. 195, *198 straightforward, even for liquid, risk-neutral plaintiffs, 10 and it may be particularly difficult for such mechanisms to optimize the incentives of plaintiffs who might not have the funds to pay sanctions [*199] or opponents' legal expenses. A requirement that plaintiffs put up a bond may arbitrarily screen out good cases if the plaintiffs have no access to litigation finance. It may be easier to design mechanisms that affect the returns of the lenders, so that their screening will be closely aligned with social interest. This Article describes such a mechanism, along with a number of variations, and identifies its advantages relative to alternatives. The core mechanism consists of a fee limitation, specifying the maximum amount that the lender can receive if the plaintiff prevails. 11 In addition to receiving back the principal that it has lent, the lender, in the most basic case, can receive the plaintiff's reasonable legal expenses 12 once more plus a regulated ordinary interest rate on the money lent. The intuition underlying this general approach is that what the lender can receive as profit when the plaintiff wins should be tailored to the amount that the lender puts at risk. It is straightforward to show that this approach will give the litigation finance company the incentive to lend money only when it believes that the plaintiff is more likely than not to prevail in the litigation, if the case is certain to be tried. This approach could be mandated by state law or voluntarily adopted by industry in an attempt to forestall state regulation, for example through the American Legal Finance Association, which has published lists of industry "best practices." 13 [*200] This approach alone, however, will not be sufficient to screen claims that the litigation finance company

believes are low quality, for the same reason that contingency fee screening may be inadequate. Even if a lender would not lend when sure that a case would go to trial, the lender might well lend because of the possibility or likelihood that the case would settle well before trial. If the lender expects the plaintiff to be able to achieve a quick settlement, then in effect the lender anticipates a very high probability that the plaintiff will recover something through settlement, even if there is a relatively low probability that the plaintiff would recover at trial. An ideal mechanism would allow the lender to recover only to the extent that the plaintiff would be able to prevail at trial. This adjustment is straightforward if the amount of damages the plaintiff would receive if liability were found at trial is known. The fee limitation formula must include an adjustment for partial recoveries by the plaintiff, including partial recoveries achieved through settlement. For example, if the plaintiff receives only one-tenth of the total

10

The analysis in this Article generally assumes risk-neutrality for simplicity of analysis. A behavioral economics analysis suggests that in relatively low-probability cases, plaintiffs in fact tend to be risk-seeking and defendants tend to be risk-averse. See Chris Guthrie, Framing Frivolous Litigation: A Psychological Theory, 67 U. Chi. L. Rev. 163 (2000). 11

Susan Martin discusses the possibility of restricting fees to a reasonable rate of return, as is the practice with various regulated industries. See Martin, supra note 1, at 102-04. Such an approach might be appropriate if there is concern that fees will be systematically excessive. This Article, however, advances a fee limitation out of concern for the interests of defendants and derivatively of society generally, and seeks to develop a mechanism that can improve litigation finance companies' incentives in particular cases. 12

This refers only to the legal expenditures funded by the litigation finance company. Often, litigation finance companies work with plaintiffs who will pay most of their expenses through a contingency fee arrangement. See, e.g., Grous, supra note 3, at 209 (citing Approval Factors, Oasis Legal Fin., https://www.oasislegal.com/legal finance services/lawsuit funding approval factors (last visited Nov. 11, 2013) (describing one litigation finance company that requires its clients to work with contingency fee lawyers). Because the contingency fee that the lawyer receives from the client's winnings is not money put up by a litigation finance company, this money should not increase the maximum amount that the litigation finance company can receive. 13

See Industry Best Practices ALFA's Code of Conduct, Am. Legal Fin. Ass'n, http://www.americanlegalfin.com/IndustryBestPractices.asp (last visited Nov. 11, 2013) (listing six best practices). One of the best practices seems designed to allay concerns that litigation finance companies might fund low-probability litigation and derive settlements by credibly threatening to take such cases to trial. See id. ("Each member agrees that they will not intentionally over-fund a case in relation to their perceived value of the case at the time of such advance."). This requirement is quite vague, however, especially because it does not make clear what constitutes over-funding relative to perceived value. For a discussion of ALFA self-regulation, see Grous, supra note 3, at 233-36. Grous notes that so far, "ALFA's goals and mission fail to make lowering excessive interest fees a priority." Id. at 235.

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Page 5 of 23 63 DePaul L. Rev. 195, *200 damages, then the maximum amount that the plaintiff could pay back to the lender would be only two-tenths of the amount lent, resulting in a loss for the lender. To implement this in practice, however, requires an assessment of the damages that the plaintiff would receive if successful at trial, which compared with the damages actually received produces a measure of the plaintiff's degree of success. A simple approach is to request that the plaintiff self-assess the damages that would be awarded if the plaintiff wins, and allow the defendant to agree to this damages figure should the plaintiff win. The plaintiff and lender will not want to select too low a number, lest the defendant agree to that damages level, or too high a number, lest the fee limitation be too severe. It is also possible to combine the fee limitation approach with a fee-shifting requirement. For example, a litigation finance company might be required to pay the reasonable legal expenses of the defendant if a lawsuit that it funds is unsuccessful, or to the extent that it is unsuccessful in the event of a settlement. Because the potential feeshifting increases the downside for the litigation finance company in the event that the plaintiff loses, it should lead to a corresponding relaxation of the fee limitation requirement. An advantage of combining the fee limitation with fee-shifting is that it reduces the danger that the parties might collude to evade a fee limitation requirement if the parties should reach a settlement before the production of a reliable estimate of the damages that the plaintiff would receive if liability was found. Such incentives to collude could exist because litigation finance companies, [*201] as repeat players, might seek to establish reputations for going to trial even when it is not within their economic interest, if the defendant fails to agree to an early nuisance settlement. The fee-shifting component will increase the defendant's incentive and ability to resist any such efforts. This Article proceeds as follows. Part II analyzes unregulated litigation finance and compares its incentives to those provided by contingency fee arrangements. It shows that although litigation finance provides some incentive for lenders to choose high-probability cases, there may also be incentives to fund relatively low-probability cases. Part III describes the basic mechanism. It details how to calculate the fee limitation for any desired probability threshold below which it is deemed desirable to encourage litigation finance companies to screen claims, both with and without fee-shifting. Part IV elaborates on variations and extensions to the basic approach, including how it could be used in disputes over damages rather than liability, in suits in which there are one or more claims for injunctive relief, where the litigation finance company provides financing in installments, and where only some of the plaintiff's financing is to be provided by a litigation finance company. Part IV also evaluates the settlement incentives produced by the fee limitation rule and its variations, noting that it should generally increase rather than decrease the plaintiff's incentives to settle cases. Finally, it considers the possibility that if the fee limitation approach successfully induces companies to screen low-probability cases, partial litigation finance should be required as an alternative to other mechanisms for discouraging frivolous litigation. Part V concludes. II. A Model of Contingency Fees and Litigation Finance This Part offers a brief explanation of why low-probability lawsuits should be seen as problematic, and why the screening that lawyers conduct before agreeing to contingency fee cases and that litigation finance companies perform before extending nonrecourse loans still may not provide socially adequate incentives to block lowprobability lawsuits. If legal expenses were entirely predictable then a very simple mechanism, a limit on the fee recovery to the amount lent plus an adjustment for the time value of money, could discourage litigation finance companies from supporting low-probability cases. But litigation expenses are not entirely predictable, particularly because while most cases settle, a few cases will go to trial. The result is that this simple fee limitation will not be effective in screening low-probability lawsuits. [*202]

A. The Problem with Low-Probability Lawsuits

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Page 6 of 23 63 DePaul L. Rev. 195, *202 The economic literature on frivolous litigation sometimes equates frivolousness with a case having a negative expected value for the plaintiff if it were tried. 14 This definition has been criticized, however. 15 A meritorious lawsuit might have a negative expected value merely because it would be expensive to try, but it might be both privately and socially worthwhile, given the likelihood of settlement. On the other hand, a lawsuit that the vast majority of judges and juries would reject might still have positive expected value, if a rogue judge or idiosyncratic jury on occasion might grant a significant damages award. The traditional definition of "frivolousness" may follow naturally as a matter of semantics. For example, it might seem odd to say that a claim with a 25% chance of winning is frivolous, because a 25% chance is nontrivial. Nonetheless, such cases may be normatively undesirable, because 75% of judges would reject the plaintiff's claim. This Article's concern is thus with cases in which the plaintiff is expected to have a low probability of winning. Given the semantic concern, the Article will avoid applying the "frivolous" label to such cases, 16 but the normative premise is that it is generally beneficial to discourage plaintiffs from pursuing cases that the defendants will probably win, or at least those that the defendants have a very high probability of winning. 17 [*203] Consider, for example, a case in which 25% of juries would find for the plaintiff, while 75% of juries would not. One might disagree about whether juries tend to be biased toward the plaintiff or toward the defendant, or whether the law is biased unfairly in one direction or another. In evaluating the hypothetical, however, we should place aside these concerns, both because addressing legal substance and procedure simultaneously complicates the issues, and also because such issues are better addressed through substantive law or jury reform. Of course someone who does believe, for example, that substantive tort law is too defendant friendly may rationally conclude that a case in which 25% of juries would impose liability is one in which more than 50% of juries should impose liability. But it is most straightforward to analyze the hypothetical with an assumption that the legal system is at least minimally accurate. Specifically, we will assume that the decision that a majority of courts would reach is more likely than not the correct one. From this, the conclusion that cases with only a 25% chance of prevailing should be blocked follows straightforwardly, if only it were possible to measure this chance reliably.

14

See, e.g., Peter H. Huang, Lawsuit Abandonment Options in Possibly Frivolous Litigation Games, 23 Rev. Litig. 47, 59 (2004) (noting that a relatively "inclusive definition of frivolous litigation also includes negative-expected-value lawsuits"). See generally Lucian Arye Bebchuk, Suits with Negative Expected Value, in 3 The New Palgrave Dictionary of Economics and the Law 551 (Peter Newman ed., 1998) (providing an overview of the economics of negative-expected-value suits). 15

See, e.g., Robert G. Bone, Modeling Frivolous Suits, 145 U. Pa. L. Rev. 519, 530 (1997) (offering a simple example that illustrates the problem). 16

Bone rejects the notion that frivolousness should be equated with low probability of success, because a case with a high probability of success should count as frivolous if the party knows that there is only a small chance that the defendant is in fact liable. Id. at 530-31. This helps explain why this Article will generally avoid the "frivolous" label. Any attempt, however, to define frivolousness to include cases in which the plaintiff will generally win even though the plaintiff should not win seems unlikely to be able to generate mechanisms for combating such frivolousness, because the legal system by definition will be unable to identify those cases. 17

For a previous analysis of the case against "long shot" cases, see Charles M. Yablon, The Good, the Bad, and the Frivolous Case: An Essay on Probability and Rule 11, 44 UCLA L. Rev. 65, 99-101 (1996). Yablon also offers some arguments in favor of long shot cases. See id. at 101-04. One limitation of his analysis lies in the statement, "whether a losing case is deterred or is filed and ultimately lost, the 'right' legal result occurs. No injustice has been done … ." Id. at 101. This ignores two possibilities: first, long shot cases that win even though most courts would reject them; and second, long shot cases that produce settlements where the defendant ideally would not pay any liability. Yablon also argues that "there are important societal values inherent in maintaining a system of courts that is available and open to all sincerely brought claims for redress, even those with low probabilities of success." Id. at 105. If there is some value, independent of traditional economic concerns such as litigation accuracy and compensation, in keeping the court system open, then that would militate against the premise adopted here.

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Page 7 of 23 63 DePaul L. Rev. 195, *203 It might seem that cases in which the plaintiff has a 25% chance of prevailing should simply receive 25% damages roughly the result that one would ordinarily obtain by allowing such cases to be brought and then settled. 18 This argument appeals to intuitions that disagreement is best resolved through compromise. If the substantive law allowed for partial recoveries (for example, for slight negligence), that would support such intuitions, but still only when the plaintiff had at least a 50% chance of receiving this reduced recovery. We may place aside, however, situations in which the substantive law allows for partial recoveries - for example on a ground of contributory negligence - because we are focusing for now on whether there should be some liability, not how great liability should be. When the substantive law does not allow partial recovery, most decision makers would rule that the best answer is that the plaintiff should receive nothing. The only reason to allow a partial recovery then would be the possibility that a majority of decision makers are wrong. [*204] A counterargument may be that the cases in which defendants wrongly must pay some settlement roughly balance out the cases in which defendants wrongly escape liability. Sometimes, a defendant may be liable, but only pay 75% damages in a settlement, because of the 25% chance that a judge or jury will wrongly find the defendant not liable. But these errors do not efficiently cancel each other out. The plaintiffs might be different. Even from a deterrence perspective, the defendants may be different too. The well-behaved defendant who is wrongly charged with liability may be different from the poorly behaved defendant wrongly absolved. The literature does suggest mechanisms for enhancing damages to compensate for a situation in which a particular defendant may have escaped payment in other circumstances, 19 but rough justice across defendants will not optimize deterrence.

The strongest justification for a partial recovery may then be an insurance justification. Even though a majority of decision makers believe that the correct legal result is for no recovery, giving the plaintiff some recovery essentially provides the plaintiff with insurance against the possibility that the majority in fact reached the wrong conclusion. Perhaps if transactions costs were sufficiently low and adverse selection not a problem people would buy insurance that would award them something when courts concluded that they might be right but were probably wrong. A system that allows partial recoveries by permitting low-probability lawsuits and settlements may provide a form of such insurance. This argument becomes weaker the lower the probability that the plaintiff would earn a recovery. Perhaps when 51% of decision makers would rule for the defendant, there is sufficient uncertainty about the law that the benefits of such an insurance function exceed the costs. When 95% of decision makers believe that the correct result under substantive law is zero recovery rather than even a small recovery, however, the insurance justification for providing that small recovery is weak. As a result, if claim screening is possible, then it will be desirable at least below some set probability threshold. Much of the analysis that follows assumes for the sake of analytical clarity that the relevant threshold is 0.5, but the mechanism is easily extended to work for any probability threshold. The closer the probability threshold [*205] to zero, the stronger the normative case for any mechanisms that will tend to ensure that plaintiffs with cases below the threshold receive zero recovery rather than a proportionate one. Even someone who believes that plaintiffs ideally would receive probability-adjusted recoveries might still favor mechanisms that would screen out some low-probability suits. First, there may be a fixed component to the transactions cost of litigating a case for a claimed amount of damages. That transactions cost might be worthwhile when there is a large chance that the plaintiff will receive a full or substantial recovery, but not when the lawsuit either ends up settled for a nominal recovery or goes to trial as a lottery ticket. Second, plaintiffs with very lowprobability claims may be able to settle the claims for considerably more than their probability-adjusted value. If, for example, a plaintiff has a 1% chance of winning $ 100,000, the defendant may be willing to pay considerably more

18

For a more comprehensive analysis of such compromise verdicts, see Michael Abramowicz, A Compromise Approach to Compromise Verdicts, 89 Calif. L. Rev. 231 (2001), which argues that such compromises might be justifiable near the middle of the probability spectrum but not near the ends of the probability spectrum. 19

Specifically, some have suggested punitive damages inversely proportional to the probability that a defendant's actions would be detected. See Robert D. Cooter, Punitive Damages for Deterrence: When and How Much?, 40 Ala. L. Rev. 1143, 1149-53 (1989); see also A. Mitchell Polinsky & Steven Shavell, Punitive Damages: An Economic Analysis, 111 Harv. L. Rev. 869 (1998).

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Page 8 of 23 63 DePaul L. Rev. 195, *205 than $ 1,000 to avoid the cost of litigation. The plaintiff must bear the cost of litigation as well, so if the parties' expected litigation costs are the same, the midpoint of the bargaining range is still $ 1,000 and simple models of bargaining would predict a settlement at that level. 20 Often, however, the defendant's expected litigation costs will be higher, in part because the defendant cannot predict whether the plaintiff will drop the case just before trial, and so the plaintiff may be able to obtain a settlement considerably higher than the probability-adjusted value. There is thus a theoretical case for eliminating at least lawsuits where the probability of winning is very low. Three caveats are appropriate. First, this is not a problem uniquely associated with litigation finance. The question here is simply whether, given the screening that litigation financing involves in any event, lenders can be given strong incentives not to support what they believe are low-probability claims. Later, we will consider whether the mechanism might be extended to cases in which parties ordinarily would not seek any third-party litigation financing. 21 Second, the problem of low-probability defenses presents many of the same issues as lowprobability claims. We ignore these problems for now simply because defendants are generally liquid enough to pay their litigation costs; otherwise, they would not be attractive targets for litigation. To the extent that defendants may seek third-party litigation support, the analysis in this Article extends easily. Third, the analysis assumes that the probability that the plaintiff will win is known and constant through the lawsuit. Often, [*206] the probability may initially be low as the plaintiff conducts discovery, and if discovery is successful, the probability will then rise. It may be desirable for plaintiffs to be able to bring low-probability claims that have a chance of becoming high-probability claims before trial and then to continue to pursue such cases only if supporting evidence materializes. 22 B. A Single-Period Model To assess the effects of litigation finance, consider first a simple model in which the costs of litigation are predictable and the decision whether to finance a case is made at a single point in time. Because an existing alternative to litigation finance, at least in the United States, is contingency fee litigation, the ultimate question is which lawsuits will litigation finance support that contingency fee lawyers would reject. We can thus start with a simple model of the contingency fee, assuming for simplicity that contingency fee lawyers are risk-neutral. Let p represent the probability that the plaintiff will win the lawsuit, and assume that this is known to third parties, such as contingency fee lawyers. Let d represent the fixed damages that the plaintiff would recover if the plaintiff wins the lawsuit, c represent the proportion of the recovery that the contingency fee lawyer would receive, and e represent the expense of litigating the suit, including the opportunity cost of the contingency lawyers' time. A lawyer will then accept a contingency fee case where the expected value of the fees more than covers the expense, that is where pdc > e. Thus, a contingency fee regime will screen cases where p < e/(dc). Note that if we assume that c = 1/3 (a common contingency fee), then the lawyer will only accept cases where p > 3e/d. This means that the contingency fee lawyer will accept some cases with a low p because the damages are high, and will reject some cases with a high p because damages are low or expenses are high. We now introduce a litigation finance company, with the same information as the contingency fee lawyer. Let r represent the interest rate on the loan that the plaintiff must repay if the plaintiff wins; this is the total interest rate over the course of the litigation, not the interest rate per year. For now, place aside the time value of money by assuming that the litigation occurs instantaneously, immediately after the loan. The finance company will loan the expenses e if epr > (1 - [*207] p)e (the expected interest received in the event the plaintiff wins is greater than the expected expenses lost in the event the plaintiff loses), assuming d > e(1 + r) (the damages would be great enough to allow the plaintiff to repay). It follows that litigation finance will support a lawsuit where r > (1 - p)/p. We can

20

See, e.g., Lucian Arye Bebchuk, A New Theory Concerning the Credibility and Success of Threats to Sue, 25 J. Legal Stud. 1, 13 (1996) (adopting such an assumption). 21

See infra Part IV.B.

22

For economic analyses of the discovery process, see Robert D. Cooter & Daniel L. Rubinfeld, An Economic Model of Legal Discovery, 23 J. Legal Stud. 435 (1994); Bruce L. Hay, Civil Discovery: Its Effects and Optimal Scope, 23 J. Legal Stud. 481 (1994).

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Page 9 of 23 63 DePaul L. Rev. 195, *207 consider a marginal contingency fee case, where p = e/(dc) and determine the minimum interest rate that must be charged to make litigation finance possible. It can be shown that r > (dc - e)/e, where dc > e. The intuition is that the greater the contingency fee is relative to expenses, the larger the interest rate must be for litigation finance companies to support a lawsuit that contingency lawyers would reject. For example, if e = $ 50,000, d = $ 500,000, and c = 1/3, then contingency fee lawyers will take the case if p > 0.3. At p = 0.3, a litigation finance company will be willing to take the case if r > 2.33. In this single-period model, it is straightforward to devise a solution that would lead to greater screening by litigation finance companies. Suppose, for example, that it is deemed desirable for litigation finance companies to finance only lawsuits that the litigation finance companies believe are more likely than not to be successful. Then, because the constraint for litigation finance companies is that r > (1 - p)/p, a rule capping r at 1.0 would achieve the desired result. This is the appropriate cap, however, only under the above assumption that litigation is instantaneous. Ideally, some allowance should be made for the time value of money because the litigation finance company not only assumes a risk of defeat, but also loses interest that it could earn on the money loaned during the period of the litigation. A simple approach is to cap r at 1.0 plus an ordinary (nonusurious) interest rate. For example, if an ordinary interest rate is 5% and the litigation lasts two years, then the maximum r would be 1.10. That is, the plaintiff would pay back 210% of the amount originally lent. Of course, the formula can be applied for any desired level of screening. If, for example, it is deemed desirable for litigation finance companies to finance only lawsuits that they believe have at least a 25% chance of succeeding, then r should be capped at 3.0 (plus an ordinary rate of interest). Note that this means that the most that can be repaid to the litigation finance company would be four times what was lent. As this ratio suggests, if m is designated as the maximum total repayment multiple (excluding ordinary interest), then m = e/p*, where p* is the target probability threshold below which we would like litigation finance companies to screen claims. Litigation finance companies and plaintiffs could still reach an agreement for a lower [*208] cap, and different companies could compete to provide loans to plaintiffs at the most advantageous rates. There is a possibility that such competition might change the analysis. For example, if litigation finance companies suffer from a winner's curse, 23 then the company that makes the loan may be the one that most overestimates the probability that the plaintiff will prevail in the lawsuit. This analysis assumes that the probability of success is known to all parties or that companies rationally adjust for the winner's curse. 24 Similarly, if litigation finance companies wish to increase market share by making loans, then they might be willing to make loans with negative expected value at first. The model here focuses on equilibrium behavior. On the other hand, if litigation finance companies are risk-averse, then they may be stingier about making loans. In practice, the above formula is not likely to cause companies to screen cases at exactly the desired probability threshold, but it accomplishes this goal at least crudely, and the interest rate can be adjusted to counter any observed deviation from the desired threshold. C. A Two-Period Model In practice, a simple interest rate cap is unlikely to work. The critical assumption above is that there is a single litigation period, in which the money loaned will definitely be spent and the litigation will reach a clear conclusion, with the plaintiff either winning or losing. Perhaps this assumption might be applicable in some circumstances, for example if a case is just about to go to trial and the parties have already exhausted the possibility of settlement, or under a hypothetical legal regime in which the defendant forgoes the possibility of settlement in the hope that the

23

See E.C. Capen et al., Competitive Bidding in High-Risk Situations, 23 J. Petroleum Tech. 641, 643 (1971) (offering a classic illustration of the winner's curse); see also Richard H. Thaler & William T. Ziemba, Anomalies: Parimutuel Betting Markets: Racetracks and Lotteries, J. Econ. Persp., Spring 1988, at 161 (discussing the winner's curse more generally).

24

See Otis W. Gilley et al., Uncertainty, Experience and the "Winner's Curse" in OCS Lease Bidding, 32 Mgmt. Sci. 673, 678 (1986) (arguing that rational adjustment for the winner's curse can be observed); see also Stuart E. Thiel, Some Evidence on the Winner's Curse, 78 Am. Econ. Rev. 884, 884-86 (1988). But see Barry Lind & Charles R. Plott, The Winner's Curse: Experiments with Buyers and with Sellers, 81 Am. Econ. Rev. 335 (1991) (illustrating that experimental subjects did not always adjust adequately for the winner's curse).

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Page 10 of 23 63 DePaul L. Rev. 195, *208 plaintiff will drop the lawsuit but the plaintiff does not do so. 25 Some plaintiffs may have enough funding to get to trial, [*209] but not enough to get through trial. Permitting litigation finance subject to the above rules could ensure that plaintiffs with limited liquidity and (seemingly) sufficiently high-probability cases will be able to afford trial. A more general approach must account for the possibility of settlement. This implies at least two periods: the first in which the parties perform some initial research and legal maneuvering, and the second in which the parties try the case if they cannot reach a settlement agreement after the first period. Of course, a still more realistic model would involve many periods of successive information acquisition and negotiation, but this simple two-period model is sufficient to show that a straight interest rate cap will not produce the desired screening behavior by litigation finance companies. Consider a simple example where d, the damages if the plaintiff wins, equals $ 100,000. Let e, each party's expenses if the lawsuit is settled, equal $ 10,000, and e, each party's expenses if trial occurs, equal $ 50,000. Further, suppose that p = 0.25, so this is a case that we hope to screen out, on the simplifying assumption that 0.5 is viewed as the desirable threshold. Note that if the case were sure to go to trial, the expected return (0.25 X $ 100,000) would not be great enough to cover the expenses ($ 50,000), so the litigation finance company would not lend the funds. If a litigation finance company were to offer a line of credit limited to $ 10,000, the defendant will decline settlement, because the plaintiff's best strategy will be to drop the case. If, however, the litigation finance company extends the line of credit to a total of $ 50,000 or more, then the plaintiff has a credible threat to continue the case. The defendant's expected total cost if the case goes to trial is $ 50,000 + (0.25 X $ 100,000) = $ 75,000. Thus, the defendant should be willing to settle for up to $ 75,000. Because the loan is nonrecourse, if the interest rate is the maximum of 1.0, then the plaintiff will turn over the entire $ 100,000 to the litigation finance company if the plaintiff wins, which is the same result that the plaintiff will receive if it loses. Thus, the plaintiff should be willing to settle for any amount over zero. This creates a bargaining range of between $ 0 and $ 75,000. Under simple economic models of settlement, cases settle at the midpoint of the bargaining range, so the settlement will be around $ 37,500. The plaintiff will then pay $ 20,000 of this back to the litigation finance company and keep $ 17,500. Anticipating this result, the litigation finance company will have an incentive to offer the $ 50,000 line of credit. Indeed, at least under these assumptions, this would provide a risk-free 100% return on the $ 10,000 actually taken [*210] from the credit line, so competition among litigation finance companies would drive down the interest rate. To be sure, not all examples will be this drastic, but this demonstrates that an interest rate cap will not necessarily provide adequate incentives for screening claims. It might seem that a remedy would be to prohibit agreements to extend lines of credit, allowing litigation finance only as expenses become due. The company, after all, would have an incentive to withdraw financing if the case above really were destined for trial, because trial is a losing proposition. Anticipating this, the defendant would have no incentive to settle. This might help, but lawyers may be hesitant to work with uncertain financing. 26 Moreover, the incentives for a litigation finance company still might not be optimal. In considering whether to extend financing at any given time, the litigation finance company will take into account all expenses that it has previously lent. 27 If it refuses further financing, those expenses will not be paid back, but they might be if further financing is offered. Although this would not change incentives in the

25

See David Rosenberg & Steven Shavell, A Solution to the Problem of Nuisance Suits: The Option to Have the Court Bar Settlement, 26 Int'l Rev. L. & Econ. 42 (2006) (proposing to allow defendants to bar settlement as a mechanism for discouraging frivolous suits). But see Ted Sichelman, Why Barring Settlement Bars Legitimate Suits: A Reply to Rosenberg and Shavell, 18 Cornell J.L. & Pub. Pol'y 57 (2008) (offering a number of points against Rosenberg and Shavell). 26

One reason for this is that the lawyer may have difficulty withdrawing from the litigation if the financing fails to materialize. See Dean R. Dietrich, Withdrawing When a Client Doesn't Pay, Wis. Law., Sept. 2005, at 20 (noting that a lawyer in this situation may need to obtain a tribunal's permission to withdraw, and that the tribunal may decline such permission). 27

These are not sunk costs, because of the possibility that these loans might still be paid back.

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Page 11 of 23 63 DePaul L. Rev. 195, *210 example above, it might in a real case - especially one in which financing is awarded in small amounts over numerous points in time. We can thus reach some tentative conclusions. First, left entirely unregulated, litigation finance can promote both high-probability and low-probability cases. The net social welfare effects depend on the distribution of cases across the probability spectrum. Because contingency fee lawyers may already take high-probability cases, and because low-probability cases may be more numerous than high-probability cases, the net welfare effects of litigation finance could be negative. Second, if financing were limited to cases that are sure to go to trial, then a simple restriction on the interest rate could prevent financing of low-probability suits. A legal regime that requires a litigation finance company that has not previously lent the plaintiff any funds to provide any needed funding for trial, combined with a legal rule preventing settlement after such financing is provided and a cap on the interest rate equal to the plaintiff's legal expenditures plus ordinary interest, would provide appropriate screening incentives. It may, however, be impractical to introduce an independent company at this stage of litigation and counterproductive to block settlement. [*211] Without this combination of rules, litigation finance companies will sometimes be willing to finance cases in which the expected probability of winning is low, if they expect to be able to settle these cases. III. A Fee Limitation Mechanism for Litigation Finance The challenge remains to devise a mechanism that will encourage litigation finance companies to lend money only for cases that have a high probability of winning if the cases are actually tried. The mechanism must work ex ante even when there is some chance that the case can be settled. No mechanism can be perfect, because what matters is the probability estimate of the litigation finance company, and in a realistic model, the company's estimate of the probability of winning may deviate from the actual probability. But encouraging the lender to screen based on its probability assessment should improve results if the lender's estimates are reasonably accurate. Moreover, if the lender's estimates are noisy, the appropriate response is to lower the target probability threshold rather than to allow all suits. This Part describes a simple mechanism that can achieve these objectives, building on the simple interest rate cap discussed in Part II. The principal extension is to impose the fee limitation for settlements as well, in proportion to the plaintiff's success in the litigation. Thus, if the plaintiff received in settlement only 50% of the damages they would have received if a court had found liability, the fee limitation would be half as great as if the plaintiff prevailed at trial and received those damages, assuming constant legal expenses. There are two key challenges that we must overcome to allow this to work. First, we must provide a mechanism that gives the plaintiff, perhaps along with other parties, incentives to accurately estimate the damages that the plaintiff would receive if successful. Second, we must guard against the danger that before the damages estimate is obtained, the parties will have incentives to reach a collusive nuisance settlement with a low damages estimate. A. Addressing Settlements and Partial Victories Conceptually, adjusting the fee limitation mechanism to address partial victories is simple. Let us suppose that the plaintiff receives, in settlement or at trial, x% of what might be seen as a complete victory for the plaintiff. The maximum fee the lender could charge would be capped at x% of what the cap otherwise would be. Suppose again that the target probability, below which we would like litigation finance companies to refuse to extend loans, is p*. Then, we can set the maximum [*212] repayment multiple m at xe/p*, plus ordinary interest. A lender will be willing to lend e only when E(x)e/p* > e, and thus E(x) > p*, i.e. where the expected value of x is greater than the target probability. This mechanism succeeds at inducing the litigation finance company to lend only if it expects that the recovery proportion exceeds the probability threshold. A case that settles at 25% of damages is a case in which the plaintiff has approximately a 25% chance of winning; this mechanism thus at least crudely optimizes incentives for any given desired probability level. There is, however, a rub. To determine x, we need to have a sense of what would be a complete victory for the plaintiff. If the plaintiff were making the demand without any intervention by the litigation finance company that had lent it financing, then the plaintiff's incentive would be to make an unrealistically high damages request, because the Theresa Coetzee

Page 12 of 23 63 DePaul L. Rev. 195, *212 plaintiff would want to decrease the fee that it must pay. It thus makes more sense to allow the litigation finance company to have some role, for example, by requiring a specific damages request as a condition of the contract. The litigation finance company may well be willing to reduce its allowable fee by allowing the plaintiff to make a high damages request, but this is not a problem, since it suggests that the fee limitation is unnecessary. If, however, the litigation finance company has a role in making the demand, we must worry that the litigation finance company will insist on an unrealistically low damages level to increase x and thus the allowable fee. The litigation system therefore must incorporate additional rules that discipline the plaintiff's demand so that the plaintiff, working with the litigation finance company, will not have incentives to announce an unrealistically low level. It might seem that an appropriate solution would be for the defendant to have the option of settling the case at the demand. The goal, however, is for the plaintiff to announce the damages that it would expect if it prevails on a liability claim, not a fair settlement level. Suppose, for example, that p = 0.25 and d = $ 100. The plaintiff could safely announce a demand somewhat over $ 25, and this would make a settlement for $ 25 appear to be largely a complete victory for the plaintiff. This would mean that the fee limitation would be set too high, and litigation finance companies would have weak incentives to screen claims. A more promising approach might be to cap damages at the announced demand in the event that the plaintiff wins. The plaintiff then would not want to select an unrealistically low demand, because doing so would limit the amount that the plaintiff could receive in the event of a win. While this would have appropriate incentive effects in [*213] generating realistic demands, the consequences of the rule might be unduly harsh. Suppose, for example, that if the plaintiff prevails on liability, there is a 75% chance of $ 100 in damages and a 25% chance of $ 200 in damages. The plaintiff and litigation finance company might simply decide to announce a $ 100 demand to increase the maximum fee that can be paid to the litigation finance company in the event of a reasonable settlement. But if there is no settlement, then this eliminates the plaintiff's chance to receive $ 200 in damages, and the elimination of that chance itself will be reflected in the settlement. Arguably, this is normatively desirable. 28 Just as the goal of inducing screening by litigation finance companies is to block plaintiffs from pursuing cases with a low total probability of winning, so too it might be desirable to block a plaintiff from pursuing specific claims with a low probability of winning. But the normative desirability is less clear. Once a lawsuit is brought, the litigation costs associated with making a marginal request for extra damages are relatively low. Moreover, the chance that the plaintiff receives too much in damages in a particular case may roughly balance the chance that the plaintiff receives too little, at least in terms of deterrence effects on the defendant. This is different from the situation with liability, where, as noted above, the fact that some defendant pays too much in damages cannot balance the fact that some other defendant pays too little. An alternative approach with a less dramatic effect is to give the defendant the option of selecting the plaintiff's demand as the damages that it will pay to the plaintiff in the event that the plaintiff prevails in the liability phase. For example, if the plaintiff announces a damages demand of $ 125, the defendant could not simply settle for that amount, but could exercise an option that would mean that the damages would be set at $ 125 if the plaintiff were to win. The plaintiff and litigation finance company would then have an incentive to set the demand level at a value approximately equal to the expected value of damages contingent on prevailing at the liability phase. With this approach, the demand should reflect the possibility of a high damages award by a jury that has found liability. While this approach gives reasonable incentives, it is not perfect. The plaintiff and litigation finance company still might decide to set the demand at a slightly lower level, recognizing that the defendant will likely exercise its option, to increase the amount of payment. Moreover, if there is asymmetric information between the plaintiff [*214] and litigation finance company on one side, and the defendant on the other, there is a chance that the plaintiff and litigation finance company will simply make a mistake in setting a demand level and the defendant will take advantage of this. This is particularly problematic because the demand must be set at a relatively early stage of

28

See infra Part IV.A.1 (modifying the mechanism developed in this Article if it is deemed desirable to block clients from pursuing low-probability litigation).

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Page 13 of 23 63 DePaul L. Rev. 195, *214 litigation. A partial remedy is to allow the plaintiff and the litigation finance company to lower the demand over time. Still, it might distort litigation outcomes to require the plaintiff to announce a demand that gives the defendant an option to set damages and not to require the defendant to do the same. A more complicated mechanism might allow for symmetric demands. That is, the plaintiff and the defendant would both simultaneously announce damages demands, and either side would have the right to exercise the option to set damages at the level announced by the other side, which would be paid only if the plaintiff prevailed. If an option were exercised, then that value would serve to determine the fee limitation. If both sides simultaneously exercised the option, then the agreed upon damages level would be the average. The defendant will not want to announce too high a damages demand, because otherwise the plaintiff might exercise its option, but the defendant also will not want to announce too low a damages demand, because that might facilitate a litigation finance contract. The contract between the plaintiff and litigation finance company, which might be kept from the defendant, could specify some damages demand level above which the litigation finance company would withdraw its support. Of course, because the plaintiff is seeking financing and the defendant is not, the incentives of the two parties are not precisely identical, and the equilibrium may not exactly equal the average of the two parties' damages expectations, but this approach should at least give a crude estimate of the actual expected damages, and thus of x in the event of a settlement. This approach, which finds inspiration in Saul Levmore's idea of self-assessment mechanisms that give parties incentives to announce honest valuations of property rights, 29 is not the only possible approach for estimating x. A much more conventional approach would require a court to estimate x. If one party voluntarily made an offer to set liquidated damages at a particular value, that might then be evidence the court could consider. Note that in any such litigation, the adversarial parties would need to be the plaintiff and the litigation finance company. The plaintiff's incentive would be to show that the [*215] settlement reflected a low x, while the litigation finance company would want to show that the settlement reflected a high x. This makes, of course, for an awkward litigation, as the plaintiff's incentive essentially would be to show that its case was weak. For that reason, using a conventional adversary adjudicative proceeding to estimate x might be undesirable. A separate approach, also a form of self-assessment, would require separate settlements to determine p and d. For example, the plaintiff and defendant might first settle by agreeing that the plaintiff had a 30% chance of winning a liability finding, and then later settle by agreeing that the expected damages would be $ 100. In that case, a $ 30 settlement payment would be due. If the parties settled on p but not d, a damages proceeding would be held, with the fact-finder instructed to determine damages on the assumption that liability was appropriate; if the parties settled on d but not p, only the liability portion of a trial would be necessary. Whenever there was a settlement at p, then x would be set to p for the purpose of determining the fee limitation and the maximum payment to the lender. The concern about this approach is that the parties might cooperate to produce unrealistic results. If the litigation finance company has no role, then the plaintiff and defendant would collude to announce a low p and a high d. If the litigation finance company is involved in settlement negotiations, then the parties might collude to announce a high p and a low d. This might be countered by requiring the settlements to be entered into at different times, perhaps at least some days apart. That would allow a party that received a favorable deal on the first part of the settlement not to go through on the second part. Nonetheless, there is a danger of implicit collusion, particularly if the parties (or their lawyers) are repeat players, and wish to establish a reputation for meeting their implicit commitments. As a result, this approach may not be entirely successful. B. Fee Limitation with Fee-Shifting The possibility of collusion illustrates a further potential vulnerability of the mechanism described above. For example, suppose that a litigation finance company is considering funding a potential plaintiff. Before filing a complaint, the litigation finance company and plaintiff might initiate negotiations with a defendant. If they can reach an agreement promptly, then they can agree to an unrealistically low d and thus allow a high x and a

29

See generally Saul Levmore, Self-Assessed Valuation Systems for Tort and Other Law, 68 Va. L. Rev. 771 (1982).

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Page 14 of 23 63 DePaul L. Rev. 195, *215 relatively high fee limitation. The defendant, of course, might not cooperate, recognizing that if it refused to cooperate then the plaintiff would choose a higher damages demand [*216] level, and if the litigation finance company still funded the plaintiff, it would receive only a minimal payment even if the defendant agreed to a nuisance settlement. But the litigation finance company might establish a reputation for bringing claims that have a low probability of success and pursuing them to trial, in the hope that it can convince potential defendants that it has a credible threat of bringing a case and that it is thus in their interest to cooperate with pre-settlement negotiations. Indeed, simply by entering into a finance contract with a plaintiff, the litigation finance company may credibly show that it intends to follow through on a lawsuit that would be unprofitable with a realistic, higher damages demand, and so it may be in the defendant's interest to cooperate. It is not clear how great a danger such collusion would be. A possible remedy would be to require the damages demand to be entered into at the time of the litigation finance contract, and to not allow that number to be lowered over time. Even then, the litigation finance company might enter into informal negotiations, holding off on agreeing to a formal contract with the plaintiff. To generate nuisance settlements in such cases, the litigation finance company would need to follow through on money-losing litigation to establish a reputation as sufficiently aggressive. As a result, it may be desirable to bolster the mechanism with an additional component that would discourage such manipulation by litigation finance companies and cooperation by potential defendants who would prefer a nuisance settlement to protracted litigation. If this problem is indeed sufficiently serious, then adding a fee-shifting requirement to the fee limitation might be an effective strategy. The fee-shifting requirement would be simple, if unconventional. The litigation finance company would be required by law to promise to pay the defendant's reasonable legal expenses if the defendant prevails at trial. Measuring reasonableness of legal expenses is not a trivial task, but it is one with which the courts have familiarity, 30 and while further improvement of the courts' approaches might be achieved, that is beyond the scope of this Article. What is novel about this approach, of course, is that it is the litigation finance company, rather than the plaintiff, that is obliged to pay the defendant's reasonable legal expenses. This is equivalent to requiring the plaintiff to pay the defendant's reasonable litigation expenses, a conventional one-way fee-shifting mechanism, and requiring the litigation finance company [*217] to finance this aspect of the plaintiff's expenses if it finances other expenses. The litigation finance company should be required to post a bond demonstrating proof of an ability to pay the defendant's expenses. This fee-shifting requirement in turn would have implications for the fee limitation. Assuming that the target probability threshold is 0.5 and that the plaintiff prevails in litigation, the lender could receive back what it lent in legal expenses to the plaintiff, plus the same amount again (the plaintiff's reasonable legal expenses), plus the defendant's reasonable legal expenses, plus ordinary (nonusurious) interest. 31 This fee limitation is equivalent to the interest rate cap described above, except that it is somewhat looser in that it also allows the plaintiff to pay back to the litigation finance company an additional amount equivalent to the defendant's reasonable legal expenses. Taken in isolation, the fee limitation is thus more lenient and should encourage less claim screening by litigation finance companies. But in combination with the fee-shifting requirement, this approach should produce appropriate incentives to screen out cases below the target probability threshold.

30

In the process of doing so, the courts at times assess even the ex ante probability that the plaintiff had of winning a lawsuit. See, e.g., Lindy Bros. Builders v. Am. Radiator & Standard Sanitary Corp., 487 F.2d 161, 167-68 (3d Cir. 1973). 31

Currently, litigation finance arrangements generally set forth the total amount that the litigation finance company can receive by specifying a percentage rate on an annual or monthly basis. This has led to findings that these rates are usurious. See Grous, supra note 3, at 219-20. The approaches described here would seek to separate out the portions of the finance company's compensation, beyond return of principal, into the amount due because of the risk that the lawsuit might fail and the amount due because of the time value of money. The purpose of barring usurious rates (or, more strongly, insisting on market rates) is to prevent litigation finance companies from evading the limitation on the amount that they can receive as compensation for risk. Even separate from that, this approach may help strengthen plaintiffs' bargaining position. A high annual interest rate may force a plaintiff to take a below-market settlement.

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Page 15 of 23 63 DePaul L. Rev. 195, *217 We must again adjust for partial victories, however. With a partial victory, the fee-shifting requirement would be that the lender pay (1 - x)e to the defendant, where e represents the defendant's litigation expenses and x represents the proportion of the damages demand that the plaintiff receives. The fee limitation - the maximum amount that could be repaid to the litigation finance company - would equal x(e + ((1 - p*)/p*)(e + e)), where e represents the plaintiff's litigation expenses, plus ordinary interest. The intuition behind this formula can be viewed by replacing p* and x with E(x) in the above formula, to examine the target marginal case for the litigation finance company. The target marginal case is the case for which the expected value of x equals p*, that is, E(x) = p*. The formula for the maximum fee then reduces to e + (1 - E(x))e, the amount that the litigation finance company should expect to pay to litigate the dispute, including both [*218] the plaintiff's expenditures and fee-shifting. This shows that in the target marginal case for the litigation finance company, the expected upside benefit is exactly equal to the expected downside risk. Thus, the target marginal case would in fact be the case in which the litigation finance company would be indifferent about providing financing. This approach addresses concerns about collusion in two ways. First, it increases the cost to the litigation finance company of aggressive behavior. If the litigation finance company brings some low-probability cases in the hope of getting a reputation for pursuing low-probability suits and thus gaining the cooperation of defendants in other cases, then it will have to pay far more dearly in the low-probability cases. The lower the probability that the plaintiff prevails, the more it will expect to pay. Second, the approach should decrease the defendant's willingness to enter into a nuisance settlement. A defendant that anticipates that its fees will likely be reimbursed has little to fear from litigation. A litigation finance company should thus not be able to bully such a defendant into a nuisance settlement with a collusively set damages demand. This is not, of course, proof that it will never be in a litigation finance company's interest to pursue a case below the target probability threshold in hope of obtaining a reputational benefit sufficiently large to offset the expected loss from bringing the case. That may sometimes still occur, and defendants may sometimes agree to a collusive settlement that allows a relatively high fee in other cases. Rather, the point is that fee-shifting means that a company pursuing such a strategy will expect to lose money in a higher percentage of cases because of defendants' incentives to resist nuisance settlements, thus losing more money than they otherwise would. At some level of fee-shifting, the costs of seeking to build reputational capital by bringing low-probability cases would exceed the benefits. It is possible to vary the fee-shifting regime as long as appropriate changes are made to the fee limitation formula. For example, it might be possible to have a partial fee-shifting regime, in which the litigation finance company would pay at most half the defendant's legal costs. In that case, the fee limitation formula would substitute 0.5e for e. On the other hand, it would also be possible to have a regime in which the lender would pay twice (or some other multiple) the defendant's legal costs. As long as a corresponding change in the fee limitation formula is made, the within-case incentives for the litigation finance company will continue to be to screen out cases where the plaintiff's expected probability of winning is below p*. The necessary level of feeshifting depends on an appraisal of [*219] the risk that the parties will evade the fee limitation rule for settlement by implicitly colluding as to the damages demand - that is, the risk that the across-cases reputational incentives of the litigation finance company will overwhelm the within-case incentives. An additional possible variation is to require two-sided fee-shifting, so that the defendant must pay money to the lender if, or to the extent that, the plaintiff prevails in the litigation. To ensure that the litigation finance company would still have the appropriate incentives in screening cases, the gross payment by the defendant (without counting any offset from the payment by the litigation finance company to the defendant) would count as part of the fee subject to limitation. Two-sided fee-shifting has the advantage of being a more familiar mechanism, akin to a loser-pays law, but applying to cases that are settled as well. Moreover, the symmetry of two-sided fee-shifting ensures that the finance scheme is not systematically biased against one side or the other. A fee-shifting provision applying only to the litigation finance company would provide a systematic bias in favor of plaintiffs and would affect the value at which cases would settle. Thus, although requiring fee-shifting by the defendant as well as the litigation finance company is not essential to ensuring that the litigation finance company has appropriate incentives to screen out low-probability cases, it may help improve the extent to which settlements reflect the probability that the plaintiff would win the litigation. While the goal of fee limitation is to screen out cases with a

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Page 16 of 23 63 DePaul L. Rev. 195, *219 sufficiently low probability, there is no reason to adopt a system that would penalize plaintiffs who have a sufficiently high chance of winning. An additional benefit of symmetrical fee-shifting is that it may improve the defendant's incentive to make a reasonable damages demand, if that aspect of the mechanism is symmetric as well. Recall that with the plaintiff and the defendant both making damages demands, the average of the two demands would serve as the basis for measuring the extent of partial victories. A defendant making a damages demand would not want to announce too high a level, because the plaintiff would then exercise the option to set any damages at that level, or too low a level, because the defendant would then expect to have to pay more in fee-shifting. To be sure, this approach may not achieve perfect symmetry; the litigation finance company and the plaintiff acting in concert may have an incentive separate from concerns about fee-shifting to announce a damages demand that is relatively favorable to the defendant, specifically that allows for a more relaxed fee limitation. A greater level of symmetry could be achieved [*220] only by requiring the defendant to finance the litigation through a litigation finance company. Of course, it is possible that both parties will prefer not to have a fee-shifting mechanism or a fee limitation at all. The parties should be able, by mutual agreement, to opt out of this arrangement. This seems plausible, for example, on a relatively close case, where fee-shifting increases the risk inherent in litigation for both sides and where the defendant may recognize that the plaintiff is likely to be able to obtain financing even if the mechanism is in place. Opting out might be limited to before, or perhaps within, a short period of time after the complaint is filed, to reduce the chance of mutual evasion of the fee limitation approach. However, the addition of a fee-shifting component to the fee limitation reduces the risk of collusive settlements considerably, whether before or after the filing of the complaint, so this change may not be essential. IV. Extensions and Evaluation A. Extensions 1. Disputes over Damages There is less need to encourage claim screening when the defendant concedes liability or the legal system has produced a finding of liability and only the question of damages remains. At such a point, it has already been determined that the plaintiff has a valid claim. The only question is whether the plaintiff or the defendant is stubbornly refusing a settlement. A party might, for example, have an incentive to refuse a reasonable settlement if litigation costs are asymmetric. In general, because the plaintiff must prove damages, it seems more likely that the plaintiff will bear a greater burden of establishing damages, and thus there should be less need for encouraging screening by litigation finance companies. It is possible, however, to imagine scenarios in which screening might be beneficial. Suppose, for example, the vast majority of courts would conclude that a defendant owes a plaintiff only a nominal amount of damages, but the plaintiff pursues litigation in the hope of a long-shot large damages award. This is structurally similar to the situation in which a plaintiff brings a low-probability case. If such cases are of concern, the mechanism, with the addition of bidirectional fee-shifting, can be extended easily to cover disputes in which the question is not of liability, but of damages. Both the plaintiff and the defendant would make a damages demand. As before, the other side would have an option to choose the offered damages level, [*221] though because liability has been established or agreed to, this would now immediately resolve the case. If each side simultaneously accepted the other's damages demand, then the average between the two demands would be selected. The principal difference is that the measurement of the extent of a plaintiff's partial victory would be based on the location of the settlement figure relative to the two damages demands, rather than on the total percentage of damages received. For example, a settlement halfway between these damages demands would count as a 0.5 success level, and that would affect the fee limitation and the settlement. The use of a fee-shifting mechanism provides each side an incentive not to make an unrealistic damages demand. The success level would be constrained to be between 0 and 1, even if the plaintiff received more than its damages demand or the defendant paid less than its damages demand. 2. Injunctive Relief

Theresa Coetzee

Page 17 of 23 63 DePaul L. Rev. 195, *221 The possibility of injunctive relief complicates the applicability of the mechanism described here because it makes it more difficult to determine the plaintiff's degree of success, as summarized in the variable x in the formulas above. It is important, however, not to exclude cases in which injunctive relief is sought along with money damages, because doing so would allow plaintiffs and litigation finance companies to easily evade the fee limitation rule. It may be more feasible to exclude cases seeking only an injunction, but for these cases too there is a danger that plaintiffs will bring claims with only a small chance of prevailing in the hope that they can achieve a cash settlement. An alternative approach would require that the plaintiff value the injunctive relief requested. Ideally, the plaintiff should also value hypothetical partial grants of injunctive relief. There are two dangers with this approach. First, the plaintiff, in concert with the litigation finance company, might undervalue an injunction that is unlikely to be granted to reduce the applicable fee-shifting and to increase the measurement of the plaintiff's apparent success, thus relaxing the fee limitation. Second, the plaintiff might overvalue an injunction that is likely to be granted. This too would make the plaintiff appear to perform more successfully than the plaintiff in fact has performed, again reducing fee-shifting and relaxing the fee limitation. The defendant thus must be given two options to discipline the plaintiff's valuation of injunctive relief. First, the defendant would have an option to buy out any injunctive relief granted at the price specified by the plaintiff. For example, if the plaintiff indicated that injunctive relief would be worth $ 100 to it, and the plaintiff won the [*222] injunctive relief, the defendant could elect to pay $ 100 instead. Second, if the court refused injunctive relief, the defendant would have an option to give the plaintiff the relief it sought for the value specified. In the same example, if the plaintiff lost, the defendant could opt for the plaintiff to pay $ 100 for such relief. This approach is admittedly not perfect, given the likelihood that the plaintiff has limited funds, though presumably the defendant could enforce such a contract against any funds later acquired by the plaintiff. Once again, this mechanism could be made symmetric. The defendant could indicate its cost of injunctive relief requested, and it would have similar incentives to undervalue or overvalue this cost. The plaintiff would then be allowed to exercise an option to pay the specified amount to the defendant for the relief in the case that the plaintiff lost, or in the case that the plaintiff won, to take the amount indicated by the defendant in lieu of the injunctive relief. The average value of the plaintiff's and defendant's valuations would be used to measure the overall success of the plaintiff in the litigation. 3. Financing in Installments So far, we have assumed that the decision to extend a loan is made entirely at one time. This is one possible arrangement. A litigation finance company might, for example, extend a credit line of up to $ 1,000,000. If the plaintiff then uses only $ 100,000, then the additional $ 900,000 would be irrelevant for purposes of calculating the fee limitation. But this is not necessarily ideal. It may be beneficial for lenders to monitor lawsuits as they proceed to determine whether to give increased financing. Moreover, it might make sense to increase the target probability threshold from a low value to a somewhat higher one once more information is obtained. It may be socially worthwhile for plaintiffs to bring cases that have only a small chance of producing beneficial information for the plaintiffs in discovery, as the cases can then proceed to trial once discovery is complete if the probability of success at trial seems sufficiently high. Extending loans and performing screening at multiple points in time complicates the ideal rule for second and subsequent payments. The litigation finance company will recognize that if it does not provide more money, the case will end, thus depriving it of the chance of receiving a fee. In addition, under the fee-shifting rules, the lender must pay for litigation expenses that the defendant has already incurred. The company should thus be willing to lend with a lower probability of winning than it would otherwise insist upon. The simplest solution is to require the plaintiff to obtain subsequent financing from an independent [*223] company. This, however, has the obvious disadvantage of requiring another company to become familiar with the evidence in the case. An alternative is to adjust the rules on the fee limitation appropriately. The adjustment is relatively straightforward. Using a subscript 0 to refer to expenses already incurred and 1 to refer to expenses incurred after the second funding decision, the fee limitation would now be x(e + ((1 - p*)/p*)(e + e)) - e. There are three Theresa Coetzee

Page 18 of 23 63 DePaul L. Rev. 195, *223 adjustments to the formula. First, the first expenses term, which reflects return of principal, now allows recovery only of the second installment. Second, the second expenses term similarly allows fees to be recovered based on the plaintiff's expenses and the defendant's expenses, which would need to be paid with fee-shifting, after the second installment. And third, the maximum fee is reduced by the defendant's expenses to date, since this is the amount of fee-shifting that would be due if the case ended immediately. If the litigation has proceeded far enough, this is a significantly stricter fee limitation. Ideally, a litigation finance company would like to finance the litigation in small pieces so that it can pull back if the probability of victory falls too low, much as a venture capitalist will tend to give financing only in rounds. But with this fee limitation, there will be an incentive for a litigation finance company to finance the litigation only in relatively large chunks, or perhaps with a relatively small initial payment at an early phase and a large payment at a later phase. On the other hand, if the target probability threshold rises over time, that increase can compensate for the stricter fee limitation. A relatively simple approach then is for a relatively low p* for an initial investigative phase followed by a significantly higher p*, perhaps even close to 0.5, if the litigation finance company and plaintiff wish to pursue the litigation. 4. Diluted Mechanism Some plaintiffs may need only partial financing from a litigation finance company. If this is the case, the approach can be adapted simply by multiplying the fee-shifting and fee limitation amounts by the fraction of the plaintiff's total fees paid by the lender. That is, the fee-shifting and fee limitation initially would be measured in terms of the total legal fees paid by the plaintiff, but would then be adjusted based on the proportion of those fees that are paid by the litigation finance company. Note that if a plaintiff uses a contingency fee lawyer, the plaintiff's total fees would equal the contingency fee plus any additional fees paid to the contingency fee lawyer as loaned by the litigation [*224] finance company. With this approach, contingency fees and litigation finance could be used in concert. B. Evaluation 1. Settlement Incentives So far, this Article has taken a simple fee limitation designed to encourage litigation finance companies to screen out low-probability claims and made it more robust. We have seen that a basic fee limitation rule can be adjusted so that litigation finance companies can target any specified probability. More importantly, we can give the plaintiff incentives to give an honest valuation of the damages they would receive if successful on the issue of liability, so that we can measure the extent of partial victories and restrict fees accordingly. Adding a fee-shifting component makes this approach less vulnerable to collusive manipulation. Further refinements have made the mechanism applicable in situations such as when the plaintiff has sought injunctive relief, when the only issue is of damages, or when financing is provided in stages. With these refinements, the mechanism should enable a jurisdiction allowing limited litigation financing to enact rules that will make it generally disadvantageous for finance companies to lend money when they believe that the probability the plaintiff will win is below a certain threshold percentage. At least as to the cases that are screened out, the mechanism is likely to improve the accuracy of the judicial system, by ensuring that the defendant pays no damages in cases in which at least a threshold percentage of judges would conclude that no damages are appropriate. There will inevitably be false negatives - cases that plaintiffs will not be able to bring that in reality a majority of judges would support - but the mechanism should do more to prevent false positives than to create false negatives. If false negatives were deemed a more pressing concern, the probability threshold and thus the fee limitation could be adjusted to make false negatives less commonplace. A remaining question, however, is how the legal system will perform in cases that are not screened out - that is, those that receive financing. A particular concern is whether the mechanism might have adverse effects on settlement. In the past, critics of litigation finance have argued that litigation finance might provide perverse

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Page 19 of 23 63 DePaul L. Rev. 195, *224 incentives not to settle a case. 32 In one case, a tort plaintiff refused what her [*225] lawyer, who did not know that she had received financing from a litigation finance company, thought was a reasonable settlement offer. 33 It later turned out that the interest rate on the loan that she had received was so high that if she had accepted the settlement offer, she would have had to return the entire amount of the settlement over to the litigation finance company. 34 The concern is that with excessive interest rates, plaintiffs may have perverse incentives to refuse reasonable settlements. A preliminary response to this concern is that it ignores the possibility that the plaintiff and litigation finance company could renegotiate their contract in favor of a lower fee. Given that the litigation finance company will already be relatively familiar with the case, the marginal cost to the company of being informed about developments since it initially lent money should be relatively low. If a settlement offer is indeed optimal from the perspective of the litigation finance company and the plaintiff - that is, it is greater than the expected value of a trial outcome, taking into account legal costs - then the plaintiff and the litigation finance company have a strong collective incentive to take the offer. As long as bargaining costs are sufficiently low, then the Coase Theorem suggests that they will renegotiate if renegotiation is necessary to make the deal attractive for both parties. Of course, renegotiation may fail on occasion, and it might be useful to require litigation finance companies to inform plaintiffs of the possibility of renegotiation, but bargaining costs should be sufficiently low that litigation finance companies will have an adequate incentive to lower fees where necessary. Even if renegotiation were impossible, a fee limitation provision should reduce the danger that a litigation finance arrangement will discourage the plaintiff from agreeing to a settlement. A key aspect of the basic fee limitation provision developed here is that the maximum fee is tied to legal expenses actually incurred, not to the total credit line offered to the plaintiff. If, for example, a litigation finance company agrees to give the plaintiff up to $ 1,000,000, but the plaintiff ends up spending only $ 10,000 at the time a settlement is offered, then the [*226] fee limitation will be based on the $ 10,000 figure, not the $ 1,000,000 figure. (A corollary is that litigation finance is intended solely as a vehicle for paying litigation expenses, not personal expenses.) If this were not so, the fee limitation would fail to provide the appropriate case-screening incentives, as litigation finance companies could increase their effective fees simply by offering larger credit lines. 35 This approach greatly reduces the chance that a need to repay the entirety of a loan to enjoy any recovery will lead a plaintiff to turn down a settlement. Also reducing the risk is the fact that if the plaintiff accepts a low settlement relative to the damages demand, the fee limitation will be stricter and the plaintiff will not have to pay as much money. To be sure, this does not eliminate the possibility that there might be situations in which the plaintiff has an incentive to turn down a fair settlement. If, for example, the plaintiff has spent $ 100,000 in legal fees and the defendant offers $ 200,000, but the maximum repayment multiple is 2.0 or less, then the plaintiff will have an incentive to turn down the settlement if it cannot renegotiate the fee. Between the possibility of fee renegotiation and the fee limitation approach adopted, however, the danger of reduced settlements seems minimal. Plaintiffs who receive funding from litigation finance companies should generally be more willing to settle a case than self-financing plaintiffs. A self-financing plaintiff will compare a settlement to the amount that the plaintiff expects to receive at trial or at a later phase in the litigation, minus the additional legal fees incurred. A plaintiff

32

See, e.g., Rodak, supra note 1, at 522 ("Litigation finance is regarded by many as an obstacle to settlement. A rational plaintiff will not settle for any amount offered by the defendant that is less than the aggregate of the principal amount advanced to her and the current interest accrued … ."). Rodak notes, however, that "the interest on the advance, which accrues while the case is pending, creates an added incentive for the plaintiff to settle (and to do so as soon as possible)." Id. at 522-23. 33

Rancman v. Interim Settlement Funding Corp., No. 20523, 2001 WL 1339487 (Ohio Ct. App. Oct. 31, 2001), aff'd, 789 N.E.2d 217 (Ohio 2003). For an excellent discussion of the case, see Susan Lorde Martin, The Litigation Financing Industry: The Wild West of Finance Should Be Tamed Not Outlawed, 10 Fordham J. Corp. & Fin. L. 55, 59-62 (2004). 34

Martin, supra note 33, at 61-62.

35

See Part II.C.

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Page 20 of 23 63 DePaul L. Rev. 195, *226 whose fees are being paid through litigation finance, however, must take into account not just the expense of litigation - i.e., the amount that will be paid to the plaintiff's lawyer - but also the additional amount that must be paid to the litigation finance company if the plaintiff prevails. Suppose, for example, that a plaintiff receives an offer of $ 100,000 shortly before trial, and the expense of trial is $ 25,000. For a risk-neutral self-financing plaintiff, this offer would be preferable to trial as long as the expected damages at trial are less than $ 125,000. For a risk-neutral plaintiff who must pay the litigation finance company twice the amount of legal expenses (given the maximum fee with a target probability threshold of 0.5), however, this offer will be preferable as long as expected damages at trial are less than $ 150,000. In this case, a self-financing plaintiff will be more likely to accept a settlement offer than a plaintiff who receives funding from a litigation finance company. The defendant, if it knows that the plaintiff has [*227] received funding from a litigation finance company, will accordingly be somewhat less generous than it otherwise would be. But litigation finance should increase the probability of reaching a settlement by increasing the parties' bargaining range. There is one final consideration that could make cases in which a plaintiff has received litigation financing easier to settle. The litigation finance company is an independent third party that has an incentive to screen out relatively low-probability claims with the mechanism proposed above. A defendant who knows that the plaintiff has received litigation finance will then recognize that the third party believes that the plaintiff's chance of winning a finding of liability exceeds a given threshold. The defendant might not agree, of course, especially if the defendant has access to information that is unavailable to the plaintiff. But a rational defendant should adjust its estimate of the probability that the plaintiff will win at least marginally in favor of the plaintiff. Meanwhile, the fee agreement that the plaintiff receives provides a market-based assessment of the probability that the plaintiff will prevail, especially if the plaintiff attempted to obtain financing from competing companies. That is, if the fee limitation agreed upon is lower than the maximum permissible fee, then the litigation finance company has made a concession to win the plaintiff's business. By inverting the formula for the fee limitation, one can determine the minimum success probability that the finance company attributes to the plaintiff's case. Meanwhile, the fact that other companies may have refused better deals suggests that no other company believed that the plaintiff had a higher success probability. These facts should give the plaintiff better information about how an independent third party would assess the strength of its case, and if it chooses to share this information with the defendant, then the defendant should have better information as well. In short, independent assessments of the strength of the plaintiff's case may help provide useful information to both parties and perhaps even a focal point for settlement negotiations. This is important because cases are most likely to go to trial rather than settle when the parties are mutually optimistic about their probability of success in litigation. 36 For example, the plaintiff might overestimate its chance of prevailing, and the defendant might underestimate the strength of the plaintiff's case. Only in these circumstances will it make sense for each party to refuse settlement offers from the other, despite the fact [*228] that the expense of trial is likely to hurt both parties. Providing some shared information, such as third parties' independent assessments of the probability that the plaintiff will succeed, should considerably reduce the probability of such mutual optimism. Cases may fail to settle for other reasons, such as strategic bargaining that leads one or both parties to bluff about the strength of their case, but improving information may also make such bluffing more difficult, and once again improve the chance of settlement. There is at least one important caveat, however. If a fee-shifting mechanism is included, as suggested above, it may reduce the probability of settlement. The reason is that fee-shifting exacerbates mutual optimism. If each side believes that the other is likely to end up paying its expenses, then the prospect of trial does not seem so bad. The literature on the economics of litigation has long noted this effect, 37 while also noting that the prospect of fee-

36

See, e.g., Robert H. Gertner & Geoffrey P. Miller, Settlement Escrows, 24 J. Legal Stud. 87, 95 (1995); Evan Osborne, Who Should Be Worried About Asymmetric Information in Litigation?, 19 Int'l Rev. L. & Econ. 399, 400 (1999). 37

See, e.g., Robert Cooter & Thomas Ulen, Law and Economics 486 (1988); Robert Cooter & Stephen Marks with Robert Mnookin, Bargaining in the Shadow of the Law: A Testable Model of Strategic Behavior, 11 J. Legal Stud. 225, 244-46 (1982).

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Page 21 of 23 63 DePaul L. Rev. 195, *228 shifting may discourage frivolous suits and frivolous defenses. Because the defendant pays fee-shifting revenue to the litigation finance company, and because any fee-shifting in the other direction is paid by the litigation finance company, the effect should only be half as severe here as with the classic loser-pays rule. Any fee-shifting may make optimistic defendants less willing to settle, but bidirectional fee-shifting should generally make defendants with weak cases more willing to settle, and there will be no direct effect on plaintiffs' incentives. 2. Litigation Finance Fee Limitations as Tort Reform Fee-shifting proposals have the same principal goal as the mechanism developed here: to discourage frivolous litigation, or more specifically, to discourage cases that are filed or pursued even though one side has only a small chance of prevailing in the litigation. How does the fee limitation approach compare to this and other methods of discouraging litigants from bringing low-probability suits and maintaining low-probability defenses? An initial problem with this question is that the mechanism described here applies only to a relatively small percentage of cases, those in which the plaintiff cannot fund its own case and must seek outside financing. In theory, however, the mechanism described here could be mandated for all plaintiffs, at least for a portion of their financing. Indeed, with minimal adjustments, it could be mandated for all defendants as well. We have already seen that both plaintiffs and defendants may [*229] make damages demands to determine the degree to which the plaintiff has succeeded in a case. If we know how well the plaintiff has performed, then we also know how well the defendant has performed. If each side were required to obtain at least 10% of its financing from a finance company subject to the mechanism developed in this Article, then each side would have to convince a finance company that it had a relatively strong probability of winning. The mechanism described here would then be a symmetrical approach for screening out cases at both ends of the probability spectrum - those in which the plaintiff's chance of winning is so small that the lawsuit should not be brought, and those in which it is so great that the defendant ought to concede liability and contest only damages. If each side's target probability threshold were 0.5, then the mechanism would eliminate the vast majority of disputes about liability from the courts, essentially replacing the courts' role in determining liability with a market-based system operating in the shadow of the law for the vast majority of cases. But even more lenient thresholds, perhaps at 0.25 and 0.75, might have a significant effect on the volume of litigation. Consideration of this approach is relevant for two reasons. First, it effectively frames the question of how effective the fee limitation is at discouraging frivolous litigation. Second, if mandatory litigation finance for a portion of each side's expenses were in fact an effective mechanism, it might not be implausible that it could be tested in some jurisdiction. The tort reform movement has been based on the premise that there are excessive incentives for parties to engage in litigation, but critics of tort reform have pointed out legitimate weaknesses of proposed reforms. If mandatory litigation finance were superior to alternative mechanisms, then perhaps the tort reform movement should advocate it. Mandatory litigation finance is unlikely to emerge from whole cloth. But it seems plausible that the fee limitation mechanism above could be implemented in cases in which plaintiffs seek litigation finance, an already controversial practice, and that experiment could someday prompt expansion of the mechanism. There are many alternative approaches to discouraging low-probability claims, but for our limited purposes, we will focus on three leading approaches. The first, as noted above, is a fee-shifting mechanism. We have already shown that in some cases, a fee-shifting mechanism can increase the likelihood that parties will elect to go to trial. 38 This is symptomatic of a broader problem with most fee-shifting [*230] mechanisms. Because the fee-shifting depends on whether the plaintiff wins or loses in litigation, a penalty will be imposed both in cases near the end of the probability spectrum and sometimes in cases near the middle of the probability spectrum, when in fact sanctions against frivolous litigation should apply only in the former cases. It is cases near the middle of the probability spectrum, for example, where it is most likely that each party will conclude that it would benefit from fee-shifting. And when a case is near the middle of the probability spectrum, the losing party, despite having had a legitimate

38

See supra note 37 and accompanying text.

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Page 22 of 23 63 DePaul L. Rev. 195, *230 case, not only loses the case entirely, but also must pay damages. 39 This is not an issue with the fee limitation mechanism, which, depending on the probability threshold, can screen out only cases near the ends of the probability spectrum. A second mechanism for weeding out low-probability claims is to impose penalties when a judge determines that a party has advanced a frivolous position in the litigation as a whole or on a particular motion. This is the approach taken by Rule 11 of the Federal Rules of Civil Procedure. 40 This might seem to have greater potential for policing the ends of the probability spectrum, and the approach could be used to discourage financing of low-probability lawsuits, as long as a litigation finance company were obliged to pay any sanctions imposed. In practice, however, fines for frivolous claims are exceedingly rare, 41 perhaps in part because Rule 11 is seen as a mechanism for imposing punishment. Perhaps judges could be encouraged to impose sanctions for a larger number of claims, but they may have little incentive to do so. Moreover, unbridled judicial discretion could lead to abuses, 42 while intensive judicial review of sanctions could be expensive. The fee limitation described here attempts to serve a similar function, but it does not require the exercise of judicial discretion or a debate on whether a case or motion was frivolous. [*231] A third approach is to impose damages caps. 43 This approach has been recommended and implemented

most commonly for malpractice actions. 44 The analysis in this Article provides some indirect support for this approach. Perhaps there is a small chance that a rogue jury will impose a much larger damages award than other juries, 45 and a plaintiff may be able to extract a settlement that takes into account some fraction of this excess amount that the vast majority of courts would reject. If large damages awards are the result of idiosyncratic decision makers rather than idiosyncratic cases in which large damages awards are merited, then this approach may make sense. But it does cap damages even for those rare cases in which a majority of courts would impose larger damages, and it thus represents, at best, a crude attempt to control aberrant decision makers. The fee limitation approach here is better tailored to the specific claim or claims at issue in a particular case. To be sure, the fee limitation mechanism described here has its own weaknesses as a mechanism for screening out low-probability cases and defenses. First, it takes real resources for a litigation finance company to evaluate a case, and these resources will come out of the relevant litigant's pocket. Sometimes, parties might opt out. They would have incentives to do so in middle-of-the-probability-spectrum cases where it is clear that both parties will be able to obtain financing in any event, but in other cases, the third-party screening will be at least somewhat expensive. The cost might be greater in some cases than in others, specifically those that involve more unusual factual or legal issues. The question is whether the cost of this screening is worth the benefit of screening out some

39

A possible remedy is a fee-shifting regime that would take into account not only which party wins, but also the margin of victory. See Lucian Arye Bebchuk & Howard F. Chang, An Analysis of Fee Shifting Based on the Margin of Victory: On Frivolous Suits, Meritorious Suits, and the Role of Rule 11, 25 J. Legal Stud. 371 (1996).

40

See generally Yablon, supra note 17 (providing a critical overview of the effectiveness of Rule 11 against frivolous litigation).

41

A typical expression of judicial attends is "the Court does not take the imposition of sanctions lightly, and very rarely assesses them." Stanley v. Univ. of Tex. Med. Branch, 296 F. Supp. 2d 736, 740 (S.D. Tex. 2003). 42

See Sam D. Johnson et al., The Proposed Amendments to Rule 11: Urgent Problems and Suggested Solutions, 43 Baylor L. Rev. 647, 649 (1991) (noting the danger that courts can use Rule 11 to "coerce and intimidate litigants and their attorneys").

43

Cf., e.g., 42 U.S.C. § 1981a(b)(3) (2012) (imposing damages caps in certain civil rights cases, based on the size of the defendant firm). 44

For a critical analysis of the use of damages caps for malpractice cases, see Kathryn Zeiler, Turning from Damage Caps to Information Disclosure: An Alternative to Tort Reform, 5 Yale J. Health Pol'y L. & Ethics 385 (2005).

45

Some unexpectedly large damages verdicts are reversed on appeal. See, e.g., Liggett Grp. Inc. v. Engle, 853 So. 2d 434 (Fla. Dist. Ct. App. 2003).

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Page 23 of 23 63 DePaul L. Rev. 195, *231 cases on the ends of the probability spectrum. Experimentation with the fee limitation mechanism for cases in which the plaintiff would be seeking financing anyway, and thus in which these costs are inevitable, could help provide some indication of what those costs might be. Second, the market-based system by which litigation finance companies evaluate the merits of litigation may not be as accurate as the litigation system itself. Litigation finance companies may not have access to all the information that a court would have access to at the end of a case, and they might not have incentives to engage in much more [*232] than a cursory analysis of the relevant issues, especially if only providing limited financing. On the other hand, different judges may reach different decisions, perhaps because they have different ideological views about the appropriate resolution of a case, and litigation finance companies have financial incentives in assessing probabilities to average what different courts would decide. In any event, there are likely to be relatively few mistakes (for example, cases screened out where a majority of courts would find liability), especially if the fee limitation mechanism is used only to screen out cases relatively near the ends of the probability spectrum. Once again, experimentation with a fee limitation mechanism for cases in which plaintiffs are seeking financing from litigation finance companies might help provide information about the rigor of litigation finance company examination and their accuracy in assessing cases. V. Conclusion Litigation finance is a nascent field, and with relatively few companies in the market, it is likely that companies will have their pick of claims and will tend to choose relatively high-probability ones. Success by litigation finance companies, however, will inevitably spawn market entry, especially if legal uncertainties about the permissibility of litigation finance are resolved. In equilibrium, litigation finance companies will lend money whenever they think it will be profitable for them to do so. Even if this is on the whole beneficial, there may be incentives to fund some lowprobability, high-damages cases in the hope of receiving either a settlement or the possibility of a windfall at trial. This Article, however, has shown that it should be feasible to design simple mechanisms that will give litigation finance companies incentives to screen out relatively low-probability cases. These incentives can be adjusted so that only very low-probability cases are screened and to accommodate a range of procedural settings and finance company strategies. Imposition of these mechanisms is not without costs, although because litigation finance companies can be expected to perform some claim screening anyway, the marginal cost of extra review is likely to be low. If such mechanisms prove relatively effective, they might serve as a basis for restraining plaintiffs from filing low-probability claims and defendants from defending high-probability claims, even where the litigants ordinarily would not need financing. Experimentation could help establish the cost and effectiveness of litigation finance companies at screening claims when given high-powered incentives to do so. DePaul Law Review Copyright (c) 2014 DePaul University DePaul Law Review

End of Document

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ARTICLE: Resolving the Class Action Crisis: Mass Tort Litigation as Network 2005 Reporter 2005 Utah L. Rev. 863

Length: 31548 words Author: Byron G. Stier* * Associate Professor of Law, Southwestern University School of Law; B.A. University of Pennsylvania; J.D. Harvard Law School, LL.M. Temple University School of Law. For their helpful comments on this Article or the ideas expressed herein, I would like to thank Jane Baron, Richard Greenstein, Andrew Perlman, Christopher Robinette, Sheila Scheuerman, and Anne-Marie Slaughter. In addition, for their insights into mass tort litigation and class actions generally, I would like to thank Jerome Doak, Raoul Kennedy, Jeffrey Lichtman, Margaret Lyle, and Hugh Whiting. Finally, I would like to thank David Bennett, Ruth Mattson, and Maribeth Wechsler for their excellent research assistance.

Text [*864]

I. Introduction In the last few decades, mass tort litigation 1 has wrestled with widespread, multijurisdictional problems that have greatly stressed the caseloads of courts. Certifying for trial 2 multiple-incident, product-liability 3 class actions for

1

According to the Manual for Complex Litigation,

mass torts litigation "emerges when an event or series of related events injure a large number of people or damage their property." A mass tort is defined by both the nature and number of claims; the claims must arise out of an identifiable event or product, affecting a very large number of people and causing a large number of lawsuits asserting personal injury or property damage to be filed. Manual for Complex Litigation (Fourth) 22.1 (2004) [hereinafter Manual] (quoting Advisory Comm. on Civil Rules & Working Group on Mass Torts, Report on Mass Tort Litigation 10 (Feb. 15, 1999), reprinted without appendices in 187 F.R.D. 293, 300 (1999) [hereinafter Working Group Report]). 2

Mass tort class actions may also be certified for settlement purposes only or may seek only economic costs. See Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 618 (1997) ("Among current applications of Rule 23(b)(3), the "settlement only' class has become a stock device."). In Amchem, the United States Supreme Court stated that settlement classes are not ever intended to go to trial. Id. at 620. As a result, such classes need not meet the manageability criterion of Rule 23(b). Id. Settlement classes, therefore, present issues significantly different from those in a trial class action; hence, settlement classes are not analyzed in this Article. 3

In referring to product liability class actions, this Article refers to multiple alleged tortious incidents by products, rather than single accident mass torts, which may involve different class action considerations, particularly with regard to proximate cause and comparative fault. See, e.g., Amchem, 521 U.S. at 609 ("In contrast to mass torts involving a single accident, class members … were exposed to different … products, in different ways, over different periods, and for different amounts of time."); In re N. Dist. of Cal., Dalkon Shield IUD Prods. Liab. Litig., 693 F.2d 847, 853 (9th Cir. 1982) (distinguishing between "typical" mass tort based on single incidents and "products liability" mass torts in which causation and affirmative defenses "may depend on facts peculiar to each plaintiff's case"); In re Baycol Prods. Litig., 218 F.R.D. 197, 203-04 (D. Minn. 2003) ("With regard to the "typical' mass tort case, proximate cause can be determined on a class-wide basis, whereas in a products liability case,

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Page 2 of 59 2005 Utah L. Rev. 863, *864 personal injuries 4 has promised the possibility of resolution of expansive problems. Indeed, courts and commentators have claimed that such class actions present the only solution to otherwise overwhelmingly burdensome [*865] litigation that drowns court dockets 5 and effectively excludes certain plaintiffs from adjudication because of the cost of bringing claims. 6 But, as courts have increasingly held, multiple-incident, personal-injury class actions are not appropriate for class treatment because they involve numerous individualized issues that require unmanageable individualized adjudication. 7 Indeed, if a court attempts to adjudicate class action claims consonant with state substantive law and federal constitutional guarantees, 8 the individualized issues can require hundreds of years of trial and attendant hearings. 9 Class actions are only procedural methods that are not supposed to alter substantive law: 10 in a multiple-incident, personal-injury class action, state substantive law requires individualized analysis of medical and decision causation, damages, product defect (when multiple products are at issue), and affirmative defenses

individual issues must be considered in determining proximate cause and the alleged tortfeasor's affirmative defenses may depend on facts peculiar to each plaintiff."); cf. Manual, supra note 1, at 22.1 (distinguishing between "dispersed mass tort" in which ""the universe of potential plaintiffs is … seemingly unlimited and the number of potential tortfeasors is equally obtuse,'" and "single incident mass tort" in which ""the universe of potential claimants is either known or … capable of ascertainment and the event or course of conduct … occurred over a known time period and is traceable to an identified entity or entitites'" (quoting In re Chevron U.S.A., Inc., 109 F.3d 1016, 1018 (5th Cir. 1997))). 4

Apart from personal-injury claims, mass tort class actions may also seek claims for medical monitoring, which seeks to monitor the plaintiffs health for signs of onset of disease. Because medical monitoring classes may not seek to prove causation of actual disease, they, too, present significantly different issues in certification than does the personal-injury class action and are not, therefore, addressed in this Article. 5

See, e.g., Castano v. Am. Tobacco Co., 160 F.R.D. 544, 555-56, 560 (E.D. La. 1995) (certifying nationwide tobacco addiction class to avoid "the specter of thousands, if not millions, of similar trials … proceeding in thousands of courtrooms around the nation"), rev'd, 84 F.3d 734 (5th Cir. 1996). 6

This Article addresses personal-injury class actions where individual plaintiff's claims are financially substantial. See supra note 4 for further information on the scope of this Article. Therefore, while the cost of bringing individual litigation remains a factor in plaintiff counsel's decision to bring suit, these personal-injury claims do not constitute the type of "negative value" claims of individually minuscule damages used as a justification for class actions. See, e.g., Amchem, 521 U.S. at 617 ("While the text of Rule 23(b)(3) does not exclude from certification cases in which individual damages run high, the Advisory Committee had dominantly in mind vindication of "the rights of groups of people who individually would be without effective strength to bring their opponents into court at all.'" (citation omitted)). But see In re Am. Med. Sys., Inc., 75 F.3d 1069, 1084 (6th Cir. 1996) (noting class action "was not designed solely as a means for assuring legal assistance in the vindication of small cases but, rather, to achieve the economies of time, effort and expense" (internal quotation marks and citations omitted)); In re Ford Motor Co. Vehicle Paint Litig., 182 F.R.D. 214, 225 (E.D. La. 1998) (rejecting "negative value suit" argument because plaintiffs "would have to hire experts and litigate many aspects of their cases on an individual basis," and noting that "if certification will in actuality require a multitude of minitrials then the justification for class certification is absent" (internal quotation marks and citation omitted)); In re Ford Motor Co. Bronco II Prod. Liab. Litig., 177 F.R.D. 360, 375 (E.D. La. 1997) ("The meager nature of individualized recovery is but one factor considered under the superiority analysis."); In re Masonite Corp. Hardboard Siding Prods. Liab. Litig., 170 F.R.D. 417, 426-27 (E.D. La. 1997) ("The magnitude or kind of injury does not make these claims, by virtue of their character, any the more suitable for class management."). 7

See infra Part II.B (discussing problems of multiple-incident product-liability class actions for personal injuries).

8

State constitutional provisions similar to federal constitutional provisions, such as those guaranteeing a right to a jury trial, may also be implicated.

9

See, e.g., Arch v. Am. Tobacco Co., 175 F.R.D. 469, 488 n.19 (E.D. Pa. 1997) (stating that tobacco class-action trial would take approximately 250 years even if only one hour were used for individual issues per class member). 10

See, e.g., Amchem, 521 U.S. at 612-13 ("[We are] mindful that Rule 23's requirements must be interpreted in keeping with Article III constraints, and with the Rules Enabling Act, which instructs that rules of procedure "shall not abridge, enlarge or modify any substantive right.'" (citation omitted)).

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Page 3 of 59 2005 Utah L. Rev. 863, *865 such as comparative fault and statute of limitations. Moreover, under the Seventh Amendment, these issues must be addressed [*866] before a single jury, 11 lest multiple juries reexamine each other's verdicts on interrelated issues. In addition, choice-of-law issues also implicate individualized assessment, and the resulting multiplicity of applicable standards can be overwhelmingly complex for any jury. No court has completed such proceedings or meaningfully embarked on them. Therefore, some courts have decertified mass tort classes, thereby wasting the substantial resources that the parties and court had expended in the class litigation. 12 Other courts, however, trying to circumvent impossibly lengthy proceedings, have developed trial-plan approaches that, in seeking judicial efficiency, violate both state substantive law and federal constitutional law. 13 Moreover, notwithstanding growing precedent on their side, defendants may still feel compelled to settle multiple-incident, product-liability class actions for personal injuries because of the potential inability to secure adequate appellate review resulting from the difficulty of posting an appellate bond for the tremendous verdicts that may result from such class actions. 14 Fueling this class action crisis, plaintiffs' counsel have argued that the unacceptable alternative to class certification is traditional litigation by tens of thousands of individual plaintiffs, with their nearly-as-numerous counsel repeatedly litigating from scratch. 15 Attempting to defuse this crisis, Congress recently passed, and the President signed, the Class Action Fairness Act of 2005. 16 The Act greatly expands federal diversity jurisdiction over class actions, generally providing that a class action may be removed from state court to federal court as long as any class member is diverse from any defendant, and the amount in [*867] controversy exceeds $ 5 million. 17 Thus, the Act shifts more class

11

For the Seventh Amendment to apply, a jury trial must, of course, be demanded by a party.

12

See, e.g., Spitzfaden v. Dow Corning Corp., No. 92-2589, slip op. (La. Dist. Ct., Orleans Parish Dec. 1, 1997) (decertifying mass tort breast implant class action); see also Fed. R. Civ. P. 23(c)(1) ("An order under Rule 23(c)(1) may be altered or amended before final judgment."). 13

See, e.g., Cimino v. Raymark Indus., Inc., 151 F.3d 297, 313-21 (5th Cir. 1998) (reversing trial plan that used statistically extrapolated damages through expert evidence as violation of defendant's Seventh Amendment right to jury trial and requiring determination of causation "as to individuals, not groups" (internal quotation marks omitted)). 14

See, e.g., Victor E. Schwartz et al., Federal Courts Should Decide Interstate Class Actions: A Call for Federal Class Action Diversity Jurisdiction Reform, 37 Harv. J. on Legis. 483, 504 (2001) (noting pressure on tobacco industry to settle cases of attorneys general because of "oppressive bonding requirements--up to 200% of the judgment in some states--that would have been necessary to appeal the trial courts' decisions"). 15

See generally Howard M. Erichson, Beyond the Class Action: Lawyer Loyalty and Client Autonomy in Non-Class Collective Representation, 2003 U. Chi. Legal F. 519, 525-26 ("Too many judges treat class action problems as though the alternative is autonomous individual litigation, when in fact the alternative is more likely to be some form of mass collective representation."); Susan E. Kearns, Note, Decertification of Statewide Tobacco Class Actions, 74 N.Y.U. L. Rev. 1336, 1349 (1999) ("Dire warnings that denial of certification leads to thousands or millions of individual lawsuits appear superficially plausible but lack support in either practice or concept … ."). 16

Class Action Fairness Act of 2005, Pub. L. No. 109-2, 119 Stat. 4.

17

See id. 4(a)(2), 119 Stat. at 9. The federal district court may, "in the interests of justice and looking at the totality of the circumstances, decline to exercise jurisdiction … over a class action in which greater than one-third but less than two-thirds of the members of all proposed plaintiff classes in the aggregate and the primary defendants are citizens of the State in which the action was originally filed." Id. 4(a)(3), 119 Stat. at 9; see also id. 4(a)(3)(A)-(F), 119 Stat. at 9-10 (listing discretionary factors). In contrast, a federal district court must decline to exercise jurisdiction over a class in which (i) more than two-thirds of the members of all proposed plaintiff classes in the aggregate are citizens of the state in which the action is originally filed; and (ii) at least one defendant is a citizen from the state where the action was originally filed, is one whose conduct "forms a significant basis for the claims asserted by the proposed plaintiff class," and is one against whom "significant relief is sought by members of the plaintiff class." Id. 4(a)(4)(A), 199 Stat. at 10. In addition, a federal district court must decline to exercise jurisdiction when "two-thirds or more of the members of all proposed plaintiff classes in the aggregate, and the primary defendants, are citizens of the State in which the action was originally filed." Id. 4(a)(4)(B), 119 Stat. at 10. Separately, the Act also provides for greater

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Page 4 of 59 2005 Utah L. Rev. 863, *867 certification decisions from state courts to federal courts in an effort to avoid out-of-state bias. 18 Once class actions are removed to federal court, however, the Act still provides no alternative for federal courts to the Hobson's choice framed by plaintiffs' counsel: certify a class, or be inundated with thousands of unmanageable, wasteful, and repetitive individual cases. 19 But that is a false dichotomy. The alternative to mass tort class actions is not such repetitive isolated litigation, but instead an expansive set of litigation networks that provide much of the efficiency promised by class actions without violating state substantive law or federal constitutional law. 20 The participants [*868] in individual tort litigation-plaintiffs' counsel, defense counsel, judges, and even clients--have in recent decades increasingly networked with their counterparts in other jurisdictions to develop more effective and efficient litigation approaches. These networks are comprised of interconnected individuals and groups who share information, pool resources, develop specialized expertise, and coordinate strategy. In all of their endeavors, litigation networks have been aided considerably by recent advances in information technology and the Internet, which have vastly improved communication and management of litigation documents. Mass tort litigation networks also produce more accurate claim disposition than mass tort class actions, and particularly further the tort goal of corrective justice. In reversing a mass tort class action, Judge Easterbrook of the Seventh Circuit recently noted that the "vision of "efficiency' underlying this class certification is the model of the central planner… . Yet the benefits are elusive. The central planning model--one case, one court, one set of rules, one settlement price for all involved--suppresses information that is vital to accurate resolution." 21 In contrast, mass tort litigation networks result in individual verdicts in various jurisdictions for plaintiffs with various factual particularities. The verdicts supply litigants with information about the settlement value of other claims, thus resulting in more accurate disposition of claims. Moreover, once a sufficient market value of plaintiffs' claims has been achieved, the judicial burden of mass tort litigation greatly eases, as the parties may often choose to settle claims rather than undergo further litigation costs. 22 In addition to effectively and efficiently managing a particular

oversight of coupon settlements, which have not been prevalent in product-liability class actions for personal injuries. See id. 3(b), 119 Stat. at 5-9. 18

See id. 2(a)(4), 119 Stat. at 5 (stating that "state and local courts are … sometimes acting in ways that demonstrate bias against out-of-State defendants"). 19

See Castano v. Am. Tobacco Co., 84 F.3d 734, 748 (5th Cir. 1996) ("As he stated in the record, plaintiffs' counsel in this case has promised to inundate the courts with individual claims if class certification is denied."); Laura J. Hines, The Dangerous Allure of the Issue Class Action, 79 Ind. L. J. 567, 570 (2004) ("Often courts are importuned to certify a class action … to forestall an otherwise inevitable and unmanageable inundation of cases asserting injury as a result of an alleged mass tort."). 20

One scholar has recently noted the "dearth of scholarly attention to informal aggregation." See Howard M. Erichson, Informal Aggregation: Procedural and Ethical Implications of Coordination Among Counsel in Related Lawsuits, 50 Duke L.J. 381, 384 n.1 (2000); see also Samuel Issacharoff & John Fabian Witt, The Inevitability of Aggregate Settlement: An Institutional Account of American Tort Law, 57 Vand. L. Rev. 1571, 1575 (2004) (noting that "private systems of aggregation in our tort system exist in a far-flung, decentralized, and under-the-radar world that rarely comes to the attention of tort jurists," which "is perhaps why academics and courts alike have failed adequately to recognize it"); Mitchell A. Lowenthal & Howard M. Erichson, Modern Mass Tort Litigation, Prior-Action Depositions and Practice-Sensitive Procedure, 63 Fordham L. Rev. 989, 990 (1995) ("While the growth of mass tort litigation has been much discussed in the scholarly literature, as have various formal procedures for aggregating claims, insufficient attention has been given to the profound changes occurring informally, in particular, the trend toward aggregation through coordination by same-side counsel." (citation omitted)); Judith Resnik, From "Cases" to "Litigation", 54 Law & Contemp. Probs. 5, 39 (1991) (noting that "informal techniques of aggregation … are less visible to the academy"). By assessing the benefits of emergent litigation networks over traditional mass tort class actions, this Article breaks new ground in an underexamined subject. 21

In re Bridgestone/Firestone, Inc. Tires Prods. Liab. Litig., 288 F.3d 1012, 1020 (7th Cir. 2002).

22

Whether these settlements can be achieved not only through private settlements, but also through a class action presented solely for settlement purposes, is beyond the scope of this Article. See supra note 2 (explaining that settlements are beyond

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Page 5 of 59 2005 Utah L. Rev. 863, *868 mass tort litigation, networks generate improvements for management of the next mass tort. By experimenting with myriad approaches to collaboration and incorporating new advantages in information technology, mass tort litigation networks thus improve their methods with each mass tort. Part II of this Article describes the mass tort litigation crisis beginning with the multijurisdictional scope of mass tort problems. It then describes the [*869] numerous problems attending to the certification of mass tort class actions, including violations of state substantive law and federal constitutional law, the undercutting of litigant autonomy, the failure to provide sufficient information to tailor solutions to fit disputes, and the pressure on defendants to settle. Part III details current mass tort litigation networks and their benefits, and explains the role of information technology in enabling and empowering such networks. Additionally, Part III illustrates the current role of networks in mass tort litigation through the ongoing litigation concerning phenylpropanolamine ("PPA"), an ingredient previously used in cough and cold remedies and appetite suppressants that has been alleged to cause stroke. Penultimately, Part IV describes how, in contrast to class actions, mass tort litigation networks develop accurate claim values for settlement purposes and allow for improved case management over time through pragmatic experimentation. Finally, I conclude that mass tort litigation networks provide a superior alternative to multipleincident, product-liability class actions for personal injuries. Indeed, that mass tort litigation networks are superior is especially important because a judge may not certify a class action under Rule 23(b)(3) unless a "class action is superior to other available methods for the fair and efficient adjudication of the controversy." 23 Judges should therefore deny requests to certify such class actions, and instead encourage and assist in the creation and functioning of litigation networks. II. The Mass Tort Class Action Crisis A. The Multijurisdictional Burdens of Mass Tort Litigation Commentators and courts have claimed that class actions present the only solution to otherwise overwhelmingly burdensome litigation that drowns court dockets. 24 In the 1980s, mass personal injury litigation emerged as a result of mass marketing of products, mass media's attention to product injuries, 25 plaintiffs' lawyers' national advertising efforts, and more favorable rules allowing plaintiffs to sue manufacturers. 26 As a result of these trends, the number of persons potentially involved in product liability litigation greatly increased. For example, over thirty million pregnant women took Bendectin, an antinausea drug involved in litigation pertaining to birth defects; at least two million women used Dalkon Shields, an intraueterine antipregancy device [*870] involved in litigation regarding infections and miscarriages; more than two million women received silicone breast implants, which were involved in litigation regarding autoimmune disease; and tens of millions were exposed in the workplace to asbestos that

scope of this Article). Settlement class actions have been subjected to great scrutiny and have been invalidated in recent years. See, e.g., Ortiz v. Fibreboard Corp., 527 U.S. 815, 864-65 (1999) (finding failure to demonstrate that fund was limited except by agreement of parties and that fund showed exclusions from class and allocations of assets contrary to concept of limited fund treatment and structural protections of Rule 23 of the Federal Rules of Civil Procedure); Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 592-95 (1997) (finding that class did not satisfy common issue predominance and adequacy of representation requirements). Nevertheless, as mentioned supra note 2, settlement class actions need not face the manageability requirement of class actions certified for trial. 23

Fed. R. Civ. P. 23(b)(3).

24

See Castano v. Am. Tobacco Co., 160 F.R.D. 544, 555-56, 560 (E.D. La. 1995), rev'd, 84 F.3d 734 (5th Cir. 1996); see also Deborah R. Hensler & Mark A. Peterson, Understanding Mass Personal Injury Litigation: A Socio-Legal Analysis, 59 Brook. L. Rev. 961, 961 (1993) ("In some parts of the country, mass tort claims threatened to overwhelm the civil justice system … ."). 25

Id. at 1020-23.

26

See id. at 1013, 1027-30 (noting increase in application of strict liability and successor liability and liberal constructions of statutes of limitations and insurance contract applicability).

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Page 6 of 59 2005 Utah L. Rev. 863, *870 spawned litigation concerning lung cancer and mesothelioma. 27 Fearing liability, some manufacturers avoid research and development in particular products, and insurers have left certain markets altogether. 28 Because of the scope of mass tort litigation, some jurisdictions may face hundreds of thousands of plaintiffs. 29 Indeed, in one tobacco litigation, a court contemplated the "specter of thousands, if not millions, of similar trials of liability proceeding in thousands of courtrooms and around the nation." 30 Moreover, judges must often struggle to manage mass tort case loads in light of additional work. 31 In some courts, for example, mass tort filings may be more than one quarter of a court's civil caseload. 32 Judged against the usual caseloads of mass torts, asbestos litigation is, as one commentator has noted, a "mega mass tort." 33 Over 500,000 workers and their families have sued over one thousand corporations in various industries. 34 And between one and three million asbestos-related claims could ultimately be filed. 35 Over 30,000 asbestos cases remain in federal court, and many state courts face thousands each year. 36 As a result, more than forty corporations [*871] have filed for bankruptcy. 37 Insurers have paid more than $ 20 billion in damages, and the final cost of asbestos litigation may exceed $ 200 billion. 38 Because of the pressures brought on by mass tort litigation, some courts sought methods other than traditional case-by-case adjudication. 39 For example, while the scope of asbestos is singular and should "not taint our

27

Id. at 1015.

28

Id. at 961.

29

Deborah R. Hensler, A Glass Half Full, a Glass Half Empty: The Use of Alternative Dispute Resolution in Mass Personal Injury Litigation, 73 Tex. L. Rev. 1587, 1587 (1995); see also Hensler & Peterson, supra note 24, at 961 ("The 1980s marked the era of mass personal injury litigation. Hundreds of thousands of people sued scores of corporations for losses due to injuries or diseases that they attributed to catastrophic events, pharmaceutical products, medical devices or toxic substances."). 30

See Castano v. Am. Tobacco Co., 160 F.R.D. 544, 555-56, 560 (E.D. La. 1995) (certifying class based on nationwide tobacco addiction), rev'd, 84 F.3d 734 (5th Cir. 1996). 31

See Georgine v. Amchem Prods., Inc., 83 F.3d 610, 618-19 (3d Cir. 1996), aff'd sub nom. Amchem, 521 U.S. 591; see also Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 631 (1997) (Breyer, J., dissenting) (stating that asbestos litigation constituted six percent of federal court civil cases in one year); Manual, supra note 1, at 22.1 ("Judges must efficiently and fairly manage hundreds, even thousands, of related cases without unduly disrupting the court's other work."); John C. Coffee, Jr., Class Wars: The Dilemma of the Mass Tort Class Action, 95 Colum. L. Rev. 1343, 1358-59 (1995) ("Mass tort litigation is characterized by … a capacity to place logistical pressure on individual courts that is simply unequalled by any other form of civil litigation."). 32

Hensler & Peterson, supra note 24, at 961.

33

See Francis E. McGovern, An Analysis of Mass Torts for Judges, 73 Tex. L. Rev. 1821, 1836-38 (1995) (noting that "on occasion, a mass tort--such as the asbestos litigation--can become gigantic[,]" and referring to asbestos as "mega mass tort"). 34

Deborah Hensler, As Time Goes By: Asbestos Litigation After Amchem and Ortiz, 80 Tex. L. Rev. 1899, 1899 (2002).

35

Francis E. McGovern, The Tragedy of Asbestos Commons, 88 Va. L. Rev. 1721, 1725 (2002).

36 37

Id. at 1725-26. Hensler, supra note 34, at 1899-900.

38

Id.; Issacharoff & Witt, supra note 20, at 1618-19; see also McGovern, supra note 35, at 1725 (estimating that asbestos liability has reached $ 54 billion, and approximately $ 200 to $ 265 billion in liability may be incurred in future).

39

See Manual, supra note 1, at 22.1 ("The need for special judicial management of mass torts arises from the sheer volume of the litigation generated."); id. ("The sheer number of cases can create enormous pressure to aggregate or combine them in

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Page 7 of 59 2005 Utah L. Rev. 863, *871 understanding of other mass torts," 40 its burdens pushed courts into attempts to use class actions to manage their caseloads. 41 In the last twenty years, the pressure of mass tort litigation has lead courts to seek refuge in Federal Rule of Civil Procedure 23 and to certify personal-injury class actions. B. The Problems of Multiple-Incident, Product-Liability Class Actions for Personal Injuries Despite courts' turning to class actions for aid in managing the burdens of mass tort litigation, the multiple-incident, product-liability class actions for personal injuries involve individualized issues not amenable to class treatment. The proof required to resolve litigation issues determines whether a class action is appropriate. 42 A class action is adjudicated based on the evidence of class representatives being, in fact, representative for evidence of all other class members. If class representatives' evidence does not encompass that of class members, the premise of class action litigation is defeated, as is the basis for binding class members to the judgment obtained by class representatives. 43 [*872] To be certified, a class action must satisfy the requirements of Rule 23 of the Federal Rules of Civil

Procedure or its state correlate. 44 A court must undertake a "rigorous analysis" to ascertain whether Rule 23 requirements have been met. 45 To determine whether class certification is appropriate, "it may be necessary for the court to probe behind the pleadings before coming to rest on the certification question." 46 The court's discretion "must be exercised within the framework of rule 23." 47

order to reduce delay and docket congestion and to avoid the costs of repetitive litigation that can drain potential compensation funds."); Hensler & Peterson, supra note 24, at 964 ("An elite of trial judges has come forward, ready to set aside traditional case-at-a-time disposition procedures in favor of aggregative procedures for disposing of hundreds or even thousands of cases."); see also In re Bridgestone/Firestone, Inc., 288 F.3d 1012, 1020 (7th Cir. 2002) ("Tempting as it is to alter doctrine in order to facilitate class treatment, judges must resist so that all parties' legal rights may be respected."). 40

McGovern, supra note 33, at 1836-37; see also Hines, supra note 19, at 571 ("Few incipient mass torts will ever rival the scope of the asbestos cases.").

41

See infra Part II.A (discussing burdens of multiple-incident, product liability class actions for personal injuries).

42

See Coopers & Lybrand v. Livesay, 437 U.S. 463, 469 (1978) (noting that class certification decisions "involve[] considerations that are "enmeshed in the facutal and legal issues comprising plaintiffs' causes of action'" (citation omitted)); Feinstein v. Firestone Tire & Rubber Co., 535 F. Supp. 595, 601 (S.D.N.Y. 1982) ("It is necessary to analyze the nature of the putative class's claims, and the proof that would be adduced in support of them."). 43

See In re Am. Med. Sys., Inc., 75 F.3d 1069, 1085 (6th Cir. 1996); see also Gen. Tel. Co. of Southwest v. Falcon, 457 U.S. 147, 159 (1982) (decertifying class because, "instead of raising common questions of law or fact, respondent's evidentiary approaches to the individual and class claims were entirely different"). 44

The following discussion will focus on class actions under the Federal Rules of Civil Procedure, upon which state class-action rules are largely based. See Sheila Birnbaum, Class Certification--The Exception, Not the Rule, 41 N.Y.L. Sch. L. Rev. 347, 348 (1997) (noting that "most states follow the federal rule"); Schwartz et al., supra note 14, at 500 n.100 (noting that thirty-eight states have adopted amended Rule 23, some with "slight modifications"). 45

See, e.g., Falcon, 457 U.S. at 161 (noting that certification may take place only "after a rigorous analysis" concludes that Rule 23's requirements have been met); Zinser v. Accufix Research Inst., Inc., 253 F.3d 1180, 1186 (9th Cir. 2001) ("Before certifying a class, the trial court must conduct a "rigorous analysis' to determine whether the party seeking certification has met the prerequisites of Rule 23."), amended, 273 F.3d 1266 (9th Cir. 2001); Valentino v. Carter-Wallace, 97 F.3d 1227, 1233 (9th Cir. 1996) (same). 46

Falcon, 457 U.S. at 160; see also Coopers, 437 U.S. at 469 n.12 (stating that "typicality," "adequacy," and commonality are "intimately involved with the merits of the claims" and determining predominance "entails even greater entanglement with the merits"); Castano v. Am. Tobacco Co., 84 F.3d 734, 740, 744 (5th Cir. 1996) ("Going beyond the pleadings is necessary, as a court must understand the claims, defenses, relevant facts, and applicable substantive law in order to make a meaningful determination of the certification issues."); Barnes v. Am. Tobacco Co., 176 F.R.D. 479, 502 (E.D. Pa. 1997) ("When the Court

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Page 8 of 59 2005 Utah L. Rev. 863, *872 Under Rule 23(a), each putative class must meet requirements of numerosity, 48 commonality, 49 typicality, 50 and adequacy. 51 These requirements, [*873] however, generally serve to show that the claims of the putative class can be decided fairly based on the representative proofs of the named plaintiffs. 52 In [*874] addition to meeting all the requirements of Rule 23(a), a class action must qualify under Rule 23(b)(1), Rule 23(b)(2), or Rule 23(b)(3).

looks down the road to determine how this case would be tried, it is obvious that the litigation is unmanageable as a class action and would ultimately splinter into individual issues, which would have to be tried separately."), aff'd, 161 F.3d 127 (3d Cir. 1998). 47

Castano, 84 F.3d at 740.

48

Under Rule 23(a)(1), a class action is allowed only if "the class is so numerous that joinder of all members is impracticable." Fed. R. Civ. P. 23(a)(1). Large classes of injured people easily meet this requirement. See, e.g., In re Baycol Prods. Litig., 218 F.R.D. 197, 204 (D. Minn. 2003) (noting that, with regard to numerosity, "clearly, this prerequisite is met," for proposed class involving 900,000 who took Baycol, and thousands estimated in proposed personal-injury class). 49

Rule 23(a)(2) states that a class action may be certified only if "there are questions of law or fact common to the class." Fed. R. Civ. P. 23(a)(2). While any issue may show commonality in some way, Rule 23(a)'s commonality requirement calls for a common issue that advances the litigation. See, e.g., Sprague v. Gen. Motors Corp., 133 F.3d 388, 397 (6th Cir. 1998) ("At a sufficiently abstract level of generalization, almost any set of claims can be said to display commonality. What we are looking for is a common issue the resolution of which will advance the litigation."); Reilly v. Gould, 965 F. Supp. 588, 597-98 (M.D. Pa. 1997) ("Assuming arguendo that the plaintiffs possess common claims which contain common issues of law or fact, such issues are altered or changed by the individual facts and situation of each plaintiff. This destroys anything common to the class."). 50

Under Rule 23(a)(3), a class action may be maintained only if the "claims or defenses of the representative parties are typical of the claims or defenses of the class." Fed. R. Civ. P. 23(a)(3). If the evidence necessary to prove class claims is not provided by the named plaintiffs, the requirements of Rule 23(a) are not met with regard to typicality. See, e.g., Sprague, 133 F.3d at 399 (finding no typicality if "named plaintiff who proved his own claim would not necessarily have proved anybody else's claim"); Baycol, 218 F.R.D. at 205 (finding no typicality in "case involving a vast number of persons who took different dosages of Baycol, at different times, and possibly took Baycol concomitantly with other prescription drugs"); Hurd v. Monsanto Co., 164 F.R.D. 234, 239 (S.D. Ind. 1995) (reasoning that no typicality exists where "no single proximate cause inquiry applies equally to each putative class member; no one set of operative facts establishes liability"). 51

Under Rule 23(a)(4), a class action is permissible only if "the representative parties will fairly and adequately protect the interests of the class." Fed. R. Civ. P. 23(a)(4). This prong assesses whether the interests of the class representative and the class are sufficiently united. Courts must also determine that class counsel will adequately represent the interests of the class. See Fed. R. Civ. P. 23(g)(1)(B) ("An attorney appointed to serve as class counsel must fairly and adequately represent the interests of the class."); Fed R. Civ. P. 23 (g)(1)(C) ("In appointing class counsel, the court (i) must consider: the work counsel has done in identifying or investigating potential claims in the action[;] counsel's experience in handling class actions, other complex litigation, and claims of the type asserted in the action[;] counsel's knowledge of the applicable law[;] and the resources counsel will commit to representing the class; [and] (ii) may consider any other matter pertinent to counsel's ability to fairly and adequately represent the interests of the class."). Moreover, judges supervise and approve settlement and class counsel's fees. These safeguards are required to bind class members to a litigation over which they have had virtually no control. See Erichson, supra note 15, at 524 ("Importantly, the traditional understanding also correctly identifies why class actions require procedural safeguards such as the adequate representation requirement and judicial supervision over settlement and fees: in class actions, class members may be bound despite their lack of control over the litigation or any meaningful attorney-client relationship."). 52

See Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 625-26 (1997) (noting that, to satisfy adequacy and typicality, a class representative "must be part of the class and possess the same interest and suffer the same injury as the class members"); Gen. Tel. Co. of Southwest v. Falcon, 457 U.S. 147, 157 n.13 (1982) ("The commonality and typicality requirements of Rule 23(a) tend to merge. Both serve as guideposts for determining whether … the named plaintiff's claim and the class claims are so interrelated that the interests of the class members will be fairly and adequately protected in their absence."); Gen. Tel. Co. v. EEOC, 446 U.S. 318, 330 (1980) (limiting class claims to those "fairly encompassed" within claim of named plaintiff(s)); Mace v. Van Ru Credit Corp., 109 F.3d 338, 341 (7th Cir. 1997) ("The typicality and commonality requirements of the Federal Rules ensure that only those plaintiffs or defendants who can advance the same factual and legal arguments may be grouped together as a class."). Putative class representatives who attempt to bring only claims that may obtain class certification risk waiver of other claims of class members. See Fed. R. Civ. P. 23(c)(3) advisory committee's note ("Although thus declaring that the

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Page 9 of 59 2005 Utah L. Rev. 863, *874 With regard to meeting the requirements of Rule 23(b), mass tort class actions for personal injuries have generally sought class certification under Rule 23(b)(3), which requires that "the questions of law or fact common to the members of the class predominate over any questions affecting only individual members." 53 Rule 23(b)(3)'s

judgment in a class action includes the class, as defined, subdivision (c)(3) does not disturb the recognized principle that the court conducting the action cannot predetermine the res judicata effect of the judgment; this can be tested only in a subsequent action."); Williams v. Gen. Elec. Capital Auto Lease, Inc., 159 F.3d 266, 273-74 (7th Cir. 1998) (stating that class members' claims from same factual circumstances were barred "even though the claim was not presented [in the class action] and might not have been presentable in the class action" (internal quotation marks and citation omitted) (emphasis added)); Small v. Lorillard Tobacco Co., 679 N.Y.S.2d 593, 601-02 (N.Y. App. Div. 1998) ("The manner in which the named plaintiffs limited their claims makes them inadequate to represent a putative class … . We find persuasive the reasoning of the Southern District of New York in Feinstein … . The court … [found] that representatives who "tailored the class claims in an effort to improve the possibility of demonstrating commonality' obtained this "essentially cosmetic' benefit only by "presenting putative class members with significant risks of being told later they had impermissibly split a single cause of action." (citation omitted)), aff'd, 720 N.E.2d 892 (N.Y. 1999); Schwartz et al., supra note 14, at 493 ("Lawyer driven class actions can put class members' rights at risk by proceeding on a lowest-common-denominator basis … . These practices do a disservice to class members."). But see Arch v. Am. Tobacco Co., 175 F.R.D. 469, 479-80 (E.D. Pa. 1997) (finding that Pennsylvania law did not bar class members from bringing subsequent suits). However, many jurisdictions do not allow a plaintiff to split his claims into different suits. See, e.g., Tex. Employers' Ins. Ass'n v. Jackson, 862 F.2d 491, 501 (5th Cir. 1988) ("[A] single cause of action or claim cannot be "split' by advancing one part in an initial suit and attempting to reserve another part for a later suit."). As a result, representatives willing to sacrifice class members' claims in an effort to achieve class certification call into question the representatives' adequacy. See, e.g., Cosentino v. Philip Morris, Inc., No. MID-L-5135-97, slip op. at 10 (N.J. Super. Ct. Law. Div. Feb. 11, 1999) ("As a matter of law, the present plaintiffs cannot exclude absent class members' claims for personal injuries, at least not without making themselves inadequate representatives for the putative class."); Schwartz et al., supra note 14, at 493 ("Plaintiffs' lawyers may dispense with certain claims for tactical reasons--such as waiving fraud claims because they require individual demonstrations of reliance that can defeat class status. Or they may, to achieve certification, seek to consolidate claims from many different states under one state's law, even though that state's law may defeat some class members' claims."). 53

Fed. R. Civ. P. 23(b)(3). A class may also be certified under Rule 23(b)(2) or Rule 23(b)(1)(A) & (B). Rule 23(b)(2) applies where "the party opposing the class has acted or refused to act on grounds generally applicable to the class, thereby making appropriate final injunctive relief … with respect to the class as a whole." Fed. R. Civ. P. 23(b)(2). Therefore, Rule 23(b)(2) "does not extend to cases in which the appropriate final relief relates exclusively or predominantly to money damages." Fed. R. Civ. P. 23(b)(2) advisory committee's note. To ascertain whether the relief sought applies predominantly to damages, courts look to the ""realities of the litigation.'" Yeager's Fuel, Inc. v. Pa. Power & Light Co., 162 F.R.D. 471, 480 (E.D. Pa. 1995) (quoting Christiana Mortgage v. Del. Mortgage Bankers Ass'n, 136 F.R.D. 372, 380 (D. Del. 1991)). As noted supra note 6, this Article pertains to mass tort class actions for personal injuries and does not address medical-monitoring claims. Such personal-injury mass tort class actions seek money damages and, therefore, do not qualify for certification under Rule 23(b)(2). Rule 23(b)(1)(A) applies if "prosecution of separate actions … would create a risk of inconsistent or varying adjudications with respect to individual members of the class which would establish incompatible standards of conduct for the party opposing the class." Fed. R. Civ. P. 23(b)(1)(A). As the Ninth Circuit has held, however, "Rule 23(b)(1)(A) certification requires more … "than a risk that separate judgments would oblige the opposing party to pay damage to some class members but not to others or to pay them different amounts[.]' Certification under 23(b)(1)(A) is therefore not appropriate in an action for damages." Zinser v. Accufix Research Inst., 253 F.3d 1180, 1193 (9th Cir. 2001) (citation omitted). Rule 23(b)(1)(B) pertains to limited-fund situations and uses the class action to avoid consumption of all of a defendant's resources by some litigants prior to bankruptcy. See Fed. R. Civ. P. 23(b)(1)(B) advisory committee's note. First, the use of this provision requires proof that, indeed, there is a limited fund, which has increasingly been held to be a stringent test. See, e.g., Ortiz v. Fibreboard Corp., 527 U.S. 815, 842 (1999) (finding no limited fund shown in connection with asbestos settlement); In re Simon II Litig., 407 F.3d 125, 138 (2d Cir. 2005) (reversing certification of a nationwide punitive damages class, and noting that "not only is the upper limit of the proposed fund difficult to ascertain, but the record in this case does not evince a likelihood that any given number of punitive awards to individual claimants would be constitutionally excessive, either individually or in the aggregate, and thus overwhelm the available fund"); Zinser, 253 F.3d at 1196-97 (finding that plaintiffs "have not demonstrated that the assets potentially available to claimants are so limited that separate actions "inescapably will alter' the rights of other claimants"). Second, while Rule 23(b)(1)(B) does not include some of the requirements contained in Rule 23(b)(3), any multiple-incident, personal-injury trial under Rule 23(b)(1)(B) would likely encounter difficulties related to the individualized issues described below.

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Page 10 of 59 2005 Utah L. Rev. 863, *874 predominance criterion is far more demanding [*875] than the commonality required of Rule 23(a)(2). 54 A court must determine whether, in scrutinizing the evidence required to prove plaintiffs' claims, common issues of law and fact predominate uncommon issues. 55 By requiring common issues to predominate individual issues, the predominance criterion ensures judicial economy is served by a class action. 56 In addition to predominance, Rule 23(b)(3) requires that a court find "that a class action is superior to other available methods for the fair and efficient adjudication of the controversy," with the following matters being pertinent: (A) the interest of the members of the class in individually controlling the prosecution or defense of separate actions; (B) the extent and nature of any litigation concerning the controversy already commenced by or against members of the class; (C) the desirability or undesirability of concentrating the litigation of the claims in the particular forum; [and] (D) the difficulties likely to be encountered in the management of a class action. 57 Therefore, the presence of individualized issues also affects the court's understanding of not only predominance, but also superiority--especially with regard to management difficulties and the interest of class members in [*876] individually controlling the prosecution of their own actions. 58 Such management difficulties can result in a lack of judicial economy. 59 In connection with their superiority assessment, some courts properly require that plaintiffs submit a trial plan showing how the case could be tried and showing that a class action would be superior. 60

54

See Amchem, 521 U.S. at 624 (noting that "the predominance criterion is far more demanding" than commonality requirement). 55

See Castano v. Am. Tobacco Co., 84 F.3d 734, 744 (5th Cir. 1996); see also Feinstein v. Firestone Tire & Rubber Co., 535 F. Supp. 595, 601 (S.D.N.Y. 1982) (explaining that, under predominance criterion, court must "analyze the nature of the putative class's claims, and the proof that would be adduced in support of them"). 56

See In re Am. Med. Sys., Inc., 75 F.3d 1069, 1085 (6th Cir. 1996); see also Zinser, 253 F.3d at 1189 (""When individual rather than common issues predominate, the economy and efficiency of class action treatment are lost and the need for judicial supervision and the risk of confusion are magnified.'" (quoting 7A Charles Alan Wright et al., Federal Practice and Procedure 1778 (2d ed. 1986))). 57

Fed. R. Civ. P. 23(b)(3).

58

See, e.g., Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 164 (1974) (noting that manageability "encompasses the whole range of practical problems that may render the class action format inappropriate for a particular suit"). 59

See, e.g., Castano, 84 F.3d at 749 (rejecting proposals to "divide core liability from other issues such as comparative negligence and reliance" as based on notion that "the common issues will not be a part of follow-up trials," while, in fact, "the evidence presented at the class trial will have to be repeated … [and t]he net result may be a waste, not a savings, in judicial resources"); Emig v. Am. Tobacco Co., 184 F.R.D. 379, 393 (D. Kan. 1998) (finding smoker class action "does not further judicial economy because it would necessarily require some type of individual trial for every class member"); Arch v. Am. Tobacco Co., 175 F.R.D. 469, 495 (E.D. Pa. 1997) ("There may be no savings but rather a dimunition of judicial resources, and thus a reduction in judicial efficiency."); Smith v. Brown & Williamson Tobacco Corp., 174 F.R.D. 90, 94 (W.D. Mo. 1997) ("[A] class action in this case will create judicial diseconomy." (emphasis added)). 60

See, e.g., Castano, 84 F.3d at 742 ("[A] court cannot rely on assurances of counsel that any problems with predominance or superiority can be overcome."); Southwest Ref. Co. v. Bernal, 22 S.W.3d 425, 434-35 (Tex. 2000) ("When presented with significant individual issues, some courts have simply remarked that creative means may be designed to deal with them, without identifying those means or considering whether they would vitiate the parties' ability to present viable claims or defenses… . We reject this approach of certify now and worry later."); id. at 435 ("It is improper to certify a class without knowing how the claims can and will likely be tried."); see also Insolia v. Philip Morris Inc., 186 F.R.D 535, 546 (W.D. Wis. 1998) (rejecting trial plan as insufficient); Emig, 184 F.R.D. at 393-94 (same).

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Page 11 of 59 2005 Utah L. Rev. 863, *876 If a plaintiff alleges novel claims, those claims weigh against certification because the court does not have adequate information to determine superiority and predominance. 61 In contrast, individual litigation allows courts to "aggressively weed out untenable theories." 62 [*877] Under the Rules Enabling Act, class actions remain procedural methods that are not supposed to alter

substantive law. 63 As the Supreme Court noted in Amchem Products, Inc., v. Windsor, 64 the text of Rule 23 "limits judicial inventiveness." 65 Therefore, defendants must be able to raise the same rights and defenses in class litigation that they would be able to raise if the litigation only involved an individual plaintiff. 66

61

See, e.g., Castano, 84 F.3d at 747 ("[A] mass tort cannot be properly certified without a prior track record of trial from which the district court can draw the information necessary to make the predominance and superiority analysis … . This is because certification of an immature tort results in a higher than normal risk that the class action may not be superior to individual adjudication."); id. at 749 ("In the context of an immature tort, any savings in judicial resources is speculative, and any imagined savings would be overwhelmed by the procedural problems that certification of a sui generis cause of action brings with it."); Arch, 175 F.R.D. at 494 (noting importance of "prior track record of trials" as discussed in Castano, 84 F.3d at 747); In re Norplant Prods Liab. Contraceptive Litig., 168 F.R.D. 577, 578 (E.D. Tex. 1996) (dismissing claim for class certification because tort was immature); Kearns, supra note 15, at 1368-69 ("The novelty of the claim and the lack of a track record … thwarted plaintiff's efforts to demonstrate predominance and superiority."). This Article does not address speculative claims such as fearof-injury, nor does it address less common claims such as intentional or negligent infliction of emotional distress. Moreover, as noted supra note 4, this Article does not cover medical-monitoring claims, which involve separate issues than personal-injury actions. 62

Castano, 84 F.3d at 747 n.24; see also id. ("In a case such as this one, where causation is a key element, disaggregation of claims allows courts to dismiss weak and frivolous claims on summary judgment."); Ford v. Murphy Oil U.S.A., Inc., 703 So. 2d 542, 551 (La. 1997) ("With immature torts, the court must have experience with a tort in the form of several individual actions before it can certify … . A court cannot properly conduct a predominance inquiry without having any experience with that type of case."). 63

See, e.g., Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 612-13 (1997) (noting that Rule 23 must be kept within perimeters of Article III and Rules Enabling Act); Cimino v. Raymark Indus., Inc., 151 F.3d 297, 312 (5th Cir. 1998) ("Use of Rule 23(b)(3) … does not alter the required elements which must be found to impose liability and fix damages (or the burden of proof thereon) or the identity of the substantive law … which determines such elements."); Alabama v. Blue Bird Body Co., 573 F.2d 309, 318 (5th Cir. 1978) ("Just as the meaning of liability does not vary because a trial is bifurcated, the requisite proof also in no way hinges upon whether or not the action is brought on behalf of a class under Rule 23."); City of San Jose v. Super. Ct., 525 P.2d 701, 711 (Cal. 1974) ("Altering the substantive law to accommodate procedure would be to confuse the means with the ends … ."); Bernal, 22 S.W.3d at 435 (discussing boundaries of judicial interpretation of rule); Richard A. Nagareda, The Preexistence Principle and the Structure of the Class Action, 103 Colum. L. Rev. 149, 189-90 (2003) (noting that "the delegation made in the [Rules Enabling] Act must stop short of the full scope of legislative power that Congress itself might wield to "abridge, enlarge or modify' preexisting rights"); Note, The Rules Enabling Act and the Limits of Rule 23, 111 Harv. L. Rev. 2294, 2294 (1998) ("Rule 23 … does not alter substantive rights."). 64

521 U.S. 591 (1997).

65

Id. at 613, 620, 629; see also Ortiz v. Fibreboard Corp., 527 U.S. 815, 861 (1999) (noting that courts are "bound to follow Rule 23 as we understood it upon its adoption, and … are not free to alter it"). 66

See Ortiz, 527 U.S. at 845; Amchem, 521 U.S. at 613; see also id. at 623 (stating that class action is appropriate only for cases "sufficiently cohesive to warrant adjudication by representation"); Broussard v. Meineke Disc. Muffler Shops, Inc., 155 F.3d 331, 345 (4th Cir. 1998) (noting that "district court lost sight of the fact that a class action is "an exception to the usual rule that litigation is conducted by and on behalf of the individual named parties only'" (quoting Califano v. Yamasaki, 442 U.S. 682, 700-01 (1979))); Cimino, 151 F.3d at 312 (noting that "use of Rule 23(b)(3) … does not alter the required elements which must be found to impose liability and fix damages (or the burden of proof thereon) or the identity of substantive law … which determines such elements"); Blue Bird, 573 F.2d at 318 ("Just as the meaning of liability does not vary because a trial is bifurcated, the requisite proof also in no way hinges upon whether or not the action is brought on behalf of a class under Rule 23."); Nagareda, supra note 63, at 181 (arguing for "preexistence principle," which "holds that the class action has no roving

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Page 12 of 59 2005 Utah L. Rev. 863, *877 In deciding class certification, courts should therefore focus on the presence, in the entire litigation, 67 of issues that require individual [*878] determination for each class member. The presence of such issues may mean that (1) the claims of class representatives are not typical, because class members' claims rely on varying factual information or a different legal standard; (2) class representatives are not adequate representatives, because their claims differ factually or legally from the class members; (3) there may be no common issue among representatives and absent class members; (4) common issues may not predominate over individual issues; or (5) a class action may not be superior, because the adjudication of individualized issues may make the class action unmanageable. Avoiding such individual issues ensures the furtherance of judicial efficiency, accuracy, and procedural fairness, which underlie the class action's exception to the general rule that one's claims cannot be adjudicated by another. 68

Numerous individualized issues pervade mass tort litigation and render such litigation unsuitable for class treatment (as has been held recently by numerous federal 69 and state courts). 70 A list of these issues follows.

authority to alter unilaterally class members' preexisting bundle of rights, because the class action, properly understood, inherently differs from legislation enacted through the political branches of government"). 67

Rule 23(c)(4) provides that "when appropriate … an action may be brought or maintained as a class action with respect to particular issues." Fed. R. Civ. P. 23(c)(4). This provision has not been construed to allow a court to slice off any issue for class certification. See, e.g., Castano, 84 F.3d at 745 n.21 ("Reading Rule 23(c)(4) as allowing a court to sever issues until the remaining common issue predominates over the remaining individual issues would eviscerate the predominance requirement of Rule 23(b)(3); the result would be automatic certification in every case where there is a common issue, a result that could not have been intended."); id. (noting that "court cannot manufacture predominance through the nimble use of subdivision (c)(4)"); Emig v. Am. Tobacco Co., 184 F.R.D. 379, 395 (D. Kan. 1998) ("Certifying any of the common questions … will not advance this litigation… . Also, the common issues are inextricably entangled with the individual issues… . Adjudicating any of the common issues will not materially advance this litigation as a whole."); Small v. Lorillard Tobacco Co., 679 N.Y.S.2d 593, 601 (N.Y. App. Div. 1998) ("[A] trial court "cannot manufacture predominance' by "severing the defendants' conduct from reliance.'" (quoting Castano, 84 F.3d at 745 n.21 (5th Cir. 1996))), aff'd, 720 N.E.2d 892 (N.Y. 1999); Hines, supra note 19, at 610 ("The issue class action cannot escape the legitimacy and manageability concerns inherent in mass tort class actions."); Nagareda, supra note 63, at 239 (rejecting use of 23(c)(4)(a) in mass tort litigation and noting that "simply as a practical matter … the principle of comparative fault means that an individual proceeding on the damage question necessarily would have to revisit, for purposes of the required comparison, the defendant's wrongful conduct previously addressed in the class proceeding on the liability question"). 68

See Kearns, supra note 15, at 1337 (arguing that tobacco "class actions undermine[] procedural fairness, litigant autonomy, judicial efficiency, and common sense"). 69

See, e.g., Amchem, 521 U.S. at 628 (holding that individualized issues preclude class treatment); Ball v. Union Carbide Corp., 385 F.3d 713, 728 (6th Cir. 2004) (same); In re Bridgestone/Firestone, Inc. Tires Prods. Liab. Litig., 288 F.3d 1012, 1020-21 (7th Cir. 2002) (same); Zinser v. Accufix Research Inst., Inc., 253 F.3d 1180, 1196-97 (9th Cir. 2001) (same), amended by and reh'g denied, 273 F.3d 1266 (9th Cir. 2001); Barnes v. Am. Tobacco Co., 161 F.3d 127, 143 (3d Cir. 1998) (reversing certification of medical-monitoring smoker class because "addiction, causation, the defenses of comparative and contributory negligence, the need for medical monitoring and the statute of limitations present too many issues to permit certification"); Broussard, 155 F.3d at 343-44 (decertifying class and reversing $ 390 million judgment in franchisee-franchisor case and noting individual issues of misrepresentation, reliance, statutes of limitations, and damages); Cimino, 151 F.3d at 301 (reversing trial court's asbestos-case judgments because of failure to assess causation with regard to individuals, not groups, and statistical extrapolation of damages in violation of Seventh Amendment); Valentino v. Carter-Wallace, Inc., 97 F.3d 1227, 1229-32 (9th Cir. 1996) (reversing partial certification of class of 100,000 patients for personal injuries from epilepsy drug even though there was "only one manufacturer, only one product, only one marketing program, and a relatively short period of time"); Andrews v. Am. Tel. & Tel. Co., 95 F.3d 1014, 1024-27 (11th Cir. 1996) (reversing certification of class of millions bringing fraud claims against hundreds of 900-number telemarketing programs because of "individual questions of reliance"); Castano, 84 F.3d at 750 (reversing smoker class certification claiming addiction injury because of choice-of-law problems and because case was "permeated with individual issues, such as proximate causation, comparative negligence, reliance, and compensatory damages"); Georgine v. Amchem Prods., Inc., 83 F.3d 610, 634 (3d Cir. 1996) (ordering decertification of class claiming injury from asbestos exposure due to failure to meet typicality, adequacy of representation, predominance, and superiority requirements and because court could not "conceive of how any class of this magnitude could be certified"), aff'd sub nom. Amchem, 521 U.S. 591; In re Am. Med. Sys.,

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Page 13 of 59 2005 Utah L. Rev. 863, *878 [*879]

Decision Causation Individual issues surround a person's decision to use a product. For instance, in fraud claims, individual issues factor in determining whether each plaintiff relied on a particular misrepresentation, 71 which representations were [*880] seen, 72 and whether the reliance on the misrepresentation was reasonable. 73 Similar individualized issues arise under consumer-fraud claims, 74 RICO claims, 75 and express-warranty claims. 76 For fraudulent-

Inc., 75 F.3d 1069, 1084-85 (6th Cir. 1996) (decertifying penile-implant personal-injury class of 15,000 to 120,000 persons against one manufacturer with ten models of implants implanted over twenty-two years because there was "no common cause of injury"); In re Rhone-Poulenc Rorer, Inc., 51 F.3d 1293, 1297, 1304 (7th Cir. 1995) (decertifying class of approximately 10,000 hemophiliacs infected with AIDS from blood transfusion, and rejecting trial judge's plan for partial class certification and division of trial); see also Francis E. McGovern, Toward a Cooperative Strategy for Federal and State Judges in Mass Tort Litigation, 148 U. Pa. L. Rev. 1867, 1870 (2000) (noting "major shift in the mass tort litigation area," in which "courts of appeals have rejected many of the pragmatic case management approaches developed by the trial judges in the trenches"); id. ("The model of one-byone resolution of each individual's rights, either plaintiff's or defendant's, in the context of our system of federalism is the predominant model. Circumventing those principles, even if it means a more efficient outcome, is not acceptable."). 70

Although the individualized issues set forth in this Article counsel decertification of mass tort class actions in both federal and state courts, some state courts have been far more accommodating to class actions than others. Compare Southwestern Ref. Co. v. Bernal, 22 S.W.3d 425, 443 (Tex. 2000) (rejecting mass tort class certification in accord with federal approach), and Birnbaum, supra note 44, at 348 (noting "outrageous denial of due process" when "states like Alabama … certify before defendants are even served with the complaint, or prior to contested hearing"), with Mitchell v. H & R Block, Inc., 783 So. 2d 812, 818 (Ala. 2000) (Hooper, J., dissenting) ("Today's opinion suggests that Alabama seems intent upon remaining the poster child for yet another form of abuse of the judicial system--the "drive-by' class certification."), and Schwartz et al., supra note 14, at 499 (noting that over two-year period, state court in "Alabama certified almost as many class actions … as all 900 federal district courts did in a year"). One commentator has hypothesized that this is because state judges who are elected may feel pressure to bring settlement money into their jurisdictions or may feel professionally close to plaintiff's lawyers. Schwartz et al., supra note 14, at 502. 71

See, e.g., Andrews, 95 F.3d at 1024-25 (reversing certification of nationwide telemarketing fraud class and noting that "the plaintiffs would still have to show, on an individual basis, that they relied on the misrepresentations, suffered injury as a result, and incurred a demonstrable amount of damages"); Castano, 84 F.3d at 745 ("[A] fraud class action cannot be certified when individual reliance will be an issue… . The problem with the district court's approach is that after the class trial, it might have decided that reliance must be proven in individual trials. The court then would have been faced with the difficult choice of decertifying the class after phase 1 and wasting judicial resources, or continuing with a class action that would have failed the predominance requirement rule of 23(b)(3)."); Philip Morris, Inc. v. Angeletti, 752 A.2d 200, 235 (Md. 2000) ("One need only read the deposition of the named class representatives to recognize that reliance will vary from plaintiff to plaintiff."). 72

See, e.g., Szabo v. Bridgeport Machs., Inc., 249 F.3d 672, 677 (7th Cir. 2001) ("Nagging issues of choice of law, commonality, and manageability beset this case. It is unlikely that dealers in different parts of the country said the same things to hundreds of different buyers."); Clay v. Am. Tobacco Co., 188 F.R.D. 483, 492 (S.D. Ill. 1999) ("All members of the proposed class were not subjected to the same advertising and that advertising did not have a similar effect on all members. To the extent that the advertising actually reached the class members, it arrived through different mediums and with greatly varying degrees of success."). 73

See Broussard, 155 F.3d at 341 (noting "the reliance element" is "not readily susceptible to class-wide proof" because "if a plaintiff had an alternative source for the information that is alleged to have been concealed from or misrepresented to him, his ignorance or reliance on any misinformation is not reasonable"). 74

See, e.g., In re Rezulin Prods. Liab. Litig., 210 F.R.D. 61, 68 (S.D.N.Y. 2002) ("Absent a contrary showing by plaintiffs, and they have attempted none, it appears entirely probable that even a consumer fraud theory would require individualized proof concerning reliance and causation, which are hornbook elements of a fraud claim, as prerequisites to recovery by many and perhaps most of the members of the alleged class." (citation omitted)); Clay, 188 F.R.D. at 503 (finding that consumer-fraud statutes of six states "require[] the plaintiff to show that the defendants' misconduct caused the alleged harm").

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Page 14 of 59 2005 Utah L. Rev. 863, *880 concealment claims, individual issues include whether there was a duty to disclose 77 and whether the alleged disclosure would have prevented a plaintiff from using a product. 78 [*881] Similarly, in failure-to-warn claims, individual issues appear in determining whether an additional warning would have affected plaintiff's decision to use a product. 79 For both negligence and strict liability claims, individual issues exist in considering whether each plaintiff's recovery should be reduced or eliminated under the defenses of comparative fault or assumption of the risk, based on the plaintiff's awareness of the product's dangers. 80 Each plaintiff's decision to sue also implicates individual assessments in adjudicating statute-of-limitations defenses, which inquire into each plaintiff's awareness of when he or she was injured and what grounds exist to know the injury was caused by someone else. 81

75

See, e.g., Sandwich Chef of Tex., Inc. v. Reliance Nat. Indem. Ins. Co., 319 F.3d 205, 219 (5th Cir. 2003) ("The pervasive issues of individual reliance that generally exist in RICO fraud actions create a working presumption against class certification."), cert. denied, 540 U.S. 819 (2003); Patterson v. Mobil Oil Corp., 241 F.3d 417, 419 (5th Cir. 2001) (rejecting certification in RICO case based on need to prove individualized reliance); Bolin v. Sears, Roebuck & Co., 231 F.3d 970, 978 (5th Cir. 2000) (same). But see Chisolm v. TranSouth Fin. Corp., 194 F.R.D. 538, 560-62 (E.D. Va. 2000) (adopting RICO presumption of reliance based on standardized forms, but noting that "presumed reliance under civil RICO is generally disfavored outside of certain narrow contexts"). 76

See, e.g., Andrews, 95 F.3d at 1025 (rejecting class certification based on need to prove individualized reliance and other divergent issues); Fisher v. Bristol-Myers Squibb Co., 181 F.R.D. 365, 369 (N.D. Ill. 1998) (same); Marascalco v. Int'l Computerized Orthokeratology Soc'y, Inc., 181 F.R.D. 331, 339 (N.D. Miss. 1998) (same); Mick v. Ravenswood Aluminum Corp., 178 F.R.D. 90, 94 (S.D. W. Va. 1998) (same); Smith v. Brown & Williamson Tobacco Corp., 174 F.R.D. 90, 97 (W.D. Mo. 1997) (claims for express warranty were "permeated with individual issues" because they "require proof that purchasers were induced to make purchases based on affirmative representations" and "the role those representations played in individual purchasing decisions" differed among putative class members); In re Masonite Corp. Hardboard Siding Prods. Liab. Litig., 170 F.R.D. 417, 425 (E.D. La. 1997) ("It is impossible to proceed on a class warranty trial, even under one state's law or the UCC."). 77

See, e.g., In re Ford Motor Co. Vehicle Paint Litig., 182 F.R.D. 214, 224 (E.D. La. 1998) ("The core issue of fraudulent concealment involves whether the plaintiffs knew or had reasonable access to the information allegedly concealed from them."); Mack v. Gen. Motors Acceptance Corp., 169 F.R.D. 671, 677 (M.D. Ala. 1996) ("The question of whether there was a duty to disclose … depends on the facts and circumstance of each case."). 78

See, e.g., Broussard v. Meineke Disc. Muffler Shops, Inc., 155 F.3d 331, 342 (4th Cir. 1998) (finding that "each class member potentially had access to several alternative sources of the information alleged to have been fraudulently concealed" and that "extent of knowledge of the omitted facts or reliance on misrepresented facts" would differ among class members); Hardee's of Maumelle, Ark., Inc. v. Hardee's Food Sys., Inc., 31 F.3d 573, 580 (7th Cir. 1994) (requiring reliance under Indiana law for fraudulent-omission claim); Ex parte Household Retail Servs., Inc., 744 So. 2d 871, 879 (Ala. 1999) ("Under Alabama law reliance is an element necessary to establish liability for [fraudulent] suppression." (emphasis added)). 79

See, e.g., Block v. Abbott Labs., No. 99 C 7457, 2002 WL 485364, at 4 (N.D. Ill. Mar. 29, 2002) ("We are very troubled by the prospect of having to resolve the highly individualized issue of proximate cause with respect to the failure-to-warn claim."). 80

See, e.g., Barnes v. Am. Tobacco Co., 161 F.3d 127, 146-47, 149 (3d Cir. 1998) (affirming decertification of medicalmonitoring class of smokers based in part on individualized issues of comparative fault and contributory negligence); Georgine v. Amchem Prods., 83 F.3d 610, 627-28 (3d Cir. 1996) (reviewing nationwide asbestos settlement class and stating that affirmative defenses of comparative fault and statute of limitations may "depend on facts peculiar to each plaintiff's case"), aff'd sub nom. Amchem, 521 U.S. 591; In re Am. Med. Sys., Inc., 75 F.3d 1069, 1085 (6th Cir. 1996) ("The alleged tortfeasor's affirmative defenses (such as failure to follow directions, assumption of the risk, negligence, and statute of limitations) may depend on facts peculiar to each plaintiff's case."); In re Rezulin Prods. Liab. Litig., 210 F.R.D. 61, 67 (S.D.N.Y. 2002) ("The claims of many class members may be subject to individual defenses such as comparative or contributory negligence."). 81

See, e.g., Barnes, 161 F.3d at 149 ("Determining whether each class member's claim is barred by the statute of limitations raises individual issues that prevent class certification." (citation omitted)); Broussard, 155 F.3d at 343-44 (reversing class-action judgment because of inability to establish that some class members knew about defendants' conduct beyond limitations period); O'Connor v. Boeing N. Am., Inc., 197 F.R.D. 404, 410-11, 420-21 (S.D. Cal. 2000) (decertifying class).

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Page 15 of 59 2005 Utah L. Rev. 863, *881 Medical Causation In medical causation, individual issues relate to whether a particular plaintiff's disease or injury is caused by defendant's manufactured product, another defendant's product, 82 or another causative agent. 83 For example, a [*882] disease such as cancer may be caused by numerous exposures, plaintiff's life choices, or cancer that has metastasized from another part of the body. 84 Product Defect Different types or models of products may vary and require individualized analysis to determine whether a defect exists. 85 Damages Individualized issues appear in assessing each plaintiff's past lost wages, future lost wages, medical expenses, and pain and suffering. 86

82

See, e.g., Cimino v. Raymark Indus., Inc., 151 F.3d 297, 315 (5th Cir. 1998) (finding error in judgment against defendant where trial of class action had not provided "any determination of whether a Pittsburgh Corning product was a cause of [each plaintiff's] disease"); In re Agent Orange Prod. Liab. Litig., 818 F.2d 145, 173 (2d Cir. 1987) ("It is therefore impossible to attribute the exposure of an individual … to the product of a particular company."). But see Hensler & Peterson, supra note 24, at 1039 (discussing adoption of "market share" liability in DES cases based on defendant's share of market for product, but noting courts' unwillingness to apply market share outside of DES context). 83

See, e.g., Amchem, 521 U.S. at 624 (discussing difficulty of determining whether injuries trace back to defendant's product); Zinser v. Accufix Research Inst., Inc., 253 F.3d 1180, 1189 (9th Cir. 2001) ("To determine causation and damages for each of the three claims asserted here, it is inescapable that many triable individualized issues may be presented… . Was [the alleged defect] caused by improper handling of the [product] by physicians or medical staff?"), amended by 273 F.3d 1266 (9th Cir. 2001); Nickerson v. G.D. Searle & Co., 900 F.2d 412, 420 (1st Cir. 1990) (stating that defendants had right to present evidence that something other than defendant's product caused infertility of plaintiff); Agent Orange, 818 F.2d at 165 ("The relevant question … is not whether Agent Orange has the capacity to cause harm, the generic causation issue, but whether it did cause harm and to whom. That determination is highly individualistic, and depends upon the characteristics of individual plaintiffs (e.g., state of health, lifestyle) and the nature of their exposure to Agent Orange."); Southwestern Refining Co. v. Bernal, 22 S.W.3d 425, 436 (Tex. 2000) ("Causation … issues are uniquely individual to each class member."); Hensler & Peterson, supra note 24, at 1019 ("Large numbers of injuries may occur and appear to be linked to product use or exposure when an exposed population is subject to injuries from other sources. Many regarded the litigation that arose over Bendectin, the anti-nausea drug marketed to pregnant women, as a classic example of this "false positive' problem." (citation omitted)). 84

See Hensler & Peterson, supra note 24, at 1016 ("For example, lung cancer caused by asbestos exposure cannot be distinguished from lung cancer caused by smoking and a variety of other environmental exposures.").

85

See, e.g., Cimino, 151 F.3d at 331 (discussing diversity of defectiveness in different products); In re Am. Med. Sys., Inc., 75 F.3d 1069, 1081 (6th Cir. 1996) (same); Emig v. Am. Tobacco Co., 184 F.R.D. 379, 391 (D. Kan. 1998) (same); Arch v. Am. Tobacco Co., 175 F.R.D. 469, 489 (E.D. Pa. 1997) (same); Smith v. Brown & Williamson Tobacco Corp., 174 F.R.D. 90, 98 (W.D. Mo. 1997) (same); Manual, supra note 1, at 22.2 ("The number and extent of the [product] variations will affect the extent to which proof of deficiencies applies across a substantial group of claimants."). 86

See, e.g., Broussard, 155 F.3d at 343 (noting need for "individualized proof of damages" and stating that "plaintiffs attempted to substitute this "hypothetical or speculative' evidence, divorced from any actual proof of damages, for the proof of individual damages necessary to meet … standard of proof"); Allison v. Citgo Petroleum Corp., 151 F.3d 402, 419 (5th Cir. 1998) (noting recovery of damages necessitated "individualized and independent proof of injury to, and the means by which discrimination was inflicted upon, each class member"); Castano v. Am. Tobacco Co., 84 F.3d 734, 750 (5th Cir. 1996) ("This class action is permeated with individual issues, such as … compensatory damages."); In re Fibreboard Corp., 893 F.2d 706, 711 (5th Cir. 1990) (stating that "wage losses, pain and suffering, and other elements of compensation" under state law "focus upon individuals, not groups"); Bernal, 22 S.W.3d at 436 ("Damages issues are uniquely individual to each class member."); Manual,

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Page 16 of 59 2005 Utah L. Rev. 863, *882 [*883]

Choice of Law Determining which state's law applies to each plaintiff's claims also requires individual determinations. Although choice-of-law problems arise in multi-state classes, single-state classes also implicate choice-of-law issues because of the mobility of class members. 87 In addition, state laws vary significantly on numerous product-liability claims, defenses, and damages, preventing certification. 88 As a result, attempting to address these conflicts [*884] through subclassing or special jury instructions results in baffling complexity for the jury. 89

supra note 1, at 22.2 ("Proof of individual, compensatory damages will typically be specific to each claimant. Accordingly, individual decisions on actual damages are usually required."). 87

See, e.g., Emig, 184 F.R.D. at 394 (noting proposed Kansas class); Brown & Williamson, 174 F.R.D. at 94-96 (finding it "inconceivable" that Missouri law would apply to smoking injury claims of all Missouri residents); Tijerina v. Philip Morris, Inc., No. CIV.A. 2:95-CV-120-J, 1996 WL 885617, at 5 (N.D. Tex. Oct. 8, 1996) ("The latest definition of the proposed class limiting it to residents of Texas by no means eliminates difficult questions concerning which state law is applicable. With a transient population, the alleged tort could have occurred anywhere."); Reed v. Philip Morris, Inc., No. 96-5070, 1997 WL 538921, at 14 (D.C. Super. Aug. 18, 1997) (rejecting class of Washington D.C. smokers); Philip Morris, Inc. v. Angeletti, 752 A.2d 200, 254 (Md. 2000) (reversing certification of Maryland smoker class); Kearns, supra note 15, at 1370-71 & n.195 (discussing problems in application of several states' laws in certification case). 88

See, e.g., In re Bridgestone/Firestone, Inc., 288 F.3d 1012, 1018 (7th Cir. 2002) ("State consumer protection laws vary considerably, and courts must respect these differences rather than apply one state's law to sales in other states with different rules."); Szabo v. Bridgeport Machs., Inc., 249 F.3d 672, 674 (7th Cir. 2001) ("A nationwide class in what is fundamentally a breach-of-warranty action, coupled with a claim of fraud, poses serious problems about choice of law, the manageability of the suit, and thus the propriety of class certification."); Zinser, 253 F.3d at 1188 ("As the district court noted, "the laws of negligence [and] products liability … differ in some respects from state to state.'" (citation omitted)); Andrews v. Am. Tel. & Tel. Co., 95 F.3d 1014, 1024 (11th Cir. 1996) ("The appellants cite the need to interpret and apply the gaming laws of all fifty states … as foremost among the difficulties in trying the gambling claims on a class basis, and we agree … ."); Castano, 84 F.3d at 742 n.15 ("We find it difficult to fathom how common issues could predominate in this case when variations in state law are thoroughly considered."); id. at 741 ("In a multi-state class action, variations in state law may swamp any common issues and defeat predominance."); Georgine v. Amchem Prods., Inc., 83 F.3d 610, 627-28 (3d Cir. 1996) (reviewing nationwide asbestos settlement class, and noting need to "apply an individualized choice of law analysis to each plaintiff's claims," and "states['] … different rules governing the whole range of issues raised by the plaintiff's claims"), aff'd sub nom. Amchem, 521 U.S. 591; In re Am. Med. Sys., Inc., 75 F.3d 1069, 1085, 1090 (6th Cir. 1996) (granting mandamus to decertify penile-implants class because of, inter alia, choice-of-law problems); In re Rhone-Poulenc v. Rorer, Inc., 51 F.3d 1293, 1300-02 (7th Cir. 1995) (decertifying nationwide hemophiliac class infected with AIDS because of, inter alia, need to apply fifty states' laws--with their attendant differences); id. at 1300 ("Nuance can be important, and its significance is suggested by a comparison of differing state pattern instructions on negligence and differing judicial formulations of the meaning of negligence and the subordinate concepts."); In re Baycol Prods. Litig., 218 F.R.D. 197, 208 (D. Minn. 2003) (rejecting class certification and noting that "differences in state law, no matter how slight, are important and must be determined prior to certification because such differences may "swamp any common issues and defeat predominance'" (quoting Castano, 84 F.3d at 741)); In re Rezulin Prods. Liab. Litig., 210 F.R.D. 61, 71 (S.D.N.Y. 2002) (finding that "individual issues arising by virtue of the multiplicity of varying state laws predominated over common issues"); Manual, supra note 1, at 22.1 ("Some approaches, especially those that aggregate large numbers of claims with significant variations, may not comply with the underlying substantive law or may be unfair to some litigants."); Birnbaum, supra note 44, at 347 (noting that because of choice-of-law problems, "it is not possible … for a court to certify a national class of anything in the tort area"); Kearns, supra note 15, at 1364 (arguing that choice of law problems prevent class certification of tobacco addiction class actions). 89

See, e.g., In re Bridgestone/Firestone, 288 F.3d at 1018 ("Because those claims must be adjudicated under the laws of so many jurisdictions, a single nationwide class is not manageable."); In re LifeUSA Holding Inc., 242 F.3d 136, 147 (3d Cir. 2001) (stating that "the District Court failed to consider how individualized choice of law analysis of the forty-eight jurisdictions would impact on Rule 23's predominance requirement, as well as individual determinations of causation, adjudications of contract law, reliance, … and LifeUSA's defenses of contributory/comparative negligence and limitations" (citation omitted)); In re Am. Med. Sys., 75 F.3d at 1085 ("If more than a few of the laws of the fifty states differ, the district judge would face an impossible task of

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Page 17 of 59 2005 Utah L. Rev. 863, *884 In light of the problems discussed above, plaintiffs' counsel have presented, and courts have rejected, radical trial plans seeking to adjudicate these individual issues in a class setting. 90 For example, courts have rejected radical trial plans that have relied upon the following: a fictional composite of the class; 91 expert testimony to address individualized issues in an aggregate manner--such as causation or damages not as to individuals, but as to groups, using statistical methods; 92 affidavits or questionnaires to conduct the trial; 93 [*885] abstract examinations of a defendant's conduct or generic causation; 94 and awarding punitive damages prior to instructing a jury on the relevant law, yet another reason why class certification would not be the appropriate course of action."); Birnbaum, supra note 44, at 347 ("As some courts have explained--and I have experienced first-hand--it is simply impossible to synthesize the products liability law of the fifty states into a meaningful jury instruction for a class action trial without trampling on the sovereignty of those states, which have made some fundamentally different policy choices in their products liability rules."). 90

See, e.g., Amchem, 521 U.S. at 617-18 (noting ""adventuresome'" use of Rule 23 in attempt to "cope with claims too numerous to secure their "just, speedy, and inexpensive determination' one by one"); Kearns, supra note 15, at 1372 ("The magnitude of any tobacco class action may encourage innovative management techniques like sampling or other general extrapolations of liability and damages."). 91

See, e.g., Broussard, 155 F.3d at 344-45 (rejecting plaintiffs' proposed "perfect plaintiff," and noting that "plaintiffs portrayed the class at trial as a large, unified group that suffered a uniform, collective injury. And [the defendant] was often forced to defend against a fictional composite without the benefit of deposing or cross-examining the disparate individuals behind the composite creation."); In re Paxil Litig., 212 F.R.D. 539, 548 (C.D. Cal. 2003) ("[A] class trial on liability without any reference to [Defendant's defenses] runs "the real risk … of a composite case being much stronger than any plaintiff's individual action would be … [and] permitting plaintiffs to strike [Defendants] with selective allegations, which may or may not have been available to individual named plaintiffs.'" (quoting O'Connor v. Boeing N. Am., Inc., 197 F.R.D. 404, 415 (C.D. Cal. 2000)) (alterations in original) (internal quotation marks omitted)). 92

For example, as the Fifth Circuit held in an asbestos case:

A contemplated "trial" of the 2,990 class members without discrete focus can be no more than the testimony of experts regarding their claims, as a group, compared to the claims actually tried to a jury. That procedure cannot focus upon such issues as individual causation, but ultimately must accept general causation as sufficient, contrary to Texas law… . "Population-based probability estimates do not speak to a probability of causation in any one case; the estimate of relative risk is a property of the studied population, not of an individual's case." This type of procedure does not allow proof that a particular defendant's asbestos "really' caused a particular plaintiff's disease; … . This is the inevitable consequence of treating discrete claims as fungible claims… . The procedures here called for comprise something other than a trial … . It is called a trial, but is not. In re Fibreboard Corp., 893 F.2d 706, 711-12 (5th Cir. 1990); see also Cimino v. Raymark Indus., 151 F.3d 297, 300 (5th Cir. 1998) (reversing judgment based on extrapolation of average of 160 verdicts to other plaintiffs with same disease); Fibreboard, 893 F.2d at 711 (noting that causation analyses "focus upon individuals, not groups," as do "wage losses, pain and suffering, and other elements of compensation"); In re Ford Motor Co. Ignition Switch Prods. Liab. Litig., 194 F.R.D. 484, 492-93 (D. N.J. 2000) (denying class certification, rejecting statistical proof of causation, and noting that "any proffer of prima facie proof of causation must be viewed with skepticism because it fails to resolve any individual claim without more evidence, and that a threshold requirement for certification is a realistic litigation plan for resolution of individual causation"); Arch v. Am. Tobacco Co., 175 F.R.D. 469, 493 (E.D. Pa. 1997) (rejecting "use of claim forms, statistical random sampling, depositions, expert opinion and court-appointed masters" instead of individual cross-examination, and noting that such approaches "abrogate the constitutional rights of defendants"). 93

See, e.g., Barnes v. Am. Tobacco Co., 161 F.3d 127, 145-46 (3d Cir. 1998) (discussing use of questionnaire in possible certification case to prove causation of individualized injuries); Arch, 175 F.R.D. at 493, 489 n.21 (holding that use of questionnaires to establish injury and causation violated defendant's due process rights); Kearns, supra note 15, at 1374-75 (noting that any use of "non-individual determination of causation," including questionnaires, has been found violative of defendant's due process rights). 94

As the Second Circuit stated in Agent Orange:

The relevant question … is not whether Agent Orange has the capacity to cause harm, the generic causation issue, but whether it did cause harm and to whom. That determination is highly individualistic, and depends upon the characteristics of individual plaintiffs (e.g., state of health, lifestyle) and the nature of their exposure to Agent Orange. Although generic causation and

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Page 18 of 59 2005 Utah L. Rev. 863, *885 compensatory damages awards for all class [*886] members. 95 These plans may amount to a denial of due process to defendants, as well as run afoul of many of the problems mentioned above. 96 For [*887] their rights to individual circumstances concerning each plaintiff and his or her exposure to Agent Orange thus appear to be inextricably intertwined, the class action would have allowed generic causation to be determined without regard to those characteristics and the individual's exposure. In re Agent Orange Prod. Liab. Litig., 818 F.2d 145, 165 (2d Cir. 1987); see also Patterson v. Mobil Oil Corp., 241 F.3d 417, 419 (5th Cir. 2001) (stating that "effort to decide" only defendant's conduct "would be no more than the trial of an abstraction - for which subclassing and bifurcation is no cure"); Estate of Mahoney v. R.J. Reynolds Tobacco Co., 204 F.R.D. 150, 157 (S.D. Iowa 2001) ("No one seriously doubts the general premise that smoking causes cancer… . [A] plaintiff must necessarily eliminate all other risk factors as possible causes of his lung cancer."); Barreras Ruiz v. Am. Tobacco Co., 180 F.R.D. 194, 195, 197 (D.P.R. 1998) (denying class certification based on first phase trial on defendant conduct, and noting that plaintiffs' approach "suggests a nearly cavalier attitude toward the complexity of the class they propose"); Arch, 175 F.R.D. at 488 ("Unless it is proven that cigarettes always cause or never cause addiction, "the resolution of the general causation accomplishes nothing for any individual plaintiff.'" (quoting Agent Orange, 818 F.2d at 164)). 95

See, e.g., In re Simon II Litig., 407 F.3d 125, 138 (2d Cir. 2005) ("In certifying a class that seeks an assessment of punitive damages prior to an actual determination and award of compensatory damages, the district court's Certification Order would fail to ensure that a jury will be able to assess an award that, in the first instance, will bear a sufficient nexus to the actual and potential harm to the plaintiff class, and that will be reasonable and proportionate to those harms."); Allison v. Citgo Petroleum Corp., 151 F.3d 402, 417-418 (5th Cir. 1998) (stating that "because punitive damages must be reasonably related to the reprehensibility of the defendant's conduct and to the compensatory damages awarded to the plaintiffs, … recovery of punitive damages must necessarily turn on the recovery of compensatory damages" and further noting that punitive damages "require proof of how discrimination was inflicted on each plaintiff" (citations omitted)); In re Baycol Prods. Litig., 218 F.R.D. 197, 215 (D. Minn. 2003) ("Plaintiffs' proposed class trial on punitive damages poses similar due process concerns because the conduct upon which Plaintiffs would base their punitive damages claim is not specific to a particular plaintiffs' [sic] claims."); Smith v. Brown & Williamson Tobacco Corp., 174 F.R.D. 90, 97 (W.D. Mo. 1997) ("Plaintiff's proposal to have liability for punitives established in Phase I, then wait until Phase III to see if class members have suffered damages so they can "keep' the award … radically alters appropriate consideration of the issue … . Furthermore, the amount of punitives must bear a relationship to the actual damages suffered … ." (citations omitted)); Philip Morris, Inc. v. Angeletti, 752 A.2d 200, 249 (Md. 2000) ("Allowing a single jury to set irrevocably the amount of punitive damages to be imposed relative to and on behalf of several, let alone thousands of individuals, whose actual damages are themselves determined separately from each other, does not enable the jury to properly assess the amount of punitive damages that are appropriate in specific relation to differing amounts of--and reasons for--actual damages."); Southwestern Ref. Co. v. Bernal, 22 S.W.3d 425, 433 (Tex. 2000) ("Under the [trial plan], the jury would decide punitive damages for the entire class without knowing the severity of the offense or the extent of compensatory damages, if any, for each of the 885 plaintiffs. The certification order's provision to eliminate punitive damages for plaintiffs who are not able to prove actual damages may limit the harm to [defendant]. But the modified trial plan is nevertheless prejudicial because it fails to ensure that punitive damages have some understandable relationship to compensatory damages and are not grossly out of proportion to the severity of the offense for each of the 885 plaintiffs."). Indeed, the United States Supreme Court recently reiterated the need for punitive damages to be related to the harm suffered when it reversed a $ 145 million punitive damages verdict that was based on conduct dissimilar to that which was directed by a defendant toward the plaintiff seeking damages. See State Farm Mut. Auto Ins. Co. v. Campbell, 538 U.S. 408, 429 (2003); see also Simon II, 407 F.3d at 139 ("State Farm made clear that conduct relevant to the reprehensibility analysis must have a nexus to the specific harm suffered by the plaintiff, and that it could not be independent of or dissimilar to the conduct that harms the plaintiff. Harmful behavior that is not correlatable with class members and the harm to them would be precluded under State Farm." (citation omitted)); BMW of N. Am., Inc. v. Gore, 517 U.S. 559, 580 (1996) (repeating "principle that exemplary damages must bear a "reasonable relationship' to compensatory damages" and noting that "most commonly cited indicium of an unreasonable or excessive punitive damages award is its ratio to the actual harm inflicted on the plaintiff"); Honda Motor Co. v. Oberg, 512 U.S. 415, 429 (1994) (holding that due process does not allow "punitive damages of arbitrary amounts"); id. at 436 (Scalia, J., concurring) ("The deprivation of property without observing (or providing a reasonable substitute for) an important traditional procedure for enforcing stateprescribed limits upon such deprivation violates the Due Process Clause."). 96

See, e.g., Broussard v. Meineke Disc. Muffler Shops, Inc., 155 F.3d 331, 352 (4th Cir. 1998) ("Without respect for law neither the class action device nor the jury system can serve the important functions for which they were intended."); Fibreboard, 893 F.2d at 711 (rejecting trial plan and noting that problems "find expression in defendants' right to due process"); see also Nelson v. Adams USA, Inc., 529 U.S. 460, 465 (2000) ("The Federal Rules of Civil Procedure are designed to further the due process of

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Page 19 of 59 2005 Utah L. Rev. 863, *887 be preserved, defendants must be able to challenge the bases of the proof offered.

97

Moreover, proposals to decide these individual issues by empanelling separate juries in a class action may violate the Seventh Amendment. If separate juries decide commingled factual questions, one jury may reexamine the first jury's findings, thus violating the plaintiff's or defendant's Seventh Amendment right to a jury trial. 98 For example, a first jury trial verdict [*888] regarding supposedly generic issues such as fraud would be reexamined by a second jury looking into what each class member saw, knew, and relied upon. To warrant class certification, plaintiffs must submit a workable trial plan that shows how to manageably try the class action without violating defendants' rights. 99

law that the Constitution guarantees."); In re Repetitive Stress Injury Litig., 11 F.3d 368, 373 (2d Cir. 1993) (""The systemic urge to aggregate litigation must not be allowed to trump our dedication to individual justice, and we must take care that each plaintiff's--and defendant's--cause not be lost in the shadow of a towering mass litigation.'" (quoting In re Brooklyn Navy Yard Asbestos Litig., 971 F.2d 831, 853 (2d Cir. 1992))); Kearns, supra note 15, at 1364 (noting that "due process rights of defendants are implicated by trial management techniques encouraged by the magnitude of tobacco class actions" and arguing that such concerns should prevent certification of tobacco addiction class action). 97

See, e.g., Windham v. Am. Brands, Inc., 565 F.2d 59, 71 (4th Cir. 1977) (holding that court may not "deny or limit a litigant's right to offer relevant "intertwined matters'" (emphasis added)); W. Elec. Co. v. Stern, 544 F.2d 1196, 1199 (3d Cir. 1976) ("To deny [defendant's] right to present a full defense on the issues would violate due process … . Defendants must be allowed to present any relevant rebuttal evidence they choose … ."); Kline v. Coldwell, Banker & Co., 508 F.2d 226, 238 (9th Cir. 1974) (noting each defendant's "undoubted right" to offer evidence in defense); Bernal, 22 S.W.3d 425 at 437 ("And basic to the right to a fair trial--indeed, basic to the very essence of the adversarial process - is that each party have the opportunity to adequately and vigorously present any material claims and defenses. If [defendant] chooses to challenge the credibility of and its responsibility for each personal injury claim individually, then what may nominally be a class action initially would degenerate in practice into multiple lawsuits separately tried."); Chang v. State Farm Mut. Auto Ins. Co., 514 N.W.2d 399, 402 n.4 (Wis. 1994) ("[A] defendant is entitled to require that each and every class member seeking recovery prove his or her actual and individualized damages."). 98

See, e.g., Gasoline Prods. Co v. Champlin Ref. Co., 283 U.S. 494, 499-500 (1931) (holding that Seventh Amendment requires that related issues of fact be decided by one jury, not reexamined by second jury); Allison, 151 F.3d at 419-20 ("In order to manage the case, the district court faced the likelihood of bifrucated proceedings before multiple juries. This result … increased the probability that successive juries would pass on issues decided by prior ones, introducing potential Seventh Amendment problems and further decreasing the superiority of the class action device."); Cimino, 151 F.3d at 312 ("The applicability of the Seventh Amendment is not altered simply because the case is Rule 23(b)(3) class action."); id. at 319 (stating that "causation must be determined as to "individuals, not groups,'" and that "the Seventh Amendment gives the right to a jury trial to make that determination"); Castano v. Am. Tobacco Co., 84 F.3d 734, 750-51 (5th Cir. 1996) ("The Seventh Amendment entitles parties to have fact issues decided by one jury, and prohibits a second jury from reexamining those facts and issues… . Comparative negligence, by definition, requires a comparison between the defendant's and the plaintiff's conduct… . At a bare minimum, a second jury will rehear evidence of the defendant's conduct… . In such a situation, the second jury would be impermissibly reconsidering the findings of a first jury. This risk of such reevaluation is so great that class treatment can hardly be said to be superior to individual adjudication."); In re Rhone-Poulenc Rorer, Inc., 51 F.3d 1293, 1297, 1303 (7th Cir. 1995) (stating that "judge must not divide issues between separate trials in such a way that the same issue is reexamined by different juries"). 99

See, e.g., Zinser v. Accufix Research Inst., Inc., 253 F.3d 1180, 1189 (9th Cir. 2001) ("Because [Plaintiff] seeks certification of a nationwide class for which the law of forty-eight states potentially applies, she bears the burden of demonstrating "a suitable and realistic plan for trial of the class claims.'"), amended by 273 F.3d 1266 (9th Cir. 2001); Barreras Ruiz v. Am. Tobacco Co., 180 F.R.D. 194, 195, 197 (D. P.R. 1998) (rejecting plan that called for defendant-conduct-only class trial and then additional trials for individual issues, and stating that proposed trial plan "suggests a nearly cavalier attitude towards the complexity of the class [Plaintiffs] propose").

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Page 20 of 59 2005 Utah L. Rev. 863, *888 However, with regard to multiple-incident, personal-injury class actions, a class action trial that preserves due process rights will devolve into unmanageable mini-trials. 100 For example, in Engle v. R.J. Reynolds Tobacco [*889] Co., 101 a class action of Florida smokers against the tobacco industry, the trial court stated that trial proceedings would continue until "the 23rd century." 102 Similarly, in Broin v. Philip Morris Inc., 103 a class action of flight attendants nationwide suing the tobacco industry for secondhand smoke exposure, the court stated that after six years of litigation, it still contemplated "years of additional litigation to adjudicate the individual issues as to all class members," and noted that "the mind boggles at the thought of Jury Instructions, and the attendant hearings thereto." 104 Notwithstanding these problems, defense counsel may still feel compelled to settle class actions, because the defendant may not be able to obtain appellate review of a class action. If plaintiffs prevail in a product-liability class action, the verdict is likely to be so gargantuan that the defendants may not be able to post the bond necessary to

100

See, e.g., Zinser, 253 F.3d at 1192 (finding no superiority in proposed pacemaker implantee class and noting that "if each class member has to litigate numerous and substantial separate issues to establish his or her right to recover individually, a class action is not "superior'"); In re LifeUSA Holdings Inc., 242 F.3d 136, 148 (3d Cir. 2001) (noting, in case involving alleged annuities fraud, that "in terms of efficiency, a class of this magnitude and complexity could not be tried. There are simply too many uncommon issues, and the number of class members is surely too large. Considered as a litigation class, then, the difficulties likely to be encountered in the management of this action are insurmountable."); Patterson v. Mobil Oil Corp., 241 F.3d 417, 419 (5th Cir. 2001) ("To determine reliance for each individual class member would defeat the economies ordinarily associated with the class action device. An effort to decide … whether Mobil was effectively insured … would be no more than the trial of an abstraction - for which subclassing and bifurcation is no cure."); Barnes v. Am. Tobacco Co., 161 F.3d 127, 149 (3d Cir. 1998) ("[A] class action will devolve into a lengthy series of individual trials."); Valentino v. Carter-Wallace, Inc., 97 F.3d 1227, 1234 (9th Cir. 1996) (finding no predominance for putative class of 100,000 epilepsy patients against drug manufacturer because there was "no showing by Plaintiffs of how the class trial could be conducted"); Castano, 84 F.3d at 748 (noting "severe manageability problems"); Insolia v. Philip Morris, Inc., 186 F.R.D. 535, 546 (W.D. Wis. 1998) (calling trial plan "sheer fantasy" because putative class was "plagued by individual issues"); Emig v. Am. Tobacco Co., 184 F.R.D. 379, 393 (D. Kan. 1998) (noting that "proposed trial plan does not overcome the management problems that would arise if the action were certified"); Barreras Ruiz, 180 F.R.D. at 198 ("Managing such a fluid class would undoubtedly overwhelm this district court."); Arch v. Am. Tobacco Co., 175 F.R.D. 469, 492 (E.D. Pa. 1997) ("The manageability problems which would be encountered in litigating and trying this case are staggering."); Smith v. Brown & Williamson Tobacco Corp., 174 F.R.D. 90, 98 (W.D. Mo. 1997) (finding proposed trial plan "not workable or feasible"); In re Masonite Corp., 170 F.R.D. 417, 424-26 (E.D. La. 1997) ("Fragmenting issues into a "core liability' trial on manufacturer conduct, to be followed by mini-trials on causation, comparative fault, reliance, and others seems to defeat the purported economies of class treatment."); Ford v. Murphy Oil, 703 So. 2d 542, 548-49 (La. 1997) (rejecting separate trial of individual issues and finding no predominance based on defendants' gas emissions because "each class member will necessarily have to offer different facts to establish that certain defendants' emissions, either individually or in combination, caused them specific damages"); Spitzfadden v. Dow Corning Corp., 833 So. 2d 512, 520-21 (La. App. 2002) ("Fault and causation as elements of liability are too closely interrelated to be tried separately, and sound policy reasons dictate that a defendant should not be subjected to a determination of his fault before the court even considers whether that fault caused the plaintiff's damages… . This litigation, if it were to proceed as a class action, would quickly disintegrate into an unmanageable multitude of small suits with individual issues and evidence, violating the policy of judicial efficiency which the class action is designed to serve." (internal quotation marks and citations omitted)). 101

No. 94-08273 CA-22, slip op. (Fla. Cir. Ct. Jan. 15, 1998).

102

Id. at 33.

103

No. 91-49738, slip op. (Fla. Cir. Ct. Feb. 5, 1998).

104

Id.; see also In re Hotel Tel. Charges, 500 F.2d 86, 89 (9th Cir. 1974) (rejecting class treatment because "approximately one hundred years would yet be required to adjudicate the claims"); Arch, 175 F.R.D. at 488 n.19 (estimating trial could take approximately 250 years if certified); Kearns, supra note 15, at 1349 ("While hundreds of tobacco or hemophiliac claims certainly clog the dockets of the courts, the size of this burden seems minuscule when compared to the thousands or millions of individual minitrials that result from class certification.").

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Page 21 of 59 2005 Utah L. Rev. 863, *889 obtain appellate review. 105 The recent adoption of Rule 23(f), under which a federal appellate court may, in its discretion, accept an appeal of a class certification decision, does not fully remedy this problem. 106 Even if an appellate court does approve a certification decision, a subsequent trial plan may be prejudicial to defendants and result in massive liability. For example, in R.J. Reynolds Tobacco Co. v. Engle, 107 involving a class of Florida smokers against the tobacco industry, the Florida appellate court affirmed the certification of the class. 108 Subsequently, the trial court adopted and began implementing a multiphase trial plan in which punitive damages were to be awarded to the class before any finding of compensatory damages. 109 The jury found the defendants liable, and awarded the class $ 145 [*890] billion in punitive damages. 110 To obtain an appeal of the verdict, applicable Florida law required that defendants post an appellate bond equal to 120% of the verdict, or approximately $ 174 billion - an amount that may well have bankrupted all defendants, who represented an entire industry. 111 The Florida legislature responded by passing a law limiting the appellate bond requirement to $ 100 million, and the defendants posted the bond. 112 When the appellate court finally reviewed what had occurred in the class action case since its last affirmance, it reversed the verdict and decertified the class. 113 Had the Florida legislature not acted to limit the appellate bond amount, an entire industry may have been bankrupted based on an impermissible trial plan adopted subsequent to appellate affirmance of class action certification. In addition to assessing the impact on settlement that radical trial plan procedures that may not be subject to appeal have, defendants must also consider that the claims against them may be inflated in other ways by the class action mechanism. In individual litigation, a defendant can predict its exposure by evaluating the strengths, weakness, and venues of particular cases. 114 A defendant can then assess the likelihood of winning or losing, and assess an average jury award. 115 Facing a class action, however, a defendant must assume that class counsel will bring only the strongest plaintiffs as class representatives, and recognize that potentially bankrupting liability may rest upon a

105

See McGovern, supra note 35, at 1740 ("The mere act of appealing is unavailable if the bonding requirements alone would wreak financial havoc on a defendant."); Schwartz et al., supra note 14, at 504 (noting pressure on tobacco industry to settle case of attorneys general because of "oppressive bonding requirements - up to 200% of the judgment in some states - that would have been necessary to appeal the trial courts' decisions"). 106

Fed. R. Civ. P. 23(f).

107

672 So. 2d 39 (Fla. Dist. Ct. App. 1996).

108

Id. at 42.

109

Michael Finch, Giving Full Faith and Credit to Punitive Damage Awards: Will Florida Rule the Nation?, 86 Minn. L. Rev. 497, 498 (2002). 110

See Liggett Group, Inc. v. Engle, 853 So. 2d 434, 441 (Fla. Dist. Ct. App. 2003), review granted by 873 So. 2d 1222 (Fla. 2004). 111

Finch, supra note 109, at 499 (citing Fla. R. App. P. 9.310(b)(1)).

112

Id. at 500 n.17.

113

See Engle, 853 So. 2d at 470 (entitling final part of its opinion, "Conclusion: Awarding the GNP of Several European Countries Is Error"). The Florida Supreme Court recently accepted an appeal of the intermediate appellate court's decision. See Engle v. Liggett Group, Inc., 873 So. 2d 1222 (Fla. 2004). 114

Birnbaum, supra note 44, at 350.

115

Id.

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Page 22 of 59 2005 Utah L. Rev. 863, *890 single jury decision. 116 The judgment for these stronger class [*891] representatives would then be extrapolated to absent class members without discounting the weakness of their claims. 117 Moreover, the very presence of aggregated personal-injury claimants may skew the jury's judgment and produce higher awards per plaintiff. 118 Indeed, even an appellate court review, if obtained, may be affected by judges' reluctance to overturn such a massive, high-profile verdict that affects so many people. 119 All of these concerns have produced the sentiment that there is a mass tort class action crisis. Indeed, some have called the settlements that have resulted from the pressure of class actions "legalized blackmail." 120 In 1979,

116

Id.; see also Lawrence T. Hoyle, Jr. & Edward W. Madeira, Jr., "The Philadelphia Story": Mass Torts in the City of Brotherly Love, 2 Sedona Conf. J. 119, 122 (2001) ("Aggregation is viewed by other defendants as exerting unreasonable pressure to settle relatively weak, and arguably spurious, claims because the alternatives to settlement - including a single jury verdict determining the defendant's total liability - are risky. That risk puts the defendants under enormous pressure to agree … to "blackmail settlements.'"). Defendants are led toward settlement not only by their own risk averseness, but by that of potential investors and strategic partners. With the risk of a potentially bankrupting verdict, stock prices decrease. Birnbaum, supra note 44, at 350-51. The litigation risk may also prevent a company from completing strategic objectives such as mergers and acquisitions. See id. In addition, it may be unable to borrow adequately, because of the possibility of bankruptcy. Id. While companies' risk averseness disposes them to settle, investors' risk and risk averseness leads them to limit or avoid investment. See id. at 351 ("Markets value certainty, and the pressure to bring an end to even meritless class actions can be almost irresistable to corporate defendants … ."). As a result, defendants are biased toward settlement, regardless of the merits of the litigation against them. See id. ("The class action - a "procedural' device intended to achieve certain efficiencies of scale through aggregation - is a mighty sword that can affect the substantive outcome of the litigation without regard to the "merits' of the claims."). Moreover, even a non-risk-averse risk analysis may lead defendants to settle for significant sums in situations not only where the defendant believes it will lose, but also where the defendant thinks the overwhelming likelihood is that it will prevail. For example, if a class action loss would result in a $ 1 billion verdict, and defendant believes that there is only a five percent chance that the class will be certified and prevail at trial, a basic risk-benefit analysis would assess a settlement of $ 50 million to be equivalent to the risk of proceeding. 117

Birnbaum, supra note 44, at 350.

118

See, e.g., Kohn v. Am. Hous. Found., Inc., 178 F.R.D. 536, 543 (D. Colo. 1998) ("It is understandable that plaintiffs seek the advantages created by certification, including dramatic improvement of chances of success and higher damage awards, but to confer that advantage without determining legally essential elements of liability does not comport with fairness or rational decision-making." (citation omitted)); Schwartz et al., supra note 14, at 491-92 ("Evidence indicates that the aggregation of claims increases both the likelihood that a defendant will be found liable and the size of any damages award which may result."). 119

See, e.g., Parkinson v. April Indus., Inc., 520 F.2d 650, 653 (2d Cir. 1975) ("An appellate court, in reviewing a final decision on substantive issues, would be reluctant to upset the class status after the expenditure of time and effort the parties and the district court expended in reaching that final decision. Thus, deferring review until after the entry of a final judgment may well prevent any effective review at all of the class action designation."); see also Schwartz et al., supra note 14, at 489 ("Far too often, unrestrained class action litigation leaves defendants with no choice but to settle claims of little or no merit in order to avoid the enormous risks associated with defending class action suits."). In addition, a publicized class action may attract weak or fanciful claims against a defendant. Id.; see also Kearns, supra note 15, at 1349-50 ("Without the cloak of a class action, claims lacking the validity to stand on their own would not attract sufficient attention from the plaintiff's bar."). 120

See, e.g., Castano v. Am. Tobacco Co., 84 F.3d 734, 746 (5th Cir. 1996) ("In addition to skewing trial outcomes, class certification creates insurmountable pressure on defendants to settle, whereas individual trials would not. The risk of facing an all-or-nothing verdict presents too high a risk, even when the probability of an adverse judgment is low. These settlements have been referred to as judicial blackmail." (citations omitted)); In re Gen. Motors Corp. Pick-Up Truck Fuel Tank Prods. Liab. Litig., 55 F.3d 768, 784-85 (3d Cir. 1995) ("Another problem is that class actions create the opportunity for a kind of legalized blackmail: a greedy and unscrupulous plaintiff might use the threat of a large class action, which can be costly to the defendant, to extract a settlement far in excess of the individual claims' actual worth."); In re Rhone-Poulenc Rorer, Inc., 51 F.3d 1293, 1298 (7th Cir. 1995) ("Judge Friendly, who was not given to hyperbole, called settlements induced by a small probability of an immense judgment in a class action "blackmail settlements.'" (citing Henry J. Friendly, Federal Jurisdiction: A General View 120 (1973))); Parkinson, 520 F.2d at 654 ("Admittedly the impact of large plaintiff class actions upon defendants is great. The expense of defense increases with the introduction of the enlarged class, with the broadening of the substantive issues, and with

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Page 23 of 59 2005 Utah L. Rev. 863, *891 Professor [*892] Arthur Miller wrote that to some, the class action seemed a "Frankenstein monster," while to others, the class action seemed a knight in shining armor. 121 As one commentator recently noted: "Today there is again a sense that monsters are loose in the land. Some believe that American courts are overrun with class litigation." 122 But pressured by heavy mass tort litigation dockets and inundated with plaintiffs' counsels' claims that class certification denial will lead to wasteful and repetitive case-by-case adjudication, judges have been left with no systemic alternative to class actions. III. Mass Tort Litigation as Network Mass tort litigation as network provides a case management alternative to the flawed approach of multiple-incident, product-liability class actions for personal injuries. Today, any particular mass tort litigation involves so many interrelated issues that counsel, litigants, judges, and the general public refer to it as a coherent whole, for example, calling it the "tobacco litigation." 123 Under [*893] a network approach to mass tort litigation, plaintiffs' counsel, defense counsel, judges, and clients involved in individual cases (often consolidated solely for pretrial management), communicate with each other to share information, pool resources, develop specialized expertise, and coordinate strategy. While each individual or group in these networks may itself undertake complex case management, each individual's or group's ability is greatly enhanced by connecting to others facing similar problems in cases related to the same mass tort. For example, while a plaintiffs' firm may already represent plaintiffs in thousands of cases stemming from a particular mass tort, and have considerable resources within its firm, that firm's ability to sue defendants is much improved and is rendered more efficient by being able to link with other plaintiffs' counsel around the country in the same mass tort litigation. Similarly, while a judge may be effectively managing all of the cases pertaining to a mass tort in his or her state, through transfer and pretrial

the preliminary pretrial skirmishing. Of perhaps greater importance in realistic terms is the increase in potential liability which could force the defendant to settle plaintiffs' claims regardless of the merits of the plaintiffs' cases."); Marascalco v. Int'l Computerized Orthokeratology Soc'y, Inc., 181 F.R.D. 331, 339 n.19 (N.D. Miss. 1998) ("Class certification magnifies and strengthens the number of unmeritorious claims." (quoting Castano, 84 F.3d at 746)); Birnbaum, supra note 44, at 350 ("[Class actions] lead to "legalized blackmail.'"); Schwartz et al., supra note 14, at 491 ("Defendants who are forced to settle in order to avoid the remote, but potentially crippling, lightning-strike verdict at trial are denied appellate review, the most important safeguard against unfairness in the court system."); Kearns, supra note 15, at 1351 ("The coercive impact of certification undermines fairness as a justification for class actions … ."). But see Charles Silver, "We're Scared to Death": Class Certification and Blackmail, 78 N.Y.U. L. Rev. 1357, 1357-58 (2003) (challenging charge that class actions produce "blackmail" settlements). 121

Arthur Miller, Of Frankenstein Monsters and Shining Knights: Myth, Reality, and the "Class Action Problem", 92 Harv. L. Rev. 664, 665 (1979). 122

See Deborah R. Hensler, Revisiting the Monster: New Myths and Realities of Class Action and Other Large Scale Litigation, 11 Duke J. Comp. & Int'l L. 179, 180 (2001). So prevalent is the sense of class action crisis that it has become an important national political issue. Both major candidates in the 2004 presidential election recognized the serious problems posed by class actions. See, e.g., The President's Six Point Plan for Strengthening the Economy, at http://www.whitehouse.gov/news/releases/2003/10/20031009-1.html (Oct. 9, 2003) (listing as one point, "Reducing the Lawsuit Burden on Our Economy," and stating that "President Bush has proposed, and the House has approved, measures that would allow more class action and mass tort lawsuits to be moved into Federal court so that trial lawyers will have a tougher time shopping for a favorable court"); The Kerry-Edwards Plan to Foster a Climate for America's Businesses to Create Good-Paying Jobs, at http://www.institutionalinvestor.com/pdf/ pressroom/presscoverage/Kerry-Edwards_plan.pdf (Aug. 4, 2004) (listing as one point, "Making American Businesses More Competitive," and stating, "There is no question that frivolous … class actions waste time and money. That is wrong, and John Kerry and John Edwards support reforms that prevent and punish these abuses - while at the same time preserving the principles of responsibility and fairness that make our system work."). 123

See Erichson, supra note 20, at 384 ("Although the thousand widgium claims have not been aggregated through any formal procedural mechanism, the lawsuits of these widget consumers against the various defendants are informally aggregated through the coordinated efforts of the lawyers. Lawyers, judges, politicians, the press, and the public understandably refer to this mass of cases in the singular, as "the widgium litigation'."); id. at 386 ("Complex litigation often proceeds as a number of formally independent lawsuits, yet we refer to multi-suit litigations in the singular: "the tobacco litigation,' "the TWA Flight 800 litigation,' "the Microsoft antitrust litigation.'").

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Page 24 of 59 2005 Utah L. Rev. 863, *893 consolidation, that judge's contribution to the effective, efficient management of the mass tort is significantly improved by linking with other state and federal judges managing the same mass tort. Moreover, pursuing his or her own interests, an individual or group in one type of network may further contribute to sound management of a mass tort by aiding in the creation of another type of network. For example, in seeking to educate all clients about the progress of a litigation, a plaintiffs' counsel network may contribute to the creation of a network of clients who may then begin communicating among themselves. Indeed, multidistrict litigation courts have become clearinghouses of networks where plaintiffs' attorneys, defense counsel, clients, and even many state and federal judges meet and form networked responses to the challenges of mass tort litigation. 124 The emergence of networks does much to remedy or eliminate disparate resources between plaintiffs' counsel and defense counsel. 125 Indeed, in mass tort litigation, plaintiffs' counsel and defense counsel have similar [*894] organizational structures. 126 As a result of litigation networks lowering the cost of litigation, sharing information, and harmonizing approaches, plaintiffs' lawyers are not outgunned by defense counsel, 127 and the argument that

124

Pending congressional legislation would make the Multi-District-Litigation ("MDL") court even more powerful in managing mass tort litigation. The Multidistrict Litigation Restoration Act of 2005, which passed the House of Representatives, would allow MDL courts to try the cases that are currently referred to them only for pretrial management. See The Multidistrict Litigation Restoration Act of 2005, H.R. 1038, 109th Cong.

125

See Howard M. Erichson, The End of the Defendant Advantage in Tobacco Litigation, 26 Wm. & Mary Envtl. L. & Pol'y Rev. 123, 123, 131 (2001) (noting that because of information sharing, pooling of resources, and coordination among plaintiffs' counsel, "the systematic defendant advantage in mass tort litigation is dead"); Stephen C. Yeazell, Re-Financing Civil Litigation, 51 DePaul L. Rev. 183, 202 (2001) ("The plaintiffs' bar, with its system of referrals, is achieving transactionally the kinds of specialization and breadth that the corporate bar is achieving by growth in firm size."). 126

See Hoyle & Madeira, supra note 116, at 122 ("The parties on both sides of the courtroom are represented by highly financed and competent lawyers who specialize in mass torts. Both plaintiffs' and defendants' counsel network among themselves, coordinating cases throughout the nation."). 127

See Lowenthal & Erichson, supra note 20, at 1007-08 ("With the involvement of a plaintiffs' litigation group, steering committee or other central authority, plaintiffs enjoy (or suffer) the same litigation control structure for centralized strategizing and information-gathering as that practiced by the defense."); id. at 1008 ("Litigation groups create "an ad hoc plaintiffs' national law firm.'"); Peter H. Schuck, Mass Torts: An Institutional Evolutionist Perspective, 80 Cornell L. Rev. 941, 956 (1995) (noting that because of coordination and innovation, plaintiffs' lawyers "have achieved a level of parity with their corporate opponents that was unimaginable as recently as twenty years ago"); Yeazell, supra note 125 at 207 ("The plaintiffs' bar is professionally and economically on a par with their defense counterparts in the litigation that forms the great bulk of the caseload."); id. at 210 (recognizing "revolution in the plaintiffs' bar, which at the end of the twentieth century had the intellectual and financial capital to inflict bankruptcy or a near-equivalent on a major industry"). In the tobacco class-certification context, courts have rejected plaintiff counsel's claims that individual suits are impossible to bring because of financial concerns. See, e.g., Arch v. Am. Tobacco Co., Inc., 175 F.R.D. 469, 496 n.28 (E.D. Pa. 1997) (rejecting "David versus Goliath" analogy in tobacco litigation, finding "Goliath versus Goliath" more apt, and stating that there "does not appear to be a significant financial disparity in the parties' ability to finance these putative litigations"); Mike France, The Litigation Machine, Bus. Wk., Jan. 29, 2001, at 118 ("Traditionally, plaintiffs' attorneys have had two key disadvantages in their war against Corporate America: They were outnumbered, and they were outspent. To even the scales, tort lawyers have made amazing advances - particularly in the crucial arenas of research, teamwork, and finance. As a result of this unheralded management revolution, a sole practitioner based in a Buffalo strip mall can fight on equal terms with a company boasting bigger revenues than a Third World country."); see also Castano v. Am. Tobacco Co., 84 F.3d 734, 747 n.25 (5th Cir. 1996) ("The class is represented by a consortium of wellfinanced plaintiffs' lawyers."); Reed v. Philip Morris, Inc., No. 96-5070, 1997 WL 538921, at 12 (D.C. Super. Aug. 18, 1997) ("This Court is not persuaded … that a class action would promote either efficiency or fairness… . Plaintiff cannot offer this Court evidence to show that the reason potential plaintiffs are not filing lawsuits to recover from tobacco-related injuries is due to the disparity of resources. [Plaintiff] is represented by three well-established law firms… . It is just as reasonable to speculate that individuals are not filing claims because they feel they have no compensable injury.").

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Page 25 of 59 2005 Utah L. Rev. 863, *894 class certification is required to equalize resources may no longer be pertinent. 128 [*895] Defense counsel now often operate as a lead counsel responsible for the management of numerous local counsel. Similarly, plaintiffs' lawyers have also created a centralized coordinating entity. As Professor Howard Erichson has noted, each relies on a "hub-and-spoke formation." 129 Although a networked approach to mass tort litigation may not seem as swift as a single class action verdict, such a verdict cannot be obtained without the seemingly endless hearings or violations of defendants' rights discussed above in Part III. 130 When combined with judge coordination and client networks, counsel coordination renders seemingly separate cases deeply coordinated and produces effective and efficient mass tort case management. 131 A. The Role of Information Technology In all of their endeavors, mass tort litigation networks have been aided considerably by recent advances in information technology and the Internet. 132 Information technology has enabled far-flung counsel and judges to communicate by e-mail and attach electronic versions of documents that transmit virtually instantaneously. E-mail Listservs, which automatically forward one's e-mail onto all members designated in a group, also enable counsel to be kept up-to-date on recent developments in the litigation. In addition, the Internet has allowed for online repositories of documents and orders that are accessible to judges and counsel nationwide. The ease and low cost of copying CD-ROMs, which can hold thousands of pages of documents, also aids in the dissemination of documents among counsel and judges. In fact, counsel on the same side of a litigation may exchange CD-ROMs of [*896] documents that have been strategically organized and highlighted. Supplementing these more recent advances are conference calls, in which local, regional, or national counsel - and sometimes judges - speak regularly by phone and face-to-face conferences, and in which counsel and sometimes judges periodically fly to a particular location to discuss developments and strategy. 133

128

Because of the importance of plaintiffs' counsel networks in equalizing each side's representation in a mass tort litigation, their structure and development is given greater detail in Part III.B of this Article. Moreover, apart from networks, the financial burden of bringing such claims has also been eased by the increasing availability of commercial financing for plaintiffs' counsel. See Yeazell, supra note 125, at 203-04 (noting that "most major commercial banks now routinely extend lines of credit to firms that can present a plausible business plan" and that there exists "other, more imaginative forms of investment and finance," such as venture capital). Indeed, even General Electric Capital Corporation has entered the business of litigation finance. Id. at 205. In addition, plaintiffs' lawyers have supported the cost of such litigation by diversifying their "litigation portfolio" so as to include both long-term cases, and shorter-term, quick-paying cases. See id. at 213-14 (stating that plaintiffs' lawyers "often operate in firms that consciously seek to balance lines of work, mixing some cases with a low but relatively certain return with others that have a much higher but far less certain payoff"). 129

Lowenthal & Erichson, supra note 20, at 1007.

130

Professor David Rosenberg has argued that coordination and communication in individual litigation among plaintiffs' firms still presents higher transaction costs than does a class action and, therefore, he favors class actions. See David Rosenberg, The Regulatory Advantage of Class Action, in Regulation Through Litigation 244 (W. Kip Viscusi ed., 2002) (noting, inter alia, higher costs of acquiring clients and coordinating). If class action verdicts cannot be obtained without seemingly endless hearings or violation of state substantive law or federal constitutional law, however, class actions are not plausible options regardless of their somewhat lesser transaction costs. See infra Part III.B (discussing implications of litigation networks); see also Nagareda, supra note 63, at 231 (arguing that Professor Rosenberg's position "stems … at bottom, from a deeper sense that the choices made in current law are simply ill-advised"). 131

See Lowenthal & Erichson, supra note 20, at 991 (noting coordination among counsel and stating that "the litigation likely proceeds as a number of formally independent cases, but with litigation control structures that render case management a highly coordinated, collective process"). 132

See Hensler, supra note 122, at 212 ("If there is a key that has unlocked … [large-scale litigation's] cage, it is the information science revolution and … the Internet, which have provided the means for people to become informed about such injuries and the tools for individuals, organizations, and attorneys to organize to secure remedies."); Lowenthal & Erichson, supra note 20, at 998 n.39 ("Information sharing is made easier by the capabilities of modern litigation computer databases." (citation omitted)). 133

For specific instances of the use of these technologies, see infra Part III.B.

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Page 26 of 59 2005 Utah L. Rev. 863, *896 In the tobacco litigation, for example, plaintiffs have been able to access defendants' documents through a document depository in Minnesota, implemented by the defendants as a result of a settlement with the Minnesota Attorney General. The depository contains more than 24 million pages of indexed documents. It also provides searching instructions, has on-site staff, and provides copying assistance. In addition, the depository must be updated by defendants with additional material made available in pending cases. The vast majority of this material is also available on the Internet, including documents selected by the Minnesota Attorney General, depositions of tobacco company employees, and trial exhibit lists. 134 B. Varieties of Networks 1. Networks of Plaintiffs' Counsel (a) The Benefits and Structure of Plaintiffs' Counsel Networks Before analyzing the extent of litigation networks, one must first appreciate the strength and scope of modern mass tort plaintiffs' firms. In modern mass tort litigation, a single plaintiff's firm likely has numerous similarly situated clients. 135 Indeed, plaintiffs' counsel seek clients nationwide. 136 In addition, plaintiff's firms increasingly use the Internet to [*897] locate such clients by advertising for particular types of claims. 137 Moreover, plaintiffs' attorneys use mass meetings to generate clients. 138 Additional clients appear if the lawyer succeeds and develops a reputation in a particular area. 139 By handling many similar claims, a firm gains from economies of scale. 140 Moreover, plaintiffs' attorneys often specialize in a particular mass tort. 141 For example, fewer than fifty law firms specialize in asbestos litigation, and only a few are dominant. 142 In the Dalkon Shield litigation, of the 44,000 victims who were most seriously injured, six attorneys represented over 8000 of them, and another forty-three

134

See Tobacco Archives, at http://www.tobaccoarchives.com (last visited May 15, 2005).

135

See Coffee, supra note 31, at 1358-59 ("Mass tort litigation is characterized by … a highly concentrated plaintiffs' bar, in which individual practitioners control exceptionally large inventories of cases, sometimes totaling in the tens of thousands… ."); id. at 1364 (noting that "a handful [of firms] dominate the field" of asbestos litigation, and "some thirty firms represented the majority of the Dalkon Shield claimants"); John C. Coffee, Jr., The Regulation of Entrepreneurial Litigation: Balancing Fairness and Efficiency in the Large Class Action, 54 U. Chi. L. Rev. 877, 886 (1987) ("In the Bhopal litigation … one American attorney managed to obtain retainer agreements from over 7,000 individual clients in less than a week; other individual attorneys claimed to represent as many as 57,000 clients." (citations omitted)); Deborah R. Hensler, Resolving Mass Toxic Torts: Myths and Realities, 1989 U. Ill. L. Rev. 89, 96 (1989) ("In the Dalkon Shield litigation, two plaintiff attorneys represented nine hundred clients over a relatively brief time."). 136

See, e.g., Coffee, supra note 135, at 885-86 ("In mass torts, … increasingly, the lead counsel may engage in a nationwide solicitation for eligible plaintiffs, as in the Agent Orange action."). 137

See Erichson, supra note 20, at 387 ("Through niche marketing, lawyers can attract substantial numbers of clients with similar claims … ."). 138

See Hensler, supra note 135, at 96 ("In asbestos litigation, initial lawyer contacts with claimants often involved mass meetings or bureaucratic intake procedures rather than intimate conversations between lawyer and client.").

139

See Erichson, supra note 20, at 387 ("As a lawyer develops a track record in a particular type of claim, similarly situated clients flock to the lawyer.").

140

See id. (noting "economies of scale" of representing multiple similar claims).

141

See Hensler, supra note 135, at 102; see also Issacharoff & Witt, supra note 20, at 1618 (noting that "market pressures and the benefits to be gained from economies of scale seem to lead to the concentration of market share on both the plaintiff and defense sides into a small number of repeat actors"). 142

Coffee, supra note 31, at 1364.

Theresa Coetzee

Page 27 of 59 2005 Utah L. Rev. 863, *897 attorneys represented over 13,000. 143 Similarly, in the asbestos litigation, plaintiffs' counsel obtained thousands of clients through mass screenings at workplaces, spreading the cost of discovery and increasing leverage for mass settlement negotiations. 144 Indeed, because of such economies of scale, a few plaintiffs' firms represented a majority of the asbestos plaintiffs. 145 Multiple client representation within a firm provides the benefits of information exchange. Each client benefits from general legal research and factual investigation. 146 Plaintiffs' counsel also benefit by recouping general [*898] costs of legal and scientific research over many cases rather than merely one. 147 Moreover, client communication is facilitated because lawyers can meet with clients in large groups. 148 These firms may also use Listservs and Internet discussion groups to keep clients and potential clients informed about medical and litigation developments. 149 In addition, plaintiffs' counsel may file a "master complaint" for many clients 150 and use standardized discovery. 151 Moreover, plaintiffs' counsel may negotiate settlement for numerous clients with defense counsel. 152

143

Id.

144

See Hensler, supra note 34, at 1913 ("The leading asbestos plaintiffs' firms had large inventories of cases … .").

145

Id.; see also Issacharoff & Witt, supra note 20, at 1624 (stating that, in asbestos litigation, "the result is a highly concentrated market in which roughly ten firms account for more than 50 percent of the asbestos claims in the country and fifty firms effectively control the market").

146

See Michael D. Green, Bendectin and Birth Defects: The Challenges of Mass Toxic Substances Litigation 240-41 (1996) (discussing economies of scale of multiple Bendectin cases represented by Melvin Belli and likening it to formally aggregated litigation); Erichson, supra note 20, at 388 ("Knowledge gained through the representation of each client inures to the benefit of other clients. Generally applicable legal research and factual investigation are conducted once on behalf of all the clients."); McGovern, supra note 35, at 1732 ("If plaintiffs' counsel has multiple claims that have overlapping discovery, it is not difficult to create significant economies of scale. If liability development costs can be prorated over multiple cases, the per-case cost to counsel decreases."); James F. Early et al., Asbestos, at http://www.mesothelioma.com/asbestos.htm (last visited May 15, 2005) ("The research we do for our client's cases results in a large amount of pertinent and up to date information on asbestos, the asbestos industry, asbestos diseases and treatment options. We have compiled that information here in an on-line information library. We hope that by providing this information, we create a valuable resource, which will benefit people who have access to it."). 147

Hensler & Peterson, supra note 24, at 1043.

148

See Erichson, supra note 20, at 388 (noting that plantiffs' "lawyers may meet with their clients in large groups rather than individually"); Michael J. Saks & Peter David Blanck, Justice Improved: The Unrecognized Benefits of Aggregation and Sampling in the Trial of Mass Torts, 44 Stan. L. Rev. 815, 840 (1992) ("Even in the absence of formal aggregative procedures, lawyers informally aggregate cases by representing hundreds or thousands of clients and meeting with them in large groups."). 149

See James F. Early et al., Fen-Phen, at http://www.elslaw.com/redux.htm (last visited May 15, 2005) (providing Fen-Phen Listserv); James F. Early et al., Phenylpropanolamine (PPA), at http://www.elslaw.com/ppa.htm (last visited May 15, 2005) (providing PPA Listserv); James F. Early et al., Bulletin Boards, at http://www.mesothelioma.com/board.htm (last visited May 15, 2005) (providing on-line forum for variety of asbestos-related topics). 150

Resnik, supra note 20, at 38.

151

See Hensler, supra note 135, at 96 (noting that, in asbestos litigation, "pleadings and discovery were highly standardized").

152

Erichson, supra note 20, at 388 (noting that plaintiffs' lawyer "settlements may be negotiated during a single negotiating session with opposing counsel"). Under Model Rule of Professional Conduct 1.8(g), [a] lawyer who represents two or more clients shall not participate in making an aggregate settlement of the claims of or against the clients, … unless each client gives informed consent, in a writing signed by the client. The lawyer's disclosure shall include the existence and nature of all the claims or pleas involved and of the participation of each person in the settlement.

Theresa Coetzee

Page 28 of 59 2005 Utah L. Rev. 863, *898 [*899] Plaintiffs' counsel networks begin when a plaintiff's law firm refers its case to another firm. In this arrangement, the initial firm earns a fee for referring the case. 153 For example, in the asbestos litigation, some firms obtained clients and did pretrial development and then referred the cases to other firms for trial or settlement. 154 As a result, some plaintiffs' firms have handled tens of thousands of claims relating to a similar product. 155

Plaintiffs' counsel networks can also arise when one plaintiffs' firm with numerous clients affiliates with other local plaintiffs' firms to assist in litigation management. 156 In the asbestos litigation, for example, one prominent South Carolina plaintiffs' firm focused on national litigation issues, such as defendant discovery and general liability issues, while leaving plaintiff-specific issues - such as individual causation and damages - to local affiliated firms. 157 The firms then split the fees. 158 Most powerful among plaintiffs' networks, however, is the plaintiffs' counsel litigation network that arises when various plaintiffs' firms, each with their own clients, communicate with each other to gain the advantages of

Model Rules of Prof'l Conduct R. 1.8(g) (2003); see also Erichson, supra note 20, at 388 n.7 (discussing applicability of Rule 1.8(g)); Charles Silver & Lynn Baker, Mass Lawsuits and the Aggregate Settlement Rule, 32 Wake Forest L. Rev. 733, 736-38 (1997) (same). Nevertheless, block settlements often occur. See Jack B. Weinstein, Individual Justice in Mass Tort Litigation 74 (1995) ("Even though bulk settlements may technically violate ethical rules, judges often encourage their acceptance to terminate a large number of cases."); Erichson, supra note 20, at 388 n.7 ("Such block settlements are not uncommon."); Resnik, supra note 20, at 38 ("While in theory and in form each case is separate, in practice lawyers on both sides deal with the cases as a group, sometimes making "block settlements' - in which defendants give a lawyer representing a group of plaintiffs money that is then allocated among a set of clients."); Paul D. Rheingold, Ethical Constraints on Aggregated Settlements of Mass-Tort Cases, 31 Loy. L.A. L. Rev. 395, 398-401 (1998) (explaining that block settlements occur frequently despite ethical problems). Professor Erichson has argued sensibly that, in the context of mass tort litigation, Rule 1.8 should only require disclosure of "the total amount of the settlement, the number of plaintiffs, and any formula or grid used in calculating settlement amounts," and that each plaintiff should retain a right to decline his or her portion of the proposed settlement. See Erichson, supra note 15, at 575. 153

See Deborah Hensler et al., Class Action Dilemmas: Pursuing Public Goals for Private Gain 102 (2000) (stating that plaintiffs' attorneys "found clients not only through attorneys' references and advertising, but also through attorneys, who referred cases to them and, in return, took a percentage of the specialist's fee"); Yeazell, supra note 125, at 201 ("To get the client to the right lawyer requires fairly sophisticated inter-lawyer marketing and exchange of claims. Via referrals and various forms of permitted fee-sharing, a lawyer with a potential case can get it to a specialized, well-capitalized firm who can first make an intelligent evaluation of it and then, if warranted by the facts, afford to take it deep enough into discovery to achieve a good settlement."); id. at 205 (noting that even if plaintiffs' lawyers with clients "are low on skill, they have easy access to networks of more skilled and better capitalized lawyers with whom they can make fee arrangements, thus putting the plaintiff in the hands of a lawyer who can afford to take her case as deep into litigation as the amount at stake warrants" and that "that itself is an enormous change"). 154

See Hensler, supra note 34, at 1913 (characterizing these referrals as based on "networks of relationships developed among firms"). 155

See Erichson, supra note 20, at 387 n.3 (discussing handling of thousands of asbestos lawsuits by Ness Mottley firm and handling of nearly 20,000 asbestos plaintiffs by Law Offices of Peter G. Angelos). 156

See id. ("The Ness Mottley firm established affiliate relationships with lawyers throughout the United States, sharing responsibility for and fees from thousands of asbestos cases filed by such "affiliated counsel.'"); Lowenthal & Erichson, supra note 20, at 999 ("Multiple plaintiffs with separate counsel may be connected by an affiliate relationship with a single prominent plaintiffs' firm."). 157

See Erichson, supra note 20, at 387 n.3 ("As the lead firm, Ness Mottley focused on national discovery and issues of general liability, while the local lawyers or firms handled such case-specific matters as proving individual exposure and damages."); Lowenthal & Erichson, supra note 20, at 999 (mentioning "one South Carolina firm, which has represented more asbestos plaintiffs in the past twenty years than any other firm [and] shares responsibility and fees for thousands of cases brought by "affiliated counsel' around the country").

158

Lowenthal & Erichson, supra note 20, at 999.

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Page 29 of 59 2005 Utah L. Rev. 863, *899 information 159 and strategy harmonization. 160 Plaintiffs' networks empower [*900] plaintiffs, 161 render litigation more efficient, 162 impose order for judges on otherwise sprawling litigation, 163 pool resources, 164 and provide specialization and economies of scale similar to large law firms. 165 [*901] Claiming "common interest privilege" to protect confidential communications,

166

plaintiffs exchange information through newsletters, sharing discovery, trial-in-a-box materials on CD-ROMs, seminars on current litigation, and litigation "schools," where plaintiffs' counsel are taught how to bring a case. 167 Plaintiffs' lawyers

159

See Hensler & Peterson, supra note 24, at 1026; Resnik, supra note 20, at 38-39; see also John C. Coffee, Jr., Rethinking the Class Action: A Policy Primer on Reform, 62 Ind. L.J. 625, 650 (1987) ("Recently, in a number of mass tort cases, litigation networks have developed by which cooperating plaintiff's attorneys litigating separate individual actions involving the same subject matter (for example, a particular drug or toxic product) share the fruits of their discovery (for example, expert witnesses, epidemiological studies, depositions of the defendant's witnesses, and so on). Such information networks obviously reduce waste and achieve some of the advantages of consolidated pre-trial discovery in a federal court, without exposing each individual attorney to the loss of his client (and his fee award) to the attorneys controlling the class action."); John C. Coffee, Jr., Understanding the Plaintiff's Attorney: The Implications of Economic Theory for Private Enforcement of Law Through Class and Derivative Actions, 86 Colum. L. Rev. 669, 710 (1986) [hereinafter Coffee, Understanding] ("Plaintiff's attorneys have developed elaborate litigation information networks through which scientific data, pleadings, and depositions can be shared."); Lowenthal & Erichson, supra note 20, at 1002-03 ("A primary activity of plaintiffs' groups is sharing information. Information may be conveyed by word of mouth, newsletter or, … by a pre-packaged "trial packet' that provides an instruction manual to lawyers … often with a collection of material documents (organized, sometimes, on trial-ready CD-ROM)." (citation omitted)). 160

See Erichson, supra note 20, at 381, 383-84, 389, 391; Hensler & Peterson, supra note 24, at 1026; Resnik, supra note 20, at 38-39; Paul D. Rheingold, The Development of Litigation Groups, 6 Am. J. Trial Advoc. 1, 5 (1982); see also Coffee, supra note 135, at 921 (noting "growth of nationwide litigation networks that today link plaintiffs' attorneys handling individual actions involving the same subject matter in different forums"); Lowenthal & Erichson, supra note 20, at 991 ("Eventually, dozens of plaintiffs' lawyers find themselves prosecuting very similar cases. Sensibly, they coordinate their efforts, establishing a networked team of lawyers on the plaintiffs' side, with a committee or other vehicle to coordinate strategy and the exchange of information." (emphasis added)); id. at 995-96 ("With commonality of interest as the carrot, and the sheer magnitude and dispersion of mass litigation as the stick, litigation control structures on each side of the modern mass tort litigation have evolved into complex coordinated networks of attorneys." (emphasis added)). 161

Lowenthal & Erichson, supra note 20, at 1004.

162

Id.

163

Id.

164

See Hensler & Peterson, supra note 24, at 1026, 1043; Lowenthal & Erichson, supra note 20, at 1005; see also Issacharoff & Witt, supra note 20, at 1623-24 (noting advent of "litigation consortium," and that "either formally through the Multi-District Litigation process, or informally through private agreement, or more likely through both, plaintiffs' firms undertook joint ventures to pool risk and capitalize expensive litigation efforts"); Ingrid L. Dietsch Field, Comment, No Ifs, Ands or Butts: Big Tobacco Is Fighting for Its Life Against a New Breed of Plaintiffs Armed with Mounting Evidence, 27 U. Balt. L. Rev. 99, 115 (1997) ("The pooling of resources is now a more widespread practice. By combining resources, plaintiffs are now in a better position to handle the demands placed on them by tobacco company attorneys."); cf. Hensler & Peterson, supra note 24, at 964 ("The specialized mass tort plaintiffs' bar that emerged during the 1980s has accumulated capital as a result of its success in litigating earlier mass claims, and is skillful and aggressive in identifying new investment opportunities."); France, supra note 127, at 122 ("To compensate for their small size, tort lawyers have built an extensive network of mostly invisible alliances."). 165

France, supra note 127, at 122; see Yeazell, supra note 125, at 199 ("Lawyers and firms can market themselves, primarily to other lawyers, as experts in particular forms of litigation. Such marketing can produce enough referrals to justify maintaining this specialized intellectual capital."). 166

Lowenthal & Erichson, supra note 20, at 1001.

167

Erichson, supra note 20, at 389, 392; Lowenthal & Erichson, supra note 20, at 998, 1002 -03; Resnik, supra note 20, at 3839; Paul D. Rheingold, The MER/29 Story - An Instance of Successful Mass Disaster Litigation, 56 Cal. L. Rev. 116, 122-23, 131 (1968).

Theresa Coetzee

Page 30 of 59 2005 Utah L. Rev. 863, *901 also offer training sessions on how to bring a case. 168 In some mass tort litigations, lead plaintiffs' trial lawyers have trained others in how to try the case. 169 In certain litigations, plaintiffs' counsel have put together handbooks and trial packets. 170 Outside commercial organizations, such as Mealeys, organize conferences where attendants can pay a fee and obtain information on how to pursue certain litigation. 171 Plaintiffs' counsel networks also coordinate retaining and preparing expert witnesses, processing scientific research, and running jury focus groups. 172 Plaintiffs' counsel may also obtain an agreement that discovery can be obtained by a plaintiffs' representative for all plaintiff cases, using standard interrogatories. 173 Plaintiffs' lawyers can also pool resources for experts, 174 use online databases, 175 or set up an Internet site. 176 Plaintiffs' lawyers often share [*902] costs of discovery, 177 as well as exchange discovery materials 178 and often use CD-ROMs or other recent advanced technology. Shared discovery costs can include the costs of coding documents, attaching

168

Erichson, supra note 20, at 384, 389.

169

See id. at 389 (discussing Dalkon Shield and MER/29 litigation schools); id. at 390 (discussing tobacco lawyer Woody Wilner's tutelage of attorney, Madelyn Chaber, who "said to Woody, "Download your brain to me'"; Ms. Chaber later won $ 51.5 million verdict against tobacco industry); id. at 393 (noting that ""MER/29 School' [formed] to teach [plaintiffs'] lawyers how to try cases"). 170

See id. at 389; see also France, supra note 127, at 114 ("Step Two: Get a Litigation Packet[.] How-to guides exist for suits against handgun makers, tobacco companies, and Warner-Lambert diabetes drug Rezulin, among other things. Generally costing less than $ 200, they include almost everything a lawyer needs to get a case started."). 171

See Lexis Nexis, Professional Development Center, Conference Schedule, at http://www.mealeys.com/conferences_schedule.html (last visited May 15, 2005) (listing conferences for 2005, including "Asbestos Litigation 101 Conference" and "Vioxx Litigation Conference"). 172

Lowenthal & Erichson, supra note 20, at 998; see also France, supra note 127, at 114 ("Step Three: Find an Expert[.] A credible physician or engineer can do wonders for a jury. Web sites such as DepoConnect.com specialize in helping tort lawyers find good expert witnesses. Professional experts also rent booths at attorneys' conventions and advertise in legal trade journals."). 173

See Rheingold, supra note 167, at 127-30; see also Erichson, supra note 20, at 392-93 (describing similar agreement in MER/29 litigation). 174

See Erichson, supra note 20, at 384; Resnik, supra note 20, at 38-39; see also France, supra note 127, at 114 ("By typing the words "Firestone' and "tread separation' into a search engine on DepoConnect.com, a Web site that can be accessed only by plaintiffs' attorneys with passwords, it's possible to get the names of expert witnesses who specialize in tire failures - as well as full copies of their prior courtroom and deposition testimony.").

175

Erichson, supra note 20, at 389.

176

See id. at 391 (noting fen-phen ""plaintiffs' consortiums … Internet site for sharing information").

177

See id. at 384; Attorneys Debate Merits of Fen-Phen Multi-District Litigation, 1 Mealey's Litig. Rep. Fen-Phen/Redux 11 (1998) (noting ""loose confederation'" of plaintiffs' counsel created to obtain discovery).

178

See Rheingold, supra note 167, at 122-24; see also Erichson, supra note 20, at 390 (discussing sharing of documents through Tobacco Trial Lawyers Association); id. at 393 (discussing MER/29 plaintiffs' group exchange of "key liability documents, trial transcripts, and other materials"); Erichson, supra note 125, at 130 (noting that small-firm plaintiff lawyer, Michael Piuze, won $ 3 billion verdict against tobacco industry, on ""shoe-string budget'" through ""trial-in-a-box' strategy" using limited witnesses, and using documents obtained during Attorney General lawsuits and sifted by other plaintiffs' counsel); France, supra note 127, at 120 ("The true temple of plaintiffs' lawyer research, though, is the little-known Attorneys Information Exchange Group, which has its own Web site at aieg.com. Housed in a nondescript office building in Birmingham, Ala., the nonprofit cooperative supports lawyers suing car, motorcycle, truck, boat, and other types of transportation companies. The AIEG is founded on a simple principle: Every time one of the group's 600 members unearths interesting corporate documents in a lawsuit, they should all be forwarded to a central repository to be shared with other lawyers.").

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Page 31 of 59 2005 Utah L. Rev. 863, *902 documents, and producing CD-ROMS. 179 Moreover, plaintiffs' counsel networks allow particular specialist lawyers to concentrate on difficult issues of science and review of "hundreds of thousands of documents," while other plaintiffs' counsel become comfortable with the trial issues surrounding the proof of damages. 180 Some plaintiffs' litigation groups have submitted amici curiae briefs on issues related to their mass tort. 181 Other firms that attempt to free ride on the investment made by a firm may find themselves shut out when a defendant settles only with a particular firm. 182 A hub-and-spoke structure yields the individual lawyer control of his or her cases, but with close consultation and coordination with a central group, perhaps an Association of Trial Lawyers of America ("ATLA") group, a court[*903] designated steering committee, or lead counsel. 183 Some of these groups are sponsored by the ATLA, a leading organization for plaintiffs' lawyers, 184 while others are not sponsored but arise from discussions between lawyers within ATLA. 185 Some firms find each other through advertisements. 186 ATLA sponsors "annual seminars, programs, and panels." 187 According to one ATLA section chair, ATLA sections provide "an invaluable source for locating experts, getting the low-down on opposing experts, and sharing technical information." 188

179

See Erichson, supra note 20, at 391 (noting that, in fen-phen litigation, "plaintiffs' lawyers contributed money toward the cost of putting [defendants'] documents in optical character recognition form, worked collaboratively to code the documents, and allowed other plaintiffs' firms to buy into the arrangement"). 180

Lowenthal & Erichson, supra note 20 at 1003-05; see also Coffee, Understanding, supra note 159, at 710-11 ("Networking has developed in the "mass tort' field, possibly because the incidence of recurring cases is too low and the nature of the factual research, which frequently involves highly technical medical or scientific issues, is too "case specific' for individual firms to invest in acquiring expertise in advance."); Yeazell, supra note 125, at 199 (noting that "[plaintiffs' counsel] specialization allows firms to amass intellectual capital - in pilot training and air traffic control, in damage assessment, in banks of experts, and the like" - and that "such lawyers and firms can market themselves, primarily to other lawyers, as experts in particular forms of litigation"); id. at 200 ("The plaintiffs' bar, more deeply capitalized, specialized, and expert, has managed to capture a part of practice previously left to solo generalists. Put differently, lawyers who fifty years ago would have operated on their own have combined, allowing deeper intellectual and financial capitalization.").

181

Lowenthal & Erichson, supra note 20, at 1003.

182

Hensler & Peterson, supra note 24, at 1043-44, 1043 n.353.

183

See Lowenthal & Erichson, supra note 20, at 1006-07 ("The tension between efficient coordination and individual case management results in a litigation control structure that neither foregoes centralized control nor deprives individual lawyers of the power to shepherd their own cases."); see also id. at 993 (noting that hub consists of coordinating committee or "information exchange vehicle"). 184

See Erichson, supra note 20, at 383-84, 394; see also Issacharoff & Witt, supra note 20, at 1610 (noting that precursor to ATLA, the National Association of Claimants' Compensation Attorneys, "had become a clearinghouse for information among the plaintiffs' personal injury bar, forging referral networks and sharing information about settlement techniques, claims valuation formulae, and the like"); Yeazell, supra note 125, at 201-02 ("A glance at the 1,200-page directory of the American Trial Lawyers Association, with on-line access, fields of specialization, and cross-indexing of members, gives one a glimpse into the expertise and the sub-specialization achieved by what was once a marginal, and marginally competent, group of lawyers. The plaintiffs' bar, with its system of referrals, is achieving transactionally the kinds of specialization and breadth that the corporate bar is achieving by growth in firm size." (citation omitted)).

185

See Erichson, supra note 20, at 394 ("ATLA provides opportunities for networking lawyers to coordinate work on similar cases.").

186

See id. at 394 n.41 (stating that "each month, ATLA publishes classified advertisements in which lawyers seek to contact lawyers handling related cases" and noting recent ad concerning ""info re Slim Fast causing diabetes/gall bladder problems'").

187

Id. at 394.

188

Id. (quoting attorney, Denise Young, chair of ATLA Professional Negligence Section).

Theresa Coetzee

Page 32 of 59 2005 Utah L. Rev. 863, *903 ATLA also sponsors "litigation groups," which have included numerous mass tort topics. 189 According to ATLA, "litigation groups provide a network for ATLA members handling similar cases to exchange information and share [*904] successful strategies." 190 Such exchanged information can include "smoking gun" documents, depositions of expert witnesses, interrogatories, lists of lawyers and experts, legal memoranda and briefs, litigation manuals, reports of nationwide verdicts and settlements, and video instruction on how to try the case. 191 Indeed, the Breast Implant Litigation Group "maintains a full time staffed office to exchange information on litigation and various settlement programs." 192 It works ""to permit each victim of breast implant injuries to benefit from the collected experience, discovery tactics, and litigation strategies of plaintiffs' attorneys who have handled or are handling similar cases.'" 193 ATLA also provides an Internet site to its members that includes over 300,000 documents organized by searchable databases and indexes. 194 TIPS, the Task Force for Plaintiff's Involvement, was established to facilitate plaintiff attorneys' networking and exchanging of information relating to plaintiffs' practice. 195 The Task Force aids in the combination of resources and knowledge about new developments and practice methods. 196 Its motto is ""bringing together plaintiff's attorneys, defense attorneys, and insurance and corporate counsel for the exchange of information and ideas.'" 197 Indeed, "through the Task Force, the attorneys communicate with a vast network of attorneys from diverse practice

189

Hensler & Peterson, supra note 24, at 1026; see also Lowenthal & Erichson, supra note 20, at 1000 ("At the center of the movement toward voluntary coordination is the Association of Trial Lawyers of America … and the "litigation groups' it sponsors."); Ass'n of Trial Lawyers of Am., Litigation Groups, at http://www.atla.org/Networking/Tier3/LitigationGroups.aspx (last visited May 15, 2005) [hereinafter Litigation Groups]. Litigation groups exist and have existed in the past for AIDS, Battery Explosion, Benzene/Leukemia, Birth Defect, Breast Cancer, Breast Implants, Carbon Monoxide, Cardiac Devices, Complex Regional Pain Syndrome/"RSD", Contraceptive Implants, Crane and Aerial Lift Injury, DES, Diet Product: Fen-Phen, Electrical Accidents, Firearms and Ammunition, Latex Allergy, Lead Paint, Liquor Liability, Mis-Read Pap Smears, Orthopedic Implants, Parlodel, Patient Abuse in Psychiatric Hospitals, Pharmacy Liability, Steroids, Tobacco Products, Toys and Recreational Equipment, Transmissions/Sudden Accceleration, Traumatic Brain Injuries, Tylenol and NSAIDS, Vaccines, Vehicle Back-Up Alarms, and Workplace Injury. Erichson, supra note 20, at 395, 395 n.43; Lowenthal & Erichson, supra note 20, at 1000-01, 1000 n.52. 190

Erichson, supra note 20, at 394 n.43; see also Lowenthal & Erichson, supra note 20, at 1000 ("The purpose of a litigation group is to permit plaintiffs "to benefit from the collected experience, materials, and information in the possession of the plaintiffs' attorneys litigating similar cases, while reducing the high costs of litigation. The litigation group provides a collegial networking structure whereby members exchange information, share experiences, and develop discovery and litigation strategies in the spirit of professional cooperation toward mutually held goals.'" (quoting ATLA Guide to Litigation Groups, Trial, July 1991, at S1, S2)). 191

See Erichson, supra note 20, at 395 & n.45 (discussing ATLA transmission/sudden acceleration group and nursing litigation group); Lowenthal & Erichson, supra note 20, at 998-99 (noting that "popular mechanisms" of plaintiff coordination include "newsletters, shared discovery, prepared trial packets, seminars on pending litigation, joint strategic planning, coordinated identification and preparation of expert witnesses, centrally handled scientific research and jury focus groups, and "schools' to educate individual lawyers about their tort and how to try the case").

192

See Erichson, supra note 20, at 395 n.45 (internal quotation marks omitted).

193

Lowenthal & Erichson, supra note 20, at 1000 n.52 (quoting J. Douglas Peters & Margaret M. Aulino, Breast Implants: Science and Litigation, Trial, Nov. 1991, at 26, 31). 194

Erichson, supra note 20, at 396.

195

Dick A. Semerdjian, The Task Force for Plaintiff's Involvement: A Leader in the ABA's Voice for Public Policy, 32 Brief 9 (Summer 2003). 196

Id.

197

Id.

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Page 33 of 59 2005 Utah L. Rev. 863, *904 backgrounds who are at the forefront of these changes, and that are of vital concern to consumers and plaintiffs' bar." 198 TIPS also aids in providing contacts and referrals to attorneys who work on similar cases. 199 [*905] Plaintiffs may also organize through "lead counsel," "liaison counsel," or "plaintiff's steering committees" ("PSCs") when before a judge with numerous cases. 200 PCSs can be formed through plaintiffs' counsels, informal or formal election, or though court appointment - possibly in connection with multidistrict litigation or other consolidation. 201 Judges may appoint a ""lead counsel,'" a PSC, or a "plaintiffs litigation committee" ("PLC") to coordinate with other plaintiffs' counsel and speak to the court and defendants on behalf of all plaintiffs. 202 Members of the steering committee have greater power and obtain greater fees, so they are widely sought. 203 As commentators have noted, PSCs are tantamount to "ad hoc law firms" assembled for a particular litigation. 204 Courts may also appoint a liaison counsel who is the contact person for communications with the court and opposing counsel. 205 Although in some instances PSCs may work from their own offices, travel minimally, and rely on telecommunications, other times PSCs may rent and equip offices, print stationery, retain experts, and take depositions. 206 Steering committees may negotiate protocols regarding the authenticity and admissibility of documents distributed, making even more useful trial-in-a-box CD-ROMs. 207 For example, the swine-flu plaintiffs' steering committee assembled a five- [*906] volume trial handbook. 208 Sometimes, however, the coordinating counsel arise without judicial involvement, and are instead chosen by plaintiffs' counsel. 209

(b) The Development of Plaintiffs' Counsel Networks 198

Id.

199

Id.

200

Dennis E. Curtis & Judith Resnik, Contingency Fees in Mass Torts: Access, Risk, and the Provision of Legal Services When Layers of Lawyers Work for Individuals and Collectives of Clients, 47 DePaul L. Rev. 425, 431 (1998); see also Erichson, supra note 15, at 525 ("In litigation formally aggregated by procedures such as multidistrict litigation transfer and statewide consolidation, lead and liaison counsel and steering committee members handle significant portions of the work on behalf of the entire group of similarly situated clients."); Erichson, supra note 20, at 390 ("Where a class action or multidistrict litigation forms part of the litigation, there may be a judicially appointed lead counsel or plaintiffs' steering committee that takes the lead in coordinating the lawyers' efforts."); Lowenthal & Erichson, supra note 20, at 993 ("The plaintiffs' litigation control structure consists of individual plaintiffs' lawyers at the spokes and a coordinating committee or information exchange vehicle at the hub."); Hoyle & Madeira, supra note 116, at 132, 142 (noting use of Plaintiffs' Legal Committee, consisting of nationally known attorneys, in Orthopedic Bone Screw multidistrict litigation). 201

Curtis & Resnik, supra note 200, at 431; Lowenthal & Erichson, supra note 20, at 999. Steering committees have also been appointed in connection with class actions. Id. 202

Curtis & Resnik, supra note 200, at 431; see also Hoyle & Madeira, supra note 116, at 142 (discussing multidistrict litigation appointment of eleven-member Plaintiffs' Management Committee, after viewing twenty lawyers' presentations regarding their experiences); Lowenthal & Erichson, supra note 20, at 999 (noting that, in multidistrict litigation and consolidation, "the court may (and usually does) impose a structure and set ground rules for a "steering committee,' and decisions of the committee bind all of the aggregated claims"). 203

Lowenthal & Erichson, supra note 20, at 999-1000.

204

Curtis & Resnik, supra note 200, at 437.

205

See Lowenthal & Erichson, supra note 20, at 999 ("In addition to a steering committee or lead counsel, the court may require the appointment of "liaison counsel' to serve as a link among the steering committee, the individual plaintiffs' lawyers, and the court.").

206

Curtis & Resnik, supra note 200, at 437.

207

Lowenthal & Erichson, supra note 20, at 1003.

208

Id.

209

Erichson, supra note 20, at 390; see also Schuck, supra note 127, at 952 (noting "a high degree of informal coordination, continuity, and learning across different mass torts").

Theresa Coetzee

Page 34 of 59 2005 Utah L. Rev. 863, *906 The first known instance of a plaintiffs' counsel network occurred in 1963, when various plantiffs' counsel brought claims regarding MER/29, an anticholesteral drug, in federal and state courts against manufacturer RichardsonMerrell, Inc. 210 Plaintiffs claimed that the drug caused cataracts, and 1500 plaintiffs brought suit in federal and state courts. 211 Among the materials distributed by the plaintiffs' litigation group were newsletters, RichardsonMerrell documents, medical analyses, and trial transcripts. 212 In addition, the group created the "MER/29 School," which taught attorneys trial strategy. 213 In addition, a voluntary agreement with the defendant lowered discovery costs for both plaintiffs and defendant by providing that discovery by the group's representatives applied to all cases - including those subsequently filed. 214 The group's trustee eventually copied and made available over 100,000 documents. 215 Moreover, the plaintiffs' group served a standard set of interrogatories, and defendants provided consistent answers. 216 In the end, group members were more successful in obtaining settlements than those attorneys who did not join the group. 217 Richardson-Merrell, Inc. ultimately paid more than $ 200 million related to civil suits. 218 In the 1970s, plaintiffs' groups developed further in the Dalkon Shield litigation - litigation pertaining to injuries received by the Dalkon Shield intrauterine device. 219 Indeed, many Dalkon Shield plaintiffs' group members were previously part of the MER/29 litigation group. 220 One attorney, who was part of the Dalkon Shield Group, remarked, ""Early on I got a box of what I call smoking-pistol papers that would have been difficult, if not impossible, to [*907] get hold of on my own.'" 221 Plaintiffs' counsel litigation groups also held "schools" on how to bring a case. 222 Indeed, in 1982, one prominent plaintiffs' attorney noted, Whereas in the first two decades of groups there were perhaps only six that ran well and made achievements, it is easy to predict that there will be many more in the near future. The courts are consolidating litigation to diminish their own burdens and thereby bringing plaintiff's groups into existence, willingly or otherwise. Manufacturers are putting out more bad products that cause widespread injury; the high costs of handling a product case and the

210

See Lowenthal & Erichson, supra note 20, at 1001; Rheingold, supra note 167, at 116; see also Erichson, supra note 20, at 392 ("In 1963, thirty-three lawyers pursuing claims against the manufacturer of the anti-cholesterol drug MER/29 formed the first major plaintiffs' group … ."); Hensler & Peterson, supra note 24, at 978 ("MER-29 is said to be the first mass tort litigation in which a plaintiff's attorneys' litigation group was established to coordinate efforts against the defendant."). 211

Lowenthal & Erichson, supra note 20, at 1001; Resnik, supra note 20, at 39 n.166.

212

Lowenthal & Erichson, supra note 16, at 1001.

213

Id.

214

Id. at 1001-02.

215

Id. at 1002.

216

Id.

217

Id.

218

Hensler & Peterson, supra note 24, at 978.

219

Lowenthal & Erichson, supra note 20, at 1002.

220

Id.

221

Id.

222

Id. at 1003 n.74.

Theresa Coetzee

Page 35 of 59 2005 Utah L. Rev. 863, *907 increased expertise needed to develop one properly drive plaintiff's lawyers together. No longer can each lawyer afford the time and money to become an expert in one case. 223 In the 1990s, networks of plaintiffs' counsel continued to spread and deepen. For example, ATLA's 300-attorney Ltryptophan group combined resources to research issues related to jurisdiction, find a laboratory able to analyze Ltryptophan pills, and hire a research group to investigate scientific and medical parts of the claims. 224 In addition, the group completed jury research using focus groups, 225 published a monthly newsletter, maintained document depositories, and created deposition teams of lawyers for the scientists of the manufacturer. 226 The group also coordinated discovery with foreign lawyers. 227 In addition, the L-tryptophan group assembled 300 attorneys to serve as the multidistrict litigation steering committee. 228 One ATLA newsletter described plaintiffs' L-tryptophan coordination as ""the greatest example of information and work sharing in the history of the United States civil justice system.'" 229 Within a year of the Twin Towers bombing litigation in 1993, plaintiffs' counsel filed 126 personal injury suits and seventeen property damage suits. 230 One of the plaintiffs' attorneys contacted others and scheduled a meeting, [*908] which over fifty plaintiffs' lawyers attended. 231 By the first conference, the plaintiffs' group had formed a tentative steering committee and liaison attorney. At the conference, which eighty lawyers attended, the judge stated, "we have to have coordination to avoid wasting your time and my time," adding that repetitive papers generated without coordination would be "anti-ecological." 232 The lawyers subsequently finalized the steering committee plan and submitted it to the court for approval. 233 Moreover, in the breast implant litigation, plaintiffs' counsel formed litigation groups and assembled a "Master Complaint," which was filed in the multidistrict litigation court, and a "Complaint and Adoption by Reference," which was for filing by counsel in any federal district court. 234 In each individual complaint, counsel need only insert plaintiff's name, dates of implantation, defendants (out of a list of thirty-five suggested possible defendants), and adopt by reference claims from twenty-eight potential causes of action from the Master Complaint. 235 Moreover, over 150 plaintiffs' counsel became part of an "information clearing-house" through Public Citizen, an attorneysupported entity. 236

223

Id. at 1005 (quoting Rheingold, supra note 160, at 12-13). One example of this coordination was the formation of plaintiffs' litigation groups in the Bendectin litigation. See Green, supra note 146, at 170-73, 240-41; Erichson, supra note 20, at 392; Joseph Sanders, The Bendectin Litigation: A Case Study in the Life Cycle of Mass Torts, 43 Hastings L.J. 301, 311, 354 (1992). 224

Erichson, supra note 20, at 392; Hensler & Peterson, supra note 24, at 1026; Lowenthal & Erichson, supra note 20, at 1004.

225

Lowenthal & Erichson, supra note 20, at 1004.

226

Hensler & Peterson, supra note 24, at 1026.

227

Id.

228

Id.

229

Lowenthal & Erichson, supra note 20, at 1007 n.92.

230

Id. at 1005.

231

Id.

232

Id.

233

Id. at 1006; see also id. at 1006 n.88 (noting that any objector to plan had opportunity to be heard before court ruled).

234

Erichson, supra note 20, at 392 & n.27; Lowenthal & Erichson, supra note 20, at 1004.

235

Lowenthal & Erichson, supra note 20, at 1004.

236

Hensler & Peterson, supra note 24, at 1026.

Theresa Coetzee

Page 36 of 59 2005 Utah L. Rev. 863, *908 Beginning in the mid 1990s, many of the nation's most prominent plaintiffs' attorneys joined together to sue the tobacco industry. 237 In one group, which became known as the Castano PLC, the firms each contributed at least $ 100,000 toward expenses, creating a common fund of $ 4 million. 238 The group was coordinated by a Plaintiffs' Executive Committee consisting of twelve lawyers. 239 One attorney noted, "the fact that so many of the important plaintiffs' firms nationally have now joined this fight in my opinion tips the scales in favor of the plaintiffs in cigarette litigation." 240 Moreover, other plaintiffs' counsel paid $ 5000 each to cover administrative costs to an informationsharing group called the Tobacco Trial Lawyers Association, headed by successful tobacco plaintiffs' counsel Woody Wilner. 241 [*909] Moreover, in the tobacco litigation, plaintiffs' counsel gained synergies with government lawyers bringing

lawsuits against the same defendants. 242 Governments may seek reimbursement of government moneys paid to persons injured allegedly as a result of defendants' conduct. 243 Indeed, sometimes, governments may hire out their claims to plaintiffs' lawyers. 244 In the tobacco litigation, once the state attorneys general joined forces with leading mass tort plaintiffs' lawyers, who were hired under contingency fee contracts, defendants began pursuing settlement discussions. 245 Moreover, other plaintiffs' counsel benefited from a thirty-five million page document depository, largely available on the Internet, created in connection with settlement of a tobacco lawsuit by Minnesota. 246 In the fen-phen litigation, plaintiffs' attorneys in Pennsylvania and New Jersey began litigation in 1998. 247 In addition to conducting their own discovery, they coordinated with Texas lawyers who had been litigating since 1997, and obtained their discovery, as well. 248 Subsequently, New York lawyers joined the Pennsylvania and New

237

See Erichson, supra note 20, at 392 n.30; Lowenthal & Erichson, supra note 20, at 1006 n.88; see also Erichson, supra note 125, at 129-30 (noting creation of "elite cadre of mass tort lawyers who have taken the experience and fees accumulated in earlier mass tort litigation and continued to invest it in subsequent matters," and that plaintiffs' lawyers may collect $ 10 billion in fees from tobacco litigation over two decades). 238

See Lowenthal & Erichson, supra note 20, at 1006 n.88; see also Erichson, supra note 20, at 393-94 (noting Castano tobacco plaintiffs' counsel group, each of whom contributed $ 100,000 to expenses).

239

Lowenthal & Erichson, supra note 20, at 1006 n.88.

240

Id.

241

Erichson, supra note 20, at 388-90.

242

See Field, supra note 161, at 125 (noting that tobacco companies "entered settlement talks with an anti-tobacco alliance comprised of states' attorney generals, plaintiffs' lawyers, and public health advocates"). 243

See Hensler, supra note 122, at 206-07 ("This new [tobacco] litigation comprises a mix of private personal injury claims pursued collectively (that is, mass torts) and public actions brought by state attorneys general and other public officials… . Public officials and private attorneys are collaborating on this litigation, which also has the support of advocacy groups such as public health organizations, gun control advocates, and consumer health care advocates."). 244

See Field, supra note 161, at 116-17 (stating that, with regard to state tobacco Medicaid suits, "the plaintiffs[] [were] represented by government attorneys working with experienced products liability lawyers in an effort to "establish for the first time that the tobacco companies have as much [of an] obligation to compensate the states for damages caused by their product as an oil company has for the cost of cleaning up a spill" (third alteration in original)). 245

Hensler, supra note 122, at 208-09.

246

See Howard M. Erichson, Coattail Class Actions: Reflections on Microsoft, Tobacco, and the Mixing of Public and Private Lawyering in Mass Litigation, 34 U.C. Davis L. Rev. 1, 11-12 (2000) (noting availability of trial exhibits from Washington state litigation and other state-case pleadings and decisions). 247

Paul D. Rheingold, Prospects for Managing Mass Tort Litigation in the State Courts, 31 Seton Hall L. Rev. 910, 915 (2001).

248

Id.

Theresa Coetzee

Page 37 of 59 2005 Utah L. Rev. 863, *909 Jersey lawyers; the lawyers from these three states became known as "the Mid-Atlantic group." 249 Not only was discovery shared, but it was applied to new cases by stipulations with defendants. 250 As additional litigation occurred in another state, stipulations again brought in prior discovery. 251 The Mid-Atlantic group also scanned defendants' documents, making them searchable by other lawyers. 252 [*910]

2. Networks of Defense Counsel Like plaintiffs' counsel, defense counsel have also created networks, providing similar benefits for the efficient and effective management of litigation. Defense counsel networks, of course, arise differently than plaintiffs' networks: multiple defense counsel nationwide often represent the same corporate defendant, while plaintiffs' counsel share similar interests, but represent different clients. When a defendant becomes involved in a mass tort, the defendant first retains a law firm to act as lead counsel. 253 The lead counsel, in turn, begins hiring local counsel wherever lawsuits are filed or expected to be filed, because the lead counsel is not likely to have offices in all of those places. 254 As with plaintiffs' counsel, the defense control structure is hub-and-spoke, with lead counsel at the hub, and local counsel acting as spokes. 255 Lead counsel keep local counsel informed through seminars, mailings, and email. 256 When multiple defendants are involved, lead counsel for the various defendants often begin networking among themselves. Joint defense consortia form to exchange information and coordinate strategy, 257 communicating pursuant to joint defense agreements. 258 Defense counsel have joint-defense meetings to coordinate strategy and

249

Id.; see also Erichson, supra note 20, at 391 ("[A] number of lawyers formed a "plaintiffs' consortium for handling state court cases around the country.").

250

Rheingold, supra note 247, at 915.

251

Id.

252

Id.

253

See Lowenthal & Erichson, supra note 20, at 990; see also Issacharoff & Witt, supra note 20, at 1621 ("In the defense context, one or more powerful institutional actors select lawyers to serve as organizers of their defense across a large number of cases.").

254

See Erichson, supra note 20, at 384 ("Not only have lawyers for different defendants worked together, counsel for each defendant has coordinated the handling of its own batch of lawsuits. For defendants sued in multiple jurisdictions, local counsel in each jurisdiction handles the representation in consultation with lead counsel … ."); Lowenthal & Erichson, supra note 20, at 990, 991 (noting that this process "establishes what may become a vast, networked team of defense lawyers"). 255

Lowenthal & Erichson, supra note 20, at 993.

256

Id. at 996.

257

See Erichson, supra note 125, at 125; see also George S. Mahaffey, Jr., All for One and One for All? Legal Malpractice Arising from Joint Defense Consortiums and Agreements, The Final Frontier in Professional Liability, 35 Ariz. St. L.J. 21, 28 (2003) ("In more recent times, joint defense consortiums have become di rigueur in complex, multi-party, civil litigation as a means by which multiple co-defendants represented by separate counsel can share information and cooperate in formulating a defense to a common plaintiff's claims."). 258

See Erichson, supra note 20, at 384 ("The defense has coordinated as well. Counsel for the widget manufacturers and widgium suppliers have held joint defense meetings to share information and discuss strategy, pursuant to a written joint defense agreement."); Mahaffey, supra note 257, at 29 ("Generally, before a full-blown conference is held to formulate a common defense pursuant to a joint defense consortium, a written JDA [Joint Defense Agreement] will be executed… . The written JDA can take many forms, from a one-page letter to a prolix and complicated memorandum.").

Theresa Coetzee

Page 38 of 59 2005 Utah L. Rev. 863, *910 share information, as well as joint-defense conference calls. 259 For particular purposes or cases, lead defense counsel for [*911] each corporation may decide upon a lead counsel to take primary responsibility for the entire group, and perhaps to speak to the court for the group. 260 In multidistrict litigation, lead defense counsel may be appointed by the court. 261 Sometimes, varying litigation goals can create subgroups within the group of larger defendants, 262 especially if defendants seek to blame a particular defendant for the mass tort. 263 Defense counsel networks aid in the undertaking of numerous tasks. Certain lead counsel may also undertake work that benefits other lead counsel pursuant to indemnification agreements, or merely by mutually agreed upon division of labor. 264 This allows defendants to save costs. 265 For example, defense firms may share the costs of additional scientific study of a supposedly toxic substance, 266 and defense counsel may submit joint briefs to a court. 267 On procedural matters, defendants may collaborate in venue transfer, forum non conveniens, and removal. 268 For example, defendants jointly sought removal from Florida state court in a tort litigation relating to the DBCP agricultural chemical, and together brought motions to dismiss under forum non conveniens. 269 Defense counsel may also collaborate in coordinating discovery efforts. 270 The Defense Research Institute ("DRI") facilitates networking among defense counsel by providing seminars and research for defense counsel. 271 A [*912] counterpart to ATLA for plaintiffs, 272 DRI has created litigation groups for defense lawyers regarding product liability litigation. 273 In addition, DRI offers case-handling guidelines

259

See Lowenthal & Erichson, supra note 20, at 998 (noting "periodic meetings"); Mahaffey, supra note 257, at 29 ("Once the JDA [Joint Defense Agreement] is executed, counsel can engage in a number of activities ranging from the mere sharing of documents and other memoranda, to meetings between co-defendants and their respective counsel wherein confidential matters are disclosed and a unified defense created.").

260

See Lowenthal & Erichson, supra note 20, at 998 (noting ""the use of one attorney or firm to represent, where appropriate, more than one defendant'" (quoting O.J. Weber, Mass Tort Litigation: The Pot Boils Over, 6 J. Prod. Liab. 273, 280 (1983))). 261

See Hoyle & Madeira, supra note 116, at 143 (discussing, in diet drugs multidistrict litigation, court appointment of lead and liaison counsel for defendants).

262

See Lowenthal & Erichson, supra note 20, at 996-97 ("Even where coordination is informal, alliances and divisions of interests and ideas form rapidly and shift often."). 263

See id. at 997; see also Mahaffey, supra note 257, at 29 ("The interests of defendants may ultimately diverge as the litigation ensues."). 264

See Lowenthal & Erichson, supra note 20, at 996, 998 (noting "delegation of particular tasks to specific attorneys").

265

See Mahaffey, supra note 257, at 28 ("By engaging in joint defense consortiums, counsel can … apportion the everincreasing costs of litigation."); Resnik, supra note 20, at 38 ("Defense lawyers may also pool resources to defend … ."). 266

See Erichson, supra note 20, at 384 ("[Defense counsel] have jointly commissioned a scientific study into the toxicity of widgium.").

267

See Manual, supra note 1, at 22.2 ("In appropriate cases, the court should encourage defendants to present joint defenses or to coordinate motions and eliminate repetitive arguments.").

268

Lowenthal & Erichson, supra note 20, at 997-99.

269

Id. at 997-98.

270

Id. at 998.

271

Id. at 996 n.31.

272

See Def. Research Inst., About DRI, at http://www.dri.org/dri/about/index.cfm (last visited May 15, 2005) (noting that goals include "Balance: To be a counterpoint to the Association of Trial Lawyers of America"). 273

Id.

Theresa Coetzee

Page 39 of 59 2005 Utah L. Rev. 863, *912 regarding billing and case management, 274 seminars on recent developments in the law, 275 access to twenty-five substantive law committees, 276 various defense practitioner publications, 277 an expert witness database on over 50,000 plaintiff and defense experts, 278 and a webpage to keep its members informed of its services. 279 3. Networks of Judges Networks of judges assist judges in the task of case management. By eliminating duplicative actions and coordinating, judges greatly increase the efficiency of litigation and reduce costs. 280 By ordering the disclosure of related cases, judges may learn of mass tort cases that would benefit from [*913] networked treatment. 281 Such information is required for "case-management decisions, including the appropriate level of communication, cooperation, or coordination with other courts." 282 After gaining control of these related cases, judges might hold joint discovery, joint pretrial hearings, and use special masters. 283 Coordination may include discovery, pretrial motions, and trial schedules. 284 Federal and state court networks also benefit the treatment of litigation. Such networks can improve discovery efficiency by use of joint scheduling, use of common discovery productions, deciding jointly regarding disputes, and

274

Def. Research Inst., Case Handling Guidelines, at http://www.dri.org/dri/ about/guidelines.cfm (last visited May 15, 2005).

275

See Def. Research Inst., Seminar Schedule, at http://www.dri.org/dri/cle-seminars (last visited May 15, 2005) (noting upcoming topics for 2005 summer conferences). 276

Def. Research Inst., Committees, at http://www.dri.org/dri/committees (last visited May 15, 2005).

277

Def. Research Inst., Publications, at http://www.dri.org/dri/publications (last visited May 15, 2005).

278

Def. Research Inst., Member Benefits, at http://www.dri.org/dri/membership (last visited May 15, 2005).

279

See Def. Research Inst., The Voice of the Defense Bar, at http://www.dri.org/dri/ (last visited May 15, 2005).

280

See Francis E. McGovern, Rethinking Cooperation Among Judges in Mass Tort Litigation, 44 UCLA L. Rev. 1851, 1851-52 (1997) ("Our appreciation of the benefits of cooperation among judges is increasingly obvious. These benefits parallel the strengths of cooperation among adversaries: savings in cost and time, quality of outcomes, and increased satisfaction and fairness."); McGovern, supra note 69, at 1872 (noting that "joint gains … stem only from the reduction of duplicative efforts and the increase in consistency amongst outcomes, but do not extend further"); William W. Schwarzer et al., Judicial Federalism in Action: Coordination of Litigation in State and Federal Courts, 78 Va. L. Rev. 1689, 1690-91 (1992) ("Insufficient attention has been given to the extensive coordination between state and federal courts that can be achieved without new legislation or rules, and without subordinating one system to the other… . We conclude that when litigation spans state and federal courts, informal coordination can advance judicial economy, efficiency, and fairness."). Professor McGovern has stated that "if a judge decides to create an inexpensive and expeditious case management procedure via trial or settlement, the judge invites new filings," noting that "if you build a super-highway, there will be a traffic jam." McGovern, supra note 69, at 1870. While the burden of new filings is always a concern, the goal of courts in mass torts should not be to discourage the filing of further claims in the name of case management, but to manage efficiently those claims that are brought, and to sort those that are meritorious from those that are not. 281

See Manual, supra note 1, at 22.2 ("Courts routinely order counsel to disclose, on an ongoing basis past, and pending related cases in state and federal courts and to report on their status and results."); Resnik, supra note 20, at 37 (noting disclosure of "relatedness" to another action on federal civil cover sheet used in twenty-five jurisdictions).

282

Manual, supra note 1, at 22.2.

283

Resnik, supra note 20, at 5, 37; Schwarzer et al., supra note 280, at 1707-12.

284

See Schwarzer et al., supra note 280, at 1707-14; see also Manual, supra note 1, at 22.2 ("Formal and informal techniques to coordinate discovery, pretrial motions, rulings on class certification, trial schedules, and other matters should be considered.").

Theresa Coetzee

Page 40 of 59 2005 Utah L. Rev. 863, *913 implementing joint document depositories. 285 Courts may also use a common special master. 286 Furthermore, courts may hold joint settlement conferences and alternative dispute resolution, and pursue coordinated settlement strategies. 287 In addition, courts may use joint pretrial orders and hearings regarding pretrial management and trial planning. 288 Consolidated state mass tort transferee courts are particularly well-suited to cooperate with federal courts in managing mass tort litigation, as has occurred in New Jersey where Judge Corodemus has worked extensively with federal judges to coordinate mass tort litigation. 289 Moreover, state courts may share information with each other. 290 In the federal system, at the center of many such mass tort networks and making maximum use of technology is the multidistrict litigation ("MDL") transferee court. Under the MDL statute, the Judicial Panel on Multidistrict Litigation ("Panel") may transfer all pending federal litigation on a particular matter to a single federal district court for pretrial management if the litigation [*914] involves one or more common issues of fact, would serve the convenience of parties and witnesses, and would promote the just and efficient conduct of such actions. 291 After pretrial management, cases must then be transferred back to their original jurisdictions for trial. 292 Since the beginning of the MDL in 1968, the Panel has decided approximately 1300 motions for transfer, about ten percent of which have been mass torts. 293 And the panel has granted fifty-nine percent of the motions for transfer that it has heard. 294 As an MDL court, judges have obtained control over many claims. For example, in the Agent Orange litigation, Judge Weinstein in the Eastern District of New York gained control over 240,000 claims. 295 Similarly, in 1991, the Panel on Multidistrict Litigation transferred 27,000 asbestos claims to Judge Weiner in the Eastern District of Pennsylvania. 296 The MDL court has been an integral part in the development of networks as an effective, efficient alternative to mass tort class actions. MDL courts have facilitated the creation of plaintiffs' networks among state counsel by creating organizational structures based on MDL lead counsel. 297 MDL court proceedings have also facilitated

285

Michael Dore, Reforming the New Jersey Supreme Court's Procedures for Consolidating Mass Tort Litigation: A Proposal for Disclosing the Rules of the Game, 55 Rutgers L. Rev. 591, 601 n.54 (2003); Schwarzer et al., supra note 277, at 1707-12. 286

Dore, supra note 285, at 601 n.54; Schwarzer et al., supra note 280, at 1709-10; see also Hoyle & Madeira, supra note 116, at 132, 143 (noting Judge Bechtle's appointment of special masters in multidistrict litigations for discovery issues concerning orthopedic bone screw and diet drugs).

287

Dore, supra note 285, at 601 n.54; Schwarzer, et al., supra note 280, at 1715-21.

288

Dore, supra note 285, at 601 n.54.

289

See id. (noting that "the successes of the Middlesex County Mass Tort Court have been particularly noteworthy in the area of state/federal cooperation" and that "Judge Corodemus has pioneered New Jersey mass tort cooperative efforts in almost all of these areas"). 290

See McGovern, supra note 33, at 1840-41 ("State judges have created institutions to enable them to communicate among themselves."). 291

292

See 28 U.S.C. 1407(a) (2000). Lexecon, Inc. v. Milberg Weiss Bershad Hynes & Lerach, 523 U.S. 26, 28 (1998).

293

Hensler, supra note 122, at 186.

294

Id.

295

Coffee, supra note 31, at 1366.

296

See id.; Hensler, supra note 34, at 1901; see also Hoyle & Madeira, supra note 116, at 124-30 (describing asbestos multidistrict litigation proceedings); id. at 131-37 (discussing orthopedic bone screw multidistrict litigation proceedings); id. at 137-39 (discussing latex gloves multidistrict litigation); id. at 140-49 (describing diet drugs multidistrict litigation). 297

See Lowenthal & Erichson, supra note 20, at 991.

Theresa Coetzee

Page 41 of 59 2005 Utah L. Rev. 863, *914 networked coordination of discovery. 298 MDL court proceedings have also streamlined pleadings, by allowing the filing of "short-form" complaints, which the parties deemed to include complete allegations and defenses. 299 MDL courts have also provided for master sets of discovery requests. 300 In addition, MDL courts have provided for defendants' documents to be produced to a central document depository, open to federal and state plaintiffs' counsel. 301 MDL courts may also use webpages to make [*915] available information on court orders and proceedings to state courts, state counsel, and anyone interested in the litigation, including clients. 302 In addition, MDL courts have required plaintiffs' counsel to provide completed questionnaires to defendants providing various information about their plaintiffs, as well as authorizations for records. 303 MDL courts have also provided a location for the development of scientific information through expert panels. 304 Other federal judges are of course willing to cooperate with MDL court judges. For example, after asbestos litigation had been transferred via the MDL to Judge Weiner of the Eastern District of Pennsylvania, Chief Judge Parker of the Eastern District of Texas wrote in a letter to him, "I view your role as one of the commanding generals. You are the Eisenhower of this D-Day operation. The rest of us are colonels prepared to take orders in this joint effort." 305 State courts also cooperate with federal judges in managing mass tort litigation. 306 Federal and state judges have cooperated in rendering multijurisdictional mass tort litigation more efficient, expediting case processing, and

298

See Green, supra note 146, at 175-77 (describing discovery coordination among counsel); Lowenthal & Erichson, supra note 20, at 991 ("MDL court-sanctioned mechanisms render coordination among counsel even more highly structured than in nonMDL mass tort litigation.").

299

See Hoyle & Madeira, supra note 116, at 132 (noting that Judge Bechtle allowed filing of "short-form" complaints in Orthopedic Bone Screw multidistrict litigation, "which, by stipulation of the parties, were deemed to state all elements of each of the claims for relief. Also by stipulation it was deemed that defendants denied all allegations and raised all affirmative defenses without the need for defendants to answer the complaints."). 300

See id. at 144 (noting, in diet drug multidistrict litigation, that court required that "all defendants respond to a master set of interrogatories from the PMC and to a master request for production of documents").

301

See id. at 133 (noting that, in Orthopedic Bone Screw multidistrict litigation, "defendants produced millions of pages of documents in response to a master set of interrogatories and master request for production of documents to the PLC who maintained a document depository … . All documents produced were made available to all plaintiffs' counsel of record in [the MDL], as well as state court plaintiffs' counsel pursuant to specific criteria."); id. at 143 (discussing use of document depository, open to all state and federal plaintiffs' counsel in diet drug multidistrict litigation, provided they agreed to master confidentiality stipulation). 302

See, e.g., id. at 143 (noting use of website for orders and decisions in diet drugs multidistrict litigation).

303

See id. at 133 (noting that, in Orthopedic Bone Screw multidistrict litigation, "Judge Bechtle used to great effect … a jointly developed questionnaire that plaintiffs were required to submit to the defendant manufacturer of their implanted device. The questionnaire incorporated authorizations for medical, employment, and workers' compensation records."); id. at 138 (stating that, in latex glove multidistrict litigation, "each plaintiff is required to fill out an extensive form (over 40 pages in length) that provides information about product exposure, product identification, medical treatment for allergies, and relevant documents. Plaintiffs must also provide completed medical, school, tax, military, social security, and employment record authorization forms." (citation omitted)); id. at 143-44 (noting requirement of twenty-four page "Plaintiff's Fact Sheet" and signed authorizations in diet drug multidistrict litigation). 304

See Howard M. Erichson, Mass Tort Litigation and Inquisitorial Justice, 87 Geo. L.J. 1983, 1990-91 (1999) (discussing role of scientific expert panels in settlement). 305

Coffee, supra note 31, at 1390 (quoting Letter from The Honorable Robert M. Parker, Chief Judge, United States District Court, Eastern District of Texas, to The Honorable Charles R. Weiner, United States District Court, Eastern District of Pennsylvania 1-2 (Aug. 1, 1991) (on file with Columbia Law Review)). 306

See William B. Rubenstein, A Transactional Model of Adjudication, 89 Geo. L.J. 371, 425 (2001) ("It is now commonly accepted that federal judges will coordinate their activities with state judges, and across states.").

Theresa Coetzee

Page 42 of 59 2005 Utah L. Rev. 863, *915 prodding a global settlement. 307 MDL courts share information [*916] with state courts, 308 and state courts have coordinated discovery with federal judges. 309 Further cooperation among federal and state judges in the future would improve the achievement of such goals, 310 although federalism values properly prevent state courts from surrendering complete decisionmaking or adopting a joint approach that does not faithfully adhere to their states' particular requirements. 311 For example, in the latex glove multidistrict litigation, the MDL court ordered that copies of MDL case management orders be made available to state court judges. 312 Moreover, the court created, updated, and provided to state courts a National Latex Glove Litigation Trial Calendar of all state and federal trials. 313 In addition, the MDL court corresponded and spoke with all state judges regarding the resolution of common issues such as privilege, and initiated the creation of a state courts committee of eight judges to increase state-federal coordination of discovery and other pretrial issues. 314 Depositions could be cross-noticed for state and federal courts, and document depositories were open to all plaintiffs and defense attorneys. 315 The MDL court also consulted state courts regarding potential coordinated Daubert hearings 316 regarding expert witness opinion admissibility. 317

307

See Hensler & Peterson, supra note 24, at 1054; see also Hoyle & Madeira, supra note 116, at 144 (describing, in diet drug multidistrict litigation, court creation of Discovery Committee of attorneys in state and federal cases to reduce discovery costs, and State/Federal Coordination Committee for nondiscovery issues); Rheingold, supra note 247, at 917 ("In the past decade, federal judges managing MDLs have made a special effort to deal with state court cases, often by appointing a special master or a state court liaison committee to interface with the state judges handling the same cases, or to interface with the parties' attorneys.").

308

See McGovern, supra note 33, at 1841 ("The MDL judges have established ad hoc information-sharing mechanisms with state judges … ."). 309

See Sandra Mazer Moss, Response to Judicial Federalism: A Proposal to Amend the Multidistrict Litigation Statute from a State Judge's Perspective, 73 Tex. L. Rev. 1573, 1573 (1995) ("Using standardized pleadings and interrogatories that are deemed accepted, as far as practicable in multiple courts, has cut litigation costs dramatically. Not only are coordinated depositions cost-effective, but they also enable expert witnesses and corporate executives to streamline their litigation schedules, testifying on global topics only once for use in every jurisdiction. Although some courts have resisted ad hoc cooperation as being beyond their inherent powers, the majority have embraced coordinated litigation enthusiastically."). One commentator, however, has noted that "bottom-up" cooperation between state and federal courts has recently lost strength, in part because of the failure of courts to use anything other than "two speed" cooperation of deferring or not deferring. See McGovern, supra note 69, at 1881-82. 310

See Hensler & Peterson, supra note 24, at 1054-55 ("Federal-state coordination … is a logical next step along the path that judges have trod in dealing with mass personal injury claims over the past decade: It aims to achieve more efficient resolution of mass claims, without addressing the equity issues that inhere in them."). 311

McGovern, supra note 69, at 1874.

312

See Hoyle & Madeira, supra note 116, at 139; cf. id. at 144 (noting, in diet drug litigation, Joint Agreement between MDL court and state judge responsible for all California cases, merging state and federal committees for discovery, which included depositions). 313

Id. at 139.

314

Id.

315

Id.

316 317

Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579 (1993). See id. (referring to Court's opinion governing standard for admissibility of expert opinion evidence).

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Page 43 of 59 2005 Utah L. Rev. 863, *916 [*917] Federal and state courts also coordinated well in the silicone breast implant litigation. 318 The Panel on

Multidistrict Litigation transferred approximately 9600 silicone breast implant cases from other courts. 319 In addition, the state courts had thousands of similar cases. 320 Judge Pointer, the MDL transferee judge, met with state tort judges from the Mass Tort Litigation Committee just two weeks after his appointment, and agreed to designate certain upcoming Texas depositions as official ones for the MDL litigation. 321 The MDL transferee judge also appointed a special master to encourage state and federal cooperation. 322 In response to efforts by Judge Pointer, the state judges agreed to let the MDL court schedule global depositions pertaining to their jurisdictions. 323 The federal and state judges also created joint depositories for depositions and documents. 324 During the litigation, Judge Pointer attended meetings of the state judges in the Mass Tort Litigation Committee, and the judges discussed case management approaches. 325 Judge Pointer also occasionally deferred to state court discovery rulings. 326 Moreover, Judge Pointer created regional meetings to hear from other state judges and local attorneys. 327 As a result, certain state judges received responsibility for particular aspects of the common discovery program, such as creating standard interrogatories. 328 Other state courts received responsibility for addressing difficult state law issues that arose in federal diversity cases. 329 Judge Pointer also conferred with state judges to address conflicting rulings. 330 In addition, Judge Pointer appointed a "National Science Panel," and sought recommendations from a "Selection Panel" to discuss scientific issues. 331 After the panel reported in 1998 that studies generally do not show a link between silicone breast implants and disease, the litigation vastly diminished. 332 [*918] Proceedings similar to the MDL have also occurred within states. California and West Virginia have procedures designed for the consolidation of mass tort litigation. 333 In California, a judicial council determines whether statewide aggregation is appropriate, and if so, selects a judge to oversee the cases. 334 Similarly, West

318

See Rheingold, supra note 247, at 917 ("In the [silicone breast implant litigation], Judge Sam Pointer made an extensive effort to become involved with the state court cases, and met with moderate success aggregating the cases."). 319

Sam C. Pointer, Jr., Reflections by a Federal Judge: A Comment on Judicial Federalism: A Proposal to Amend the Multidistrict Litigation Statute, 73 Tex. L. Rev. 1569, 1569 (1995).

320

Id.

321

Moss, supra note 309, at 1574.

322

McGovern, supra note 69, at 1881.

323

Moss, supra note 309, at 1574.

324

Id. at 1574-75.

325

Id. at 1575.

326

McGovern, supra note 69, at 1881-82; see also McGovern, supra note 280, at 1864-65 ("The federal court used the preexisting California interrogatories and answers in lieu of its own interrogatories.").

327

Moss, supra note 309, at 1575.

328

Pointer, supra note 319, at 1571.

329

Id.

330

See Moss, supra note 309, at 1575 ("On one occasion, Judge Pointer and I jointly resolved, by a conference call, crucial discovery disputes that arose because of our conflicting rulings.").

331

Erichson, supra note 304, at 1990.

332

Id.

333

See Dore, supra note 285, at 595-96 & n.30 (discussing California and West Virginia procedures).

334

Id. at 596; see also Rheingold, supra note 247, at 911-12 ("Undoubtedly, California offers the most organized procedures for handling multi-county suits involving the same product. Since 1974, California's civil practice code has provided detailed rules for

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Page 44 of 59 2005 Utah L. Rev. 863, *918 Virginia recently enacted a rule creating a Mass Litigation Panel consisting of six circuit judges; it authorized them to transfer and consolidate mass tort litigation if "common questions of law or fact" are present. 335 Under the rule, the West Virginia panel has consolidated claims including asbestos, coal, and timber operator flood liability claims. 336 In New Jersey, the supreme court transferred certain cases as mass torts, such as PPA, Propulsid, Norplant, tobacco, diet drugs, breast implants, Rezulin, and lead paint, to Middlesex County before Judge Marina Corodemus. 337 The transfer avoided inconsistent rulings on discovery and substantive issues, developed particularized expertise in the mass tort in the transferee court, and many of the cases have been timely resolved. 338 The New Jersey Supreme Court has transferred some cases merely for pretrial management, but others for both pretrial and trial proceedings. 339 In contrast, New York uses a statewide administrative judge, often at the request of a party or particular judge, to decide whether cases in multiple counties should be transferred to one judge. 340 Other states have used general case consolidation rules for mass torts. 341 Pennsylvania has the Philadelphia Court of Common Pleas mass tort program, which began in 1992 in response to the demands of asbestos litigation. 342 [*919] Using "standardized case management procedures and scheduling," the program has facilitated the litigation of thirty-seven mass tort matters, with over 7000 cases currently in litigation. 343 To further cooperation, state judges created the Mass Tort Litigation Committee of the Conference of Chief Justices. 344

Numerous organizations exist to facilitate federal-state coordination. Organizations actively promoting such cooperation have included the Federal Judicial Center, the National Center for State Courts, the Judicial Conference of the United States, the Conference of Chief Justices, and the National Judicial Council of State and Federal Courts. 345

the aggregation of cases and for their management. Under the code, a judicial council decides whether particular cases should be aggregated. If the decision is positive, then a judge is selected to oversee the preparation of the cases. As with the federal MDL, steering committees are appointed, document depositories are established, depositions taken, and management orders issued. The steering committee's decision binds all cases. Unlike many other states, California seems as willing as the MDL to create aggregations, if not more so." (citations omitted)). 335

Dore, supra note 285, at 595-96 & n.30.

336

See W. Va. Trial Ct. R. 26.01 (2004); Dore, supra note 285, at 596-97.

337

Dore, supra note 285, at 591, 599; see also id. at 599 n.46 (noting that, in 2003, New Jersey Supreme Court consolidated Vioxx mass tort cases in Atlantic County before Judge Higbee); Rheingold, supra note 247, at 912 ("Many widespread injury mass torts have been organized under [New Jersey's] procedures. Under the New Jersey rules, these cases have been managed extremely well through to resolution."). 338

Dore, supra note 285, at 599, 601.

339

Id. at 600-01.

340

Rheingold, supra 247, at 912.

341

See id. ("Some states have used existing procedural rules to try to organize mass tort litigation within their borders, most often by formal consolidation of cases pursuant to the state court equivalent of Rule 42 of the Federal Rules of Civil Procedure."); Dore, supra note 285, at 595 n.30 (discussing Pennsylvania, Minnesota, and Texas). 342

Engstrom v. Bayer Corp., 2004 PA Super. 223, P 1 n.1, 855 A.2d 52, 54 n.1.

343

Id.; see also Pearson v. Bayer Corp., No. 0258, 2003 WL 22299786, at 13-14 (Pa. Ct. Com. Pl. Sept. 24, 2003) (noting that Pennsylvania state courts are "an admitted leader in the Mass Tort Pharmaceutical area" and that "the congestion is not in the Philadelphia Courts generally, … but in the Mass Tort Litigation section in which Philadelphia has been a pioneer and the effectiveness of which is now in jeopardy because of the nationwide infusion of cases without significant contact or connection to Pennsylvania"), aff'd sub nom. Engstrom, 2004 PA Super. 223, 855 A.2d 52.

344

McGovern, supra note 35, at 1746.

345

McGovern, supra note 69, at 1879.

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Page 45 of 59 2005 Utah L. Rev. 863, *919 4. Networks of Clients Plaintiff-client networks, while still largely undeveloped, hold the promise of enhancing the efficiency and effectiveness of mass tort litigation. Plaintiff-client networks begin with groups informing potential plaintiffs that they may have claims, helping with the plaintiff screening process, and directing potential plaintiffs to lawyers. 346 Labor unions or other social organizations, for example, may help their members in this regard. 347 In the asbestos litigation, unions conducted disease screenings and referred union members to qualified plaintiffs' lawyers. 348 Similarly, in the Agent Orange litigation, Vietnam veterans' organizations helped begin the litigation against manufacturers, explained possible health risks to veterans, enlisted veterans' participation, and looked for lawyers to represent Agent Orange victims. 349 Once claims have been initiated, groups linking plaintiffs can also aid in the prosecution of claims. 350 In the asbestos litigation, for example, labor [*920] unions worked with medical researchers to research information about the health risks of asbestos. 351 Client networks also supply information to clients so as to increase their autonomy and control of attorneys. 352 Indeed, clients already turn to support networks to gain information not provided by

346

Hensler & Peterson, supra note 24, at 1023.

347

Id.

348

Id.

349

Id.

350

By relying on individual litigation, mass tort litigation as network of course provides greater litigant autonomy than class actions. Especially in a personal-injury action, a plaintiff has a strong interest in controlling the prosecution of his own case. See, e.g., Georgine v. Amchem Prod., Inc., 83 F.3d 610, 633 (3d Cir. 1996) ("Each plaintiff has a significant interest in individually controlling the prosecution of separate actions."), aff'd sub nom. Amchem Prods., Inc. v. Windsor, 521 U.S. 591 (1997); Emig. v. Am. Tobacco Co., Inc., 184 F.R.D. 379, 392-93 (D. Kan. 1998) ("In the instant case, members of the proposed class would also have an interest in making individual decisions."); Philip Morris, Inc. v. Angeletti, 752 A.2d 200, 221 (Md. 2000) (discussing statutory and additional prerequisites for class certification). But class actions limit participation by class members in the class litigation. See Erichson, supra note 15, at 524 ("The traditional class action picture gets some things right. It gets right the general description of class actions as litigation over which most class members have no control."). Indeed, even class representatives have merely token power; the litigation is largely run by class counsel. See John C. Coffee, Jr., Class Action Accountability: Reconciling Exit, Voice, and Loyalty in Representative Litigation, 100 Colum. L. Rev. 370, 384 (2000) ("In the class action, the class representative is usually a token figure, with the class counsel being the real party in interest."); Schwartz et al., supra note 14, at 492 ("In theory, a plaintiff's lawyer is supposed to be the servant of his client. In class action practice, however, the roles of servant and master are often reversed … ."). For example, class representatives may not fire class counsel. See Fed. R. Civ. P. 23 advisory committee's note ("The class representatives do not have an unfettered right to "fire' class counsel."). Additionally, they may not reject a proposed settlement. See id. ("In the same vein, the class representatives cannot command class counsel to accept or reject a settlement proposal. To the contrary, class counsel must determine whether seeking the court's approval of a settlement would be in the best interests of the class as a whole."). Even the idea of a suit is often hatched by plaintiffs' lawyers, rather than their clients. See Schwartz et al., supra note 14, at 492 (stating that "many [class actions] arise simply as a result of the creativity of entrepreneurial contingency fee lawyers" and noting that, in one newspaper report of Alabama class action, ""plaintiffs had no plans to sue, and no idea they might have cause to, until a lawyer or a friend of a lawyer told them they'd been wronged'"). Sometimes, class representatives are friends or employees of class counsel, further limiting absent class members' chance of adequate representation. Id. 351

Hensler & Peterson, supra note 24, at 1023.

352

See Hensler, supra note 29, at 1626 ("Just as supporters of ADR in the business community have recently sought to bring business leaders into the dialogue on how to handle business disputes, it is time to bring plaintiffs into the dialogue on mass personal injury litigation."); cf. id. at 1622 ("When there is little or no information dissemination or party participation, parties have little ability to control their attorneys."). For example, in class action settlement hearings, judges have tried to involve clients so as to make sure that their attorneys best represent their interests. See id. at 1622 & n.190 (discussing Judge Weinstein's efforts in holding Agent Orange class-action settlement fairness hearings in Brooklyn, Chicago, Houston, Atlanta, and San Francisco, and his meeting in chambers with DES claimants to discuss settlement).

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Page 46 of 59 2005 Utah L. Rev. 863, *920 their attorneys. 353 For example, in the breast implant litigation, clients monitored the class action attorneys and created networks to monitor settlement issues and communicate with class members. 354 Clients can gain information on their claims and follow developments through court webpages discussing mass [*921] torts. 355 Moreover, some plaintiffs' attorneys employ many paralegals and others to discuss litigation developments and answer questions. 356 Victim groups may supply emotional support to clients. 357 In addition, victim groups may provide information to plaintiffs about the litigation. 358 These groups may also speak out on members' behalf, and direct media attention. 359 Victim groups have appeared for asbestos, 360 Dalkon Shield, 361 and silicone breast implants. 362 So far, victim groups have not greatly affected the conduct of the litigation itself, 363 but in the future, they may do so. Defendant client networks can also aid in the processing of litigation. For example, during the 1980s, asbestosproducing defendants created a consortium to coordinate defense and settlement, behind a single counsel. 364 Defendants initially formed an Asbestos Claims Facility to settle asbestos claims. 365 Subsequently, in 1988, a smaller entity, the Center for Claims Resolution, settled cases for twenty companies defending asbestos litigation. 366 Over twelve years, the Center for Claims Resolution settled approximately 350,000 claims and paid more than $ 5 billion. 367 One consultant to the Center for Claims Resolution used a computer database of 100,000 claims and more than a million documents. 368 C. PPA as an Example of a Networked Mass Tort Litigation The ongoing litigation regarding PPA provides an example of mass tort litigation as network. In the PPA litigation, the MDL court recognized that [*922] problems of case management difficulties would have been exacerbated by 353

See id. at 1626 n.210 ("Breast implant plaintiffs have often turned to support networks for information that they cannot get from their attorneys."). 354

Coffee, supra note 31, at 1407.

355

See, e.g., N.J. Judiciary, Mass Tort Information Center, at http://www.judiciary.state.nj.us/mass-tort/index.htm (last visited May 15, 2005) (providing information on mass torts). 356

See Hensler, supra note 29, at 1622 n.210 (discussing efforts of Frederick Baron, prominent plaintiffs' attorney, in asbestos litigation). 357

Hensler & Peterson, supra note 24, at 1023-24.

358

Id.

359

Id. at 1024.

360

See id. (discussing Asbestos Victims of America).

361

See id. at 1024 & n.314 (mentioning Dalkon Shield Information Network, Dalkon Shield Women's Support Group, International Dalkon Victims' Education Association, and Dalkon Shield Victims' Association).

362

Id. at 1024.

363

Id.

364

See Coffee, supra note 31, at 1365 & n.83 (noting that consortium was originally known as Asbestos Claims Facility, then, bankruptcy of several defendants resulted in smaller entity called Center for Claims Resolution); see also Issacharoff & Witt, supra note 20, at 1630 ("The growth of claims management facilities on the defense side has led to not only reporting and analysis of claims, but also a one-stop online resource for outsourced settlement negotiation.").

365

See Hensler & Peterson, supra note 24, at 1005-06 (describing functioning of CCR and prior Asbestos Claims Facility).

366

Id.

367

Hensler, supra note 34, at 1906.

368

Lowenthal & Erichson, supra note 20, at 998 n.39.

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Page 47 of 59 2005 Utah L. Rev. 863, *922 class treatment. Instead, shepherded by the MDL court, mass tort litigation networks of judges, plaintiffs' counsel, and defense counsel have facilitated processing of the litigation. And incipient client networks have suggested the promise of further benefits, if those client networks more fully develop. PPA was an ingredient found in cough/cold remedies and appetite suppressants, and was among the most used drugs in the country for decades. 369 Since 1979, various medical case reports appeared positing a link between PPA use and stroke and hypertension. 370 Although two studies in the 1980s found no association between PPA and stroke, 371 the Yale Hemorrhagic Stroke Project in the 1990s conducted an epidemiological study inquiring into any link between PPA and hemorrhagic strokes. 372 In May 2000, the HSP reported that it found an "association" or a "suggestion of an association" between PPA and hemorrhagic stroke. 373 As a result of the study, in November 2000, the FDA requested that manufacturers voluntarily remove from the [*923] market PPA-containing products, and the manufacturers did so. 374 As a result, plaintiffs' counsel filed hundreds of cases in federal and state courts. 375 Certain plaintiffs' counsel moved the federal Panel on Multidistrict Litigation to transfer all federal cases to a single court for pretrial management. 376 In August 2001, the Panel decided to transfer all federal cases to Judge Barbara

369

See, e.g., In re Phenylpropanolamine Prods. Liab. Litig., 289 F. Supp. 2d 1230, 1234 (W.D. Wash. 2003) ("By the 1970s, PPA was widely used in over-the-counter ("OTC') and prescription cough and cold and appetite suppressant products."); In re Phenylpropanolamine Prods. Liab. Litig., 208 F.R.D. 625, 628 (W.D. Wash. 2002) ("Numerous prescription and non-prescription decongestants and appetite suppressants included phenylpropanolamine ("PPA') for a number of years."); In re Phenylpropanolamine (PPA), 2003 WL 22417238, at 2 (N.J. Super. Ct. Law Div. July 21, 2003) (noting that "billions of doses of PPA have been sold"); Judge Threatens to Strike Remand Motions in Partially Briefed PPA Cases, 9 Andrews Class Action Litig. Rep., Sept. 2003, at 23, 23 [hereinafter Judge Threatens] (noting that PPA had been "on the market for more than 60 years"). 370

See Phenylpropanolamine, 289 F. Supp. 2d at 1235 (noting FDA review, by Heidi Jolson, of spontaneous reporting of cerebrovascular accidents finding that "the data suggested that PPA-containing diet pills increase the risk of cerebrovascular accidents," and that "some animal studies and human clinical trials demonstrated sudden increases in blood pressure in response to PPA"); Phenylpropanolamine, 208 F.R.D. at 628 (discussing factual background of case). 371

See Phenylpropanolamine, 289 F. Supp. 2d at 1235 (referring to 1984 Jick epidemiological study finding no significant association between PPA and hemorrhage stroke, and mid-1980s O'Neill and Van de Carr unpublished study finding no association based on computer Medicaid databases). 372

See id.; Phenylpropanolamine, 208 F.R.D. at 628.

373

Phenylpropanolamine, 208 F.R.D. at 629; see also Phenylpropanolamine, 289 F. Supp. 2d at 1236 ("The investigators found that, for women, the use of a PPA-containing appetite suppressant was associated with an increased risk of hemorrhagic stroke … . The investigators also found a suggestion of an association in women with any first use of PPA, all of which involved cough or cold products … . Because no men reported use of appetite suppressants and only two reported first use of a PPA-containing product, the investigators could not determine whether PPA posed an increased risk for hemorrhagic stroke in men."); Walter N. Kernan et al., Phenylpropanolamine and the Risk of Hemorrhagic Stroke, 343 New. Eng. J. Med. 1826 (2000) (suggesting that "phenylpropanolamine in appetite suppresents, and possibly in cough and cold remedies, is an independent risk factor for hemorrhagic stroke in women"). 374

See Phenylpropanolamine, 289 F. Supp. 2d at 1236; see also Phenylpropanolamine, 208 F.R.D. at 629 (discussing voluntary removal of PPA-containing products). 375

See In re Phenylpropanolamine Prods. Liab. Litig., 214 F.R.D. 614, 621 (W.D. Wash. 2003) ("Almost 900 PPA-related personal injury actions had been transferred. This number does not account for the many state court cases, nor the cases awaiting transfer into the MDL, nor even those not yet filed in federal courts around the country."). 376

In re Phenylpropanolamine Prods. Liab. Litig., 173 F. Supp. 2d 1377, 1378 (J.P.M.L. 2001); see also Phenylpropanolamine, 208 F.R.D. at 629 (noting that Panel acted "following the filing of numerous lawsuits throughout the country").

Theresa Coetzee

Page 48 of 59 2005 Utah L. Rev. 863, *923 Rothstein in the Western District of Washington. 377 In its order, the Panel first recognized that the PPA cases represented a single mass tort litigation, even though individualized issues were rife: Notwithstanding differences among the actions in terms of named defendants, specific products involved, legal theories of recovery … and/or types of injury alleged, all actions remain rooted in complex core questions concerning the safety of Phenylpropanolamine (PPA) - a substance which, until it recently became the subject of a public health advisory issued by the Food and Drug Administration, was used as an ingredient in many nasal decongestants and weight control products. 378 As a result, the Panel noted that transfer would "eliminate duplicative discovery, [and] prevent inconsistent pretrial rulings (especially with respect to questions of privilege issues, confidentiality issues and class certification)." 379 In addition, the Panel assumed that defense and plaintiffs' counsel would combine and collaborate, creating litigation networks: "It is most logical to assume that prudent counsel will combine their forces and apportion their workload in order to streamline the efforts of the parties and witnesses, their counsel and the judiciary, thereby effectuating an overall savings of cost and a minimum of inconvenience to all concerned." 380 Accordingly, the court concluded that transfer would "serve the convenience of the parties and witnesses and promote the just and efficient conduct of the litigation." 381 [*924] In the MDL court, plaintiffs sought to certify four nationwide classes and one Lousiana state class. 382

Among those included in the proposed classes were persons "who have ingested products containing PPA, and … who have sustained injury or damage." 383 The proposed nationwide class asserted claims for "strict products liability, defective product design and composition, failure to warn, negligence, misrepresentation and concealment, and breach of implied and express warranties." 384 The statewide class brought claims under the Louisiana Products Liability Act. 385

377

Phenylpropanolamine, 208 F.R.D. at 629.

378

Phenylopropanolamine, 173 F. Supp. 2d at 1379.

379

Id.

380

Id.

381

Id. Cases filed after the transfer order were considered by the Panel, and transferred to the MDL court, if appropriate. See, e.g., In re Phenylpropanolamine Prods. Liab. Litig., No. 1407 (W.D. Wash. Nov. 22, 2002) (Case Mgmt. Order No. 10) ("As of today there are approximately 1,500 total plaintiffs in 736 cases either in or pending transfer to this MDL."); In re Phenylpropanolamine Prods. Liab. Litig., No. CV01J2303NW, 2002 WL 31108228, at 1 (J.P.M.L. Mar. 4, 2002) (transferring nine cases to MDL court).

382

Phenylpropanolamine, 208 F.R.D. at 629. Later, plaintiffs also sought to certify an economic-injuries class of purchasers of PPA products seeking refund of the amount each class member spent on PPA-containing products - perhaps $ 3 per package. In re Phenylpropanolamine Prods. Liab. Litig., 214 F.R.D. 614, 615 (W.D. Wash. 2003). The court denied class certification because, inter alia, of the "host of mini-trials" required to determine who bought a PPA-containing product given the unlikelihood of kept receipts, the weakening of memory over two years or more, and the multitude of similar products, only some of which contained PPA. Id. at 617-20. The court also found such a class unnecessary, since manufacturers already maintained refund programs. Id. at 622. 383

See Phenylpropanolamine, 208 F.R.D. at 629 (noting also that other proposed class members included those "who may suffer such injury or damage in the future, or … who have sustained a justifiable fear of sustaining such injury or damage in the future"). 384

Id.

385

Id.

Theresa Coetzee

Page 49 of 59 2005 Utah L. Rev. 863, *924 Noting that a trial court must conduct a "rigorous analysis" to determine if the prerequisites of Rule 23 are met, 386 the court examined the claims of plaintiffs and the evidence needed to prove them, and determined that class certification was not warranted under any subsection of Rule 23(b). 387 The court noted that "many courts have recognized the potential difficulties of "commonality' and "management' inherent in certifying products liability class actions," 388 and referenced courts' distinction between products liability actions, which may involve issues of causation and affirmative defenses that ""depend on facts peculiar to each plaintiff's case,'" and "typical mass torts," based on a single incident where proximate cause is the same for each plaintiff. 389 [*925] Turning to the predominance inquiry of Rule 23(b)(3), Judge Rothstein found that predominance had not been met. Indeed, the court noted that the vast differences among plaintiffs 390 rendered specific causation rife with individual issues:

For each individual class member, an inquiry into specific causation might require a court to examine, among other things: an individual's family and medical history; age; gender; diet; lifestyle, including the use of alcohol, tobacco, and other legal or illegal drugs; the product used and the amount of PPA, if any, contained within that product; the timing of ingestion of the product; whether the individual followed the directions accompanying the product, exceeded the recommended dosage, or combined the product with other products and the effect of that combination; [and] whether that individual suffered an injury, when the injury occurred, the type of injury suffered, and the number of occurrences of injury … . 391 As a result, the court found that "the number of individual questions posed by the proposed classes clearly overwhelm any common questions, rendering class treatment inappropriate." 392 Because plaintiffs failed to meet the predominance requirement, the court did not need to address any further class certification requirements. 393

386

Id. at 630.

387

Id. at 634.

388

Id. at 630 (internal quotation marks and citation omitted).

389

Id. at 631 (quoting N. Dist. of Cal., Dalkon Shield IUD Prods. Liab. Litig., 693 F.2d 847, 853 (9th Cir. 1982)); see also id. at 632 (distinguishing cases cited by plaintiffs because they "dealt with "typical' mass torts, and, thus, involved individual issues relating only to the extent of injuries and damages sustained"). The complete quoted section from Dalkon Shield follows: In the typical mass tort situation, such as an airplane crash or a cruise ship food poisoning, proximate cause can be determined on a class-wide basis because the cause of the common disaster is the same for each of the plaintiffs. In products liability actions, however, individual issues may outnumber common issues. No single happening or accident occurs to cause similar types of physical harm or property damage. No one set of operative facts establishes liability. No single proximate cause applies equally to each potential class member and each defendant. Furthermore, the alleged tortfeasor's affirmative defenses (such as failure to follow directions, assumption of the risk, contributory negligence, and the statute of limitations) may depend on facts peculiar to each plaintiff's case. Id. at 631 (quoting Dalkon Shield, 693 F.2d at 853). 390

As the court noted,

Here, the proposed classes comprise a multitude of individuals with different backgrounds, personal characteristics, medical histories, health problems, and lifestyles. These individuals allegedly consumed one or more of a variety of different PPAcontaining products, produced by various defendants. The products were consumed at different times, in different amounts, and with varying results. That is, some individuals sustained a single injury, others multiple injuries, and still others no physical injuries whatsoever. Id. at 631. 391

Id. at 631-32 (citations omitted).

392

Id. at 632-33.

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Page 50 of 59 2005 Utah L. Rev. 863, *925 [*926] Rather than utilizing a class action, the court pursued an approach consonant with mass tort litigation as network. For example, Judge Rothstein created committees of counsel that aided in the creation of counsel networks and judge networks. 394 Judge Rothstein appointed lead counsel and liaison counsel for defendants and plaintiffs. 395 The court then created among counsel a Plaintiffs' Steering Committee, Plaintiffs' Discovery Committee, State/Federal Coordination Committee, and Joint Science Committee. 396 In addition, from these committees, the court appointed a subcommittee - the Common Benefit Fund Committee - to oversee the reimbursement of plaintiffs' counsel from a common fund for activities benefiting all plaintiffs; activities include discovery from defendants, preparation of an "MDL Trial Package and Materials Included Therein," work related to generic expert testimony and the MDL court Daubert hearing regarding the admissibility of plaintiffs' expert opinions regarding generic causation, and work relating to mass settlement in the MDL. 397 The court sought to obtain funds for these payments by requiring defendants to deduct four percent from payments to any federal court plaintiff, and three percent from payments to any state court coordinating case. 398 To obtain any of the proprietary attorney work product produced by the MDL plaintiffs' attorneys, the court required that state counsel [*927] agree to abide by this deduction. 399 This work product, which was to be "valuable in the litigation of state court proceedings involving PPA induced injuries," included:

a. CD-ROMs and a virtual depository containing images of the key documents selected by the PSC from the document productions of the defendants and third-parties in MDL 1407;

393

Id. at 633 n.10. Plaintiffs also sought class certification under Rule 23(b)(1)(A) and (B). Id. at 633-34; see also supra note 48 (discussing Rule 23). The plaintiffs argued that "the risk of two exactly similarly situated individuals in different jurisdictions receiving contrasting verdicts suffices to meet the requirements of Rule 23(b)(1)(A)," which pertains to the "risk of … incompatible standards of conduct" for the defendant based on "inconsistent or varying jurisdictions." Phenylpropanolamine, 208 F.R.D. at 633. But the court rejected this argument, noting that "this argument has been squarely rejected by most courts, including the Ninth Circuit." See id. ("Certification under Rule 23(b)(1)(A) is … not appropriate in an action for damages."). Moreover, the court rejected plaintiffs' request for a limited-fund class action under Rule 23(b)(1)(B) on the grounds that plaintiffs had not provided any evidence "as to the assets and potential insolvency of the defendants." Id. at 634. 394

In re Phenylpranolamine Prods. Liab. Litig., No. 1407 (W.D. Wash. Nov. 19, 2001) (Order Appointing Lead and Liaison Counsel). 395

Id.; Judge Threatens, supra note 369 (noting that defendants' lead counsel is Randolph Sherman of Kaye Scholer in New York and Terry O. Tottenham of Fulbright & Jaworski in Austin; defendants' liaison counsel are Joseph Hurson of Lane, Powell, Spears, Lubersky LLP and Douglas Hofman of Williams, Kastner & Gibbs, both in Seattle; plaintiffs' lead counsel are Arthur Sherman of Sherman, Salkow, Petoyan & Weber in Los Angeles and Richard Lewis of Cohen, Milstein, Hausfield & Toll in Washington; and plaintiffs' liaison counsel is Lance Palmer of Levinson Friedman in Seattle). Only lead and liaison counsel attended regular monthly status conferences. In re Phenylpropanolamine Prods. Liab. Litig., No. 1407 (W.D. Wash. Jan. 31, 2002) (Case Mgmt. Order No. 4). In the PPA litigation, I served as counsel for Defendant, The Delaco Company, successor by merger to Thompson Medical Company, Inc. 396

See In re Phenylpropanolamine Prods. Liab. Litig., No. 01-MD-01407-ORD, 2004 WL 1784348, at 1 (W.D. Wash. Aug. 2, 2004) (referring to "Plaintiffs' Discovery Committee" and "Plaintiffs' Steering Committee"); Frederick T. Kuykendall, III, Ephedra and PPA, in Ass'n of Am. Trial Law., Annual Convention Reference Materials (2002) (noting appointment of "lead and liaison counsel, the Steering Committee, State/Federal Coordination Committee, [and] the Joint Science Committee"). 397

Phenylpropanolamine, 2004 WL 1784348, at 2. The court also provided details about the rates at which such expenses would be reimbursed. In re Phenylpropanolamine Prods. Liab. Litig., No. 1407 (W.D. Wash. June 4, 2002) (Case Mgmt. Order No. 7).

398

In re Phenylpropanolamine Prods. Liab. Litig., No. 1407 (W.D. Wash. July 9, 2002) (Amended Case Mgmt. Order No. 8). Judge Rothstein recently raised the requisite deduction to eight percent for both federal and state plaintiffs receiving settlements relating to the PPA-containing product, Dexatrim, for which a global settlement was negotiated. In re Phenylpropanolamine Prods. Liab. Litig., No. 1407, slip op. (W.D. Wash. Dec. 13, 2004). 399

Id. ""Proprietary attorney work product' of the PSC [does] not include fact depositions taken in these MDL proceedings, transcripts and videotapes thereof and/or exhibits thereto, and shall not include any documents produced in PPA litigation by any party or by any non-party pursuant to any Notice of Subpoena served in these MDL proceedings." Id.

Theresa Coetzee

Page 51 of 59 2005 Utah L. Rev. 863, *927 b. a bibliographic database providing a "coded' index of such key documents; c. the depositions of each generally applicable fact witness taken in MDL 1407 and in any coordinated state-court actions in the form of paper transcripts, text searchable computer disks and CD-ROMs and videotapes of videotaped depositions; and d. time-lines, casts of characters, and other work product relating to the facts at issue in MDL 1407.

400

Eighty state court plaintiff's firms from twenty-seven states subsequently agreed to abide by the MDL fee assessment in return for use of MDL proprietary work product. 401 Further building judge networks, Judge Rothstein appointed Professor Francis McGovern as a Special Master "to assist the court in coordinating case management matters between this court's MultiDistrict Litigation and the pending related litigation in the various state courts." 402 Judge Rothstein also created procedures for crossnoticing and conducting expert witness depositions for experts also appearing in state court proceedings, noting that her provisions were not "an injunctive or equitable order affecting state court proceedings," but instead "reflected this Court's desire for voluntary state-federal coordination." 403 In addition, deriving efficiency for her pretrial consolidation of PPA cases, Judge Rothstein greatly streamlined discovery. Judge Rothstein allowed each side to create a document depository at its own cost. 404 As of February 2003, the PPA document depository, located in Minneapolis, contained more [*928] than three million documents submitted by defendants. 405 In addition, Judge Rothstein required that plaintiffs submit a "Plaintiff's Fact Sheet," once their case is transferred to the MDL court. 406 Judge Rothstein also limited the amount of case-specific discovery each side could take. 407 Moreover, Judge Rothstein provided for the taking of Preservation Deposition to preserve the testimony of witnesses who might not be able to appear at every trial. 408 The MDL court's Daubert hearing - pertaining to the admissibility of the plaintiffs' expert opinions regarding PPA and health problems - provides a particular example of the interaction of judge and counsel networks. Judge Rothstein invited state court judges to the Daubert hearing and offered to provide videoconferencing for other judges. As a result, at the Daubert hearing, "in attendance were several state court judges from the western United States, with New Jersey, Pennsylvania, and New York jurists invited via live videoconferencing between Seattle, Washington,

400

In re Phenylpropanolamine Prods. Liab. Litig., No. 1407 (W.D. Wash. July 9, 2002) (Amended Case Mgmt. Order No. 8, Ex.

1). 401

W. Dist. of Wash. U.S.D.C., MDL 1407 State http://www.wawd.uscourts.gov/wawd/mdl.nsf/ (last visited May 15, 2005).

Firms

Subject

to

MDL

Assessment,

at

402

In re Phenylpropanolamine Prods. Liab. Litig., No. 1407 (W.D. Wash. Jan. 17, 2002) (Order Appointing Special Master); Kuykendall, supra note 396.

403

In re Phenylpropanolamine Prods. Liab. Litig., No. 1407 (W.D. Wash. Dec. 16, 2002) (Case Mgmt. Order No. 12 Regarding Expert Dep. Disc.).

404

In re Phenylpropanolamine Prods. Liab. Litig., No. 1407 (W.D. Wash Jan. 29, 2002) (Case Mgmt. Order No. 1).

405

See Sharon J. Arkin, Hot Topics: Prescriptions for Handling Pharmaceutical Cases, in Ass'n of Am. Trial Law., Annual Convention Reference Materials (2003) ("At this point, over three million documents have already been received from the major defendants, and documents are still being produced on a rolling basis."). 406

Kuykendall, supra note 396.

407

See id. (noting that plaintiffs and defendants each had ten case-specific interrogatories and document requests, and defendants had maximum of ten case-specific depositions).

408

In re Phenylpropanolamine Prods. Liab. Litig., No. 1407 (W.D. Wash. Dec. 17, 2002) (Case Mgmt. Order No. 11, Regarding Noticing and Conducting of Trial Dep.).

Theresa Coetzee

Page 52 of 59 2005 Utah L. Rev. 863, *928 and New Brunswick, New Jersey." 409 "Through arrangements to be made by [the New Jersey] Court," defendants were allowed to question plaintiffs' experts in the [federal] MDL Daubert hearing concerning admissibility issues under New Jersey law, and that testimony was to be considered by Judge Corodemus in her admissibility decision. 410

At the Daubert hearing, the Plaintiffs' Steering Committee moved to admit the opinions of fourteen experts, representing fields of pharmacology, epidemiology, neurology, toxicology, and pediatrics. 411 In advance of the hearing, plaintiffs' counsel for all the plaintiffs submitted a single brief, and national defense counsel for the defendants also submitted a single brief. At the hearing, various plaintiffs' counsel who specialized in scientific evidence made presentations to the judges in attendance, as did defense counsel who similarly specialized in scientific evidence. The court determined admissible "expert testimony as to an association between PPA and hemorrhagic or ischemic stroke, in either gender and any age group," but excluded "expert testimony associated with seizures, psychoses, injuries occurring more than three days [*929] after ingestion of a PPA-containing product, and cardiac injuries." 412 When Judge Corodemus in New Jersey ultimately also decided in favor of the admissibility of PPA evidence, her opinion "incorporated the testimony, transcript, arguments, and briefs from the United States District Court for the Western District of Washington to the extent they apply to experts offered by Plaintiffs in New Jersey." 413 Apart from the MDL court, all PPA litigation in the state courts of New Jersey was transferred by order of the New Jersey Supreme Court to Judge Corodemus for pretrial management with the aid of a special master. 414 Judge Corodemus, however, pursued a coordinated approach with the MDL court, obtaining the benefits of judge networks. Indeed, Judge Corodemus noted that "this court has total cooperative interaction with the PPA MDL Court." 415 Judge Corodemus also stated that "the New Jersey PPA Litigation … shall coordinate, to the extent possible, with the [federal] Multi-district Litigation … and other coordinated proceedings in other state courts." 416 Judge Corodemus appointed Interim Liaison Counsel for Multi-District Litigation Coordination from defense and plaintiffs' counsel. 417 In addition, Judge Corodemus ordered that "depositions shall be conducted in accordance with the procedures … in the MDL, as set forth in MDL CMO No. 1," and that notice of state depositions be given to MDL Liaison Counsel, who was a state court attorney in the New Jersey litigation responsible for cross-noticing the deposition in the MDL proceedings. 418 "Recognizing that voluntary state-federal coordination is desirable," Judge Corodemus also adopted the MDL notice and conduct procedures for trial depositions. 419

409

In re Phenylpropanolamine (PPA), 2003 WL 22417238, at 1 (N.J. Super. Ct. Law Div. July 21, 2003). Because of the many judges in attendance, Judge Rothstein held the hearing in the more spacious courtroom for the Ninth Circuit Court of Appeals.

410

In re PPA (Phenylpropanolamine), No. 264 (N.J. Super. Ct. Law Div. Jan. 16, 2003) (Case Mgmt. Order No. 7).

411

In re Phenylpropanolamine Prods. Liab. Litig., 289 F. Supp. 2d 1230, 1236 (W.D. Wash. 2003).

412

Id. at 1251.

413

Phenylpropanolamine, 2003 WL 22417238, at 1. Judge Corodemus held inadmissible expert opinions regarding a connection between stroke and PPA taken more than three days earlier. Id. at 32. She also held inadmissible testimony that PPA can cause seizures or other nervous-system injuries, but she deferred consideration of expert opinions as to whether PPA could cause cardiac injuries. Id. 414

See Order RE: Designation of Phenylpropanolamine ("PPA') Litigation as a Mass Tort (N.J. Sept 17, 2001) (stating that cases are to be returned to their original county of venue for trial), available at http://www.judiciary.state.nj.us/notices/n010926c.htm.

415

Parrotta v. Novartis Consumer Health, Inc., No. MRS-L-815-01, slip op. at 16 (N.J. Super. Ct. Law Div. Oct. 7, 2002).

416

In re PPA (Phenylpropanolamine), No. 264 (N.J. Super. Ct. Law Div. Nov. 27, 2001) (Case Mgmt. Order No. 2).

417

Id.

418

In re PPA (Phenylpropanolamine), No. 264 (N.J. Super. Ct. Law Div. July 7, 2002) (Case Mgmt. Order No. 5).

Theresa Coetzee

Page 53 of 59 2005 Utah L. Rev. 863, *929 To help manage several hundred cases and keep counsel and clients informed as to developments, 420 Judge Corodemus maintained a web page [*930] providing extensive information about the PPA litigation, 421 including a list of all plaintiffs and defense counsel; 422 pretrial and case management orders, such that a client could follow any orders pertaining to his or her case; 423 and all court departmental and staff personnel for PPA. 424 For defense counsel, the court listed both national and local counsel for each defendant. 425 In addition to appointing liaison counsel for plaintiffs and defendants, Judge Corodemus aided in the creation and specialization of counsel networks by forming various committees of defense and plaintiffs counsel regarding Technology, Pleadings, Motions Communications, and Discovery; she also appointed a cochair from plaintiff's and defense counsel. 426 Judge Corodemus also ordered that e-mail was the preferred mode of communication with the court. 427 Other states also utilized pretrial common management of PPA cases, remaining in contact with their counterparts in other jurisdictions. In California, for example, Judge Anthony Mohr of Los Angeles County Superior Court coordinated all PPA cases. 428 Judge Mohr ruled that documents produced to the MDL document depository were considered produced in the California state cases. 429 In addition, state court litigation occurred in Philadelphia in the Philadelphia Court of Common Pleas mass tort program. 430 Networks also formed outside judicially formed committees. For example, ATLA formed a plaintiffs' PPA Litigation Group. 431 At ATLA conventions, ATLA distributed materials describing the science surrounding PPA and the [*931] current status of PPA litigation. 432 Moreover, lawyers in New Orleans formed a PPA Litigation Group. 433

419

In re PPA (Phenylpropanolamine), No. 264 (N.J. Super. Ct. Law Div. July 3, 2003) (Case Mgmt. Order No. 13).

420

See, e.g., Smith v. Am. Home Prods. Corp. Wyeth-Ayerst Pharm., 855 A.2d 608, 625 (N.J. Super. Ct. Law Div. 2003) (noting that "there are approximately 300 PPA cases on this court's docket and only one and a half months until trial"); N.J. Judiciary, Case List, at http://www.judiciary.state.nj.us/mass-tort/ppa/case_list.htm (last updated Sept. 21, 2005) (noting that, as of May 12, 2005, ninety-eight PPA cases were assigned to Judge Corodemus). 421

N.J. Judiciary, PPA (Phenylpropanolamine), at http://www.judiciary.state.nj.us/mass-tort/ppa/index.htm (last visited May 15, 2005). 422

N.J. Judiciary, Counsel List, at http://www.judiciary.state.nj.us/mass-tort/ppa/counsel.htm (last visited May 15, 2005).

423

See N.J. Judiciary, Case Management Orders, at http://www.judiciary.state.nj.us/mass-tort/ppa/cmorders.htm (last visited May 15, 2005); see also N.J. Judiciary, Calendar of Events, at http://www.judiciary.state.nj.us/mass-tort/ppa/calendar.htm (posted Aug. 9, 2005) (listing cases set for trial, settled, and dismissed). 424

N.J. Judiciary, Departmental Staff and Contacts, at http://www.judiciary.state.nj.us/mass-tort/ppa/department.htm (last visited May 15, 2005). 425

N.J. Judiciary, Counsel List, at http://www.judiciary.state.nj.us/mass-tort/ppa/counsel.htm (last visited May 15, 2005).

426

In re PPA (Phenylpropanolamine), No. 264 (N.J. Super. Ct. Law Div. Oct. 27, 2001) (Case Mgmt. Order No. 2).

427

Id.

428

See Arkin, supra note 405.

429

Id.

430

See Engstrom v. Bayer Corp., 2004 PA Super. 223, P 1 n.1, 855 A.2d 52, 54 n.1 (noting that 186 cases of 203 cases in which Bayer was defendant involved nonresident cases). 431

See Janet L. Holt, PPA Litigation on the Rise After FDA Warning, Trial, June 2001, at 14, 14 (noting "ATLA's new PPA Litigation Group," with Roger Phillips of Concord, New Hampshire, as co-chair); Litigation Groups, supra note 189 (listing Litigation Group for "PPA (Phenylpropanolamine)").

432

See Arkin, supra note 405 (illustrating types of materials ATLA distributed); Kuykendall, supra note 396 (same).

Theresa Coetzee

Page 54 of 59 2005 Utah L. Rev. 863, *931 While not formally present in the courts, incipient client networks also formed in the PPA litigation. For example, one PPA-victim stroke support group formed on the Internet. 434 Apart from providing each other with emotional support, members sought information from each other about PPA products, the effects of stroke, and the PPA litigation; they drew on one another's knowledge of attorneys and checked the conduct of their attorney against that of other attorneys in the litigation. 435 IV. Network Information and Accuracy Advantages over Class Actions While real efficiency and economy is the principal purpose of the class action, 436 multiple-incident, product-liability class actions for personal injuries in fact supply little of either, because they do not develop the information for accurate resolution of a mass tort. Reviewing such a class action, Judge Easterbrook of the Seventh Circuit recently dramatically articulated the inaccuracies attendant to class-action adjudication due to its central-planner, rather than market, model: Efficiency is a vital goal in any legal system - but the vision of "efficiency" underlying this class certification is the model of the central planner. Plaintiffs share the premise of the ALI's Complex [*932] Litigation Project (1993), which devotes more than 700 pages to an analysis of means to consolidate litigation as quickly as possible, by which the authors mean, before multiple trials break out. The authors take as given the benefits of that step. Yet the benefits are elusive. The central planning model - one case, one court, one set of rules, one settlement price for all involved - suppresses information that is vital to accurate resolution. What is the law of Michigan, or Arkansas, or Guam, as applied to this problem? Judges and lawyers will have to guess, because the central planning model keeps the litigation far away from state courts… . And if the law were clear, how would the facts (and thus the damages per plaintiff) be ascertained? One suit is an all-or-none affair, with high risk even if the parties supply all the information at their disposal. Getting things right the first time would be an accident. Similarly Gosplan or another central planner may hit on the price of wheat, but that would be serendipity. Markets instead use diversified decisionmaking to supply and evaluate information. Thousands of traders affect prices by their purchases and sales over the course of a crop year. This method looks "inefficient" from the planner's perspective, but it produces more

433

See, e.g., In re Phenylpropanolamine Prods. Liab. Litig., No. 01-MD-01407-ORD, 2004 WL 1784348 (W.D. Wash. Aug. 2, 2004) (listing among plaintiffs' counsel, several attorneys from "PPA Litigation Group, L.C., New Orleans, LA").

434

See, e.g., Yahoo Health Groups, Women Stroke Survivors and PPA, at http://health.groups.yahoo.com/group/womenstrokesurvivorsandppa/ (last visited May 15, 2005) (noting recently formed PPA support group). 435

See, e.g., Yahoo Health Groups, Messages, Women Stroke Survivors and PPA, at http://health.groups.yahoo.com/group/womenstrokesurvivorsandppa/message/ 9 (Feb. 14, 2001) ("I began this group as a forum to post any legal updates or questions regarding the class action suit as I did not feel it was fair to discuss in my regular support group PPA issues."); Yahoo Health Groups, Messages, RE: Women Stroke Survivors and PPA, at http://health.groups.yahoo.com/group/womenstrokesurvivorsandppa/message/10 (Feb. 14, 2001) ("Im [sic] glad we possibly have some way of keping [sic] up with the latest news regarding the class action suit. Please post any information here you see on the internet. Please read over your info packet when it comes in the mail. I got info from 3 different lawyers and their fees ranged from 40% to 30% … . Read carefully before signing with one."); Yahoo Health Groups, Messages, Women Stroke Survivors and PPA, at http://health.groups.yahoo.com/group/womenstrokesurvivorsandppa/message/379 (Feb. 14, 2002) ("How are the law suits going? … I spoke with the legal asst [sic] yesterday and was told that it can take about a year to hear. Is that the same for everybody?"). 436

See Gen. Tel. Co. of Southwest v. Falcon, 457 U.S. 147, 159 (1982) (noting ""the efficiency and economy of litigation which is a principal purpose of the procedure'" (quoting Am. Pipe & Constr. Co. v. Utah, 414 U.S. 538, 553 (1974))).

Theresa Coetzee

Page 55 of 59 2005 Utah L. Rev. 863, *932 information, more accurate prices, and a vibrant, growing economy… . When courts think of efficiency, they should think of market models … . 437 Mass tort litigation as network provides such a market-oriented model. In contrast to class actions, mass tort litigation networks result in individual verdicts in various jurisdictions for plaintiffs with various factual particularities. 438 The resulting verdicts supply litigants with information about the settlement value of other claims, resulting in more accurate disposition of claims. 439 Indeed, a court might aid the assembling of sufficient information to settle by striving to try cases that represent different types of plaintiffs. 440 In a typical tort action, such as an automobile accident, the liability of one driver is [*933] unrelated to that of another. 441 In mass tort litigation, however, settlement values are highly interdependent: first, scientific causation for a product may be involved; second, the cases involve repeat players of attorneys, and information travels quickly within a concentrated and networked plaintiffs' counsel involved in a particular mass tort. 442 As a result, settlement values may change significantly based on a particular verdict, discovery development, or evidentiary decision. 443 Thus, the monetary value - and hence settlement value - of cases within a particular mass tort are highly interdependent. 444 A finding that a product may cause a particular illness in a particular case affects the settlement value of other cases alleging that illness. 445 Of course, litigants must attempt to quantify variations based on differences in factual circumstances, local law, and particular judges. 446

437

In re Bridgestone/Firestone, Inc., 288 F.3d 1012, 1020 (7th Cir. 2002); see also In re Agent Orange Prod. Liab. Litig., 818 F.2d 145, 165 (2d Cir. 1987) (noting that "potential plaintiffs in toxic tort cases" may do better in individual litigation as result of "differences in the strength of their claims"). 438

Cf. Manual, supra note 1, at 22.2 ("Consider whether there is a need for more trials of individual cases to determine whether claims should be aggregated and on what terms."). 439

See Coffee, supra note 31, at 1358 (noting "high case interdependency so that litigated outcomes in any mass tort area quickly impact on the settlement value of other pending cases in that same field"); McGovern, supra note 35, at 1743 ("A … hybrid strategy [for defense of mass torts] is a selective combination of litigation and settlement. This is currently the favored approach for most defendants in mass torts.").

440

McGovern, supra note 69, at 1883. "To phrase the same thought more bluntly, try cases individually and in a systematic manner to set value, and then resolve globally." Id. at 1867.

441

See Coffee, supra note 31, at 1359-60 (comparing ordinary and mass torts litigation); Hensler & Peterson, supra note 24, at 967 (same).

442

Coffee, supra note 31, at 1359-60, 1360 n.55; see also Hensler & Peterson, supra note 24, at 968 (comparing automobile torts and noting that "the interdependence of values in mass tort claims is far more striking. No claim in a mass tort litigation will have value until plaintiffs are able to establish causation, liability, and damages for at least a few representative claims."); Issacharoff & Witt, supra note 20, at 1630 (noting that because of Lexis electronic guide, "a plaintiff's lawyer can discover in seconds various jury verdicts against defendants in, for example, asbestosis claims brought by working class carpenters and laborers"); id. (stating that, at Mealey's seminars on asbestos, "individual sessions focus entirely on the valuation of claims, as well as on techniques that heighten plaintiffs' chances of success"). 443

See Hensler & Peterson, supra note 24, at 967 (explaining effects of each decision); Issacharoff & Witt, supra note 20, at 1617 (stating that "private settlement markets in tort claims developed dynamic grids in which claims values were constantly in flux"); McGovern, supra note 35, at 1740 (noting, with regard to asbestos litigation, that "courts never adopted offensive collateral estoppel, but settlement values reflect a reality as if there were collateral estoppel"). 444

Hensler & Peterson, supra note 24, at 967.

445

Coffee, supra note 31, at 1360.

446

See Issacharoff & Witt, supra note 20, at 1629 (noting, in asbestos context, formulation of "settlement grids," including factors such as "duration of exposure, age of the plaintiff, and smoking habits"); McGovern, supra note 69, at 1873 (noting that, unless litigation is centralized in single court, assembling verdict data points for comprehensive settlement may be skewed by "non-representative jurisdictions").

Theresa Coetzee

Page 56 of 59 2005 Utah L. Rev. 863, *933 Indeed, in several mass torts, the settlement value has changed markedly based on litigation developments. For example, in the asbestos litigation, claims became feasible after a court applied strict liability to manufacturers for workers' injuries. 447 Similarly, all breast implant claims increased in settlement value after a multi-million dollar verdict by a San Francisco jury. 448 On the other hand, after a defense verdict in a consolidated Bendectin trial, thousands of other Bendectin claims lost value, and the litigation ultimately disappeared. 449 [*934] Moreover, once a sufficient market value of plaintiffs' claims has been achieved, the judicial burden of mass tort litigation greatly eases, as the parties may often choose to settle claims rather than undergo further litigation costs. 450 Some of these settlements have been sought to be achieved by settlement class actions, which are presented to courts with the agreement of defendants for purposes only of settlement, not trial; other settlements may not involve settlement class actions. 451 For example, in the Copper-7 litigation, defendant Searle agreed to settle all 130 suits by one law firm after the firm achieved a $ 8.75 million verdict for one client, including $ 7 million in punitive damages. 452 Moreover, through a variety of procedures to encourage settlement, Judge Weiner - as of March 2001 - has settled 65,409 of the 99,000 asbestos cases in the multidistrict litigation transferee court. 453 Other settlements seeking to resolve all future claims, as well as pending claims, have been attempted through settlement class actions. Such settlements occurred, for example, in the silicone breast implant litigation and Shiley Heart Valve litigation. 454 The parties to a litigation may also design claims resolution facilities to more expeditiously resolve the litigation. 455

As numerous courts and commentators have pointed out, one problem with such settlements by plaintiffs' counsel with numerous clients is the great [*935] risk that plaintiffs will not be adequately represented by attorneys whose economic interest may differ. For example, in a settlement class action, plaintiffs' counsel might collude with

447

See Hensler & Peterson, supra note 24, at 968 (discussing Borel v. Fibreboard Paper Prods., 493 F.2d 1076 (5th Cir. 1973)). 448

Id. at 968, 1040.

449

Id.

450

See Hensler, supra note 122, at 188 ("In mature mass torts, where there may be a widely-shared understanding of the value of certain types of claims, thousands of lesser-value claims may be resolved en masse according to negotiated schedules of damages that pay little attention to individual claim differences and involve little adversarial litigation."); Issacharoff & Witt, supra note 20, at 1575 ("The replacement for pre-modern group litigation has not been individualized claims adjudication but rather privatized mechanisms of settlement that take classes of claimants as aggregates and develop mechanisms for the settlement of claims at the wholesale level rather than the retail level."); id. at 1618 (noting that, "as patterns of liability and damages stabilize, trials seem to become increasingly exceptional as claims are handled through routinized negotiations between established representatives"); McGovern, supra note 69, at 1882 ("One such strategy would treat each case resolved by traditional litigation as a data point, while treating the overall litigation process as an information system. Eventually, an adequate number of cases will be resolved, providing sufficient information to make informed decisions regarding the litigation as a whole; the mass tort will become mature. At this point, it might be possible to achieve a global outcome."). 451

See Resnik, supra note 20, at 38 ("While in theory and in form each case is separate, in practice lawyers on both sides deal with the cases as a group, sometimes making "block settlements' - in which defendants give a lawyer representing a group of plaintiffs money that is then allocated among a set of clients."); see also supra note 152 (discussing block settlements). A complete analysis of the problems attending settlement class actions is beyond the scope of this Article. 452

Hensler & Peterson, supra note 24, at 1041; see also sources cited supra note 451 (discussing block settlements).

453

See Hoyle & Madeira, supra note 116, at 129-30 (noting use of Special Asbestos Clerk, mandatory settlement conferences, and ordering of plaintiffs' medical expert report prior to settlement conference). 454

Hensler & Peterson, supra note 24, at 1047-48.

455

See id. at 1059 (noting that claims resolution facilities "appear to offer the most promise for resolving mass personal injury litigation, although the promise has yet to be realized," and discussing benefits and difficulties of claims resolution facilities).

Theresa Coetzee

Page 57 of 59 2005 Utah L. Rev. 863, *935 defendants to settle claims for less than they are worth, in exchange for their fee. 456 In a non-class settlement, a similar risk exists that plaintiffs' counsel representing thousands of clients will neglect the interests of certain clients to obtain a broader settlement of the whole, also increasing plaintiff counsel's fee. 457 Plaintiff client networks provide a potential solution to this problem. As discussed above, organized, interconnected groups of plaintiffs could remain abreast of the course of the litigation - including trial verdicts that might affect the value of their claims - as well as the types of distinctions that might lead their particular claims to be more or less valued. In addition to being informed, these plaintiffs would have the incentive to press for the full value of their claims, since they themselves would receive the compensation. Thus, client networks could police any variations of plaintiffs' counsel from the clients' interests in settlement. Professor Deborah Hensler has proposed that courts use electronic bulletin boards to offer current information on settlement negotiations, thereby enhancing litigant control and participation in the settlement process. 458 She has also proposed that courts appoint "plaintiffs' panels" of diverse plaintiffs who monitor settlements and report back to plaintiffs. 459 Such network [*936] approaches might easily grow from the client support networks already extant, regardless of court support. 460 In sum, mass tort litigation as network adequately informs the litigants about their chances of success in litigation, contributing to what has been termed the "maturity" of a mass tort. 461 In so doing, and by providing data about actual verdicts of types of plaintiffs, networks facilitate accurate settlement proposals and assessments. These accurate settlements not only particularly further the tort goal of corrective justice, but also greatly diminish the stress of mass torts on the court system. In addition to resolving a particular mass tort, the experimentalism of mass tort litigation networks leads to innovation and improvement in the management of mass tort litigation. Whereas variations in personal-injury class actions for multiple-incident mass torts have articulated variations on a fruitless approach - which have been rejected by appellate courts one after another - mass tort litigation as network progresses as a management method. Mass tort litigation networks encourage pockets of pragmatic experimentation where judges, counsel, and litigants across the country can try various methods of mass tort case management and strategy in response to

456

See, e.g., Coffee, supra note 135, at 883-87 (noting, in class actions, risk of plaintiffs' attorneys trading high fees for low class recovery); Coffee, supra note 159, at 628-34 (noting potential adverse interests between class action attorneys and clients); Schwartz et al., supra note 14, at 494-95 (noting examples). A complete assessment of the proper role of settlement class actions, which involve additional issues such as future-injury plaintiffs, is beyond the scope of this Article. 457

See Erichson, supra note 15, at 525 ("I mean to describe non-class litigation that functions like class actions in the sense described above: numerous plaintiffs depend upon the work of counsel with whom they have no meaningful individual lawyerclient relationship, over whom they have no meaningful control, and whose loyalty is directed primarily to the interests of the group as a whole."); id. ("Lawyers representing the mass of plaintiffs often have little or no incentive to allocate settlements fairly among their clients, and may have incentives to allocate settlements unfairly."); Hensler, supra note 29, at 1626 ("The same practices that enable plaintiffs' attorneys to litigate these cases successfully - securing large numbers of clients, standardizing the preparation of their cases, and negotiating group settlements - inhibit attorneys from establishing personal relationships with their clients."); id. at 1625-26 ("In my view, the primary obstacle to greater involvement of parties in the litigation process is the myth that their interests can be fully represented by their attorneys in this type of dispute."). In response to this problem, Professor Erichson has proposed that courts should be involved in overseeing and scrutinizing the fairness of, not only class settlements, but also non-class mass settlements and, also, that plaintiffs' attorneys should have ethical responsibilities to the group as a whole. Erichson, supra note 15, at 525-27.

458

Hensler, supra note 29, at 1624.

459

See id. (noting, also, that videoconferencing may be possible).

460

See id. at 1624-25 ("Although individual claimants might not have the financial means or training to use these services by themselves, the various support networks that attempt to disseminate information about specific mass tort litigations could use them.").

461

See McGovern, supra note 69, at 1882-83.

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Page 58 of 59 2005 Utah L. Rev. 863, *936 their cases. Judges, counsel, and litigants can then share the successful, as well as failed, attempts, producing innovation. Having forged connections with each other in one mass tort, the participants in one mass tort can use their connections to more easily link and expand connections for even more effective, efficient management of the next mass tort. Innovative approaches used in one mass tort can be adapted and applied in the next mass tort. Improvements passed on are refined and extended within a framework that operates within legal boundaries and furthers policy goals of individual autonomy, corrective justice, and adequate compensation. Moreover, these litigation management methods might themselves change constantly, not only with regard to scientific and technological changes in mass torts, but also technological changes in the means counsel and judges have to grapple with mass tort litigation. For example, in one mass tort, a judge might use e-mail Listserves to contact other judges around the country about litigation progress. Comfortable with the benefits of such contact, the judge may experiment with holding joint hearings with those judges in the next mass tort. Similarly, plaintiffs' attorneys in one mass tort might have found useful the coordination of written discovery against a defendant. In the next mass tort, those attorneys might jointly seek out expert witnesses. The permutations and possibilities spiral onward, creating [*937] a system that improves in effectiveness and efficiency over time, evincing an approach of pragmatic experimentalism. 462 Courts have already begun experimenting under the demands of mass tort litigation. 463 For example, courts might experiment with the use of summary trials and alternative dispute resolution. 464 Other courts might try using a court-appointed expert or panel of experts, a technical advisor, or a special master. 465 Such experimentation, however, must continue with sensitivity to legal and constitutional demands, and the policies underlying them. 466 Mass tort litigation as network, unlike its class action counterpart, provides a framework that remains within state substantive law and federal constitutional strictures. V. Conclusion Mass tort litigation as network provides a promising alternative to the unproductive path of personal-injury class actions for multiple-incident mass torts. Having developed over the last forty years, these networks of counsel, judges, and even clients are radically improving as a result of recent advances in information technology. They now

462

Experimental improvement need not only lead to the convergence of courts' approaches; it might also lead, in some instances, to divergence. Interestingly, these experimental improvements may permit the evolution of a diversity of approaches to case management in various jurisdictions that combine the common quest for efficiency with each jurisdiction's particular mix of legal values, embedded in its tort and procedural law. For example, courts might differentiate from one another in line with the civil justice values emphasized in their particular jurisdiction. Pragmatic experimentalism thus allows a flowering of that jurisdiction's legal culture, as well as a common search among jurisdictions to effectuate jointly held values. Indeed, the prioritizing of various jointly held values is, itself, an expression of a particular legal culture. Accordingly, a court's assessment of experimental progress in other jurisdictions would need to be filtered through an assessment of any value differences underlying that jurisdiction's law. In addition, comparisons of case results for settlement purposes by counsel would need to factor in any differences in legal culture among jurisdictions. Such differences are likely to be minimal among federal courts each working within the Federal Rules of Civil Procedure, but differences may be more significant between state courts from different states. In adjudicating issues of state law in accordance with the demands of Erie R.R. v. Thompkins, 304 U.S. 64 (1938), however, federal courts may also need to be mindful of state-law differences in evaluating experiments in various states. 463

See Manual, supra note 1, at 22.1 ("That pressure has led to creative and experimental procedures by attorneys and judges. A "process of common law evolution' and "a growing corps of experienced litigators' have helped "state and federal courts continue to experiment with existing procedures and allocations of jurisdiction.'" (quoting Working Group Report, supra note 1, at 316)). 464

See id. 22.2 & n.1058.

465

See id. 22.2.

466

See id. 22.1 ("The absence of precedent or of legislative or rule-making solutions should not foreclose innovation and creativity. Such creativity must be carefully applied, accompanied by an examination of the specific issues raised in each case, the legal authority for and against the procedures devised, and other factors that might affect fairness and efficiency.").

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Page 59 of 59 2005 Utah L. Rev. 863, *937 provide efficient and effective [*938] adjudication of mass torts, and develop a market of claims that offers accurate settlement values for mass settlements. Interestingly, recent scholarship on the use of networks in international law has shown the development of similar networks, whereby government officials and subgroups have used decentralized networks, aided by information technology, to achieve global resolution of problems without the perceived drawbacks of global government. 467 The development of these similar approaches in disparate fields suggests that information technology holds the possibility for empowerment of individually focused methods of problem solving in multiple areas of the law. Mass tort litigation as network provides a potent example of the advantages of that approach. Copyright (c) 2005 Utah Law Review Society Utah Law Review

End of Document

467

See Anne-Marie Slaughter, A New World Order passim (2004).

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ARTICLE: ALTERNATIVE LITIGATION FINANCE AND THE WORK-PRODUCT DOCTRINE Winter, 2012 Reporter 47 Wake Forest L. Rev. 1083

Length: 29756 words Author: Grace M. Giesel* * Bernard Flexner Professor & Distinguished Teaching Professor, University of Louisville, Louis D. Brandeis School of Law.

LexisNexis Summary … Massachusetts Institute of Technology, "The attorney client privilege is designed to protect confidentiality, so that any disclosure outside the magic circle is inconsistent with the privilege; by contrast, work-product protection is provided against "adversaries,' so only disclosing material in a way inconsistent with keeping it from an adversary waives work-product protection." … While the situation before the Deloitte court did not present a confidentiality agreement, the court found that a reasonable expectation of confidentiality existed because the audited entity disclosed materials protected by the work-product doctrine to independent auditors who were ethically obligated under the Code of Professional Conduct of the American Institute of Certified Public Accountants "to refrain from disclosing client information." … In finding that the disclosure of the documents did not waive that work-product protection, the court stated that the documents "were disclosed subject to nondisclosure agreements and thus did not substantially increase the likelihood that an adversary would come into possession of the materials." … Likewise, courts will likely find materials created in the ALF setting to be created "in the anticipation of litigation" even though they were also created to obtain funding or to continue to cooperate with the ALF entity who has already invested in the matter. … United States, the court decided that the auditor was neither a potential adversary nor a conduit to an adversary for purposes of waiver, and it based this conclusion on the fact that the auditor was bound by a confidentiality agreement. … Second, sharing protected materials with ALF entities should not waive that protection if ALF entities enter into binding nondisclosure agreements with regard to any shared materials.

Text [*1083]

Introduction The United States judicial system is in the midst of great and fundamental change with regard to the funding of litigation. Historically, parties financed litigation out of their own literal or figurative pockets or, perhaps, with the assistance of some sort of contingent fee representation. 1 Third-party financing of litigation was frowned upon, if not specifically forbidden. 2 But, now, third-party litigation funding entities have begun, with much more frequency and success, to provide funding for small matters such as individual personal injury claims as well as larger

1

See Am. Bar Ass'n Comm'n on Ethics 20/20, Informational Report to the House of Delegates 1, 4-5 (2012) [hereinafter ABA Report], available at http://www.americanbar.org/content/dam/aba/administrative/ethics_2020 /20111212_ethics_20_20_alf_ white_paper_final_hod_informational _report.authcheckdam.pdf. 2

See Maya Steinitz, Whose Claim Is This Anyway? Third-Party Litigation Funding, 95 Minn. L. Rev. 1268, 1286-91 (2011) (explaining historical antipathy to maintenance and champerty); see also infra notes 33-36 and accompanying text.

Theresa Coetzee

Page 2 of 44 47 Wake Forest L. Rev. 1083, *1083 commercial litigation matters between businesses. 3 The demand for this alternative litigation finance ("ALF") 4 clearly exists, 5 and the supply [*1084] of funding has developed despite historical obstacles. 6 Doctrines such as champerty have faded somewhat 7 from the legal landscape, and old fears of having litigation funded and controlled by evil actors equal to the worst villain in any Dickens novel have receded in light of the notion that everyone deserves access to justice regardless of bank account balance. As historical obstacles to litigation funding have waned, a new reality has emerged in which ALF entities increase access to justice 8 - at least for some. For others, funding from these entities allows litigants who have the means to fund litigation to shift risk. 9 Litigation funding alters the relative power of players in the justice system; it provides access to the playing field and also ensures that the teams show up at the field with the same equipment. 10 [*1085] In this new and quickly developing ALF reality, new utilitarian questions have emerged. Perhaps the most important of these is the effect the involvement of ALF entities has on the attorney-client privilege and the work-

3

See Eileen Malloy, Third-Party Financing for U.S. Litigation Profitable Endeavor for U.K. Funding Firm, 28 A.B.A. Law. Manual Prof. Conduct Newsl. 229. 229 (2012) (stating that Burford, an international entity that finances high-end litigation, reported a $ 15.9 million profit in 2011); Binyamin Appelbaum, Lawsuit Loans Add New Risk for the Injured, N.Y. Times, Jan. 17, 2011, at A1 (discussing loans to individuals); see also infra Part I. 4

The American Bar Association Commission on Ethics 20/20 in its Informational Report to the House of Delegates in February 2012 adopted the term "alternative litigation finance ("ALF")" to refer to any funding of litigation "by entities other than the parties themselves, their counsel, or other entities with a preexisting contractual relationship with one of the parties, such as an indemnitor or a liability insurer." See ABA Report, supra note 1, at 1. Steven Garber had earlier used the term. See generally Steven Garber, RAND Inst. for Civ. Just., Alternative Litigation Financing in the United States: Issues, Knowns, and Unknowns (2010), available at http://www.rand.org /content/dam/rand/pubs/occasional_papers/2010/RAND _OP306.pdf. 5

The annual report released in April of 2012 of Burford, a high-end ALF entity, states, "While uncertain economic conditions, rising litigation costs and shrinking corporate budgets have helped generate interest in Burford's proposition, the fundamental driver of our success to date has simply been a thirst for financial options." See Malloy, supra note 3. Burford, for example, claims to have worked with approximately one-half of the top fifty law firms in the United States. Id.; see also William Alden, Looking to Make a Profit on Lawsuits, Firms Invest in Them, N.Y. Times, May 1, 2012, at B3, available at http://query.nytimes.com/gst/fullpage.html?res=9405E4DA1F38F932 A35756C0A9649D8B63 ("[ALF] is increasingly gaining backing from some of the country's top law firms … ."). 6

See Catherine Ho, Investment Firms Playing Role in Legal Field, Wash. Post (Dec. 11, 2011), http://www.washingtonpost.com/business/capitalbusiness /investment-firms-playing-role-in-legal-field/2011/12/05/gIQAurh7nO _story.html (discussing the financing activities of BlackRobe Capital, Burford, Juridica, and Credit Suisse); see also Melissa Maleske, Hedging Bets: As Litigation Activity Rises, Some U.S. Hedge Funds Are Investing in Corporate Lawsuits, Inside Couns., Dec. 2009, at 18, 18-21, available at http://www.insidecounsel.com/2009/12/01/hedging-bets (discussing the increase in third-party litigation financing and historical obstacles). See generally Jason Lyon, Comment, Revolution in Progress: ThirdParty Funding of American Litigation,58 UCLA L. Rev. 571 (2010). 7

See infra Part II.

8

See Douglas R. Richmond, Other People's Money: The Ethics of Litigation Funding, 56 Mercer L. Rev. 649, 649-50 (2005); Steinitz, supra note 2, at 1276. 9

See generally Catherine Dunn, Litigation Financing Becoming a Useful Tool for In-House Counsel, Corp. Couns., Dec. 19, 2011 (discussing risk shifting). 10

See Binyamin Appelbaum, Betting on Justice: Putting Money on Lawsuits, Investors Share in the Payouts, N.Y. Times, Nov. 15, 2010, at A1 ("[The money] is helping to ensure that cases are decided by merit rather than resources… . But … borrowed money is also fuelling abuses."). Christopher Bogart, Burford CEO and former general counsel of Time Warner, has stated, "The reality of litigation is that litigation is so expensive that that [sic] fair and impartial process can be influenced by two imbalances." Dunn, supra note 9. He notes that one imbalance is "an imbalance of resources," while the other is "an imbalance of risk tolerances." Id.

Theresa Coetzee

Page 3 of 44 47 Wake Forest L. Rev. 1083, *1085 product doctrine. 11 The desire to preserve privilege and work-product protection will likely mold the shape of the day-to-day operations of litigation finance entities and the ALF market in general. A body of law has not yet developed dealing with the application of the attorney-client privilege or work-product doctrine to the involvement of ALF entities. Only one case has dealt substantively with the applicability of the attorney-client privilege in the litigation finance setting. 12 Case law applying the work-product doctrine in the litigation finance setting likewise is scant. 13 This Article attempts a complete consideration of the application of the work-product doctrine to the ALF situation, while leaving for a later date a consideration of the application of the attorney-client privilege. ALF entities can be involved in a litigation matter in two ways that may call into question the work-product doctrine. First, the financing entity must have access to information in order to decide whether to initially invest in a particular matter. 14 Second, if an [*1086] ALF entity decides to invest, it may require updates on that matter as a way of monitoring the investment. 15 In either context, the ALF entity may require two types of disclosure. The entity may require the attorney and client team to supply it with materials already created in pursuit of the litigation matter. In addition, the ALF entity may require the creation of new materials critically evaluating the litigation matter. The entity may require such evaluative information for the investment decision and also after the entity becomes involved in the matter as an investor. With regard to previously created materials protected by the work-product doctrine and shared with the ALF entity, the question that arises is whether the act of sharing waives the protection. With regard to evaluative material specifically created for the ALF entity, the initial question is whether the work-product doctrine applies at all. If the materials are protected, the question of whether sharing such information with the ALF entity waives the protection arises as well. Parties and attorneys will be much less inclined to share materials with ALF entities if in so doing they destroy the protection afforded by the work-product doctrine. Similarly, an ALF entity has no desire to lower or completely 11

See infra Part III.

12

See Mondis Tech., Ltd. v. LG Elecs., Inc., Nos. 2:07-CV-565-TJW-CE, 2:08-CV-478-TJW, 2011 WL 1714304, at 1-3 (E.D. Tex. May 4, 2011) (raising the issue but deciding the matter on the basis of the work-product doctrine); Leader Techs., Inc. v. Facebook, Inc., 719 F. Supp. 2d 373, 376-77 (D. Del. 2010) (holding that, at the investment decision stage, no attorney-client privilege is applied because no common interest exists between the party to the litigation and the ALF entity); Bray & Gillespie Mgmt. LLC v. Lexington Ins. Co., No. 6:07-cv-222-Orl-35KRS, 2008 WL 5054695, at 1-3 (M.D. Fla. Nov. 17, 2008) (holding that no attorney-client privilege exists with respect to an ALF entity that entered into a confidentiality agreement and shared materials for an investment decision but that did not subsequently invest). 13

See infra Part VI. Commentators have noted the issue but have not provided a thorough analysis. See, e.g., ABA Report, supra note 1, at 32-36 (discussing both the attorney-client privilege and the work-product doctrine); Richmond, supra note 8, at 674-76. 14

See Alden, supra note 5 ("Firms have to be selective about the cases they pick, combining a lawyer's legal sense with an investor's knowledge of risk. Deals are customized for each case, after a due diligence process that often includes analysis of a case's facts, witnesses, opposing counsel and potential recoveries."). For example, in Fausone v. U.S. Claims, Inc., the court noted that the plaintiff's "attorneys also provided U.S. Claims with information about her claim to assist U.S. Claims in deciding whether to advance her funds." 915 So. 2d 626, 628 (Fla. Ct. App. 2005); see also Jonathan T. Molot, A Market in Litigation Risk, 76 U. Chi. L. Rev. 367, 391 (2009) (noting that any prudent investor would want access to information as part of "due diligence"). 15

See Maleske, supra note 6 (quoting Juridica's CEO, Richard Fields, as stating that he expects "clients to keep [Juridica] informed if some material event happens in the case, and [to provide] quarterly reports"); Nate Raymond, Top Australian Litigation Finance Company Opens New York Subsidiary, Am. Law., Oct. 10, 2011, at 1 (noting that, while BlackRobe Capital Partners and Fulbrook Management LLC seek active roles, Bentham Capital LLC does not seek control).

Theresa Coetzee

Page 4 of 44 47 Wake Forest L. Rev. 1083, *1086 destroy the value of a litigation matter it is considering for investment or in which the entity is already involved. If the materials available to ALF entities are also available to litigation adversaries, the value of many litigation matters would be reduced greatly. In Part I, this Article presents an overview of the ALF phenomenon. Part II reviews the current status of the major historical obstacles to ALF. Part III outlines the history and parameters of the work-product doctrine. Part IV discusses the existing case law applying the work-product doctrine to the ALF context. Part V addresses the similarity of applying the work-product doctrine to situations involving ALF entities and to situations involving independent auditors. Part VI discusses courts' treatment, especially in the independent auditor context, of the question of whether the work-product doctrine protects materials that evaluate litigation. Part VII discusses courts' treatment of the question of whether the sharing, in the independent auditor context, of materials otherwise protected by the doctrine waives the protection. [*1087] This Article concludes that materials that evaluate litigation, even if created in the ALF setting, are likely protected by the work-product doctrine. The Article further concludes that materials likely do not lose protection when an attorney and client team shares them with an ALF entity. This is true, however, only if the ALF entity enters into a binding nondisclosure agreement with regard to any shared materials.

I. The Alternative Litigation Finance Phenomenon The beginning of modern ALF took the form of relatively small lending businesses recognizing the need for litigation funding and seeking to answer that need. These entities loaned money to plaintiffs, usually individuals, in exchange for a share of the recovery - that is, if there was a recovery. 16 This activity has been called "first-wave litigation funding." 17 While many of these businesses were probably completely reputable, some engaged in predatory practices 18 and thus tarnished the general reputation of the entire ALF community. 19 Today, hundreds of entities are in the business of making loans related to litigation. 20 In just a few years, the ALF market has expanded to include sophisticated litigation investing. In this "second-wave litigation funding," 21 funders include sophisticated entities such as banks, investment funds, and insurance companies, as well as specialized entities that are publicly traded. 22 For example, Juridica and Burford, two of the many financing entities investing in litigation in the United States, are traded on the Alternative Investment Market

16

See Courtney R. Barksdale, Note, All That Glitters Isn't Gold: Analyzing the Costs and Benefits of Litigation Finance, 26 Rev. Litig. 707, 710-16 (2007) (describing the financing arrangement provided to plaintiffs). 17

Steinitz, supra note 2, at 1277.

18

See, e.g., Kelly, Grossman & Flanagan, LLP v. Quick Cash, Inc., No. 04283-2011, 2012 WL 1087341, at 1-2 (N.Y. Sup. Ct. Mar. 29, 2012) (discussing a case involving forty percent interest on loans to attorneys); Rancman v. Interim Settlement Funding Corp., 789 N.E.2d 217, 218 (Ohio 2003) (describing a loan arrangement with an interest rate of 180 percent). 19

For discussions of the predatory issue, see generally Andrew Hananel & David Staubitz, The Ethics of Law Loans in the PostRancman Era, 17 Geo. J. Legal Ethics 795 (2004); Susan Lorde Martin, Litigation Financing: Another Subprime Industry that Has a Place in the United States Market, 53 Vill. L. Rev. 83 (2008). 20

See, e.g., Fausone v. U.S. Claims, Inc., 915 So. 2d 626, 627 (Fla. Ct. App. 2005) (discussing finance provided to an individual); Quick Cash, 2012 WL 1087341, at 1 (discussing small-scale litigation finance provided to a law firm). 21

Steinitz, supra note 2, at 1277.

22

See Lyon, supra note 6, at 573 (discussing entities whose sole business is ALF, as well as other entities who have other businesses such as banking); Ho, supra note 6 (discussing various ALF entities such as BlackRobe, Burford, and Juridica, as well as banking entity Credit Suisse).

Theresa Coetzee

Page 5 of 44 47 Wake Forest L. Rev. 1083, *1087 [*1088] ("AIM") that is a part of the London Stock Exchange. 23 Australia's largest funder, IMF (Australia) Ltd.,

launched a U.S. subsidiary in 2011, and many other entities opened for business in recent years. 24 These ALF entities provide funding to plaintiffs and defendants in a variety of settings. 25 For example, the Burford Group, in its Annual Report issued in the spring of 2012, noted that it had committed $ 280 million in more than thirty-six investments. 26 These investments include contract disputes and other general business matters, real estate matters, intellectual property matters, environmental disputes, and trade secret litigation. Burford reported a $ 15.9 million profit. 27 The ALF industry is indeed enjoying much success. 28 II. The Historical Barriers and the Modern Environment A. Champerty Long ago, people feared that the powerful among them would "buy up claims and, by means of their exalted and influential positions, overawe the courts, secure unjust and unmerited [*1089] judgments, and oppress those against whom their anger might be directed." 29 The litigation often involved land, and, in exchange for funding the litigation, the wealthy and powerful party would obtain a share of the land. 30 The poorer claimholder had little choice, while the wealthy and powerful party became wealthier and more powerful by the increase in land ownership. 31

23

See Richard Lloyd, The New, New Thing, Am. Law., May 17, 2010, at 1; see also Lyon, supra note 6, at 573 (discussing Burford and Juridica).

24

The subsidiary is named Bentham Capital LLC. Raymond, supra note 15; see Alden, supra note 5 (noting that, in January of 2012, Credit Suisse's litigation finance group departed and formed Parabellum Capital); Tim Scrantom and Sean Coffey Announce the Formation of BlackRobe Capital Partners, LLC, a "Next Generation" Commercial Claim Investor, PR Newswire (Oct. 3, 2011), http://www.prnewswire.com/news-releases/tim-scrantom-and -sean-coffey-announce-the-formation-of-blackrobecapital-partners-llc-a-next -generation-commercial-claim-investor-130995228.html (stating that BlackRobe Capital Partners and Fulbrooke Management LLC opened in 2011). 25

See ABA Report, supra note 1, at 5 (noting that a spectrum of transactions by ALF suppliers exists); see also Steinitz, supra note 2, at 1277 (describing such settings as including "corporate defendants, classes (in class action cases), and individual plaintiffs in non-personal injury cases"). Juridica states that it often invests in patent disputes and competition law infringement matters. Alex Spence, The £ 8 Slice of Courtroom Winnings, with More to Come, The Times (London), Jan. 5, 2012, at 39.

26

Jonathan T. Molot, Burford Chief Investment Officer Authors Major White Paper Detailing Impact of Litigation Funding on Large-Scale Commercial Disputes, PR Newswire (Apr. 26, 2012), http://www.prnewswire.com/news -releases/burford-chiefinvestment-officer-authors-major-white-paper-detailing-impact-of-litigation-funding-on-large-scale-commercialdisputes149092565.html. 27

See Malloy, supra note 3.

28

Juridica, in January of 2012, announced a stock payout as a result of success in seven matters in the patent and antitrust fields. See Spence, supra note 25. The United Kingdom and Australia have been ahead of the United States in the establishment and acceptance of ALF. See Lee Aitken, "Litigation Lending' After Fostif: An Advance in Consumer Protection or a Licence to "Bottomfeeders', 28 Sydney L. Rev. 171, 177 (2006); Ho, supra note 6. 29

Casserleigh v. Wood, 59 P. 1024, 1026 (Colo. App. 1900).

30

Ronald C. Minkoff & Andrew D. Patrick, Taming the Champerty Beast: A Proposal for Funding Class Action Plaintiffs, 15 Prof. Law. 1, Spring 2004, at 1. 31

See 15 Grace McLane Giesel, Corbin on Contracts § 83.10 (Joseph M. Perillo ed., 2003) (discussing the historical motivators to the development of the doctrines of champerty, maintenance, and barratry). See generally Max Radin, Maintenance by Champerty, 24 Calif. L. Rev. 48 (1935) (describing the history of champerty). As the South Carolina Supreme Court noted in Osprey, Inc. v. Cabana Ltd. Partnership, this type of activity was "a resistance of the moneyed class to capitalistic forces that had begun to take root across Europe in the eleventh and twelfth centuries." 532 S.E.2d 269, 274 (S.C. 2000).

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Page 6 of 44 47 Wake Forest L. Rev. 1083, *1089 To control such conduct, England created rules limiting a third party's involvement in another's litigation. 32 In particular, rules were created to prohibit maintenance, champerty, and barratry. 33 The Supreme Court, in In re Primus, 34 provided a very basic definition of each: "maintenance is helping another prosecute a suit; champerty is maintaining a suit in return for a financial interest in the outcome; and barratry is a continuing practice of maintenance or champerty." 35 These rules often took the form of criminal provisions, tort causes of action, or contract enforcement defenses. 36 Perhaps because the need for these rules has faded, 37 courts have expressed displeasure with these ancient doctrines. For [*1090] example, in Giambattista v. National Bank of Commerce of Seattle, 38 the court noted, "In no state are these doctrines and the laws relating to them preserved with their original rigor." 39 Similarly, the Court of Appeals for the Ninth Circuit in Del Webb Communities, Inc. v. Partington 40 has stated, "The consistent trend across the country is toward limiting, not expanding, champerty's reach." 41 Many states no longer recognize tort causes of action or criminal prohibitions. 42 Some states also have significantly curtailed recognizing the doctrines

32

For example, a statute enacted in the thirteenth century in the time of Edward I stated:

No officer of the King by themselves, nor by other, shall maintain pleas, suits, or matters hanging in the King's courts, for lands, tenements, or other things, for to have part or profit thereof by covenant made between them; and he that doth, shall be punished at the King's pleasure. Percy H. Winfield, The History of Maintenance and Champerty, 35 Law Q. Rev. 50, 59 (1919). 33

34

See id. at 59-71. 436 U.S. 412 (1978).

35

Id. at 424 n.15; Anthony J. Sebok, The Inauthentic Claim, 64 Vand. L. Rev. 61, 73 n.43 (2011) (quoting Osprey, 532 S.E.2d at 273). See generally Paul Bond, Comment, Making Champerty Work: An Invitation to State Action, 150 U. Pa. L. Rev. 1297 (2002) (discussing the history and current status of causes of action for champerty). 36

See, e.g., N.Y. Judiciary Law § 489 (McKinney 2005) (making champerty a crime); see also Winfield, supra note 32 (explaining that champerty and maintenance were crimes). 37

Courts have recognized that the justice system has other tools to control any improper use of the system, such as abuse of process actions and malicious prosecution actions. See, e.g., Security Underground Storage, Inc. v. Anderson, 347 F.2d 964, 969 (10th Cir. 1965) (noting that no tort cause of action was recognized but that actions might be maintained for malicious prosecution or abuse of process). In addition, the logic of applying rules related to the champerty doctrine is suspect, given that the U.S. justice system has long accepted an obvious type of champerty - the contingency fee. See Model Rules of Prof'l Conduct R. 1.5 (2012) (describing the ethical guidelines regarding contingency fees); see also Sebok, supra note 35, at 99 ("Technically, of course, all fifty-one jurisdictions permit at least one form of maintenance: the contingency fee."). 38

586 P.2d 1180 (Wash. Ct. App. 1978).

39

Id. at 1186.

40

652 F.3d 1145 (9th Cir. 2011).

41

Id. at 1156; see also TMJ Hawaii, Inc. v. Nippon Trust Bank, 153 P.3d 444, 449 (Haw. 2007) ("This court has repeatedly rejected blind adherence to rules crafted to meet anachronistic societal demands and has expressed skepticism about the continued potency of the doctrines of champerty and maintenance."). 42

See, e.g., Del Webb, 652 F.3d at 1157 (explaining that "there was no adequate basis, in short, for the federal district court, applying Nevada law, to recognize a tort claim for champerty"); Hall v. Delaware, 655 A.2d 827, 830 (Del. Super. Ct. 1994) (noting that there is no champerty crime in Delaware).

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Page 7 of 44 47 Wake Forest L. Rev. 1083, *1090 as a defense to contract enforcement. 43 For example, in Osprey, Inc. v. Cabana Ltd. Partnership, 44 the South Carolina Supreme Court refused to recognize champerty as a defense to enforcement of a contract, stating that a court can evaluate a suspect contract in light of other doctrines such as unconscionability, duress, and good faith. 45 At least twenty-eight U.S. jurisdictions expressly allow champerty with varying degrees of limitation. 46 In addition to this general negative view of champerty, some decisions in recent years in situations specifically involving ALF show that at least some courts have not been receptive to champerty [*1091] claims. 47 For example, in Odell v. Legal Bucks, LLC, 48 the North Carolina Court of Appeals rejected a claim that an ALF arrangement was champertous: Our Courts have held for at least a century that an outsider's involvement in a lawsuit does not constitute champerty or maintenance merely because the outsider provides financial assistance to a litigant and shares in the recovery. Rather, "a contract or agreement will not be held within the condemnation of the principles … unless the interference is clearly officious and for the purpose of stirring up "strife and continuing litigation.'" 49 The court saw nothing champertous about the arrangement before it.

50

The ABA's Commission on Ethics 20/20 addressed the ALF phenomenon in its Informational Report to the House of Delegates in early 2012. 51 The Commission concluded that champerty is not an obstacle to ALF in many states. 52 Specifically, the Commission noted that if a state allows champerty in some form, an arrangement would not likely be contrary to the champerty restrictions if the funder is not encouraging frivolous litigation, if the funder is not motivated by an improper motive also referred to as "malice champerty," and if the funder does not involve itself with the conduct of the litigation such as exercising control over strategic decisions. 53

43

See, e.g., Saladini v. Righellis, 687 N.E.2d 1224, 1226-27 (Mass. 1997) (refusing to recognize champerty as a defense to enforcement of a contract). 44

532 S.E.2d 269 (S.C. 2000).

45

Id. at 277 ("The doctrines of unconscionability, duress, and good faith establish standards of fair dealing between opposing parties."). 46

Sebok, supra note 35, at 98-99; see also Bond, supra note 35, at 1333-41. A few states have approved of some traditional forms of champerty by statute. See, e.g., Me. Rev. Stat. tit. 9-A, §§12-101 to -107 (2009); Ohio Rev. Code Ann. § 1349.55 (LexisNexis 2012). 47

See, e.g., Echeverria v. Estate of Linder, No. 018666/2002, 2005 WL 1083704, at 4, 6-7 (N.Y. Sup. Ct. Mar. 2, 2005) (holding no permissible champerty); Odell v. Legal Bucks, LLC, 665 S.E.2d 767, 774 (N.C. Ct. App. 2008) (holding no permissible champerty); see also Core Funding Grp., LP v. McIntire, No. 07-4273, 2011 WL 1795242, at 4 (E.D. La. May 11, 2011) (holding that a loan to attorneys to fund litigation was not champertous because it was not a loan to a party and not contingent solely on the outcome of the underlying litigation). 48

Odell,665 S.E.2d 767.

49

Id. at 775 (quoting Smith v. Hartsell, 63 S.E. 172, 174 (N.C. 1908) (citation omitted)).

50

Id.

51

See generally ABA Report, supra note 1.

52

Id. at 11-12.

53

See id. at 11; see also Sebok, supra note 35, at 98-99 (discussing the various forms of champerty permitted by the various jurisdictions).

Theresa Coetzee

Page 8 of 44 47 Wake Forest L. Rev. 1083, *1091 When measuring ALF arrangements against these limits, courts should not generally find such arrangements to be champertous. ALF entities certainly do not seek to create or further baseless claims. ALF business models require investment in strong claims with substantial merit. 54 ALF entities have no malicious [*1092] motive. Rather, they are motivated by a singular desire to maximize recovery on the investment. 55 In addition, ALF entities are aware of the lines they cannot cross in terms of exercise of control over the litigation matter in which the entities invest. 56 ALF arrangements, therefore, are not likely to encounter difficulty in many jurisdictions on the basis of champerty or related doctrines. This is especially so since some parts of society do not view litigation as evil but rather a means to vindicate rights and pursue social change. 57 Even so, the champerty doctrine is alive and well in many jurisdictions, so adverse judgments are possible. For example, in Johnson v. Wright, 58 an ALF entity sought to enforce an arrangement in which the entity financed the litigation in exchange for a piece of any recovery. The court found the arrangement champertous. 59 Such decisions create uncertain terrain for ALF arrangements. B. Usury Courts also have viewed ALF arrangements suspiciously in light of laws prohibiting usury. Modern laws prohibit excessive interest charges. Jurisdictions have a variety of statutes that outlaw a variety of interest rates for a variety of arrangements. 60 The modern rationale for these statutes is the protection of debtors who have weak bargaining strength and little sophistication from stronger and more sophisticated creditors. 61 ALF arrangements often involve a relatively high interest rate, 62 so challengers to ALF arrangements sometimes argue that [*1093] such arrangements are usurious. 63 Yet, usury laws generally apply only when the interest is charged for the use of the money and the borrower unconditionally promises to repay the principal and the interest. This is the classic loan situation. 64 ALF arrangements usually do not involve an unconditional promise to repay the

54

See Alden, supra note 5 (stating that ALF entities "insist they only invest in cases that they believe have merit").

55

Id.; see also Malloy, supra note 3 (discussing Burford's profit-seeking success).

56

Burford has stated about itself that it "is simply a provider of investment capital and … the litigant retains control of its case." Malloy, supra note 3. 57

See Stephen C. Yeazell, Brown, The Civil Rights Movement, and the Silent Litigation Revolution, 57 Vand. L. Rev. 1975, 2000 (2004) (discussing "civil litigation as an instrument of social change"). 58

682 N.W.2d 671 (Minn. Ct. App. 2004).

59

Id. at 678-79.

60

See Susan Lorde Martin, Financing Litigation On-Line: Usury and Other Obstacles, 1 DePaul Bus. & Com. L.J. 85, 89-90 (2002) (discussing some of the variations in usury statutes). 61

See, e.g., Agapitov v. Lerner, 133 Cal. Rptr. 2d 837, 843 (Cal. Ct. App. 2003) ("The usury laws protect against the oppression of debtors through excessive interest rates charged by lenders. Usury laws "protect the public from sharp operators who would take advantage of unwary and necessitous borrowers.'"(citation omitted)). 62

See, e.g., Kelly, Grossman & Flanagan LLP v. Quick Cash, Inc., No. 04283-2011, 2012 WL 1087341, at 1 (N.Y. Sup. Ct. Mar. 29, 2012) (discussing forty percent interest on a loan to attorneys). 63

See, e.g., Dopp v. Yari, 927 F. Supp. 814, 820 (D.N.J. 1996); Odell v. Legal Bucks, LLC, 665 S.E.2d 767, 776 (N.C. Ct. App. 2008). 64

See Lloyd v. Scott, 29 U.S. (4 Pet.) 205, 226 (1830) ("Where a loan is made to be returned at a fixed day with more than the legal rate of interest, depending upon a casualty which hazards both principal and interest, the contract is not usurious; but where the interest only is hazarded, it is usury."); see also Martin, supra note 60, at 90-91.

Theresa Coetzee

Page 9 of 44 47 Wake Forest L. Rev. 1083, *1093 principal and interest. 65 Rather, the typical ALF arrangement provides that the funder will be paid only if the litigation is successful. ALF arrangements, therefore, are a classic investment, not a loan. 66 A typical reception for a challenge to an ALF arrangement on the basis of usury is illustrated in Anglo-Dutch Petroleum International, Inc. v. Haskell. 67 Anglo-Dutch entered into an ALF arrangement in order to pursue what it believed to be meritorious litigation but also to avoid bankruptcy. 68 The finance group provided $ 560,000 and was to receive recompense and a return above that amount only if the litigation was successful. 69 The Texas Court of Appeals stated that Anglo-Dutch had "no obligation to reimburse [the funding group] for the principal amount invested, much less pay [the funders] any return on their investment" and so "as a matter of law, the agreements could not be usurious." 70 Other courts have reached the same conclusion that ALF arrangements are not usurious. 71 [*1094] Some courts have reached a contrary result. 72 For example, the court in Echeverria v. Estate of Lindner 73

concluded that the probable success for the claim in a strict liability labor law case was a "sure thing." 74 Thus, in the court's view, there was no realistic possibility that the funder would not receive repayment. 75 Finding the arrangement usurious, the court stated that "it is ludicrous to consider this transaction anything else but a loan unless the court was to consider it legalized gambling." 76 Similarly, the court in Lawsuit Financial, LLC v. Curry 77 found a usurious arrangement when the funding arrangement was entered into after the jury had rendered its

65

See Martin, supra note 60, at 102 ("Declaring the advances of funds to be loans subject to usury laws is unrealistic."); Richmond, supra note 8, at 665-66. 66

See Quick Cash, 2012 WL 1087341, at 1. The Quick Cash court faced a typical, small-scale ALF arrangement and stated, "In fact, the Defendants were always at risk of no recourse whenever one of the underlying cases went to trial and resulted in no recovery. Such circumstances simply cannot be stated to constitute a "loan.'" Id. at 5.

67

193 S.W.3d 87 (Tex. Ct. App. 2006).

68

Id. at 90-91.

69

Id. at 91.

70

Id. at 96-97.

71

See, e.g., Quick Cash, 2012 WL 1087341, at 6 ("The concept of usury applies to loans, which are typically paid at a fixed or variable rate over a term. The instant transaction, by contrast, is an ownership interest in proceeds for a claim, contingent on the actual existence of any proceeds, [sic] Had respondents been unsuccessful in negotiating a settlement or winning a judgment, petitioner would have no contractual right to payment. Thus, usury does not apply to the instant case."); see also Dopp v. Yari, 927 F. Supp. 814, 823-24 (D.N.J. 1996); Kraft v. Mason, 668 So. 2d 679, 684 (Fla. Dist. Ct. App. 1996). 72

See, e.g., Lawsuit Fin., LLC v. Curry, 683 N.W.2d 233, 239 (Mich. Ct. App. 2004) (concluding that, because the funding arrangement was entered into after the jury verdict, the funding recovery was fairly certain and thus usurious); Echeverria v. Estate of Lindner, No. 018666/2002, 2005 WL 1083704, at 9 (N.Y. Sup. Ct. Mar. 2, 2005) (concluding that, because success on the claim was a "sure thing" and the funder was sure to be repaid, the funding arrangement was usurious); see also Odell v. Legal Bucks, LLC, 665 S.E.2d 767, 776-79 (N.C. Ct. App. 2008) (finding an ALF agreement to be an "advance" and therefore usurious). 73

Echeverria, 2005 WL 1083704.

74

Id. at 9.

75

See id. (explaining that loaning money on a contingency to a plaintiff in a strict liability labor law action is a "sure thing").

76

Id.

77

683 N.W.2d 233 (Mich. Ct. App. 2004).

Theresa Coetzee

Page 10 of 44 47 Wake Forest L. Rev. 1083, *1094 verdict in favor of the party seeking funding. 78 Both of these cases presented out-of-the-ordinary facts that gave the respective courts reason to stretch to find usurious arrangements. 79 While these sorts of results are possible, they are unlikely in a typical ALF situation. C. Professional Responsibility Issues Even if ALF arrangements are not champertous or usurious, they create professional responsibility dilemmas that hinder their use. Numerous ethics opinions have addressed various ethical issues raised as objections to ALF arrangements. 80 Generally, the ethics opinions conclude that no professional responsibility issue [*1095] makes these arrangements impossible, 81 though the potential for problems argues for caution. It is possible that an ALF entity could improperly interfere with the attorney's exercise of judgment in representing the client. This could occur if the entity attempted to take control of the conduct of the litigation, including strategy. 82 Several of the ABA's Model Rules of Professional Conduct prohibit improper interference. 83 Yet, ethics opinions do not forbid ALF entity involvement but rather warn lawyers to guard against such interference. 84 In addition, ethics opinions warn lawyers dealing with ALF entities to be wary of conflicts of interest that might arise from the tripartite relationship. 85 These ethics opinions have stated that the [*1096] Model Rules require lawyers

78 79

Id. at 239. See Richmond, supra note 8, at 668 (discussing Curry and arguing that the case "must be limited to its unusual facts").

80

See, e.g., Del. State Bar Ass'n Comm. on Prof'l Ethics, Op. 2006-2 (2006), available at http://www.dsba.org/pdfs/2006-2.pdf (discussing the ethical implications of ALF on the attorney); Mich. Ethics Op. RI-336 (2005), available at http://www.michbar.org/opinions/ethics/numbered_opi nions/RI-336.htm (discussing whether a lawyer can fund litigation costs through a loan from a third-party lending institution). See generally ABA Report, supra note 1; Richmond, supra note 8 (discussing the various ethical issues involved in litigation funding). 81

See, e.g., Del. State Bar Ass'n Comm. on Prof'l Ethics, Op. 2006-2 (2006), available at http://www.dsba.org/pdfs/2006-2.pdf ("The Attorney may comply with such an arrangement under the proper circumstances."); Mich. Ethics Op. RI-336 (2005), available at http://www.michbar.org/opinions/ethics /numbered_opinions/RI-336.htm ("The various State Bar ethics opinions have concluded that litigation-financing arrangements similar to those described above are permissible, as long as it is the lawyer … who is the obligor on the loan, and there is full disclosure to the client."); see also ABA Report, supra note 1, at 39 (concluding that lawyers must abide by the rules of professional responsibility in dealing with a representation involving ALF); Richmond, supra note 8, at 669-81 (discussing the various ethics issues raised by ALF). 82

See Richmond, supra note 8, at 669-70 (discussing the possibility of a litigation funding company to influence the process of litigation). 83

See, e.g., Model Rules of Prof'l Conduct R. 2.1 (2012) ("[A] lawyer shall exercise independent professional judgment and render candid advice."); Model Rules of Prof'l Conduct R. 1.8(f) (2012) (providing that a third party can pay only if there is no improper interference); Model Rules of Prof'l Conduct R. 5.4(c) (2012) (disallowing interference).

84

See, e.g., Ky. Bar Ass'n, Ethics Op. E-432 (2011), available at http://www.kybar.org/documents/ethics_opinions/kba_e432.pdf ("The lawyer shall not allow the lender to control the representation or interfere with the lawyer's independent professional judgment."); N.Y.C. Bar Ass'n, Formal Op. 2011-02 (2011), available at http://www.nycbar.org/ethics/ethics-opinions -local/2011-opinions/1159-formal-opinion-2011-02 ("While a client may agree to permit a financing company to direct the strategy or other aspects of a lawsuit, absent client consent, a lawyer may not permit the company to influence his or her professional judgment in determining the course or strategy of the litigation, including the decisions of whether to settle or the amount to accept in any settlement."). 85

See, e.g., N.Y.C. Bar Ass'n, Formal Op. 2011-02 (2011), available at http://www.nycbar.org/ethics/ethics-opinions-local/2011opinions/1159-formal -opinion-2011-02 (cautioning about conflicts of interest); Me. Prof'l Ethics Comm'n, Op. 191 (2006), available at http://www.maine.gov/tools/whatsnew /index.php?topic=mebar_overseers_ethics_op inions&id=87348&v=article ("The lawyer must be wary of conflicts of interest … ."). Model Rule 1.7 prohibits, absent informed consent, representation if

Theresa Coetzee

Page 11 of 44 47 Wake Forest L. Rev. 1083, *1096 to inform clients about engaging an ALF entity and the various issues surrounding the funder's involvement, such as whether disclosure of information to the funder might waive privilege or work-product protection. 86 Also, ethics opinions caution lawyers not to disclose confidential client information but rather to abide by the lawyer's duty of confidentiality. 87 Model Rule 1.6 requires lawyers to protect "information relating to the representation" unless the client consents to disclosure or if one of the very few specific exceptions apply. 88 Generally, in an ALF setting none of the specific disclosure exceptions apply, so a lawyer must obtain informed client consent for disclosures to funders at any stage of the relationship. 89 At this point in the life of ALF, the champerty doctrine is no longer a significant constraint in many jurisdictions. 90 Usury laws are likewise not a likely regulator of ALF. 91 Lawyer professional [*1097] responsibility rules provide limits on the form of ALF arrangements but do not prohibit such arrangements. 92 Thus, the question of the effect the presence of ALF entities has on the work-product doctrine looms large. III. The Work-Product Doctrine A. A Little History The work-product doctrine was developed in response to an increase in civil discovery made possible by the new Federal Rules of Civil Procedure, which came into effect in the late 1930s. 93 The expanded discovery framework there is a "significant risk" that the lawyer's representation of the client will be "materially limited" by the lawyer's relationship with another such as the ALF entity. Model Rules of Prof'l Conduct R. 1.7 (2012); see also ABA Report, supra note 1, at 15-18 (discussing the conflict issue). 86

See, e.g., N.Y.C. Bar Ass'n, Formal Op. 2011-02 (2011), available at http://www.nycbar.org/ethics/ethics-opinions-local/2011opinions/1159-formal -opinion-2011-02 (stating that a lawyer should provide candid advice and should discuss the potential for waiver of the attorney-client privilege); Me. Prof'l Ethics Comm'n, Op. 191 (2006), available at http://www.maine.gov/tools /whatsnew/index.php?topic=mebar_overseers_ethics _opinions&id=87348&v=article (stating that a client must be advised of potential waiver of privilege); see also Model Rules of Prof'l Conduct R. 1.1 (2012) ("A lawyer shall provide competent representation … ."); Model Rules of Prof'l Conduct R. 2.1 (2012) ("[A] lawyer shall … render candid advice."). 87

See, e.g., N.Y.C. Bar Ass'n, Formal Op. 2011-02 (2011), available at http://www.nycbar.org/ethics/ethics-opinions-local/2011opinions/1159-formal -opinion-2011-02 (noting that client consent is necessary before disclosure); Del. State Bar Ass'n Comm. on Prof'l Ethics, Op. 2006-2 (2006), available at http://www.dsba.org/pdfs/2006-2.pdf (providing that disclosure is allowed only with client consent); Me. Prof'l Ethics Comm'n, Op. 191 (2006), available at http://www.maine.gov/tools/whatsnew/index.php?topic=mebar_overseers _ethics_opinions&id=87348&v=article (stating that client consent is necessary before disclosure); see also ABA Report, supra note 1, at 31-32 (discussing the requirement of informed consent prior to waiver). 88

Model Rule 1.6 allows disclosure absent informed consent only if the disclosure is impliedly authorized or the lawyer believes disclosure is necessary "to prevent reasonably certain death or substantial bodily harm," to prevent or rectify harm to another in certain circumstances, to obtain legal ethics advice, or to comply with other law or an order of a court. Model Rules of Prof'l Conduct R. 1.6 (2012).

89

See N.Y.C. Bar Ass'n, Formal Op. 2011-02 (2011), available at http://www.nycbar.org/ethics/ethics-opinions-local/2011opinions/1159-formal -opinion-2011-02 (stating that client consent is necessary before disclosure); Del. State Bar Ass'n Comm. on Prof'l Ethics, Op. 2006-2 (2006), available at http://www.dsba.org/pdfs/2006-2.pdf (providing that disclosure is allowed only with client consent). 90

See discussion supra Part II.A.

91

See discussion supra Part II.B.

92

See discussion supra Part II.C.

93

See Restatement (Third) of the Law Governing Lawyers, ch. 5, topic 3, intro. note (2000) ("The Federal Rules of Civil Procedure of 1938, with their expansion of pretrial discovery, gave impetus to the work-product doctrine, first in the Supreme

Theresa Coetzee

Page 12 of 44 47 Wake Forest L. Rev. 1083, *1097 of the new rules permitted attorneys to discover much of the opposition's trial preparation because these rules permitted liberal use of depositions, interrogatories, and requests for production of documents. 94 In 1947, the Supreme Court decided Hickman v. Taylor 95 and thus established a federal common law work-product doctrine. B. The Hickman Opinion The Supreme Court, in Hickman v. Taylor, faced the question of the discoverability of interviews with witnesses to a tugboat accident that killed five crewmembers. 96 The attorney for the tugboat owners interviewed witnesses. These interviews resulted in signed, written statements from some witnesses, notes of the attorney regarding interviews with other witnesses, and the attorney's thoughts and impressions formed as a result of the interviews, but which had not been preserved in tangible form. 97 In the resulting litigation, opposing counsel sought access to these materials. 98 Though the materials were arguably within the parameters of allowable discovery provided for in the Federal Rules, the Supreme Court determined that the materials need not be [*1098] produced. 99 In so doing, the Court recognized a qualified immunity from discovery for the work product of attorneys. 100 The Court stated that "all written materials obtained or prepared by an adversary's counsel with an eye toward litigation are necessarily free from discovery in all cases," 101 absent a showing that a denial of production "would unduly prejudice" the plaintiff or cause "hardship or injustice." 102 With such a showing of necessity, discovery of work product in the form of signed written statements from witnesses might be appropriate. 103 The Court indicated that statements of witnesses not yet memorialized in any way should receive additional protection from discovery since any production would, of necessity, be tangled with the attorney's mental impressions. 104 The Court stated, "We do not believe that any showing of necessity can be made under the circumstances of this case so as to justify production." 105 C. Rationale for the Doctrine

Court's 1947 decision in Hickman v. Taylor."); see also Jeff A. Anderson et al., The Work Product Doctrine, 68 Cornell L. Rev. 760, 764-65 (1983) (discussing the history of the work-product doctrine); Michele DeStefano Beardslee, Taking the Business Out of Work Product, 79 Fordham L. Rev. 1869, 1891 (2011) (outlining a brief history of the work-product doctrine). 94

See Anderson et al., supra note 93, at 767 n.46.

95

329 U.S. 495 (1947).

96

Id. at 498-500.

97

Id. at 498, 500; Anderson et al., supra note 93, at 773.

98

Hickman, 329 U.S. at 499.

99

Id. at 510 ("It falls outside the arena of discovery and contravenes the public policy underlying the orderly prosecution and defense of legal claims. Not even the most liberal of discovery theories can justify unwarranted inquiries into the files and the mental impressions of an attorney."). 100

Id.

101

Id. at 511.

102

Id. at 509.

103

Id. at 511.

104

Id. at 512-13.

105

Id. at 512.

Theresa Coetzee

Page 13 of 44 47 Wake Forest L. Rev. 1083, *1098 The Supreme Court's policy basis for its creation of the work-product concept in Hickman was that attorneys should have an assurance of privacy so that they can investigate matters and prepare cases. 106 The Hickman Court stated: It is essential that a lawyer work with a certain degree of privacy, free from unnecessary intrusion by opposing parties and their counsel. Proper preparation of a client's case demands that he assemble information, sift what he considers to be the relevant from the irrelevant facts, prepare his legal theories and plan his strategy without undue and needless interference. That is the historical and the necessary way in which lawyers act within the framework of our system of jurisprudence to promote justice and to protect their clients' interests. This work is reflected, of course, in the interviews, statements, memoranda, correspondence, briefs, mental impressions, personal beliefs, and countless other tangible and intangible ways-aptly though roughly-termed … as the "work product of the lawyer." Were such materials open to opposing [*1099] counsel on mere demand, much of what is now put down in writing would remain unwritten. An attorney's thoughts, heretofore inviolate, would not be his own. Inefficiency, unfairness and sharp practices would inevitably develop in the giving of legal advice and in the preparation of cases for trial. The effect on the legal profession would be demoralizing. And the interests of the clients and the cause of justice would be poorly served. 107 Since the Hickman decision, courts and commentators have agreed that the goal of the doctrine is protecting the "privacy of preparation that is essential to the attorney's adversary role." 108 The system is a competitive one; each side has the responsibility to develop a case, including investigating the matter, researching the law, and preparing the matter for presentation at trial. 109 The working assumption is that "truth emerges from the adversary presentation of information by opposing sides, in which opposing lawyers competitively develop their own sources of factual and legal information." 110 The work-product doctrine eliminates an unfair shortcut to preparation for attorneys who would rather not do the work themselves. 111 It also prevents the system from disincentivizing investigation and preparation by the other attorney. 112 In United States v. American Telephone & Telegraph Co. ("AT&T"), 113 the court captured this focus on encouraging investigation and preparation by attorneys on both sides of a matter: [*1100]

106

Id.

107

Id. at 510-11. Justice Jackson stated, "Discovery was hardly intended to enable a learned profession to perform its functions either without wits or on wits borrowed from the adversary." Id. at 516 (Jackson, J., concurring). See generally Christopher B. Mueller & Laird C. Kirkpatrick, Federal Evidence § 5:37 (3d ed. 2011) (discussing Hickman and the underlying policy). 108

Anderson et al., supra note 93, at 784; see also Beloit Liquidating Trust v. Century Indem. Co., No. 02C50037, 2003 WL 355743, 11 (N.D. Ill. Feb. 13, 2003) ("The purpose of the work product doctrine is to protect the "adversarial process by providing an environment of privacy in which a litigator may creatively develop strategies, legal theories, and mental impressions outside the ordinary liberal realm of federal discovery provisions, thereby insuring that the litigator's opponent is unable to ride on the litigator's wits.'" (quoting Certain Underwriters at Lloyds v. Fid. & Cas. Co. of New York, No. 89C0876, 1997 WL 769467, at 3 (N.D. Ill. Dec. 9, 1997))). 109

Anderson et al., supra note 93, at 784-85.

110

Restatement (Third) of the Law Governing Lawyers § 87 cmt. b (2000).

111

Anderson et al., supra note 93, at 786.

112

See Center Partners, Ltd. v. Growth Head GP, 957 N.E.2d 496, 503 (Ill. Ct. App. 2011) ("The work-product doctrine is designed to protect the right of an attorney to thoroughly prepare his case and to preclude a less diligent adversary attorney from taking undue advantage of the former's efforts."). 113

642 F.2d 1285 (D.C. Cir. 1980).

Theresa Coetzee

Page 14 of 44 47 Wake Forest L. Rev. 1083, *1100 The work product privilege does not exist to protect a confidential relationship, but rather to promote the adversary system by safe-guarding the fruits of an attorney's trial preparations from the discovery attempts of the opponent. The purpose of the work product doctrine is to protect information against opposing parties, rather than against all others outside a particular confidential relationship, in order to encourage effective trial preparation. 114 With regard to the justifying rationale for protecting materials that reveal an attorney's thoughts about a matter, the court in United States v. Adlman 115 stated, "Special treatment for opinion work product is justified because, "at its core, the work-product doctrine shelters the mental processes of the attorney, providing a privileged area within which he can analyze and prepare his client's case.'" 116 D. The Modern Work-Product Doctrine 1. Parameters of the Doctrine In 1970, the work-product doctrine became a part of the Federal Rules of Civil Procedure in Rule 26(b)(3). 117 Today's work-product doctrine is a product of Rule 26(b)(3) as well as the common law that has developed in the wake of Hickman. 118 The doctrine provides qualified protection for materials from disclosure in discovery and at trial. 119 Even if a court determines [*1101] that the work-product doctrine protects material, that material can be discovered upon a showing of "substantial need" and "undue hardship" in gaining the "substantial equivalent of the materials by other means." 120 Federal Rule of Civil Procedure 26(b)(3) protects "documents and tangible things" that are "prepared in the anticipation of litigation or for trial." 121 Though litigation need not be in progress, 122 it must be, as some courts

114

Id. at 1299 (emphasis omitted). The work-product rationale contrasts with the accepted rationale of the attorney-client privilege: to protect and encourage the confidential communications between an attorney and that attorney's client. The theory behind the attorney-client privilege is that protecting the communications will increase the flow of information to the attorney and the attorney can render the best possible legal advice to the client. See Upjohn Co. v. United States, 449 U.S. 383, 390 (1981); see also Grace M. Giesel, End the Experiment: The Attorney-Client Privilege Should Not Protect Communications in the Allied Lawyer Setting, 95 Marq. L. Rev. 475, 492-93 (2012). 115

134 F.3d 1194 (2d Cir. 1998).

116

Id. at 1196 (quoting United States v. Nobles, 422 U.S. 225, 238 (1975)).

117

See Fed. R. Civ. P. 26, advisory committee's note; 48 F.R.D. 487, 499-500 (1970); see also Restatement (Third) of the Law Governing Lawyers, ch. 5, topic 3, intro. note (2000) ("The Federal Rules were extensively amended in 1970 to incorporate Hickman v. Taylor and related common-law decisions."). 118

See, e.g., United States v. Deloitte LLP, 610 F.3d 129, 136 (D.C. Cir. 2010) ("The government mistakenly assumes that Rule 26(b)(3) provides an exhaustive definition of what constitutes work product. On the contrary, Rule 26(b)(3) only partially codifies the work-product doctrine announced in Hickman."); see also Restatement (Third) of the Law Governing Lawyers § 87 (2000). 119

See Nobles, 422 U.S. at 239 (noting that work-product protection does "not disappear once trial has begun").

120

Fed. R. Civ. P. 26(b)(3); see also In re Seagate Tech., LLC, 497 F.3d 1360, 1375 (Fed. Cir. 2007) ("Unlike the attorneyclient privilege, which provides absolute protection from disclosure, work product protection is qualified and may be overcome by need and undue hardship."). 121

Fed. R. Civ. P. 26(b)(3).

122

See In re Vioxx Prods. Liab. Litig., No. MDL1657, 2007 WL 854251, at 3 (E.D. La. Mar. 6, 2007) ("The existence of litigation is not a prerequisite.").

Theresa Coetzee

Page 15 of 44 47 Wake Forest L. Rev. 1083, *1101 state, "fairly foreseeable." 123 As one court has stated, "For a document to meet this standard, the lawyer must at least have had a subjective belief that litigation was a real possibility, and that belief must have been objectively reasonable." 124 Section 87 of the Restatement (Third) of the Law Governing Lawyers states that, to enjoy protection, the material must be prepared "for litigation then in progress or in reasonable anticipation of future litigation." 125 Courts have interpreted litigation to include, of course, judicial proceedings and also negotiations, governmental investigations, grand jury subpoenas, and arbitrations. 126 As for the causal relationship of the materials and the litigation - the "in the anticipation of" 127 requirement - the vast majority of federal courts apply a "because of" test. 128 A minority of federal courts apply a "primary motivating purpose" test. 129 With the "primary motivating purpose" test, the litigation must be the "primary motivating purpose" of the existence of the material [*1102] in question. 130 As the Court of Appeals for the Fifth Circuit stated in United States v. Davis, 131 "Litigation need not necessarily be imminent … as long the primary motivating purpose behind the creation of the document was to aid in possible future litigation." 132 Courts applying the "because of" test ask whether the materials "can fairly be said to have been prepared or obtained because of the prospect of litigation." 133 Some courts also consider whether the materials were created

123

See, e.g., Coastal States Gas Corp. v. Dep't of Energy, 617 F.2d 854, 865 (D.C. Cir. 1980); Resident Advisory Bd. v. Rizzo, 97 F.R.D. 749, 754 (E.D. Pa. 1983). 124

In re Sealed Case, 146 F.3d 881, 884 (D.C. Cir. 1998).

125

Restatement (Third) of the Law Governing Lawyers § 87(1) (2000).

126

See Charles M. Yablon & Steven S. Sparling, United States v. Adlman: Protections for Corporate Work Product?, 64 Brook. L. Rev. 627, 636 (1998). 127

Fed. R. Civ. P. 26(b)(3).

128

See, e.g., United States v. Deloitte LLP, 610 F.3d 129, 137 (D.C. Cir. 2010); Sandra T.E. v. S. Berwyn Sch. Dist. 100, 600 F.3d 612, 622 (7th Cir. 2009); United States v. Roxworthy, 457 F.3d 590, 593 (6th Cir. 2006); In re Grand Jury Subpoena, 357 F.3d 900, 907 (9th Cir. 2004); PepsiCo, Inc. v. Baird, Kurtz & Dobson LLP, 305 F.3d 813, 817 (8th Cir. 2002); Maine v. U.S. Dep't of the Interior, 298 F.3d 60, 68 (1st Cir. 2002); Nat'l Union Fire Ins. Co. v. Murray Sheet Metal Co., 967 F.2d 980, 984 (4th Cir. 1992); In re Grand Jury Proceedings, 604 F.2d. 798, 803 (3d Cir. 1979). See generally Beardslee, supra note 93, at 1903-05 (discussing the courts' reception of the tests). 129

See, e.g., United States v. El Paso Co., 682 F.2d 530, 542 (5th Cir. 1982).

130

See, e.g., United States v. Gulf Oil Corp., 760 F.2d 292, 296 (Temp. Emer. Ct. App. 1985) ("If the primary motivating purpose behind the creation of the document is not to assist in pending or impending litigation, then a finding that the document enjoys work product immunity is not mandated."). 131

636 F.2d 1028 (5th Cir. 1981).

132

Id. at 1040; see also Murphy v. Gorman, 271 F.R.D. 296, 311 (D.N.M. 2010) ("Litigation need not necessarily be imminent as long as the primary motivating purpose behind the creation of the document was to aid in possible future litigation."). 133

This language originates in Wright and Miller's federal practice treatise. 8 Charles Alan Wright et al., Federal Practice and Procedure § 2024 (3d ed. 2010). For a sampling of cases using this language, see United States v. Richey, 632 F.3d 559, 568 (9th Cir. 2011); Bickler v. Senior Lifestyle Corp., 266 F.R.D. 379, 383 (D. Ariz. 2010).

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Page 16 of 44 47 Wake Forest L. Rev. 1083, *1102 in the ordinary course of business. 134 The courts are not uniform in the value that they give the ordinary course of business factor. Some courts apply work-product protection even if the materials would have been created in the ordinary course of business unless the materials would have been created "in essentially similar form irrespective of the litigation." 135 For example, in United States v. Adlman, the court stated, "Where a document was created because of anticipated litigation, and would not have been prepared in substantially similar form but [*1103] for the prospect of that litigation, it falls within Rule 26(b)(3)." 136 The Adlman court clarified its stance by stating, "The fact that a document's purpose is business-related appears irrelevant to the question whether it should be protected under Rule 26(b)(3)." 137 Similarly, the court in United States v. Deloitte LLP 138 noted that "material generated in anticipation of litigation may also be used for ordinary business purposes without losing its protected status." 139 The Deloitte court clarified, "In short, a document can contain protected work-product material even though it serves multiple purposes, so long as the protected material was prepared because of the prospect of litigation." 140 Courts following this approach thus apply work-product protection if one of the motivations for the creation of the material is the anticipation of litigation. 141 Some courts use the ordinary business concept as a disqualifier of work-product protection. These courts take the stance that even if materials were created in part in the anticipation of litigation, those materials are not protected if

134

See, e.g., Sandra T.E. v. S. Berwyn Sch. Dist. 100, 600 F.3d 612, 622 (7th Cir. 2009) ("There is a distinction between precautionary documents "developed in the ordinary course of business' for the "remote chance of litigation' and documents prepared because "some articulable claim, likely to lead to litigation [has] arisen.' Only documents prepared in the latter circumstances receive work-product protection." (citations omitted)); Sullivan v. Warminster Twp., 274 F.R.D. 147, 152 (E.D. Pa. 2011) ("Documents prepared in the regular course of business rather than for purposes of the litigation are not eligible for workproduct protection, even if the prospect of litigation exists." (citing Wright et al., supra note 133)). 135

See, e.g., United States v. Adlman, 134 F.3d 1194, 1202 (2d Cir. 1998) ("The "because of' formulation that we adopt here withholds protection from documents that are prepared in the ordinary course of business or that would have been created in essentially similar form irrespective of the litigation."); see also Beardslee, supra note 93, at 1905 (discussing the lack of protection for materials prepared in the ordinary course of business, even if the work would be "helpful" if litigation were to ensue); Thomas Wilson, Note, The Work Product Doctrine: Why Have an Ordinary Course of Business Exception?, 1988 Colum. Bus. L. Rev. 587, 604 (1988) (discussing the implications of not applying work-product protection to documents prepared in the ordinary course of business). 136

Adlman, 134 F.3d at 1195; see also United States v. Deloitte LLP, 610 F.3d 129, 138 (D.C. Cir. 2010) (quoting Adlman, 134 F.3d at 1195); In re Grand Jury Subpoena, 357 F.3d 900, 908 (9th Cir. 2004) (quoting Adlman, 134 F.3d at 1195); Marciano v. Atlantic Med. Specialties, Inc., No. 08-CV-305-JTC, 2011 WL 294487, at 2 (W.D.N.Y. Jan. 27, 2011) (quoting Adlman, 134 F.3d at 1195). 137

Adlman, 134 F.3d at 1200.

138

Deloitte, 610 F.3d 129.

139

Id. at 138.

140

Id.

141

See, e.g., United States v. Richey, 632 F.3d 559, 568 (9th Cir. 2011) ("In applying the "because of' standard, courts must consider the totality of the circumstances and determine whether the "document was created because of anticipated litigation, and would not have been created in substantially similar form but for the prospect of litigation.'" (quoting In re Grand Jury Subpoena, 357 F.3d 900, 908 (9th Cir. 2004))).

Theresa Coetzee

Page 17 of 44 47 Wake Forest L. Rev. 1083, *1103 they, in addition, were created in the ordinary course of business. 142 This position has received criticism for adding an exception to the rule that is not contained in the rule's own language. 143 [*1104] Some courts state that they are applying the "because of" standard but do so in a more exacting manner.

For example, in In re Grand Jury Subpoena, 144 the district court applied the "because of" test and noted that the materials' creation need not be "primarily" motivated by the possibility of litigation. 145 The court continued by stating, however, that litigation must be an important motivating factor. 146 Similarly, in United States v. Textron Inc., 147 the Court of Appeals for the First Circuit seemed to create a modified "because of" test. The Textron court appeared to require that the materials be "prepared for use in possible litigation." 148 Requiring that the materials be prepared for use in litigation is a "much more exacting standard" 149 than requiring that the materials be prepared "because of" litigation. 150 According to Rule 26(b)(3) of the Federal Rules of Civil Procedure, materials are protected if they are prepared by or for a party or a "representative" of a party. 151 "Representative" includes an "attorney, consultant, surety,

142

See, e.g., Sullivan v. Warminster Twp., 274 F.R.D. 147, 152 (E.D. Pa. 2011) ("Documents prepared in the regular course of business rather than for purposes of the litigation are not eligible for work-product protection, even if the prospect of litigation exists."). 143

See Anderson et al., supra note 93, at 852-55 (discussing the exception and concluding that "the exception upsets the effective operation of rule 26(b)(3)"); see also Fontaine v. Sunflower Beef Carrier, Inc., 87 F.R.D. 89, 92 (E.D. Mo. 1980) (stating that the exception "twists the language of the Rule"). This more limited focus on the ordinary course of business may have originated in a comment by the Advisory Committee when the 1970 version of Rule 26 of the Federal Rules of Civil Procedure was in consideration. The comment was that "materials assembled in the ordinary course of business … are not under the qualified immunity provided by" the rule. See Proposed Amendments to the Fed. R. Civ. P. Relating to Discovery, 48 F.R.D. 487, 501 (1970). 144

44.In re Grand Jury,220 F.R.D. 130.

145

Id. at 146.

146

Id. at 162.

147

577 F.3d 21 (1st Cir. 2009).

148

Id. at 27.

149

United States v. Deloitte LLP, 610 F.3d 129, 138 (D.C. Cir. 2010) (discussing the difference between the traditional "because of" test and the test applied in Textron). 150

Judge Torruella, in his dissent in Textron, states:

The majority purports to follow [the "because of"] test, but never even cites it. Rather, in its place, the majority imposes a "prepared for" test, asking if the documents were "prepared for use in possible litigation." This test is an even narrower variant of the widely rejected "primary motivating purpose" test used in the Fifth Circuit and specifically repudiated by this court. In adopting its test, the majority ignores a tome of precedents from the circuit courts and contravenes much of the principles underlying the work-product doctrine. It also brushes aside the actual text of Rule 26(b)(3), which "nowhere … states that a document must have been prepared to aid in the conduct of litigation in order to constitute work product." Further, the majority misrepresents and ignores the findings of the district court. All while purporting to do just the opposite of what it actually does. Textron, 577 F.3d at 32 (Torruella, J., dissenting) (citations omitted). 151

Fed. R. Civ. P. 26(b)(3)(A).

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Page 18 of 44 47 Wake Forest L. Rev. 1083, *1104 indemnitor, insurer, or agent." working independently. 153

152

Courts apply the doctrine even if a nonlawyer created the materials while

[*1105] Courts have taken special care to protect opinion work product. 154 Rule 26(b)(3)(B) states, "If the court

orders discovery of [work product] materials, it must protect against disclosure of the mental impressions, conclusions, opinion, or legal theories of a party's attorney or other representative concerning the litigation." 155 Some courts, therefore, have required a more substantial showing of need and hardship to overcome the workproduct doctrine protection for this type of work product. 156 Other courts may not require disclosure regardless of the showing of need. 157 Opinion and ordinary work product can be found in tangible or intangible form. Rule 26(b)(3) states that workproduct protection applies to "documents and tangible things," 158 but courts recognize that the work-product doctrine also protects intangibles, such as "the memory of the attorney (or agents of the attorney or the client) as to oral statements by eyewitnesses that were not transcribed or recorded and the attorney's "mental impressions' and thoughts about the case and the underlying legal principles and issues." 159 [*1106]

2. Waiver

152

Id.; see also Mueller & Kirkpatrick, supra note 107.

153

See, e.g., Caremark, Inc. v. Affiliated Computer Servs., Inc., 195 F.R.D. 610, 615 (N.D. Ill. 2000) ("Materials prepared in anticipation of litigation by any representative of the client are protected, regardless of whether the representative is acting for the lawyer."). 154

See Restatement (Third) of the Law Governing Lawyers § 87(2) (2000) ("Opinion work product consists of the opinions or mental impressions of a lawyer."); see also In re Doe, 662 F.2d 1073, 1076 n.2 (4th Cir. 1981) ("[Ordinary work product is] those documents prepared by the attorney which do not contain the mental impressions, conclusions or opinions of the attorney. "Opinion work product' is work product that contains those fruits of the attorney's mental processes."); Mueller & Kirkpatrick, supra note 107, § 5:38. 155

Fed. R. Civ. P. 26(b)(3)(B).

156

See, e.g., Upjohn Co. v. United States, 449 U.S. 383, 401-02 (1981) (holding that attorney notes are not always protected, but a "far stronger showing of necessity and unavailability" is required to obtain disclosure); In re Seagate Tech., LLC, 497 F.3d 1360, 1375 (Fed. Cir. 2007) ("Whereas factual work product can be discovered solely upon a showing of substantial need and undue hardship, mental process work product is afforded even greater, nearly absolute, protection."). The Restatement (Third) of the Law Governing Lawyers states that opinion work product is immune from disclosure unless "extraordinary circumstances justify disclosure." Restatement (Third) of the Law Governing Lawyers § 89 (2000). 157

See, e.g., In re Columbia/HCA Healthcare Corp. Billing Practices Litig., 293 F.3d 289, 294 (6th Cir. 2002) ("Absent waiver, a party may not obtain the "opinion' work product of his adversary."); Duplan Corp. v. Moulinage et Retorderie de Chavanoz, 509 F.2d 730, 734 (4th Cir. 1974) ("In our view, no showing of relevance, substantial need or undue hardship should justify compelled disclosure of an attorney's mental impressions, conclusions, opinions or legal theories."). 158

Fed. R. Civ. P. 26(b)(3)(A).

159

Mueller & Kirkpatrick, supra note 107. The Hickman opinion itself dealt with this kind of work product. See supra Part III.B (discussing Hickman); see also In re Cendant Corp. Sec. Litig., 343 F.3d 658, 662 (3d Cir. 2003) ("It is clear from Hickman that work product protection extends to both tangible and intangible work product."); In re Grand Jury Subpoena Dated Nov. 8, 1979, 622 F.2d 933, 935 (6th Cir. 1980) (noting that the work-product doctrine applies to "tangible and intangible material which reflects an attorney's efforts at investigating and preparing a case"). The Restatement includes intangible material in the definition of work product. Restatement (Third) of the Law Governing Lawyers § 87(1) (2000) ("Work product consists of tangible material or its intangible equivalent in unwritten or oral form.").

Theresa Coetzee

Page 19 of 44 47 Wake Forest L. Rev. 1083, *1106 Sharing work product with third parties does not generally waive the doctrine's protection because the doctrine does not, unlike the attorney-client privilege, demand confidentiality. 160 The attorney-client privilege demands confidentiality because the privilege exists to encourage communications between attorney and client that would not occur absent confidentiality. 161 If a party discloses a communication, otherwise privileged, to an outsider to the attorney-client relationship, then that party has indicated that confidentiality is not a motivator for that communication and so no privilege is necessary. 162 Likewise, the attorney-client privilege does not apply in the first instance if an outsider to the attorney-client relationship is present when the communication occurs. 163 The rationale of the work-product doctrine is quite different; thus the standard for waiver is quite different as well. As the Court [*1107] of Appeals for the First Circuit stated in United States v. Massachusetts Institute of Technology, 164 "The attorney client privilege is designed to protect confidentiality, so that any disclosure outside the magic circle is inconsistent with the privilege; by contrast, work-product protection is provided against "adversaries,' so only disclosing material in a way inconsistent with keeping it from an adversary waives work-product protection." 165

Disclosure can waive work-product protection if the client or lawyer or a representative of either discloses the materials voluntarily to the adversary or discloses the materials in a way that "substantially increases the opportunities for potential adversaries to obtain the information." 166 The Restatement states that waiver occurs if

160

See United States v. Deloitte LLP, 610 F.3d 129, 139 (D.C. Cir. 2010) ("While voluntary disclosure waives the attorney-client privilege, it does not necessarily waive work-product protection."); United States v. Mass. Inst. of Tech., 129 F.3d 681, 687 (1st Cir. 1997) ("Nonetheless, the cases approach uniformity in implying that work-product protection is not as easily waived as the attorney-client privilege. The privilege, it is said, is designed to protect confidentiality, so that any disclosure outside the magic circle is inconsistent with the privilege; by contrast, work product protection is provided against "adversaries' so only disclosing material in a way inconsistent with keeping it from an adversary waives work product protection."). 161

See Upjohn, 449 U.S. at 389 ("[The] purpose [of the privilege] is to encourage full and frank communication between attorneys and their clients and thereby promote broader public interests in the observance of law and the administration of justice. The privilege recognizes that sound legal advice or advocacy serves public ends and that such advice or advocacy depends upon the lawyer's being fully informed by the client."). 162

For a discussion of the confidentiality requirement for the attorney-client privilege, see generally Melanie B. Leslie, The Costs of Confidentiality and the Purpose of the Privilege, 2000 Wis. L. Rev. 31 (2000); Paul R. Rice, A Bad Idea Dying Hard: A Reply to Professor Leslie's Defense of the Indefensible, 2001 Wis. L. Rev. 187 (2001); Paul R. Rice, Attorney-Client Privilege: The Eroding Concept of Confidentiality Should be Abolished, 47 Duke L.J. 853 (1998). 163

See In re Chevron Corp., 650 F.3d 276, 289 (3d Cir. 2011) (""If persons other than the client, its attorney, or their agents are present, the communication is not made in confidence, and the privilege does not attach.' Here, the communications captured on film clearly were not made "in confidence' due to the presence of the filmmakers at the time of the communications, and so the protections of the attorney-client privilege never attached to those communications." (quoting In re Teleglobe Commc'ns Corp., 493 F.3d 345, 359 (3d Cir. 2007))). 164

64.129 F.3d 681 (1st Cir. 1997).

165

Id. at 687; see also Westinghouse Elec. Corp. v. Republic of the Phil., 951 F.2d 1414, 1428 (3d Cir. 1991) ("As we have explained, the attorney-client privilege promotes the attorney-client relationship, and, indirectly, the functioning of our legal system, by protecting the confidentiality of communications between clients and their attorneys. In contrast, the work-product doctrine promotes the adversary system directly by protecting the confidentiality of papers prepared by or on behalf of attorneys in anticipation of litigation. Protecting attorneys' work product promotes the adversary system by enabling attorneys to prepare cases without fear that their work product will be used against their clients."). 166 Wright

et al., supra note 133; see also In re Chevron Corp., 633 F.3d 153, 165 (3d Cir. 2011) ("It is only in cases in which the material is disclosed in a manner inconsistent with keeping it from an adversary that the work-product doctrine is waived.");

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Page 20 of 44 47 Wake Forest L. Rev. 1083, *1107 the lawyer or client or a representative of either "discloses the material to third persons in circumstances in which there is a significant likelihood that an adversary or potential adversary in anticipated litigation will obtain it." 167 In determining whether a disclosure constitutes a waiver, courts have taken a variety of paths. 168 A common approach is for a court to ask whether the party disclosed the materials under circumstances "inconsistent with the maintenance of secrecy from the disclosing party's adversary." 169 If the disclosure is "inconsistent with the maintenance of secrecy," the disclosure waives work-product protection. 170 [*1108] In United States v. Deloitte LLP, the court explained that this ""maintenance of secrecy' standard" requires that materials not be disclosed to any adversary or potential adversary or a conduit to an adversary. 171 If "the disclosing party had a reasonable basis for believing that the recipient would keep the disclosed material confidential," the Deloitte court stated that the recipient was not a conduit to an adversary. 172

The Deloitte court explained that such a reasonable expectation of confidentiality can be present in two situations. First, a reasonable expectation of confidentiality can be present when the disclosing party and receiving party share "common litigation interests." 173 The logical presumption is that parties who share "common litigation interests" are not likely to make disclosures to adversaries. 174 The Deloitte court continued that the second way a disclosing party might have a reasonable expectation of confidentiality is if the disclosing party and the receiving party have a relatively unqualified confidentiality agreement or a similar arrangement. 175 While the situation before the Deloitte court did not present a confidentiality

United States v. AT&T, 642 F.2d 1285, 1299 (D.C. Cir. 1980) ("A disclosure made in the pursuit of such trial preparation, and not inconsistent with maintaining secrecy against opponents, should be allowed without waiver of the privilege."). 167

Restatement (Third) of the Law Governing Lawyers § 91(4) (2000).

168

See Dale G. Wills, Note, Waiver of the Work Product Immunity, 1981 U. Ill. L. Rev. 953, 965-66 (1981) (noting various approaches used). 169

AT&T, 642 F.2d at 1299.

170

Id. ("A disclosure made in the pursuit of such trial preparation, and not inconsistent with maintaining secrecy against opponents, should be allowed without waiver of the privilege."); see also Monarch Fire Prot. Dist. of St. Louis Cnty. v. Freedom Consulting & Auditing Servs., No. 4:08CV01424ERW, 2009 WL 2155158, at 2 (E.D. Mo. July 16, 2009) ("The work product doctrine will protect opinion work product that has been disclosed to third parties "unless disclosure is inconsistent with maintaining secrecy from possible adversaries.'" (quoting Stix Prods. Inc. v. United Merchs. & Mfrs., 47 F.R.D. 334, 338 (S.D.N.Y. 1969))). 171

United States v. Deloitte LLP, 610 F.3d 129, 140-41 (D.C. Cir. 2010). The court was careful to note that the test is not whether a party might be a potential adversary in any litigation but whether the party might be an adversary with respect to the materials disclosed. Id. at 140. 172

Id. at 141.

173

Id.; see also In re Subpoenas Duces Tecum, 738 F.2d 1367, 1372 (D.C. Cir. 1984) (noting that common interest might be the basis for an expectation of confidentiality). 174

See Deloitte, 610 F.3d at 141 (""The existence of common interest between transferor and transferee is relevant to deciding whether the disclosure is consistent with the nature of the work product privilege.' … This is true because when common litigation interests are present, "the transferee is not at all likely to disclose the work product material to the adversary.'" (quoting AT&T, 642 F.2d at 1299)). 175

See id. ("Alternately, a reasonable expectation of confidentiality may be rooted in a confidentiality agreement or similar arrangement between the disclosing party and the recipient. Nevertheless, a confidentiality agreement must be relatively strong and sufficiently unqualified to avoid waiver.").

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Page 21 of 44 47 Wake Forest L. Rev. 1083, *1108 agreement, the court found that a reasonable expectation of confidentiality existed because the audited entity disclosed materials protected by the work-product doctrine to independent auditors who were ethically obligated under the Code of [*1109] Professional Conduct of the American Institute of Certified Public Accountants "to refrain from disclosing client information." 176 The court in Schanfield v. Sojitz Corp. 177 undertook a similar analysis. In Schanfield, a party disclosed material protected by the work-product doctrine to employees of the adversary. The adversary had also employed the disclosing party. 178 The court noted that "it is simply common sense … that such material will reach others within the corporation." 179 The court found no common interest, defining common interest as a "demonstrated cooperation in formulating a common legal strategy." 180 In addition, the court observed that the party disclosed the materials to employees who were not bound by confidentiality agreements. 181 While the disclosing party may have thought the employees would not disclose to the employer, the adversary, the court concluded that the disclosing party had not provided proof that he reasonably expected the materials to remain confidential. 182 The disclosing party in Schanfield also shared materials protected by the work-product doctrine with three family members. 183 The court found no waiver from these disclosures, stating that the disclosures "did not significantly increase the likelihood that [the employer adversary] would obtain private information by sharing." 184 With regard to the relatives, the court found neither a common interest nor an actual confidentiality agreement. 185 The court did not apply a formalistic analysis but rather looked to the ultimate question of whether the likelihood that the adversary would access the materials had been "significantly increased." 186 Evidently, the court concluded that the disclosure to relatives had not substantially increased the likelihood that the [*1110] adversary would access the information. 187 Disclosure to a relative was the equivalent to disclosing to someone who was bound by a confidentiality agreement. 188

176

Id. at 142. Rule 301.01 of the American Institute of Certified Public Accountants Code of Professional Conduct states: "A member in public practice shall not disclose any confidential client information without the specific consent of the client." Code of Prof'l Conduct § 301.01 (Am. Inst. of Certified Pub. Accountants 1992), available at http://www.aicpa.org/Research/Standards /CodeofConduct/Pages/et_300.aspx#et_301; see alsoSEC v. Vitesse Semiconductor Corp., 771 F. Supp. 2d 310, 313 (S.D.N.Y. 2011) (noting that a finding of a common interest or the finding of a nonwaiver agreement may stymy any claim of waiver). 177

258 F.R.D. 211 (S.D.N.Y. 2009).

178

Id. at 212.

179

Id. at 215.

180

Id. at 216 (quoting Bank Brussels Lambert v. Credit Lyonnais (Suisse) S.A., 160 F.R.D. 437, 447 (S.D.N.Y. 1995)).

181

Id.

182

Id. at 215-16.

183

Id. at 216.

184

Id.

185

See id. at 216-17.

186

Id. at 216.

187

See id. at 216-17.

188

Compare id. at 216-17 (holding that Schanfield did not waive work-product protection by "sharing [the] materials with his two sisters and another close relative"), with id. at 216 (implying that Schanfield's case for work-product protection would be stronger if "he had a prior confidentiality agreement with [the people to whom he disclosed the emails at issue]").

Theresa Coetzee

Page 22 of 44 47 Wake Forest L. Rev. 1083, *1110 Some courts, in determining whether a party's disclosure has waived the work-product doctrine, go no further than the common interest analysis. 189 This is perfectly logical; these courts have no need to go further in the analysis because once a court finds a common interest, the court concludes that there has been no waiver. 190 As the Deloitte and Schanfield courts have recognized, however, lack of a common interest does not make the recipient of materials an adversary or one likely to pass materials to an adversary. 191 A problematic aspect of any focus on a common interest is that there is no useful definition of that term for purposes of the work-product doctrine. Just as the Schanfield court did, other courts dealing with the question of waiver of the work-product doctrine have looked to the definition of common interest as the concept has developed in attorneyclient privilege jurisprudence. 192 Unfortunately, courts have struggled with defining and applying the [*1111] concept in determining waiver in the attorney-client privilege context, 193 so its usefulness in the work-product context is questionable. In the attorney-client privilege context, the courts are not in agreement about many aspects of the doctrine but especially do not agree as to what, exactly, constitutes a common interest. For example, some courts require "an identical legal interest with respect to the subject matter of a communication." 194 One court requires "a common legal interest, not merely a common commercial interest" and further defines that interest to be present "where "the parties have been, or may potentially become, co-parties to a litigation … or have formed a coordinated legal strategy.'" 195 Another court requires only a common interest about a legal matter. 196 As the court in Miller v.

189

See, e.g., Trs. of Elec. Workers Local No. 26 Pension Trust Fund v. Trust Fund Advisors, Inc., 266 F.R.D. 1, 15 (D.D.C. 2010) ("Disclosure to a person who shares a common interest with the party claiming the privilege cannot therefore work a forfeiture."); Lectrolarm Custom Sys., Inc. v. Pelco Sales, Inc., 212 F.R.D. 567, 572 (E.D. Cal. 2002) (concluding that an insured and an insurer share a common interest so there is no waiver of the attorney-client privilege or the work-product doctrine). 190

See, e.g., Lectrolarm, 212 F.R.D. at 572 ("The Court finds that the common-interest doctrine applies to protect at least those communications between Pelco and Fireman's Fund relating to the claims and defenses in the underlying lawsuit. As to these communications, there is a commonality of interest and the attorney client privilege and the attorney work privilege are not waived by the disclosure to Fireman's Fund."). 191

See United States v. Deloitte LLP, 610 F.3d 129, 140-41 (D.C. Cir. 2010); Schanfield, 258 F.R.D. at 216; see also Trs. of Elec. Workers Local No. 26 Pension Trust Fund, 266 F.R.D. at 14-15 ("The disclosure instead must be to a party who is an adversary or does not have a common interest with the party claiming the privilege."). 192

See, e.g., Frontier Ref., Inc. v. Gorman-Rupp Co., 136 F.3d 695, 705 (10th Cir. 1998) (expressing doubt as to whether the common-interest doctrine applied but finding that, under the standard of common interest applicable to the attorney-client privilege, no shared interest existed); Pulse Eng'g, Inc. v. Mascon, Inc., No. 08cv0595 JM (AJB), 2009 WL 3234177, at 3 (S.D. Cal. Oct. 2, 2009) (applying the common interest concept applicable to the attorney-client privilege to work-product doctrine). 193

See Trs. of Elec. Workers Local No. 26 Pension Trust Fund, 266 F.R.D. at 15 ("There is no clear uniformity in the case law "as to when parties share a common interest and how that interest is to be defined.'" (quoting Miller v. Holzmann, 240 F.R.D. 20, 22-23 (D.D.C. 2007))); Katherine Traylor Schaffzin, An Uncertain Privilege: Why the Common-Interest Doctrine Does Not Work and How Uniformity Can Fix It, 15 B.U. Pub. Int'l L.J. 49, 51-53 (2009) (discussing the doctrine generally). 194

See, e.g., Duplan Corp. v. Deering Milliken, Inc., 397 F. Supp. 1146, 1172 (D.S.C. 1974) ("A community of interest exists among different persons or separate corporations where they have an identical legal interest with respect to the subject matter of a communication between an attorney and a client concerning legal advice… . The key consideration is that the nature of the interest be identical, not similar, and be legal, not solely commercial."). 195

See Fox News Network, LLC v. U.S. Dep't of the Treasury, 739 F. Supp. 2d 515, 563 (S.D.N.Y. 2010) (quoting In re Subpoena Duces Tecum Served on N.Y. Marine & Gen. Ins. Co., No. M 8-85 (MHD), 1997 WL 599399, at 4 (S.D.N.Y. Sept. 26, 1997)). 196

See United States v. Schwimmer, 892 F.2d 237, 243 (2d Cir. 1989).

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Page 23 of 44 47 Wake Forest L. Rev. 1083, *1111 Holzman 197 noted, "It is impossible to conclude that the common law, as interpreted in this and other jurisdictions, provides a clear explanation of what a common interest is." 198 The common-interest concept in work-product jurisprudence should simply be a shortcut to determining whether the disclosure "substantially increased the opportunities for potential adversaries to obtain the information," 199 or was "not inconsistent with maintaining secrecy against opponents," 200 or whether "the disclosing party had a reasonable basis for believing that the recipient" of the materials "would keep the disclosed material [*1112] confidential." 201 Narrow definitions of common interest, developed by courts determining whether the attorneyclient privilege applies to communications between parties and their separate attorneys, 202 are of questionable usefulness. [*1113]

IV. The Scant Case Law Regarding the Work-Product Doctrine and Alternative Litigation Finance

197

Miller, 240 F.R.D. 20.

198

Id. at 22; see also George S. Mahaffey, Jr., Taking Aim at the Hydra: Why the "Allied Party Doctrine" Should Not Apply in Qui Tam Cases When the Government Declines to Intervene, 23 Rev. Litig. 629, 656 (2004); Schaffzin, supra note 193. 199

Wright et al., supra note 133.

200

United States v. AT&T, 642 F.2d 1285, 1299 (D.C. Cir. 1980).

201

United States v. Deloitte LLP, 610 F.3d 129, 141 (D.C. Cir. 2010).

202

In the attorney-client privilege context, the common-interest concept has been used by modern courts as a way of determining whether to apply privilege protection to communications in situations involving parties not represented by the same attorney but who claim that they should be treated as if they shared an attorney. This expanded application of the privilege was first used by the Virginia Supreme Court in Chahoon v. Commonwealth, 62 Va. (21 Gratt.) 822, 839-40 (1871). The court did not find a waiver of the privilege when communications were shared with attorneys who represented other defendants but not the defendant who was a party to the communication. Id. Modern courts often find a communication occurring or shared outside an attorney-client relationship - a communication that historically would waive the privilege or would not be privileged in the first instance - is privileged and retains that status if the disclosure involves parties or attorneys of parties who share a common interest. See, e.g., United States v. Gonzalez, 669 F.3d 974, 981 (9th Cir. 2012) (discussing how privilege may apply to communications between defendants and their attorneys); Hunton & Williams v. U.S. Dep't of Justice, 590 F.3d 272, 277-78 (4th Cir. 2010) (noting that privilege applied to communications between parties and attorneys); see also In re Teleglobe Commc'ns Corp., 493 F.3d 345, 364 (3d Cir. 2007) (discussing the doctrine in general). See generally Giesel, supra note 114 (discussing the doctrine in the attorney-client privilege context). This context and the use of the common interest in this context are conceptually distant from the work-product waiver analysis. This setting of attorney-client privilege application has many names - common-interest doctrine, joint-defense privilege, community of interest doctrine, allied-party doctrine, and others. See, e.g., Hunton & Williams, 590 F.3d at 274 (common-interest doctrine); In re United States, 590 F.3d 1305, 1310 (Fed. Cir. 2009) (community of interest doctrine), rev'd sub nom. United States v. Jicarilla Apache Nation, 131 S. Ct. 2313 (2011); United States v. Austin, 416 F.3d 1016, 1019 (9th Cir. 2005) (jointdefense privilege); Mass. Eye & Ear Infirmary v. QLT Phototherapeutics, Inc., 412 F.3d 215, 225 (1st Cir. 2005) (commoninterest exception); see also Lugosch v. Congel, 219 F.R.D. 220, 236 (N.D.N.Y. 2003) ("This joint defense privilege has many monikers such as the common-interest doctrine, common interest arrangement doctrine, or pooled information doctrine."). Historically, the attorney-client privilege has always been recognized as applying to communications among a group comprised of joint clients of one attorney. By definition, those parties have a common interest that is evident from the fact that the parties chose to be represented by the same counsel and that counsel agrees to represent the parties jointly. The communications to which the privilege applies are truly communications between attorney and clients. See, e.g., Whiting v. Barney, 38 Barb. 393, 397 (N.Y. Gen. Term 1862) (holding joint clients' communications with counsel were privileged), rev'd, 30 N.Y. 330 (1864).

Theresa Coetzee

Page 24 of 44 47 Wake Forest L. Rev. 1083, *1113 To date, only one reported court decision has addressed the application of the work-product doctrine to an ALF scenario. In Mondis Technology, Ltd. v. LG Electronics, Inc., 203 after a group of potential investors agreed to keep any disclosed information confidential, a company provided the investors with slide presentations and other documents that disclosed litigation strategies and estimates of litigation costs and recoveries. 204 The company sought to interest investors in the endeavor of the company and fund the company's efforts to "license and litigate its various patent programs." 205 In later litigation involving a subsidiary of the company, the litigation adversary sought access to all information shared with the investors. The subsidiary claimed work-product protection and attorney-client privilege. 206 In finding that the work-product doctrine protected the shared materials, the district court stated: "The documents were at a minimum created for possible future litigation… . All of the documents were prepared … with the intention of coordinating potential investors to aid in future possible litigation." 207 The Mondis court concluded that the materials were created "in anticipation of litigation" even though the court applied the more stringent minority test that "the primary motivating purpose" for the creation must be ""to aid in possible future litigation.'" 208 In finding that the disclosure of the documents did not waive that work-product protection, the court stated that the documents "were disclosed subject to nondisclosure agreements and thus did not substantially increase the likelihood that an adversary would come into possession of the materials." 209 Other courts facing the same question in a similar ALF context should reach similar results. The issue of the application of the work-product doctrine to an ALF setting was also present in Bray & Gillespie Management LLC v. Lexington Insurance Co. 210 In that case, Bray & Gillespie ("B&G") [*1114] shared materials with Juridica, an ALF entity, in an attempt to interest Juridica in investing in a litigation matter. 211 Juridica entered into a confidentiality agreement with B&G but ultimately passed on the investment opportunity. 212 The opposing party in the litigation sought disclosure of the materials shared with Juridica. 213 The court overruled any instructions or objections based on the work-product doctrine because the party seeking the protection of the doctrine did not follow the court's proper procedure for asserting protection by the doctrine. 214 The opinion's lack of substantive analysis means that the opinion is of little help in applying the work-product doctrine to the litigation finance context, though the facts of the case provide a real-life example of how the questions of work-product protection and waiver can arise with the involvement of ALF entities. V. Lessons from Independent Auditor Cases

203

Nos. 2:07-CV-565-TJW-CE, 2:08-CV-478-TJW, 2011 WL 1714304 (E.D. Tex. May 4, 2011).

204

Id. at 2.

205

Id.

206

Id.

207

Id. at 3.

208

Id. at 2 (quoting In re Kaiser Aluminum & Chem. Co., 214 F.3d 586, 593 (5th Cir. 2000)).

209

Id. at 3. The court, having resolved the disclosure issue with the work-product doctrine, declined to discuss the application of the attorney-client privilege. Id.

210

No. 6:07-cv-222-Orl-35KRS, 2008 WL 5054695, at 1 (M.D. Fla. Nov. 17, 2008).

211

Id.

212

Id. at 2.

213

Id. at 1.

214

Id. at 4. The court's required procedure, contained in a Standing Order of the court, required the facts supporting the assertion of protection to be stated on the record at the time of the objection or instruction to the witness. The court was of the opinion that the party asserting work-product doctrine protection had failed to follow this mandatory procedure. Id.

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Page 25 of 44 47 Wake Forest L. Rev. 1083, *1114 A. Why the Independent Auditor Cases Are Helpful While case law dealing with the work-product doctrine in the ALF context is meager, a substantial body of case law dealing with the work-product doctrine in the independent auditor setting exists. The independent auditor cases provide an excellent basis for determining the proper application of the work-product doctrine to the ALF situation because similar issues arise with regard to application of the doctrine in each context. In both settings, the attorney and client team may be asked to create materials that evaluate a litigation matter. 215 In addition, in both contexts the attorney and client team may be asked to share evaluative or other materials created for other reasons relating to a litigation matter. 216 Such materials might be prepared by the party, by the party's lawyer or other agent, or by the third party in the form of the auditor or the ALF entity. 217 Additionally, in both contexts, one must determine whether the work-product doctrine protects such materials as an initial matter. 218 In both contexts, one must [*1115] determine whether sharing materials protected by the doctrine with the third-party auditor or ALF entity waives the protection. 219 The courts' treatment of these issues when the third party is an independent auditor is, therefore, extremely instructive of the treatment courts might give the same issues when the third party is an ALF entity. B. What Is an Independent Auditor? The law applicable to publicly traded companies requires that financial information relating to litigation and other actual or potential liabilities be reviewed by auditors who are completely independent of the audited companies. 220 This information must then be reported to the Securities and Exchange Commission ("SEC"). 221 A rule of the entity overseeing the audit process states that the auditing "public accounting firm and its associated persons must be independent of the firm's audit client throughout the audit and professional engagement period." 222 In addition, the American Institute of Certified Public Accountants ("AICPA") emphasizes the [*1116] requirement of

215

See supra Part III.D.1; see also Bray & Gillespie, 2008 WL 5054695, at 1-2.

216

See supra Part IV.

217

See supra Part III.D.1.

218

See supra Introduction.

219

See supra Part III.D.2.

220

See W.R. Koprowski et al., Financial Statement Reporting of Pending Litigation: Attorneys, Auditors, and Differences of Opinions, 15 Fordham J. Corp. & Fin. Law 439, 439, 442 (2010). 221

See, e.g., 15 U.S.C. § 78l(b)(1)(J) (2006) (requiring audited financial statements to be filed with the SEC before a company can be listed on an exchange); Id. § 78m (requiring periodic reports to be filed with the SEC). These financial statements must be audited in accordance with Generally Accepted Auditing Standards. See Definitions of Terms Used in Regulation S-X, 17 C.F.R. § 210.1-02(d) (2012) (requiring financial statements to be audited "in accordance with generally accepted auditing standards"). The Generally Accepted Auditing Standards require auditors, who must be Certified Public Accountants ("CPAs"), to review the company's financial and related information to ensure that the financial statements filed with the SEC are prepared in conformity with Generally Accepted Accounting Principles. See Codification of Accounting Standards and Procedures, Statement of Auditing Standards No. 1, § 110.01 (Am. Inst. of Certified Pub. Accountants 1972). See generally Aaron J. Rigby, The Attorney-Auditor Relationship: Responding to Audit Inquiries, the Disclosure of Loss Contingencies and the Work-Product Privilege, 35 No. 3 Sec. Reg. L.J. 1 (2007) (discussing the auditor's task). The Generally Accepted Accounting Principles have been the financial accounting principles that govern the preparation of financial statements since 1972. See Statement of Policy on the Establishment and Improvement of Accounting Principles and Standards, SEC Release No. AS-150, 1973 WL 149263, at 2 (Dec. 20, 1973). 222

Professional Standards Rule 3520, Pub. Co. Accounting Oversight Bd., available at http://pcaobus.org/Rules/PCAOBRules/Documents/Section _3.pdf. The Sarbanes-Oxley Act emphasized the importance of the independence of the auditors in this process by establishing the Public Company Accounting Oversight Board to provide better oversight of public accounting firms performing audits. See15 U.S.C. § 7211 (2006).

Theresa Coetzee

Page 26 of 44 47 Wake Forest L. Rev. 1083, *1116 independence by stating that "a member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services." 223 In performing an audit in accord with all relevant standards and principles, an independent auditor must have access to information relating to current and potential liabilities that could have an impact on the company's financial situation. For example, in the tax realm, Generally Accepted Accounting Principles mandate that a company record adequately account for liabilities in situations in which the company is espousing an uncertain tax position. 224 The company must note questionable positions, set a liability prediction, and then record a tax reserve on the company's financial statements based upon the liability prediction. 225 The calculations, assumptions, and conclusions regarding the tax positions are usually contained in tax accrual workpapers and related documents. 226 Such documents may be prepared by accountants and, perhaps, by attorneys in the company or external to the company and are shared with the auditor. Some materials may be prepared to further elucidate the tax positions in the course of the audit. These materials may be prepared by the company, its representatives, or the auditor. [*1117] Another type of information auditors must review relates to accounting for potential adversities in litigation of all sorts. Accounting standards require certain disclosures and statements of potential losses regarding pending or potential litigation. 227 The auditor must review any evidence about the uncertainty of the occurrence of potential litigation-related loss or its amount. 228 Auditors obtain this information from the company but also rely on attorneys representing the company to provide the appropriate factual and evaluative information about pending litigation along with as-yet unasserted, but probable, claims. 229 In particular, the auditor asks attorneys representing the company to describe and evaluate pending or threatened litigation, the progress of the case to date, the likelihood of an unfavorable outcome, and to estimate, if possible, the amount or range of the potential loss. 230

223

Code of Prof'l Conduct § 55 (Am. Inst. of Certified Pub. Accountants 1992), available at http://www.aicpa.org/Research/Standards/CodeofConduct /Pages/et_55.aspx. In United States v. Arthur Young & Co., the Supreme Court stated that a company's auditors and accountants "assume[] a public responsibility transcending any employment relationship with the client."465 U.S. 805, 817 (1984). The law requires that the audit committee of a company oversee the work of the public accountants, but the auditors "owe[] ultimate allegiance to the corporation's creditors and stockholders, as well as the investing public… . This "public watchdog' function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust." Id. at 818. The independent auditor's goal is to issue an unqualified opinion "finding that the company's financial statements fairly present the financial position of the company, the results of its operations, and the changes in its financial position for the period under audit, in conformity with consistently applied generally accepted accounting principles." Id. at 818 n.13. 224

See Accounting for Uncertainty in Income Taxes, Interpretation No. 48 (Fin. Accounting Standards Bd. 2006) (codified at FASB Codification § 740-10-25-16 (FASB 2009)).

225

Id. P 6. The company must determine that it is more likely than not that the tax position will prevail. If so, the company must set aside a reserve related to the possibility of success. Id.; see also Tracy Hamilton, Work Product Privilege: The Future of Tax Accrual Work Paper Discovery in the Eleventh Circuit After Textron, 27 Ga. St. U. L. Rev. 729, 732 (2011). 226

See, e.g., United States v. Textron Inc., 577 F.3d 21, 22-23 (1st Cir. 2009); see also Hamilton, supra note 225, at 729-30.

227

A company must accrue potential losses from pending litigation. See Accounting for Contingencies, Statement of Fin. Accounting Standards No. 5, at 4-6 (Fin. Accounting Standards Bd. 1975); see also Koprowski et al., supra note 220, at 442 (discussing pending litigation reporting).

228

See Inquiry of a Client's Lawyer Concerning Litigation, Claims and Assessments, Statement on Auditing Standards No. 12, § 337 (Am. Inst. of Certified Pub. Accountants 1972). 229

Id. The auditors must ask the company to send its attorneys a "letter of [audit] inquiry." Id. § 337.06. This letter "is the primary means of obtaining corroborating evidence of information furnished by management concerning litigation." Id. § 337.08.

230

See id. § 337.09(d)(1)-(2). Since 1975, the American Bar Association has had a Statement of Policy Regarding Lawyers' Responses to Auditors' Requests for Information. See generally American Bar Association, Statement of Policy Regarding

Theresa Coetzee

Page 27 of 44 47 Wake Forest L. Rev. 1083, *1117 This regulatory framework results in the independent auditor being in a similar situation to that of an ALF entity. An independent auditor is the recipient of evaluative and other materials that the work-product doctrine otherwise protects as well as, perhaps, materials specifically created in the audit. An ALF can be the recipient of evaluative and other materials that the work-product doctrine otherwise protects as well as, perhaps, materials specifically created in the ALF setting. [*1118]

VI. Does the Work-Product Doctrine Protect Materials That Evaluate Litigation? A. Materials Created by the Party or an Agent of the Party In either the initial investment investigation stage or in the later monitoring stage, the ALF entity may require the attorney and client team to create materials that critically evaluate the matter and assess the risk. In addition, the funder may ask the party and attorney team to supply it with materials, created in another context, that evaluate the matter. In the audit context, most courts in recent years have determined that the work-product doctrine protects materials that critically evaluate litigation whether or not the materials were prepared specifically for the audit process or, rather, were prepared in other pursuit of the litigation. 231 A few courts have disagreed. 232 1. Evaluative Materials Prepared in the Audit Process or in Other Contexts Are or May Be Protected The work-product doctrine and particularly Federal Rule of Civil Procedure 26(b)(3) protect materials prepared "in the anticipation of litigation." 233 Many courts addressing the issue have determined that evaluative materials prepared in the audit setting or other contexts are prepared, at least in part, because of the threat or reality of litigation and thus are protected by the work-product doctrine. 234 Many courts have determined that the doctrine protects the materials even though they may have a business purpose in being a part of the SEC disclosure process. 235 For example, in United States v. Adlman, the Court of Appeals for the Second Circuit established that the workproduct doctrine might apply to a study prepared for an attorney assessing the likely result of litigation. 236 The attorney had the study done so a decision could be reached as to whether the company should complete the transaction that would cause the litigation; the study was not created as part of the audit process. 237 The court determined that the work-product doctrine protected the study if it "was created because of anticipated litigation, Lawyers' Responses to Auditors' Requests for Information, 31 Bus. Law. 1709 (1976). The focus of this aspirational, but not mandatory, Statement of Policy is on limiting disclosure to auditors so as not to eliminate attorney-client privilege and workproduct doctrine protections. The tension between the auditor's need to have access to evaluative information from the attorneys and the attorneys' desire to limit disclosure that might harm their clients has perhaps increased in recent years in the wake of the Sarbanes-Oxley Act. See generally Rigby, supra note 221 (discussing the Statement of Policy). 231

See infra Part VI.A.1.

232

See infra Part VI.A.2.

233

Fed. R. Civ. P. 26(b)(3); see also discussion supra Part III.D.1.

234

See, e.g., United States v. Adlman, 134 F.3d 1194, 1196-98 (2d Cir. 1998); Vacco v. Harrah's Operating Co., No. 1:07-CV0663, 2008 WL 4793719, at 4-5 (N.D.N.Y. Oct. 29, 2008); Lawrence E. Jaffe Pension Plan v. Household Int'l, Inc., 237 F.R.D. 176, 178-79 (N.D. Ill. 2006). 235

See, e.g., Adlman, 134 F.3d at 1197-98.

236

Id. at 1201.

237

Id. at 1195.

Theresa Coetzee

Page 28 of 44 47 Wake Forest L. Rev. 1083, *1118 and would not have been prepared [*1119] in substantially similar form but for the prospect of that litigation." The court remanded for application of this test. 239

238

Similarly, in Lawrence E. Jaffe Pension Plan v. Household International, Inc., 240 the court determined that the doctrine protected letters summarizing threatened and pending litigation created in the audit process even though the letters were part of the company's compliance with SEC regulations. 241 The court reasoned that if there was no litigation and no threat of it, there would have been no need for the letters discussing such. Thus, the letters were prepared ""because of' pending or threatened litigation." 242 In Tronitech, Inc. v. NCR Corp., 243 the court held that the work-product doctrine protected an audit-response letter, prepared by counsel, which evaluated a litigation matter. 244 The court stated: An audit letter is not prepared in the ordinary course of business but rather arises only in the event of litigation. It is prepared because of the litigation, and it is comprised of the sum total of the attorney's conclusions and legal theories concerning that litigation. Consequently, it should be protected by the work-product privilege. 245 In Vacco v. Harrah's Operating Co., 246 the materials in question were reports prepared by the company at the request of the auditors that discussed pending litigation. 247 The court determined that the work-product doctrine protected the materials. 248 Likewise, in [*1120] Merrill Lynch & Co. v. Allegheny Energy, Inc., 249 the company created two reports evaluating litigation in an internal investigation and shared the reports with the company's independent auditor. 250 The court found that the documents were, without doubt, protected by the work-product doctrine. 251

238

Id.

239

Id. at 1203-04.

240

237 F.R.D. 176 (N.D. Ill. 2006).

241

Id. at 181.

242

243 244

Id. 108 F.R.D. 655 (S.D. Ind. 1985). Id.

245

Id. at 656. A California appellate court reached a similar conclusion in a case involving a lawyer's response to an audit inquiry relating to the client's insurer's auditor. In Laguna Beach County Water District, 22 Cal. Rptr. 3d 387 (Cal. Ct. App. 2004), the plaintiff sued the Water District for negligent construction of a reservoir. Id. The plaintiff sought to obtain materials, including the Water District's attorney's audit response, from the public entity charged with insuring the Water District. Id. The materials dealt with the potential liability related to the construction of the reservoir. Id. at 389. The court stated that the audit response was clearly protected by the work-product doctrine. Id. at 392. In response to the argument that there can be no work-product protection because the auditor was performing a public function, the court stated that the "conclusion has no basis in law or logic." Id. The court continued that the fact that the auditor was performing a public function "does not mean it would divulge protected information." Id. 246

No. 1:07-CV-0663, 2008 WL 4793719 (N.D.N.Y. Oct. 29, 2008).

247

Id. at 1.

248

Id. at 8.

249

229 F.R.D. 441 (S.D.N.Y. 2004).

250

Id. at 444.

Theresa Coetzee

Page 29 of 44 47 Wake Forest L. Rev. 1083, *1120 In Frank Betz Associates, Inc. v. Jim Walter Homes, Inc., 252 the court found that the doctrine protected materials containing litigation reserve amounts. 253 The court quoted language from other cases stating that the reserve amount reflected an attorney's professional opinion and noted testimony to the effect that the reserve was created in the anticipation of litigation. 254 Even when applying the minority "primary motivating purpose" test, as opposed to the more lenient "because of" test, 255 courts find evaluative materials protected by the work-product doctrine. The court in Southern Scrap Material Co. v. Fleming 256 determined that the doctrine protected audit response letters prepared by an attorney and provided to an independent auditor. 257 The documents were prepared because of litigation and not in the ordinary course of business 258 and reflected the attorney's "mental impressions, opinions, and litigation strategy." 259 In In re Pfizer Inc. Securities Litigation, 260 the court applied the "primary motivating purpose" test and concluded "that the primary motivating purpose behind the communications concerning individual case reserves was preparation for litigation." 261 [*1121] The district court in In re Raytheon Securities Litigation 262 did not go so far as to state that the work-

product doctrine protects all materials prepared by counsel for use in the audit and shared with the independent auditor. 263 The court carved out a set of materials that would not enjoy the protection of the doctrine. The court stated that the work-product doctrine does not protect information in audit-opinion letters and other documents prepared by counsel if the information "must be disclosed in the public financial statements of the company being

251

Id. at 445.

252

226 F.R.D. 533 (D.S.C. 2005).

253

Id. at 535.

254

Id. at 534; see also Gramm v. Horsehead Indus., Inc., No. 87CIV.512(MJL), 1990 WL 142404, at 2 (S.D.N.Y. Jan. 25, 1990) (applying the work-product doctrine to materials that discussed settlement discussions regarding a claim against it). 255 256 257

See supra Part III.D.1. No. 01-2554, 2003 WL 21474516 (E.D. La. June 18, 2003). Id. at 9.

258

Id. ("An audit letter is not prepared in the ordinary course of business but rather arises only in the event of litigation. It is prepared because of the litigation, and it is comprised of the sum total of the attorney's conclusions and legal theories concerning that litigation. Consequently, it should be protected by the work product privilege.").

259

260

Id. No. 90 Civ. 1260 (SS), 1993 WL 561125 (S.D.N.Y. 1993).

261

Id. at 4. The court clarified that aggregates of reserves are not protected by the work-product doctrine; they have only a business purpose. Id.; see also Simon v. G.D. Searle & Co., 816 F.2d 397, 401 (8th Cir. 1987) ("The individual case reserve figures reveal the mental impressions, thoughts, and conclusions of an attorney in evaluating a legal claim. By their very nature they are prepared in anticipation of litigation and, consequently, they are protected from discovery as opinion work product."); In re Honeywell Int'l, Inc. Secs. Litig., 230 F.R.D. 293, 300 (S.D.N.Y. 2003) (applying the work-product doctrine to documents created and/or produced in the audit process); Gutter v. E.I. DuPont de Nemours & Co., No. 95-CV-2152, 1998 WL 2017926, at 1 (S.D. Fla. May 18, 1998) (noting that materials dealing with liability reserves are protected by the work-product doctrine "because they reflect an attorney's professional opinion about the value of a particular lawsuit"). 262

218 F.R.D. 354 (D. Mass. 2003).

263

Id. at 358-59.

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Page 30 of 44 47 Wake Forest L. Rev. 1083, *1121 audited." 264 In the Raytheon matter, the court requested that the materials be produced for an in camera review so that the court could determine whether they were the kind of materials that would be, eventually, disclosed in public financial statements and thus not deserving of the protection of the doctrine. 265 2. Evaluative Materials Are Not Protected Not all courts agree that the work-product doctrine protects materials that critically evaluate existing or potential litigation. All of these cases are suspect, however, because they do not apply, in the traditional manner, the majority "because of" test for determining when material is prepared "in the anticipation of litigation" and therefore is protected by the doctrine. 266 Perhaps the most significant denial of work-product protection is United States v. Textron Inc. 267 In Textron, the Court of Appeals for the First Circuit, en banc, refused to find that the work-product doctrine applied to tax accrual work papers prepared by Textron's employees and others and shared with auditors. 268 These work papers dealt with the accounting of reserves for contingent tax liabilities. 269 The Internal Revenue Service ("IRS") sought these documents as well as documents prepared by Textron's independent auditor relating to the same matters. 270 All of the documents had [*1122] the "immediate purpose … to establish and support the tax reserve figures for the audited financial statements." 271 The court determined that the work-product doctrine did not protect these materials because they were not documents that were prepared "in the anticipation of litigation." 272 For the doctrine to protect the materials, the court required that the materials be prepared for use in litigation, not simply "in the anticipation of litigation" as determined by the "because of" test. 273 Noting that the doctrine does not protect materials prepared "in the ordinary course of business, or pursuant to public requirements unrelated to litigation, or for other nonlitigation purposes," 274 the court surmised that "[a] set of tax reserve figures, calculated for purposes of accurately stating a company's financial figures, has in ordinary parlance only that purpose: to support a financial statement and the independent audit of it." 275 Thus, the court denied that the work-product doctrine protected the materials. 276

264

Id. at 359.

265

Id.

266

See supra Part III.D.1.

267

577 F.3d 21 (1st Cir. 2009).

268

Id. at 26.

269

Id. at 23.

270

Id. at 24.

271

Id. at 25.

272

Id. at 31-32.

273

See id. at 27 ("The district judge did not say that the work papers were prepared for use in possible litigation - only that the reserves would cover liabilities that might be determined in litigation"); id. at 30 ("But many of the debatable cases affording work product protection involve documents unquestionably prepared for potential use in litigation if and when it should arise. There is no evidence in this case that the work papers were prepared for such a use or would in fact serve any useful purpose for Textron in conducting litigation if it arose."); id. ("It is only work done in anticipation of or for trial that is protected."); see also discussion supra Part III.D.1. 274

Id. (quoting Fed. R. Civ. P. 26, advisory committee's note (1970)).

275

Id.

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Page 31 of 44 47 Wake Forest L. Rev. 1083, *1122 Other cases in which courts have denied application of the work-product doctrine hail from the 1980s, and the courts clearly did not apply the "because of" test. 277 For example, in Independent Petrochemical Corp. v. Aetna Casualty & Surety Co., 278 the question before the court was whether the work-product doctrine applied to letters from the attorney for the company to the company's independent auditor. 279 The court held that the letters were not in anticipation of litigation but rather were "prepared to assist [the accountants] in the performance of regular accounting work done by such accounting firms." 280 The court continued by noting that "the motivating purpose behind the creation of the document is thus of [*1123] critical importance." 281 These letters were for "accountingbusiness purposes and not for litigation purposes." 282 The court's analysis makes clear that the court is willing to apply the work-product doctrine only if litigation is the primary motivating purpose. Likewise, in In re Diasonics Securities Litigation, 283 the court evaluated the application of the work-product doctrine to materials, some of which assessed litigation as part of an independent audit. 284 The court refused protection because "the documents were generated for the business purpose of creating financial statements which would satisfy the requirements of the federal securities laws and not to assist in litigation." 285 In United States v. Gulf Oil Corp., 286 the court applied the "primary motivating purpose" test and determined that the work-product doctrine did not protect materials discussing and evaluating litigation prepared by or for the auditors. 287 The court took the view that the materials were not created to assist in litigation; rather they were created so the auditor could "prepare financial reports which would satisfy the requirements of the federal securities laws." 288 The court stated, "We hold that these documents do not constitute attorney work product because they were created primarily for the business purpose of compiling financial statements which would satisfy the requirements of the federal securities laws." 289 Similarly, in United States v. El Paso Co., 290 the Court of Appeals for the Fifth Circuit refused to apply the workproduct doctrine to tax accrual work papers. 291 Adopting the "primary motivating purpose" test, 292 the court

276

Id. at 31.

277

See, e.g., United States v. Gulf Oil Corp., 760 F.2d 292, 296 (Temp. Emer. Ct. App. 1985); Indep. Petrochemical Corp. v. Aetna Cas. & Sur. Co., 117 F.R.D. 292, 298 (D.D.C. 1987); In re Diasonics Secs. Litig., No. C-83-4584-RFP, 1986 WL 53402, at 1 (N.D. Cal. June 15, 1986). 278

Indep. Petrochemical Corp., 117 F.R.D. 292.

279

Id. at 293.

280

Id. at 298.

281

Id.

282

Id.

283

No. C-83-4584-RFP (FW), 1986 WL 53402 (N.D. Cal. June 15, 1986).

284

Id. at 1.

285

Id.

286

760 F.2d 292 (Temp. Emer. Ct. App. 1985).

287

Id. at 296.

288

Id. at 297.

289

290

Id. 682 F.2d 530 (5th Cir. 1982).

Theresa Coetzee

Page 32 of 44 47 Wake Forest L. Rev. 1083, *1123 concluded that the "primary motivating purpose" of the tax pool analysis is to "anticipate, for financial reporting purposes, what the impact of litigation might be on the company's tax liability." 293 In the court's view, El Paso created the tax pool analysis "with an eye on its business needs, not on its legal ones." 294 Thus, the court concluded, "the tax pool [*1124] analysis does not contemplate litigation in the sense required to bring it within the work-product doctrine." 295 B. Materials Created by the Litigation Finance Entity An ALF entity might create materials itself that speak to the litigation and its benefits and burdens. A funder might do this as part of a study of a potential investment or in monitoring an existing investment. Because these materials likely reflect information from the attorney and client team and may include an attorney's thoughts and impressions about litigation theory and strategy, these materials might be a fertile source of information for an adversary if such materials enjoy no work-product protection. The work-product doctrine appears not to protect materials prepared by the ALF entity unless the entity is a representative of the party. 296 Crafting an argument that the ALF entity is a representative of the party would be a difficult task indeed. Thus, materials prepared by a litigation funder would appear to have no work-product protection. The doctrine, however, protects a lawyer's mental impressions. 297 It seems illogical that work-product protection would be withheld from this type of information, the very type of information the doctrine is designed to protect, simply because the creator of the tangible material containing the information is not a representative of the party. A few courts have addressed the question of whether the work-product doctrine applies to documents created by an independent auditor. 298 In United States v. Deloitte LLP, Deloitte, the independent auditor of Dow Chemical Company, prepared a document summarizing a meeting in which the possibility of litigation and the accounting reserve requirements for such litigation were discussed. 299 The government claimed that the memorandum created by the auditor could not enjoy work-product protection because the auditor created it and the auditor was not a representative of the company. 300 The government also claimed that the memorandum could not enjoy work-product protection because the auditor created it as part of the audit process, and thus the auditor did not create it "in the anticipation of litigation." 301

291

Id. at 542.

292

Id. (quoting United States v. Davis, 636 F.2d 1028, 1040 (5th Cir. 1981)).

293

Id. at 543.

294

Id.

295

Id.

296

See Fed. R. Civ. P. 26(b)(3). The rule defines "representative" of a party as "attorney, consultant, surety, indemnitor, insurer, or agent." Id. 297

Id.; see also discussion supra Part III.D.1.

298

See generally, e.g., United States v. Arthur Young & Co., 465 U.S. 805 (1984); United States v. Deloitte LLP, 610 F.3d 129 (D.C. Cir. 2010). 299

Deloitte, 610 F.3d at 133.

300

Id. at 135.

301

Id. at 136.

Theresa Coetzee

Page 33 of 44 47 Wake Forest L. Rev. 1083, *1124 [*1125] The court acknowledged that, if the auditor was not a representative of the company, the protection of Rule 26(b)(3) did not apply. 302 Yet, the court did not see the auditor's possible lack of representative status as determinative of the applicability of the work-product doctrine. 303 The court reasoned that, because the workproduct doctrine also protects an attorney's mental impressions, if the auditor's memo contained the "thoughts and opinions of counsel developed in anticipation of litigation," the memo could be protected work product. 304

In response to the argument that the auditor prepared the memo in the course of the audit and not "in the anticipation of litigation," the court treated the document as it would all other materials prepared by a party or a party's counsel. The court applied the majority "because of" test 305 and noted that "the question is whether [the document] records information prepared by Dow or its representatives because of the prospect of litigation." 306 The court focused not solely on the function of the document, which might be to facilitate an audit, but also on the content of the document. 307 A document might be used for ordinary business purposes and yet also be protected by the work-product doctrine. 308 The court remanded for a determination of whether the document might contain material not protected along with the protected information. 309 The Supreme Court, in United States v. Arthur Young & Co., 310 also evaluated auditor-created materials. The IRS sought access to a company's tax accrual work papers dealing with contingent tax liabilities prepared by the company's independent auditor. 311 The Court held that no independent work-product protection existed for independent auditors and grounded this position in the public role of auditors: By certifying the public reports that collectively depict a corporation's financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public [*1126] accountant performing this special function owes ultimate allegiance to the corporation's creditors and stockholders, as well as to investing public. This "public watchdog' function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust. To insulate from disclosure a certified public accountant's interpretations of the client's financial statements would be to ignore the significance of the accountant's role as a disinterested analyst charged with public obligations. 312 While the Court in this opinion made clear that no auditor work-product privilege exists, it did not address the issue of whether a document prepared by an auditor that contains an attorney's thoughts and opinions about potential litigation may enjoy general work-product protection. 313

302

Id.

303

Id.

304

Id.

305

Id.

306 307

Id. at 137. Id.

308

Id. at 138 ("Under the more lenient "because of' test, material generated in anticipation of litigation may also be used for ordinary business purposes without losing its protected status."). 309

Id. at 139.

310

465 U.S. 805 (1984).

311

Id. at 808.

312

Id. at 817-18.

313

See id. at 815-19.

Theresa Coetzee

Page 34 of 44 47 Wake Forest L. Rev. 1083, *1126 C. Implications for Alternative Litigation Finance Analysis of this body of case law relating to auditors suggests that courts are likely to conclude that the workproduct doctrine protects evaluative materials. This is true even if those materials are created in the ALF setting and even if the funder creates the materials. The only court opinion addressing the question of whether the work-product doctrine protects materials created in the ALF context has concluded that the doctrine protects such materials. In Mondis Technology, Ltd. v. LG Electronics, Inc., 314 the district court concluded that the work-product doctrine applied, as an initial matter, to materials created for and shared with potential investors who would potentially fund litigation because "those documents were at a minimum created for possible future litigation." 315 Most courts facing the issue of whether the work-product doctrine protects the materials will apply the majority "because of" test to determine whether the materials were created "in the anticipation of litigation" and are therefore worthy of protection. 316 Those courts likely will follow the lead of Mondis and the many independent auditor cases of recent years 317 (cases decided in a very [*1127] similar context) and find that the doctrine protects materials created by the attorney and client team that evaluate existing or future litigation. The "because of" test does not require that litigation be the only motivating reason for the materials' creation; it must be a cause - not the only cause and not the most important cause. 318 Courts applying the "because of" test will likely conclude that the materials "can fairly be said to have been prepared or obtained because of the prospect of litigation." 319 Without doubt, these materials were "created because of anticipated litigation, and would not have been prepared in substantially similar form but for the prospect of that litigation." 320 In the audit setting, courts have found that materials were created "in the anticipation of litigation" even though they were also created to comply with audit procedures mandated by the SEC. 321 Likewise, courts will likely find materials created in the ALF setting to be created "in the anticipation of litigation" even though they were also created to obtain funding or to continue to cooperate with the ALF entity who has already invested in the matter. Indeed, the preparation of the materials in the ALF setting has an even tighter nexus to the litigation than is true in the audit setting. In the audit setting, the audit and all the materials required for it occur because an SEC regulatory framework requires it. 322 In the ALF setting, the materials are created so that the litigation can progress. The causal connection exists and is close. 323

314

No. 2:07-CV-565-TJW-CE, 2011 WL 1714304 (E.D. Tex. May 4, 2011).

315

Id. at 3.

316

Beardslee, supra note 93, at 1903 ("The majority of [federal appellate courts] apply the "because of test.'").

317

See, e.g., United States v. Adlman, 134 F.3d 1194, 1200 (2d Cir. 1998); Vacco v. Harrah's Operating Co., No. 1:07-CV-0663, 2008 WL 4793719, at 6 (N.D.N.Y. Oct. 29, 2008); Lawrence E. Jaffe Pension Plan v. Household Int'l, Inc., 237 F.R.D. 176, 18081 (N.D. Ill. 2006); In re Honeywell Int'l, Inc. Sec. Litig., 230 F.R.D. 293, 300 (S.D.N.Y. 2003). 318

See supra text accompanying notes 144-45.

319

Wright et al., supra note 133; see also United States v. Richey, 632 F.3d 559, 568 (9th Cir. 2011); Bicker v. Senior Lifestyle Corp., 266 F.R.D. 379, 383 (D. Ariz. 2010). 320

Adlman, 134 F.3d at 1195 (stating a version of the "because of" test).

321

See, e.g., Lawrence E. Jaffe, 237 F.R.D. at 181.

322

See supra note 221.

323

See Mondis Tech., Ltd. v. LG Elecs., Inc., No. 2:07-CV-565-TJW-CE, 2011 WL 1714304, at 3 (E.D. Tex. May 4, 2011) (recognizing the connection between materials prepared for possible ALF investors and "future possible litigation").

Theresa Coetzee

Page 35 of 44 47 Wake Forest L. Rev. 1083, *1127 While courts like the court in In re Raytheon Securities Litigation may be concerned that work-product protection not extend to information that must be disclosed as part of a company's public securities disclosure obligation, 324 such courts will not have a similar concern in the ALF context. Any disclosure made by the attorney and client team in an ALF setting is not a part of any regulatory scheme such as the securities laws. An ALF entity or an attorney and client team has no disclosure obligation akin to that imposed on entities by securities laws. Some courts, such as those in the Independent Petrochemical, Gulf Oil, and El Paso cases, have not applied the doctrine in the [*1128] analogous situation of independent auditors. 325 Courts dealing with the question of application of the work-product doctrine in the ALF setting are not likely to find these opinions precedential because, in these cases, the courts did not use the majority "because of" test for whether the materials were created "in the anticipation of litigation." In contrast, these courts required litigation to be the "primary motivating purpose" for the creation of the materials. As the Mondis case illustrates, 326 however, even a court applying the "primary motivating purpose" test can find that materials created in the ALF context are materials created primarily because of litigation since those documents would not be created absent litigation. Similarly, courts evaluating the application of the work-product doctrine to the ALF setting will not likely follow the approach of the court in In re Diasonics Securities Litigation. 327 That court appeared to use a test that does not allow the work-product doctrine to apply if a motivation for the creation of the material was an ordinary course of business motivation. 328 Even if a court were inclined to follow the approach of Diasonics, such a court might well determine that materials created in an ALF setting were not created in the ordinary course of business since the funding motive is integrally tied to the underlying litigation or threat of it. The court in Textron also applied a test that has not been a part of the mainstream of work-product doctrine, a test requiring that the materials be "prepared for use in possible litigation." 329 Thus, it is unlikely courts for which Textron is not precedential will follow it. Even for courts that follow it, a claim of work-product protection for materials created in an ALF setting would be more doubtful but would not necessarily fail. The Textron court stated that the doctrine should not apply to materials prepared "in the ordinary course of business, or pursuant to public requirements unrelated to litigation, or for nonlitigation purposes." 330 For materials specifically prepared for the ALF entity, there is an argument that the materials are prepared for nonlitigation purposes because the materials are for funding, not instrumental pursuit of the claim or defense, and certainly not "for use" in litigation. Of course, there is a strong argument that the materials, though on a micro level, for funding, are, in a macro sense, in pursuit of the claim or defense that requires the financing. [*1129] The fact that materials might be created by ALF entities may not be a bar to work-product protection. These

materials can reflect the mental impressions, thoughts, and opinions of the lawyer for the party whose litigation matter the funder is evaluating. While an ALF entity has its own powers of evaluation, the funder must base its evaluation upon materials conveyed by the lawyer and client team. As the Deloitte opinion suggests, work-product

324

In re Raytheon Sec. Litig., 218 F.R.D. 354, 359 (D. Mass. 2003).

325

See id. at 358.

326

See supra Part IV.

327 328

No. C-83-4584-RFP, 1986 WL 53402 (N.D. Cal. June 15, 1986). Id. at 1.

329

United States v. Textron Inc., 577 F.3d 21, 27 (1st Cir. 2009).

330

Id. at 30 (quoting Fed. R. Civ. P. 26, advisory committee's note (1970)).

Theresa Coetzee

Page 36 of 44 47 Wake Forest L. Rev. 1083, *1129 protection may be available for portions of the materials relating to the lawyer's impressions. opinion does not contradict this application of the doctrine. 332

331

The Arthur Young

VII. Does Disclosure to Alternative Litigation Finance Entities Waive Work-Product Doctrine Protection? In both the audit setting and in the ALF setting, the lawyer and client team shares materials with a third party to the litigation, the auditor or the ALF entity. 333 If a court determines that the work-product doctrine applies to materials in the first instance, the next issue that must be addressed is whether sharing the materials with the auditor or the ALF entity waives the work-product protection already enjoyed by the materials. 334 The courts' analysis of the waiver question in independent auditor cases focuses on the policy behind the doctrine: protecting the adversary process and system. 335 Consistent with this policy, courts generally find no waiver if disclosure does not increase the likelihood that the materials will find their way to an adversary. 336 Similar analysis and similar results should occur in the ALF setting. A. Disclosure to an Auditor Does Not Waive Protection Most courts that have dealt with the issue have found that independent auditors are not adversaries of the companies the auditors audit in the work-product doctrine sense of that term. 337 The courts also have held that disclosure to auditors does not otherwise increase the likelihood that adversaries will have access [*1130] to the materials disclosed. 338 The courts recognize that the auditors are, in fact, independent. 339 The courts additionally note that the job of the auditor is to critically analyze the financial information regarding the company and to insure that an accurate picture of the financial state of the company is reported to the public. 340 The courts further recognize that the auditor has a professional obligation to the company to keep information disclosed to the auditor confidential. 341 The courts thus recognize that the auditor and the company may not have universally unified interests. but that fact does not mean that disclosure to auditors increases the likelihood of adversary access. 342 Thus, waiver does not result from disclosure to auditors.

331

See United States v. Deloitte LLP, 610 F.3d 129, 138 (D.C. Cir. 2010).

332

See United States v. Arthur Young & Co., 465 U.S. 805, 817, 819 n.15 (1984).

333

See, e.g., Deloitte, 610 F.3d at 133; Merrill Lynch & Co. v. Allegheny Energy, Inc., 229 F.R.D. 441, 444 (S.D.N.Y. 2004).

334

See, e.g., Merrill Lynch, 229 F.R.D. at 445 (determining that the court must answer the question of whether the work-product privilege was waived after the parties agreed the doctrine applied to the documents in question). 335

336

Deloitte, 610 F.3d at 139-40. See, e.g., id. at 143; Merrill Lynch, 229 F.R.D. at 449.

337

Deloitte, 610 F.3d at 139 ("No circuit has addressed whether disclosing work product to an independent auditor constitutes waiver. Among the district courts that have addressed this issue, most have found no waiver."). 338

Merrill Lynch, 229 F.R.D. at 447.

339

See, e.g., id. (emphasizing the independence of auditors and referring to the Sarbanes-Oxley Act, which recognized the independence of auditors).

340

Id.

341

See, e.g., Deloitte, 610 F.3d at 142; Merrill Lynch, 229 F.R.D. at 448.

342

See Deloitte, 610 F.3d at 142 (holding that, even though Deloitte did not share common litigation interests with Dow, Deloitte was an unlikely conduit to leak protected documents due to ethical obligations); Merrill Lynch, 229 F.R.D. at 447-48 (finding that

Theresa Coetzee

Page 37 of 44 47 Wake Forest L. Rev. 1083, *1130 An example of recent treatment of the waiver issue in the audit context is United States v. Deloitte LLP, in which the Dow Chemical Company disclosed materials to its independent auditor that related to a tax dispute with the government. 343 Dow disclosed these materials, materials protected by the work-product doctrine, to the auditor so the auditor could "review the adequacy of Dow's contingency reserves for" certain transactions. 344 In addressing the waiver issue, the Deloitte court stated that waiver occurs if the disclosure is "inconsistent with the maintenance of secrecy from the disclosing party's adversary." 345 According to the court, waiver can occur through disclosure to an adversary or to a "conduit to an adversary." 346 The Deloitte court concluded that the auditor was not the adversary or potential adversary of the company because Deloitte could not "be Dow's adversary in the sort of litigation the Dow Documents address." 347 In addition, the court concluded that the auditor was not a "conduit to Dow's adversaries." 348 The Deloitte court looked to [*1131] "whether the disclosing party had a reasonable basis for believing that the recipient would keep the disclosed material confidential." 349 Such a belief, said the Deloitte court, can be present if the discloser and the recipient share "common litigation interests." 350 The court added that such a belief can also originate in "a confidentiality agreement or similar arrangement." 351 The court was of the opinion that disclosure of work-product protected materials to the auditor was consistent with the "maintenance of secrecy" because Dow had a reasonable basis for believing that the auditor would keep the disclosed material confidential. 352 This reasonable basis was grounded in the fact that the auditor had an ethical and professional obligation to keep material revealed in an audit confidential. 353 Many other courts have agreed that a disclosure to an independent auditor is not a waiver. 354 For example, in Merrill Lynch & Co. v. Allegheny Energy, Inc., the court determined that [*1132] two reports created by the Merrill Lynch and its auditor did not share common litigation interests; however, the auditor was also not a likely conduit for providing adversarial access to the protected documents). 343 344

345

Deloitte, 610 F.3d at 133. Id. Dow claimed that Deloitte required access to the documents in order to render an unqualified audit opinion. Id. Id. at 140 (quoting Rockwell Int'l Corp. v. U.S. Dep't of Justice, 235 F.3d 598, 605 (D.C. Cir. 2001)).

346

Id.

347

Id.

348

Id. at 141.

349

Id.

350

Id. (citing In re Subpoenas Duces Tecum, 738 F.2d 1367, 1372 (D.C. Cir. 1984)).

351

Id.

352

Id. at 141-42.

353

Id. at 142 ("A member in public practice shall not disclose any confidential client information without the specific consent of the client."); Code of Prof'l Conduct § 301.01 (Am. Inst. of Certified Pub. Accountants 1992). 354

See, e.g., SEC v. Berry, No. C07-04431 RMW (HRL), 2011 WL 825742, at 8 (N.D. Cal. Mar. 7, 2011) (disclosing information gleaned from an investigation of back-dating practices to independent auditors did not waive the work-product doctrine); SEC v. Schroeder, No. C07-03798 JW (HRL), 2009 WL 1125579, at 9 (N.D. Cal. Apr. 27, 2009) ("Disclosures to outside auditors do not have the "tangible adversarial relationship' requisite for waiver." (quoting Merrill Lynch & Co. v. Allegheny Energy, Inc., 229 F.R.D. 441, 447 (S.D.N.Y. 2004))); Westernbank Puerto Rico v. Kachkar, No. 07-1606 (ADC/BJM), 2009 WL 530131, at 8 (D.P.R. Feb. 9, 2009) ("The court agrees with the majority of courts … which have held that disclosure of work product protected material to outside auditors does not constitute waiver of work product protection."); Regions Fin. Corp. v. United States, No. 2:06-CV-00895-RDP, 2008 WL 2139008, at 8 (N.D. Ala. May 8, 2008) (stating that the independent auditor had agreed not to disclose information about the company and was not a potential adversary, so the auditor was not likely to disclose to another

Theresa Coetzee

Page 38 of 44 47 Wake Forest L. Rev. 1083, *1132 company as part of an internal investigation were protected by the work-product doctrine absent disclosure 355 and remained protected even though the reports were shared with the company's auditor. 356 The court recognized that waiver does not occur "unless disclosure is inconsistent with maintaining secrecy from possible adversaries." 357 Such a disclosure would occur "only if the disclosure "substantially increases the opportunity for potential adversaries to obtain the information.'" 358 Recognizing that auditors must maintain independence from the entity being audited, the court acknowledged that some might consider this independence as adversarial. 359 The court refused to so conclude, stating: Any tension between an auditor and a corporation that arises from an auditor's need to scrutinize and investigate a corporation's records and book-keeping practices simply is not the equivalent of an adversarial relationship contemplated by the work product doctrine. A business and its auditor can and should be aligned insofar as they both seek to prevent, detect, and root out corporate fraud. Indeed, this is precisely the type of limited alliance that courts should encourage. 360 The Merrill Lynch court noted that the auditor had "an ethical and professional obligation to maintain materials received from its client confidential, unless disclosure was required by law or accounting standards." 361 The court concluded that there could be no required disclosure other than a general statement by the auditor that a proper audit was impossible because of "internal control deficiencies." 362 Thus, the auditor was neither an adversary nor a conduit to an adversary, and disclosure to the auditor did not waive the work-product protection. 363 In Lawrence E. Jaffe Pension Plan v. Household International, Inc., 364 the district court acknowledged that waiver can occur with disclosure to third parties "in a manner which substantially increases the opportunity for potential adversaries to obtain the [*1133] information," 365 but the court refused to find that disclosure to an auditor was such a disclosure. The Jaffe court stated that "the fact that an independent auditor must remain independent from the company it audits does not establish that the auditor also has an adversarial relationship with the client as

party); Lawrence E. Jaffe Pension Plan v. Household Int'l, Inc., 237 F.R.D. 176, 183-84 (N.D. Ill. 2006) (finding no waiver); Merrill Lynch, 229 F.R.D. at 446 (concluding that disclosure to a corporation's auditor does not constitute a waiver); In re Raytheon Sec. Litig., 218 F.R.D. 354, 360 (D. Mass. 2003) ("There is no evidence that materials disclosed to an independent auditor are likely to be turned over to the company's adversaries except to the extent that the securities laws and/or accounting standards mandate public disclosure."); Gutter v. E.I. DuPont de Nemours & Co., No. 95-CV-2152, 1998 WL 2017926, at 3 (S.D. Fla. May 18, 1998) (finding no waiver); In re Pfizer Inc. Sec. Litig., No. 90 Civ. 1260 (SS), 1993 WL 561125, at 6 (S.D.N.Y. Dec. 23, 1993) (finding no waiver for the disclosure to the outside auditor because the auditor was not "a conduit to a potential adversary"). 355

Merrill Lynch, 229 F.R.D. at 445.

356

Id. at 446.

357

Id. at 445 (quoting Stix Prods., Inc. v. United Merchs. & Mfrs., Inc., 47 F.R.D. 334, 338 (S.D.N.Y. 1969)).

358

Id. at 445-46 (quoting In re Pfizer, 1993 WL 561125, at 6).

359

Id. at 447.

360

Id. at 448.

361

Id.

362

Id. at 448-49.

363

Id. at 449.

364

237 F.R.D. 176 (N.D. Ill. 2006).

365

Id. at 183 (quoting Vardon Golf Co. v. Karsten Mfg. Corp., 213 F.R.D. 528, 534 (N.D. Ill. 2003)).

Theresa Coetzee

Page 39 of 44 47 Wake Forest L. Rev. 1083, *1133 contemplated by the work product doctrine." 366 In the court's view, "disclosing documents to an auditor does not substantially increase the opportunity for potential adversaries to obtain the information." 367 Likewise, in Regions Financial Corp. v. United States, 368 the court decided that the auditor was neither a potential adversary nor a conduit to an adversary for purposes of waiver, and it based this conclusion on the fact that the auditor was bound by a confidentiality agreement. 369 The court noted, "Perhaps most importantly, a confidentiality agreement protected any documents [the company] gave to [the auditor], an agreement that assured that [the auditor] could not give the documents to another party." 370 In Gutter v. E.I. DuPont de Nemours & Co., 371 the court determined that disclosure of materials to an independent auditor does not waive the work-product protection because "there is an expectation that confidentiality of such information will be maintained by the recipient." 372 The court also stated: "Transmittal of documents to a company's outside auditors does not waive the work product privilege because such a disclosure "cannot be said to have posed a substantial danger at the time that the document would be disclosed to plaintiffs.'" 373 In In re Pfizer Inc. Securities Litigation, 374 the court refused to find a waiver of work-product protection for materials shared with an independent auditor. 375 The court stated that waiver occurs "only if disclosure "substantially increases the opportunity for potential adversaries to obtain the information.'" 376 In the situation at hand, the court noted that the company and the auditor [*1134] "obviously shared common interests in the information." 377 The court concluded that the auditor was "not reasonably viewed as a conduit to a potential adversary." 378 Other courts have reached similar results in the audit context. 379

366

Id.

367

Id.

368

No. 2:06-CV-00895-RDP, 2008 WL 2139008, at 1 (N.D. Ala. May 8, 2008).

369

Id. at 8.

370

Id.

371

No. 95-CV-2152, 1998 WL 2017926, at 1 (S.D. Fla. May 18, 1998).

372

Id. at 3.

373

Id. at 5 (quoting Gramm v. Horsehead Indus., Inc., No. 87 CIV. 5122 (MJL), 1990 WL 142404, at 5 (S.D.N.Y. Jan. 25, 1990)).

374

No. 90 Civ. 1260 (SS), 1993 WL 561125, at 1 (S.D.N.Y. Dec. 23, 1993).

375

Id. at 6.

376

Id. (quoting In re Grand Jury Subpoenas Dated Dec. 18, 1981 & Jan. 4, 1982, 561 F. Supp. 1247, 1257 (E.D.N.Y. 1982)).

377

Id.

378

Id.

379

See, e.g., Vacco v. Harrah's Operating Co., No. 1:07-CV-0663 (TJM/DEP), 2008 WL 4793719, at 1, 6, 7 (N.D.N.Y. Oct. 29, 2008) (rejecting the argument that the independent auditor was adversarial and determining that sharing material with the independent auditor did not waive work-product protection); S. Scrap Material Co. v. Fleming, No. 01-2554, 2003 WL 21474516, at 1, 9 (E.D. La. June 18, 2003) (holding that the response letters prepared by an attorney and provided to the company's independent auditor were protected by the work-product doctrine and that disclosure to the auditors was not waiver of that protection); Laguna Beach Cnty. Water Dist. v. Superior Court, 22 Cal. Rptr. 3d 387, 392-93 (Cal. Ct. App. 2004) (holding that the attorney's disclosure of audit response letters to an independent auditor did not waive work-product protection). In response to the argument that there could be no work-product protection because the letters were disclosed to an auditor who was performing a public function, the Laguna Beach court stated that the "conclusion has no basis in law or logic." Laguna Beach, 22 Cal. Rptr. 3d at 392. The court continued that the fact that the auditor was performing a public function "did not mean it would divulge protected information." Id.; see also Gramm v. Horsehead Indus., Inc., No. 87 CIV. 5122 (MJL), 1990 WL 142404, at 4

Theresa Coetzee

Page 40 of 44 47 Wake Forest L. Rev. 1083, *1134 B. Disclosure to an Auditor May or May Not Waive Protection The court in In re Raytheon Securities Litigation was more tentative. The court began its waiver analysis with the familiar touchstone that a disclosure not "inconsistent with maintaining [*1135] secrecy against opponents" does not act as a waiver. 380 Rather, a waiver occurs if a disclosure "substantially increases the opportunities for potential adversaries to obtain the information." 381 The court then noted that no evidence suggested that materials disclosed to an auditor "are likely to be turned over to the company's adversaries except to the extent that the securities laws and/or accounting standards mandate public disclosure." 382 Because the record lacked sufficient evidence to determine what an auditor might be expected to disclose, the court ordered further evidentiary proceedings to make these determinations. 383 Thus, the court indicated that disclosure of materials to an auditor waives the protection of the doctrine if public disclosure is to follow but does not waive the protection of the doctrine if further disclosure is not required. 384 C. Disclosure to an Auditor Waives Protection In contrast, a few courts have found that disclosure of materials to an auditor waives work-product protection. The most recent of these is Medinol, Ltd. v. Boston Scientific Corp. 385 In Medinol, the company shared minutes of a special litigation committee meeting with the independent auditor. 386 The court stated that sharing materials with entities that share an interest with the company does not waive the work-product protection. 387 The Medinol court continued: "However, where the third party to whom the disclosure is made is not allied in interest with the disclosing party or does not have litigation objectives in common, the protection of the doctrine will be waived." 388 Because, in the court's view, by definition, independent auditors "must not share common interests with the

(S.D.N.Y. Jan. 25, 1990) (evaluating whether the work-product doctrine protected documents shared with accountants which discussed the settlement of a claim against it). The Gramm court stated: Waiver of work-product protection will be implied only if the document is disclosed in circumstances that make it substantially more likely that the document will be revealed to the party's adversary. Thus, disclosure to another person who has an interest in the information but who is not reasonably viewed as a conduit to a potential adversary will not be deemed a waiver of protection of the rule. Gramm, 1990 WL 142404, at 5. That court determined that any disclosure to the accountants of Horsehead was not a waiver because there was no substantial danger that the documents would be disclosed to the plaintiffs because accountants have a duty of confidentiality. Id. at 5 n.8; see also Tronitech, Inc. v. NCR Corp., 108 F.R.D. 655, 655, 657 (S.D. Ind. 1985) (holding that work-product protection covered an audit letter evaluating the financial implications of a lawsuit that an attorney disclosed to an independent auditor and that there was no waiver of this protection because "communications between accountant and client [were] privileged under Indiana law, and audit letters [were] produced under assurances of strictest confidentiality." (citation omitted)). 380

In re Raytheon Secs. Litig., 218 F.R.D. 354, 359-60 (D. Mass. 2003) (quoting United States v. AT&T, 642 F.2d 1285, 1299 (D.C. Cir. 1980)). 381

Id. at 360.

382

Id.

383 Id. 384

at 360-61.

Id. at 359-60.

385

214 F.R.D. 113 (S.D.N.Y. 2002).

386

Id. at 114.

387

Id. at 115.

388

Id.

Theresa Coetzee

Page 41 of 44 47 Wake Forest L. Rev. 1083, *1135 company they audit," disclosure to auditors waives work-product protection. 389 The court stated that "the sharing by Boston Scientific's lawyers of selected aspects of their work product, although perhaps not substantially increasing the risk that such work product would reach potential adversaries … did not serve any litigation interest … or any other policy underlying the work [*1136] product doctrine." 390 The court thus created a novel requirement that all disclosures are waivers unless the disclosures "serve the privacy interests that the work product doctrine was intended to protect." 391 The Medinol court's position is in stark contrast to the virtually universal position of other courts that disclosures are not waivers unless the disclosures harm the purpose of the doctrine by making access by an adversary more likely. 392 Because the company and the auditor in Medinol "did not share "common interests' in litigation," and because, in the court's view, disclosures to the auditor "did not therefore serve the privacy interests that the work product doctrine was intended to protect," the court determined that disclosure to the auditor waived work-product protection. 393 Since the Medinol decision, several courts have specifically considered it and have declined to find that disclosure to auditors waives the work-product doctrine. 394 An earlier case had reached a similar result as that in the Medinol case. In In re Diasonics Securities Litigation, 395 the company disclosed materials to its auditor that had been prepared regarding an acquisition and that the court acknowledged may have been protected absent the disclosure. 396 The court then found that disclosure of the documents to the auditor waived any possible work-product protection. 397 The court stated that "while disclosure to one with a common interest under a guarantee of confidentiality does not necessarily waive the protection, … the relationship between public accountant and client is at odds with such a guarantee because the public accountant has responsibilities to creditors, stockholders, and the investing public which transcend the relationship with the client." 398 [*1137]

D. Implications for Alternative Litigation Finance In deciding whether disclosure of materials protected by the work-product doctrine to an ALF entity waives that protection, one must begin where courts evaluating disclosures in the independent auditor setting begin: with the question of whether the disclosure is "inconsistent with the maintenance of secrecy from the disclosing party's adversary." 399 As many courts have explained, waiver occurs if a disclosure "substantially increases the

389 390

391 392

393

Id. at 116. Id. Id. at 117. See discussion supra Part III.D.2. Medinol, 214 F.R.D. at 117.

394

See, e.g., SEC v. Berry, No. C07-04431 RMW (HRL), 2011 WL 825742, at 7 (N.D. Cal. Mar. 7, 2011) (rejecting Medinol's view); SEC v. Roberts, 254 F.R.D. 371, 381-82 (N.D. Cal. 2008) (declining to follow Medinol's position that sharing materials with an auditor waives the work-product doctrine for the materials); Vacco v. Harrah's Operating Co., No. 1:07-CV-0663, 2008 WL 4793719, at 6 (N.D.N.Y. Oct. 29, 2008) ("Medinol, however, has been almost uniformly rejected as adopting far too restrictive a view regarding the circumstances under which a waiver can occur."). 395

No. C-83-4584-RFP (FW), 1986 WL 53402 (N.D. Cal. June 15, 1986).

396

Id. at 1.

397

Id.

398

Id.

399

United States v. Deloitte LLP, 610 F.3d 129, 140 (D.C. Cir. 2010) (quoting Rockwell Int'l Corp., v. U.S. Dep't of Justice, 235 F.3d 598, 605 (D.C. Cir. 2001)).

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Page 42 of 44 47 Wake Forest L. Rev. 1083, *1137 opportunities for potential adversaries to obtain the information." 400 The court in United States v. Deloitte LLP posed an analysis that asks whether the party to whom the protected materials are disclosed is an adversary or a conduit to an adversary. 401 In answering this query, the Deloitte court focused the analysis on "whether the disclosing party had a reasonable basis for believing that the recipient would keep the disclosed material confidential." 402 A reasonable basis might exist with a shared common interest between the discloser and the recipient or it might exist if the recipient had an obligation or other reason to keep the materials disclosed confidential. 403 Applying this analysis in the ALF setting should result in a finding that the ALF entity is not an adversary and is not a conduit to an adversary. Thus, a court should find no waiver of protection if the ALF entity is bound by a confidentiality agreement. Absent such an agreement, a finding of waiver is possible. If the attorney and client team discloses work-product protected materials to assist the ALF entity in the decision whether to invest in the matter, the possibility of a finding of waiver is at its highest. At this point in the relationship, the ALF entity has no particular affinity for the litigation adversary, so there is no obvious motivation for the potential funder to share the information with the adversary. 404 Yet, the ALF entity has very little affinity for the attorney and client team at this juncture either ; it may walk away from the team without investing in the matter. 405 As courts do not view auditors as adversaries of the sharing company, likewise, courts are not likely to view ALF entities to be [*1138] adversaries for purposes of the work-product doctrine. Yet, at the initial investment investigation stage of the entity's involvement, a court may not find a legally sufficient common interest, just as courts sometimes do not recognize a sufficient common interest between auditors and the audited company. If the ALF entity decides to pass on the investment opportunity, there is no solid basis for a reasonable belief on behalf of the attorney and client team that the disclosed material will not find its way to an adversary. A court might find that disclosure to the ALF entity waives work-product protection absent some other basis for a reasonable belief in confidentiality on the part of the ALF entity. A reasonable expectation of confidentiality can be created, however, as the Deloitte court noted, by "a confidentiality agreement or similar arrangement." 406 If the ALF entity enters into a binding and unqualified agreement not to disclose the materials shared with the entity, the attorney and client team likely has a reasonable expectation that the ALF entity will not disclose the materials. The entity is not an adversary and by contract has made clear it is not a conduit to an adversary. Thus, there is no waiver of the work-product doctrine. Because confidentiality is essential for work-product protection to exist, and because work-product protection is important for the ALF market to thrive, ALF entities should have no objection to binding themselves to a duty of confidentiality in the initial evaluation stage. In the second scenario of disclosure, a lawyer and client team may disclose protected materials to an ALF entity as part of a status reporting obligation after the entity has decided to invest in the matter. In analyzing whether such a

400

See Wright et al., supra note 133; see also In re Chevron Corp., 633 F.3d 153, 165 (3d Cir. 2011) ("It is only in cases in which the material is disclosed in a manner inconsistent with keeping it from an adversary that the work-product doctrine is waived."); discussion supra Part III.D.2. 401

Deloitte, 610 F.3d at 140.

402

Id. at 141.

403

Id.

404

See id. at 140; see also Wright et al., supra note 133, § 2016.4.

405

See Wright et al., supra note 133, § 2016.4.

406

Deloitte, 610 F.3d at 141.

Theresa Coetzee

Page 43 of 44 47 Wake Forest L. Rev. 1083, *1138 disclosure increases the likelihood that the materials will find their way to the hands of an adversary, it is not likely that a court would find the entity to be an adversary or a conduit to an adversary. Because the ALF entity maximizes investment value if the litigation matter ends in success for the attorney and client team, courts may find that the entity and the attorney and client team share a common interest such that no waiver of work-product privilege occurs with disclosure to the ALF entity. At the very least, the shared interest eliminates any conclusion that the funder is an adversary. Courts may have concern, however, that the ALF entity might be a conduit to an adversary. While the entity's and the discloser's interests are more aligned than if the entity had not yet decided to invest, because the standards of commonality some courts apply are stringent, 407 some courts might fall short of recognizing that the entity has a legally sufficient common interest with the attorney and [*1139] client team such that the entity is not a conduit to an adversary. Framing the issue as the Deloitte court did, the attorney and client team may not have a "reasonable basis for believing that the recipient would keep the disclosed material confidential." 408 Once again, an unconditional and binding agreement in which the ALF entity agrees to treat all disclosed materials confidentially can provide a reasonable basis for a belief that the entity will not further disseminate the material but will keep the material confidential. 409 Thus, a court can conclude that a disclosure to an ALF entity as part of the entity's monitoring role does not waive the work-product protection. These conclusions are supported by the only published case in which a court has dealt substantively with the question of whether a disclosure to an ALF source waives work-product protection for the shared materials. The court in Mondis Technology, Ltd. v. LG Electronics, Inc. opined that sharing materials with potential investors who had entered into nondisclosure agreements "did not substantially increase the likelihood that an adversary would come into possession of the materials." 410 Thus, the court refused to find a waiver of the work-product doctrine. 411

In addition, courts have repeatedly concluded that auditors are not adversaries or conduits to adversaries, though the auditors' interests and the interests of the company may not be identical. 412 Repeatedly, courts have determined that disclosures to auditors do not increase the likelihood that the materials will come into the hands of adversaries. 413 Several courts have placed weight on the fact that auditors have an obligation of confidentiality that exists as the result of a nondisclosure agreement or that exists in the professional code that regulates the conduct of auditors. 414 Even if a court were inclined to look to the Medinol opinion for guidance, as other courts have not done, 415 the court may not find a waiver. In the Medinol court's view, to avoid waiver, the disclosure must "serve any litigation

407

408

See discussion supra Part III.D.2. Deloitte, 610 F.3d at 141.

409

See id.

410

Mondis Tech., Ltd. v. LG Elecs., Inc., No. 2:07-CV-565-TJW-CE, 2011 WL 1714304, at 3 (E.D. Tex. May 3, 2011).

411

Id.; see also discussion supra Part IV.

412

See, e.g., Deloitte, 610 F.3d at 139 (citing numerous cases in which courts held that auditors are not adversaries or conduits to adversaries for the purposes of the work-product doctrine). 413

See discussion supra Part VII.A.

414

See, e.g., Deloitte, 610 F.3d at 142; Regions Fin. Corp. v. United States, No. 2:06-CV-00895-RDP, 2008 WL 2139008, at 8 (N.D. Ala. May 8, 2008). 415

See discussion supra Part VII.B.

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Page 44 of 44 47 Wake Forest L. Rev. 1083, *1139 interest, or any other policy underlying [*1140] the work product doctrine." 416 Even with this analysis, a court might find that disclosure to an ALF entity furthers the litigation interest of success on the underlying claim such that the court might not find a waiver. Because the Medinol court indicated that even a disclosure that does not substantially increase the risk of disclosure to adversaries might constitute a waiver, 417 the existence of a confidentiality agreement would be irrelevant except, perchance, as evidence of common interest. Conclusion As the ALF market develops, the question of the effect of the presence of ALF entities in litigation on the protection of the work-product doctrine looms as a significant issue. This Article concludes that the involvement of ALF entities should not affect work-product protection. Materials evaluating litigation and created in the context of ALF should enjoy (and courts will likely conclude that they enjoy) the protections of the work-product doctrine, even if an ALF entity creates those materials. Second, sharing protected materials with ALF entities should not waive that protection if ALF entities enter into binding nondisclosure agreements with regard to any shared materials. Wake Forest Law Review Copyright (c) 2012 Wake Forest Law Review Association, Inc. Wake Forest Law Review

End of Document

416

Medinol, Ltd. v. Bos. Scientific Corp., 214 F.R.D. 113, 116 (S.D.N.Y. 2002).

417

Id. at 116-17.

Theresa Coetzee

ARTICLE: THE LITIGATION FINANCE CONTRACT November, 2012 Reporter 54 Wm. & Mary L. Rev. 455

Length: 25639 words Author: Maya Steinitz* * Associate Professor, University of Iowa College of Law. I thank Herb Hovenkamp, Steve Burton, Todd Pettys, Michelle Falkoff, Tom Gallanis, Alan Morrison, Rob Rhee, Nathan Miller and the participants of the University of Iowa College of Law and University of Wisconsin Law School workshops for the comments. A special thanks to Victor Goldberg for stimulating conversations about the similarity between venture capital and litigation finance as well as comments on an early draft.

Highlight Abstract Litigation funding-for-profit, nonrecourse funding of a litigation by a nonparty-is a new and rapidly developing industry. It has been described as one of the "biggest and most influential trends in civil justice" today by RAND, the New York Times, and others. Despite the importance and growth of the industry, there is a complete absence of information about or discussion of litigation finance contracting, even though all the promises and pitfalls of litigation funding stem from the relationships those contracts establish and organize. Further, the literature and case law pertaining to litigation funding have evolved from an analogy between litigation funding and contingency fees. Much of that literature and case law views both forms of dispute financing as ethically compromising exceptions to the champerty doctrine. On that view, such exceptions create the risks of an undesirable loss of client control over the case, of compromising a lawyer's independent judgment, and of potential conflicts of interest between funders, lawyers, and clients. This Article breaks away from the contingency analogy and instead posits an analogy to venture capital (VC). It shows the striking resemblance of the economics of litigation funding with the well-understood economics of VC. Both are characterized by extreme (1) uncertainty, (2) information asymmetry, and (3) agency costs. After detailing the similarities and differences between these two types of financing, this Article discusses which contractual arrangements developed in the area of venture capitalism can be directly applied to litigation finance, which ones need to be adapted, and how such adaptation can be achieved. As much of the theory, doctrine, and practice of VC contracting can be applied or adapted to litigation finance, practitioners and scholars can be spared decades of trial and error in developing standardized contractual patterns. In addition, the analogy turns most of the conventional wisdom in the field on its head. This Article argues that funders should be viewed as real parties in interest, funders should obtain control over a funded litigation, and attorneys should take funders' input into account. In return, funders should pay plaintiffs a premium for the control they receive, subject themselves to a compensation scheme that aligns their interests with those of the plaintiffs, and enhance the value of claims by providing noncash contributions. Indeed, on the suggested view, noncash contribution-as much as if not more than, capital contribution-should be seen as a key benefit of litigation finance. Courts and regulators should devise rules that enhance the transparency of the industry-in particular the performance outcomes of various litigation funding firms and their ethical propensities. Such a legal regime will foster the emergence of a reputation market that will police the industry and support contractual arrangements.

Text [*459]

Theresa Coetzee

Page 2 of 38 54 Wm. & Mary L. Rev. 455, *459 Introduction Litigation finance-for-profit, nonrecourse funding of a litigation by a nonparty-is a new and rapidly developing industry globally, and in the United States in particular. 1 So much so, that the RAND Institute for Civil Justice has dubbed it one of the "biggest and most influential trends in civil justice," 2 and the New York Times has recently reported on it at length on its front page and in its "Betting on Justice" series. 3 More generally, litigation funding in all of its forms-law lending, contingency fees, and nonrecourse funding-is pivotal for understanding civil litigation as a whole: "[T]he most … important phenomena of modern litigation are best understood as results of changes in the financing and capitalization of the bar." 4 For example, in the United States a market in bankruptcy claims emerged some twenty years ago and "nothing has changed the face of bankruptcy in the last decade as much as the newfound liquidity [*460] in claims." 5 Due to litigation funding's increasing salience, courts, legislatures, regulators, and academics have all, as of late, started grappling with the phenomenon head on. 6

1

New York City Bar Ass'n, Formal Op. 2011-2 § I (2011) ("As of 2011, [the third-party litigation financing] industry has continued to grow, both as to the number and types of lawsuits financed and financing provided. The aggregate amount of litigation financing outstanding is estimated to exceed $ 1 billion."). On trends in law firm finance, see Larry Ribstein, The Death of Big Law, 2010 Wis. L. Rev. 749, 754-59, 788-97 (discussing both traditional and emerging law firm models). 2

Third Party Litigation Funding and Claim Transfer, RAND Corp., http://www. rand.org/events/2009/06/02.html (last visited Oct. 10, 2012); see also Maya Steinitz, Whose Claim Is This Anyway? Third-Party Litigation Funding,95 Minn. L. Rev. 1268, 1270-71 & n.4 (2011). Litigation funding is accelerated by the global recession, which has created more claims but less funds to pursue them as well as an appetite for new, alternative assets. See id. at 1283-85. The expansion of litigation funding is also driven by a global transformation of legal services egged on by the Legal Profession Act 2004 (NSW) ch 2, pt 2.6, div 2, which allows incorporation of legal practices in Australia, and the Legal Services Act, 2007, c. 29, §§ 71-111, which allows investment in British law firms. 3

E.g., Binyamin Appelbaum, Investors Put Money on Lawsuits to Get Payouts, N.Y. Times, Nov. 15, 2010, at A1. The report was accompanied by Susan Lorde Martin, Op- Ed., Leveling the Playing Field, N.Y. Times (Nov. 15, 2010), http://www.nytimes.com/ roomfordebate/2010/11/15/investing-in-someone-elses-lawsuit/leveling-the-playing- field, and was followed by an additional report on the finance of divorce litigation. See Binyamin Appelbaum, Taking Sides in a Divorce, Chasing Profit, N.Y. Times, Dec. 5, 2010, at A1; see also Peter Lattman & Diana B. Henriques, Speculators Are Eager to Bet on Madoff Claims, N.Y. Times Dealbook (Dec. 13, 2010), http://dealbook.nytimes.com/2010/12/13/speculators-are-eager-to-bet-onmadoff-claims/ (discussing how investment firms are attempting to buy trustee-approved claims against Bernard L. Madoff). 4

Stephen C. Yeazell, Abstract, Refinancing Civil http://papers.ssrn.com/so13/papers.cfm?abstract id=315759.

Litigation,

Soc.

Sci.

Res.

Network

(June

18,

2002),

5

Glenn E. Siegel, Introduction: ABI Guide to Trading Claims in Bankruptcy: Part 2 ABI Committee on Public Companies and Trading Claims, 11 Am. Bankr. Inst. L. Rev. 177, 177 (2003).

6

For recent cases addressing litigation funding, see In re September 11 Litig., 723 F. Supp. 2d 534, 545-46 (S.D.N.Y. 2010) (stating that lawyers cannot pass on to their clients the cost of financing a contingency suit); Leader Techs. v. Facebook, Inc., 719 F. Supp. 2d 373, 376 (D. Del. 2010) (refusing to extend the common-interest exception to attorney-client privilege waiver to include a financier); Abu-Ghazaleh v. Chaul, 36 So. 3d 691, 693-94 (Fla. Dist. Ct. App. 2009) (holding that given the level of control exerted by a funder, that funder rose to the level of "party"). On the legislative front, Maine became the first state to pass legislation regulating litigation finance. See An Act to Regulate Presettlement Lawsuit Funding, 2007 Me. Laws 394 (codified at Me. Rev. Stat. tit. 9-A, §§ 12-101 to -107 (2007)). Shortly thereafter, Ohio legalized lawsuit financing by passing H.B. 248, 127th Gen. Assemb. (Ohio 2008) (codified at Ohio Rev. Code Ann. § 1349.55 (West 2008)), and in 2010, Nebraska approved the Nonrecourse Civil Litigation Act, Legis. B. 1094, 101st Leg., 2d Sess. (Neb. 2010) (codified at Neb. Rev. Stat. §§ 25-3301 to 3309 (2010)). Legislation is currently pending in New York, see An Act to Amend the General Obligations Law, in Relation to the Regulation of Non-Recourse Civil Litigation Advance Contracts, Assemb. B. 5410, 2011 Gen. Assemb., Reg. Sess. (N.Y. 2011), and Delaware, see An Act to Amend Title 6 of the Delaware Code Relating to Consumer Legal Finance Transactions, H.B. 422, 145th Gen. Assemb., Reg. Sess. (Del. 2010). Regulatory efforts have also been made by the American Bar Association, see ABA Comm'n on Ethics 20/20, White Paper on Alternative Litigation Finance (Draft Oct. 1 9 , 2 0 1 1 ) , a v a i l a b l e a t http://www.americanbar.org/content/dam/aba/administrative/ethics 2020/20111019 draft alf white paper

Theresa Coetzee

Page 3 of 38 54 Wm. & Mary L. Rev. 455, *460 Litigation funding is largely understood as composed of two sub-industries. One is usually referred to as "consumer funding"-the funding of relatively small personal claims, predominantly personal injury and divorce cases. 7 This subindustry has a somewhat longer history in the United States, going back approximately fifteen years, to what has in the past been called "law lending." The second, newer subindustry is "commercial funding." This industry relates to the funding of business disputes, such as disputes relating to intellectual property, antitrust, business contracts, and international commercial and investment arbitration-brought by sophisticated [*461] parties and involving larger stakes. 8 This Article focuses exclusively on commercial funding. 9 Specialized investment firms dedicated exclusively to litigation funding have pioneered it in the United States. However, in addition, what started as a trickle of investments by hedge funds-not specializing in litigation but rather investing opportunistically-has recently turned into a flood. 10 But this growing industry is shrouded in secrecy 11 and, to make matters more complicated, its funding structures are "as various as snowflakes." 12 Commentators have identified a variety of possible investment structures. These include recourse and nonrecourse loans, which can be either secured or nonsecured. 13 Investments may take the form of a purchase, an assignment of a claim, or even the sale of an interest in the judgment. 14 These, in turn, may be directly or indirectly syndicated. 15 Funders may form joint ventures with other funders; law firms may cofinance with other law firms using cocounseling agreements; and insurance companies may offer [*462] litigation

posting.authcheckdam.pdf, and the New York City Bar Association, see New York City Bar Ass'n, Formal Op., supra note 1. For a literature review of the budding academic discourse, see infra notes 119-21, 123-26, 130. For a literature survey of earlier works that focused predominantly on law lending-that is, personal injury recourse loans-and Australian and English literature studying litigation finance in those pioneering jurisdictions, see Steinitz, supra note 2, at 1279-82. 7

See Steven Garber, Rand Corp., Alternative Litigation Financing in the United States 9-10 (2010) (RAND Corp. occasional paper), available at http://www.rand.org/ pubs/occasional papers/ 2010/RAND OP306.pdf. 8

See id. at 13-15. See a discussion of the "first wave" and "second wave" of litigation funding, including a literature review relating to the former, in Steinitz, supra note 2, at 1277-78.

9

Although acknowledging that litigation funding is a controversial practice, this Article assumes that litigation funding is an industry whose time has come and proceeds from that premise to discuss how-not whether-it should take place. 10

Margie Lindsay, Third-Party Litigation Funding Finds Favour with Hedge Funds, Hedge Funds Rev. (Jan. 19, 2012), http://www.hedgefundsreview.com/hedge-funds-review/ news/2139727/audio-party-litigation-funding-favour-hedge-funds. This information is also based on off-the-record interviews conducted by the author with various investors. 11

See Roger Parloff, Have You Got a Piece of This Lawsuit?, Fortune (May 31, 2011, 5:00 AM), http://features.blogs.fortune.cnn.com/2011/05/31/have-you-got-a-piece-of- this-lawsuit; see also Neil Rose, Whatever You Want, Law Soc'y Gazette (Jan. 17, 2008), http://www.lawgazette.co.uk/features/whatever-you-want ("This is very much a bespoke market."). 12

See Lindsay, supranote 10 (quoting Selvyn Seidel, Founder and Chairman of Fulbrook Management) (internal quotation marks omitted).

13

Introduction to UCLA Law-RAND Ctr. for Law & Pub. Policy Conference Proceedings: Third-Party Litigation Funding and Claim Transfer 1, 1 (Geoffrey McGovern et al. eds., 2010) [hereinafter Conference Proceedings], available at http://www. rand.org/content/dam/rand/pubs/conf proceedings/2010/RAND CF272.pdf; Selvyn Seidel, Stakeholders and Products in ThirdParty Funding Arrangements, in Conference Proceedings, supra, at 4, 5; see also Nathan M. Crystal, Professional Ethical Issues in Third-Party Litigation Financing, in Conference Proceedings, supra, at 15, 15-18; Timothy D. Scrantom, Sources and Structures of Claim Investments, in Conference Proceedings, supra, at 11, 11-12. 14

Crystal, supra note 13, at 15.

15

Selvyn Seidel, An Overview, in Conference Proceedings, supra note 13, at 68.

Theresa Coetzee

Page 4 of 38 54 Wm. & Mary L. Rev. 455, *462 insurance products. Other forms of indirect investments in legal claims, which are beyond the scope of this Article, include law firm loans offered by banks and equity investment in law firms. 16 One litigation funding firm has disclosed its investment structures to its investors in the following terms: The Company intends to make use of a wide variety of investment structures … Examples of possible structures include, inter alia: funding the legal expenses associated with pursuing or defending a claim in exchange for a payment based on the claim's outcome; acquiring an interest in all or a part of a claim or claimant at various stages during the adjudication process, including after a judgment or award has been rendered; lending money, either directly or through a law firm established by the Principals, to fund the activities of a law firm, the litigation of a portfolio of cases, or the litigation of a single case; arranging and participating in structures that remove the risk of liability from companies' balance sheets; acquiring interests in intellectual property that is the subject of claimed infringement; and participating in post-insolvency litigation trust structures.

17

Even within the paradigmatic investment structure of the first bullet above, which is modeled on the contingency fee, variations abound. 18 How parties choose to structure their litigation funding agreements depends on a variety of factors such as: (1) the type of investor-ad hoc institutional investors, such as a hedge fund or [*463] bank, or specialized institutional investors, either private or public; (2) the investor's needs; (3) regulatory or ethical restrictions; and (4) tax considerations. 19 Despite the increasing importance and growth of the industry, there is a complete absence of either information about or discussion of litigation funding contracting-both its theory and its practice. 20 Further study of litigation funding agreements is badly needed. To state the obvious, the litigation funding contract is the foundation and framework of the funding relationship. The absence of any guidance on how to contract for litigation funding significantly raises the transaction costs of such funding because parties must start from scratch when entering a litigation funding agreement. 21 This void also creates an uneven playing field for unsophisticated clients who 16

Crystal, supra note 13, at 16; Roundtable Discussion Summary, in Conference Proceedings, supra note 13, at21, 22; James E. Tyrell, LawyerInvestments in Claims, in Conference Proceedings, supra note 13, at 9, 9; Stephen Yeazell, Third-Party Finance: Legal Risk and Its Implications, in Conference Proceedings, supra note 13, at 18, 19. 17

Admission Document from Burford Capital Ltd. 21 (Oct. 21, 2009) [hereinafter Burford IPO memo], available at http://www.burfordfinance.com/docs/default-document-library/ burford-admission-document.pdf. 18

See Rose,supra note 11 ("Allianz has a starting point of 30% of the first 350,000 recovered, and 20% on anything above that. IM relates its take to when monies are recovered, ranging from 25% for up to six months from the letter of intent, to 50% for over 18 months. S&W ranges anywhere between 15% and 45%. In general, a funder will be looking for at least three or four times the sum invested."). 19

See Burford IPO memo, supra note 17, at 12-17, 21-22.

20

Given the novelty of the phenomenon, no model contracts exist. As discussed below, funders regard such contracts as proprietary and include nondisclosure clauses in them. Few cases dispute the funding agreement itself and, therefore, no examples of contracts can be gleaned from courts' opinions. Even fewer cases have led to public disclosure of the actual underlying contracts. These are discussed infra Part I.

21

As one litigator framed it, in a private conversation, "litigators like me find themselves in a position where they have to negotiate highly complex financial deals. This is not what we are trained to do. And it's too time consuming to expect a partner from the finance department to assist since he cannot bill for that time."

Theresa Coetzee

Page 5 of 38 54 Wm. & Mary L. Rev. 455, *463 cannot afford to negotiate a form contract presented by an experienced funder. In other words, there is both an efficiency-based and justice-based need for academic discussion of the litigation finance contract, both of which this Article seeks to address. Additionally, the void leads to a public policy discourse based, at least partially, on ignorance of how funding arrangements operate in practice or in theory. Finally, by breaking away from the analogy to contingency fees, and positing instead an analogy to venture capital, it becomes clear that in addition to a justice argument in favor of litigation finance-for example, access to justice-litigation financiers may be valuable because they can enhance the value of lawsuits, to the benefit of the original claim holders, by way of noncash contributions. This Article therefore aims to fill this gap. The Article develops an analogy between the economics of venture capital (VC) and of litigation finance. Both are forms of finance characterized by extreme (1) uncertainty, (2) information asymmetry, and (3) agency [*464] costs. 22 Therefore, much of the theory, doctrine, and practice of VC contracting, which developed over more than half a century to deal with similar problems, can be adapted to the litigation funding context. This insight can represent a quantum leap for practitioners and scholars-who will not have to muddle through decades of trial and error-and can allow them to start from a standardized set of contractual patterns. Part I explores, as a case study, Burford's investment in the high-stakes, high- profile Chevron/Ecuador dispute. It illustrates that certain funding relationships make use of VC features but mostly in order to address funders' interests, whereas the unequal bargaining power, regulatory restrictions, and underdeveloped reputational markets conspire to prevent the development of correlating protections for the plaintiffs. Part II describes the economics of litigation funding. It details how the ethical constraints-for example, the risk of plaintiffs losing control to funders, of waiver of attorney-client privilege, and of diminished independent judgment by lawyers-translate in economic terms into magnified agency costs and information asymmetries. Part II also applies economic, finance, and behavioral literature to an analysis of legal claims as assets, showing these assets to be highly risky and uncertain. Part III describes VC's lessons learned-how to control similar extreme uncertainty, information asymmetry, and agency costs through organizational and contractual arrangements-and suggests arrangements that protect plaintiffs while accommodating value enhancements by funders. This Part sets out the benefits of organizing litigation finance firms as limited partnerships, with an incentive- aligning compensation scheme, that are incentivized and expected to provide plaintiffs with noncash contributions. This Part also suggests that contracts between litigation finance firms and plaintiffs make use of staged financing, representation in case management, certain negative covenants, and exit provisions. And it emphasizes the role of reputation and therefore transparency in policing ethics. This analysis suggests that control should be allocated to funders, but that funders must pay for itincluding with upfront cash when appropriate. It also suggests how the contract [*465] between the litigation finance firm and its investors, on the one hand, and the attorney retention agreement, on the other, can be structured to support the litigation finance firm-plaintiff contract. The Article concludes with a set of conceptual and practical recommendations. These include reframing our understanding of funders as real parties in interest, extending attorney-client privilege to facilitate the noncash contribution of funders, pricing and paying for the complete control endowed to plaintiffs by operation of law, and encouraging plaintiffs and their lawyers to disfavor funders who are not specialized and organized as proposed herein. I. A Case Study: Burford's Investment in the Chevron/Ecuador Dispute This Part will explore Burford's investment in the Chevron/ Ecuador dispute as a case study of: (1) how private ordering in litigation funding is evolving to adopt contractual structures not dissimilar to those documented in the VC industry pertaining to funders' interest in reducing extreme uncertainty, information asymmetry, and agency costs; and (2) how regulatory restrictions coupled with a lack of transparency and the consequently limited reputational

22

See infra Part II.C-D.

Theresa Coetzee

Page 6 of 38 54 Wm. & Mary L. Rev. 455, *465 markets conspire to prevent the development of the correlating protections of the plaintiffs, such as compensation for transfer of control, noncash contribution, and monitoring. Fortune magazine covered Burford's investment in the Chevron/ Ecuador dispute based on the premise that Burford is … "the largest and most experienced international dispute funder in the world," as its promotional materials state, so we're not looking here at some aberrational outlier in the field… [And,] we can be assured that Burford's conduct probably represents the very best practices the young industry has to offer. 23 [*466]

A. Background: The Chevron/Ecuador Dispute On February 14, 2011, an Ecuadorian court issued an $ 18 billion judgment against Chevron in an environmental litigation brought against it by a group of indigenous peoples in the Amazonian rain forest of Ecuador. 24 The litigation stems from personal injuries and environmental damage in the form of the pollution of rain forests and rivers in Ecuador. 25 These damages are a result of oil operations conducted by Texaco, subsequently acquired by Chevron in 2001, during drilling operations that lasted from 1964 to 1990. 26 When Chevron acquired Texaco, it also "acquired" what became known as the Chevron/Ecuador case. 27 The award is the largest judgment ever imposed for environmental contamination in any court, and the litigation has been ongoing for over seventeen years. 28 The costs of the litigation up to the [*467] judgment were borne by the

23

Parloff, supra note 11. Similarly, Professor Anthony Sebok, "who has made a sub- specialty of probing the legal and ethical questions surrounding litigation finance," has been quoted as saying that there is "nothing unusual from [the] point of view of the litigation finance world" in this contract. Daniel Fisher, Litigation-Finance Contract Reveals How Investors Back Lawsuits, Forbes (July 6, 2011), http://www.forbes.com/sites/danielfisher /2011/06/07/litigation-finance-contract- reveals-how-investorsback-lawsuits. It is also the experience of this author, based on interviews as well as a review of the litigation finance contracts listed below, that the contract, although lengthier and more involved than some, is not an aberration as it relates to the issues discussed herein. That said, it should be noted that this investment has some features that may distinguish it from most investments. The Chevron/Ecuador litigation is a cross-border litigation. Underlying it is a form of class action. And an unusually large foreign judgment had already been rendered at the time of the investment. For a prophecy that litigation funding of transnational disputes is set to rise, see Cassandra Burke Robertson, The Impact of Third Party Financing on Transnational Litigation,44 Case W. Res. J. Int'l L. 159 (2011). Additional contracts reviewed include those underlying the following litigations: In re Parmalat Sec. Litig., 659 F. Supp. 2d 504 (S.D.N.Y. 2009); Trust for the Certificate Holders of Merrill Lynch Mortg. Investors v. Love Funding Corp., 918 N.E.2d 889 (N.Y. 2009); Anglo-Dutch Petroleum Int'l, Inc. v. Haskell, 193 S.W.3d 87 (Tex. App. 2006). Also reviewed were the "Minor Investor" contracts relating to the Chevron/Ecuador investment discussed below, see Exhibits to Declaration of Kirsten L. Hendricks, Chevron Corp. v. Donziger, No. 11-cv-00691-LAK (S.D.N.Y. Nov. 29, 2011), ECF No. 355 [hereinafter Minor Funder Contracts], and, for the sake of comparison, standard forms of consumer investment contracts developed to comply with different states' consumer protection legislations, see, e.g., Purchase Agreement Between Dean Plaintiff and Oasis Legal Finance, LLC (Sept. 13, 2010) (on file with author). 24

See Chevron Corp. v. Donziger, 768 F. Supp. 2d 581, 621 (S.D.N.Y. 2011).

25

See id.

26

See id. at 597. The claim is a "popular action," the closest form of joinder to class action available in Ecuador. See Thomas T. Ankersen, Shared Knowledge, Shared Jurisprudence: Learning to Speak Environmental Law Creole (Criallo), 16 Tul. Envtl. L.J. 807, 814 (2003). 27

See Chevron Corp., 768 F. Supp. 2d at 594 & n.2.

28

Patrick Radden Keefe, Reversal of Fortune, New Yorker, Jan. 9, 2012, at 38; Simon Romero & Clifford Krauss, Chevron Is Ordered to Pay $ 9 Billion by Ecuador Judge, N.Y. Times, Feb. 15, 2011, at A4. The judgment ordered $ 9 billion dollars in compensatory damages and another $ 9 billion dollars in punitive damages, which would become effective if Chevron did not

Theresa Coetzee

Page 7 of 38 54 Wm. & Mary L. Rev. 455, *467 attorneys who took the case on a contingency basis. 29 Far from concluding the dispute, the Ecuadorian judgment was the opening gunshot in a new phase of appellate proceedings in Ecuador and parallel proceedings in the United States and in various foreign and international fora. 30 In a satellite litigation in which Chevron is currently suing claimants' former lead attorney, Steven Donziger, and advancing various allegations under the RICO statute, Chevron requested, and was granted by U.S. District Court Judge Kaplan, Donziger's entire case file-documents spanning nearly two decades. 31 Among these documents was the funding agreement between the plaintiffs and Burford. B. The Investment Structure Burford invested $ 4 million as a first round of investment in the Ecuadorians' case in exchange for a 1.5 percent stake in any recovery, and agreed to provide two additional rounds of investment, in the amount of $ 5.5 million each, entitling it to a 5.5 percent share of the recovery. 32 The investment was effected through a Cayman Islands entity called Treca Financial Solutions (Treca). Treca entered into a funding agreement (hereinafter, the Treca Agreement or Agreement) with Friends of the Defense of the Amazon (FDA), a nonprofit, and some forty named individuals (Claimants) who represent thousands of other villagers. Fortune magazine summed up the deal: If Burford ponies up the full $ 15 million and the plaintiffs end up recovering $ 1 billion, Burford will get $ 55 million. If the plaintiffs recover $ 2 billion, Burford gets $ 111 million, and so on. [*468] But here's the best part for investors: If the plaintiffs recover less than $ 1 billion-all the way down to a mathematical floor of about $ 69.5 million-Burford still gets the same payout it would have received if there had been a $ 1 billion recovery. In other words, if there were a $ 69.5 million recovery, Burford would still get $ 55 million, though that sum would, under the circumstances, constitute almost 80% of the pot. In that event, by the way, the remaining 20% would not go to the plaintiffs; rather, it would go to other investors, who are also supposed to get their returns on investment (not just their capital outlays) before the plaintiffs start seeing a dime. In fact, under the "distribution waterfall" set up by the 75-page contract, it is only after eight tiers of funders, attorneys, and "advisers" (including the plaintiffs' e-discovery contractor) have fed at the trough that "the balance (if any) shall be paid to the claimants." 33 The deal is structured as an assignment of all litigation rights to a trust set up by the Claimants 34 and governed under Ecuadorian law (the Trust). 35 The Trust holds "all of the litigious rights as well as any and all interest in the

apologize by February 3, 2012. Chevron did not apologize. See Ecuador: Chevron Will Not Apologize for Pollution, Even to Save $ 8.5 Billion, N.Y. Times, Feb. 4, 2012, at A7. 29

See Keefe, supra note 28.

30

See Memorandum by Patton Boggs, Invictus: Path Forward: Securing and Enforcing Judgment and Reaching Settlement 7-8, 12-13, 17-21, available at http://www.earthrights. org/sites/default/files/documents/Invictus-memo.pdf (setting forth the details of the plaintiffs' enforcement strategy). 31

Order on Plaintiff's Motion for a Temporary Restraining Order at 2, Chevron Corp. v. Donziger, No. 11-cv-00691-LAK (S.D.N.Y. Feb. 8, 2011), ECF No. 77. 32

Funding Agreement Between Treca Financial Solutions, Friends of the Defense of the Amazon, and forty named claimants §§ 2.1(a), 3(h) (Oct. 31, 2010) [hereinafter Treca Agreement] (on file with author).

33

Parloff, supra note 11.

34

Although some forty individuals are named as parties to the agreement, Treca Agreement, supra note 32, sched. 1, it is the FDA that is "the sole beneficiary of the Claim as a result of the designation by the Claimants," id. sched. 1, § 21. The Agreement purports to bind Claimants who have not signed the agreement. See, e.g., id. § 1.3 (defining the term "obligations of the Claimants" to mean "obligations expressed to be performed by the Claimants, whether or not those Claimants are signatories to this Agreement"); id. § 8.4-5 (asserting that FDA must secure the obligations of Claimants whether or not they are bound by the Agreement). The Agreement purports to empower the FDA to act on behalf of all Claimants, named and unnamed, including Claimants who are not signatories to the Agreement. See id. § 8.4. 35

Id. § 23.1.

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Page 8 of 38 54 Wm. & Mary L. Rev. 455, *468 Claim, the Award, any proceedings of the enforcement enforce [sic] the Award, and any proceeds … of any of the foregoing held by the Claimants as of the date of the assignment … (collectively, the 'Litigation Rights')." 36 The term "Award"- namely the actual, ex post value of the claim, if successful-is, in turn, described in a page-long definition and includes: [The] gross … value awarded … by virtue (directly or indirectly) of … the Claim, whether by negotiation, arbitration, mediation, diplomatic efforts, lawsuit, settlement, or otherwise … plus … [*469] any recovered interest, penalties, attorneys' fees and costs … plus … any interest awarded or later accruing … [And also] cash, real estate, negotiable instruments, choses in action, contract rights, membership rights, subrogation rights, annuities, claims, refunds … [And] including … the value of, or any obligation to perform or conduct, any investigation or other assessment (including … to assess risk to any human or the environment), clean-up, remediation, or mitigation or prevention or measures arising from or relating to the Claim … "Award" shall include [all of the above] awarded by the courts of the Republic of Ecuador otherwise than to the Claimants as a result of the application of … Ecuador's Environmental Management Act. 37 Once the Trust is established, the FDA must cause each claimant to assign all of his or her litigation rights in exchange for a "beneficial interest in the Trust." 38 Each Claimant must further "irrevocably assign to the Trust all of his … rights under th[e] Agreement." 39 In a section titled "Independent Actors," the parties agree that the arrangement "does not create any joint venture, partnership, or any … type of affiliation, nor [does it] create a joint ownership of the Claim." 40 Once the Trust is established, the Trustee must "execute and deliver to the Funder a joinder agreement by which it assumes the obligations … to be performed by the Claimants, whether or not those Claimants are signatories to" the Treca Agreement. 41 The Trustee and FDA must grant the Funder a "valid, perfected and [*470] first ranking security interest" in the claim and the award. 42 In other words, if a court awards remedial measures for the benefit of the harmed community, the Claimants must pay the monetary value of the Funder's portion of such remedial measures. The Claimants may also need to pay the Funder if any award is granted to nonparties. 43

36

Id. § 8.1(a).

37

Id. sched. 3. The term "Claim" itself is defined to include "proceeding[s] in any jurisdiction … as the same may be varied or enlarged by the addition of claims and/or additional parties … and shall include … appellate, annulment[,] … enforcement, ancillary, parallel or alternative dispute resolution proceedings[,] … diplomatic or administrative proceedings[,] … arrangements, settlements, [and] negotiations." Id. 38

Id. § 8.2. Any Claimant who "executes an Assignment Agreement shall have exactly the same rights, obligations and expectations with respect to the Claim and the Award … as such Claimant had immediately prior to executing" the assignment. Id. 39

Id. § 8.3.

40

Id. § 16.1. The stated purpose of this section is to avoid any tax implications such structures may entail, id., but in all likelihood, the purpose is also to avoid any fiduciary duties, id. § 16.4 ("[N]othing in this Agreement shall give rise … [to] a fiduciary, lawyer-client, agency or other relationship between the Parties or between their counsel, notwithstanding the information or observations or opinions that may be shared between them.").

41

Id. § 8.4.

42

Id. § 8.5

43

Commentators who have written about the commodification problem of litigation funding have suggested that this may have a chilling effect on accepting remedial measures. This risk is heightened in tort cases. See infra notes 124-25. It is very likely that these provisions would not be enforced as against public policy. It is also likely that a court would cap an arrangement whereby upward of 80 percent of the settlement proceeds go to the Funder. For example, this is achieved in United States contingency fee cases through the "lodestar standard"-the standard courts use to assess the reasonableness of attorneys' fees in class action cases. According to this standard, courts multiply counsel's reasonable hours by a reasonable hourly rate, which is then adjusted by several factors. See Lindy Bros. Builders, Inc. v. Am. Radiator & Standard Sanitary Corp., 487 F.2d 161, 166-69 (3d

Theresa Coetzee

Page 9 of 38 54 Wm. & Mary L. Rev. 455, *470 The extensive provisions relating to perfecting a first ranking security, transferring all rights and proceeds into a Trust, and installing trusted lawyers and Trustees to manage the Trust are all mechanisms put in place in order to address one of the greatest uncertainties relating to litigation, especially transnational litigation or arbitration-the uncertainty regarding the cross-border enforceability of the rights in an award, as well as the award itself. 44 The investment in the Chevron/Ecuador litigation has been syndicated by Burford, the "Major Funder," among a variety of "Minority Funders." 45 Chevron describes in a pleading the entire web of investment relationships in the following terms: [*471]

Defendants secured new funding from litigation investment firms, attorneys, and freelance investors. Much of their new funding came from New York-based Burford Advisors … [A]t the same time they executed the Treca Funding Agreement and the Intercreditor Agreement, the parties were finalizing an agreement with Torvia Limited, a company incorporated under the laws of Gibraltar and owned by Russell DeLeon, a person of interest in an ongoing federal criminal investigation ("Torvia Agreement"). Torvia initially invested $ 2 million in the litigation on March 4, 2010 and further transferred $ 1.25 million to [the former lead plaintiffs' attorney] on August 17, 2010 for a 3% cut of the "Net Plaintiff Recovery" from the Judgment. 46 Having provided an overview of the agreement, the following Subsections will highlight similarities between Burford's approach to the funding of the Ecuadorians' claims and mechanisms developed by venture capitalists to protect themselves against challenges arising from information asymmetry, agency costs, and extreme uncertainty. These mechanisms include control, staged financing, information sharing, the duty to cooperate, negative covenants, and operational efficiencies. This will set the stage for the general theoretical discussion of litigation finance contracting in Parts II and III. C. The Distribution of Control Between Burford and the Ecuadorian Claimants The Trust described above is directed and controlled by "the Claimants' Representatives, or a board of managers constituted under the Trust Deed." 47 These representatives and managers have, specifically, "the right to direct and control the Trustee with respect to the pursuit of the claim," including "the litigation strategy, … the appointment and direction of counsel[,] and approval of any settlement that the Claimants' Representatives or … board may authorize." 48 The Trust Deed is to be drafted in cooperation by [*472] Claimants' and Funders' attorneys, and the drafting of the deed is subject to a special dispute resolution mechanism that is different than the one governing the

Cir. 1973) (establishing the lodestar standard). See generally Jonathan R. Macey & Geoffrey P. Miller, Judicial Review of Class Action Settlements, 1 J. Legal Analysis 167, 193 (2009) (analyzing court standards of review for class action settlements). 44

On the challenges of enforcing against foreign assets in transnational litigation and international arbitration, see Jane L. Volz & Roger S. Haydock, Foreign Arbitral Awards: Enforcing the Award Against the Recalcitrant Loser, 21 Wm. Mitchell L. Rev. 867, 871 (1995). 45

See generally Intercreditor Agreement between Treca Financial Solutions, Torvia Limited, and others (Oct. 31, 2011) [hereinafter Intercreditor Agreement] (on file with author); Minor Funder Contracts, supranote 23. The Intercreditor Agreement isa contract entered into by the Claimants via their representative FDA, Treca/Burford as a "Major Funder," certain other "Minority Funders," and the American and Ecuadorian counsel for the Claimants. It is incorporated by reference into the Treca Agreement, supra note 32, sched. 4, and it ensures all of the Treca Agreement provisions apply equally to all past, present, and future investors, Intercreditor Agreement, supra, § 1.28. 46

Chevron's Memorandum of Law in Support of Its Motion for an Order of Attachment and Other Relief at 12-13, Chevron Corp. v. Doziger, 840 F. Supp. 2d 773 (S.D.N.Y. 2012) (No. 11-cv-00691-LAK) (citations omitted); see also id. at 13-14 (going on to list additional individuals and entities investing anywhere from $ 50,000 to $ 1 million). 47

Treca Agreement, supra note 32, § 8.1(b).

48

Id.

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Page 10 of 38 54 Wm. & Mary L. Rev. 455, *472 rest of the agreement. 49 For instance, "the Trustee is the only [p]erson entitled to … pursue the Claim and enforce … the award." 50 All proceeds of the award are to be paid to the Trust and then distributed in accordance with the Intercreditor Agreement. 51 The Agreement states that both sides agree their "common interest is served by settling the Claim for a commercially reasonable amount." 52 In a provision that seems contradictory with the investment structure described above, and which is probably meant to provide cover in relation to the rules of professional responsibility that leave absolute control over settlement in clients' hands, the Agreement also states that "the Claimants may at any time without the consent of the Funder either settle or refuse to settle the Claim for any amount." 53 The key mechanism that provides control to the Funders is the installment of "Nominated Lawyers." The Nominated Lawyers are defined as lawyers "selected by the Claimants with the Funder's approval." 54 The law firm of Patton Boggs LLP has been selected to serve in this capacity, and they have selected James Tyrrell as the lead Patton Boggs lawyer. 55 In fact, the execution of engagement agreements between the Claimants and Patton Boggs, a firm with close ties to the Funder, is a condition precedent to the funding. 56 [*473] Patton Boggs is also one of the "Active Lawyers"-the lawyers conducting the representation. 57 In addition to being actively involved in conducting the representation, the Nominated Lawyers control the purse strings. During the course of the litigation, authorization of the named, lead Nominated Lawyer must be obtained for all expenses, 58 and only he can effect the payment. 59 At the conclusion of the litigation, the award proceeds must be delivered to either the Nominated Lawyers or the Trustee, who will manage and distribute them according to the distribution waterfall. 60 In addition to exerting control, it is clear that the Nominated Lawyers, who among other things control the purse strings and serve as monitors, supervise the costs and course of the litigation. 61

49

Id. § 8.1(d).

50

Id. § 8.1(a).

51

Intercreditor Agreement, supra note 45, § 2.2.

52

Treca Agreement, supra note 32, § 4.2.

53

Id. § 4.2.

54

Id. sched. 3.

55

Id. sched. 1, §§ 2.1(a), 3(b).

56

Id. § 2.1(c). The ties between Burford and Patton Boggs generally, and the lead Patton Boggs attorney named in the Agreement specifically, has been described thus: Tyrrell is a former [partner] of Burford['s] chairman … from the days when both were partners at Latham & Watkins… [As Burford was negotiating the Treca Agreement, it was] subleas[ing] its office space from Patton Boggs's New York office, which Tyrrell heads… [And, most importantly,] Burford is a client of Tyrrell's. Parloff, supra note 11.

57

Treca Agreement, supra note 32, sched. 1, § 3(c). The overlap is reinforced in the definition of the "Nominated Lawyers Representative," which is defined as James Tyrrell or, if he "ceases to act in [that] capacity, then another lawyer prominently and actively involved in the Claim selected by the Claimants with [Burford's] approval." Id. sched. 3 (emphasis added). 58

Id. sched. 1, § 2.1. "Expenses" are defined at length and include, among other things, fees and expenses of lawyers, and fees and expenses associated with any court or arbitral proceedings, id., but exclude "any expenses of the Claimants themselves" and any "awards against the Claimants," id. sched. 1, § 2.2(a), (d). 59

Id. sched. 1, § 2.1.

60

Intercreditor Agreement, supra note 45, §§ 2-3.

61

The explicit language of the contract declares that the Funder is engaged in the business of investment and not the practice of law or other professional activities, and that it will not "give or interfere with counsel's giving of legal advice." Treca Agreement, supra note 32, § 16.2-3. This language, however, is probably intended to avoid a charge of the unauthorized practice of law in any of the jurisdictions implicated in the Agreement.

Theresa Coetzee

Page 11 of 38 54 Wm. & Mary L. Rev. 455, *473 D. Staged Financing and Right of First Refusal In the timing of Burford's provision of funds under the Agreement we see a form of staged financing common in venture capital. As discussed above, the litigation funding firm's capital commitment is to be funded in three tranches: an initial tranche of $ 4 million and two additional tranches of $ 5.5 million each. 62 The Funder retains a right of first refusal on subsequent rounds, and if it declines to fund a tranche, the Claimants have a right to secure funding from other sources. 63 In addition, the Funder has termination rights: it [*474] may terminate the Agreement in case of a breach of a material condition, representation, or warranty, as well as due to a breach of the duty to cooperate 64 -discussed below. The staged financing reduces information asymmetry, uncertainty, and agency costs. 65 E. Information Sharing, Duty to Cooperate, and Common Purpose A detailed information-sharing regime is prescribed in a provision entitled "Claimants' Duty to Co-Operate." 66 It provides that the Claimants "irrevocably instruct the Nominated Lawyers to keep the Funder fully and continually informed of all material developments … and to provide the Funder with copies of all material documents." 67 In a separate provision, the Agreement emphasizes that the Claimants' duty to cooperate is "of the essence of the Agreement" as well as a "condition thereof." 68 And in fulfillment of another condition precedent, the Claimants instruct the Nominated Lawyers to provide the Funder all material documentation and material written advice provided by the Nominated Lawyers to the Claimants, to "respond to reasonable requests for material information from the Funder" on an ongoing basis, and to inform the Funder of any form of discontinuance of the action. 69 The contract then goes on to specify, with some detail, the duties of cooperation, including duties to: devote sufficient time and attention[,] … provide all … material Documentation[,] … submit to examination by the [lawyers] for the preparation of written statements[,] … consult with the [lawyers] as they [prepare to pursue, enforce or settle] the Award[,] … appear at any proceedings or hearings[,] … [and] [*475] cause all persons related to the Claim … to submit to examination by the [lawyers]. 70 Given that the information sharing regime structured by the Agreement would potentially create a waiver of attorney-client privilege, work-product doctrine, and similar protections, as discussed below, 71 the contract includes a number of provisions aimed at minimizing this risk. For example, the Agreement states that "[t]he Parties acknowledge and mutually represent to each other that it is their common purpose … to enable the Claimants to

62

See supra note 32 and accompanying text.

63

Treca Agreement, supra note 32, §§ 2.1(f), 19.1. However, such funding from third parties must be consistent with the Intercreditor Agreement. Id. § 2.1(f). 64

Id. §§ 11.1, 13.4.

65

See infra Part III.B.2.a.

66

Treca Agreement, supra note 32, § 5.

67

Id. § 5.1. In an attempt to preserve the attorney-client privilege over the communication between Claimants and the Nominated Lawyer, the provision goes on to state the following: "The Claimants and the Funder agree that the Nominated Lawyers may not disclose information or documents that the Nominated Lawyers reasonably believe could or would jeopardize any privilege." Id.

68

Id. § 13.4.

69

Id. § 13.1(a)-(d).

70

Id. § 5.1.

71

See infra notes 116-17, 137-40 and accompanying text.

Theresa Coetzee

Page 12 of 38 54 Wm. & Mary L. Rev. 455, *475 pursue their Claim," 72 as well as, broadly, "that they have a 'common legal interest' in the Claim, [the] Agreement, and any discussion, evaluation and negotiation and other communications and exchanges of information relating thereto." 73 The parties designate as "Common Interest Material" legal advisers and attorneys' work product protected by any privilege in any jurisdiction, as well as "information … prepared by the Funder." 74 The parties express their intention that "any Common Interest Material shall at all times remain subject to all applicable privileges and protections from disclosure," and assert that "[i]t is the good faith belief of the [parties] that common interest privilege attaches to the Common Interest Material." 75 The Agreement also creates a broad category of "Confidential Information" in a clause that provides a glimpse into the information the parties anticipated exchanging. 76 The term encompasses matters such as transactional documents and discussions relating to them; "the existence of the funding … [and] the identity of the Funder[s;] … the factual, legal … [and] economic … background of the claim; … the procedural status of the claim; the planned strategies and the tactics[;] … the expected recover[y;] … billing arrangements[;] … litigation risk product[s] [and] information on litigation risk markets[;] … [and] risk modeling." 77 The Agreement [*476] specifically prohibits any "announcement concerning the existence of th[e] Agreement, the funding of the Claim ..., or the identity of the Funder." 78 In other words, in this Agreement the parties forgo any reputational benefits that may be reaped from making the involvement of a Funder known, especially one that is a market leader. And, neither party may disclose "for a period of seven … years following [the] termination of th[e] Agreement any Confidential Information or Common Interest Material." 79 These multiple, elaborate, and at times contradictory provisions capture the tension between the economic imperatives to reduce information asymmetry and the recognition that the law operates to increase it. F. Negative Covenants, Representations, and Warranties The Treca Agreement contains a number of negative covenants, representations, and warranties designed to address the problems of extreme uncertainty, information asymmetry, and agency costs. 80 Examples include the Claimants' covenants not to engage in any conduct that is "likely to have a material adverse impact in any way on the Claim [or] the value of the Recovery," 81 not to execute "any documents which would materially or adversely affect the Claim or the recoverability of the Award," 82 not to engage in any conduct "that would result in the Funder receiving proportionately less payments or less favourable treatment" as compared with other rights holders in the

72

Treca Agreement, supra note 32, § 4.1.

73

Id. § 13.2.

74

Id. sched. 3; see also id. § 12 ("Confidentiality"); id. § 13 ("Information and Privilege").

75

Id. § 13.3.

76

Id. sched. 3.

77

Id.

78

Id. § 12.3.

79

Id. § 12.2.

80 A

representation is a statement of fact as of a moment in time intended to induce reliance." Tina L. Stark, Drafting Contracts 12 (2007). A misrepresentation gives rise to a cause of action sounding in tort and allows restitutionary recovery, rescission, and-if fraudulent-punitive damages. Id. at 14-15. A warranty is a promise by the maker of a statement that the statement is true. Id. at 13. Its breach gives rise to a cause of action sounding in contract and may afford the injured parties damages. Id. at 14-15. Therefore, such broad representations and warranties provide the Funder with breach of contract and tort claims. 81

Treca Agreement, supra note 32, § 5.2.

82

Id. § 10.2(g).

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Page 13 of 38 54 Wm. & Mary L. Rev. 455, *476 litigation, 83 and not to "institute any [legal] action … against any Defendant." 84 By anticipating actions that may [*477] be beneficial to the Claimants but not to the Funders, these provisions address agency costs. Claimants agree not to sell any further portions of the case to other investors without first providing notice to the Funder, nor to do so in a way that is inconsistent with the associated Intercreditor Agreement. 85 The contract includes a representation that Claimants have received "legal advice in relation to [the] Agreement and all other arrangements between themselves, the Funder and the Nominated Lawyers," 86 as well as, more broadly, that they have "received independent legal advice on the terms and effect of the Transaction Documents." 87 This language is aimed at a potential charge of a conflict of interest between the Funder and the Claimants. The Claimants further represent and warrant that they have not made any material omissions; 88 that they have disclosed "all documentation and other information in [their] possession or control relevant to the Claim that is … likely to be material to the Funder's assessment of the Claim and [that they] believe[] … that the Claim is meritorious and likely to prevail;" 89 and that they did "not fail[] to disclose … any facts … which … would … have led the Funder not to enter into th[e] agreement." 90 These overlapping and somewhat redundant representations and warranties address information asymmetries. Finally, any attempt to seek relief for breach of the Treca Agreement in a court of law, as opposed to the international arbitration institute specified in the agreement; to seek any other relief or remedies in any forum; or to assert personal jurisdiction over the investors in a U.S. court, all constitute a breach of the Agreement. 91 Instead, the parties opt for confidential international [*478] arbitration and, more broadly, for a highly structured and somewhat unusual dispute resolution mechanism. All but one of the provisions of the Agreement are governed by the laws of England. 92 The Trustee and the FDA's obligation to provide a valid, perfected, first-ranking security interest is governed by the law of New York. 93 All disputes other than the disputes regarding the value of a noncash award are subject to international arbitration by a three-member panel administered by the International Centre for Dispute Resolution (ICDR). 94 Disputes regarding noncash award value are to be resolved by a single arbitrator, who is an accounting or valuation expert, in an expedited process. 95 The legal seat chosen for any arbitration is London, but the physical location of any

83

Id. § 10.2(h).

84

Id. § 5.3.

85

Id. § 2.1(f). They also covenant not to assign or convey the Agreement or any rights or obligations thereunder. Id. § 22.1.

86

Id. § 6.1.

87

Id. § 10.2(d).

88

Id. § 10.2(h). For an example of a court recognizing that a litigation funding agreement may be terminated because of an omission of material fact, see Chevron Corp. v. Doziger, No. 11-cv-00691-LAK, 2012 WL 1711521, at *15-17 (S.D.N.Y. May 14, 2012).

89

Treca Agreement, supra note 32, § 10.2(1).

90

Id. § 10.2(p).

91

Id. §§ 7.8, 23.7-.8. For further discussion of the dispute resolution mechanism in its entirety, see infra notes 93-96 and accompanying text.

92

Treca Agreement, supra note 32, § 23.1.

93

Id.

94

Id. § 23.2-.4.

95

Id. § 23.4.

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Page 14 of 38 54 Wm. & Mary L. Rev. 455, *478 proceeding is in the Cayman Islands. mechanism. 97

96

As noted, the drafting of the Trust Deed has a separate dispute resolution

The champerty doctrine, discussed below, creates a legal gray zone for litigation funding in many jurisdictions; 98 this is a characteristic and, more specifically, a risk factor of litigation as an asset. By tailoring the dispute resolution process and penalizing any attempt to turn to national courts, the parties are endeavoring to reduce and control this risk factor and the uncertainty that the prospect of litigating the Agreement creates. More broadly, these restrictions on using domestic and foreign courts of law are aimed at minimizing the uncertainty relating to the many unsettled and controversial issues regarding the possible interpretation of a third-party litigation funding agreement by American and other courts. 99 They are also more generally aimed at minimizing the uncertainty inherent in dispute resolution by a judge or jury. 100 [*479]

G. Operational Efficiencies The Treca Agreement seeks to enhance returns to the Funders' investors by minimizing any tax liabilities that may be imposed on the Award. The Claimants commit to structure the Award, as broadly defined, 101 "in the most taxefficient manner practicable" and to "consider … commercially reasonable methods," such as a trust, to achieve that purpose. 102 And any taxes that cannot be avoided are to be borne by the Claimants under the Agreement. 103

Other value enhancements by litigation funders via operational efficiencies can be inferred from the parties' anticipation of information exchange regarding accountants, law firms, advisors, and suppliers; business plans and business relationships; market opportunities and marketing plans; and algorithms, intellectual property, ideas, know-how, knowledge, and research. 104 These represent noncash contributions that the Funder will be bringing to the table. With this concrete example of Burford's investment in the Chevron/Ecuador litigation, the following Section turns to a general discussion of the economics of litigation finance generally. II. The Economics of Litigation Finance

96

Id. § 23.5.

97

See id. § 8.1(d).

98

See infra notes 131, 134-35 and accompanying text.

99

See generally Steinitz, supra note 2, at 1278-82 (putting the United States regulatory environment regarding litigation funding in a global context). On the more relaxed attitudes of international arbitration tribunals towards litigation funding, see generally J.M. Matthews & M. Steinitz, Editorial, Special Issue: Contingent Fees and Third Party Funding in Investment Arbitration Disputes, Transnat'l Disp. Mgmt., Oct. 2011. 100

Some have described international arbitration as more predictable relative to domestic adjudication by judges, and certainly juries, because of the perceived tendency of arbitrators-who rely on satisfied attorneys, that is, attorneys who have not lost in their courtroom-to reappoint them in future cases. See Stephanie E. Keer & Richard W. Naimark, Arbitrators Do Not "Split the Baby": Empirical Evidence from International Business Arbitrations, 18 J. Int'l Arb. 573, 576-78 (2001) (discussing both the perception and the empirical evidence of arbitration decisions). 101

See supra note 37 and accompanying text.

102

Treca Agreement,supra note 32, § 20.1; cf. Ronald J. Gilson & David M. Schizer, Understanding Venture Capital Structure: A Tax Explanation for Convertible Preferred Stock, 116 Harv. L. Rev. 874 (2008) (discussing tax implications in the VC context). 103

Treca Agreement, supra note 32, § 20.2-.3.

104

Id. sched. 3.

Theresa Coetzee

Page 15 of 38 54 Wm. & Mary L. Rev. 455, *479 A. The Litigation Finance-Venture Capital Analogy in a Nutshell The term "venture capital" refers to capital that is pooled, invested in securities, usually stocks, of enterprises in different stages of development, often in their early days, and professionally managed. 105 Venture capital funds (VCFs) raise money from [*480] individuals and institutions for investment in early-stage businesses that offer high potential returns on investment but carry significant risk of failure. 106 The risk is mitigated through diversificationVCFs develop portfolios of companies, referred to individually as a "portfolio company." 107 As noted earlier, the term "litigation finance firms" refers to the practice of specialized funds investing in litigation by providing finance in return for an ownership stake in a legal claim and a contingency in the recovery. Like VCFs, which create and manage portfolios of high risk in potentially high-return companies, litigation finance firms develop portfolios of high-risk, high-return litigations. 108 To state the obvious, both litigation finance and VC are forms of finance. Financial contracts, generally speaking, are designed to respond to three problems: uncertainty, information asymmetry, and agency costs. The special character of VC contracting-the essence of which is investment in high-technology, cutting-edge, science-based companies-is that it presents these problems in an extreme form. 109 The same is true of litigation finance, the essence of which is investing in legal disputes before all facts and procedural aspects have been ascertained, leading to risks similar to those inherent to VC investing. Before expounding on these and other similarities, it should be noted that there are also important dissimilarities. The first difference, from which others follow, is simply the nature of the asset [*481] in question. VCFs invest in companies-usually early-stage companies. 110 Litigation finance firms invest in legal claims. 111 One consequence of this difference is that there is more of an understanding and a track record relating to the performance of the former asset but not of the latter one. Another consequential difference relates to the social utility of the asset in question. The positive social utility of VC is universally accepted: "The venture capital market and firms whose creation and early stages were financed by venture capital are among the crown jewels of the American economy. Beyond representing an important engine of macroeconomic growth and job creation, these firms have been a major force in commercializing cutting-edge science." 112 To name but a few examples of companies that were created with the support of VC, one could list Apple, Intel, FedEx, and Microsoft. 113 Conversely, the social utility of litigation funding is controversial. 114

105

William A. Sahlman, The Structure and Governance of Venture-Capital Organizations, 27 J. Fin. Econ. 473, 473 (1990).

106

Francesca Cornelli & Oved Yosha, Stage Financing and the Role of Convertible Securities, 70 Rev. Econ. Stud. 1, 1 (2003).

107

Sahlman, supra note 105, at 474-75. Venture capital firms are usually set up as either open-end funds or closed-end funds. The analysis below applies equally to both. Venture capital is also sometimes provided by "angel investors"-individuals, often times friends or family members-who provide seed funding at very early stages of the enterprise's life. Similarly, individuals-be they family members or professional investors-may provide funding to a litigant with an expectation of making a profit should the litigant prevail. 108

Descriptions of such portfolios can be found in the disclosures of the publicly traded litigation funds. See, e.g., Burford Capital Interim Report 3-4 (2011), available at http:// www.burfordfinance.com/docs/default-document- library/burford capital interim 2011 web.pdf; Juridica Invs. Ltd., Half Yearly Report and Unaudited Condensed Consolidated Financial Statements 6 (2011), available athttp://www.juridicainvestments .com//media/Files/J/Juridica/pdfs/hy2011- report.pdf. 109

Ronald J. Gilson, Engineering a Venture Capital Market: Lessons from the American Experience, 55 Stan. L. Rev. 1067, 1069 (2003). 110

See supra note 106 and accompanying text.

111

See supra notes 7-8 and accompanying text.

112

Gilson, supra note 109, at 1068.

Theresa Coetzee

Page 16 of 38 54 Wm. & Mary L. Rev. 455, *481 Finally, this non-exhaustive list of differences must include the fact that any litigation funding scheme involves not only investors, an investment fund, and an investment, but also attorneys- sometimes acting purely as the representative of the plaintiff and sometimes acting also as investors in the litigation, through contingency fees or other forms of alternative billing schemes. The involvement of an attorney creates a triangular attorney-client-funder relationship, which raises its own set of agency problems. The attorney-client relationship is a regulated relationship, and this regulation further complicates the agency problems: Beyond concerns relating to control[,] … [fragmentation of the attorney's relationship with the client, on the one hand, and the funder, on the other] creates conflicts between an attorney's interest to maximize fees and those of the financier to do the same. These divergent interests may lead one to settle early but the other to proceed to trial … Similarly, if fee splitting is prohibited and the attorney receives a flat or hourly fee instead of a percentage of the recovery, the attorney has less incentive to properly vet a case as [he] transfer[s] all risk to the funder. [*482] This moral hazard can increase if claims are then securitized and further distributed. While both attorneys and funders, as savvy repeat players, have an interest in creating and preserving reputational gains, this interest may pull them in different directions in any given litigation and may not be aligned with the client's interest. 115 Conflicts of interest are not the only complication created by the triangular attorney-client-funder relationship, which is artificially fragmented through the operation of the rules of legal professional responsibility. Client or attorney communication with the financier, which is necessary for the financier to monitor the litigation, breaks the attorneyclient privilege. 116 "[A] lack of such communication creates information asymmetries between the attorney and the funder and lowers the funder's ability to supervise the attorney's work," thereby significantly reducing the potential to have an "agents-watching-agents" effect, namely the potential cross-monitoring of the lawyers and funders. 117 In sum, the triangular, fragmented attorney-client-funder relationship creates, by design, expanded information asymmetries and has the side effect of magnifying agency costs. The next Subsection further elaborates on how the ethics regime regulating litigation funding must affect our understanding of legal claims as assets. Specifically, it addresses how the path-dependent regulation of third-party funding, originally developed to address the role thirdparty funding played in land disputes amongst lords in medieval England, 118 affects valuation of legal claims today. It sets the stage for the argument that we should break away from this path and instead connect to the path through which the law governing venture capitalism developed. [*483]

B. Ethical Bounds to Third-Party Profit Making in Litigation Litigation funding is a controversial industry. Proponents of litigation funding cite access to justice, leveling of the playing field between plaintiffs and defendants, free speech, and private enforcement of the law as key advantages

113

Sahlman, supra note 105, at 482.

114

See infra text accompanying notes 124-28.

115

Steinitz, supra note 2, at 1324.

116

E.g., Leader Techs. v. Facebook, Inc., 719 F. Supp. 2d 373, 376 (D. Del. 2010).

117

Steinitz, supra note 2, at 1324-25 & n.200; see also Bernard S. Black, Agents Watching Agents: The Promise of Institutional Investor Voice, 39 UCLA L. Rev. 811, 850 (1992) (developing the concept of "[a]gents [w]atching [a]gents," which describes situations when the self-interests of one set of agents involves monitoring other agents who have a different set of self-interests that, in turn, may conflict with the interests of the principals); John C. Coffee, Jr., Litigation Governance: Taking Accountability Seriously, 110 Colum. L. Rev. 288, 342 (2010) (describing scenarios in which attorneys' and funders' respective self-interests counterbalance each other). 118

Steinitz, supra note 2, at 1287.

Theresa Coetzee

Page 17 of 38 54 Wm. & Mary L. Rev. 455, *483 of the practice. 119 "Third-party funding promotes access to justice by enabling plaintiffs who have meritorious cases to bring litigation they would otherwise be unable to bring and to avoid premature settlements at a discount due to the exhaustion of funds." 120 Funding can level the playing field not only at the level of any given dispute but also on a system-wide level, altering the social function of courts by systemically equalizing the ability of society's "have-nots" to use the courts to affect the path and content of judge-made law via litigation. 121 First Amendment arguments in support of litigation funding include the recognized notion that the right to sue is a First Amendment right particularly, but not exclusively, in the context of civil rights litigation, as well as the more contentious claim that restricting certain forms of law firm financing is a violation of attorneys' freedoms of speech and association. 122 Last but not least, private law enforcement is the enforcement of the law by private parties pursuing legal action for profit, often times using nonclient financing: "[T]o a unique degree, American law relies upon private [*484] litigants to enforce substantive provisions of law that in other legal systems are left largely to the discretion of public enforcement agencies." 123 The industry's critics retort with fear of a deluge of nonmeritorious claims, a distaste for nonparty profiteering from litigation, a concern about commodification of causes of action, and an objection to the use of the taxpayer-funded court system for investment purposes. 124 The most vocal opponent of the litigation finance industry in the United States is the U.S. Chamber of Commerce, which describes the practice in these words: In a typical case[,] a hedge fund, acting on behalf of already wealthy investors, will seek to accumulate yet more money-not by investing in business enterprise or wealth creation-but by gambling on the outcome of a legal action

119

See id. at 1276 n.12, 1303 (commenting on access to justice and on how litigation funding can alter repeat players' power dynamics).

120

Id. at 1276 & n.12.

121

See id. at 1299-1301, 1303-18 (building upon Marc Galanter's classical essay Why the "Haves" Come Out Ahead: Speculations on the Limits of Legal Change, 9 Law & Soc'y Rev. 95 (1974)). 122

NAACP v. Button, 371 U.S. 415, 428-29 (1963) (holding that litigation to enforce civil rights is a form of expression protected by the First and Fourteenth Amendments). In a currently pending lawsuit before three federal district courts, the plaintiffs' firm Jacoby & Meyers has sued the states of New York, New Jersey, and Connecticut claiming that state laws prohibiting nonlawyers from owning a stake in law firms unconstitutionally restricts freedom of speech and association as well as interstate commerce. See Jacoby & Meyers, LLP v. Presiding Justices, 847 F. Supp. 2d 590, 591-92 (S.D.N.Y. 2012); Complaint at 3-4, Jacoby & Meyers Law Offices, LLP v. Justices of the Supreme Court of N.J., No. 11-cv-02866-JAP (D.N.J. May 18, 2011), ECF No. 1; Complaint at 3-4, Jacoby & Meyers Law Offices, LLP v. Judges of the Conn. Superior Court, No. 11-cv-00817-CFD (D. Conn. Mar. 18, 2011), ECF No. 1; see also Case Comment, Constitutional Law: First Amendment Limitations on State Regulation of the Legal Profession-Litigation as a Protected Form of Expression, 1963 Duke L.J. 545, 550-54. 123

John C. Coffee, Jr., Understanding the Plaintiff's Attorney: The Implications of Economic Theory for Private Enforcement of Law Through Class and Derivative Actions, 86 Colum. L. Rev. 669, 669 (1986); see also Coffee, supra note 117, at 341-42 (arguing that nonprofit groups in Europe should join forces with litigation funders); Louis Kaplow & Steven Shavell, Why the Legal System Is Less Efficient than the Income Tax in Redistributing Income, 23 J. Legal Stud. 667, 674-75 (1994). 124

See, e.g., Stephen B. Presser, A Tale of Two Models: Third Party Litigation in Historical and Ideological Perspective 27 (Northwestern Univ. Sch. of Law Searle Ctr. on Law, Regulation & Econ. Growth, Pub. Policy Roundtable on Third Party Fin. of Litig., Discussion Draft, Oct. 2009); see also Vicki Waye, Trading in Legal Claims: Law, Policy & Future Directions in Australia, UK & US 48 (2008) (discussing commodification of legal claims); Paul H. Rubin, On the Efficiency of Increasing Litigation 10-11 (Sept. 24-25, 2009) (unpublished manuscript), available at http://www.law.northwestern.edu/searlecenter/papers/ RubinThirdPartyFinancingLitigation.pdf (arguing that the costs imposed by litigation on defendants are greater than costs borne by plaintiffs, especially when plaintiffs are individuals or class members and defendants are business firms).

Theresa Coetzee

Page 18 of 38 54 Wm. & Mary L. Rev. 455, *484 for damages. They have no interest in the justice or otherwise of [sic] the case-only in the chances of success-as they will demand a share of the damages awarded in return for putting up the stake money. 125 Another key concern is that third-party funding will diminish clients' control over their claims generally, and in particular in connection with the decision of when and for how much to settle: "The argument against litigation funding based on the client's [*485] diminished control is, in essence, one of separation of ownership and control between the client and the funder (like the attorney in contingency cases)." 126 The Chamber of Commerce report emphasizes that "litigation-financing arrangements undercut the plaintiff's control over his or her own claim because investors inherently desire to protect their investment and will therefore seek to exert control over strategic decisions in the lawsuit." 127 From the courts' perspective the difficulty posed by litigation funding is that organisations like [the funders] play more shadowy roles than lawyers. Their role is not revealed on the court file. Their appearance is not announced in open court… [T]he court is in a position to supervise litigation conducted by persons who are parties to it; it is less easy to supervise litigation, one side of which is conducted by a party, while on the other side there are only nominal parties, the true controller of that side of the case being beyond the court's direct control. 128 Despite the controversy, litigation funding is rapidly expanding and is, in all likelihood, here to stay. 129 To date, those studying the young litigation funding industry have focused almost exclusively on the ethics of the practice and its relation to the rules of profes- [*486] sional responsibility. 130 This Article breaks away from this paradigm. However, before turning to that discussion, it is worth touching on the historical and current ethical constraints on litigation funding in order to reframe those constraints as forces that shape the economics of litigation funding. Where allowed, litigation funding is an exception to the ancient common law prohibition on champerty. A champertous agreement is one in which an owner of a legal claim and a third, unrelated party agree to divide amongst themselves the proceeds of a litigation, if successful. It has also often been referred to pejoratively as an arrangement between an "officious intermeddler" and a litigant whereby "the intermeddler helps pursue the litigant's claim as consideration for receiving part of any judgment proceeds." 131 The origin of the champerty doctrine is in medieval English law, wherein maintenance (the provision of something of value to a litigant in order to support a 125

John Beisner et al., Selling Lawsuits, Buying Trouble: Third-Party Litigation Funding in the United States 3 (Oct. 2009), available at http://www.instituteforlegal reform.com/sites/default/files/thirdpartylitigationfinancing.pdf (released by the U.S. Chamber Institute for Legal Reform).

126

Steinitz, supra note 2, at 1323. That article goes on to argue that: This is, however, a conceptual confusion that is caused by the tendency to treat third-party funding as identical to attorney funding, in which the party with the purse strings exerts undue control. But unlike the case of attorney funding, with litigation funding and claim transfer the client relinquishes full or partial ownership over its claim. (In fact, arguably, the attorney and client are now both agents of the funder who co-owns part or the entire claim.) The law should acknowledge that the client relinquishes or should relinquish partial control over the litigation as it transfers partial ownership thereof. This, of course, should be factored into the pricing of the finance in favor of the client. Id. at 1323-24. The argument herein builds on this view and elaborates on how we can conceptualize and regulate the funder-client relationship once we let go of the path-dependent contingency lawyering analogy and view the funders as real parties in interest. 127

Beisner et al., supra note 125, at 7.

128

Campbells Cash & Carry Pty Ltd. v Fostif Pty Ltd. (2006) 229 CLR 386, 487 (Austl.) (Callinan, J & Heydon, J, concurring).

129

Lloyd's, Litigation and Business: Transatlantic Trends 10 (2008), available at http://www.Lloyds.com//media/Lloyds/Reports/360/360%20Liability%20Reports/360 Litiga tionandbusiness.pdf ("Businesses should expect third party litigation funding to rise on both sides of the Atlantic."). 130

E.g., Douglas R. Richmond, Other People's Money: The Ethics of Litigation Funding, 56 Mercer L. Rev. 649, 660-64, 669-81 (2005). 131

Steinitz, supra note 2, at 1286-87 (quoting Black's Law Dictionary 262 (9th ed. 2009)).

Theresa Coetzee

Page 19 of 38 54 Wm. & Mary L. Rev. 455, *486 litigation), champerty (maintenance for a profit), and barratry (the bringing of vexatious litigation) were crimes and torts. 132 During the nineteenth and twentieth centuries these crimes and torts have been abolished throughout the common law world and replaced with legal ethics rules. 133 During the first decade of the twenty-first century the common law world trend to loosen up champerty restrictions-now predominantly an ethical violation- continued. 134 Nonetheless, champerty is very much a live and operative doctrine in many jurisdictions. In the United States, champerty is [*487] a common law doctrine which varies by state and entails fact-specific, case-by-case analysis: "Of the twenty-eight states that permit maintenance in some form, sixteen explicitly permit maintenance for profit. The remaining states probably permit champerty -it is just that they do not explicitly cite the investment by contract into a stranger's suit as a permissible form of maintenance." 135 Champerty is not the only ethical hurdle to litigation funding. Law lenders, who provide recourse loans, are subject to usury laws, namely the prohibition on excessive interest rates. 136 Lawyers involved in financed cases must make sure not to run afoul of professional responsibility rules such as the prohibition on fee sharing, 137 the duty to exercise independent professional judgment, 138 and the duty of loyalty to the client. 139 Close attention has particularly been given, in the context of the rise of litigation funding, to the need not to violate or waive attorneyclient privilege or the protection of the attorney work-product doctrine when communicating with funders. 140 Particularly in the United States, ethical rules rooted in the desire to allow plaintiffs to retain maximum control over their claims have naturally led to discussions of the industry in ethical terms, creating a clear obstacle to litigation funding. In economic terms, however, current ethical rules greatly increase information asymmetries, and the described conflicts of interest increase agency costs, while the nature of legal claims-as assets-contributes to extreme uncertainty. The following Subsections will show that litigation funding shares those same characteristics with VC, paving the way for the argument that the successful approaches to [*488] structuring VC can be applied, and in some cases adapted, to litigation funding. C. Information Asymmetry and Agency Costs

132

See Ari Dobner, Comment, Litigation for Sale, 144 U. Pa. L. Rev. 1529, 1543-45 (1996) (discussing the history of champerty and maintenance laws). 133

For example, in England the crime of champerty has been abolished. See Criminal Law Act, 1967, c. 58, § 13, sch. 1 (Eng.). In Australia, champerty and maintenance have been abolished through statutes such as Maintenance and Champerty Abolition Act 1993 (NSW) and the Wrongs Act 1958 (Vic) s 32.

134

The two pivotal decisions are the English Court of Appeal's decision in Arkin v. Borchard Lines Ltd., [2005] EWCA (Civ) 655, [16], [45], [2005] 3 All. E.R. 613, which held that third-party funding is acceptable and even desirable as a way of increasing access to justice, and the Australian High Court's decision in Campbells Cash & Carry Pty Ltd. v Fostif Pty Ltd. (2006) 229 CLR 386, 434-35 (Austl.), which permitted third-party funding and even approved of the funder having broad powers to control the litigation. 135

Anthony J. Sebok, The Inauthentic Claim, 64 Vand. L. Rev. 61, 107 (2011); see also id. at 98-120 (providing a survey and analysis of the law of maintenance, champerty, and assignment in all fifty-one jurisdictions and concluding that the answer to the question of how states determine whether, and to what degree, nonlawyer third parties may support meritorious litigation is complex and that confusion reigns over the doctrines and their application). 136

Susan Lorde Martin, Financing Litigation On-Line: Usury and Other Obstacles, 1 DePaul Bus. & Com. L.J. 85, 89-91 (2002). 137

Model Rules of Prof'l Conduct R. 5.4(a) (2010).

138

Id. R. 5.4(a)-(d).

139

Id. R. 1.7 cmt. 1.

140

See id. R. 1.6(a) ("A lawyer shall not reveal information relating to the representation of a client."); id. cmt. 3 (discussing the attorney work-product doctrine).

Theresa Coetzee

Page 20 of 38 54 Wm. & Mary L. Rev. 455, *488 Venture capitalists face extreme information asymmetry because the entrepreneurs have all the information about the invention. In particular, the fact that the company's technology often involves cutting-edge science creates substantial information asymmetries in favor of the entrepreneur, a specialist in said science, over the venture capitalist. Information asymmetries between investors and entrepreneurs are further expanded due to the fact that the intentions and abilities of the entrepreneurs are hard to observe and assess. 141 Litigation financiers face similar asymmetries, because the plaintiffs have private knowledge of the facts, including knowledge of potentially key facts, harmful "smoking gun" documents, potentially harmful or weak witnesses, and the like. 142 Current ethical rules act to reinforce plaintiffs' disincentive to share that private knowledge with anyone other than their attorneys by withholding privilege from communications to nonattorney parties. 143 The plaintiff's intentions and abilities are as hard to observe as those of an entrepreneur. For example, a plaintiff's willingness or capacity to cooperate effectively with counsel-for instance, by timely producing documents, or by ensuring that witnesses make themselves available for deposition-are unknown to the funder. Whether and to what degree the plaintiff is susceptible to "litigation fatigue" caused by the emotional stress of litigation, or is an effective witness, are similarly unknown. These information asymmetries are compounded by the deliberate information asymmetries that result from the attorney-client privilege, discussed above. Venture capitalists face extreme agency costs because the success of the venture depends on the efforts of the entrepreneurs, who have been compensated up front. 144 The importance of future managerial [*489] decisions in the early stage venture creates agency costs that are amplified by the fact that an entrepreneur's interest in the venture, which is now backed by VC, is appropriately understood-in the same manner as litigation-as an option. 145 Therefore, the entrepreneur is now in a conflict of interest vis-a-vis the VC investors with respect to such issues as the desirable level of risk and the investment duration. 146 The entrepreneur will now be inclined to assume more risk and hold the investment longer than she would have had the venture been self-financed. The venture capitalist, by contrast, will be incentivized to liquidate the investment as early as possible. 147 This latter agency problem has been referred to as "grandstanding" or the "early harvesting" problem. 148 The early harvesting problem in the VC context is identical to the early settlement problem-one of the most commonly cited concerns of both proponents and opponents of litigation funding. 149 Here, the concern is that funders are incentivized to settle early for a discounted but secure amount rather than proceed to a costly trial that may result in a loss or low recovery. They are also incentivized to underinvest in the litigation because they face

141

See Gilson, supra note 109, at 1076-77.

142

See supra notes 116-17 and accompanying text.

143

See supra notes 137-40 accompanying text.

144

See Gilson, supra note 109, at 1083-84.

145

Id. at 1077; see also Fischer Black & Myron Scholes, The Pricing of Options and Corporate Liabilities, 81 J. Pol. Econ. 637, 650-52 (1973) (describing corporate stocks in terms of options).

146

Gilson, supra note 109, at 1077.

147

Id. at 1074.

148

See id. at 1074-75; Paul A. Gompers, Grandstanding in the Venture Capital Industry, 42 J. Fin. Econ. 133, 133 (1999) (testing, specifically, "the hypothesis that young venture capital firms take companies public earlier than older venture capital firms in order to establish a reputation and successfully raise capital for new funds," and showing, inter alia, that "young venture capital firms have been on the board of directors a shorter period of time … and time the IPO to precede or coincide with raising money for follow-on funds"). 149

Steinitz, supra note 2, at 1313; see also Nicholas Dietsch, Note, Litgation Financing in the U.S., the U.K., and Australia: How the Industry Has Evolved in Three Countries, 38 N. Ky. L. Rev. 687, 692-93 (2011).

Theresa Coetzee

Page 21 of 38 54 Wm. & Mary L. Rev. 455, *489 diminishing returns the longer the litigation proceeds. 150 And the plaintiff, who no longer bears the risk of a loss, may now have an incentive to resist a reasonable and rational early settlement in favor of a late [*490] settlement or even a risky and expensive trial. 151 Litigation financiers also face extreme agency costs because success depends on plaintiffs' cooperation in the prosecution of the case after they have transferred the risk-litigation costsand a large portion of the rewards-a significant percentage of the recovery. 152 This particular agency problem, or moral hazard, is well known from the insurance context in which insurers take on the burden of litigation but require, via contractual obligations, the cooperation of the insured. 153 D. Legal Claims as Assets and Extreme Uncertainty Ventures backed by VC are characterized by great uncertainty and high failure risk and are therefore typically not financed by banks. 154 The general uncertainty inherent in financing is magnified in the VC context because the portfolio company is at an early stage and most of the important decisions bearing on the portfolio company's success remain to be made. The quality of the company's management has yet to be ascertained and investors do not have certainty regarding the technological soundness or science underlying the venture's business. 155 Further, one of the key risks associated with a VC portfolio company's investment returns is their variability. 156 Research has shown that while a small number of VC investments yield a very high return many more result in partial or [*491] complete loss. For these reasons, VC returns have been likened to options-both are characterized by a very small chance of a very large payout. 157 Litigation funding has a similar degree of extreme uncertainty as does VC. In the case of litigation funding, the litigation is usually at an early stage and discovery of facts is preliminary at best. Furthermore, when the subject matter of the litigation requires specialized know-how-for example, in intellectual property cases, which can be technology-centered, or in antitrust cases, which can involve advanced economic theory-or when the case involves new legal frontiers where doctrine and precedent are undeveloped-such as in cross-border human rights and mass

150

Steinitz, supra note 2,at 1313; see also Macey & Miller, supranote 43, at 192-94 (2009) (discussing similar agency problems between contingency fee lawyers and clients in settlementnegotiations); Steinitz, supra note 2, at 1313 ("Both problems are exacerbated by the fact that [funders] make decisions across a portfolio of cases-trading off a small gain in one case for a larger gain in another case achieved with the same time-investment and reputational costs.").

151

See Steinitz, supra note 2, at 1313 n.166.

152

Cf. John F. Dobbyn, Insurance Law in a Nutshell 317 (4th ed. 2003) (discussing the same agency problem between insurer and insured).

153

See, e.g., id.; Michelle Boardman, Insurers Defend and Third-Parties Fund: A Comparison of Litigation Participation 15-16 (George Mason Law & Econ. Ctr., Working Paper, 2011) (noting that courts might imply a duty of cooperation even absent a contractual obligation). Insurance funding of defense is a long-standing form of litigation finance as is contingency fee, on the plaintiff's side. 154

See Paul A. Gompers & Josh Lerner, The Venture Capital Cycle 127 (1999) [hereinafter Gompers & Lerner, The Venture Capital Cycle] (explaining why traditional sources of financing are unsuitable for VC projects); Paul Gompers & Josh Lerner, The Use of Covenants: An Empirical Analysis of Venture Partnership Agreements, 39 J.L. & Econ. 463, 465 (1996) [hereinafter Gompers & Lerner, Covenants] (discussing the high-risk investments of venture capitalists and the tools they use to better manage such investments). In addition, banks do not invest in litigation financing because it is financing provided upfront with no expected cash flow for an extended period of time. I thank Victor Goldberg for this comment. 155

See Gilson, supra note 109, at 1076-77.

156

See id. at 1076.

157

John H. Cochran, The Risk and Return of Venture Capital, 75 J. Fin. Econ. 3, 5 (2005); Gilson, supra note109, at 1076; seealso Sahlman, supra note 105,at 482-83 (emphasizing the great uncertainty regarding returns on individual VC projects). For example, one of the earliest VC investments, American Research and Development Corporation's "ARD," the first-ever professional VCF formed in 1946, invested in Digital Equipment Corporation and yielded a return of more than 70,000 percent. See Spencer E. Ante, Creative Capital: Georges Doriot and the Birth of Venture Capital 107-08, 196 (2008).

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Page 22 of 38 54 Wm. & Mary L. Rev. 455, *491 tort cases 158 -subject matter uncertainty can increase overall uncertainty in the same manner that scientific uncertainty operates in the VC context. The client's and the attorney's control over the litigation create further uncertainty for the financier. The attorney's influence over the litigation, as discussed below, 159 is not dissimilar to management's influence over a portfolio company. In other words, the quality of the attorney's decision making, a relative or complete unknown to the funder, contributes to the uncertainty, especially when the attorney has been retained prior to the funder's involvement and without the funder's input. 160 But the most significant source of uncertainty for litigation funding is the nature of litigation itself. According to a new body of literature that applies financial theory to law, litigation should be [*492] analyzed as an option, because during the course of a case each party has an option to settle or select trial. This choice suggests the application of an option pricing model to legal valuation: "The case assessment of a civil action follows a random walk like that of a stock. The up-down movement of probability (expectations [of the parties]) is a function of information dissemination." 161 Similarly, according to financial theorists of law, legal probability is not statistical or objective. It is logical and subjective, changing over the lifetime of a litigation as facts unfold. Thus, while the law and economics literature models probability as an empirical and quantifiable concept, when mathematicians considered the application of probability to legal action they rejected the notion that statistical probability could apply or that such probability was measurable. 162 Further, while classical economic theory of law assumes that decision standards of deliberative bodies-such as courts and arbitral tribunals-are a fixed point of reference, both financial theorists and behavioral economists of law argue, and show, that the assumption that these bodies apply consistent standards in similar disputes is unrealistic. This is because judicial proceedings are not predictable and because the ability of parties and their lawyers to predict such outcomes are inherently, and deeply, flawed. 163 In particular, behavioral economic analysis of the law literature, which emerged in the late 1990s and the 2000s and has focused in no small part on litigation, shows that litigation behavior can be expressed in terms of three important "bounds" on human behavior: bounded rationality, willpower, and self-interest. 164 Each of the [*493] three bounds has a documented effect on the ability to generate sound predictions of the litigation process. 165

158

The Supreme Court is, as of this writing, hearing a pivotal case with broad implications as to the question of whether corporations can be held accountable for cross-border human rights and environmental abuses. Kiobel v. Royal Dutch Petroleum Co., 132 S. Ct. 472 (2011). I note this example because the test case described in Part I is a cross-border mass-tort case. 159

See infra Part III.A.

160

See Steinitz, supra note 2, at 1313 (discussing the motives underlying attorney underinvestment in any given litigation).

161

Robert J. Rhee, A Price Theory of Legal Bargaining: An Inquiry into the Selection of Settlement and Litigation Under Uncertainty, 56 Emory L.J. 619, 664 (2006). A "random walk" is a mathematical expression of a trajectory that consists of taking successive random steps. Karl Pearson first used the expression in The Problem of the Random Walk, 72 Nature 294 (1905). According to Rhee, like stock prices, perceived case values fluctuate based on new information. Rhee, supra, at 664. 162

See Rhee, supra note 161, at 645-50 (distinguishing statistical probability from logical probability-the latter being a relationship between premises, facts, inferences, and conclusions-and discussing the mathematical literature).

163

See id. at 637. The decision of a deliberative body "does not exist ex ante as a fixed reference point that the parties must discover, but is simply an ex post result that the parties achieve if they opt for trial." Id. at 663-64 (emphasis added).

164

Christine Jolls et al., A Behavioral Approach to Law and Economics, 50 Stan. L. Rev. 1471, 1476-77 (1998).

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Page 23 of 38 54 Wm. & Mary L. Rev. 455, *493 For example, parties, lawyers, judges, and juries operate based on heuristics and biases, creating uncertainty as to a dispute's outcome. Further, empirical evidence reveals that litigants are not optimal processors of information. Consequently, parties' assessments of the likely outcome of the litigation diverge, rather than converge, as more facts are disclosed-usually, through the discovery regime. 166 It turns out that in reality shared information is likely to be interpreted egocentrically by disputants. 167 Parties tend to "either be overoptimistic in the assessments of cases or construe the fairness of the situation in a self-serving fashion." 168 Self-serving inferences and the sunk costs bias have been shown to explain why certain procedural mechanisms designed to cause more upfront information sharing and evaluation, "like liberalized summary judgment … standards and mandatory disclosures … may not have the desired pro- settlement effects" intended. 169 Several studies have demonstrated that even experienced litigators are not good predictors of claim value. "The results are consistent: lawyers, insurance adjusters, and judges all err by very substantial amounts when asked to estimate either the settlement value or predicted trial outcomes." 170 Empirical research shows that [*494] lawyers tend to be generally overconfident, and especially so in cases in which they initially made highly confident predictions. 171 Additionally, most lawyers are not experienced trial lawyers since the vast majority of cases settle. 172 They therefore do not have the required experience that would, perhaps, have afforded them the ability to soundly assess the likelihood of how a judge or a jury would decide. The rarity of trials also complicates efforts to value or model litigation outcome because it results in a lack of adequate data upon which lawyers or financiers can rest their predictions. Furthermore, while there is a huge number of settlements-the market in settlements is estimated to have an annual value of $ 50 billion, which is similar to the U.S. housing market-this market is unusual in that we have no information about it. 173 Consequently, pricing information for civil settlements badly lags behind information about comparable markets. "Lacking information about comparable transactions, litigants and their lawyers price

165

See generally 3 Behavioral Law and Economics (Jeffrey J. Rachlinski ed., 2009); Donald C. Langevoort, Behavioral Theories of Judgment and Decision Making in Legal Scholarship: A Literature Review, 51 Vand. L. Rev. 1499, 1508, 1511 (1998).

166

See Rhee, supra note 161, at 653.

167

George Lowenstein & Don A. Moore, When Ignorance Is Bliss: Information Exchange and Inefficiency in Bargaining, 33 J. Legal Stud. 37, 37 (2004). 168

Langevoort, supra note 165, at 1510-11.

169

Id. at 1511; see also Samuel Issacharoff & George Loewenstein, Second Thoughts About Summary Judgment, 100 Yale L.J. 73 (1990); Samuel Issacharoff & George Loewenstein, Unintended Consequences of Mandatory Disclosure, 73 Tex. L. Rev. 753 (1995); Donald C. Langevoort, Where Were the Lawyers? A Behavioral Inquiry into Lawyers' Responsibility for Clients' Fraud, 46 Vand. L. Rev. 75, 100-01 (1993) (suggesting that once lawyers commit to client representation they may be biased in their construal of information and hence miss warning signs of client fraud); Elizabeth F. Loftus & Willem A. Wagenaar, Lawyers' Predictions of Success, 28 Jurimetrics J. 437, 450 (1988) (discussing the effects of overoptimism on how lawyers assess the probability of success). 170

Stephen C. Yeazell, Transparency for Civil Settlements: NASDAQ For Lawsuits? 9 (UCLA Sch. L. & Econ. Research Paper Series, Research Paper No. 08-15, 2008), available at http://papers.ssrn.com/sol3/papers.cfm?abstract id=1161343##. 171

See Loftus & Wagenaar, supra note 169, at 450.

172

Steven Shavell, Foundations of Economic Analysis of Law 410 (2004) ("[O]ver 96 percent of civil cases do not go to trial… [In] 2001 almost 98 percent of federal civil cases were resolved without trial… [B]ecause many disputes are settled before any complaint is filed, 96 percent or 98 percent may understate the settlement rate."). 173

Yeazell, supra note 170, at 6.

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Page 24 of 38 54 Wm. & Mary L. Rev. 455, *494 [settlements] in the dark." 174 Financial economics has conclusively shown that accurate predictions of future prices by individual participants, even in normal markets, are impossible, and there is no reason why this truth does not apply with more force to the predictions of legal decisions given that a civil action is not subject to market pricing, is not supported by risk management services or a derivative market, and is one of the most illiquid of assets. 175 In sum, it appears that parties and their lawyers cannot be expected to accurately predict the decisions of deliberative bodies, accurately assess the risks inherent in litigation, or reliably valuate a claim. In other words-and alluding to one, oft-cited definition of risk and uncertainty, according to which risk exists when alternative future states of the world occur with quantifiable probability, [*495] whereas uncertainty exists when alternative future states of the world occur without quantifiable probability 176 -investing in legal claims is both a risky and a highly uncertain endeavor. Therefore, it is not surprising that emerging evidence, as well as the budding literature, suggests that litigation finance returns are highly variable. Indeed, some have gone so far as characterizing litigation finance in its entirety as "speculative" and "subprime." 177 The upshot, however, is that case outcomes are not completely random. Although litigation finance is highly uncertain, funders may still be able to enhance value through aggregation of claims in a diversified portfolio and through noncash contributions including investment of human capital such as expertise, enhancing reputation, and monitoring. In this-as in the magnified information asymmetries and agency costs characteristic of litigation funding -litigation funding is similar to venture capital. With this overview of legal claims as risky and uncertain investments, of the magnified information asymmetries, and of agency costs in mind, the next Part offers solutions adapted from VC. Organizationally, the hallmark solutions are the use of limited partnerships-in which investors are passive limited partners, and the general partner is a company comprised of investment professionals who contribute expertise, more so than funds-and an incentive-aligning compensation scheme. Contractually, the cornerstones are staged financing, the role of management, use of negative covenants, mid-length investment terms with mandatory distributions, and liquidation. Also key are reputation markets. The next Part focuses on the recommended contract between the litigation funding firm and the plaintiff because this relationship is the heart of the arrangement, is the focus of the concerns surrounding litigation finance, and is a new relationship regarding which there is virtually no publicly available information. But the Part also briefly makes recommendations regarding the litigation funding firm's contractual relationships with its investors and highlights the special role the attorney retention agreement can [*496] play in supporting the desirable litigation funding firmplaintiff equilibrium. III. Venture Capital's Lessons Learned: Controlling Extreme Uncertainty, Information Asymmetry, and Agency Costs Through Organizational and Contractual Arrangements A. Recommended Organizational Structure Organizational features of VCFs and the choices made in structuring the funds, such as profit-sharing rules and self-liquidation, have long-lasting effects on the behavior of venture capitalists and profound implications for the

174

Id. at 2.

175

Rhee, supra note 161, at 627.

176

Frank H. Knight, Risk, Uncertainty and Profit 19-20 (1921).

177

See, e.g., Susan Lorde Martin, Litigation Financing: Another Subprime Industry that Has a Place in the United States Market, 53 Vill. L. Rev. 83, 95 (2008).

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Page 25 of 38 54 Wm. & Mary L. Rev. 455, *496 financed portfolio company and the funds' investors. 178 The key organizational features- limited partnerships, compensation, and noncash contribution-are discussed in this Section. 1. Limited Partnerships and Syndication Most of the financial literature regards the structure of private equity organizations, and in particular the reliance on limited partnerships with finite durations, as critical to their success. 179 The typical form of organization in the VC market involves institutional investors who rely on VCFs, structured as limited partnerships, to manage their investments. 180 The institutional investors are the passive limited partners, and the general partner (GP) is a money management company that employs professionals with specialized expertise. These professionals select and then monitor the VCF's investments on behalf of the ultimate investors with the expectation of going back to the market to raise additional funds for future [*497] funds. 181 The limited partnership agreement sets the fund's corporate governance arrangements. 182 Pursuant to the laws that govern limited partnerships, the limited partners are precluded from interfering in the day-to-day fund management, especially as it may relate to investments in a given portfolio company. 183 Usually, the investment is then syndicated to include additional VCFs as investors in the fund's portfolio. 184 2. Compensation The GP's compensation is composed of a small annual management fee calculated as a low percentage of committed capital-2 percent is common-and "carried interest," which is usually 20 percent of the realized profits. 185 Although superficially homogenous, there are subtle and important differences across the compensation provisions in VCF-investor agreements, with larger, more established VCFs, for example, providing for more variable compensation schemes that are more finely tuned to reflect performance. The compensation scheme plays a central role in the VC setting because the limited partners cannot use many of the methods of disciplining managers found in corporations-such as a powerful board of directors and the market for corporate control. "[I]ndividual partnership agreements are rarely renegotiated … [and] compensation is one of

178

See Cornelli & Yosha, supra note 106, at 3, 26-27.

179

Paul A. Gompers & Josh Lerner, The Determinants of Corporate Venture Capital Success: Organizational Structure, Incentives, and Complementarities, in Concentrated Corporate Ownership 17, 17, 19-20 (Randall K. Morck ed., 2000) (examining the finance literature's maxim that the structure of VCFs "has been identified as critical to their success," and concluding that the key determinant is the presence of "a strong strategic focus"). 180

Gilson, supra note 109, at 1070; see also Michael J. Halloran et al., Agreement in Limited Partnership, in 1 Venture Capital & Public Offering Negotation 1-1, 1-4 to 1- 5 (Michael J. Halloran ed., 3d ed. 2011); Sahlman, supra note 105, at 487. 181

Gilson, supra note 109, at 1071.

182

Id.; see also Sahlman, supra note 105, at 489.

183

Gilson, supra note 109, at 1071. This alone solves some conflicts of interest that currently exist in litigation funding but are beyond those that arise in the triangular attorney-client-funder relationship and therefore are not the focus of this Article. For example, the individuals who invest in the litigation funding firm may do so in order to gain access to the confidential information of, or cause trouble to, a competitor who is the target of a funded lawsuit.

184

Id. at 1073; see also Josh Lerner, The Syndication of Venture Capital Investments, 23 Fin. Mgmt. 16, 16-17 (1994) (researching the patterns of syndication and explaining the different motivations of syndicating the first round of investments as opposed to later rounds and the conflicts of interest between the lead investor and other investors in later rounds). 185

Gilson, supra note 109, at 1072. This is a generic description of the compensation structure. For a more nuanced, empirical analysis of VC compensation agreements, see also Kate Litvak, Venture Capital Limited Partnership Agreements: Understanding Compensation Arrangements, 76 U. Chi. L. Rev. 161, 172-75 (2009).

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Page 26 of 38 54 Wm. & Mary L. Rev. 455, *497 the most contentious issues between limited and [*498] general partners of venture funds." 186 If adopted in the litigation funding industry, similar compensation structure will, as detailed in the next Section, align the GP's interests with those of both the investors and the plaintiffs. 3. Noncash Contribution "The GP's principal contribution to the [VCF] is expertise, not capital." 187 Although not formally-that is, contractually-required, the GP "is also expected to make … noncash contributions to the portfolio company … [in the form] of management assistance, … intensive monitoring of the portfolio company's performance … and the use of the [GP]'s reputation to give the portfolio company credibility with potential customers, suppliers, and employees." 188 For this reason, "[v]enture capitalists are generally seen as value-added investors who have played a significant role in the development of many entrepreneurial businesses." 189 This point has far-reaching implications for how we conceptualize the role of litigation funders. Perhaps one of the key insights that the analogy between the two forms of financing provides is the noncash contributions of the GPs to the fund and the investments -that is, the litigations. Given the uncertainty and variability of legal claims, it could be argued that the major value added by the GP to the litigation funding firm is similarly the expertise of the principals. Rather than attempting to restrict this contribution as we do now by frowning upon any shift of control from the plaintiff to the litigation funding firm-and rather than impeding communication between the funder, on the one hand, and the plaintiff and [*499] her lawyer, on the other-the law should endorse and facilitate private ordering that opts into these value-enhancing arrangements. They benefit the plaintiffs as much as they do the funder. The principals of litigation funding firms tend to be seasoned lawyers who build heavily on their reputation and connections within the legal community. 190 Their background and standing as senior lawyers position them to select promising cases, assets that the investors-pension funds, university endowments, wealthy individuals, and so on-do not have specialized expertise in selecting for themselves. They can and do assist in case development, 191 for example making litigation strategy choices and developing novel legal theories. In other words, they can enhance value by reducing unique, case-specific risk. In addition, litigation funding firms appear to be in the early stages of developing subject-matter specializations. 192 Some funds, for example, invest exclusively or predominantly in intellectual property cases. 193 Other funds concentrate on international arbitration and have in

186

Paul A. Gompers & Josh Lerner, An Analysis of Compensation in the U.S. Venture Capital Partnership, 51 J. Fin. Econ. 3, 4 (1999) (internal quotation marks omitted).

187

Gilson, supra note 109, at 1071.

188

Id. at 1072.

189

Vance H. Fried et al., Strategy and the Board of Directors in Venture Capital-Backed Firms, 13 J. Bus. Venturing 493, 493 (1998); see also Christopher B. Barry et al., The Role of Venture Capital in the Creation of Public Companies: Evidence from the Going-Public Process, 27 J. Fin. Econ. 447, 449 (1990) (examining a set of IPOs "by [VC]-backed companies between 1978 and 1987," and finding "that venture capitalists specialize their investments in firms to provide intensive monitoring services," and further finding that "[t]he quality of their monitoring services appears to be recognized by capital markets through lower underpricing for IPOs with better monitors"). 190

See Steinitz, supra note 2, at 1300.

191

Lindsay, supra note 10("Fulbrook, sa[id] Seidel, is different fromother litigation funders. 'We not only evaluate a case and fund it by advancing capital, but we also put together integrated human resources to evaluate and enhance claims. We do not just advance money, but also work with the claim after it's funded to try to enhance, to give value. This is a little different than most established funders,' he explain[ed]."). 192

See Steinitz, supra note 2, at 1316-17.

193

These are sometimes referred to as "patent trolls." See, e.g., Caroline Coker Coursey, Battling the Patent Troll: Tips for Defending Patent Infringement Claims by Non-Manufacturing Patentees, 33 Am. J. Trial Advoc. 237, 237 (2009).

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Page 27 of 38 54 Wm. & Mary L. Rev. 455, *499 fact evolved from firms that specialize in conducting discovery or enforcement in foreign jurisdictions. 194 Some funds emphasize their intention to avoid investing in class actions. 195 Such subject-matter expertise will further enable funders to reduce unique risk. The personal experience and reputations of these lawyers-cum-financiers further position them to monitor both plaintiffs and [*500] lawyers, thereby reducing the costs of the litigation. 196 Lawyers are in a better position to know how other lawyers may squander resources. If allowed, this is the second key way in which litigation funding firms can enhance value not only for themselves and their investors, but also for the plaintiffs. Finally, the involvement of the litigation funding firm, "if known to the opposing party, [is likely to serve] as a signal … regarding the strength of the case." 197 This may induce earlier, and therefore more cost-effective, settlements. Given the strong similarities between the economic problems of VC-which have resulted in the evolution of these organizational structures-and those that characterize litigation funding, litigation funding firms would be well served by organizing similarly. Namely, litigation funding firms should be specialized funds that operate based on the principles of modern portfolio theory. The pooled investments that are litigation funding firms should be organized as limited partnerships. This structure will recognize that the GPs should exert disproportionate control over the investments and over their management. 198 Their compensation structure should also be composed of a small management fee and a large uplift in case of success. This compensation structure will align the GP's interests with those of the investors-the GP's disproportionate control over the various investments and over the litigation funding firms notwithstanding-and facilitate the GP's noncash contribution to both investors and plaintiffs. Finally, this structure will isolate investors from their cases, avoiding potential conflicts with defendants. With this suggested organizational structure in mind, the next Sections will describe in brief the recommended contractual structure for the litigation funding firm-investor contract, the attorney retention agreement, and in length the key contract: the litigation funding firm-plaintiff contract. The emphasis on the litigation funding firm-plaintiff contract is due to its centrality to the claim transfer transaction, the near-complete lack of publicly available information regarding these crucial contracts, and the fact that the [*501] litigation funding firm-investor contract and the retention agreement should be quite similar to the well-documented and -theorized VCF-investor contract and contingency fee agreements, respectively. I will nonetheless describe both briefly, for the sake of completion and in order to show their beneficial effects by way of their "braiding," described below, with the litigation funding firm-plaintiff contract. B. Recommended Contractual Structure This Section will detail the recommended structure of the three contracts that govern litigation finance: the litigation funding firm-investor contract, the litigation funding firm-plaintiff contract, and the attorney retention agreement. 1. The Litigation Finance Fund-Investor Contract The way to achieve the organizational structure recommended above is through the contract between the investors and the litigation funding firm. The litigation funding firm-investor contract should be similar to the VCF-investor

194

For example, one company based out of London specializes in "cost assessment for international arbitration" and "management of cross border litigation [and] international arbitration for claimants [and] funders." Services, Global Arb. Litig. Services, http://www. globalarbitrationlitigationservices.com/services.html (last visited Oct. 20, 2012).

195

Juridica, for example, states that it "focus[es] exclusively on business-to-business related claim[s]" and that "[i]t does not invest in personal injury, product liability, mass tort, or class action claims." About Juridica, Juridica Investments LTD., http://www. juridicainvestments.com/about-juridica/investment-policy.aspx (last visited Oct. 20, 2012).

196

See Steinitz, supra note 2, at 1276, 1336.

197

Id. at 1305.

198

See infra Part III.B.1.a.

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Page 28 of 38 54 Wm. & Mary L. Rev. 455, *501 contract: a limited partnership agreement. This means that it will be characterized by "[near-] complete control vested in the GP, [a] highly incentivized compensation [scheme], mandatory distribution of realized investments, and mandatory liquidation after a fixed term." 199 These are described briefly below. a. Control and Compensation As noted before, the GP's main contribution is its noncash contribution. In order for the investors to benefit from the GP's skill and experience, however, they must give significant discretion and control to the GP. In fact, GPs of VCFs obtain control that is completely disproportionate to both their capital contribution and their carried interest. 200 The consequence is a VCF corporate governance scheme that brings the general corporate governance [*502] problem of the separation of ownership and control to an extreme. 201 Such discretion is counteracted through the compensation structure. Most of the GP's compensation, as discussed above, consists of the carried interest. The distribution of carried interest, which happens only when profits are realized, is simultaneous to the GP and to the investors. The GP's carried interest compensation can be subjected to claw back provisions. 202 Such a compensation structure compensates for the conflicts created by the separation of ownership and control by realigning the interests of the GP and the investors. 203 b. Mandatory Distributions and Liquidation The aforesaid compensation structure creates another agency problem: under certain circumstances it may incentivize the GP "to prefer investments of greater risk than the investors" would prefer. 204 One response to this agency problem is the VCF's fixed term. "The … fixed term assures that at some point [in time] the market will [fix and] measure the GP's performance, making [it] readily observable" to future investors in successor funds. 205 Fixed terms are key to reputation markets, which, in turn, are key for the ability to raise successive funds. 206 Moreover, both "[m]andatory distribution of the proceeds from realized investments and the … fixed term … allow the investors to measure the [GP's] performance against [available] alternatives." 207 The desirability of separation of ownership and control coupled with an incentive-aligning compensation structure are applicable in a straightforward fashion to the recommended litigation funding [*503] firm-investor contract. It is already the case that-at least in some reported cases- investors, in fact, typically do not know which cases the litigation funding firm is invested in. 208 The key difference between the VCF-investor contract and the litigation funding firm-investor contract is the need, in the latter case, for an ethical wall between the investors and the litigation funding firm so that any privileged information provided to the litigation funding firm is preserved, assuming

199

Gilson, supra note 109, at 1087-88.

200

Id. at 1088; see also Litvak, supra note 185, at 173, 175.

201

Gilson, supra note 109, at 1088. Also referred to as the Berle-Means problem, this term refers to the fact that shareholders as individuals lack the ability to control a corporation even though in the aggregate they are its owners. The professional management-who are conceptually employees of the shareholders-have greater control over the corporation's resources than do the actual owners. See generally Adolf A. Berle & Gardner C. Means, The Modern Corporation and Private Property 3-5, 64-67 (rev. ed. 1968). 202

Gilson, supra note 109, at 1089.

203

Id. Gilson describes how this compensation structure creates an incentive for the GP to realize profitable investments prematurely and how so-called "claw back provisions" deal with this particular agency problem. See id. at 1072, 1074 (internal quotation marks omitted).

204

Id. at 1089.

205

Id. at 1090.

206

See id.

207

Id. at 1089-90; see also Sahlman, supra note 105, at 499.

208

See Parloff, supra note 11.

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Page 29 of 38 54 Wm. & Mary L. Rev. 455, *503 the latter benefits from the attorney-client privilege. Such a wall will obviously increase the information asymmetry between the investors and the litigation funding firm. But the limited partnership structure already accounts for such expanded information asymmetry. The application of the use of mandatory distribution and liquidation is a bit less straight forward. Although these are beneficial for the investors-and although the average length of a large-scale business dispute litigation is three years, 209 making it naturally suited for midterm investments-any given litigation may take longer. The most obvious example is when an appeal may be required. Therefore, a plaintiff may wish to contract for a commitment to provide additional funds or at least a right of first refusal for funds from the GP's successor funds. 2. The Litigation Finance Fund-Plaintiff Contract This agreement is the heart of the suggested scheme because at the heart of litigation finance is the transfer of all or part of a claim from the plaintiff to the funder. This section will explore the key features such a contract should include: staged financing, negative covenants, representation in management, highly incentivized compensation, and appropriately timed exit provisions. It will also note the important role of a reputation market as an economic force that further binds, informally and implicitly, the GP. [*504]

a. Staged Financing The first recommendation is to contract for staged financing. Staging, a widely used financing technique in VC, refers to the infusion of capital over time. 210 It helps mitigate all three problems: extreme uncertainty, information asymmetry, and agency costs. 211 In staged financing, [t]he venture capitalist retains the option to abandon the venture whenever the forward looking net present value of the project is negative. Financing rounds are usually related to significant stages in the development process such as completion of design, pilot production, first profitability results, or the introduction of a second product. At every stage, new information about the venture is released. 212 Thus, generally speaking, uncertainty is decreased with every further round of investment because new information becomes available. First round investors are not obligated to participate in later rounds of investment though they may do so, but they would have to negotiate the terms of such later rounds at the time such investments are made, which is usually after certain milestones have been reached. In contrast, the VCF may reserve the right to participate in the later rounds through a right of first refusal provision. 213 Often, the entrepreneur retains the right to seek additional financing from sources other than the VCF if the latter does not wish to further invest or if it is requiring too high a price in order to do so. 214 Litigation funding can similarly be staged. Examples of relevant milestones in the litigation context would be the survival of a case past an important motion, such as a motion to dismiss, the completion of some or all of the documentary discovery, the completion of a first round of depositions, or the exchange of expert reports. At [*505]

209

John B. Henry, Fortune 500: The Total Cost of Litigation Estimated at One-Third Profits, Metropolitan Corp. Couns., Feb. 1, 2008, at 28, available at http://drystonecapital .com/pdf/total cost litigation.pdf. 210

Gilson, supra note 109, at 1073.

211

Id. at 1078-81.

212

Cornelli &Yosha, supra note 106, at 1; see also Sahlman, supra note 105, at 505.

213

Gilson, supra note 109, at 1073.

214

Id. at 1079.

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Page 30 of 38 54 Wm. & Mary L. Rev. 455, *505 each one of these junctures new information is revealed and uncertainty reduced. Financiers may participate in future rounds of investments but the elimination of the right of first refusal may be a desirable modification in the litigation funding context. Such a modification would strengthen the plaintiff vis-a-vis the funder, thus addressing the litigation-specific public policy concerns regarding disproportionate control without disrupting the equilibrium achieved in the VC context. Beyond shifting exogenous uncertainty from the funder to the entrepreneur or plaintiff, staged financing aligns the interests of the funder and the entrepreneur or plaintiff by tying additional funding to performance and achievements. Endogenous uncertainty, namely uncertainty caused by the entrepreneur's or plaintiff's ability to influence the value of the venture through his or her actions or inaction, is also reduced by staged financing because such staging increases the incentives of the entrepreneur or plaintiff to expand the effort needed to maintain or enhance the value of the venture or litigation. 215 In other words, it reduces agency problems. 216 The first information asymmetry problem addressed by staged financing is the fact that when deciding between various possible investments-be they startup companies or litigations-a funder has to differentiate between desirable and undesirable investments even though the funder is disadvantaged in comparison to the entrepreneur or plaintiff because the latter have better, private information regarding his or her skills, or about the merit of his or her claim in the case of litigation. It is obviously in the self-interest of the entrepreneur or plaintiff to overstate the quality and likely outcome of the company or of the litigation. "Because the incentive[s] created by staged financing [are] more valuable to a good entrepreneur [or plaintiff] than a bad one," staging operates as a sorting mechanism. 217 The readiness of an entrepreneur or plaintiff [*506] to hold off and receive additional rounds of funding only after milestones have been achieved serves as a signal of skill or of the merits of the case, as applicable. Such a signal is particularly important in the absence of a performance track record in the case of a first-time entrepreneur or a nonrepeat-player plaintiff. 218 In both contexts, the information asymmetry problem persists beyond the initial selection phase. In fact, the information asymmetry gap is likely to increase over time as the entrepreneur or plaintiff learns more about the company or the litigation. The information asymmetry is even more pronounced in the litigation funding context than in the VC context because of the limitations on communication set by the attorney-client privilege and because of the value-diminishing effect that any disclosure of communication between the attorney and the client to the funder would have if privilege is not extended. Staged financing, by pegging additional funding to the achievement of milestones-and by imposing penalties should the entrepreneur or plaintiff fail to meet those milestones, which have been specified ex ante-renders the entrepreneur's or plaintiff's projections more credible. 219 Staged financing is also understood by economists as one of three mechanisms that allocate control. The typical VC arrangement allocates to the VCF control over the entrepreneur and the enterprise through at least three mechanisms-one of which is the mechanism of staged funding. The second and third mechanisms are the use of negative covenants and representation on the portfolio company's board of directors. 220 The latter two mechanisms provide for control, and reduce uncertainty, in between financing rounds. 221 The former mechanism

215

Id. at 1080.

216

Id. at 1079-80; see also Paul A. Gompers, Optimal Investment, Monitoring, and the Staging of Venture Capital, 50 J. Fin. 1461, 1461-63 (1995) (finding that "[a]gency costs increase as the tangibility of assets declines, the share of growth options in firm value rises, and asset specific grows;" noting that "higher R&D intensities" function similar to discovery by "lead[ing] to shorter funding durations;" and providing evidence that staging "allows [VCs] to gather information and monitor the progress of firms"). 217

Gilson, supra note 109, at 1080.

218

Cf. Gompers & Lerner, The Venture Capital Cycle, supra note 154, at 128-30.

219

Gilson, supra note 109, at 1081.

220

Id. at 1073-74.

221

Id. at 1082.

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Page 31 of 38 54 Wm. & Mary L. Rev. 455, *506 provides control at the time of the funding rounds themselves and, by providing an "out," reduces overall uncertainty. 222 [*507]

b. Role in Management The problem of control, from an economics rather than ethics perspective, is that the entrepreneur, and by analogy the plaintiff, exercises discretion and control over the portfolio company's or the litigation's day-to-day decision making. 223 They also have increased information as the company or litigation develops. Furthermore, since no contract between an entrepreneur and a venture capitalist can anticipate every possible disagreement, 224 the venture capitalist typically plays a role in the operation of the company. 225 Control in the form of representation on the portfolio company's board of directors often takes the form of "disproportionate representation or even [complete] control of the portfolio company's board of directors." 226 Venture capitalists sit on boards of directors, help recruit and compensate key individuals, work with suppliers and customers, help establish tactics and strategy, play a major role in raising capital, and help structure transactions such as mergers and acquisitions. They often assume more direct control by changing management and are sometimes willing to take over day-to-day operations themselves. All of these activities are designed to increase the likelihood of success and improve return on investment. 227 [*508]

Applying this insight to litigation funding, one could envision a recognized role for the litigation financiers in the day-to-day management of the litigation. Such a role can include the raising of additional funds, helping in formulating legal tactics and litigation strategy, and assisting in structuring the ultimate settlement agreement in the same manner as VCFs help structure key deals executed by portfolio companies. The influence funders appear to require in particular over the attorney-of both her selection and her strategic decisions-can be viewed as the functional equivalent of the VCF's representation on the portfolio company's board of directors. Therefore, part of the newly allocated control could take the form of approval of the selection of attorneys, who are the "managers" of litigation because they usually make most, if not all, of the tactical and strategic decisions during the course of the litigation. Control allocated to the funder will encourage ongoing monitoring of the investment, namely of the company or the litigation. 228

222

Id. at 1078-79.

223

See supra note 201.

224

As such, the VC and litigation funding contracts are "incomplete contracts." On incomplete contracts, also known as relational contracts, see Ian R. Macneil, Contracts: Adjustment of Long-Term Economic Relations Under Classical, Neoclassical, and Relational Contract Law, 72 Nw. U. L. Rev. 854, 886-900 (1978), and Ian R. Macneil, Reflections on Relational Contract Theory After a Neoclassical Seminar, in Implicit Dimensions of Contract 207, 207-17 (David Campbell et al. eds., 2003).

225

Sahlman, supra note 105, at 508 (documenting that lead venture investors spend an average of 100 hours in direct contact with each portfolio company). 226

Gilson, supra note109, at 1082; see alsoFried et al., supra note189, at 493, 495 (noting that "[o]ne of the most significant value-added activities of the venture capitalist is involvement with strategy," and contrasting boards of VC-backed funds with "board members in public companies who are typically either managers (insiders) or outsiders hand-picked by the CEO. As a result they may emphasize politeness and courtesy at the expense of truth and frankness" (internal quotation marks omitted)). 227

Sahlman, supra note 105, at 508; see also id. at 506 ("Most agreements call for venture capitalist representation on the company's board of directors … Often, the agreement calls for other mutually acceptable people to be elected to the board."). 228

See M.J. Goldstein, Should the Real Parties in Interest Have to Stand Up?-Thoughts About a Disclosure Regime for ThirdParty Funding in International Arbitration, Transnat'l Disp. Mgmt., Oct. 2011, at 9-10 ("A decade ago when third-party finance in international arbitration was truly in its infancy … [funders imposed] contract terms on the financed party that created release

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Page 32 of 38 54 Wm. & Mary L. Rev. 455, *508 As the analysis of the financing of the Ecuadorian plaintiffs in the Chevron/Ecuador dispute in Part I illustrates, control, or at least involvement in and influence over the selection or approval of attorneys, is de facto practiced by some in the industry. 229 Such involve [*509] ment, influence, and control can take the form of installing a chosen lawyer, as in the Chevron/Ecuador example; providing a list of preapproved law firms to select from; or passing over a claim due to the existence of a representation not acceptable to the funder. But the transfer of control has a price for the venture capitalist. The capital structure of VC represents a calculus of the private value for control-namely, it assigns a value to the transfer of control from the entrepreneur to the VCF. 230 Litigation financiers would similarly have to pay for the additional control. Moreover, the pricing of the control in the litigation funding context would have to take into account the extra control-indeed, absolute control- endowed by operation of law to the plaintiff, an endowment that takes the form not only of the champerty doctrine but also the duties of loyalty and independent judgment, which require that the attorney be controlled by the client alone. 231 c. Negative Covenants Control is also exercised in VC through the use of negative covenants. Examples of the restriction of the entrepreneur's discretion through the use of negative covenants include restrictions on the entrepreneur's ability to make certain key decisions that may significantly influence the course of business of the venture, or the ability to significantly depart from any business plan approved by the VCF. 232 By analogy, litigation funding contracts can and do include covenants that require approval by, or at least consultation in good faith with, the litigation funding firm before making strategic litigation decisions such as forum selection, the filing of key [*510] motions, and the decision to settle. Each level of control, as discussed, will have to be bargained and paid for. Indeed, one can envision legal claims so attractive that a funder will not only foot the bill but also pay an additional cash amount to the plaintiff. d. Highly Incentivized Compensation, Exit, and Reputation As mentioned before, the GP's compensation is composed of a small management fee, which represents a small percentage of committed capital and, more significantly, the carried interest, which represents a much larger percent, often twenty. This compensation structure responds to the agency costs and information asymmetry

points for the financers. Finance contracts … not infrequently provided that a financer could discontinue financing if developments in the case gave rise to a materially increased risk … of an unfavorable outcome. Some finance contracts of that era provided that the financed party … bore an obligation to prosecute the arbitration in a reasonably prudent fashion, and upon breach of this duty the financer could elect to discontinue financing while retaining its interest in the proceeds-this election being provided either expressly or, less transparently, as a principle of the applicable contract law selected by the financer in its standard contract. And some such contracts included as express conditions the commitment of the financed party to seek from the arbitral tribunal an accelerated determination of one or more issues material to the claimant's prospects of ultimate successso that the financer could reach an early decision point to continue or terminate financing based on re-assessment of the risk."). 229

The Australian legal system has arrived at a similar conclusion and allows for a good measure of funder control. The lead case is the High Court's 2006 decision Campbells Cash & Carry Pty Ltd. v Fostif Pty Ltd. (2006) 229 CLR 386 (Austl.), in which a five-to-two majority held that third-party funders may exercise significant control over the litigation, and that this control is not an abuse of process and does not offend the public policy in states that have abolished maintenance and champerty. Id. at 388-89. The New York City Bar notes in its opinion that a client may agree to permit a financing company to direct the strategy or other aspects of a lawsuit, including whether and for how much to settle, and similarly acknowledges the potential value of funder involvement, but leaves it to private contracting rather than interpret the law as allocating any control to the funder. See New York City Bar Ass'n, supra note 1, § II.E. 230

See Bernard S. Black & Ronald J. Gilson, Venture Capital and the Structure of Capital Markets: Banks Versus Stock Markets, 47 J. Fin. Econ. 243, 252-53, 258-59 (1998) (discussing models that seek to explain the incentive function of capital structure and that calculate the private value for control); see also Rhee, supra note 161, at 629-38 (discussing the standard economic model of bargaining).

231

See supra notes 115-17, 126-27, 131-40 and accompanying text.

232

Gilson, supra note 109, at 1074. But see Gompers & Lerner, Covenants, supra note 154, at 472-74.

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Page 33 of 38 54 Wm. & Mary L. Rev. 455, *510 problems by creating a powerful performance incentive that aligns the incentives of the VCF with that of the portfolio company, as the overwhelming majority of the fund managers' compensation depends on the success of the portfolio company. 233 This compensation structure does, however, incentivize the entrepreneur to take on more risk than she would have had the risk/reward balance not been altered by the provision of capital by the VCF. But since the risk has shifted from the entrepreneur to the VCF, the latter now has an incentive to monitor the portfolio company. In the litigation funding context, such a structure is only a slight modification of the contingency fee, in which there is no management fee at the outset, but it includes a return on investment that is usually a large percentage of the settlement or judgment. 234 At the conclusion of an investment, a VCF exits by selling the portfolio company or by taking it public. The limited partnerships usually have ten year terms, or medium-term investments. 235 This creates a strong incentive [to the GP] to cause the fund's portfolio company investments to become liquid as quickly as possible. Assuming that the GP has invested [all] of a fund's capital by [*511] the midpoint of the fund's life, the GP then must seek to raise additional capital for a new fund in order to remain in the VC business. Because the performance of a GP's prior funds will be an important determinant of its ability to raise capital for a new fund, early harvesting of a fund's investments will be beneficial to the GP. 236 Whereas VCFs exit during an IPO or the sale of the company, a successful exit for the litigation funder takes the form of either a settlement or a favorable judgment. That means that instead of investment bankers and the markets pricing investments, it is juries, judges, and arbitral tribunals who substitute for markets in the litigation funding arena. 237 And because the average life of a complex business litigation is three years, 238 litigation naturally presents a similar medium-term investment horizon. The equilibrium struck by the organizational and contractual structure of VC, including the characteristic implicit contractual provisions of such arrangements, is supported and policed first and foremost by the market forces of the greater VC market-including the force of reputation. For example, a claim by an entrepreneur that a venture capitalist declined an IPO when one was offered by a reputable investment banker would quickly circulate through the community and hurt the venture capitalist in the future when competing with other venture capitalists. 239 This is especially true given that the pool of portfolio companies that merit investing in, and the pool of VCFs, are both small. Effective reputation markets are characterized by the following: First, the party that has discretion and whose reputation is in question, namely the investment firm, must be a repeat player. Second, market participants must have similar normative views on what is appropriate behavior on the part of financiers. Third, compliance or breach of the implicit contract, described below, by the litigation funder must be observable. 240 233

Gilson, supra note 109, at 1083.

234

See Herbert M. Kritzer, Seven Dogged Myths Concerning Contingency Fees, 80 Wash. U. L.Q. 739, 757-59 (2002) (challenging the myth that contingency fees are standardized at a rate of 33 percent and, instead, documenting a broad range of fee arrangements); Rose, supra note 11 (documenting the broad range of percentages and associated contingencies in the litigation finance context). 235

Gilson, supra note 109, at 1074.

236

Id. at 1074-75; see also Bernard S. Black & Ronald J. Gilson, Does Venture Capital Require an Active Stock Market?, J. Applied Corp. Fin., Winter 1999, at 36, 44. 237

See Yeazell, supra note 170, at 2.

238

See supra note 209 and accompanying text.

239

See Gilson, supra note 109, at 1087.

240

Id. at 1086; see also D. Gordon Smith, Venture Capital Contracting in the Information Age, 2 J. Small & Emerging Bus. L. 133, 157-62 (1998) (discussing the characteristics of the reputation market for venture capitalists).

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Page 34 of 38 54 Wm. & Mary L. Rev. 455, *511 [*512]

The analogy between litigation funding and VC helps us see that some of the protection to plaintiffs that counterbalances the transfer of control in the suggested investment structure comes from the "braiding" of the VCFinvestor contract with the VCF-entrepreneur contract-especially the braiding of reputation and exit. "Braiding"-observable in business contexts characterized by high levels of uncertainty such as VC and corporate acquisitions-refers to the intertwining of two or more contracts such that each contract includes provisions that operate as implicit terms in support of the arrangements contained in the other. As a consequence of braiding, the contractual efficiency of both of the braided contracts is increased. 241 Often, formal contracting in one contract is used to create arrangements that render transparent the abilities and character of the parties, thus creating trust. That trust supports a second "braided" contract. Braiding has been observed in situations in which the project's-or, in our case, the litigation's-exact trajectory or goal cannot be defined and predicted with precision, but rather emerges over time and through the parties' joint efforts. 242 Analogously, the manner of the litigation's development is uncertain: costs, duration, and the disposition of pretrial disputes-to name but just a few examples- are unclear and communication and cooperation between two or more parties-the litigation funding firm, the plaintiff, and the lawyers-are required. Also analogous is [*513] the nature of the complex commercial disputes that are invested. These too have imprecise goals, such as whether to go to trial, engage in mediation, or negotiate a settlement, and then what type of relief to pursue. In the VC context, two forms of braiding are at play: the braiding of the reputation markets and the braiding of exit. The VCF's noncash contribution is most valuable to the portfolio early on in the venture's life. As the venture develops, and the entrepreneurs gain experience and develop their own reputation, the value of the VCF's management experience, reputation, and similar noncash contribution diminishes. As a consequence, the value of the VCF's noncash contribution to a given portfolio company diminishes over time, and the closer that portfolio company gets to a sale or to an IPO, the more profitable it is for the VCF to reinvest its noncash contribution in new ventures with less experience and reputation. Economies of scope, however, create a nexus between cash and noncash contributions because cash contribution acts as a signal that enhances the reputation of the portfolio company. Therefore, "recycling the venture capital fund's noncash contributions also requires recycling its cash contributions." 243 The braiding of exit enables investors to evaluate a GP's capabilities and candor, and therefore align the GP's interests with those of the investors. The need to exit the relationship with the investors forces the VCF also to exit its relationship with the entrepreneur. The VCF's exit from its relationship with the entrepreneur, in turn, gives the entrepreneur a performance incentive. 244 The operation of the reputation markets is similarly braided. They constrain the GP in its dealings with the entrepreneur because reputation affects the investor-VCF relationships, which are necessary for future fund raising

241

Gilson, supra note 109, at 1091; see also Ronald J. Gilson et al., Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine, 110 Colum. L. Rev. 1377, 1386, 1422-23 (2010); id. at 1377 ("Parties respond to rising uncertainty by writing contracts that intertwine formal and informal mechanisms … in a way that allows each to assess the disposition and capacity of the other to respond cooperatively and effectively to unforeseen circumstances. These parties agree on formal contracts for exchanging information about the progress and prospects of their joint activities, and it is this information sharing regime that 'braids' the formal and informal elements of the contract and endogenizes trust."). 242

Gilson et al., supra note 241, at 1385; see also Ronald J. Gilson et al., Contracting for Innovation: Vertical Disintegration and Interfirm Collaboration, 109 Colum. L. Rev. 431, 450-51 (2009) ("In the new arrangements … the primary output is an innovative 'product,' one whose characteristics, costs, and manufacture, because of uncertainty, cannot be specified ex ante… [T]he process of specification and development will be iterative … Thus, central to these transactions are communication and cooperation across the two (or more) firms-the design, specification, and determination of manufacturing characteristics will be the result of repeated interactive collaborative efforts by employees of separate firms with distinct capabilities." (emphasis added)). 243

Gilson, supra note 109, at 1076.

244

Id.; see also Gilson et al., supra note 241, at 1412-15.

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Page 35 of 38 54 Wm. & Mary L. Rev. 455, *513 by the GP. The entrepreneur receives a "windfall" in the form of fair play and competence by the GP who wishes to maintain a good reputation in order to succeed in raising new funds. 245 Like the limited universe of portfolio companies, the universe of commercial disputes large enough to yield the three- to four-times [*514] multiplier return, as a third of the settlement or award, is limited. Additionally, a finite list of "Biglaw" firms serve as gatekeepers of such claims. 246 Therefore, the conditions are ripe for a reputation market to emerge. For the full benefits of the organizational and contractual structure offered herein to inhere in the litigation funding industry, we must witness the emergence of a robust, mature litigation finance reputation market. And for that to happen, transparency regarding both contractual arrangements and a fund's performance is necessary. There are indications that we are headed in that direction. For example, recent negative publicity regarding Burford's investment in the Chevron/Ecuador case in financial publications such as Fortune is a reputational cost to the firm and its principals. The intense focus on the industry generally, which is only likely to increase given how much litigation funding is expected to reshape civil litigation, is further reason to believe that the emergence of a reputation market is imminent. 247 Beyond the need for the three attributes discussed above to be present in the litigation funding reputation market, it is advisable for investors and plaintiffs who wish to benefit from the favorable effect of reputation on their litigation finance contract to prefer specialized, repeat-player firms. Similarly, courts should encourage transparency by refraining from sealing finance contracts when they are subject to litigation, as they currently often do. 248 Finally, good practice guidelines should be developed. In sum, if litigation funding firms will organize in the same manner as VCFs, as I suggest, the benefits of the braiding of reputation and exit will inhere to both the investors and the plaintiffs in [*515] a similar fashion as in the VC context. Both instances of braiding will serve to enhance the efficiency of the litigation funding firm-investor and the litigation funding firm-plaintiff contracts. In addition, the need to go back to the markets and raise successive funds will buttress the protection of plaintiffs, despite the relinquishment of control. Like the litigation funding firm-investor contract, the attorney retention agreement is important, and implicit, in an analysis of the litigation funding firm- plaintiff's contract. The litigation funding firm-investor contract is braided not only with the litigation funding firm-plaintiff contract but with the attorney retention agreement as well. Therefore, the next Subsection describes briefly this agreement as well as its braiding effects. 3. The Attorney Retention Agreement

245

See Gilson, supra note 109, at 1072, 1075-76; Gilson et al., supra note 241, at 1392-97.

246

See Yeazell, supra note 170, at 5-6 (estimating the average value of a federal lawsuit settlement as $ 10,000). The American Lawyer's-the leading trade publication- Am Law 100 list can fairly be considered the list of gatekeeper "Biglaw" firms. See The Am Law 100 2011, Am. Law. (May 1, 2011), http://www.americanlawyer.com/PubArticleTAL.jsp?id=12025502 68433.

247

See, e.g., Richard Lloyd, The New, New Thing, Am. Law. (May 17, 2010), http://www. americanlawyer.com/PubArticleFriendlyTAL.jsp?id=1202457711273 (showing the cover story in the leading trade journal); supra note 3 (discussing a series of New York Times write-ups).

248

This has been the case, for example, in a recent dispute between Juridica, a litigation finance firm, and a former investee, S & T Oil Equipment & Machinery. See S & T Oil Equip. & Mach., Ltd. v. Juridica Invs. Ltd., No. 11-H-0542, 2011 WL 1565996 (S.D. Tex. Apr. 25, 2011), appeal dismissed, 456 F. App'x 481 (5th Cir. 2012).

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Page 36 of 38 54 Wm. & Mary L. Rev. 455, *515 Attorneys' retention agreements, also known as engagement letters, are nonmandatory, have come into the mainstream in the past couple of decades, and are underresearched. 249 Nonetheless, some general practices are observable. Retention agreements often include "boiler plate" provisions such as identification of the client and definition of the scope of representation, withdrawal from and closing of representation, and dispute resolution. 250 Some questionable provisions, such as a "right to settle" provision purporting to disallow settlement without the lawyer's consent, also appear with some frequency. 251 Fees, costs, and billing, including clarifications regarding the advancement of costs by the lawyer, are at the heart of even the most concise of retention agreements. 252 As retention agreements get more complex, they include contingency fee representations and closing calculation clauses, and settlement structures become more common and elaborate. These [*516] detail methods for accounting for final distribution to the client when various items are to be deducted from the gross recovery and order of payment. Such agreements also provide for division of fees among lawyers. Last but not least, cooperation clauses that place an affirmative obligation on the client to cooperate with the attorney and, at times, specify the form of cooperation expected-for example, supply of documents and attendance at hearings-appear in both standard and customized agreements. 253 It is clear that some of these elements would braid the litigation funding firm- plaintiff relationship on the one hand, with the plaintiff-attorney relationship on the other. Cooperation with the attorney would by necessity benefit the litigation funding firm who is similarly concerned with client shirking once risk has been shifted onto the litigation funding firm. The attorney's monitoring of the client benefits the litigation funding firm. The fee arrangements, including negotiating and specifying division of fees, and precise mechanisms for collecting fees out of the settlement or judgment can similarly benefit the funder who has a parallel collection concern and interest in avoiding ex post disputes regarding calculating the division of the spoils. This is doubly true because a key concern for investors in litigation-especially international arbitration or transnational litigation, as previously discussed-is securing a right in the judgment or award and effecting a collection. Conversely, VCFs do not face such a risk of an entrepreneur running off with the spoils at the time of exit, via sale or IPO, because VCFs hold shares in the portfolio company so any withdrawal necessarily involves compensation for the entrepreneur's equity in the enterprise. 254 All of this braiding enhances the efficiency of the litigation funding firm- plaintiff relationship as well as that of the attorney and her client. And, as noted before, the more inclusive the attorney-client arrangement is of the funder-for example, if the client authorizes certain types of information to be divulged to the funder either in the retention agreement or ad hoc during the course of the representation-the more all parties can enjoy enhanced efficiency generated by the agents-watching-agents effect. The more lawmak- [*517] ers protect attorney and/or client communication with the funder under such doctrines as the common-interest doctrine, the more clients and others will benefit. 255

249

See D. Christopher Wells, Engagement Letters in Transactional Practice: A Reporter's Reflections, 51 Mercer L. Rev. 41, 41 (1999); see also William C. Becker, The Client Retention Agreement-The Engagement Letter, 23 Akron L. Rev. 323, 323-24 (1990). 250

See Wells, supra note 249, at 49.

251

Becker, supra note 249, at 328 (notingthat some of the agreements studied provided that the client would not settle the case without a lawyer's consent or without the consent of both client and lawyer, and characterizing such provisions as questionable given the client's absolute right to decide on settlement, enshrined in the rules of professional responsibility).

252

Id. at 329-32.

253

See id. at 328-40.

254

See Gilson, supra note 109, at 1086.

255

But see Leader Techs., Inc. v. Facebook, Inc., 719 F. Supp. 2d 373, 376 (D. Del. 2010) (refusing to extend the commoninterest exception to include a financier); Bray & Gillespie Mgmt. LLC v. Lexington Ins. Co., No. 6:07-CV-222-Orl-35KRS, 2008

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Page 37 of 38 54 Wm. & Mary L. Rev. 455, *517 Conclusion Preliminarily, the key contribution of the foregoing analysis is that VC contracts can be viewed as a template and springboard for parties contemplating entering into litigation funding arrangements. Despite the absence of publically available samples or forms, a model for similar contracting already exists and there is no need to reinvent the wheel. The litigation funding industry can be spared years of evolution by looking at, and learning from, the VC industry. VC contract theory, practice, and doctrine can guide plaintiffs, lawyers, financiers, and courts on what can be done, what should be done, and how to do it. In particular, many of the concerns raised by critics of litigation funding-pressure to settle early, or late; loss of client control; compromise of attorney's independent judgment-are reframed in one, all-encompassing system of checks and balances that satisfies both ethical and economic concerns. Just as VCFs purchase shares and thereby become part owners of a portfolio company, litigation funders should be viewed as co-owners of the legal claim and therefore as real parties in interest. 256 Some conceptual consequences follow. These conceptual points should guide lawmakers and regulators. First, funders should ob[*518] tain control over the funded litigation. Second, attorneys should take funders' input into account. Third, litigation funding firms should be allowed, and required by their investors, to monitor their investment. Lawmakers should facilitate this key function-which enhances value for the client as well as for its co-owner(s)-by extending the attorney-client privilege to the funders and possibly the attorney work-product doctrine to work-product that is developed by the funder, that is legal in nature, and that is in direct relation to the litigation. Fourth, funders should pay plaintiffs a premium for the control they receive, be compensated through a scheme that aligns their interests with those of the clients, and enhance the value of the claim by providing noncash contributions, including monitoring and reputation. Fifth, regulators and lawmakers, including judges, should consider the critical role of reputation markets which, in turn, rely on the transparency of the industry. In particular, providing information regarding the performance outcomes of litigation funding firms and their ethical propensities when dealing with plaintiffs and investors will facilitate the emergence of a reputation market that can police the industry and support contractual arrangements. This necessitates choosing transparency over secrecy whenever the option arises. For example, when requested to seal a litigation finance contract, such decision makers can instead follow the precedent set by Judge Kaplan in the Chevron/Ecuador litigation. 257 Sixth, there is also a cautionary note to both investors and plaintiffs that they should disfavor intermediaries who are not organized as described herein, such as hedge funds that do not specialize in litigation funding, and therefore cannot effectively monitor or reduce unique risk and are not subject to reputation markets. William & Mary Law Review

WL 5054695, at *3 (M.D. Fla. Nov. 17, 2008) (ruling that the attorney-client privilege between Juridica and Bray & Gillespie had not been established). 256

See Fed. R. Civ. P. 17(a). At least one U.S. court of appeals has taken that approach when the funder financed and controlled the litigation. He was to receive 18.33% of any award the plaintiffs received plus reimbursement for the expenses of the case. Additionally, [the Funder] had to approve the filing of the lawsuit; controlled the selection of the plaintiffs' attorneys; recruited fact and expert witnesses; received, reviewed and approved counsel's bills; and had the ability to veto any settlement agreements. Abu-Gh zaleh v. Chaul, 36 So. 3d 691, 693 (Fla. Dist. Ct. App. 2009). Consequently, the court held that given the level of control exerted by the funder, he had risen to the level of "party." Id. at 694. 257

See supra note 31 and accompanying text. Several consumer financing companies doing business in New York State have entered into a stipulation with the Attorney General of New York that requires the law lending firms who are members of the American Legal Finance Association to follow certain guidelines. See Assurance of Discontinuance Pursuant to Executive Law § 63(15), Eliot Spitzer, Att'y Gen. N.Y. (Feb. 17, 2 0 0 5 ) , a v a i l a b l e a t h t t p : / / www.americanlegalfin.com/alfasite2/documents/ALFAAgreementWith AttorneyGeneral.pdf (showing the American Legal Finance Association's agreement with the Attorney General of New York and the Bureau of Consumer Frauds and Protection to comply winess practices).

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Page 38 of 38 54 Wm. & Mary L. Rev. 455, *518 Copyright (c) 2012 William & Mary Law Review William & Mary Law Review

End of Document

Theresa Coetzee

LITIGATION FINANCE ISSUE: NOTE: Litigation Financing in the U.S., the U.K., and Australia: How The Industry Has Evolved In Three Countries 2011 Reporter 38 N. Ky. L. Rev. 687

Length: 15274 words Author: Nicholas Dietsch*

Text [*687]

I. Introduction More than fifteen years ago, plaintiffs in the United States began to realize that litigation financing could enable them to pursue their legal rights. 1 While litigation financing has the potential to increase access to justice for plaintiffs who otherwise could not afford to bring a suit, 2 concerns about predatory lending practices, ethical violations, and the potential illegality of these types of agreements hinder the development of litigation financing. 3 This article provides an examination of the current state of the litigation financing industries, first in the United States, second in the United Kingdom, and finally in Australia. Additionally, a comparison of the industry's evolution in each country will provide a look into the future of litigation financing. II. Litigation Financing - How It Works For plaintiffs without the financial means to support themselves, their families, and a lawsuit at the same time, litigation finance companies offer one possible route to justice. 4 These companies advance money to plaintiffs and [*688] attorneys to cover personal and legal expenses while pursuing litigation. 5 The money advanced is not

1

Susan Lorde Martin, Litigation Financing: Another Subprime Industry That Has a Place in the United States Market, 53 Vill. L. Rev. 83, 83 (2008); see also Paul H. Rubin, Third Party Financing of Litigation, presentation at the Third Party Financing of Litigation Roundtable at Searle Center, Northwestern University Law S c h o o l ( S e p t . 2 4 - 2 5 , 2 0 0 9 ) , a v a i l a b l e a t http://www.law.northwestern.edu/searlecenter/uploads/Rubin- thirdpartyfinancinglitigation.pdf (stating that in the past 75 years, plaintiff's law firms, and their ability to finance and take on large scale and long-term litigation, has substantially increased) (citing Stephen C. Yeazell, Re-Financing Civil Litigation,51 DePaul L. Rev. 183, 217 (2001)). 2

See generally Michael Legg & Louisa Travers, Necessity is the Mother of Invention: The Adoption of Third Party Litigation Funding and the Closed Class in Australian Class Actions, 38 Common L. World Rev. 245, 254 (2009) (stating that litigation finance has been promoted on the premise of extending access to justice). 3

Martin, supra note 1, at 86-95.

4

See id. at 83 (discussing the nonrecourse loans provided by litigation financing firms); see also Michael Herman, Fear of Third Party Litigation Funding is G r o u n d l e s s , T i m e s O n l i n e , O c t . 2 5 , 2 0 0 7 , http://business.timesonline.co.uk/tol/business/law/article2738493.ece (stating that litigation funding allows those with money to provide the capital for court cases on behalf of those without the finances). 5

Courtney R. Barksdale, All That Glitters Isn't Gold: Analyzing the Costs and Benefits of Litigation Finance, 26 Rev. Litig. 707, 708 (2007); see also U.S. Chamber Institute for Legal Reform, Third Party Financing: Ethical & Legal Ramifications in Collective Actions 1 (2009), http://www.instituteforlegalreform.com/images/stories/documents/pdf/research/ thirdpartyfinancingeurope.pdf [hereinafter U.S. Chamber Institute for Legal Reform Report] (stating that funds provided by litigation finance companies are used for many different expenses including lawyer fees, court costs, expert witness fees, and plaintiff's living expenses while the

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Page 2 of 21 38 N. Ky. L. Rev. 687, *688 always a loan in the traditional sense, 6 and often the advances are "nonrecourse"; that is, the repayment of the advance is contingent on the plaintiff's recovery, either through a settlement or judgment. 7 Furthermore, the amount the plaintiff repays to the litigation finance company does not depend on the amount the plaintiff recovers, 8 but instead depends on the amount borrowed, the length of the litigation and a predetermined fee schedule. 9 In spite of the sometimes exorbitant fees financing companies charge, for many plaintiffs with valid legal claims, litigation finance companies provide a financially viable option to pursue a lawsuit. 10 Therefore, for a significant portion of the population without the resources to support costly court cases, litigation financing is a solution to "a social demand crying to be met." 11 III. Issues with Litigation Financing A. Champerty and Maintenance In the early 1990s, the U.S. litigation financing industry's emergence came under fire for violations of the largely archaic 12 and closely linked doctrines of [*689] maintenance and champerty. 13 Maintenance is "[i]mproper assistance in prosecuting or defending a lawsuit given to a litigant by someone who has no bona fide interest in the case." 14 Champerty, a type of maintenance, is "[a]n agreement to divide litigation proceeds between the owner of the litigated claim and a party unrelated to the lawsuit who supports or helps enforce the claim." 15

litigation is pending). 6

See Barksdale, supra note 5, at 708-09 (stating that the litigation finance loans are nonrecourse if a plaintiff fails to recover a judgment they are not responsible for repayment of the loan). 7

Richard H. Braun, Settle Now, Pay Later: A Caution About Personal Injury Loans, Or. St. B. Bull., May 2002, at 9; see also U.S. Chamber Institute for Legal Reform Report, supra note 5, at 4 (stating that since the loans are nonrecourse, litigation financers are able to sidestep laws and prohibitions against excessive interest rates); Rancman v. Interim Settlement Funding Corp., 789 N.E.2d 217, 218-19 (Ohio 2003). 8

Braun, supra note 7, at 9. But see U.S. Chamber Institute for Legal Reform Report, supra note 5, at 4 (stating that the litigation finance company's recovery is a pre-determined percentage of what the plaintiff eventually recovers). 9

Braun, supra note 7, at 9.

10

George Steven Swan, The Economics of Usury and the Litigation Funding Industry: Rancman v. Interim Settlement Funding Corp., 28 Okla . City U. L. Rev. 753, 758 (2003); see also Geoffrey McGovern et al., Third -Party Litigation Funding and Claim Transfer: Trends and Implications for the Civil Justice System, RAND Institute for Civil Justice 19 (2009) (stating that, putting ethical issues aside, litigation finance can help level the playing filed for litigants who have "legitimate" claims but who are not financially able to litigate and have their day in court). 11

Swan, supra note 10, at 785.

12

Susan Lorde Martin, Syndicated Lawsuits: Illegal Champerty or New Business Opportunity?, 30 Am. Bus. L.J. 485 (1992) (citing Killian v. Millard, 279 Cal. Rptr. 877 (Cal. Ct. App. 1991); Intex Plastic Sales Co. v. Hall, 20 U.S.P.Q.2d (BNA) 1367 (N.D. Cal. 1991)).; See generally Percy Henry Winfield, The History of Conspiracy and Abuse of Legal Procedure 22-25 (Harold Dexter Hazeltine , Litt.D. ed., Fred B. Rothman & Co. 1982) (1921) (discussing the Statute of Conspirators in England and the prohibitions against and penalties of champerty and maintenance, as well as the penalties for engaging in such practices). 13

See Martin, supra note 12, at 485 (defining champerty and maintenance, stating that champerty is essentially a "kind of maintenance"). 14

Black's Law Dictionary 1039 (9th ed. 2009).

15

Id. at 262.

Theresa Coetzee

Page 3 of 21 38 N. Ky. L. Rev. 687, *689 Champerty has long been prohibited in the United States for fear that allowing the involvement of third parties in a lawsuit would promote frivolous litigation, increase damages, and hinder settlements. 16 However, many exceptions to the champerty doctrine in the U.S. exist, the most notable of which are contingency fee arrangements. 17 All courts in the U.S. permit contingency fees to allow plaintiffs without the financial means the opportunity to sustain a lawsuit. 18 Contingency fees have been permitted on the principle that allowing a plaintiff with a meritorious claim to pursue justice is more important than preventing champerty, which court supervision can effectively eliminate. 19 Additionally, as exceptions to the champerty doctrine have developed, different states treat champertous agreements in unique ways, 20 or have eliminated champerty prohibitions altogether. 21 [*690]

B. Usury Because of high fees demanded in litigation financing agreements, these agreements are frequently met with challenges under usury laws. 22 Usury is "the exacting, taking, or receiving of a greater rate of interest than is allowed by law for the use or loan of money." 23 State usury laws are similar to state champerty laws in that they both trace their roots to a long legal history and tradition. 24 The main purpose of usury laws is to protect vulnerable borrowers from predatory lending practices. 25 If a contract is found to be usurious, usury law invalidates the illegal

16

Susan Lorde Martin, Financing Plaintiffs' Lawsuits: An Increasingly Popular (and Legal) Business, 33 Mich. J. L. Reform 57, 58 (2000); see also Rubin, supra note 1, at 2 (stating that champerty was forbidden by the common law due to "correct" fears that it would result in increased litigation). But see Herman, supra note 4 (arguing that litigation finance will not lead to frivolous claims, because the financing companies operate on profit making principals and will evaluate potential claims in great detail to ensure a return on their investment). 17

Martin, supra note 16, at 58. See generally Adam Shajnfeld, A Critical Survey of the Law, Ethics, and Economics of Attorney Contingent Fee Arrangements, 54 N.Y.L. Sch. L. Rev. 773 (2009) (discussing the historical roots, parameters, and general issues of the contingency fee agreement). 18

Susan Lorde Martin, The Litigation Financing Industry: The Wild West of Finance Should Be Tamed, Not Outlawed, 10 Fordham J. Corp. & Fin. L. 55, 57 (2004); see also Rubin, supra note 1, at 4 (stating that many plaintiffs are able to use the contingency fee agreement to pursue their claims notwithstanding their lack of personal assets). 19

Martin, supra note 18, at 57.

20

Lauren J. Grous, Note, Causes of Action For Sale: The New Trend of Legal Gambling, 61 U. Miami L. Rev. 203, 213 (2006). See generally Maya Steinitz, Whose Claim is This Anyway? Third Party Litigation Funding, 95 Minn. L. Rev. (forthcoming 2011) (discussing treatment and case law showing the changing attitudes toward champerty and maintenance in U.S. states). 21

Martin, supra note 16, at 57; see also Paul Bond, Comment, Making Champerty Work: An Invitation to State Action, 150 U. Pa. L. Rev. 1297, 1333-41 (2002) (discussing significant case law in all fifty states relating to their respective treatment of champerty and maintenance). 22

See Swan, supra note 10, at 764-771 (stating that usury arises when a level of interest is "unjust and unfair"). See generally James Avery Webb, A Treatise on the Law of Usury, and, Incidentally, of Interest (The F.H. Thomas Law Book Co.) (1899) (providing an in-depth discussion on the history and origin of usury, including significant case law that developed and changed usury law).

23

Black's Law Dictionary 2183 (9th ed. 2009).

24

Mariel Rodak, Comment, It's About Time: A Systems Thinking Analysis of the Litigation Financing Industry and its Effect on Settlement, 155 U. Pa. L. Rev. 503, 512 (2006). 25

Id.

Theresa Coetzee

Page 4 of 21 38 N. Ky. L. Rev. 687, *690 interest term, and the lender can only recover the debt and the legal interest. 26 Although economists and commentators have argued that such laws inhibit economic growth and stifle efficiency, most states retain usury laws. 27 The legal interest rates and elements of usury vary between states, but in most states the elements of usury include: [1] an agreement to lend money; [2] the borrower's absolute obligation to repay with repayment not contingent on any other event or circumstance; [3] a greater compensation for making the loan than is allowed under a usury statute or the State Constitution; [4] and an intention to take more for the loan of the money than the law allows. 28 In the litigation financing industry, the second element is crucial because repayment of an advance is often contingent on recovery in the lawsuit. 29 However, critics of litigation financing argue that the advances are not contingent because the financing companies use information about each lawsuit to calculate the probability of recovery and advance money only when that probability is very high. 30 Critics further contend that the risk of nonrepayment [*691] of an advance is less than the risk of non-repayment of a traditional loan. 31 They explain that although all unsecured lenders accept some risk of non-repayment of loans, traditional lenders may be less informed about their patrons than litigation finance companies. 32 While traditional lenders typically know an individual's credit history and income information, litigation finance companies make their lending decisions after learning the details of the lawsuit in question. 33 Despite these criticisms, only a small number of state courts have directly addressed whether usury laws invalidate litigation finance agreements. 34 Because litigation finance agreements, by their terms, do not always require an absolute obligation to repay the advance, 35 U.S. courts may not have had occasion to confront this issue.

26

Douglas R. Richmond, Other People's Money: The Ethics of Litigation Funding, 56 Mercer L. Rev. 649, 665 (2005).

27

Grous, supra note 20, at 214.

28

Martin, supra note 18, at 58-59; see also Webb, supra note 22, at 18 (stating that the first three elements must be proven by sufficiency of the evidence, while the fourth element, "intention to violate the law," may be implied if the other elements are expressed on the face of the agreement).

29

Richmond, supra note 26, at 665; see also Webb, supra note 22, at 24 (stating that the obligation to pay back the loan principal is absolute). 30

Richmond, supra note 26, at 666; see also Herman, supra note 4 (supporting the argument that the risk is minimal because litigation finance companies operate for profit and therefore meticulously examine the claim before investing); Richard Lloyd, Litigation and Dispute Resolution: The New, New Thing, Legal Wk., Sept. 30, 2010, http://www.legalweek.com/legalweek/analysis/1736124/litigation-dispute-resolution (discussing New York based litigation finance company, Juridica Capital Management, which invests a significant amount of its capital into antitrust cases, particularly those in which liability has been admitted. Richard Fields, co-founder of Juridica, states that this investment strategy makes it "as close to a sure thing as you can get in litigation financing"). 31

Julia H. McLaughlin, Litigation Funding: Charting a Legal and Ethical Course, 31 Vt. L. Rev. 615, 637-38 (2007).

32

Id.

33

Id. at 638; see also Barksdale, supra note 5, at 713-14 (noting that litigation finance firms request a plaintiff's medical records, accident reports and attorney-client privileged information to evaluate a claim). 34

McLaughlin, supra note 31, at 635.

35

See George Steven Swan, Economics and the Litigation Funding Industry: How Much Justice Can You Afford?, 35 New Eng. L. Rev. 805, 826 (2001) (discussing Perry Walton, who runs Resolution Settlement Corporation in Las Vegas, and who arguably "discovered the litigation finance company market niche." Mr. Walton states that usury law does not apply to the litigation financing company, mainly because there is no obligation to pay back the loan if the plaintiff's suit is lost.).

Theresa Coetzee

Page 5 of 21 38 N. Ky. L. Rev. 687, *691 Nonetheless, courts in Michigan and New York have applied a flexible definition of usury and the absolute obligation of repayment requirement to invalidate litigation finance agreements. 36 C. Ethical Issues Litigation finance poses a host of legal ethics issues. Arizona, Florida, New York, Ohio, South Carolina, Utah and Virginia state courts have all handed down judgments that demonstrate litigation finance's unresolved ethical questions. 37 The most glaring ethical issue is a financing agreement's potential impact on the attorney-client relationship. 38 Litigation finance agreements [*692] require that clients order their counsel to give the finance company access to their case file. 39 Such disclosure almost certainly means that attorney-client privilege is waived. 40 Consequently, a defense attorney may be able to uncover that a plaintiff has obtained an advance on a claim, identify the financing company, and obtain discovery from that company, including any documents provided by the plaintiff's lawyer. 41 Thus, opposing counsel could obtain formerly privileged information from the finance company, substantially damaging the plaintiff's claim. 42 Another ethical concern is the litigation finance agreement's impact on the ability to terminate the attorney-client relationship. 43 Many litigation finance agreements stipulate that the entire balance of the advance and all interest accrued is immediately due if the attorney-client relationship ends. 44 Therefore, if an attorney wants to terminate the relationship with a client after the client has obtained an advance, the attorney may be unable to do so without avoiding potential ethical and malpractice claims. 45 Further, an advance from a litigation finance company may influence a client's decision-making during a lawsuit. 46 Because fees increase as a lawsuit continues, a client's net recovery potentially diminishes the longer litigation

36

McLaughlin, supra note 31, at 635.

37

Rodak, supra note 24, at 509.

38

See U.S. Chamber Institute for Legal Reform Report, supra note 5, at 3 (arguing that litigation finance negatively impacts the attorney-client relationship and raises the question of the funder's position in the relationship). Funders are solely in the business to make profit; they have no obligations to "zealously" pursue their clients claim and protect confidential information. Id. But see Christy B. Bushnell, Champerty is Still No Excuse in Texas: Why Texas Courts (and the Legislature) Should Uphold Litigation Funding Agreements, 7 Hous. Bus. & Tax L.J. 358, 385 (2007) (focusing on the benefits of litigation financing in allowing plaintiffs without adequate assets to pursue their claims, and further arguing that third party finance does not negatively impact the attorney-client relationship by allowing outside investors to profit from the plaintiff's claim because the financing agreements do not "deprive the original parties of their legal rights or misalign the parties"). 39

Braun, supra note 7, at 11.

40

Id.

41

Id.

42

Id.

43

Id. at 12.

44

Id.

45

Braun, supra note 7, at 12.

46

Id.; see also U.S. Chamber Institute for Legal Reform Report, supra note 5, at 13 (arguing that litigation finance companies have incentive to prolong the litigation to ensure that they obtain the value contemplated by the agreement); Steinitz, supra note 21, at 53-56 (discussing "[t]he fragmentation of the attorney- client-funder relationship," including issues of client control and conflicts of interest).

Theresa Coetzee

Page 6 of 21 38 N. Ky. L. Rev. 687, *692 continues. 47 This may cause a plaintiff to be more prone to accept an early settlement offer to stop the accrual of interest owed to the litigation finance company, 48 even in cases where their attorney advises that a favorable judgment resulting in a higher recovery is likely. 49 If the client follows the attorney's [*693] advice to hold out for a higher recovery, and the claim eventually fails, the client could sue the attorney for malpractice or breach of fiduciary duty. 50 IV. Litigation Financing in the U.S. Despite potential ethical hurdles, the U.S. litigation financing industry began to take root in the late 1980s and early 1990s. 51 Financing companies began accepting primarily corporate lawsuits, but have since expanded, with most of the current academic and media attention focusing on litigation financing for poor, individual plaintiff lawsuits. 52 Indeed, litigation financing companies currently work with all types of lawsuits including personal injury, patent litigation, copyright infringement, and employment discrimination. 53 The varied treatment of litigation financing in courts throughout the country demonstrates a need for a clearer, structured approach to litigation finance agreements. 54 A. Saladini and the "Liberal" Approach Some states have been extremely receptive to litigation financing. 55 For example, the Massachusetts Supreme Court has eliminated the doctrines of champerty and maintenance. 56 In Saladini v. Righellis, the parties had previously entered into an agreement for the plaintiff to support the defendant in a separate dispute over real estate.

47

Braun, supra note 7, at 12; see also Rancman v. Interim Settlement Funding Corp., 789 N.E.2d 217, 218-19 (Ohio 2003) (setting the litigation finance company's recovery amounts dependent upon whether the case settled within twelve, eighteen, and twenty-four months). 48

Braun, supra note 7, at 12; see also U.S. Chamber Institute for Legal Reform Report, supra note 5, at 13 (noting that because the litigation finance agreement usually creates a disincentive to settle below the amount contemplated by the agreement, the plaintiff may be put in a position of refusing a settlement offer that is a fair value of the claim). 49

Braun, supra note 7, at 12; see also U.S. Chamber Institute for Legal Reform Report, supra note 5, at 13 (stating that third party financing agreements create the same issues contingency fees create; the plaintiff's attorney has a financial incentive to hold out for the highest settlement amount). 50

Braun, supra note 7, at 12.

51

Yifat Shaltiel & John Cofresi, Litigation Lending for Personal Needs Act: A Regulatory Framework to Legitimize Third Party Litigation Finance, 58 Consumer Fin. L.Q. Rep. 347, 348 (2004). 52

Martin, supra note 1, at 84-85. See generally Swan, supra note 35 (discussing how a great number of commentators have been proponents of litigation finance due to its result of helping the poor assert their rights in the "halls of justice"). 53

Shaltiel & Cofresi, supra note 51, at 348; see also William Arthur Haynes, Silicon Valley Companies Get Funding Source for Litigation, Silicon V a l l e y / S a n J o s e B u s . J . , J a n . 1 8 , 2 0 1 0 , http://www.bizjournals.com/sanjose/stories/2010/01/18/focus2.html?b=1263790800%255E27 35141&page=2 (discussing litigation finance company Arca Capital Partners LLC, and their investments in Silicon Valley, particularly patent infringement cases that require an investment of $ 3 million to $ 10 million for each individual case). 54

Bond, supra note 21, at 1333-41. See generally Bushnell, supra note 38 (discussing litigation finance and its particularities in the state of Texas). 55

See Bond, supra note 21, at 1333-41 (discussing significant case law in all fifty states relating to their respective treatment of champerty and maintenance). 56

Saladini v. Righellis, 687 N.E.2d 1224, 1226 (Mass. 1997); see also Michael Abramowicz, On the Alienability of Legal Claims, 114 Yale L.J. 697, 700 (discussing Massachusetts's abolition of the doctrines of champerty and maintenance) (citing the court's reassurance in Saladini that the decision would not legalize "the syndication of lawsuits").

Theresa Coetzee

Page 7 of 21 38 N. Ky. L. Rev. 687, *693 57

Although the defendant settled the previous dispute, the plaintiff did not receive any funds pursuant to their agreement, 58 and when the plaintiff brought suit to enforce the agreement, the defendant moved for [*694] summary judgment on the grounds that the agreement was champertous. 59 The Superior Court judge allowed both parties to submit memoranda on the issue of whether the agreement between the parties was champertous, 60 and after a hearing, a different judge held that "the agreement was champertous and unenforceable as against public policy." 61 On appeal, the Massachusetts Supreme Court ruled that the champerty doctrine was no longer legally effective and that modern rules were appropriate to address claims involving improper or illegal agreements. 62 The court noted that it had previously recognized a public policy against the recovery of excessive fees. 63 Further, the court held that state rules for the regulation of misconduct and frivolous lawsuits, as well as the doctrines of public policy, duress, and good faith, were more appropriate to address the validity of the modern litigation finance agreement. 64

Other states that have invalidated champerty laws have largely followed the Saladini's rationale. 65 For example, in Osprey Inc. v. Cabana Ltd. Partnership, the Supreme Court of South Carolina abolished champerty, stating "[w]e are convinced that other well-developed principles of law can more effectively accomplish the goals of preventing speculation in groundless lawsuits and the filing of frivolous suits than dated notions of champerty." 66 Like the Massachusetts Supreme Court in Saladini, the Osprey court pointed out that state rules of professional conduct, contract law, and the doctrines of unconscionability, duress, and good faith are more appropriate ways to challenge questionable litigation finance agreements. 67 Massachusetts, New Jersey and Arizona all take similar approaches to litigation financing by refusing to enforce the doctrine of champerty. 68 These states represent a more liberal exception to the general rule in most states that still prohibit champerty in some way. 69 B. Rancman and the "Conservative" Approach

57

Saladini, 687 N.E.2d 1224, 1224.

58

Id. at 1225.

59

Id.

60

Id.

61

Id.

62

Id. at 1226.

63

Saladini, 687 N.E.2d 1224, 1226.

64

Id. (citing Berman v. Linnane, 679 N.E.2d 174, 178 (Mass. 1997); Mass. R. Civ. P. 11; Mass. Gen. Laws ch. 237, § 6f (1986)).

65

See Bond, supra note 21, at 1333-41 (discussing significant case law in all fifty states relating to their respective treatment of champerty and maintenance). 66

Osprey, Inc. v. Cabana Ltd. P'ship, 532 S.E.2d 269, 277 (S.C. 2000).

67

Id.

68

Grous, supra note 20, at 213.

69

Id.; see also Bond, supra note 21, 1333-41 (discussing significant case law in all fifty states relating to their respective treatment of champerty and maintenance).

Theresa Coetzee

Page 8 of 21 38 N. Ky. L. Rev. 687, *694 Some states take a more traditional approach to champerty and litigation financing. 70 A 2003 Ohio Supreme Court ruling caused a stir in the litigation [*695] financing industry and among those that follow the industry. 71 In Rancman v. Interim Settlement Funding Corporation, the plaintiff Roberta Rancman was severely injured after a car accident and subsequently sued her insurance provider to obtain insurance benefits paid to her estranged husband. 72 Before the parties resolved the lawsuit, Rancman entered into a litigation financing agreement with Interim Settlement Funding Corporation ("Interim") and Future Settlement Funding Corporation ("FSF") for a $ 6,000 nonrecourse advance. 73 The terms of Rancman's agreement stipulated that she would repay Interim $ 16,800 if the case was resolved within twelve months, $ 22,000 if the case was resolved within eighteen months, and $ 27,600 if the case was resolved within twenty-four months. 74 Additionally, before resolving the suit against the insurance company, Rancman obtained another advance from Interim for $ 1,000, for which she agreed to pay $ 2,800 if she received a settlement or favorable judgment. 75 During the lawsuit against co-defendants Interim and FSF, Rancman testified that she understood the terms of the financing agreements. 76 Rancman settled her lawsuit with the insurance company for $ 100,000 in less than twelve months, but refused to repay Interim the agreed upon amount. 77 Instead, Rancman filed a lawsuit against Interim and FSF seeking rescission of the contracts, and a declaratory judgment that the companies engaged in "unfair, deceptive, and unconscionable sales practices." 78 Eventually, the Ohio Supreme Court held in Rancman's favor, not on the grounds of unconscionability, but on the grounds of champerty and maintenance. 79 Although the judgment relied on champerty and maintenance, the court recognized that "[i]n recent years, champerty and maintenance have lain dormant in Ohio courts." 80 Despite acknowledging that the two doctrines were largely outdated, the court found that the agreements were champertous, since Interim and FSF sought to profit from Rancman's case. 81 The Ohio Supreme Court also found that the advances constituted maintenance, because Interim and FSF each purchased a share of a lawsuit in which they did not have an independent interest, and the agreements discouraged Rancman from settling her case. 82 The court stated that the repayment terms of the contract with Interim, combined with the contingency fee Rancman owed her attorney, meant that Rancman owed so [*696] much that if she settled within twelve months for less than $ 28,000, she would receive nothing. 83

70

Martin, supra note 1, at 83-86 (referring to the Rancman case).

71

Id. at 88.

72 73

74 75

Rancman v. Interim Settlement Funding Corp., 789 N.E.2d 217, 218 (Ohio 2003). Id. Id. at 219. Id.

76

Rancman v. Interim Settlement Funding Corp., No. 20523, 2001 WL 1339487, at *3 (Ohio Ct. App. Oct. 31, 2001).

77

Rancman, 789 N.E.2d at 219.

78

Id. at 219.

79

80

Id. Id. at 220.

81

Id.

82

Id.

83

Rancman, 789 N.E.2d at 221.

Theresa Coetzee

Page 9 of 21 38 N. Ky. L. Rev. 687, *696 Because of the involvement of Interim and FSF in the litigation, the court reasoned that the co-defendants forced Rancman to hold out for a higher settlement than she would have without their involvement. 84 Indeed, this seems to be a valid assertion - earlier in the case Rancman rejected a settlement offer from the insurance company for $ 35,000. 85 Additionally, the court was averse to Interim and FSF speculating in a lawsuit for profit, 86 and expressed a strong distaste for arrangements like the one between the parties by stating "a lawsuit is not an investment vehicle." 87 The Rancman holding, which affirmed Ohio's common law prohibition of champerty, has generated a significant amount of commentary. 88 The case highlights a number of obstacles that litigation finance companies struggle with in the U.S. today. 89 In addition to the traditional fears that champerty and maintenance guard against, some courts are weary of predatory lending practices in the litigation financing industry, and of investors profiting from placing bets on the outcome of litigation. 90 Despite the reasoning used by the Ohio Supreme Court to support its hard-line stance against litigation financing and champerty in Rancman, the effect of the judgment on future plaintiffs, as well as its potentially detrimental impact on the poor's access to litigation, should not be overlooked. 91 C. Fausone and the Need For Regulation The Florida case Fausone v. U.S. Claims, Inc. is another example of the varied approach U.S. state courts take to litigation finance agreements. 92 In 2000, Ms. Fausone commenced two lawsuits, a personal injury claim and an unrelated products liability claim. 93 In 2001, Fausone contacted U.S. Claims, Inc. ("Claims") and obtained three separate advances totaling $ 30,000. 94 In mid- [*697] 2003, the case settled for over $ 200,000, which meant Fausone had to pay $ 50,937 to Claims under the financing agreement's repayment schedule. 95 Instead of honoring the agreement, she instructed her lawyer to withhold payment from Claims, who subsequently initiated arbitration proceedings. 96 In response, Fausone filed a petition for declaratory judgment, arguing that the

84

Id.

85

Rancman, 2001 WL 1339487, at *3.

86

Rancman, 789 N.E.2d at 221.

87

Id.

88

Martin, supra note 1, at 83-86. See generally Jonathan D. Petrus, Legal and Ethical Issues Regarding Third-Party Litigation Funding, 32 Los Angeles Lawyer 16 (2009) (discussing how the issue of litigation finance has resulted in a "relatively small but quickly growing body of case law"). 89

Martin, supra note 18, at 63 ("[T]he Rancman case is an excellent example of the more emotional problems faced by the litigation financing industry: courts just do not like it."). 90

Id. at 62-65 (discussing how investors can make large amounts of money with little risk from the legal claims of impoverished individuals, which makes litigation financing look like predatory lending).

91

Susan Lorde Martin, Financing Litigation On-Line: Usury and Other Obstacles, 1 Depaul Bus. & Com. L.J. 85, 92 (2002). See also Steinitz, supra note 20, at 9 (arguing that third party finance allows poor plaintiffs to pursue their legal rights and have their day in court). 92

Fausone v. U.S. Claims, Inc., 915 So. 2d 626, 627 (Fla. Dist. Ct. App. 2005).

93

Id. at 627.

94

Id. at 628.

95

Id. at 628-29.

96

Id. at 629.

Theresa Coetzee

Page 10 of 21 38 N. Ky. L. Rev. 687, *697 agreement with Claims was unconscionable and violated usury law. 97 Ultimately, the District Court of Appeals of Florida found in favor of Claims, reasoning that litigation finance agreements are not treated the same as consumer loans, and finding that there are no Florida laws that regulate such agreements. 98 The common law doctrine of champerty did not apply in Fausone because Florida state law requires "officious intermeddling" as an essential element of champerty. 99 In Florida, officious intermeddling is "offering unnecessary and unwanted advice or services; meddlesome, [especially] in a highhanded or overbearing way." 100 The court found that no officious intermeddling had occurred, because Fausone contacted Claims first, and Claims had not sought out Fausone,. 101 The court's opinion also addressed the benefits and disadvantages of litigation finance, and highlighted the need for clear rules and regulation in the industry. 102 The court cited a Florida Bar ethics opinion, which discussed that it was ethical for Florida attorneys to provide information on litigation financing to clients, and to share information with litigation finance companies. 103 On the other hand, the ethics court discussed the potential of predatory practices by litigation finance companies, and highlighted the need for the legislature to address the matter with regulation. 104 The Fausone case illustrates the unsettled approach to litigation financing in the U.S. 105 A lack of regulation regarding litigation financing means that the litigation financing industry is plagued with uncertainty. 106 Finance agreements [*698] create a number of conflicting issues, and without clear rules or legislation to interpret the agreements, courts throughout arrive at a wide variety of conclusions. 107 Consequently, the U.S. needs a more uniform approach to litigation financing. 108 An examination of litigation financing in the U.K. and Australia provides a better understanding of the relevant issues that accompany this uncertainty and potential ways to resolve conflicts regarding the litigation financing industry.

97

98

Id. Fausone, 915 So. 2d at 629.

99

Grous, supra note 20, at 214. See generally Bushnell, supra note 38, at 372 (discussing "officious intermeddling" and whether a litigation financer violates this rule by "aggressively" advertising their service and soliciting potential legal claims to invest in).

100

Grous, supra note 20, at 214 (emphasis added).

101

Fausone, 915 So. 2d at 627.

102

Id. at 629-30.

103

Id.

104

Id. at 630.

105

Id. at 627-30.

106

See McGovern et al., supra note 10, at 21 (discussing the proper role of regulation in the litigation financing industry and arguing that regulation should first focus on requiring plaintiffs to provide the litigation finance company with full disclosure of all relevant information). The article asserts that this failure of complete disclosure by the litigants has prevented third party financing companies from fully evaluating the risk of particular claims, thus stifling the litigation funding market. 107

See Bond, supra note 21, at 1333-41 (discussing significant case law in all fifty states relating to their respective treatment of champerty and maintenance).

108

See Anthony J. Sebok, The Inauthentic Claim, 64 Vand. L. Rev. 61 (2011) (contending that instead of declaring that maintenance agreements interfere with the attorney-client relationship, bar associations and other parties should institute rules providing that communication between litigants and litigation financers does not destroy the privileges inherent in the attorneyclient relationship).

Theresa Coetzee

Page 11 of 21 38 N. Ky. L. Rev. 687, *698 V. Litigation Financing in the U.K. In recent years, common law countries, including the U.K., have revised champerty laws. 109 The litigation financing industry in the U.K. has experienced problems and successes similar to those experienced in the U.S. 110 Litigation financing agreements encounter problems with U.K. champerty law which, like U.S. champerty law, has a long tradition of barring such agreements. 111 However, unlike in the U.S., champerty law in the U.K. traditionally barred the contingency fee, making access to justice for the poor in the U.K. even more restrictive than in the U.S. 112 The U.K. previously barred the contingency fee for many of the same reasons litigation financing is criticized in the U.S. 113 In an effort to expand the poor's access to justice and reduce taxpayers' expenditures on the nation's legal aid system, the U.K. relaxed its laws regarding champerty in recent decades. 114 In 1967, the U.K. decriminalized champerty and maintenance, and abolished any tort liability that may have stemmed from the two doctrines. 115 In 1990, Parliament passed the Courts and Legal Services Act, making it legal for a lawyer and client to enter into a conditional fee [*699] agreement. 116 As a result of the act, the U.K. allowed the use of a "conditional fee," which is a type of contingency fee that features an agreed-upon hourly rate for legal services, and an "uplift," which represents an additional percentage of the original hourly fee if the case succeeds. 117 This uplift can be up to 100% of the original hourly fee, or up to 25% of the damages recovered. 118 Consequently, the abolition of champerty and the introduction of the conditional fee agreement opened the door to litigation financing in the U.K. 119 One case in particular, Arkin v. Borchard Lines, Ltd., has been a catalyst for expansion in the industry. 120 Yeheshkel Arkin, the owner of BCL Shipping Line Ltd. ("BCL"), sued four members of the United Information Systems Conference ("UNISCON"), a European shipping conference, accusing them of predatory pricing and other unlawful activities that resulted in BCL becoming insolvent. 121 Mr. Arkin entered into an agreement with Managers and Processors of Claims, Ltd. ("MPC"), a professional financing company, to fund a

109

Martin, supra note 17, at 72-73.

110

Id. (stating that the U.S. and England have "relaxed" their prohibitions on champerty); see also U.S. Chamber Institute for Legal Reform Report, supra note 5, at 7 (noting that litigation funding agreements in England and Wales are still vulnerable to arguments that they are against public policy). 111

Martin, supra note 17, at 73.

112

See id. (stating that contingency fees were banned due to the belief that they degraded the legal profession, had the potential to create unfair bargains between attorney and client, promote solicitation, and increase frivolous litigation). 113

Id. (citing reasons much as apprehensions regarding improper influence on the attorney-client relationship, and he encouragement of frivolous litigation).

114

Id.

115

Rachael Mulheron & Peter Cashman, Third Party Funding: A Changing Landscape, 27 Civ. Just. Q. 312, 318 (2008).

116

Susan Dunn, Paying For Personal Injury Claims - What Are the Options for Clients and their Representatives?, 2009 J. Pers. Inj. L. 218, 220.

117

Martin, supra note 16, at 73.

118

Id.

119

See id. at 73-74 (noting that since 1998, conditional fees have been allowed in all sorts of civil cases, with the exception of family law matters).

120

Arkin v. Borchard Lines, Ltd., [2005] 1 W.L.R. 3055.

121

Id. at 3060.

Theresa Coetzee

Page 12 of 21 38 N. Ky. L. Rev. 687, *699 portion of the litigation expenses. 122 Under the agreement, MPC would have been paid only if Arkin's claim succeeded, 123 which it did not. 124 The U.K. takes a "loser pays" approach to legal fees, so the losing party must pay the winner's legal costs. 125 Under this rule, Arkin should have paid the other party's legal costs. 126 However, Arkin was insolvent, so the defendants sought an order for MPC, the litigation finance company, to pay their legal fees. 127 A judge denied the order on the ground that litigation finance furthered public policy by providing access to justice. 128 Further, the judge ruled that if litigation finance agreements are not champertous, the agreements should not be discouraged by forcing the finance company to pay the adverse party's legal fees. 129 [*700]

On appeal, the court reversed the initial judgment and ordered MPC to pay the opposing parties' costs to the extent of the funding provided. 130 The court balanced the "loser pays" rule of attorney fees with the benefits that litigation financing presents in the U.K. 131 Applying this reasoning, the court refused to force MPC to pay the opposing parties' entire costs, fearing that such a rule would serve as a disincentive for litigation finance companies to fund litigation. 132 Instead, by making the litigation finance company liable for only a portion of the opposing parties' costs, the court reasoned that the result would be to create some sort of industry regulation. 133 For instance, financiers would be inclined to cap the funds they make available to each case to limit their own liability risk, and evaluate cases with more scrutiny, funding only those with high probabilities of success. 134 In addition, Arkin proved important because the court supported the important role litigation finance companies can play, and all but endorsed the litigation financing industry. 135 The decision laid down a clear-cut rule for litigation finance companies, limiting their liability in the event of a loss to the amount of money advanced, and also provided a judicial "green light" for financiers. 136

122 123 124

Id. at 3061. Id. Id. at 3059.

125

Michael Napier et al., Civil Justice Council, The Future Funding of Litigation - Alternative Funding Structures 55-57 (2007), h t t p : / / w w w . c i v i l j u s t i c e c o u n c i l . g o v . u k / files/future funding litigation paper v117 final.pdf.

126

Id. at 56; see also Rubin, supra note 1, at 8 (explaining that in Britain, the plaintiff who brings a claim and subsequently loses must personally pay for the defendants costs). Under British law, the plaintiff's attorney is prohibited from paying the costs. Rubin, supra note 1, at 8.

127

Arkin, 1 W.L.R. at 3060.

128

Id. at 3062.

129 130 131

Id. Id. at 3069. Id.

132

Id. at 3069-70.

133

Arkin, 1 W.L.R. at 3069-70.

134

Id. at 3069-70.

135 136

Dunn, supra note 116, at 220. Arkin, 1 W.L.R. at 3069-70.

Theresa Coetzee

Page 13 of 21 38 N. Ky. L. Rev. 687, *700 In addition to Arkin, the Civil Justice Council showed support for litigation financing through its report regarding improving access to justice in the U.K. 137 First, the report noted that U.K. courts have accepted third party funding as a permissible means of financing lawsuits, and that an individual's right of access to justice should supersede the doctrines of champerty and maintenance. 138 Second, the Civil Justice Council concluded that, subject to the rules in Arkin, third party funding should be encouraged. 139 Finally, the Council recommended the adoption of regulation to protect consumers and the attorney-client relationship. 140 In the 2008 case London & Regional (St. George's Court) Ltd. v. Ministry of Defence, the court summarized the state of litigation finance law in the U.K. The court explained that when examining a financing agreement, "the question is whether the agreement has a tendency to corrupt public justice . . . . " 141 The L & [*701] R court also noted that modern authorities have demonstrated a flexible approach to financing agreements and have generally enforced these agreements. 142 However, in spite of the growth of the U.K.'s litigation financing industry, a recent study suggests the industry has not provided an adequate solution to "access to justice" problems for poor individuals. 143 Researchers from Oxford and Lincoln Universities in the U.K. issued preliminary findings showing that while current financing models have improved access to justice for small- to medium-sized companies, individual plaintiffs have not received the same benefit. 144 This paints a clear picture of the U.K.'s litigation financing industry today. 145 Instead of focusing on catering to lower-income individual plaintiffs, the industry takes a complex investment approach to financing lawsuits. 146 Hedge funds, insurers, large investment companies and private investors all finance lawsuits in the U.K. 147 In fact, most financing companies are large corporate entities with huge budgets, 148 typically

137

Michael Napier et al., supra note 125, at 53.

138

Id. at 54.

139

Id. at 66.

140

Id.

141

London & Reg'l (St. George's Court) Ltd. v. Ministry of Def., [2008] EWHC 526 (TCC) para. 103 (citation omitted).

142

London, EWHC 526.

143

University of Oxford, Third Party Litigation Funding Has Not Helped Ordinary Consumers, http://www.ox.ac.uk/media/news stories/2010/100602.html (last visited Feb. 20, 2011). See generally Nate Raymond, More Attorneys Exploring Third- Party Litigation Funding, N.Y. L.J., June 4, 2010, available at http://www.law.com/jsp/article.jsp?id=1202459195060& slreturn=1&hbxlogin=1 (stating that the "new phenomenon" is investors entering the litigation finance market and financing commercial law suits between companies). 144

University of Oxford, supra note 141. In addition to the study's findings on the litigation finance industry's effect on access to justice, it also revealed the participants' sentiments on regulation of the industry in the U.K. Consumer groups interviewed for the study felt that industry self-regulation was insufficient and more governmental regulation was necessary, while litigation financiers recognized the need for regulation to prevent rogue litigation finance companies from entering the industry, and that such regulation may increase the public's confidence in litigation financing. 145

Id.

146

Martin, supra note 1, at 113; see also Claire Ruckin & Sofia Lind, External Funding Booms as Litigators Plot Upturn, Legal Wk., Mar. 20, 2008, available at http://www.law.com/jsp/article.jsp?id=1206009902544 (discussing the rise of litigation finance companies and outside investors entering the litigation financing business); Raymond, supra note 141 (stating that until recently, the U.S. litigation finance companies primarily lent small amounts of capital to claimants in personal injury cases in return for a percentage of any subsequent recovery). 147

Martin, supra note 1, at 113; see also Securities Docket, Global Securities Litigation and Enforcement Report, Litigation Funding Starting to Pay Off, May 5, 2009, http://www.securitiesdocket.com/2009/05/05/litigation-funding-starting- to-pay-off/ (stating that insurance companies such as Allianz (Germany) and other independent investors have begun investing in lawsuits).

Theresa Coetzee

Page 14 of 21 38 N. Ky. L. Rev. 687, *701 funding lawsuits with claims that value well over 100,000. 149 The type of corporate clients who would ordinarily enter into these agreements are usually represented by large law firms, [*702] which have now begun to partner with third party litigation finance companies to offer advances to clients. 150 For example, eight of the top ten firms in the U.K. now offer, or are considering offering, external financing to clients in some cases. 151 The cooperation of large law firms and litigation finance companies in the U.K. demonstrates a "big business" approach to litigation financing, with the industry moving away from access to justice concerns and increasingly towards an investment mindset. 152 One possible reason for the investment approach to litigation finance in the U.K. is Rule 9 of the Solicitor's Code of Conduct. 153 The U.K. originally adopted Rule 9 to maintain control over claims management companies that incorporated shares of each client's damages into their referral fee. 154 The rule deals with personal injury claims, and effectively prohibits lawyers from associating with any company that funds litigation and receives a contingency fee. 155 While Rule 9 is currently under review by the Solicitor's Rule Authority and may be changed, 156 the only way a lawyer may currently circumvent the rule is by applying for waiver and making a claim that a particular suit is of public interest and therefore deserves funding. 157 However, when no waiver is granted, Rule 9 continues to be a significant burden to poor individual plaintiffs and effectively bars the assistance of third party litigation finance. 158

The litigation financing industry is still developing in the U.K. 159 However, in Australia, the industry has become widely accepted and arguably more successful than the U.S. and U.K. in incorporating financing agreements into the country's legal system. 160 VI. Litigation Financing in Australia Litigation financing in Australia, much like the U.K. and parts of the U.S., benefitted from the abolition of maintenance and champerty. Maintenance and [*703] champerty have been abolished in the Australian Capital

148

Id.; see also Raymond, supra note 141 (discussing Juridica Investments Limited, which is reported to have committed $ 123 million to fifteen investments in twenty-two cases, and Burford Capital Ltd., which has invested $ 40 million in ten cases).

149

University of Oxford, supra note 141. See generally Petrus, supra note 88 (stating that small and middle-sized companies with limited budgets are seeking litigation financing for their commercial claims against their highly funded adversaries).

150

Ruckin & Lind, supra note 144.

151

Id.

152

See Rachel M. Zahorsky, Third-Party Litigation Funding Picks Up as U.K. Investors Eye U.S. Cases, A.B.A. J., June 4, 2010, http://www.abajournal.com/news/article/third- party litigation funding picks up as uk investors eye u.s. case/ (discussing two U.K. litigation finance companies, which have invested more than $ 160 million in at least thirty cases, including international arbitrations). 153

Dunn, supra note 116, at 222.

154

Id.

155

Id.

156

Id.

157

Id.

158

Id.

159

See generally Raymond, supra note 141 (discussing the increase in law firms and attorneys considering litigation finance, as well as the rise in U.K. investment firms branching out to advance more funds for litigation in different areas of law). 160

See Standing Committee of Attorneys-General, Discussion Paper on Litigation Funding in Australia, 4 (May 2006) [hereinafter Discussion Paper] (discussing the acceptance of litigation finance by Australian courts).

Theresa Coetzee

Page 15 of 21 38 N. Ky. L. Rev. 687, *703 Territory, New South Wales, South Australia, and Victoria. 161 While early cases involving litigation finance agreements resulted in their invalidation under traditional doctrines, courts in Australia now endorse the positive role litigation finance can play in litigation. 162 The Australian litigation financing industry began around 1995 when insolvency practitioners were legally sanctioned to contract for the funding of lawsuits characterized as company property. 163 More recently, litigation finance companies have funded and managed class actions in Australia. 164 Australian litigation finance companies typically contract with potential plaintiffs to pay the plaintiff's costs, accept the risk of paying opposing counsel's costs if the lawsuit fails, and control the lawsuit. 165 Under these contracts, litigation finance companies often receive 25% to 40% of the lawsuit's recovery, though in some cases, companies have sought up to 75% of the recovery. 166 Australia has been more receptive to litigation financing agreements than the U.S. or the U.K. 167 In 2005, the Supreme Court of New South Wales refused to rescind a financing agreement on the grounds that the financing firm had controlled too much of the litigation. 168 The court noted that there was no public policy against such agreements, 169 and even went so far as to point out the irony of using a financing firm to finance litigation, then suing the firm based on the terms of the original agreement. 170 The Federal Court of Australia gave its support to litigation financing in QPSX Communications Pty. Ltd. v. Ericsson Australia Pty. Ltd. 171 In QPSX, Ericsson failed to make royalty payments for its use of QPSX technology in [*704] Ericsson products and failed to comply with other terms of the contract between the parties. 172 QPSX brought suit against Ericsson for breach of a licensing agreement and deceptive conduct in violation of the Australian Trade Practices Act. 173 Ericsson moved to stay the proceedings on the grounds that QPSX had entered

161

Michael Legg et al., Litigation Funding in Australia 3 (Univ. of N.S.W. Faculty of Law Research Series, Working Paper No. 12, 2009), available at http://ssrn.com/abstract=1579487.

162

Bernard Murphy & Camille Cameron, Access to Justice and the Evolution of Class Action Litigation in Australia, 30 Melb. U. L. Rev. 399, 435 (2006). But see Legg & Travers, supra note 2, at 254 (stating that although the Australian courts no longer strike down litigation financing agreements on maintenance and champerty grounds, the abolition of the two doctrines does not prevent a court from finding the agreements invalid if they are contrary to public policy or illegal). 163

Legg et al., supra note 159, at 4.

164

See generally Legg & Travers, supra note 2 (providing a detailed explanation of class actions in Australia and how litigation finance has recently been allowed to fund such cases). 165

Renee Leon, Chief Executive, ACT Dep't of Justice & Cmty. Safety, Speech at the 2007 Conference of the Australian Insurance Law Association: Funding Litigation: A Need for Regulation? 2 (Sept. 21, 2007), available at http://www.aila.com.au/speakersPapers/ downloads/2007 Conference/07-09- 21 Renee Leon2.doc. 166

Id.

167

See generally U.S. Chamber Institute for Legal Reform Report, supra note 5, at 17-22 (discussing Australia's acceptance of litigation finance and the Fostif case, in which the Australian High Court upheld a financing agreement when the litigation finance company had "pervasive" control over the plaintiff's case). 168

Domson Pty. Ltd. v. Zhu, [2005] N.S.W.S.C. 1070, 1070.

169

Id. at 1071.

170

Id.

171

QPSX Commc'ns Pty. Ltd. v. Ericsson Austl. Pty. Ltd., [2005] 219 A.L.R. 1.

172

Id. at para. 2.

173

Id. at para. 2.

Theresa Coetzee

Page 16 of 21 38 N. Ky. L. Rev. 687, *704 into a litigation financing agreement with IMF Limited ("IMF"), claiming that the agreement was an abuse of process, champertous, and against public policy because IMF and QPSX were "trafficking in litigation." 174 Ericsson argued that, in sum, the agreement allowed IMF to control the course of the litigation in pursuit of its own financial gain. 175 First, the court addressed Ericsson's champerty argument, stating that the concerns of third parties encouraging litigation were less important than the concerns of ordinary litigants gaining access to courts. 176 The court then commended the role that litigation finance companies play in planning budgets and improving the efficiency of litigation. 177 The court found the contention that IMF might seek to control or prolong the litigation to increase its fee unpersuasive, since Ericsson could not prove the manner in which IMF might have done so. 178 Ultimately, the court found that the financing agreement did not give IMF the ability to control the litigation, because there was no agreement between IMF and QPSX's counsel. 179 In dismissing the motion to stay proceedings, the court characterized the financing agreement as "an arm's length agreement conferring what the parties plainly adjudge to be economic benefits in relation to the enforcement of claimed intellectual property rights." 180 Another watershed moment for the Australian litigation finance industry came in the 2006 case Campbell Cash and Carry Pty. Ltd. v. Fostif Pty. Ltd. 181 Firmstones, a litigation financier, began contacting tobacco retailers and encouraging them to sue tobacco wholesalers to recover tobacco license fees owed to the retailers. 182 Firmstones offered to act on the retailers' behalf, obtain representation, and fund the lawsuit in exchange for one-third of the recovery. 183 Fostif, one of the tobacco retailers that worked with Firmstones, subsequently sued the tobacco wholesaler Campbell's Cash and Carry to recover the back license fees. 184 [*705]

The High Court expressly stated that fears of adverse effects on the litigation process and predatory agreements between litigation finance companies and litigants did not warrant a broad public policy against litigation financing, nor a law that would require such agreements to meet specific standards and regulations. 185 Much like previous Australian litigation financing cases, the court seemed concerned with ensuring that the financier did not commit an abuse of the legal process, 186 holding that the degree of control the financing company had over the litigation was permissible and did not constitute officious intermeddling. 187 The result was clear - in Australia,

174

Id. at para. 11.

175

Id. at para. 11.

176

Id. at para. 53 (citing Magic Menu Sys. v. AFA Facilitators Pty. Ltd., [1997] 72 F.C.R. 261, 267).

177

QPSX, 219 A.L.R. at para. 56.

178

Id. at para. 61.

179

Id.

180

Id.

181

Legg et al., supra note 159, at 6-7.

182

Campbell's Cash & Carry Pty. Ltd. v. Fostif Pty. Ltd., [2006] 229 C.L.R. 386.

183

Id. at 390.

184

Id. at 390.

185

Id. at 433-34.

186

Vicki Waye, Conflicts of Interests Between Claimholders, Lawyers, and Litigation Entrepreneurs, Bond L. Rev., July 1, 2007, at 225. See generally Legg & Travers, supra note 2, at 254 (stating that the common law prohibition against third party funding of lawsuits was primarily to prevent abuses of the court process).

187

Legg et al., supra note 159, at 6-7.

Theresa Coetzee

Page 17 of 21 38 N. Ky. L. Rev. 687, *705 financing companies focused on profiting from litigation can be involved in lawsuits without creating an abuse of process. 188 Overall, Australian litigation finance companies have enjoyed freedom to operate and encountered little judicial resistance in cases where financing agreements have been challenged compared to their U.S. and U.K. counterparts. 189 VII. Comparing Litigation Financing in the U.S., U.K. and Australia Though litigation financing began to develop in the U.S., the U.K. and Australia during the 1990s, there are large differences in the way that the industry operates in each respective market. From the types of clients served, to the manner in which it is viewed by courts and the legal community at large, each nation's interpretation of litigation finance is drastically different. 190 Beyond the nuances of legal history, there are a number of reasons for the varied paths that litigation finance follows in each country. A. Litigation Finance Companies Developed To Serve Different Markets In Each Country One of the readily observable differences between the litigation finance industries in the U.S., U.K. and Australia is the different types of clients who seek funding, the type of cases that receive funding, and the type of financier that [*706] supplies funding. 191 While litigation financing began in the three countries due to common concerns about access to justice, 192 each country's industry developed to serve different markets. 193 The U.K. has taken a rather narrow approach to litigation finance. 194 For U.K. litigation finance companies, litigation financing is big business, with the majority of financiers retaining massive amounts of money to fund litigation involving corporate clients. 195 Further, litigation finance is largely seen as an investment, with sophisticated litigation finance companies analyzing probable outcomes of cases, investing large sums of money, and seeking even larger returns. 196 A number of successful U.K. litigation finance companies have begun to

188

Waye, supra note 184, at 225; see also Legg & Travers, supra note 2, at 255 (stating that the High Court in Campbell's Cash held that the "existing doctrines of abuse of process and the courts' ability to protect their processes" were enough to protect against a third party funder's acts that would violate principles of justice). 189

See, e.g., Campbell's, 229 C.L.R. at 388-90.

190

See generally Steinitz, supra note 20 (discussing the rise of litigation financing, particularly the evolutions in Australia and U.K., and the expanse of the U.S. market). 191

Compare Raymond, supra note 141 (stating that until recently, the U.S. litigation finance companies primarily loaned small amounts of capital to claimants in personal injury cases), and Shaltiel & Cofresi, supra note 51, at 348 (stating that US litigation finance companies are engaged in an assortment of suits, and thus finance private and corporate plaintiffs), with Legg et al., supra note 159, at 4 (stating that recently, Australian litigation funding companies have financed class actions, particularly in competition securities law), Martin, supra note 1, at 113 (stating that the U.K. litigation financers primarily invest large amounts of capital in commercial suits), and University of Oxford, supra note 141 (stating that Britain litigation financers primarily fund corporate litigation). 192

See generally Steinitz, supra note 20 (arguing that litigation finance companies enable plaintiffs to pursue their legal rights and access justice when they advance the necessary capital required to pursue litigation). 193

See generally supra note 189 (comparing the markets the litigation financing industries in the U.S., U.K., and Australia serve). 194

Martin, supra note 1, at 113; see also University of Oxford, supra note 141 (discussing how U.K. financers have not geared their investments to poor plaintiffs, but rather to large corporations).

195

Martin, supra note 1, at 113; see also Zahorsky, supra note 150 (discussing U.K. investment companies that have invested millions of dollars into various legal disputes). 196

Mulheron & Cashman, supra note 115, at 315-316.

Theresa Coetzee

Page 18 of 21 38 N. Ky. L. Rev. 687, *706 finance litigation in other countries. 197 It is for these reasons that U.K. litigation financiers largely do not address the "access to justice" issues that were the impetus of litigation finance. 198 In contrast to litigation financing in the U.K., litigation financing in the U.S. has grown to support a wide variety of cases and clientele. 199 Though many states still prohibit or discourage financing agreements, 200 litigation finance is common for individual and corporate plaintiffs where such agreements are legally permissible. 201 In this respect, the U.S. litigation financing industry has done more to open access to courts for poor individual plaintiffs than either of its [*707] English-speaking counterparts. 202 For example, plaintiffs in personal injury suits in the U.S. frequently enlist the assistance of litigation finance companies. 203 Perhaps one reason for this is that U.S. litigation finance companies work on a smaller scale than those in the U.K. or Australia. 204 Additionally, because of the limited number of states that have abolished champerty laws, the market in the U.S. for litigation finance companies is not as open as those in Australia or the U.K. 205 Nonetheless, improved access to justice does not mean that litigation financing is without its opponents. 206 The division of opinion regarding litigation finance is most pronounced in the U.S. 207 Many argue that litigation finance companies are taking advantage of poor, under-educated and vulnerable plaintiffs, and that it has become a subprime industry. 208 U.S. litigation finance companies' fees typically take a higher percentage of the final recovery than in the U.K. or Australia. 209 The high fees that some litigation finance companies charge might explain why arguments based on usury law have appeared more often in cases in the U.S. than in the U.K. or Australia. 210

197

See Zahorsky, supra note 150 (discussing Juridica Investment's funding of a case being tried in New York).

198

University of Oxford, supra note 141.

199

Shaltiel & Cofresi, supra note 51, at 348 (discussing funding companies' investments in personal injury, patent and copyright infringement, and employment law cases).

200

See generally Bond, supra note 21, at 1333-41 (discussing significant case law in all fifty states relating to their respective treatment of champerty and maintenance); Martin, supra note 18, at 62-63. 201

Shaltiel & Cofresi, supra note 51, at 348; see also Haynes, supra note 53 (discussing litigation finance companies and their entrance into the Silicon Valley market). 202

See supra note 189 (comparing the markets litigation financing industries in the U.S., U.K., and Australia serve).

203

Shaltiel & Cofresi, supra note 51, at 348.

204

See generally Martin, supra note 1, at 107-10 (discussing small U.S litigation financing companies that provide small amounts of capital to personal injury plaintiffs); Raymond supra note 141 (discussing how U.S. litigation funders have primarily focused on smaller cases with advances of $ 1,750.00 to $ 4,500.00). 205

Shaltiel & Cofresi, supra note 51, at 349.

206

Rubin, supra note 1 (discussing the external costs caused by litigation funding, particularly costs on defendants in the U.S. who, unlike the U.K., are forced to pay their own legal costs despite their successful defense).

207

Martin, supra note 1, at 84-85 (referring to commentators' disdain for the high fees litigation funders receive when a plaintiff's case is successful, and the positive aspect of litigation finance in promoting access to the courts). 208

Id.; see also Shaltiel & Cofresi, supra note 51, at 348 (discussing the position of investors, who are careful not to call the advances loans, and the predatory issues that arise when the agreements are carefully examined).

209

See generally Shaltiel & Cofresi, supra note 51, at 348 (comparing litigation finance rates to pay day loans, with some financers charging plaintiffs a 435% APR); U.S. Chamber Institute for Legal Reform Report, supra note 5, at 5 (discussing European financiers' interest rates of 200% or more). 210

See generally Martin, supra note 91, at 89-94 (discussing the usury issues that arise in litigation finance agreements, and specifically examining the Rancman case).

Theresa Coetzee

Page 19 of 21 38 N. Ky. L. Rev. 687, *707 In some ways, Australia's litigation finance industry is the most "accepting" of the three countries. 211 Like their counterparts in the U.K., financiers in Australia deal largely with corporate plaintiffs, 212 but have branched out into [*708] class action suits comprised of individuals. 213 Australian litigation finance companies have enjoyed fewer legal attacks. 214 While ethical and legal issues hinder the development of the U.S. litigation finance industry, critics in Australia have been silenced by uniform support from the courts. 215 As the QPSX court stated, "the development of modern funding services in commercial litigation may be seen as indicative of a need in the market place to which those developments are legitimate responses." 216 In Australia, litigation financing is regarded as a legitimate part of a lawsuit that serves a purpose. 217 B. Varied Interpretation of Champerty Law The manner in which courts in the U.S., U.K. and Australia interpret and apply champerty law illustrates some of the substantial differences between litigation finance among the three countries. 218 In Australia and the U.K., the laws against champerty have been abolished, and parties attempting to challenge litigation finance agreements must find other legal arguments to do so. 219 Australian courts have typically noted that challenging a financing agreement requires a party to prove an abuse of process through the financier's improper control of the lawsuit. 220 With such a high burden to meet, the likelihood of success when challenging litigation finance agreements in Australia has been very low. 221 Although several cases were stayed until the terms of the agreements could be amended, by-and-large the constraints on litigation finance companies in Australia are few. 222 Similarly, in the U.K., a defendant's hopes of invalidating a financing agreement were dealt a severe blow in 1999 by the Access to Justice Act. 223 That year, the Act added a clause to the Courts and Legal Services Act of 1990 stating [*709] that no agreement that met legal contract requirements under the Act would be found unenforceable

211

See generally Legg & Travers, supra note 2; Legg et al., supra note 159 (looking in-depth at the litigation funding industry in Australia, particularly case law that has been instrumental in the growth of the industry). 212

See U.S. Chamber Institute for Legal Reform Report, supra note 5, at 17 (stating that Australian litigation finance companies primarily focus on commercial litigation and group proceedings). 213

Legg et al., supra note 159, at 4; see also Murphy & Cameron, supra note 160, at 434-35 (discussing financing of class actions).

214

Legg et al., supra note 159, at 3; Campbell's Cash & Carry Pty. Ltd. v. Fostif Pty. Ltd., [2006] 229 C.L.R. 386; QPSX Commc'ns Pty. Ltd. v. Ericsson Austl. Pty. Ltd., [2005] 219 A.L.R. 1.

215

Campbell's, 229 C.L.R. 386; QPSX, 219 A.L.R. 1.

216

QPSX, 219 A.L.R. at para. 54.

217

See generally Legg et al., supra note 159 (discussing the Australian courts recognition of the value of litigation finance and examining cases such as Campbell's that have helped expand the industry in Australia). 218

See generally Steinitz, supra note 20 (discussing litigation finance in the U.S., U.K., and Australia, and the change in the laws of maintenance and champerty). 219

Mulheron & Cashman, supra note 115, at 318; Legg et al., supra note 159, at 3.

220

QPSX, 219 A.L.R. at para. 57.

221

Discussion Paper, supra note 158, at 4 (noting that of the twenty cases challenging litigation finance in Australia between 1998 and 2006, all upheld the validity of litigation finance agreements). 222

Id.

223

See Mulheron & Cashman, supra note 115, at 319 (discussing the Access to Justice Act); see also Michael Napier et al., supra note 125, 53-55 (discussing the legal aid, conditional fee agreements, and litigation funding agreements provided for under the Access to Justice Act).

Theresa Coetzee

Page 20 of 21 38 N. Ky. L. Rev. 687, *709 simply because it was a litigation finance agreement. 224 With this amendment, the U.K. took a clear stance that litigation finance companies offer a legitimate legal service, and any action against them would require a showing of illegality. 225 As the industry grows, courts in the U.K. have only shown a willingness to strike down financing agreements if they find potential an abuse of process, public policy violations, or illegality. 226 In contrast to the U.K. and Australia, the U.S. generally takes a conservative approach to applying champerty law in order to determine the validity of financing agreements. 227 In the U.S., no single body of law governs litigation financing or champerty; the matter is left to the states. 228 Even so, some states like Massachusetts have opened the door to litigation finance companies by striking down champerty laws, 229 while others like Ohio have affirmed the strict application of champerty law. 230 Between those extremes, a significant number of states retain and apply champerty laws in some form, 231 though they are frequently poorly defined. 232 Courts in only a few states have directly addressed the validity of litigation finance agreements, but when such cases do arise, they are often left to turn to relics of case law in order to evaluate the legality of the agreement. 233 Even in states with clearly defined laws, the elements are not always the same. 234 This lack of legal uniformity among the states results in stunting the growth of the litigation finance industry in the U.S., and prevents companies operating in the U.S. from reaching the larger scale of those in [*710] Australia and the U.K. 235 This trend is likely to continue, since the legal risks of operating in multiple states are likely too high for many financing companies. 236 VIII. Conclusion

224

Mulheron & Cashman, supra note 119, at 319.

225

Id.

226

See generally Michael Napier et al., supra note 125, at 53-59 (discussing Arkin v. Borchard Lines, Ltd.); U.S. Chamber Institute for Legal Reform Report, supra note 5, at 7 (stating that although the U.K has abolished champerty and maintenance, they will still strike down third party funding agreements if they violate public policy or are deemed illegal). 227

See generally Steinitz, supra note 20, at 18-24 (discussing champerty and maintenance in the U.S., noting that a majority of states still maintain their prohibitions with "varying degrees of zeal").

228

Grous, supra note 20, at 213-214.

229

Id. at 214. Another example is Kraft v. Mason, 668 So. 2d 679 (Fla. Dist. Ct. App. 1996), in which a Florida court held that a litigation financing agreement between a sister and brother for an anti-trust action was not champertous or usurious. But see Steinitz, supra note 20, at 21 (stating that a majority of states still prohibit maintenance and champerty). 230

Rancman v. Interim Settlement Funding Corp., 789 N.E.2d 217, 221 (Ohio 2003).

231

Bond, supra note 21, at 1333-41 (discussing significant case law in all fifty states relating to their respective treatment of champerty and maintenance); Steinitz, supra note 20, at 21 (stating that a majority of states still prohibit maintenance and champerty).

232

Bond, supra note 21, at 1333-41; see also Steinitz, supra note 20, at 22 ("[I]t is the duty of the court to dismiss a case in which the evidence discloses that the assignment of the cause of action sued upon was tainted with champerty.") (quoting Hall v. State, 655 A.2d 827, 830 (Del. Super. Ct. 1994)). 233

See generally Bond, supra note 21 at 1333-41 (discussing significant case law in all fifty states relating to their respective treatment of champerty and maintenance). 234

Id. (noting that some states, like Florida and Oklahoma, require additional elements, such as "officious intermeddling").

235

See generally id. at 1333-41. But see Haynes, supra note 53 (highlighting litigation funding in Silicon Valley).

236

See generally Bond, supra note 21, at 1333-41 (discussing significant case law in all fifty states relating to their respective treatment of champerty and maintenance).

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Page 21 of 21 38 N. Ky. L. Rev. 687, *710 The growth of the litigation finance industry in the U.S., the U.K., and Australia has not necessarily translated into improved access to justice for many poor, individual plaintiffs. 237 Instead, U.K. and Australian financiers deal primarily with corporate clients, 238 and U.S. financiers are only able to operate in a limited number of states where litigation financing has been received positively by courts. 239 While litigation financing, in theory, represents a lofty goal of "leveling the playing field" for poor plaintiffs, 240 that goal has yet to be fully realized. 241 In order to give it a chance at success, Australia, the U.K. and particularly the U.S. need clear laws crafted by legislatures to govern the litigation finance industry. Currently, case law and broad common law doctrines are the basis for decisions in cases in which financing agreements are at issue. 242 Given the current operating environment, litigation finance companies will minimize risk, follow established case law, and continue funding only a select few types of clients and cases. 243 Such legislation is necessary to protect consumer- plaintiffs by limiting the amount of fees a financier may charge, as well as the amount of control they may exert over a lawsuit. 244 It would also ease industry concerns regarding vague champerty and predatory lending laws, which have led to [*711] unpredictable judgments. 245 By dictating clear rules for litigation financing industries, countries can ensure better access to justice for the poor, and make strides toward equal protection under the law. Northern Kentucky Law Review Copyright (c) 2011 Northern Kentucky University Northern Kentucky Law Review

End of Document

237

University of Oxford, supra note 141.

238

Id.; Martin, supra note 1, at 108-109.

239

See generally Bond, supra note 21, at 1333-41(listing states in which courts have upheld litigation finance agreements).

240

See McGovern et al., supra note 10, at 1 (stating that litigation financing "has the potential to equalize the bargaining power of litigants"). 241

See University of Oxford, supra note 141 (discussing litigation finance in the U.K as being focused on commercial litigation); see also Petrus, supra note 88, at 17 (noting that third party finance in commercial cases helps small businesses pursue their legal claims). 242

See McLaughlin, supra note 31, at 627 (referring to personal injury cases).

243

See generally Shaltiel & Cofresi, supra note 51 (discussing the need for regulation in the litigation finance industry); Bond, supra note 21, at 1333-41 (highlighting the inconsistencies in the treatment of litigation finance agreements in the U.S.). 244

See generally Martin, supra note 1, at 114 (arguing that all state legislatures should abolish champerty, thus encouraging the growth of the litigation finance industry and creating more competition and lower fees for plaintiffs); Shaltiel & Cofresi, supra note 51, app. at (discussing the proposed "Litigation Lending for Personal Needs Act" (LLPNA) and the prohibition on interfering with the plaintiff's decisions in the litigation). 245

See generally Petrus, supra note 88, at 17 (observing that jurisdictional differences in the treatment of champerty force one to research the pertinent law before a litigation funding agreement can be executed).

Theresa Coetzee

THE SECOND CIRCUIT REVIEW -- 1986-1987 TERM: ETHICS: ETHICAL LIMITATIONS ON CREATIVE FINANCING OF MASS TORT CLASS ACTIONS. SUMMER, 1988 Reporter 54 Brooklyn L. Rev. 539

Length: 16796 words Author: Vincent Robert Johnson * * Judicial Fellow, Supreme Court of the United States (1988-89) and Professor of Law, St. Mary's University, San Antonio, Texas; B.A., St. Vincent College (Pa.); J.D., University of Notre Dame; LL.M., Yale University. The author gratefully acknowledges that this article benefited from the assistance of four St. Mary's students (Susan A. Bowen, '88; Curtis L. Cukjati, '89; William C. McMurrey, '89, and John P. Palmer, '88) and the comments of two colleagues (Professors Gerald S. Reamey and Victoria M. Mather).

Text [*539] I. COGITATIONS ON EUCLID, EINSTEIN, AND THE EVOLUTION OF LEGAL ETHICS

When the rules governing the professional conduct of attorneys were first given shape in the late nineteenth and early twentieth centuries, 1 an important assumption as to the nature [*540] of law practice animated their structure. Specifically, the lawyer-client relationship was envisioned almost exclusively in terms of a simple, elegant

1

The professional norms applicable to practicing attorneys were first codified by the American Bar Association (ABA) in 1908 in the Canons of Professional Ethics (1908 Canons). These provisions were based in large measure upon three earlier sources of ethical guidance: (1) Baltimore practitioner and University of Maryland professor David Hoffman's "Fifty Resolutions in Regard to Professional Deportment," published in 1836; (2) University of Pennsylvania professor and later Pennsylvania Chief Justice George Sharswood's 1854 essay on "Professional Ethics"; and (3) the Alabama Code of Ethics of 1899 (which drew heavily on Sharswood's writings and was first adopted in 1887). See C. WOLFRAM, MODERN LEGAL ETHICS § 2.6.2, at 53-54 nn.20 & 21 (1986) (noting significance of early scholars); Armstrong, A Century of Legal Ethics, 64 A.B.A.J. 1063-64 (1978) (pre-1908 Canons history); Bloomfield, David Hoffman and the Shaping of a Republican Legal Culture, 38 MD. L. REV. 673, 677-79 (1979) (tracing Hoffman's legal career); Jones, Canons of Professional Ethics, Their Genesis and History, 7 NOTRE DAME LAWYER 483, 494 (1932) (discussing Alabama Code as foundation of 1908 Canons); and 32 A.B.A. REPS. (preface) (1907) (biographical sketch of Sharswood). See also D. HOFFMAN, A COURSE OF LEGAL STUDY 752-75 (2d ed. 1836) (Fifty Resolutions in Regard to Professional Deportment), reprinted in 31 A.B.A. REPS. 717-35 (1907); G. Sharswood, Professional Ethics (1854), reprinted in 32 A.B.A. REPS. 1 (1907); and ALABAMA ST. B.A., CODE OF ETHICS (1899), reprinted in H. DRINKER, LEGAL ETHICS 352-63 (Appendix F) (1953). The ABA Code of Professional Responsibility replaced the 1908 Canons of Professional Ethics as a statutory model in 1969. Although subsequently amended and then superseded as model legislation, the 1969 Code is the basis for the codes of ethics still in force in approximately twenty states. See C. WOLFRAM, supra, § 2.6.3, at 56-57. In 1983, the ABA promulgated the Model Rules of Professional Conduct. (All citations in this Article to the Model Rules of Professional Conduct refer to the 1983 Rules and Comments.) The Model Rules have been adopted, with substantial local variations, in twenty-six jurisdictions: Arizona, Arkansas, Connecticut, Delaware, Florida, Idaho, Indiana, Kansas, Louisiana, Maryland, Michigan, Minnesota, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, North Dakota, Oklahoma, Pennsylvania, South Dakota, Washington, Wisconsin, and Wyoming. See [Manual] LAW. MANUAL ON PROF. CONDUCT (ABA/BNA) 01:3 (1988) [hereinafter ABA/BNA MANUAL]; 2 G. HAZARD & W. HODES, THE LAW OF LAWYERING app. 4, at 865 (1987). In North Carolina, Oregon, and Virginia, the substance of some provisions in the 1983 Rules have been incorporated into hybrid codifications based on the Model Code. Id. vol. 2, app. 4, at 865.

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Page 2 of 34 54 Brooklyn L. Rev. 539, *540 paradigm that centered on a one-to-one personal relation between the layman and the professional. 2 The ethical norms that emerged during that era typically spoke only to those dilemmas likely to be confronted by a general practitioner, who, working on his own or as part of a small firm, had been personally selected by an individual to render partisan services for a fee. 3 The nascent codes left other aspects of practice -- such [*541] as the intricacies of corporate or government representation -- largely unaddressed. 4 Not surprisingly, the emergence of 5 the class action such exotic developments in the delivery of legal services as the multistate "mega-firm," 6 7 plaintiffs' management committee, and multidistrict litigation were wholly unforeseen. Only the most prescient

2

The 1908 Canons were "imbued with the heavily individualistic flavor of honorable relations between individuals, paying little attention to larger issues of how lawyers relate to each other and to the bar and the general society." C. WOLFRAM, supra note 1, at 54.

[Even today, the] mental image [connoted by the term "client"] is that of an individual person who has come to the lawyer for a particular bit of legal advice or assistance about a discrete legal problem. . . . The image is antique. It brings to mind the relationship that is thought to have existed between solo practitioners and individual adult clients in the middle and upper class in the period before the Civil War. It survives in some present-day representations. But to a large extent, the model ignores the great diversity of clients, lawyers, and work settings in which lawyers function and by which they are constrained. Corporate clients, the poor, clients with disabilities, those accused of serious crime, government agencies, and other clients are as much unlike the model as they are unlike each other. Id. at 147-48. 3

See G. HAZARD, ETHICS IN THE PRACTICE OF LAW XV (1978) ("Traditionally, the idealized professional is a soloist, technically and ethically sufficient unto himself."); id. at 7 (Reporting criticism that 1969 Code was "[m]ade for downstate Illinois in the 1860s" and did "not directly deal with the lawyer's role when he acts other than as an advocate . . . for example when he is a negotiator, mediator, or trustee."). 4

C. WOLFRAM, supra note 1, § 2.6.2, at 54 (1908 Canons displayed narrowness of vision and spoke almost exclusively to issues concerned with courtroom practice). Cf. HAZARD, supra note 3, at 7 (Reporting criticisms that "[e]xcept in one or two isolated contexts, the [1969] Code does not deal with situations in which legal advice is being provided by a firm or other group of lawyers rather than an individual practitioner."); Kutak, The Next Step in Legal Ethics: Some Observations About the Proposed Model Rules of Professional Conduct, 30 CATH. U.L. REV. 1, 5 (1980) ("At the time the Code was adopted, in 1969, its focus was [still] on the lawyer as a private practitioner working alone or in a very small firm.").

5

See Rosen, The Large-Firm Boom Continues: A 10-Year Look, Nat'l L.J., Sept. 28, 1987, at S-2, col. 2:

In the world of the large American law firm, exponential growth has been the overriding characteristic of the last 10 years. In 1978, a firm with 50 attorneys would have been among the largest in the country. . . . Now a firm with 100 attorneys is no longer among the largest 250. . . . . . . Much of . . . [the] growth has taken place in branch offices, as firms have attempted to expand their national and regional reach. See also L. PATTERSON, LEGAL ETHICS: THE LAW OF PROFESSIONAL RESPONSIBILITY 645-47 (2d ed. 1984) (discussing interstate law firms and interstate practice). 6

See MANUAL FOR COMPLEX LITIGATION, Second, § 20.221, at 16 (1985) [hereinafter MANUAL] (discussing committees of counsel in complex litigation, including management committees); 2 H. NEWBERG, NEWBERG ON CLASS ACTIONS 284 (2d ed. 1985) (discussing formal and informal creation of class action steering committees). 7

Federal law permits the transfer and consolidation of pretrial proceedings in cases where common facts are at issue. 28 U.S.C. § 1407 (1982). "The [section] 1407 concept originated in the recommendations of the Coordinating Committee for Multiple Litigation which was appointed by Chief Justice Burger in the 1960s." V. SCHWARTZ, P. LEE & K. KELLY, GUIDE TO MULTISTATE LITIGATION 19 (1985); see generally MANUAL, supra note 6, § 31.12.

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Page 3 of 34 54 Brooklyn L. Rev. 539, *541 could have foretold a day when lawyers, by reason of the nature of class action practice or the multilayer hierarchy of a large firm, might never meet or have substantial dealings with the clients whose work they performed. 8 [*542] Much of the intellectual effort in the field of legal ethics during the past quarter century has been an attempt to reevaluate the rules that emerged during the "golden age" of the solo practitioner and the small firm. Scholars, disciplinary authorities, and jurists have endeavored to articulate norms of professional conduct sensitive to changing modes of practice and to models of the lawyer-client relationship other than that embraced by the traditional one-lawyer-one-client paradigm. 9 Thus, for example, recent codifications of legal ethics have attempted to define the ethical obligations of subordinate attorneys within a firm; 10 attorneys moving between firms 11 or between government service and private practice; 12 participants in legal services organizations; 13 and lawyers hired not to act as partisans, but to function as intermediaries 14 or as evaluators rendering opinions for the benefit of nonclient third persons. 15

One question that has begun to arise with frequency in the ongoing reassessment of ethics rules is whether standards well-suited to governing everyday, commonplace occurrences are also capable of dealing fairly with extra-ordinary arrangements or events. For example, it has been held that, in the context of class action representation, the usual rule of disqualifying an attorney from representing one of two or more former joint clients [*543] whose interests subsequently become adverse 16 must give way to a balancing test for resolving questions of disqualification. 17 Recognizing the special nature of the class action form of litigation, one court has declared

8

In re "Agent Orange" Product Liab. Litig., 611 F. Supp. 1452, 1462 (E.D.N.Y. 1985) (noting lack of personal relationship between most class members and the attorneys representing them), rev'd on other grounds, 818 F.2d 216 (2d Cir. 1987). Cf. Rosenberg, Class Actions for Mass Torts: Doing Individual Justice by Collective Means, 62 IND. L.J. 561, 561 (1987). Rosenberg states: From the perspective of the common law tradition of individual justice, class actions . . . loom as a subversive element . . . because they import the processes of bureaucratic justice -- a mode of decision-making associated with administrative agencies, which lacks the common law's traditional commitment to party control and focus on the discrete merits of each claim. Id. 9

See Kutak, supra note 4, at 2-5; cf. MODEL RULES OF PROFESSIONAL CONDUCT Preamble (1983) (describing lawyer's multiple roles as advisor, advocate, negotiator, intermediary, and evaluator). 10

11

MODEL RULES OF PROFESSIONAL CONDUCT Rule 5.2 and comments (1983). Id. Rule 1.10 and comments 7-13.

12

Id. Rule 1.11 and comments; see also ABA Comm. on Ethics and Prof. Responsibility, Informal Op. 84-1504 (1984) (use of letters seeking employment by attorney returning to private practice); ABA Comm. on Professional Ethics, Informal Op. 1104 (1969) (employment limitations applicable to former prosecutor); and ABA Comm. on Ethics and Professional Responsibility, Formal Op. 342 (1975) (employment restrictions applicable to former government attorneys).

13

MODEL RULES OF PROFESSIONAL CONDUCT Rule 6.3 and comments; see also ABA Comm. on Professional Ethics, Informal Op. 1137 (1970) (legal aid attorney's revelation of client's status to legal aid society); ABA Comm. on Professional Ethics, Formal Op. 324 (1970) (obligations of legal aid society governing board); and ABA Comm. on Ethics and Professional Responsibility, Formal Op. 347 (1981) (obligations of lawyers to clients of legal services offices when those offices lose funding). 14

15

MODEL RULES OF PROFESSIONAL CONDUCT Rule 2.2 and comments. Id. Rule 2.3 and comments.

16

Id. Rule 1.7 comment 1 and Rule 1.9 (affected party may waive disqualification); see also MODEL CODE OF PROFESSIONAL RESPONSIBILITY EC 5-15 (1980) (disqualification required where interests of multiple clients begin to differ). 17

In re "Agent Orange" Prod. Liab. Litig., 800 F.2d 14, 18-20 (2d Cir. 1986). Judge Amalya Kearse wrote for the court:

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Page 4 of 34 54 Brooklyn L. Rev. 539, *543 that to hold otherwise "would substantially diminish the efficacy of class actions as a method of dispute resolution." 18 Similarly, while it is generally agreed that a firm normally cannot avoid disqualification by screening from participation in a case a firm member who has a conflict of interest, 19 there is modest authority that the entire staff of a large [*544] multioffice legal aid organization will not be vicariously disqualified where the size and structure of the office make it unlikely that other attorneys will have access to relevant information possessed by the "infected" attorney. 20 Again, this suggests that, at least under some circumstances, the larger law practice will be subject to its own rules. Finally, in an analogous vein, Ephraim Margolin, a California practitioner and legal educator, recently argued that in criminal "mega trials" -- cases involving hundreds or thousands of criminal counts, of hours of tape recordings, or of documents -- the constitutional right to effective assistance of counsel takes on a different meaning, forcing the usual standards of competent representation to give way. 21 "Like capital punishment, mega trials require rules of their own," he states. 22 The leitmotif running throughout these examples, and the relation of these developments to the evalution of legal ethics, is brilliantly captured in metaphor by Margolin:

Class action litigation presents additional problems that must be considered in determining whether or not to disqualify an attorney. . . . These problems are created by, inter alia, the facts that there are, by definition, numerous class members and that there is often no clear allocation of the decision-making responsibility between the attorney and his clients. . . . Automatic application of the traditional principles governing disqualification of attorneys on grounds of conflict of interest would seemingly dictate that whenever a rift arises in the class, with one branch favoring a settlement or a course of action that another branch resists, the attorney who has represented the class should withdraw entirely and take no position. . . . Nonetheless, . . . although automatic disqualification might "promote the salutary ends of confidentiality and loyalty, it would have a serious adverse effect on class actions." When many individuals have modest claims against a single entity or group of entities, the class action may be the only practical means of vindicating their rights, since otherwise the expense of litigation could exceed the value of the claim. . . . The actions [here] have been pending for some eight years, and we have been advised in connection with one of the appeals emanating from the proposed settlement that "hundreds of thousands of private corporate documents [were] produced in the course of discovery." . . . If the thousands of objectors were now deprived of the services of . . . [the two attorneys whose disqualification is sought], all of the choices confronting the court would be unattractive. Id. (citations omitted). See also In re Corn Derivatives Antitrust Litig., 748 F.2d 157, 163 (3d Cir. 1984) (Adams, J., concurring) (similar arguments; "courts cannot mechanically transpose to class actions the [ethics] rules developed in the traditional lawyerclient setting"). In a number of cases, despite the existence of a technical conflict of interest, the attorney for the class has been permitted to oppose the contentions of class members who have appeared in court in opposition to a proposed settlement of the class action. See, e.g., Malchman v. Davis, 706 F.2d 426 (2d Cir. 1983); Weinberger v. Kendrick, 698 F.2d 61 (2d Cir. 1982). 18

In re "Agent Orange" Prod. Liab. Litig., 800 F.2d at 19.

19

See 1 G. HAZARD & W. HODES, supra note 1, at 191 (Model Rule 1.10 rejected screening); Cheng v. GAF Corp., 631 F.2d 1052 (2d Cir. 1980) (screening rejected); Westinghouse Elec. Corp. v. Kerr-McGee Corp., 580 F.2d 1311 (7th Cir. 1978) ("Chinese wall" rejected). Screening may avoid government- and arbitration-related conflicts. MODEL RULES OF PROFESSIONAL CONDUCT Rules 1.11 & 1.12 (1983). 20

People v. Wilkins, 28 N.Y.2d 53, 56, 268 N.E.2d 756, 757-58, 320 N.Y.S.2d 8, 10-11 (1971) (The standard rules of disqualification applicable to law firms do not apply to a "large public-defense organization," which "consists of four branches and three units, and is undoubtedly the largest legal defense organization in the world."). See also People v. Garcia, 698 P.2d 801, 807 (Colo. 1985) (size and degree of integration in district attorney's staff relevant to issue of disqualification). 21

22

Margolin, Musings on Mega Trials and Mega Lawyers and Mega Bucks, 36 EMORY L.J. 811, 811-12 (1987). Id. at 816.

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Page 5 of 34 54 Brooklyn L. Rev. 539, *544 Things were simpler in the nineteenth century. We knew Euclid and we knew Newton. We knew their teachings and we lived by their rules. We thought that their rules had universal application. But the twentieth century taught us that these rules, while perfectly adequate for everyday affairs, are inapplicable in the worlds of the very large and the very small. In astrophysics, traditional mathematics proved inadequate to explain such phenomena as black holes. Einstein replaced Euclid. In subatomic physics, Newton gave way to quantum mechanics. We could shrug our shoulders and conclude that as long as we do not deal with astrophysics or subatomic research, Einsteinian innovations are largely irrelevant to our daily life. Indeed, we may have no need for the sophistication of the twentieth century if our lives and our practices consist of routine, small, assembly-line events. On the other hand, that Einstein had an effect on modern mathematics [*545] is no longer even a matter of debate. . . . [T]here have been substantial changes. 23 How, then, should the world of the very large -- including class action suits -- be treated in legal ethics? II. THE AGENT ORANGE DILEMMA: CREATIVE FINANCING COMES TO MASS TORT LITIGATION During the first part of the 1980s, a minirevolution in the residential and commercial property field called "creative financing" rocked, and perhaps permanently altered, the American real estate market. 24 In the simplest of terms, a bewildering array of alternative lending and repayment schemes emerged that permitted buyers and sellers to "do deals" that would have been impracticable under the constraints of conventional financing. While probably few laymen fully understood the risks and implications of these recondite arrangements, the term "creative financing" entered the common man's vocabulary. The words connoted the possibility of obtaining -- whether through legitimate ingenuity or via an illusion of "mirrors and smoke" -- that which would be unattainable under established business principles. It is not surprising that this concept of "creative financing," responsible for the transformation of the real estate market, should have exerted a gravitational force on other facets of the economic landscape, including the field of tort litigation. Tort suits require financing. Money is needed to pay for the investigation and discovery of facts, court filing costs and transcripts, preparation of exhibits, expert witness fees, and a myriad of other out-of-pocket expenditures incidental to the diligent prosecution of a claim. In the usual case, a tort victim cannot reasonably be expected to have enough cash on hand to cover these amounts, 25 any more than the tort victim can be expected to pay [*546] the attorney's fee up-front in the form of a retainer. Consequently, applicable rules of ethics -- largely on the ground of necessity -- have long permitted an attorney to pay litigation expenses on a client's behalf, that is to act as financier. 26

23

Id. at 811.

24

See, e.g., Curran, Intriguing Twists in Real Estate, FORTUNE, Mar. 21, 1983, at 157; Runde, Financing the House You've Chosen, MONEY, Apr. 1986, at 79 Real Estate: No Big Fortune Needed to Play, U.S. NEWS & WORLD REP., June 4, 1984, at 42.

25

An interesting example of a "run-of-the-mill" client is Helen Palsgraf, the plaintiff in the most famous tort case of all time, Palsgraf v. Long Island R.R. Co., 248 N.Y. 339, 162 N.E. 99 (1928). In his study of the case, Judge John T. Noonan wrote: Filling costs and the clerk's fee in the lower court came to $ 142. Dr. Hammond [an expert witness] charged $ 125. Mrs. Palsgraf made $ 416 a year. At the time of trial, she had not yet paid [her physician] Dr. Parshall's bill of $ 70, now three years due. It is improbable to the point of implausibility that she would have had the cash on hand to pay the court and Dr. Hammond a total of $ 267. J. NOONAN, JR., PERSONS & MASKS OF THE LAW 125 (1976). 26

See 1 G. HAZARD & W. HODES, supra note 1, at 164-66 (1987 Supp.) (discussing advancement of costs of litigation under 1969 Code and 1983 Rules); see also J. NOONAN, supra note 25, at 124-25 (In the 1920s, it was "not illegal in New York for a lawyer to pay the expenses of litigation if the purpose of the payment was not to induce the client to put the claim in his hands.").

Under older formulations of the rule, still in force in many states, the client is obliged to repay the advance in full. The 1969 Code provided:

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Page 6 of 34 54 Brooklyn L. Rev. 539, *546 [*547] Of course, size and cost frequently increase in more or less direct correlation. Thus, the bigger the case, the more money it normally requires. Mass tort claims 27 are often extraordinarily expensive to litigate because of

While representing a client in connection with contemplated or pending litigation, a lawyer shall not advance or guarantee financial assistance to his client, except that a lawyer may advance or guarantee the expenses of litigation, including court costs, expenses of investigation, expenses of medical examination, and costs of obtaining and presenting evidence, provided the client remains ultimately liable for such expenses. MODEL CODE OF PROFESSIONAL RESPONSIBILITY DR 5-103(B) (1980). Standards identical to this model provision are currently in force in eighteen jurisdictions whose ethics codes are modeled on the 1969 Code: Alabama, Colorado, the District of Columbia, Georgia, Hawaii, Illinois (slight variation in wording), Iowa, Kentucky, Massachusetts, Nebraska, New York, Ohio, Rhode Island, South Carolina, Tennessee, Vermont, Virginia, and West Virginia. See 1 NATIONAL REPORTER ON LEGAL ETHICS AND PROFESSIONAL RESPONSIBILITY (1987) (ethics codes set forth by state) [hereinafter NATIONAL REPORTER ON LEGAL ETHICS]. The Texas ethics code, which is also based on the ABA's 1969 Code, contains no parallel disciplinary rule, but states in EC 5-8 that the ultimate responsibility for advanced expenses "should" rest with the client. Id. North Carolina and Virginia, whose ethics codes are hybrids of the 1969 Code and its successor, the 1983 Rules, embrace the code provision. 2 G. HAZARD & W. HODES, supra note 1, app. 4. However, Oregon, another hybrid code state, expresses the 1969 Code position in more concise language. Id. As more states adopt the 1983 Model Rules of Professional Conduct, the number of states embracing the view of the 1969 Code will likely shrink, since the 1983 Rules articulate a different standard. However, at least two states that have adopted the 1983 Rules -- South Dakota and Washington -- continue to provide, as in the 1969 Code, that the client must remain ultimately responsible for the expenses advanced or guaranteed. [Current Reports] LAW. MANUAL ON PROF. CONDUCT (ABA/BNA) 439 (1988) [hereinafter ABA/BNA Current Reports] (discussing South Dakota); 2 G. HAZARD & W. HODES, supra note 1, app. 4 (quoting Washington provision). The more recent version of the rule, now in effect in about half of the jurisdictions, provides simply that the client's responsibility for repayment may be contingent on the outcome of the case and, further, that a lawyer may pay outright, without intention or obligation to seek reimbursement, the expenses of an indigent client. The relevant portion of American Bar Association's 1983 Rules states: A lawyer shall not provide financial assistance to a client in connection with pending or contemplated litigation, except that: (1) a lawyer may advance court costs and expenses of litigation, the repayment of which may be contingent on the outcome of the matter; and (2) a lawyer representing an indigent client may pay court costs and expenses of litigation on behalf of the client. MODEL RULES OF PROFESSIONAL CONDUCT 1.8(e) (1983). This provision has been adopted as part of the Model Rules in twenty states: Arizona, Arkansas, Connecticut, Delaware, Florida, Idaho, Indiana, Louisiana, Maryland, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, Pennsylvania, South Dakota, Wisconsin, and Wyoming. In addition, the Model Rules, as adopted in Minnesota, contain language identical to that quoted above, but further provide that: A lawyer may guarantee a loan reasonably needed to enable the client to withstand delay in litigation that would otherwise put substantial pressure on the client to settle a case because of financial hardship rather than on the merits, provided the client remains ultimately liable for repayment of the loan without regard to the outcome of the litigation and, further provided, that no promise of such financial assistance was made to the client by the lawyer, or by another in the lawyer's behalf, prior to the employment of that lawyer by that client. See id. at MN2-3. North Dakota has added a similar provision to its version of the Model Rules. See ABA/BNA Current Reports, supra, at 463 (1986) & 203-04 (1987). 27

A wealth of literature has begun to discuss the "mass tort" phenomenon. Writers differ as to how this class of cases should be defined. One article states:

The distinguishing feature of . . . [mass tort] litigation is the multiplicity of parties involved, and although numerical limits are admittedly arbitrary, one might do well to think in terms of at least a dozen participants combined in either the same lawsuit or in separate suits which arise out of virtually indistinguishable types of injury. . . . [T]he parties frequently number twenty, forty, sixty or a hundred.

Theresa Coetzee

Page 7 of 34 54 Brooklyn L. Rev. 539, *547 the complex legal and factual questions they typically involve. 28 Consequently, it was not unforeseeable [*548] that an interest in creative financing -- in accessing money that would otherwise be unavailable -- would surface in the largest mass tort claim in history, 29 the Agent Orange litigation. The Agent Orange class action against chemical company defendants encompassed claims of tens of thousands of veterans 30 allegedly injured by the use of defoliants in Vietnam. The suit gave rise to numerous decisions at the 31 relating to "subject matter jurisdiction, class trial and appellate levels of novel, precedent-setting issues certification, notice, conflict of laws, statutes of limitations, settlement, attorneys' fees, and distribution of settlement funds." 32 The litigation expenditures entailed by these complex questions, and by the necessity of communicating with hundreds of thousands of potential plaintiffs throughout the United States, New Zealand, and Australia, 33 ran into the millions of dollars. 34

. . . [T]he most commonly occurring factual pattern which has given rise to mass tort litigation has been a single calamity or disaster which immediately produces multiple potential plaintiffs and at least a few recognizable defendants. A second major source for mass tort litigation involves a single type of product which can ultimately cause injury to many people. Campbell & Moore, Mass Tort Litigation in Tennessee, 53 TENN. L. REV. 221, 222-23 (1986). 28

See Rosenberg, supra note 8, at 563. Professor Rosenberg states:

[In mass tort suits, the] questions of whether the defendant's conduct failed to satisfy the governing standard of liability frequently entail interrelated technological and policy issues that require extensive discovery, expertise, and preparation to present and resolve adequately. Equally demanding are the causation issues in mass tort cases, such as whether the plaintiff's condition was caused by exposure to the substance in question or to some other source of the same disease risk. Id. The high cost of presenting a mass tort claim may also be due, in part, to efforts to avoid broad liability. Coffee, The Regulation of Entrepreneurial Litigation: Balancing Fairness and Efficiency in the Large Class Action, 54 U. CHI. L. REV. 877, 890 (1987) ("We should generally expect class action defendants to be willing to litigate more vigorously, to expend more resources, to pursue more collateral matters, and to raise the 'ante' at each stage of the litigation" in order to make the suit too expensive to be worth prosecuting.). 29

Note, The Pratt-Weinstein Approach to Mass Tort Litigation, 52 BROOKLYN L. REV. 455, 455 (1986) (identifying Agent Orange action as the "largest mass tort claim in history"). 30

The ultimate settlement of the case provided for the purchase of death and disability insurance for an estimated 600,000 United States Vietnam veterans; as of the date of the opinion, 245,000 claims had been filed. In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. 1396, 1400-01 (E.D.N.Y. 1985), aff'd in part, rev'd in part, 818 F.2d 179 (2d Cir. 1987). Four million dollars was also set aside to cover claims filed by any of the 52,242 Australian and New Zealand veterans who served in Vietnam. In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1444. 31

The multiple phases in the litigation are chronicled, with supporting citations to court decisions, in Note, supra note 29, at 46092. 32

Id. at 455. "Judges Pratt and Weinstein used novel procedural and substantive rules . . . to direct the [Agent Orange] litigation and encourage the parties involved to reach a settlement." Id. at 493. 33

Pursuant to United States Supreme Court precedent, persons who can be identified by reasonable means must be given individual notice at the plaintiffs' expense. Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 173-75 (1974). Judge Weinstein approved alternative modes of notice in view of the prohibitive expense of communicating with two million potential claimants. In re "Agent Orange" Prod. Liab. Litig., 100 F.R.D. 718, 729-31 (E.D.N.Y. 1983). 34

The Plaintiff's Management Committee (PMC), as a group, expended $ 1,711,155.87 on litigation expenses. In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. 1296, 1346 (E.D.N.Y. 1985). The total expenses of PMC attorneys (individually and collectively) and non-PMC attorneys appear to have been $ 3,156,538.28. Id. at 1344-46.

Theresa Coetzee

Page 8 of 34 54 Brooklyn L. Rev. 539, *548 [*549] During the pretrial phase of the representation, a financing crisis developed: members of the Plaintiffs' Management Committee (PMC) were unable or unwilling to advance on behalf of the class the money necessary to carry forward the suit. 35 After certain members of the Committee resigned and the PMC was reconstituted, the members of the new Committee, in an effort to resolve the dilemma, reached a unanimous agreement on financing. The agreement provided that six of the nine PMC members would advance money for general litigation expenses (as distinguished from personal expenses). For each dollar thus advanced, the "investor-attorney" would be repaid, not merely the full value of the advance, but threefold that amount out of the total fees and expenses, if any, awarded by the court at the conclusion of the case to PMC attorneys and their firms, collectively or individually. 36 Thus, if the case was successful, the "investors" [*550] would garner a 300 percent return of their investment. Creative financing had come to mass tort litigation.

The effect of the treble repayment of expenses agreement was to significantly skew the compensation of individual members of the PMC. 37 Those who invested money rather than time in the case by advancing expenses were

35

Budget problems arose among the PMC attorneys almost immediately. Plaintiffs' lead counsel wanted to spend money traveling the country to sign up additional plaintiffs and to computerize information; other members wanted to invest expense funds on preparation for trial. See Note, supra note 29, at 476 & n.129; Fanning, A Piece of the Action, FORBES, Oct. 19, 1987, at 68, col. 3 (One attorney stated, "We needed a minimum of $ 2 million and a lot of bodies just to go on."). 36

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1454. The initial fee allocation agreement, signed by PMC members in December 1983, prior to the settlement, provided that fees remaining in the pool after advances were repaid threefold would be distributed pursuant to a 50-30-20 formula: 50 percent on a pro rata basis; 30% based on the number of hours each member expended; and 20 percent in accordance with certain quality and risk factors, as determined by majority vote. When, subsequent to the settlement, the district court first learned of this agreement, it expressed concern about the terms. On December 13, 1984, the PMC unanimously amended the agreement, retroactive to October 1, 1983. As revised, the agreement provided: When and if funds are received, either by the [PMC] or individual members thereof, the first priority distribution will be to distribute to Messrs. Brown, Chesley, Henderson, Locks, O'Quinn and Schwartz, an amount equivalent to the actual monies expended for which these six signatories were responsible toward the common advancement of the litigation up to $ 250,000.00 with a multiplier of three (i.e., none of these six individuals will receive more than $ 750,000.00 each), which shall be paid to them for having secured the funds for the [PMC] and to Messrs. Dean, Schlegel and Musselwhite an amount equivalent to the actual monies expended by these three signatories toward the common advancement of the litigation up to $ 50,000.00 with a multiplier of three (i.e., none of these three signatories will receive more than $ 150,000.00 each). Any additional expenses will be reimbursed without a multiplier as ordered by the Court. All of the expenses plus the appropriate multiplier will be deducted from the total fees and expenses awarded by the Court to all of the [PMC] firms. The remaining fees will then be distributed pro rata to each signatory in the proportion the individual's and/or firm's fee award bears to the total fees awarded. Id. at 1454. 37

Pursuant to the agreement, PMC members Brown, Chesley, Locks, O'Quinn and Schwartz each advanced $ 250,000 toward common expenses; Henderson advanced $ 200,000; and Dean, Musslewhite and Schlegel advanced nothing. Id. at 1455. The effect of the compensation agreement is shown by the following table drawn from the figures in the Second Circuit's opinion: COURT

FEES AWARDED

GAIN

AWARDED

UNDER

OR

FEES

AGREEMENT

LOSS

BROWN (investor)

348,331

608,162

+ 259,831

CHESLEY (investor)

475,080

647,534

+ 172,456

HENDERSON (investor)

515,163

659,975

+ 144,812

Theresa Coetzee

Page 9 of 34 54 Brooklyn L. Rev. 539, *550 well compensated -- earning a substantially greater return on their dollar than would have been possible through typical commercial forms of investment. 38 In contrast, because of the point in the litigation at which a settlement was reached (the eve of trial) and the amount of the fees and expenses approved by the district court (roughly onefourth of the amount requested), 39 those who invested time and effort, rather than money, were comparatively poorly compensated for their endeavors. 40 As the Second Circuit [*551] noted, "The distortion was so substantial as to increase the fees awarded to one investor by over twelve times that which the district judge had determined to be just and reasonable, and, in a second case, to decrease the otherwise just and reasonable compensation of a non-investor by nearly two-thirds." 41 One attorney who worked extensively on the case earned almost a million dollars less under the terms of the agreement than he would have earned in the absence of such an arrangement. 42 Predictably, the issue of the agreement's validity was placed before the courts when this attorney sought to have it declared invalid. 43

COURT

FEES AWARDED

GAIN

AWARDED

UNDER

OR

FEES

AGREEMENT

LOSS

LOCKS (investor

487,208

651,339

+ 164,171

O'QUINN (investor)

132,576

541,128

+ 408,552

41,886

513,026

+ 471,140

1,424,283

542,310

- 881,973

344,657

206,991

- 137,666

SCHWARTZ (investor) DEAN (noninvestor) MUSSLEWHITE (noninvestor)

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d 216, 221 (2d Cir. 1987). 38

Id. at 226 ("a threefold return on one's money is a rather generous return in any mark t over a short period of time").

39

The district court awarded the nine members of the committee, individually and collectively, more than $ 2.3 million in expenses and $ 4.7 million in attorney fees. In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1344-46. The PMC members had initially sought roughly $ 30 million in fees and expenses. Id. at 1462. 40

A table in the district court opinion based on preliminary figures, which the court stated showed the general fee-shifting effect of the agreement, indicated that Attorney Dean was awarded $ 225 per hour by the court, but after reallocation under the PMC pact would receive the equivalent of only $ 55.62 per hour. Id. at 1455. Another attorney, Schwartz, spent considerably less time on the case than Dean, but under the agreement saw his compensation balloon from a court-awarded rate of $ 100 per hour to $ 1732.81 per hour. Id. 41

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 222-23.

42

See note 37 supra.

43

The PMC agreement contained a clause requiring arbitration of disputes "concerning monies due a member or his rights under this agreement." In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1457. In one sense, this provision was consistent with the spirit of ethical consideration 2-23 of the 1969 Code and the comment to Rule 1.5 of the 1983 Rules. The former states in part that: "A lawyer should be zealous in his efforts to avoid controversies over fees with clients and should attempt to resolve amicably any differences on the subject." MODEL CODE OF PROFESSIONAL RESPONSIBILITY EC 2-23 (1980). The latter provides that: "If a procedure has been established for resolution of fee disputes, such as an arbitration or mediation procedure established by the bar, the lawyer should conscientiously consider submitting to it." MODEL RULES OF PROFESSIONAL CONDUCT Rule 1.5 comment 5 (1983); see also ABA Comm. on Prof. Ethics and Grievances, Formal Op. 320 (1968) (endorsing arbitration of fee disputes in discussion of legal fee financing plans); C. WOLFRAM, supra note 1, § 9.6.2., at 556-58 (discussing fee arbitration). However, the district court held -- probably correctly -- that under the present circumstances, an arbitration was inapplicable. It stated:

Theresa Coetzee

Page 10 of 34 54 Brooklyn L. Rev. 539, *551 III. BACK TO BASICS (FORGET THE CREATIVITY) The district court 44 and the court of appeals 45 disagreed as to the ethical permissibility of the PMC fee allocation agreement. [*552] At $ the trial level, Chief Judge Jack B. Weinstein of the Eastern District of New York - a man regarded by many as a preeminent federal trial judge -- subscribed to the view that mass tort cases are different. Unless ethical standards are applied to such suits with flexibility 46 and willingness to accommodate novel arrangements, "attorneys might be dissuaded from financing risky but meritorious class litigation in the future." 47 Judge Weinstein's analysis centered on two questions: first, whether the treble repayment agreement ran afoul of the prohibitions against splitting fees with attorneys in other firms; and second, whether the agreement created for the PMC attorneys an impermissible stake in the litigation giving rise to a conflict of interest between the attorneys and the members of the class. 48 The former issue was disposed of on the ground that the PMC constituted an ad hoc law firm, and, therefore, the limitations on sharing fees with outside lawyers were inapplicable. In addition, the court found the agreement met the fee-splitting requirements defined by the American Bar Association's 1983 Model Rules of Professional Conduct (Model Rules). 49 As to the conflict of interest question, the court held that a case-by-case examination was necessary to balance "the important policies favoring class litigation in many instances" against the risk that "an agreement of this kind may create an incentive toward early settlement that may not be in the interests of the class." 50 Reviewing the facts, the court determined that the PMC agreement did not compromise the interests of the class. 51 It held, however, [*553] that in future cases such financing arrangements

The legality of the fee allocation agreement under Rule 23(e) and the supervisory power of the court in ethical matters involving the bar is not an issue that the court can abandon to arbitrators. The "public interest in the dispute" is too great. To allow an arbitrator to decide the questions here involved -- questions that can be raised by the court sua sponte or by any class member - would be an abdication of responsibilities to the class and public that the law requires the court to discharge. Lawyers cannot limit the court's legal powers and duties by agreement among themselves. In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1458 (citations omitted). 44

Id. at 1452.

45

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d 216.

46

See In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1457. The court stated:

[The] ethical principles [contained in the Model Code and the Model Rules] are not dispositive. The focus of Rule 23(e) [of the Federal Rules of Civil Procedure] is prevention of harm to the rights of the class, a consideration that is independent of, albeit usually consistent with, the Code and Model Rule standards. Id. See also id. at 1458 ("other considerations render undesirable a mechanical rule against fee-sharing agreements of this kind"). Flexibility was also a hallmark of Judge Weinstein's approach to other difficult questions posed by the litigation, including the issue of certifying a class where choice of law was problematic. Note, supra note 29, at 481. 47

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1462.

48

Id. at 1458.

49

Id. at 1458-59.

50

Id. at 1460.

51

Id. at 1461 ("theoretical incentive to settle early appears not to have been an appreciable factor in inducing settlement").

Theresa Coetzee

Page 11 of 34 54 Brooklyn L. Rev. 539, *553 must be disclosed to the court at an early date in order to permit the court to adequately scrutinize their effects. 52 In short, the district court expressed a willingness to indulge creative class action financing, subject to individual case review. In reversing the district court judgment, the United States Court of Appeals for the Second Circuit, in an opinion by Judge Roger J. Miner, rejected the contention that the world of the large law practice must be judged by its own standards. The Second Circuit held that the district court erred in treating the PMC as an ad hoc law firm when considering the permissibility of the fee sharing agreement. 53 Further, the court found that the agreement, by conferring special rights on the six of the nine PMC attorneys who advanced expenses and by distorting the court's allocation of fees to individual attorneys, created impermissible conflicts of interest between the attorneys and the class. 54 In declaring the agreement invalid, the court held, in effect, that the defendants had failed to demonstrate that the issue of class action financing required special ethical treatment: everyday "euclidean" rules applied. IV. FEE SPLITTING: ONE FOR YOU AND THREE FOR ME Whatever the shortcomings of the PMC expense reimbursement agreement, it is wrong to fault the pact on the basis that it runs afoul of the ethical prohibitions against fee splitting. As to such charges, the agreement may be defended on both functional and public policy grounds. The chief objective 55 of the fee-splitting prohibitions in the [*554] American Bar Association's 1969 Code of Professional Responsibility (the Code) 56 and its successor, the Model Rules, 57 is the [*555] avoidance of

52

Id. at 1454 ("'sunshine' rule is essential to protect the interests of the public, the class and the honor of the legal profession").

53

In re "Agent Orange" Product Liab. Litig., 818 F.2d 216, 225-26 (2d Cir. 1987).

54

Id. at 224-25.

55

Other justifications for the fee-splitting rules have been suggested: the protection of the lawyer's exclusive right to the fee, C. WOLFRAM, supra note 1, § 9.2.4, at 509; the avoidance of commercialization of the profession, 1 G. HAZARD & W. HODES, supra note 1, at 85; the prevention of unnecessarily "stirring up" litigation, id.; and assurance that a client knows who will be working on his case, Fontenot & Mitchell v. Rozas, 425 So. 2d 259, 261 (La. Ct. App. 1982). However, none of these auxiliary rationales support a finding that the PMC fee allocation agreement here in issue violated professional limitations on fee splitting. First, in class action litigation, no attorney has any legitimate expectation that he will be the sole recipient of the resulting fee. Thus, even if one concedes the somewhat dubious point that in the usual case, it is reasonable to hold fee splitting unethical for the purpose of enabling a practitioner to turn aside on that ground requests by others for a share of his fee, that argument is unpersuasive in class litigation, at least vis-a-vis claims by other class attorneys. Second, it is doubtful that there is a sufficient state interest in avoiding commercialism of the legal profession to support application of the rule in the class action context or otherwise. In litigation dealing with state regulation of lawyer advertising, the United States Supreme Court has made clear that this asserted interest carries little weight when compared to constitutional interests in freedom of expression. See Bates v. State Bar of Ariz., 433 U.S. 350, 368-72 (1977); see also Zauderer v. Office of Disciplinary Counsel, 471 U.S. 626, 647 (1985) (Restrictions on lawyer advertising could not be justified by state interest in "dignity" of legal profession.). It is reasonable to argue that, just as lawyer advertising implicates the guarantees of the first amendment, so too does collaboration with and payment of money to another attorney raise constitutional questions about freedom of association and expression. Third, the Supreme Court has observed recently that not all "stirring up" of litigation is bad. Thus, in Zauderer v. Office of Disciplinary Counsel, the Court stated: [I]t is important to think about what it might mean to say that the State has an interest in preventing lawyers from stirring up litigation. It is possible to describe litigation itself as an evil. . . . But we cannot endorse the proposition that a lawsuit, as such, is an evil. Over the course of centuries, our society has settled upon civil litigation as a means for redressing grievances, resolving disputes, and vindicating rights when other means fail . . . "[W]e cannot accept the notion that it is always better for a person to suffer a wrong silently than to redress it by legal action."

Theresa Coetzee

Page 12 of 34 54 Brooklyn L. Rev. 539, *555 unnecessary increases in the cost of legal services attributable to the payment of forwarding fees. 58 In its most extreme form, a forwarding fee (sometimes called a finder's fee or referral fee) is a portion (often one-third) 59 of the total fee received by an attorney for services rendered, which is then paid to another attorney who performed no work on the case other than to refer the client to the paying attorney. 60 The reasoning generally subscribed to by the large majority of states, which either wholly or with limited exceptions prohibit such arrangements, 61 is that when a substantial amount of money is paid to one who does little more than dial a phone or write a letter, the legal system is rendered less affordable and less accessible to those who need legal services. 62 To the extent that the

471 U.S. at 642-43 (quoting Bates v. State Bar of Ariz., 433 U.S. 350, 376 (1977)). It may persuasively be argued that particularly in the context of mass torts, there is an important state interest in class action litigation going forward so that injured persons will be compensated. See note 153 infra. Fourth, assuming that the fee-splitting rules advance the salutary objective of furnishing notice to a client about who will perform the client's work and be privy to the client's secrets by requiring that the client consent to the association of an outside attorney, that goal is irrelevant here. The identities of the attorneys composing the PMC were not secret and, indeed, tens of thousands of dollars were spent attempting to provide class members with full notice of the prosecution of the action. See In re "Agent Orange" Prod. Liab. Litig., 100 F.R.D. 718, 729-31 (E.D.N.Y. 1983). 56

Disciplinary Rule 2-107(A) provided:

A lawyer shall not divide a fee for legal services with another lawyer who is not a partner in or associate of his law firm or law office, unless: (1) The client consents to employment of the other lawyer after a full disclosure that a division of fees will be made. (2) The division is made in proportion to the services performed and responsibility assumed by each. (3) The total fee of the lawyers does not clearly exceed reasonable compensation for all legal services they rendered the client. ABA MODEL CODE OF PROFESSIONAL RESPONSIBILITY DR 2-107(A) (1980). 57

Rule 1.5(e) states:

[A] division of fee between lawyers who are not in the same firm may be made only if: (1) the division is in proportion to the services performed by each lawyer or, by written agreement with the client, each lawyer assumes joint responsibility for the representation; (2) the client is advised of and does not object to the participation of all lawyers involved; and (3) the total fee is reasonable. ABA MODEL RULES OF PROFESSIONAL CONDUCT Rule 1.5(e) (1983). As to the extent to which the states now have attorney ethics codes based on either the 1969 Code or the 1983 Rules, see generally the discussion in note 1 supra. 58

See C. WOLFRAM, supra note 1, § 9.2.4, at 510 (restrictions on fee splitting designed to "avoid brokering of clients"); Coffee, supra note 28, at 900-01 (fear of referral fees underlies fee splitting rule).

59

G. HAZARD, supra note 3, at 98-99; see also Halstrom, Referral Fees Are a Necessary Evil, 71 A.B.A. J. 40, 43 n.28 (1985) (allowing 25% to 50% in referral fees). 60

See 1 G. HAZARD & W. HODES, supra note 1, at 85 (describing extreme case).

61

As of 1985, only four states -- California, Maine, Massachusetts, and Texas -- permitted straight referral fees. See Halstrom, supra note 59, at 40. For arguments favoring the minority position, see Note, Attorneys: The Referral Fee: A Split of Opinion, 33 OKLA. L. REV. 628, 633 (1980); 1 G. HAZARD & W. HODES, supra note 1, at 85, 86.1-87.

62

See C. WOLFRAM, supra note 1, § 9.2.4, at 510 (The practice of paying forwarding fees "appears wasteful because it compensates the forwarding lawyer for doing little more than passing the client's matter on to another lawyer to handle it."); Johnson, Yellow Pages Legal Ads in Texas: The Complexities of DR 2-101(B) & (C), 17 ST. MARY'S L.J. 1, 12-14 (1985)

Theresa Coetzee

Page 13 of 34 54 Brooklyn L. Rev. 539, *555 Code and [*556] Model Rules require that any splitting of a fee with an outside attorney be made in accordance with that attorney's contribution to the case, measured in terms of "services performed," 63 strict referral fees are banned. 64 The only caveat is that the Model Rules, unlike the Code, contain an exception that permits the payment of a referral fee if the client consents in writing. 65 Presumably, the justification for this exception is that the client's interests are protected by the requirement that the total fee must be reasonable and that beyond that point the maxim volenti non fit injuria 66 applies. It is clear, at a minimum, that the prohibitions on fee splitting apply only to the sharing of fees with attorneys outside of the firm. "Lawyers in the same firm may share fees in any way they choose"; 67 indeed, the collective earning and sharing of fees is a salient, if not quintessential, characteristic of a law firm. As the district court correctly recognized, it is well established that the "[b]usiness realities of law practice often require that those who bring clients and capital to a law firm be better compensated [*557] than those whose talents lie in the area of preparing legal papers and arguments." 68 The reason that in-house fee splitting is ethically permissible and safe from scrutiny is not that all intrafirm compensation agreements necessarily avoid exacerbation of the financial burden of legal services. Rather, the justification would seem to be that the profession as a whole reasonably may depend upon competing personal interests within a firm to ensure that in most instances no attorney will be overcompensated. In addition, even if one thinks that monitoring of in-firm fee allocations is warranted and would not unnecessarily intrude on individual rights, the expenses of conducting and enforcing such a program would render the endeavor impracticable. Where, (Discussing fee splitting and unnecessary brokering of legal services: "To the extent that forwarding arrangements add an unnecessary layer of middlemen to the provision of legal services, they exacerbate a critical problem besetting those who need the assistance of the profession, namely, unaffordability."). See also In re "Agent Orange" Prod. Liab. Litig., 800 F.2d 14, 18-20 (2d Cir. 1986) ("Justice demands . . . the preservation of the class action form of litigation without a wasteful multiplication of its cost."). In the early 1980s, the President of Harvard University, in a widely discussed article, described unaffordability as one of the major failings of the contemporary United States legal system. Bok, A Flawed System, HARV. MAG. 38, 40 (May-June 1983). 63

MODEL CODE OF PROFESSIONAL RESPONSIBILITY DR 2-107(A)(2) (1980); MODEL RULES OF PROFESSIONAL CONDUCT Rule 1.5(e)(1) (1983). 64

See ABA/BNA Manual, supra note 1, at 41:701 ("In jurisdictions strictly following either the Model Code or the Model Rules, a referral does not entitle the referring lawyer to a division of fees."). 65

MODEL RULES OF PROFESSIONAL CONDUCT Rule 1.5(e)(1) (1983). The major change wrought by the Model Rules is that fee splitting, even with a forwarding attorney, is permitted in "virtually all cases, provided that the client consents." 1 G. HAZARD & W. HODES, supra note 1, at 85. However, even in such instances, the attorney receiving a share of the fee must assume "joint responsibility" for the representation. MODEL RULES OF PROFESSIONAL CONDUCT Rule 1.5(e)(1) (1983). This somewhat indefinite phrase probably means that the attorney must agree to be jointly and severally responsible for legal malpractice purposes and to be bound by the standards applicable to a supervising attorney for disciplinary purposes. See C. WOLFRAM, supra note 1, § 9.2.4, at 512 n.9; MODEL RULES OF PROFESSIONAL CONDUCT Rule 1.5 comment 4 (1983). 66 He

who consents cannot receive an injury." BLACK'S LAW DICTIONARY 1746 (rev. 4th ed. 1968). This, to be sure, is a questionable use of the volenti principle, for under the 1983 Rules there is no full disclosure prior to consent. The attorneys are not obliged to inform the client as to the share of the total fee that each attorney will receive. Model Rules of Professional Conduct Rule 1.5 comment 4. Professor Wolfram persuasively argues that the better course is full disclosure. C. WOLFRAM, supra note 1, § 9.2.4, at 513 ("Forwarding is justifiable on public policy grounds only if it enhances the ability of a client to receive superior legal services. Leaving the client as far in the background as the Code and the Model Rules do is either paternalistic or ignores that policy."). 67

Id. § 9.2.4, at 511; see also 1 G. HAZARD & W. HODES, supra note 1, at 84 ("Fee splitting between lawyers, other than sharing profits and losses in a firm, is a controversial practice" (emphasis added)).

68

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. 1396, 1458 (E.D.N.Y. 1985) ("Rainmakers are usually better rewarded than those who labor in the back room.").

Theresa Coetzee

Page 14 of 34 54 Brooklyn L. Rev. 539, *557 however, a fee is split with an outside attorney, the event is probably sufficiently infrequent, and the services to which the fee relates sufficiently capable of isolation, so as to permit some degree of scrutiny. Accordingly, the boundary line between what will be reviewed, on the one hand, and what will be ignored, on the other, is normally drawn at the conceptual perimeter of the firm -- the definition of which is an ever more onerous task in an era of major developments and modifications in the delivery of legal services. Fee splitting rules, as normally applied, reach the most egregious cases: those involving no more than straight referral or perfunctory participation in a client's representation by a forwarding attorney. 69 Although the Agent Orange PMC was not a typical law firm, 70 its constituents were also not in any way involved with the forwarding of clients. All of the attorneys on the committee were appointed as class counsel by the court, acting in its role as guardian of the class. 71 There was no referral of clients by one [*558] attorney to another, no attempt to garner compensation through the mere brokering of clients, and no effort to cultivate future referrals by handsomely compensating a forwarding lawyer. What little authority there is on the question holds that fee splitting rules do not apply to situations where a client has personally engaged multiple attorneys to cooperatively work on a case. 72 This is sound, for in such instances there is no forwarding arrangement and, thus, the evil the fee-splitting rules seek to combat is nonextant. Consistent with this precedent, it is reasonable to conclude that prohibitions against fee sharing are inapplicable to the PMC fee allocation agreement at issue in the Agent Orange case. In the Agent Orange suit, each PMC attorney was appointed by the court, acting on behalf of the class, and therefore stood in a constructive attorney-client relationship with absent class members, 73 as well as in an actual attorneyclient relationship with class members the attorney individually represented. If there is no risk of the evil sought to be avoided by the rule -- namely, overcompensation of a forwarding attorney -- the ethical proscription should not apply. Cessante ratione legis, cessat et ipsa lex. 74 The district court's conclusion that the fee allocation agreement did not constitute an unethical splitting of fees was based on its finding that the PMC was the equivalent of an ad hoc partnership. This characterization is fair, from a functional perspective, for a class action PMC more closely resembles a traditional [*559] firm than it does a forwarding arrangement between independent attorneys. A PMC is a group of attorneys sharing common

69

See C. WOLFRAM, supra note 1, § 9.2.4, at 512 ("Cases have rather consistently held that 'services performed' requires, at a minimum, that the forwarding lawyer must do more than simply originate the matter and perhaps vaguely consult with the client for client relations purposes thereafter."). 70

Interestingly, however, like the usual law firm, the PMC set up a central headquarters in rented office space two blocks from the courthouse. In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1302. It also rented furniture and office equipment, and paid a separate office staff and separate telephone and photocopying expenses. Id. at 1330. 71

Cf. In re "Agent Orange" Prod. Liab. Litig., 818 F.2d 210, 222 (2d Cir. 1987) ("Fed. R. Civ. P. 23(e) . . . squarely places the court in the role of protector of the rights of the class when . . . a settlement is reached."). 72

See Fontenot & Mitchell v. Rozas, 425 So. 2d 259, 261 (La. Ct. App. 1982):

Disciplinary Rule 2-107 is aimed at full disclosure to the client by his attorney that another lawyer has been associated BY THE LAWYER, and will be sharing in the fees. . . . [I]n this case, there was as contract; a contract wherein Lonis West, himself, hired two law firms to represent him. . . . Neither [attorney] associated the other, as is contemplated by DR 2-107. 73

Note, Developments in the Law: Conflicts of Interest in the Legal Profession, 94 HARV. L. REV. 1244, 1451 (1981) (quoting Cullen v. New York State Civil Serv. Comm'n, 435 F. Supp. 546, 560 (E.D.N.Y.), appeal dismissed, 566 F.2d 846 (2d Cir. 1977)) ("By granting class status, the court places the attorney for the named parties in a position of public trust and responsibility, and in effect creates an attorney-client relationship between the absentee members and the attorney."); see also 3 H. NEWBERG, supra note 6, § 15.03, at 199 (discussing "constructive attorney-client relationship" between class attorney and absent members of class). 74 The

reason of the law ceasing, the law itself also ceases." BLACK'S LAW DICTIONARY 288 (rev. 4th ed. 1968).

Theresa Coetzee

Page 15 of 34 54 Brooklyn L. Rev. 539, *559 obligations of loyalty, fidelity, and confidentiality to the individuals, which is also true of members of a law firm. 75 There is authority, albeit slender, to support the proposition that where such a relationship exists, fee-splitting rules are inapplicable. Accordingly, it has been held that a firm may freely divide a fee with an attorney who is merely "of counsel," if that attorney effectively functions as a member of the firm. 76 Consequently, the PMC agreement may be defended on functional, as well as public policy grounds. The United States Court of Appeals for the Second Circuit, in an opinion devoid of any discussion of the goals underlying the fee-splitting rule, rejected the determination that the committee constituted an ad hoc firm. In reference to the members of the PMC, the court tersely stated, without elaboration or citation to authority: "They merely are a group of individual lawyers and law firms associated in the prosecution of a single lawsuit, and they lack the ongoing relationship that is the essential element of attorneys practicing as partners." 77 This holding is unpersuasive for it forces the fee-splitting issue to turn upon a wholly irrelevant consideration, namely the existence of an "ongoing relationship." There is nothing in the text of the fee-splitting provisions in the Code or the Model Rules that mandates such a relation. One attorney may split a fee, in any proportion whatsoever, with another attorney who joins his firm the day before the fee is received or who exits the firm the day after the division is made. Indeed, authorities specifically permit division with a departing attorney of a fee previously earned in whole or in part, notwithstanding the fact that clearly there will be no continuing relation between the participating [*560] attorneys. 78 It is difficult to see what interest would be served by imposing a continuing relation requirement on a litigation financing transaction already structured in such a manner that there will be no referral of clients or collection of forwarding fees. The plaintiffs' management committee is a relatively new innovation in law practice, which did not exist at the time prohibitions on fee splitting were first conceived and enacted. 79 Consequently, any assessment of how such entities should be treated for purposes of a fee-splitting rule must be informed by an understanding of the rule's underlying objectives. The Second Circuit's decision on the fee-splitting issue represents a failure to grapple with the question of how traditional ethics rules should be applied to new developments in the delivery of legal services. The court held, in effect, that because the Agent Orange PMC did not conform to established notions of what constitutes a law firm, the agreement to reimburse advances of common expenses threefold ran afoul of the ethical prohibition. Both wisdom and logic dictate a more flexible, less wooden, interpretation of the rule. 80

75

See Hazard, Ethical Consideration in Withdrawal, Expulsion, and Retirement, in WITHDRAWAL, RETIREMENT & DISPUTES 33 (E. Berger ed. 1986) ("All lawyers presently in the firm at any given time are bound to the duty of loyalty that governs the lawyer actually serving the affected client"); C. WOLFRAM, supra note 1, § 16.2.2, at 881 ("[E]very responsible member of the firm shares in the firm's collective responsibility for the firm's work."); id. § 16.2.3, at 886 ("[A]ssociates bear much the same responsibilities for devotion to the client service and protection as do partners."). 76

D.C. Bar. Comm. on Legal Ethics, Op. 151 (Apr. 16, 1985), summarized in [Ethics Opinions 1980-1985] LAW. MANUAL ON PROF. CONDUCT (ABA/BNA) 801:2315 (1985) [hereinafter Ethics Opinions 1980-1985].

77

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 226.

78 The

well-settled rule for the unfinished business of existing clients is that the partnership agreement controls the right of [exiting] partners to share in fees, regardless of when the fees are billed." C. WOLFRAM, supra note 1, § 16.2.3, at 888. 79

Prohibitions on fee splitting can be traced back at least as far as Canon 34 of the 1908 Canons of Professional Ethics, which provided in part: "No division of fees for legal services is proper, except with another lawyer, based upon a division of service or responsibility." CANONS OF PROFESSIONAL ETHICS Canon 34 (1908). 80

Cf. Coffee, supra note 28, at 934 ("[C]ourts must respond more sensibly to the peculiar institution of the 'ad hoc plaintiffs' firm.").

Theresa Coetzee

Page 16 of 34 54 Brooklyn L. Rev. 539, *560 It is, of course, important to note that the problems giving rise to the foregoing discussion may be substantially ameliorated by the adoption of the Model Rules' variation of the fee-splitting rule, 81 now in force in at least 17 states. 82 Under that standard, a division of fees in an amount not proportional to the [*561] services performed by each attorney is permissible where, "by written agreement with the client, each lawyer assumes joint responsibility for the representation." 83 The district court found that this provision was satisfied in the present case based on the fact that, pursuant to written court order, each PMC attorney was appointed to act on behalf of the class, and was therefore jointly responsible for the quality of the representation. 84 The district court did not, however, state that the provision in the Model Rules, rather than its more stringent counterpart in the Code, 85 set the applicable standard in this case. 86 V. A CONFLICT OF INTEREST (TOO MUCH? OR TOO LITTLE?) The second, more difficult, issue arising from the fee allocation agreement is a question of conflict of interest between lawyer and client. Specifically, does such a contract among class attorneys impermissibly tend to diminish participating attorneys' loyalty to their clients by reason of conferring upon some attorneys an unjustified stake in the litigation or by jeopardizing other attorneys' rights to adequate compensation? If either is true, then the proper course is clear. The agreement is unethical; its provisions are void; enforcement must be denied. It is a fundamental principle of legal ethics that a client is entitled to the full benefit of his attorney's independent professional judgment, unclouded by improper personal interests of the attorney. 87

81

See note 57 supra.

82

Rule 1.5(e) of the 1983 Model Rules of Professional Conduct has been enacted verbatim in Arizona, Arkansas, Delaware, Florida, Idaho, Indiana, Louisiana, Maryland, Mississippi, Missouri, Montana, New Mexico, North Carolina, Oklahoma, Pennsylvania and South Dakota. 2 G. HAZARD & W. HODES, supra note 1, app. 4 (Supp. 1987) (state variations of Model Rules); see also 1 NATIONAL REPORTER ON LEGAL ETHICS, supra note 26 (ethics codes set forth by state). Modified standards of a more or less similar nature are in effect in five other states: Minnesota, Nevada, New Jersey, Oregon, and Washington. See id.; 2 G. HAZARD & W. HODES, supra note 1, app. 4. 83

MODEL RULES OF PROFESSIONAL CONDUCT Rule 1.5(e)(1) (1983).

84

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. 1396, 1459 (E.D.N.Y. 1985). For purposes of Model Rule 1.5(e), "it is typically impossible [in a class action] to obtain the consent of each client, although presumably the court can consent for them." Coffee, supra note 28, at 901 n.52. 85

See note 56 supra.

86

When choice of law problems relating to ethical standards arise in mass tort class actions involving plaintiffs from various jurisdictions, as was true in the Agent Orange case, presumably they should be resolved in accordance with normal conflict of laws rules. See C. WOLFRAM, supra note 1, § 2.6.1, at 50 (discussing emerging choice of law issues). 87

See MODEL RULES OF PROFESSIONAL CONDUCT Rule 1.7(b) (1983) ("A lawyer shall not represent a client if the representation of the client may be materially limited by the . . . lawyer's own interests, unless . . . the lawyer reasonably believes the representation will not be adversely affected . . . [and] the client consents."); MODEL CODE OF PROFESSIONAL RESPONSIBILITY EC 5-1 (1980) ("The professional judgment of a lawyer should be exercised, within the bounds of the law, solely for the benefit of his client and free of compromising influences and loyalties."); id. at EC 5-2 ("After accepting employment, a lawyer carefully should refrain from acquiring a property right or assuming a position that would tend to make his judgment less protective of the interests of his client."); id. at DR 5-101(A) ("Except with the consent of his client after full disclosure, a lawyer shall not accept employment if the exercise of his professional judgment on behalf of his client will be or reasonably may be affected by his own financial, business, property, or personal interests."); R. MALLEN & V. LEVIT, LEGAL MALPRACTICE § 91 (1977) (discussing duty of "undivided loyalty" and perils to that duty posed by adverse interests of attorney); id. at § 99 (discussing conflicts of interest and attorney's duty to represent client fully). See also CANONS OF PROFESSIONAL ETHICS Canon 6 (1908) (obligation of "undivided fidelity"); In re "Agent Orange" Prod. Liab. Litig., 818 F.2d 216, 222 (2d Cir. 1987) ("ultimate inquiry . . . is the effect an agreement could have on the rights of a class").

Theresa Coetzee

Page 17 of 34 54 Brooklyn L. Rev. 539, *561 and the court of appeals 89 found that the expense reimbursement agreement carried with it the potential for diverting the loyalty of investor-attorneys from the interests of their clients. Surely this is correct, for it is easy to envision the pressures for premature settlement that may arise where an inadequate settlement offer is made by a defendant. 90 Faced with such an offer, an investor-attorney may conclude that the compensation likely to be awarded by the court for the hours previously worked by committee members would be sufficient, when redistributed, to cover a threefold return of all advanced expenses. If so, the attorney may be tempted (especially if he has made a large advance but has personally contributed few hours) to urge the class and court to accept the offer because of the handsome return he will reap on his investment, 91 notwithstanding the fact that the proffered settlement, being inadequate [*563] in amount, is inimical to the interests of the class. 92 Moreover, an attorney who relinquishes some or all of his expected right to compensation to an investor-attorney may thereafter lack the incentive to work diligently on the case or may be willing to gamble on high-risk litigation strategies in the hope of producing an award large enough to transform his partial fee interest into generous personal compensation. 93 [*562] Both the district court

88

However, to say that an agreement has the potential, under certain circumstances, to drive a wedge between lawyer and client is not to say that its provisions must be held impermissible. Impermissibility is a question of context. There may be interests advanced by the arrangement that make the risk of divided loyalties worth taking. Or there may be checking mechanisms, presently in place or capable of adoption, which acceptably minimize the chances of the risk coming to fruition. For example, a contingent fee contract is fraught with potential conflicts of interest. 94 An attorney employed under such a contract may be induced to pursue risky litigation strategies in search of a large contingent fee, although a conservative course would be more consonant with the interests of the client. He may also be tempted to settle a case quickly and with little expense to himself in order to maintain a high

88

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. 1452, 1460 (E.D.N.Y. 1985).

89

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 222.

90

These pressures are all the more significant in view of the fact "most of the claims arising from mass accidents are eventually settled." Rosenberg, supra note 8, at 564. See also 2 G. HAZARD & W. HODES, supra note 1, at 165 ("When a stake in the outcome of a lawsuit has been acquired by a lawyer, there is additional danger. In meritorious but close cases, a lawyer's representation may be skewed by his concern to protect his investment. . . . [T]his concern might lead a lawyer to urge acceptance of an inadequate settlement."); Coffee, supra note 28, at 883 ("substantial conflicts of interest between attorney and client can arise in class action litigation"); Rosenfield, An Empirical Test of Class-Action Settlement, 5 J. LEGAL STUD. 113, 114-17 (1976) (empirical studies show class action settlements result in pecuniary gains for attorneys at expense of class); Coffee, The Unfaithful Champion: The Plaintiff As Monitor in Shareholder Litigation, 48 LAW & CONTEMP. PROB. 5, 61 (1985) ("Under a number of circumstances, fee arrangements could enhance the danger of a premature cheap settlement not in the interests of the class."). 91

Cf. Zylstra v. Safeway Stores, Inc., 578 F.2d 102, 104 (5th Cir. 1978) ("[W]henever an attorney is confronted with a potential for choosing between actions which may benefit himself financially and an action which may benefit the class which he represents there is a reasonable possibility that some specifically identifiable impropriety will occur."). 92

The Second Circuit stated:

The conflict obviously lies in the incentive provided to an investor-attorney to settle early and thereby avoid work for which full payment may not be authorized by the district court. Moreover, as soon as an offer of settlement [sufficient] to cover the promised return is made, the investor-attorney will be disinclined to undertake the risks associated with continuing the litigation. In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 224. 93

Coffee, supra note 90, at 62.

94

See 2 G. HAZARD & W. HODES, supra note 1, at 173 (contingent fee interest "could be considered to be champerty ('investing' in litigation), and could skew a lawyer's judgment"); C. WOLFRAM, supra note 1, § 9.4.1, at 529 ("contingent fee creates incentive for 'quick kill' before many hours are spent").

Theresa Coetzee

Page 18 of 34 54 Brooklyn L. Rev. 539, *563 volume of business, even though the specific client would be better served by more vigorous litigation. Despite these risks, we permit contingent fee contracts in all but a few areas. 95 The dangers contingent fees pose to fair [*564] representation are generally though to be outweighed by the fact that such agreements perform an indispensable role in ensuring that all persons with colorable claims have access to the justice system, regardless of ability to pay. 96 In the Agent Orange suit, the point of disagreement between the district court and the court of appeals concerned whether the facts were sufficient to justify the potential conflict of interest created by the PMC agreement. Although each decision is intricately elucubrated, the critical difference in the two opinions concerns judicial assessment of the necessity for creative financing in class action suits. The district court, strongly cognizant of the fact that, prior to the signing of the agreement, the Agent Orange class action had ground to a halt for lack of sufficient money, found the agreement to be a necessary and appropriate method of resolving the financial dilemma. 97 In contrast, the circuit court, unpersuaded by such arguments, dismissed as "a matter of speculation" the contention that lack of financing would undercut and destroy the class action. 98 As the legal realists taught us, the premise from which one starts may well determine the conclusion one reaches. If one believes that adequate financial support will not otherwise be forthcoming, one may reason, as did the district court, that there [*565] are safeguards sufficient to insulate the class from the danger of premature settlement. Thus, in approving the agreement, the district court emphasized: that the class was protected from the risk of inadequate compensation by the fact that any settlement had to receive court approval; 100 that by requiring prompt disclosure of the existence and terms of a fee allocation agreement, a court (and, to a lesser extent, the class) is able to vigilantly monitor the quality of representation; 101 that any incentive such an agreement creates

99

95

MODEL RULES OF PROFESSIONAL CONDUCT Rule 1.8(j) (1983) (generally permitting contingent fees in civil cases, as exception to rule barring acquisition of proprietary interest in litigation by attorney); id. at Rule 1.5(d) (barring contingent fees in criminal cases and in domestic relations cases where payment or amount is contingent upon the securing of divorce or amount of alimony, support, or property settlement); see also MODEL CODE OF PROFESSIONAL RESPONSIBILITY DR 2-106(c) (1980) (barring contingent fees in criminal cases). 96

See 1 G. HAZARD & W. HODES, supra note 1, at 173 ("[C]ontingent fees are often thought to be necessary in civil cases, so that lawyers will be encouraged to represent clients with meritorious claims who could not otherwise afford the costs of litigation."). See also J. AUERBACH, UNEQUAL JUSTICE: LAWYERS AND SOCIAL CHANGE IN MODERN AMERICA 46 (1976) (Stating that one future United States Senator observed early in the twentieth century that "[o]nly contingent fees . . . enabled the victims of work and transportation accidents -- especially indigent immigrants -- to obtain some measure of economic recovery."); C. WOLFRAM, supra note 1, § 9.4.1, at 529 (noting relationship between contingent fee issues and unequal access to courts for poor and near poor). 97

In an opinion issued nine days prior to the ruling on the fee allocation agreement, Judge Weinstein noted that, "[b]y the summer of 1983 management problems had become serious, in part because of the great difficulty of funding such a massive litigation." In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. 1296, 1302 (E.D.N.Y. 1985). Lead counsel withdrew based upon "inability to bear the expense of continued litigation." Id. 98

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 225.

99

Cf. Peters, Common Law Judging in a Statutory World: An Address, 43 U. PITT. L. REV. 995, 996 (1982):

[T]he school of jurisprudence called legal realism challenged the methodological authority of the rule of law as elicited from a particular line of cases by demonstrating the ease with which a competing rule of law could be derived from a competing line of cases depending upon one's selection of a relevant fact pattern. Id. 100

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. 1452, 1461 (E.D.N.Y. 1985).

101

Id. at 1464.

Theresa Coetzee

Page 19 of 34 54 Brooklyn L. Rev. 539, *565 for early settlement is offset by the fact that under the hour-based lodestar formula for calculating fees, 102 there is a counter-balancing incentive for delay; 103 and that the agreement imposes no added burden on the class, for it merely redistributes, rather than increases, the amount of court awarded fees. 104 In contrast, if one sees little need for nontraditional financing, one can muster reasons to support that conclusion, too. Thus, the Second Circuit here opined: that conflicts of interest are difficult to discern and insidiously distort the quality of representation; 105 that courts and class action plaintiffs are in a poor position to scrutinize the internal fee agreements of class attorneys; 106 that a court's obligation extends beyond concern [*566] for the overall amount of fees; 107 that there is a strong public interest in ensuring that an attorney is not deprived of fair compensation for his efforts by an agreement that unnecessarily strips him of the fees to which a court has found him to be entitled; 108 that the lodestar formula does not significantly offset the risk of premature settlement because courts frequently disapprove hours for which compensation is claimed; 109 and that, consequently, the risk of premature settlement too greatly jeopardizes the litigation process. 110 That the district court and the court of appeals disagreed on many questions related to the fee allocation agreement is neither surprising nor disturbing. The issues here are difficult, and in many respects their answers are not susceptible to verification on other than intuitive grounds. How does one prove that a judge is not in a good position to root out conflicts of interest in class action representation? One could compile citations to class action stagers ad infinitum expressing opinions on each side of the question, 111 but in the end it is likely that the only definite conviction one would enjoy is that reasonable minds can differ.

102

See notes 130-33 and accompanying text infra.

103

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1461; see also Coffee, supra note 28, at 887-88 (lodestar formula creates incentive for delay and provides strong incentive for attorney to settle on eve of trial, since by then nearly all of time determining attorney's compensation has been expended). "[A] larger recovery for the client will not substantially affect . . . [the attorney's] own [compensation]." Id. at 888 (footnote omitted). But see Rosenberg, supra note 8, at 584 n.89 (risk that a timebased approach in setting class attorney fees will induce class attorney to negotiate collusive "sweetheart" agreement with defendant is diffused by allowing adjustments in "lodestar formula" for risk, success, and benefit premiums). 104

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1461.

105

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 224. A client's interests may be encroached upon by conflicts of interest falling short of major abuse. Id. (quoting Court Awarded Attorney Fees, Report of the Third Circuit Task Force, 108 F.R.D. 237, 266 (1985)). 106

Id. (quoting Court Awarded Attorney Fees, Report of the Third Circuit Task Force, 108 F.R.D. 237, 266 (1985)) (parties may be unaware of conflicts of interest at time of settlement discussions). Cf. In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 224-25 (District court's power to disapprove settlement does not protect class from dangers of conflict of interest because court's attention is directed to issue of overall reasonableness.) (citing In re Mid-Atlantic Toyota Antitrust Litig., 93 F.R.D. 485, 491 (D. Md. 1982)), and Coffee, supra note 90, at 26-27). 107

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 225.

108

Id. at 222 (PMC agreement "distorted" and "vitiated" principles district court had meticulously applied in awarding compensation.). 109

Id. at 225 (court's authority to review hours acted as direct check on alleged incentive to procrastinate).

110

Id. at 224.

111

See, e.g., Alleghany Corp. v. P. Kirby, 333 F.2d 327, 347 (2d Cir. 1964) (Friendly, J., dissenting) ("All the dynamics conduce to judicial approval of such settlements" once adversaries have locked arms and approached court.); Coffee, supra note 28, at 889 ("the court's own incentives to monitor are open to serious question"). See also Rosenberg, supra note 8, at 584

Theresa Coetzee

Page 20 of 34 54 Brooklyn L. Rev. 539, *566 What is disturbing about the decisions of the two courts is that, to greater or lesser extents, the courts -- perhaps owing to the quality or character of the advocacy in the case -- seem not to fully appreciate the larger picture of which the Agent Orange fee agreement is merely one dimension. Specifically, there are [*567] critical, unresolved questions as to whether, to what extent, and through what means, the lost time-value of money advanced to cover litigation expenses in mass tort class actions may be recouped by class attorneys. In the ordinary tort case, the "opportunity cost" 112 of money advanced for litigation expenses does not loom large. Although litigation expenditures commonly run into the thousands or tens of thousands of dollars, the interest or other investment return that could have been earned on such sums between the time of the advance and the conclusion of the case is not of Olympic proportions. Even where a suit lingers for years, lost income related to advances is normally a small figure. It is small in comparison both to the amount advanced and to the attorney's fees if the suit is successful. It is also small when viewed against the backdrop of salaries and office expenses, which form the context of contemporary law practice. 113 It is possible for the attorney in the ordinary tort case to recover, directly or indirectly, the "cost" of advancing expenses on a client's behalf. The attorney may address the issue directly -- although apparently few do 114 -- by providing in the retainer agreement that the client will be responsible not only for repayment of expenses, 115 but for reasonable interest accruing thereon from the time of the advance. 116 From an economic standpoint, [*568]

n.89 ("judicial scrutiny of the settlement and class attorney fee deters collusion"); id. at 584 n.92 ("Judicial review of class settlements provides additional, if not wholly sufficient, protection against strategic bargaining by defendants."); cf. Comment, The Attorney-Client Privilege in Class Actions: Fashioning an Exception to Promote Adequacy of Representation, 97 HARV. L. REV. 947, 947 (1984) ("[F]ederal class action procedure relies heavily upon class member dissent and close judicial scrutiny of class representatives' conduct of litigation."). 112 Opportunity

cost" has been defined as "the benefit forgone by employing a resource in a way that denies its use to someone else." R. POSNER, ECONOMIC ANALYSIS OF LAW 6 (3d ed. 1986). "[A] lawyer who uses her or his own capital [to pay for advancement of expenses] loses interest that would have been earned." In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1310. 113

See generally Address by William H. Rehnquist, Chief Justice of the United States, before the Australian Bar Association, in Sydney, Australia (Sept. 3, 1988) (discussing high attorney salaries, extravagant recruiting practices, and costly office space).

114

See J. MCRAE, LEGAL FEES & REPRESENTATION AGREEMENTS 49 (1983).

115

Client liability for advances was mandatory under the 1969 Code. MODEL CODE OF PROFESSIONAL RESPONSIBILITY DR 5-103(B) (1980). Under the 1983 Rules, repayment may be contingent. MODEL RULES OF PROFESSIONAL CONDUCT Rule 1.8(e) (1983).

116

See ABA Comm. on Ethics and Professional Responsibility, Formal Op. 338 (1974) (interest may be charged on delinquent fee and expense accounts provided client is advised and agrees); Alabama State Bar Op. RO-84-112 (1984) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:1084) (Lawyer may ask client to execute note that would require client to pay interest for all fees and costs that are not paid within sixty days, provided interest is not usurious, there is no overreaching, and client agrees prior to rendition of services or advances.); State Bar of Ariz. Comm. on Rule of Professional Conduct Op. 86-9 (1986) (summarized in ABA/BNA Manual, supra note 1, at 901:1403) (Lawyer may not charge interest on past due accounts absent prior agreement or client consent.); State Bar of Calif. Standing Comm. on Professional Responsibility and Conduct, Op. 1980-53 (1980) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:1601) (Interest on unpaid legal fees may be charged with prior client consent; rate may be adjusted to reflect later events.); Colorado Ethics Comm. Op. 66 (1984) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:1904-05) (Lawyer may not unilaterally impose interest on delinquent fee account unless client has agreed in advance and agreement states both amount of interest and specific time periods after which interest would be imposed.); Connecticut Bar Ass'n Comm. on Professional Ethics, Informal Op. 82-21 (1982) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:2058) (lawyer may not charge interest on clients' accounts receivable unless client agrees in advance of performance of services.); Florida Bar Prof. Ethics Comm. Op. 86-2 (1986) (summarized in ABA/BNA Manual, supra note 1, at 901:2501) (Attorney may charge lawful rate of interest on liquidated fees and advancements of costs, either as provided in advance written agreement or upon reasonable notice.); State Bar of Ga. State Disciplinary Board Op. 45 (1985) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:2704) (Lawyer may

Theresa Coetzee

Page 21 of 34 54 Brooklyn L. Rev. 539, *568 this approach makes sense. If the advance has been made from [*569] funds on hand, the firm has incurred an opportunity cost by foregoing the opportunity to invest and earn a return on those dollars. And if, as is true in the case of many firms, 117 the advance is made from borrowed funds, should not the firm be able to candidly pass the "borrowing cost" 118 of the loan to the client as a legitimate component of expenses? For whatever reason -perhaps owing to record keeping difficulties, or perhaps due to the prospect of competitive disadvantage vis-a-vis other firms in the client market -- most firms do not separately bill interest. 119 Where work is done on an hourly basis, the cost to the firm of providing the advance is rolled into the overall hourly rate. In the personal injury field, where fees commonly are contingent, it is likely that firms reason that when a fee is received, in this or another case, the fee will more than cover their cost of having advanced expenses when necessary. 120 unilaterally charge interest on unpaid overdue bills provided client is notified in advance and terms comply with all applicable laws, including Federal Truth in Lending and Fair Credit Billing Acts.); Indiana State Bar Ass'n Legal Ethics Comm. Op. 2 (1981) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:3303) (Lawyer may charge interest provided client agrees to pay it on accounts delinquent for more than stated period.); Mississippi State Bar Ethics Comm. Op. 100 (1985) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:5108) (Lawyer may charge interest on delinquent accounts if lawyer advises client in advance.); Iowa State Bar Ass'n Comm. on Professional Ethics 81-7 (1981) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:3605) (Provided attorney complies with relevant laws, attorney may charge interest on bills for legal services and on advances more than thirty days due.); Kansas Bar Ass'n Professional Ethics Comm. Op. 80-41 (1980) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:3804) (Attorney may create fund from which advances to clients can be made as loans for which interest would be charged where clients would be ultimately responsible for paying any and all expenses.); Maryland State Bar Ass'n Comm. on Ethics Op. 83-32 (1983) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:4326-27) (Lawyer may charge a former client interest on unpaid legal fees only if former client has agreed to the arrangement.); Maryland State Bar Ass'n Comm. on Ethics Op. 83-28 (1982) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:4326) (There are no ethical restrictions on lawyer's charging interest on delinquent accounts for fees and costs, provided client consents.); Nebraska State Bar Advisory Comm. Op. 86-3 (undated) (summarized in ABA/BNA Manual, supra note 1, at 901:5501) (Lawyer may enter into written agreement with client charging interest on unpaid accounts at reasonable rate.); Ohio State Bar Ass'n Comm. on Legal Ethics and Professional Conduct Op. 82-1 (1982) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:6827) (Lawyer may charge interest on delinquent accounts at rate set forth in writing at outset of representation, provided rate is neither excessive nor illegal.); South Carolina Bar Ethics Advisory Comm. Op. 81-1 (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:7901) (Assuming client is agreeable, lawyer may charge monthly service charge on unpaid balance of legal fees.); State Bar of Texas Prof. Ethics Comm. Op. 409 (undated) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:8303) (Lawyer may charge interest on balance of unpaid fees provided original agreement between lawyer and client is definite as to amount of interest to be charged and lawyer proves fairness of contract.); Virginia State Bar Standing Comm. on Legal Ethics Op. 426 (1983) (summarized in Ethics Opinions 19801985, supra note 76, at 801:8807) (Firm may charge interest on unpaid accounts for expenses advanced on client's behalf, provided there is prior agreement.); State Bar of Wis. Comm. on Professional Ethics Op. E-80-13 (1980) (summarized in Ethics Opinions 1980-1985, supra note 76, at 801:9102-03) (Lawyer may not unilaterally impose interest charge through provision in bill, but may charge interest if client is notified and agrees and agreement complies with applicable federal law.); see also ABA Comm. on Ethics and Professional Responsibility, Formal Op. 320 (1968) (discussing interest as related to legal fee financing plan); MODEL RULES OF PROFESSIONAL CONDUCT RULE 1.8(a) (1983) (Business transactions with client must be fair and reasonable, and client must be given opportunity to seek advice of independent counsel and must consent in writing.). 117 [M]ost

law firms today are to some extent in debt." McRae, supra note 114, at 50. Cf. Coffee, supra note 90, at 57 ("Plaintiffs' attorneys are chronically underfinanced . . . [their] cash flow predictably . . . [is] volatile."). 118 A

lawyer who borrows to pay these advances [of litigation expenses] pays interest. . . ." In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. 1296, 1310 (E.D.N.Y. 1985). "[T]he cost of money is one of the primary expenses that any business must bear." J. MCRAE, supra note 114, at 49. 119

Id. at 49.

120 Contingent

fees take into account not only the risk of nonrecovery, but the fact that the lawyer must wait for years before collecting a fee to cover long-paid out-of-pocket expenses, overhead costs and living costs." In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1310. Cf. R. POSNER, supra note 112, at 534-35. Judge Posner states: The contingent fee compensates the lawyer not only for the legal services he renders but for the loan of those services. The implicit interest rate on such a loan is high because the risk of default (the loss of the case, which cancels the debt of the client

Theresa Coetzee

Page 22 of 34 54 Brooklyn L. Rev. 539, *569 [*570] When one moves from the everyday world of law practice to the milieu of the mass tort lawyer, the issue of recovering the costs of financing litigation takes on a wholly different complexion. To begin with, the amounts at stake are no longer minor. Advancements of money for expenses, frequently running into the hundreds of thousands or millions of dollars, are commonly tied up for periods of years 121 because of the complexity of such cases. 122 In the Agent Orange case, for example, aggregate expenses totaled more than three million dollars, 123 and more than half a decade elapsed between the filing of the first suit in February 1979 124 and the settlement of the resulting class action in May 1984 for $ 180 million. 125 Whether measured in absolute or relative terms, the opportunity cost or borrowing cost of advancing expenses is high.

At the same time, the mass tort class action attorney has fewer avenues for passing through to clients the cost of advancing expenses. It is unlikely that the opportunity or borrowing cost can be directly transferred to the named plaintiffs via an interest provision in the retainer agreement, for presumably few individuals, each with a relatively limited stake in the class litigation, will agree to accept such liability. 126 In addition, as explained [*571] below, it is also unlikely that the cost will be covered through court-awarded fees or expenses, because of the manner in which such payments are set.

to the lawyer) is much higher than that of conventional loans, and the total amount of interest is large not only because the interest rate is high but because the loan may be outstanding for many years -- and with no periodic part payment, a device for reducing the risk of the ordinary lender. Id. 121

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1308 (noting complex multidistrict litigation, such as Agent Orange case, may extend over "many years"). 122

See note 28 supra (discussing complexity of mass tort cases).

123

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 229.

124

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1301. In May 1979, cases filed in various parts of the country were consolidated by the Judicial Panel on Multidistrict Litigation in the Eastern District of New York. Id. The case was tentatively approved as a class action on December 26, 1980. Id. 125

Id. at 1301.

126

Some courts, mindful of the fact that the Disciplinary Rule 5-103(B) in 1969 Code permits an attorney to advance litigation expenses only if the client agrees to be ultimately responsible for repayment, have refused to certify a class in the absence of proof of the named plaintiffs' willingness to accept such liability. See In re Mid-Atlantic Toyota Antitrust Litig., 93 F.R.D. 485 (D. Md. 1982) (Named plaintiffs were not adequate representatives of class since attorneys' statement to them, that attorneys' policy was never to seek reimbursement where action was unsuccessful, created arrangement in violation of DR 5-103(B).); cf. Sayre v. Abraham Lincoln Fed. Savings & Loan Ass'n, 65 F.R.D. 379, 383-84 (E.D. Pa. 1974) (Citing DR 5-103(B), court indicated it could grant class action certification contingent on plaintiffs' posting bond to cover probable future expenses of suit.). This approach has been criticized by courts and commentators on grounds of impracticality. See Sayre, 65 F.R.D. at 385 (courts cannot condone a policy that would effectively limit class actions to wealthy plaintiffs, such as corporations, municipalities, and rich individuals); 3 H. NEWBERG, supra note 6, § 15.21, at 233; Coffee, supra note 28, at 897-98 ("[S]mall clients will never willingly assume contingent liability for their attorney's expenses."). Named plaintiffs are not permitted to charge absent class members for reimbursement of litigation expenses if the class suit is unsuccessful. 3 H. NEWBERG, supra note 6, § 14.02, at 185. Presumably, if named plaintiffs, as self-appointed champions of the class, are reluctant to be held liable for the litigation expenses of an entire class, they will be all the less willing to agree to pay interest thereon.

Theresa Coetzee

Page 23 of 34 54 Brooklyn L. Rev. 539, *571 Where a nonstatutory class action 127 is successful, fees are paid to the attorneys for the prevailing parties on an hourly basis at a rate calculated pursuant to a lodestar 128 formula from the common fund produced by the litigation. 129 Under the lodestar approach, a court engages in a two-step fee-setting process. 130 The first step is to establish the lodestar figure, by multiplying the number of hours worked by the attorney times the rate normally charged by attorneys of like skill. 131 The second step is to increase (or decrease) the lodestar amount by application of an appropriate multiplier, if any, 132 based upon such factors [*572] as the quality of counsel's work, the risk of the litigation, and the complexity of the issues involved. 133 None of the factors deemed relevant under

127

See id., § 14.01, at 184-85 (discussing statutory and nonstatutory sources of fee awards).

128 Lodestar"

is defined as "a star that leads or guides" or "someone or something that serves as a guiding star or as a focus of hope or attention." WEBSTER'S NEW INTERNATIONAL DICTIONARY 1329 (3d ed. unabr. 1981). 129

The Agent Orange court of appeals stated:

[T]he fees in this case were awarded pursuant to the equitable fund doctrine. . . . The underlying rationale for the doctrine is the belief that an attorney who creates a fund for the benefit of a class should receive reasonable compensation from the fund for his efforts. . . . Because the calculation of fees necessarily will affect the funds available to the class, the circuit has adopted a lodestar formula for fee computation. . . . The lodestar seeks to protect the interests of the class by tying fees to the "actual effort made by the attorney to benefit the class." In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 222 (citations omitted). See generally 3 H. NEWBERG, supra note 6, § 14.01-03, at 184-91, and Feinberg & Gomperts, 14 N.Y.U. REV. L. & SOC. CHANGE 613, 615-16 (1986) (discussing common or equitable fund doctrine); Annotation, Construction and Application of "Common Fund" Doctrine in Allocating Attorneys' Fees Among Multiple Attorneys Whose Efforts Were Unequal in Benefiting Multiple Claimants, 42 A.L.R. Fed. 134 (1979). 130

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1305.

131

Although the rate normally charged by attorneys is customarily defined with respect to the area or locality in which either the court sits or the attorney in question practices, the rate may, in limited circumstances, be defined nationally. See In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 231-34. 132

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1310 (application of an increasing multiplier is not mandatory).

133

See In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 222. In Hensley v. Eckerhart, 461 U.S. 424 (1983), a statutory fee action, the Supreme Court stated: The most useful starting point for determining the amount of a reasonable fee is the number of hours reasonably expended on the litigation multiplied by a reasonable hourly rate. . . . The product of reasonable hours times a reasonable rate does not end the inquiry. There remain other considerations that may lead the district court to adjust the fee upward or downward, including the important factor of the "results obtained." Id. at 433-34. In a footnote to the last sentence, the Court further stated: "The district court also may consider other factors identified in Johnson v. Georgia Highway Express, Inc., though it should note that many of these factors usually are subsumed within the initial calculation of hours reasonably expended at a reasonable hourly rate." Id. at 434 n.9 (citation omitted). The factors stated in Johnson are as follows: (1) The time and labor required; (2) The novelty and difficulty of the questions; (3) The skill requisite to perform the legal service properly; (4) The preclusion of other employment by the attorney due to the acceptance of the case; (5) The customary fee; (6) Whether the fee is fixed or contingent; (7) Time limitations imposed by the client or the circumstances;

Theresa Coetzee

Page 24 of 34 54 Brooklyn L. Rev. 539, *572 the lodestar approach directly probe the issue of whether the attorney has advanced large amounts of [*573] money needed to finance the litigation for substantial periods of time. 134 While expenses incurred by an attorney on behalf of a class are reimbursed under the common or equitable fund doctrine as an element of compensation separate from fees, 135 they typically are paid at a flat out-of-pocket rate. 136 No allowance is made, in the usual case, for the fact that advances have long been outstanding and have therefore given rise to an opportunity cost or borrowing cost. Attorney's fees cases arising under the common fund doctrine or pursuant to statute occasionally have attempted to compensate attorneys for the costs resulting from delayed reimbursement of fees in a variety of ways. 137 Some

(8) The amount involved and the result obtained; (9) The experience, reputation, and ability of the attorneys; (10) The "undesirability" of the case; (11) The nature and length of the professional relationship with the client; and (12) Awards in similar cases. Johnson v. Ga. Highway Express, Inc., 488 F.2d 714, 717-19 (5th Cir. 1974). In Blum v. Stenson, 465 U.S. 886 (1984), another statutory fee case, the Court amplified its decision in Hensley, holding that proof of neither novelty nor complexity could be used to enhance a fee, since such factors are fully reflected in the number of billable hours; that quality of representation may be used to justify an upward adjustment in the lodestar figure only in an exceptional case, since quality is normally taken into account in determining the reasonable hourly rate; and that the results factor may be used as an enhancing factor only where the evidence shows that the benefit achieved requires an upward adjustment. "[A] delay in payment could be subsumed under the heading of one of the . . . twelve [Johnson] factors such as: the customary fee, the time required, time limitations imposed by the client or other circumstances." Amico v. New Castle County, 654 F. Supp. 982, 1003 (D. Del. 1987) (citations omitted). See generally Leubsdorf, The Contingency Factor in Attorney Fee Awards, 90 YALE L.J. 473 (1981). Statutory fee awards and common fund fee awards are governed by many of the same factors. See 3 H. NEWBERG, supra note 6, § 14.03, at 186. Common fund actions frequently cite statutory fee precedent, see In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1308 (assuming applicability of statutory fee decisional law), but "may afford courts more leeway in enhancing the lodestar, given the absence of any legislative directive," In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 234 n.2. 134

See note 133 supra discussing Johnson factors. It is possible that a court might indirectly consider the amount and age of advanced expenses in assessing the risk factor, although there is little evidence that courts do so. Thus, some commentators have suggested, that "[t]he court should look at the costs and impact on the lawyers of undertaking the case on a contingency basis, inquiring into the extent to which it required significant resources to be allocated to the case." 7B C. WRIGHT, A. MILLER & K. KANE, FEDERAL PRACTICE AND PROCEDURE: CIVIL § 1803, at 527 (1986). 135

3 H. NEWBERG, supra note 6, § 14.01, 14.02, at 184-86 (discussing entitlement to fees and expenses).

136

See, e.g., City of Detroit v. Grinnell Corp., 575 F.2d 1009 (2d Cir. 1977), amending 560 F.2d 1093 (2d Cir. 1977) (disbursements were increased only by postjudgment interest). The Agent Orange decision is illustrative. See note 150 and accompanying text infra. 137

See generally Court Awarded Attorney Fees, Report of the Third Circuit Task Force, 108 F.R.D. 237, 265 (1985), which states: [T]o recognize the economic effects of a delay in receiving attorneys' fees, the court either may use a multiplier or may make an award to the attorney under the current scheduled hourly rate rather than the one in force when the work actually was done. An award of interest at an appropriate rate also could be employed to compensate for a delay in payment. Id. See generally Annotation, Allowance of Interest on Award of Attorney's Fee Under § 706(k) of Civil Rights Act of 1964 (42 USCS § 2000e-5k), 77 A.L.R. Fed. 272, 272 (1986) (describing various methods).

Theresa Coetzee

Page 25 of 34 54 Brooklyn L. Rev. 539, *573 have increased the hourly rate on which the lodestar figure is based; 138 others [*574] have augmented the multiplier figure (which is then applied to the lodestar figure) by a percentage large enough to fairly reflect the losses caused by the delay. 139 These cases, however, normally make adjustments in attorneys' fees only; expenses are still reimbursed on a straight dollar-for-dollar basis. 140

138

Among these courts are those which have held, for example, that where an attorney's billing rate has increased over the years during which litigation was pending, the attorney's work during the early years should be compensated at a rate above what he would have charged at that time. See Daly v. Hill, 790 F.2d 1071, 1081 (4th Cir. 1986) (In civil rights statutory fee action, trial court erred in adopting historic rates without considering effect of delay in payment on value of fee.); Laffey v. Northwest Airlines, Inc., 572 F. Supp. 354, 380-81 (D.D.C. 1983) (In statutory fee action arising from employment discrimination suit, court compensated hours at current rate to offset thirteen year delay in payment.), modified on other grounds, 746 F.2d 4 (D.C. Cir. 1984); Copper Liquor, Inc. v. Adolph Coors Co., 684 F.2d 1087, 1096 n.26 (5th Cir. 1982) (Stating in dicta in 15 U.S.C. section 15 case that prevalent practice of federal courts is now to use current rates to compensate for delay.); Edmonds v. United States, 658 F. Supp. 1126, 1146-47 (D. S.C. 1987) (In common fund action, award and payment of interim attorney fees, that were not fully compensatory, did not bar use of current pay rates to compensate for delay in payment when final fee award was made under lodestar method.); Hasbrouck v. Texaco, Inc., 631 F. Supp. 258, 262 (E.D. Wash. 1986) (In Clayton Action discrimination suit, rates from most recent six years were used to compute lodestar, where services were rendered six to ten years prior.). See also Gaines v. Dougherty County Bd. of Educ., 775 F.2d 1572 (11th Cir. 1985) (In fee action pursuant to civil rights statute, adequacy of compensation for delay could not be determined absent explanation of how delay was reflected in hourly rates.). 139

See Johnson v. University Coll. of the Univ. of Ala. in Birmingham, 706 F.2d 1205, 1211 (11th Cir. 1983) (In civil rights statutory fee action, lower court, on remand, had to adjust fee award to reflect delay, either through modifying contingency multiplier or compensating at current, not historical, rates.) Amico v. New Castle County, 654 F. Supp. 982, 1004 (D. Del. 1987) (In statutory fee action, delay of four years was compensated by .135 multiplier, which reflected "legal rate of interest" as defined by statute.); Brown v. Gillette Co., 536 F. Supp. 113, 123-24 (D. Mass. 1982) (In civil rights statutory fee action, percentage adjustment to reflect delay in payment is proper where historical rates are used.); Weiss v. Drew Nat'l Corp., 465 F. Supp. 548, 552 (S.D.N.Y. 1979) (Delay factor is "better left to the court's consideration of a contingency or 'risk factor' bonus, and . . . should not find presence in the calculation of the 'lodestar' figure itself."). In one of the Agent Orange opinions, Judge Weinstein wrote: The delay or opportunity cost factor, of course, could be considered in determining whether to award a multiplier. Nevertheless, so long as the rate of increase in the applicable hourly rate does not significantly differ from the costs of delay in payment, it does not make an appreciable difference whether the opportunity cost factor is taken into account at the lodestar or the multiplier stage of analysis. In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. 1296, 1310 (E.D.N.Y. 1985) (citations omitted). See also Laffey v. Northwest Airlines, Inc., 572 F. Supp. 354, 380-81 (D.D.C. 1983), modified on other grounds, 746 F.2d 4 (D.C. Cir. 1984) (dicta stating that, in statutory fee action, court may grant additional adjustment to lodestar if use of current billing rates only partially compensates for delay). 140

But see In re Fine Paper Antitrust Litig., 751 F.2d 562 (3d Cir. 1984). The court stated:

The attorneys are entitled to a share of the fund measured at the time it comes into existence, and the class members are entitled to the balance. When, as here, the fund is earning interest, the time value of the money is, to each party entitled to a share, equal to the interest earned on that share pending its distribution. Id. at 588. Because the attorneys' interests in the fund consisted of both fees and expenses, these statements appear to reject judicial recognition of attorney entitlement to prejudgment interest on expenses, at least from the time a settlement fund arises until it is distributed. See id. at 575-77. In remanding the case, the court held that the trial court erred in disregarding the delay of payment of compensation in calculating the lodestar contingency multiplier.

Theresa Coetzee

Page 26 of 34 54 Brooklyn L. Rev. 539, *574 [*575] In one Agent Orange opinion authored by Judge Weinstein nine days prior to the ruling on the fee allocation agreement, 141 there are expressions that can be read to suggest that the judge intended to compensate attorneys in the case for the lost time-value of money advanced to cover the expenses of litigation. The opinion states:

Much of the time and money expended by the attorneys was spent a year or more before the date of this judgment, although a very large portion was spent in the critical months prior to May 1984. Interest rates were generally high during this period. It would be reasonable to allow interest for the cost of this investment. In the instant case, however, this interest factor has been taken into account by using a flat per hour rate that reflects the cost of money. 142 More specifically, what the court elected to do was to compensate all hours worked on the case at the rates currently charged by attorneys at the time of the decision, rather than at the rates historically prevailing at the point in the litigation when the hours were invested. 143 This approach was, to a large extent, the product of judicial necessity. One hundred twenty-one attorneys submitted petitions for fees or expenses in the case, 144 and the resulting administrative blunder was so great that a special staff of new law graduates had to be hired to process the applications. 145 Had the court held that it was necessary to determine not only which of the entries on tens of thousands of pages of time records and expense receipts represented legitimate claims for reimbursement, 146 but also the rate prevailing at the time [*576] hours were worked and the exact sum due, the processing of claims would have been considerably more costly to the public and, undoubtedly, greatly delayed. 147 To say, however, that the path of claim analysis chosen by the district court was a fiat of necessity should not obscure the fact that, at best, this method compensates attorneys for the "interest" 148 cost of advancing expenses only on a hit-or-miss basis. This is so for several reasons, as Judge Weinstein implicitly acknowledged when he stated that "the entire process of fee fixing is so imprecise and has so many arbitrary and subjective aspects that pretensions of exactitude about any element leads to illusory accuracy." 149

141

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. 1296 (E.D.N.Y. 1985), aff'd in part and rev'd in part, 818 F.2d 226 (2d Cir. 1987). This appeal, which related to court awarded fees and expenses, was decided by the same panel of Second Circuit judges (Miner, Winter, and Van Graafeiland, JJ.), the same day as the appeal of the decision on the fee allocation agreement. Judge Miner wrote the opinion in this case also. 142

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1328 (citations omitted and emphasis added). "The hourly rate takes account of the cost of money only up to the time of judgment." Id. The court separately provided that attorneys were entitled to postjudgment interest on amounts awarded to them. Id. at 1328-29, 1346. 143

Id. at 1327-28.

144

Id. at 1318.

145

Id. at 1319 (three temporary assistant clerks worked full-time for more than three months on the fee and expense petitions).

146

See id. at 1308 ("tens of thousands of pages of supporting documentation"); id. at 1318-22 (detailing intricate guidelines and procedures followed in assessing legitimacy of claims). 147

The magnitude of the task of ferreting out reimburseable claims from those not meriting payment, even under the court's streamlined process, is suggested by the fact that the opinion and appendix in the Federal Supplement summarizing the compensation process runs a full one hundred pages, and expressly states that supporting computations may be found in two filled five-drawer, legal-sized file cabinets in the Clerk's office, which are an "unpublished exhibit" to the opinion. Id. at 1319.

148

The term "interest," as used within this Article, refers to either the amount of money that could be earned by investing a given sum, or to the financing charge incurred by borrowing that same sum, or to both, depending on the context.

149

Id. at 1310.

Theresa Coetzee

Page 27 of 34 54 Brooklyn L. Rev. 539, *576 First, there is no necessary relationship between the amount and age of outstanding advances and the number and age of reimbursable hours worked by an attorney. Thus, if an attorney advances a substantial sum for a long period of time, but proves entitlement to fees for relatively few hours, there will be little compensation for lost interest, if for no other reason than that the compensation for delay is wholly dependent on the number of hours worked. 150 Second, reimbursement of the opportunity cost or borrowing cost of advancing expenses may be inadequate, even where [*577] an attorney is entitled to fees for a large number of hours, if a large proportion of the hours are of recent vintage. Where that is the case, there will be only nominal excess compensation as a result of the court's use of current rather than historical billing rates, since the hours, even though large in number, will be compensated essentially at fair value. Theoretically, it would be possible for an inverse scenario -- a large number of the "old" hours and a small "recent" advance of expenses -- to produce windfall "interest" on the sums advanced, but this is unlikely in practice. Courts in common fund cases are especially cautious of overcompensating plaintiffs' attorneys because the expense of such compensation will not be taxed against the defendant, but instead carved from the fund that the plaintiffs have secured through trial or settlement. 151 Thus, in the Agent Orange litigation, Judge Weinstein took great pains to explain the court's obligation to protect the corpus of the fund, and to point out that fee decisions must be guided by "a philosophy of adequacy rather than generosity." 152 To the extent that this is the case, it is quite possible that even where current rather than historical rates of compensation are employed, the calculation will produce little or no excess compensation for the attorneys' services, and thus little or nothing to serve as interest on sums advanced. In addition, the excess compensation (if any) produced by the formula must reimburse attorneys not only for the borrowing cost or opportunity cost of advancing expenses, but also for the lost time-value of attorneys' fees, which in many cases will have gone unpaid for years. Consequently, the chances that the use of current hourly rates of compensation will produce a windfall of interest on advanced expenses are not great. [*578] The issue of underreimbursement of the cost of advancing expenses in mass tort litigation is a serious problem from a societal standpoint. The class action procedural device, by avoiding unnecessary multiplication of essentially similar actions, has substantial potential for fairly redressing the widespread harm defective products and technological disasters wreak on contemporary society. 153 Yet, as previously mentioned, in many instances,

150

The Mokotoff firm advanced $ 7,000 to the quondam Agent Orange management committee. Thus, the advance apparently was outstanding for at least a year and a half prior to the district court decision awarding fees and expenses. Because no support for hours was submitted, the firm was awarded a flat $ 7,000. Id. at 1336. Others who contributed more substantial sums to the first committee were also awarded as expenses the exact amount of their advance. One such firm (Levine & Grossman) collected $ 53,208 for an expense advance; any compensation for the delay in payment of this amount would have had to come from excess compensation derived from the payment of 1022.25 hours, with no multiplier, at current billing rates. Id. at 1334-35. Another attorney, Irving Like, was awarded expenses for a similar advance of $ 49,703, but received fees for 2932.84 hours, with a 1.5 multiplier. Id. at 1336. Assuming that Mr. Like's hours were as "old" or as "young" as the Levine & Grossman hours, it seems probable that he received a greater compensation for the time-value of his advance. 151

Fee awards under the equitable fund doctrine are proper only if courts act "with moderation and a jealous regard to the rights of those who are interested in the fund." Trustee of the Internal Improvement Fund v. Greenough, 105 U.S. 527, 536-37 (1881). Cf. Feinberg & Gomperts, supra note 129, at 616 ("[C]ourts must jealously protect the litigants' interest by insuring that overly generous fee awards do not deplete the common fund."). 152

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1305. See also In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 222 (quoting City of Detroit v. Grinnell Corp., 495 F.2d 448, 469 (2d Cir. 1974)) (Adherence to lodestar principles is "essential not only to avoid awarding windfall fees to counsel, but also to 'avoid every appearance of having done so.'"). But see Rosenberg, supra note 8, at 564 ("[A]fter deducting their attorneys' shares, the victims [of a mass tort] will receive a relatively small proportion of any recovery as compensation."). 153

See In re Corn Derivatives Antitrust Litig., 748 F.2d 157, 163 (3d Cir. 1984) (Adams, J., concurring) ("Class action litigation frequently promotes and protects the legal interests of those whose rights might not be protected at all without the class action device."); Rosenberg, The Causal Connection in Mass Exposure Cases: A "Public Law" Vision of the Tort System, 97 HARV. L.

Theresa Coetzee

Page 28 of 34 54 Brooklyn L. Rev. 539, *578 154 If class attorneys are huge amounts of money are the sine qua non of successful class litigation. undercompensated for the value of the money they advance for litigation expenses, then, as rational decisionmakers, they may refuse to make such advances or to participate in such cases because lack of financing diminishes the likelihood of success. 155 The result might then be a proliferation of smaller actions, carrying less financing risk for individual attorneys, but imposing a greater burden on the judicial system by compelling essentially redundant litigation. 156 Alternatively, attorneys might continue to willingly act as class attorneys but, because of lack of financing or fear of undercompensation [*579] of the cost of advancing expenses, might feel pressured to advocate court and class acceptance of premature, inadequate settlements. 157 In that case, the resulting risk of harm to the class is apparent. Under either scenario, there may be substantial harm to the public interest, as well as to the victims of mass torts.

One plausible means of minimizing the risk of undercompensation of the cost of advancing class action expenses is through an intracommittee fee allocation agreement, such as that unanimously entered into by the Agent Orange PMC members. Subject to proper restraints, this form of agreement could achieve two desirable objectives. First, it could act as a device for spreading the risk of undercompensation of the cost of advancing expenses between both investor and noninvestor attorneys. Second, it could serve an important symbiotic function in salvaging the fee interests of the attorneys of a "bankrupt" committee, while at the same time protecting the expense interests of "rescuer" attorneys -- those who provide a vital infusion of money into a stalled or moribund committee. 158 The first point is almost too obvious for comment. To the extent that one can widely spread a risk, the risk is less likely to cast a significant shadow on the decision-making process of anyone involved. In the mass tort context, this means that the pressure that the risk of undercompensation of the cost of advancing expenses might otherwise impose upon an investor-attorney to favor a premature settlement can be diffused and rendered less potent through a fee allocation agreement structured so as to diminish the pressure on any one attorney. The second point is only slightly more complex. Where a class action steering committee has run out of funds, and is in need of a cash infusion to support the expenses of litigation, the members of a "bankrupt" committee are

REV. 851, 908 (1984) ("Class treatment of mass exposure claims would enable plaintiff attorneys to achieve same economies of scale that defendants already enjoy."); id. at 910 ("Class actions would serve in several respects to increase the system's productivity in handling marketable mass exposure claims."); Weinstein, Preliminary Reflections on the Law's Reaction to Disasters, 11 COLUM. J. ENVTL. L. 1, 28 (1986) (class action is "useful" in bringing together many plaintiffs and defendants in single binding litigation.). 154

See note 28 and accompanying text supra. See also Dowdell v. City of Apopka, 698 F.2d 1181, 1190 (11th Cir. 1983) (In civil rights litigation, complexity of issues "frequently makes . . . sizeable out-of-pocket expenditures . . . as essential to success as the intellectual skills of the attorneys."). 155

See In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1303 (In complex class actions, "substantial legal fees must be provided when a substantial fund is created if attorneys are to be induced to prosecute these actions."); Feinberg & Gomperts, supra note 129, at 616 ("Unless courts are willing to grant reasonable fees from the common fund, many plaintiffs with meritorious and socially desirable claims will go unrepresented."); see also Rosenberg, supra note 153, at 889-90 ("A claim cannot gain access to the system unless it is marketable to a plaintiff attorney. If the attorney is operating on a contingent fee basis, the claim must provide an expected return on the attorney's investment of time and money that exceeds the attorney's opportunity costs."). 156

See id. at 900 ("Besides squandering the system's resources, the duplicative adjudication of common questions generally places mass exposure claims at a competitive disadvantage in the claims market and deprives the system of their deterrence value."); id. at 902 (case to case resolution of mass exposure claims is excessively costly).

157

Coffee, supra note 90, at 57 (If the "costs [of litigation] exceed the financial resources of the plaintiff's team, the result is enhanced pressure to settle early and for a far lesser amount than they could obtain if they could secure additional financing."). 158

Cf. id. at 60 (large scale litigation requires internal fee sharing); id. at 60 n.180 (Agent Orange committee was "effectively bankrupt" when reconstituted).

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Page 29 of 34 54 Brooklyn L. Rev. 539, *579 normally in jeopardy of being denied all compensation for the work they have put into the case. 159 Compensation of these attorneys, whether under a [*580] contingent fee agreement with named plaintiffs or under the common fund doctrine, is dependent upon success. Their jeopardized fee interests may, however, be "rescued" if investorattorneys can be attracted to join the committee. 160 One way to make such entry more enticing to potential "rescuers" is, of course, to minimize the risks (including the risk of undercompensation of the costs of advancing expenses) to which the new investors will be exposed. Put differently, the money that new investor-attorneys can bring to the class action has a value to members of a bankrupt committee. It may be mutually advantageous for present committee members to guarantee new investor-attorneys interest on funds they advance. Since each of the foregoing justifications for permitting attorneys to enter into a fee allocation agreement is linked to the issue of undercompensation of the time-value of money, neither can support an arrangement structured so as to provide an investor-attorney with excessive compensation for funds invested in the case. Under normal circumstances, the upper limit of any multiplier contained in a fee redistribution agreement and applicable to priority reimbursement of expenses would seem to be set by conventional market standards. It might, for example, be appropriate to define the multiplier by reference to the return earned by an established money market fund or by certain publicly traded stocks, since this is precisely the type of readily available return an investor-attorney forgoes by allowing his money to be tied up in litigation. An agreement, of course, might provide that such a rate of return would be reduced by a percentage reflecting the committee members' prospective assessment of the extent to which an investor-attorney's cost of financing the litigation is likely to be compensated by the court. This is so because the reason for permitting such agreements is not to ensure exact reimbursement of the attorney's cost of financing or to wholly eliminate all aleatory risks, but simply to minimize those perceptions that would cause underfunding of mass tort class actions or precipitate premature settlement. To the extent that reimbursement of the cost of financing is anticipated [*581] by the attorneys involved, risks of underfunding or premature settlement do not exist, and, thus, are unlikely to exert a debilitating influence on the course of the litigation. To the extent that an intracommittee agreement guarantees an investor-attorney interest on advanced expenses at a rate greater than that which could be earned on a conventional investment or would be charged on a loan on the open market, the agreement would appear to lack justification, for presumably a sum equal to the advance could be obtained from other individuals or institutions less expensively. 161 On the one hand, the excess interest provision would give the investor attorney a greater stake in the litigation than is necessary to offset the risk of undercompensation of the cost of advancing expenses. Thus, it would risk unnecessarily distorting the investorattorney's exercise of professional judgment on behalf of the class. On the other hand, a provision allowing for excessive interest compensation would pose an unwarranted threat to the right of noninvestor attorneys to

159

See id. at 60 (prior to PMC agreement, Agent Orange committee stood to lose compensation for time already expended).

160

Cf id. at 61 ("[B]ecause banks and other institutional creditors are unwilling today to appraise the value of a contingent interest in pending litigation, it seems undesirable to discourage other attorneys, who are the one group who can evaluate such a contingent asset, from undertaking the role of financing the litigation."). 161

This assumes that at least some of the committee attorneys or their firms are creditworthy. Where that is not the case, a difficult question may arise as to whether the present committee members should be permitted to pay "above-market" interest (by conveying a right to part of their prospective fees) to new investor-attorneys in a presumably desperate effort to salvage the value of the time and work they have invested in the case. Professor Coffee opines that they should. See id. at 61. However, the dilemma may be more fictitious than real. It is well-known that attorneys compete fiercely to obtain positions on management committees in mass tort litigations. See Bell, Our Man in Bhopal, SAN ANTONIO MONTHLY, Oct. 1985, at 98 (After the mass disaster in Bhopal, India, "jockeying for position among the U.S. attorneys was fierce . . . each wanting a leadership role and a big chunk of the fame and fortune that could result.").

If no attorneys are willing to become associated with and provide financial support to a stalled committee, it seems likely that the action lacks merit and should not be further pursued. That possibility, coupled with the risk that an "above-market" interest agreement will distort noninvestor attorneys' exercise of independent professional judgment on behalf of the class, seems to argue against upholding such terms. See notes 90-93 supra.

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Page 30 of 34 54 Brooklyn L. Rev. 539, *581 adequate compensation for time they spend on the case. 162 To that extent, the agreement could adversely influence the decisionmaking of noninvestor attorneys on matters affecting the class. It might be argued that an intra-committee agreement providing for interest on advanced expenses at a rate greater than [*582] defined by market forces is justified on the ground that, unlike many forms of commercial investment (such as, for example, federally insured certificates of deposit), an attorney who invests in a mass tort class action places both interest and principal at risk. On close inspection, however, this contention should be rejected. To begin with, an investor attorney always has the option 163 -- and, indeed, may be required by local law 164 -- to contract with the named plaintiffs in a class action for reimbursement of expenses, even where the suit is ultimately unsuccessful. While there is some doubt as to whether attorneys in fact seek repayment from clients under such terms when an action fails, 165 the availability of this avenue of redress minimizes the investor-attorney's risk of loss of principal. More importantly, the public interest is not advanced by encouraging attorneys to invest in dubious class actions. 166 The attorney's guarantee of a return of the principal invested in litigation expenses should be the fact that the attorney has determined that the cause of action is sound. If he has so determined, then his conduct likely will be largely unaffected by the risk of loss of principal. And if he doubts the soundness of the litigation, then the interests of the public are best served by a rule that does not cloud that assessment by making investment in the suit unwarrantedly tempting. Finally, if an investor-attorney is determined to guard against the loss of principal, there is nothing to bar him from contracting with a noninvestor class attorney to guarantee dollar-for-dollar reimbursement of the amount advanced. Such an agreement would merely shift the loss of principal from one attorney to another. There is no rule mandating that the risk of [*583] loss of principal must be borne by any given lawyer. 167 A straight guarantee of repayment of the principal of an advance would place the guarantor-attorney in essentially the same position as if he had taken out a commercial loan to finance the litigation, which of course would be permissible. Such a guarantee of principal is wholly distinguishable from an agreement providing, as in the Agent Orange case, for a multiple return of one's investment if litigation is successful and for zero reimbursement if the suit is unsuccessful.

162

The Second Circuit found that the Agent Orange PMC agreement, "by tying the fee to be received by individual PMC members to the amounts each advanced for expenses, completely distorted the lodestar approach to fee awards." In re "Agent Orange" Prod. Liab. Litig., 818 F.2d 210, 222 (2d Cir. 1987).

163

See note 116 supra.

164

See In re Mid-Atlantic Toyota Antitrust Litig., 93 F.R.D. 485 (D. Md. 1982) (class certification denied), discussed in Coffee, supra note 28, at 897-98; see also MODEL CODE OF PROFESSIONAL RESPONSIBILITY DR 5-103(B) (1980) (Client must remain "ultimately liable" for repayment of advanced expenses.). 165

See 1 G. HAZARD & W. HODES, supra note 1, at 165 (Even under 1969 Code, "it is doubtful that in practice many lawyers insisted upon repayment of court costs when a case was lost, for usually the lawyer had advanced the costs only because the client could not afford to do so."); Coffee, supra note 28, at 897 (practice of not seeking reimbursement of expenses in unsuccessful antitrust litigation "appears to be standard"). See also Telephone interview with Dallas tort practitioner Steven Malouf, Esq. (Feb. 18, 1988) (describing customary practice of some personal injury lawyers).

166

Cf. Feinberg & Gomperts, supra note 129, at 617 ("Courts cannot be so generous as to induce attorneys to file unmeritorious claims in hopes of achieving settlements and large fee awards.").

167

Cf. Coffee, supra note 28, at 901. Professor Coffee states:

[W]hy should legal ethics prohibit one group of attorneys from occupying creditor or investor relationships with respect to another group of attorneys who actually handle the litigation of a class action? From an efficiency perspective, such a relationship promises mutual gains from exchange. Both groups thereby can diversify their portfolios, and the creditor attorneys could, in theory, lend at lower cost because they, as fellow specialists, can monitor their debtors more effectively and at a lower cost. Id.

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Page 31 of 34 54 Brooklyn L. Rev. 539, *583 As the Agent Orange district court 168 and the Second Circuit 169 both agreed, a court may require prompt disclosure of a fee allocation agreement. Such revelation permits the courts to guard against conflicts of interest by scrutinizing whether the agreement does more than fairly minimize the risk of loss of interest on advanced expenses. It also "avoids the danger of retroactive surprise that might chill the willingness of creditor attorneys to finance contingent fee litigation." 170 Where an agreement, viewed prospectively, 171 provides for priority reimbursement of the time-value of monetary advances at a rate less than the anticipated return on conventional forms of investment or the interest rate charged on standard loans, ordinarily it should be approved. In contrast, where the agreement provides for priority payment of interest on advanced expenses at rates greater than those set by the standards just described, the agreement should normally be struck down or reshaped with the assistance of counsel. 172 In cases where such provisions are permitted [*584] to stand, there would appear to be no reason for the court to modify its postjudgment procedures for awarding fees and expenses -- for example, by purging the calculations of any allowance for the costs of delayed reimbursement. Delay still should be compensated by the court (unless solely attributable to the attorney in question 173 ); an intracommittee agreement merely guards investors against the possibility that the court will not do so -- which is a wholly different issue. 174 -- as few do -- to compensate for delay by providing in a pretrial case If a court exercises its power 175 management order that interest at a reasonable rate shall accrue on advanced expenses from the time the advances are made, there would seem to be little reason for a court to permit class counsel to structure their own agreement, containing different terms, to deal with the risk of delay. A possible exception is where the attorney can demonstrate that the litigation is being funded with commercially borrowed money and that the financing charge incurred thereon substantially exceeds the rate of interest awarded by the court. Moreover, if named plaintiffs have agreed to make whole or partial periodic repayments of advanced expenses to committee attorneys, 176 or if the court plans to award interim expenses, 177 this logically may be taken into account in determining whether and to what extent a fee allocation agreement may be justified.

In reviewing the PMC fee allocation agreement in the Agent Orange litigation, the decisions of both the district court and the Second Circuit fall somewhat wide of the desired mark. The district court was too willing to indulge creative

168

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. 1452, 1462-63 (E.D.N.Y. 1985).

169

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d 216, 226 (2d Cir. 1987).

170

Coffee, supra note 90, at 60.

171

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 224 (test to be applied is whether, at time fee sharing agreement is reached, class counsel are placed in position that might endanger fair representation of class). 172

Id. at 226 (suggesting court can deal with conflict of interest by disapproving or reshaping agreement).

173

Amico v. New Castle County, 654 F. Supp. 982, 1003 (D. Del. 1987) (recognizing option to deny compensation for delay solely due to attorney). 174

Court Awarded Attorney Fees, Report of the Third Circuit Task Force, 108 F.R.D. 237, 265 (1985) ("An award of interest at an appropriate rate also could be employed to compensate for a delay in payment."). 175

MANUAL, supra note 6, § 41.32, at 374 (sample case management order on expenses, not containing interest provision).

176

Cf. Cook v. Block, 609 F. Supp. 1036, 1044 (D.D.C. 1985) (slightly over two years delay in payment of attorney who successfully represented employees in employment discrimination action did not warrant upward adjustment in fees awarded pursuant to statute where attorney was paid at reduced rate by employees as litigation progressed). 177

A court may, under special circumstances, award interim fees and expenses, subject to reevaluation at the conclusion of the litigation. MANUAL, supra note 6, § 24.13, at 184.

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Page 32 of 34 54 Brooklyn L. Rev. 539, *584 financing, and the [*585] Second Circuit was too reticent to fully consider whether such novel arrangements can serve a useful purpose in mass tort class actions. The PMC agreement, by providing for a 300 percent return of advanced funds, surely ran afoul of the principles outlined above. The "interest" it awarded to investor-attorneys was wholly unrelated either to the length of time the funds would be held or to the opportunity cost or borrowing cost incurred by the investors, as defined by market forces. Under the terms of the agreement, the "interest" earned by investor-attorneys on sums advanced for expenses would be the same regardless of whether one month or ten years had elapsed between the date of advance and the reimbursement of fees and expenses by the court. 178 As such, the agreement had a clear tendency, depending upon the "age" of the advance, the rate of inflation, and other market factors, to either confer on investor-attorneys an unjustifiably large stake in the litigation or to deprive those same attorneys of adequate protection against the risk of under-compensation of the cost of making the advance. There is broad comminatory language in the opinion of the Second Circuit suggesting that under no circumstances will innovative fee allocation agreements be held valid in the Second Circuit. Thus, Judge Miner wrote: There is authority for a court, under certain circumstances, to award a lump sum fee to class counsel in an equitable fund action under the lodestar approach and then to permit counsel to divide this lodestar-based fee among themselves under the terms of a private fee sharing agreement. We reject this authority, however, to the extent it allows counsel to divide the award among themselves in any manner they deem satisfactory under a private fee sharing agreement. . . . A careful examination of those decisions permitting internal fee sharing agreements to govern the distribution of fees reveals no case where return on investment was a factor. . . . In our view, fees that include a return on investment present the clear potential for a conflict of interest between class counsel and those they have undertaken to represent. 179 [*586] Yet, the court did not entirely rule out the possibility that such an agreement, if carefully drawn, might pass muster. Judge Miner further wrote:

[A]ny [fee allocation] agreement must comport essentially with those [lodestar] principles of fee distribution. . . . This does not mean that a fee sharing agreement must replicate the individual awards made to PMC members under the district court's lodestar analysis. Even after the court makes the allocation, the attorneys may be in a better position to judge the relative input of their brethren and the value of their services to the class. . . . [T]he needs of large class litigation may at times require class counsel, in assessing the relative value of an individual attorney's contribution, to turn to factors more subjective than a mere hourly analysis. It does mean that the distribution of fees must bear some relationship to the services rendered. 180 Depending upon which threads in the court's language one focuses, it is possible to construct an argument supporting or opposing an agreement that incorporates market-rate interest provisions. Such an agreement might satisfy the standards calling for assessment of the "individual attorney's contribution" to the case and for "some relationship" between fees received and services rendered. Any reduction in the compensation of a noninvestor attorney arguably could be viewed as an insubstantial variance from the general rule of basing compensation on services and as a legitimate reflection of the value to noninvestors of investor-attorney's financial support of the case. Conversely, if one reads the court's language as merely permitting a reassessment of the value of "services

178

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 1460 ("[A]n agreement of this kind may create an incentive toward early settlement. . . . An attorney who is promised a multiple of funds advanced will receive the same whether the case is settled today or five years from now."). 179

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 223-24 (citations omitted).

180

Id. at 223.

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Page 33 of 34 54 Brooklyn L. Rev. 539, *586 to the class," and then defines "services" to include only hours worked and not funds advanced, 181 then it is possible to arrive at a wholly different result. Undoubtedly, future cases will provide guidance as to how the above language should be read. At a minimum, it seems that the court did not totally foreclose the possibility that some agreements could be found acceptable. Indeed, in striking down the PMC agreement, Judge Miner expressly noted, "[w]e sympathize with counsel regarding the business decisions they must [*587] make in operating an efficient and manageable practice and agree that a certain flexibility on the court's part is essential." 182 The type of fee allocation agreement most likely to pass scrutiny is one that links the payment of interest on advanced expenses to a reasonable market standard, and that preserves, as far as possible, the correlation between the fee received and the work performed. Among other things, an agreement in conformance with these limitations will minimize the risk of public misunderstanding as to the interests of class counsel. 183 Judge Miner was rightfully concerned as to how the Agent Orange agreement, which awarded one attorney twelve times the court-determined value of his services, would be perceived by class members and others in view of the fact that many believed that the $ 180 million settlement did not adequately compensate individual veterans and their families. 184 The initial version of the Agent Orange PMC agreement provided that, after advanced funds were compensated three-fold, the remainder would be dispersed 50 percent in equal shares to PMC members, 30 percent in proportion to hours worked, and 20 percent based on factors similar to those taken into account by the court in setting fee award multipliers. When the court expressed doubt as to the propriety of this arrangement, the PMC members renegotiated the pact to provide that after advanced funds were reimbursed three hundred percent, all amounts would be divided among the participating firms in proportion to the awards made by the court under the lodestar formula. There seems little doubt that provisions similar to those in the quondam agreement permitting pro rata disbursement of some portion of the total fee would be held invalid in the Second Circuit. Such a division is based solely on head count and is unrelated to services performed. [*588] VI. CONCLUSION: NEWTON'S LEGACY

The PMC fee allocation agreement in the Agent Orange litigation presented difficult questions as to how far a courtappointed steering committee may go in shaping the redistribution of court-awarded fees. As other tribunals are confronted with similar problems, they will find useful analysis in the Agent Orange opinions to guide future deliberations -- though there are reasons to seriously question the result reached in the Second Circuit. Indeed a close reading of the opinions suggests that Second Circuit courts might arrive at a different conclusion if faced with a similar, but differently tailored, fee allocation arrangement. As courts attempt to chart the ethical contours of the terrain of mass tort class actions, it is ever important for them to bear in mind the special nature of this field of litigation and of the sometimes-vulnerable structures that have been erected within its bounds. Undoubtedly, the recurring theme of future cases will be to what extent ethical norms fitted to the commonplace are capable of regulating and guiding professional conduct in a world where

181

Such an argument might be difficult to defend in view of the fact that in mass tort class actions, as in civil rights litigation, the complex and protected nature of the process "frequently makes . . . sizeable out-of-pocket expenditures . . . as essential to success as the intellectual skills of the attorneys." Dowdell v. City of Apopka, 698 F.2d 1181, 1190 (11th Cir. 1983). 182

In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 225.

183

See MODEL CODE OF PROFESSIONAL RESPONSIBILITY Canon 9 (1980) ("A lawyer should avoid even the appearance of professional impropriety."); In re "Agent Orange" Prod. Liab. Litig., 818 F.2d at 225 ("[P]otential conflicts of interest in class contexts are not examined solely for the actual abuse they may cause, but also for potential public misunderstandings they may cultivate."). 184

In re "Agent Orange" Prod. Liab. Litig., 611 F. Supp. at 225; see also Feinberg & Gomperts, supra note 129, at 616-17 (Lucrative fee awards support the general perception that "[a] lawsuit is a fruit tree planted in a lawyer's garden.") (quoting Illinois v. Harper & Row Publishers, Inc., 55 F.R.D. 221, 224 (N.D. Ill. 1972)).

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Page 34 of 34 54 Brooklyn L. Rev. 539, *588 lawyers, clients, expenses, and time are all counted with large numbers. The issue is one of whether "legal rules that perform fairly well in commonplace settings . . ., like Newton's laws of physics, lose their ordering power under extraordinary circumstances." 185 Copyright (c) 1988 Brooklyn Law School Brooklyn Law Review

End of Document

185

Rosenberg, supra note 153, at 924-25.

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ARTICLE: A COMPARATIVE LEGAL AND ECONOMIC APPROACH TO THIRDPARTY LITIGATION FUNDING Spring, 2011 Reporter 19 Cardozo J. Int'l & Comp. L. 343

Length: 31403 words Author: Marco de Morpurgo* * Associate, Covington & Burling; Ph.D. candidate (Milan); LL.M. (Harvard); M.Sc. (IUC Turin). Thanks to Professors Steve Shavell, Anthony J. Sebok, Mauro Bussani, David Wilkins, Mitt Regan, Ugo Mattei, Duncan Kennedy.

LexisNexis Summary … Litigation "Loans" A market that presents very close similarities and connections to TPLF, particularly welldeveloped in the United States, is one in which private companies provide "litigation loans" to (needy) plaintiffs for covering their expenses (mainly living and medical) pending the outcome of a lawsuit, on a non-recourse basis, in exchange for a share of the proceeds of any settlement or judgment recovered (only in case a favorable outcome of the pending case results). … On one end of the spectrum, TPLF supporters argue that the industry is beneficial on the grounds of access to justice, playing an equalizing function - "leveling the playing field" - between plaintiffs and defendants, providing the former, who is typically weaker, with the resources necessary to face typically wealthy and powerful defendants. … Now consider the following table, which shows the expected payoffs of alternative scenarios (with and without TPLF) for the funder and the plaintiff respectively: Funder Plaintiff No TPLF E( pi ) = 0 E( pi ) = lambda R - (1 - lambda ) C Yes TPLF E( pi )' = lambda sigma R E( pi )' = lambda R (1 - (1 - lambda ) C sigma ) Because both the funder and the plaintiff will only be willing to contract if their respective E( pi )' > E( pi ), then the following can be said with respect to their willingness to contract: Funder iff Plaintiff iff lambda sigma R - (1 lambda R (1 - sigma ) > lambda R - lambda ) C > 0 - (1 - lambda ) C Or, lambda sigma R - C + lambda R - lambda R sigma > lambda R lambda C > 0 - C + lambda C (.6) sigma R - 40,000 + - lambda R sigma > - C + 24,000 > 0 lambda C (.6) sigma R - 16,000 - (.6) R sigma > - 16,000 > 0 (.6) sigma R > 16,000 (.6) R sigma ) and (C + C ), and, on the other, the private and social benefits of litigation, respectively lambda R, and the external effect on the behavior of potential defendants generally. … Conversely, the new position of United Kingdom courts is that no prohibition on maintenance and champerty applies, with the exception of the case of wanton and officious intermeddling and the case of trafficking in legal claims, which are often intertwined. … Germany TPLF in Germany operates in the framework of the following context: as a rule, legal costs are borne by the losing party (or apportioned between the parties); costs are often high, are fixed by law and include court fees and attorney fees; additional costs particular to a case, including witnesses and expert reports, may arise for the means of proof. … Third-party litigation funding - one of the most innovative trends in civil litigation financing today - is based on the existence of gains from trade in property rights in litigation, and permits claimholders to eliminate the risk connected to litigation.

Highlight Abstract This article represents the first attempt to apply a comparative legal and economic approach to the study of thirdparty litigation funding (TPLF) - one of the most innovative trends in civil litigation financing today. TPLF consists of the practice where a third party offers financial support to a claimant in order to cover his litigation expenses, in return for a share of damages if the claim is successful. The third party receives no compensation if the claimant Theresa Coetzee

Page 2 of 43 19 Cardozo J. Int'l & Comp. L. 343, *343 loses the suit. While such practice has been rapidly developing in the common law world (Australia, United States, and United Kingdom), in the civil law world its existence is very limited (Germany, Austria, and Switzerland). On both sides of the Ocean, a heated debate is dividing supporters and critics of TPLF, regarding its legality and desirability. Notwithstanding, the scholarly attention to TPLF has been unsatisfactory as it is too domestically oriented and scarce when compared to the long-term potential consequences of this innovative practice - only one among a series of trends based on interactions between the civil justice system and the world of finance. TPLF represents for the claimholder the possibility to deal with the costs and eliminate the risks of litigation, maximizing the expected value of his claim by bargaining with an investor over "property rights in litigation." From the economic analysis derives the conclusion that TPLF is efficient and increases access to justice, though some externality problems might exist. From the legal analysis emerges the fact that common problems and judicial orientations exist in all jurisdictions where TPLF has developed, particularly as far as the issue of control over the litigation is concerned. Finally, this Article opens to a reflection on why TPLF has not developed in the civil law world as it has in the common law and advances some hypotheses on future developments of the industry.

Text [*345]

I. Introduction New trends in civil litigation financing are transforming the way in which we conceive the civil justice system. If, on the one hand, academic and political discourses directly concerning the substance of legal rights are of fundamental importance, equally significant are the discourses about how those rights are then to be enforced in practice. Litigation is an expensive process and its costs are often prohibitive. Hence, questions on the ways in which people and other economic actors can finance litigation to obtain the fulfillment of their rights are perhaps as important as the questions on the content of those rights themselves. The traditional view of the litigation process - at least in the Western legal tradition 1 - contemplates the opposition of two parties, plaintiff and defendant, each assisted by respective lawyers, in front of an adjudicating authority. In the traditional view, the resources for financing the litigation come from the parties' personal assets or - in some jurisdictions - from their lawyers' assets. Recent trends in civil litigation financing are breaking from the traditional way of looking at the litigation process. Increasingly, interrelationships between the civil justice system [*346] and the world of finance are acquiring importance, making financial investors and capital markets play a fundamental role in (directly or indirectly) sustaining litigant parties when interacting with the civil justice system. On the one hand, a trend is taking place according to which third parties invest in litigation providing capital to plaintiffs and/or their lawyers. On the other hand, another tendency sees law firms - traditionally organized as partnerships and poorly capitalized - devise new solutions to raise capital, e.g., through private placements 2 or public offerings. 3

1

This includes both the Roman and the common law traditions. See Diego E. Lopez Medina, Teoria Impura del Derecho: la Transformacion de la Cultura Juridica Latinoamericana 12 (3d ed. 2004). 2

Dewey & LeBoeuf LLP - a New York-based, 1,200-attorney law firm - raised $ 125 million in a bond offering in April 2010. Carlyn Kolker, Dewey & LeBoeuf Issues Bonds to Refinance Debt, as Law Firms Seek Capital, Bloomberg, Apr. 17, 2010, http://www.bloomberg.com/news/2010-04-16/dewey-leboeuf-sells-125-million-of-debt-as-law-firms-search-for-capital.html. 3

An Australian law firm, Slater & Gordon, held the world's first I.P.O. for a law firm in May 2007. Anthony Notaras, Law firms: to list or not to list?, International Bar Association, http://www.ibanet.org/Article/Detail.aspx?ArticleUid=e2d1bfa3-e5c7-49e5-8e4f7171c31c119e (last visited Apr. 8, 2011).

Theresa Coetzee

Page 3 of 43 19 Cardozo J. Int'l & Comp. L. 343, *346 As the legal system becomes increasingly more expensive, particularly in certain sectors, the long-existing problem of litigation costs often prevents claimholders from using the civil justice system to enforce their rights. Throughout history, the mechanisms created to obviate the problem of litigation costs have been varied. These mechanisms have essentially responded to two types of concerns. First, in the "personal sphere" realm, exists the problem of access to justice: those who cannot afford to bear litigation costs cannot turn to the civil justice system in order to defend a right. Second, in the commercial realm, the financial risks connected to litigation are inevitable and highly problematic: claimholders have to deal with the risk of losing when they decide to bring a case to court. As far as access to justice is concerned, various attempts have been made in the direction of increasing access to the law and to the legal system. A significant historical parenthesis is represented by governments' efforts to increase access to justice through providing free legal assistance to the poor (legal aid). Legal aid has been criticized for being costly, inefficient, and arbitrary, and has come under attack at the end of the twentieth century. Recently, governments have cut public spending on legal aid. 4 The market has responded to those cuts in a way that shows its potential to acquire a new role in promoting solutions that are [*347] beneficial in terms of increasing access to justice. As far as the financial risk connected to litigation is concerned, turning to the civil justice system for the enforcement of a legal right is a risky investment, as starting a lawsuit requires substantial disbursements that not everyone is willing to undertake. Litigation is inevitably part of any business activity and, therefore, for any business litigation cost risks exist. In general, virtually all risks connected to a business activity can be eliminated or spread through the market, but that does not hold true for the risk of litigation, which traditionally cannot be transferred to whom is better able to bear it. 5 It is in light of this scenario that alternative methods for litigation risk distribution have developed. From the "traditional" systems for risk sharing, like the U.S. contingency fees or litigation expenses insurance, more innovative systems have recently emerged. 6 Those are private and market-based systems for spreading litigation risk, and are based on a conception of the claim as an object of "property rights" - in an economic sense - which can be bargained for, thereby, favoring an efficient allocation of risk. Among the most innovative systems for financing civil litigation is the after-the-event third-party investment in litigation, a practice that contemplates third parties - with no previous connection to a claimholder - investing in a claimholder's litigation, covering all his litigation costs in exchange for a share of any proceeds if the suit is successful, or, in the alternative, nothing if the case is lost. This practice, which this article refers to as "third-party litigation funding" (TPLF), emerged in the mid-1990s, and has been developing in both the common law world and to a limited extent - in the civil law world. Until recently, the scholarly interest in TPLF - and, more generally, in alternative ways to finance civil litigation has been scarce, and certainly not proportionate to the long-term potential consequences that the establishment of these innovative practices might produce both on the legal system 7 and on the way in which we conceive the civil justice system. [*348] The scholarly attention that TPLF has received has been unsatisfactory, as it is too sector-based - failing to draw the "big picture" of changes that have been taking place in civil litigation financing - and too domestically oriented - failing to show recent transformations as part of broader transnational trends. As a result, existing scholarship has been unable to show, in broad terms, what changes are taking place and toward which direction we are moving in a global, comprehensive, and comparative perspective. In today's world, looking at economic and legal phenomena exclusively from inside the box of national borders is no longer satisfactory. It also no longer

4

Ugo Mattei, Access to Justice. A Renewed Global Issue? 11.3 Electronic J. Comp. L. 1, 2-4 (2007).

5

Jonathan T. Molot, A Market in Litigation Risk, 76 U. Chi. L. Rev. 367, 368-378 (2009).

6

See infra Section II.B.

7

On the influences that differences in rules governing the costs of litigation have on the development of substantive law, see J. Robert S. Prichard, A Systemic Approach to Comparative Law: The Effect of Cost, Fee, and Financing Rules on the Development of the Substantive Law, 17 J. Legal Stud. 451 (1988).

Theresa Coetzee

Page 4 of 43 19 Cardozo J. Int'l & Comp. L. 343, *348 makes sense to limit the examination to a disciplinarily isolated process. This article represents the first attempt to apply a comparative legal and economic approach 8 to the study of third-party litigation funding. This practice is to be considered as one specific epiphany of a broader trend toward the enhancement of the interrelationships between the civil justice system (composed of its protagonist parties and institutions) and the world of finance, although in this article it is conceptually isolated from other similar practices for purposes of analysis. These interactions - as it is argued in this article - are in part founded on a conception of the lawsuit as the object of "property rights" which can be the object of bargaining between claimholders and investors. Section II of the article exposes a theory of the lawsuit as the object of property rights and provides a survey of the private and market-based solutions for financing civil litigation that has developed. Section III defines TPLF as it is considered in this article, outlines the emergence of the industry, and summarizes the debate that has arisen concerning the permissibility and desirability of TPLF. Section IV offers an economic analysis of TPLF, explaining its functionality via an analysis of the incentives it creates for parties involved in the TPLF agreement (the plaintiff and the funder). It draws a basic economic model and discusses its lessons, explaining why the parties come into contract and identifying the externality problems that TPLF creates. Section V offers a comparative analysis of the legal status of TPLF in the main jurisdictions where it has developed, and opens to a examination of the reasons for why it has not developed - with few [*349] exceptions - in the civil law world. Section VI concludes. II. Financing Civil Litigation A. Property Rights in Litigation In the law and economics literature on property law, 9 consideration is given to how alternative "bundles of rights" create incentives to use resources efficiently. 10 Property is not understood as a monolithic institution, but rather as a multifaceted right that describes what people may and may do with the resources they own. Modern law permits forms of property that were unthought of in the past, being the evolution of property law based on increasing opportunities of wealth creation. 11 Often a new form of property is created in order to take advantage of a previously unseen market opportunity. 12 The law sometimes reacts to such innovations by imposing limitations on what can be transferred as property. This usually happens when such innovations are considered undesirable. In particular, private law imposes limitations on the right to transfer, which is inherent to property, by denying contract enforcement and/or the protection that, in principle, is afforded to "entitlements" through injunction or money judgments. 13 In addition, the legal system uses regulation as a means to correct market failures. 14

8

On the benefits derived from the interaction between the two "strongest nonpositivistic approaches to legal analysis," namely comparative law and law and economics, see Ugo Mattei, Comparative Law and Economics ix. (1997).

9

See Robert Cooter & Thomas Ulen, Law & Economics 74-118 (5th ed. 2008); Steven Shavell, Foundations of Economic Analysis of Law 7-176 (2004).

10

Cooter & Ulen, supra note 9, at 78.

11

Anthony J. Sebok, The Inauthentic Claim, 64 Vand. L. Rev. 61, 63-67 (2011).

12

Id.

13

Guido Calabresi & A. Douglas Melamed, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, 85 Harv. L. Rev. 1089, 1090 (1972).

14

See generally Samuel Bowles, Microeconomics: Behavior, Institutions and Evolution (2004); 1 Alfred E. Kahn, The Economics of Regulation: Principles and Institutions (1988); John O. Ledyard, Market Failure, in The New Palgrave Dictionary of Economics (S.N. Durlauf & L.E. Blume eds., 2d ed. 2008); Kenneth J. Arrow & Gerard Debreu, Existence of an Equilibrium for a Competitive Economy, 22 Econometrica 265 (1954); Francis M. Bator, The Anatomy of Market Failure, 72 Q. J. Econ. 351 (1958); Ronald H. Coase, The Problem of Social Cost, 3 J. L. & Econ. 1 (1960); Bruce C. Greenwald & Joseph E. Stiglitz, Externalities in Economies with Imperfect Information and Incomplete Markets, 101 Q. J. Econ. 229 (1986).

Theresa Coetzee

Page 5 of 43 19 Cardozo J. Int'l & Comp. L. 343, *349 In the language of legal economists, a plaintiff (or potential plaintiff) holding a claim can be said to have "property rights" in [*350] it, including possessory rights and right to transfer. 15 By selling his claim to an assignor, or by selling an interest in the outcome of the litigation to an investor, a plaintiff transfers all or part of his property rights in litigation. A rational claimholder - by definition - will be willing to maximize the value of his property right in the lawsuit. In order to do so, of the rights included in the "bundle," he will only decide to keep those specific rights that he values more than others. He will prefer to bargain over the other rights he holds with another person who values them more. This way the claimholder will maximize the expected value of his claim. 16 Furthermore, given that litigants are usually risk averse, 17 the elimination by a claimholder of the risk connected to the litigation is something for which a claimholder may be willing to pay a price - a factor capable of increasing the expected value of the claim. TPLF is a practice through which claimholders can eliminate the risk connected to the potentially unfavorable outcome of litigation. As this article will demonstrate, a plaintiff may be willing to transfer part of his property rights in a lawsuit to a third party in exchange for having that risk eliminated, thus increasing the expected value of his claim. There are many ways in which a claimholder can transfer his property rights in litigation. As a result, and given the highly expensive and unpredictable nature of civil litigation, 18 a multicolored industry of financial services has emerged around property rights in litigation. This article focuses on the "narrow" definition of TPLF: the specific practice in which a third party offers financial support to a claimant in order to cover his litigation expenses, in return for a share of damages if the claim is successful, [*351] or nothing if the case is lost, ensuring the financier a passive role who assumes no control over the litigation. In order to clarify this "isolation" within the spectrum of ways in which a claimholder can transfer his litigation property rights so as to maximize the expected value of his claim, the following section offers a survey of a series of practices and markets that have developed to assist plaintiffs in financing civil litigation. 19 These practices are so closely related to TPLF that, in some cases, they are blended together by legal scholars and policy analysts. It is important, however, to emphasize their distinctions. B. Private Sources of Financing for Litigation This section briefly summarizes methods for financing civil litigation based on transfer of "property rights" litigation. As a starting point, the article assumes a simplified world where no financial instruments are available claimholders so as to finance their lawsuits. Starting from there - where the only means to finance a lawsuit personal assets - alternatives are explored through which the (actual or potential) claimholder has access external capital for covering litigation expenses.

in to is to

1. Self-funding If no form of external capital is available, the plaintiff must use his or her own assets to finance the lawsuit. This is the default situation in any jurisdiction. Depending on the jurisdiction, legal costs can be either borne by each party 15

On the use of the term "property rights" in the law & economics literature, see Shavell, supra note 9, at 9-11.

16

See infra Sections IV.A.1.b and 2.b.

17

See Shavell, supra note 9, at 258-259, 406-407, 430. See generally Anthony Heyes, Neil Rickman & Dionisia Tzavara, Legal Expenses Insurance, Risk Aversion and Litigation, 24 Int'l Rev. L. & Econ. 107 (2004); W. Kip Viscusi, Product Liability Litigation with Risk Aversion, 17 J. Legal Stud. 101 (1988). 18

See generally Robert B. Calihan, John R. Dent & Marc B. Victor, American Bar Association, The Role of Risk Analysis in Dispute and Litigation Management (2004); Gretchen A. Bender, Uncertainty and Unpredictability in Patent Litigation: The Time is Ripe for a Consistent Claim Construction Methodology, 8 J. Intell. Prop. L. 175 (2001); Joseph A. Grundfest & Peter H. Huang, The Unexpected Value of Litigation: A Real Options Perspective, 58 Stan. L. Rev. 1267 (2006); Evan Osborne, Courts as Casinos? An Empirical Investigation of Randomness and Efficiency in Civil Litigation, 28 J. Legal Stud. 187 (1999). 19

For a survey of recent research on empirical analysis of various ways for funding civil litigation, see Paul Fenn & Neil Rickman, The Empirical Analysis of Litigation Funding, in New Trends in Financing Civil Litigation in Europe 131 (Mark Tuil & Louis Visscher eds., 2010).

Theresa Coetzee

Page 6 of 43 19 Cardozo J. Int'l & Comp. L. 343, *351 respectively (American rule) 20 or by the losing party ("loser-pays-all" or English rule). 21 The legal and economic logic of this basic situation has been [*352] widely explored in the literature under both types of rules. 22 2. Lawyer Funding Some countries permit lawyers to take clients on a "no-win-no-fee" basis, which enables lawyers to invest in their clients' lawsuits. In the American contingency fee system, introduced in the United States (U.S.) at the turn of the twentieth century and now accepted in all U.S. states, 23 the plaintiff pays the lawyer a fraction of any positive recovery from settlement or judgment, and nothing otherwise. 24 Under the UK conditional fee scheme, introduced in England and Wales after the drastic reduction of legal aid at the end of the 1990s, 25 the plaintiff pays the lawyer's cost plus an upscale premium, unrelated to the adjudicated amount, if the case is successful, and nothing otherwise. 26 In both the contingency and the conditional fee schemes, the plaintiff essentially gives up a portion of his award (either a percentage or an unrelated upscale premium) in exchange for the elimination of the risk connected to an unfavorable outcome of the litigation. 3. Third-party Litigation Funding As articulated previously, TPLF is a practice in which a third party offers financial support to a claimant in order to cover his litigation expenses, in return for a share of damages should the claim is successful, or nothing if the case is lost. The logic is similar to the U.S.-style contingency fee scheme, except that the funds come from a third party and not from the plaintiff's lawyer. TPLF will be the object of closer analysis, but it is useful to point out here that, through a TPLF contract, a plaintiff agrees to assign to the funder a portion of the potential award in exchange for the elimination of the risk deriving from starting a lawsuit using his own resources. [*353]

4. Insurance Based Solutions Insurance companies offer a variety of products to both plaintiffs and potential plaintiffs in order to lower the risks associated with litigation. Legal expenses insurance is a type of insurance policy that covers policyholders against the potential costs of a legal action. There are two main types of legal expenses insurance: (1) before-the-event (BTE) insurance and (2) after-the-event (ATE) insurance - the "event" is an incident that entitles a party to a legal action. Under BTE legal expenses insurance contracts, the insurer obliges itself in advance, in exchange for a premium, to cover the counterpart's litigation costs in case the latter starts a lawsuit. On one hand, from the perspective of the third-party, BTE legal expenses insurance is based on a mechanism of third-party investment in (potential) litigation. Indeed, by obliging itself to pay for future possible litigation costs in exchange for a premium, the insurer indirectly invests in the insured's litigation acting as a third party. On the other hand, from the plaintiff's perspective, BTE legal

20

See Kathryn E. Spier, Litigation, in The Handbook of Law & Economics 262 (A. Mitchell Polinsky & Steven Shavell eds., 2007). See also Shavell, supra note 9, at 387-418. 21

See Ronald R. Braeutigam, Bruce Owen & John Panzar, An Economic Analysis of Alternative Fee Shifting Systems, 47 Law & Contemp. Probs. 173, 174 (1984); John C. Hause, Indemnity, Settlement, and Litigation, or I'll Be Suing You, 18 J. Legal Stud. 157, 157 (1989); Avery Katz, Measuring the Demand for Litigation: Is the English Rule Really Cheaper?, 3 J.L. Econ. & Org. 143, 144 (1987); Shavell, supra note 9, at 428-432; Spier, supra note 20, at 300-303. 22

See supra notes 20 and 21.

23

Sebok, The Inauthentic Claim, supra note 11, at 99-100.

24

On contingency fees, see Neil Rickman, Contingent fees and Litigation Settlement, 19 Int'l Rev. L. &. Econ. 295 (1999).

25

Lord Chancellor's Department, Access to Justice with Conditional Fees, 1998, at 3.3; Vicki Waye, Trading in Legal Claims: Law, Policy & Future Directions in Australia, UK & US 81-82 (2008).

26

For an economic model of the conditional fee scheme, see Fenn & Rickman, supra note 19, at 7.

Theresa Coetzee

Page 7 of 43 19 Cardozo J. Int'l & Comp. L. 343, *353 expenses insurance is a means by which a potential plaintiff can bargain, in advance on his property rights in (potential) litigation, in exchange for eliminating the risk of having to pay for litigation expenses should an event occur that entitles him to bring suit. From the viewpoint of third parties, ATE insurance is another way to invest in the outcome of litigation. ATE insurance is a particular type of insurance that can be taken out after an event, such as an accident that has caused an injury, to insure the policyholder for disbursements, as well as any costs should he lose his case. ATE insurance is fairly common in the United Kingdom (UK), where it was introduced at the end of the 1990s, together with conditional fees, as a result of the policy shift by the English government to reduce publicly funded legal aid and support privately funded systems for guaranteeing access to justice. 27 Once an event has taken place, thereby giving a claimholder the right to bring suit, ATE insurance policy indemnifies the claimholder's liability in the case of loss for adverse cost orders and the holder's own legal costs where a conditional fee agreement is not available. 28 [*354] Lastly, another market in which a (potential) claimholder can bargain over his property rights in (potential) litigation is that of first-party insurance contracts containing a subrogation clause. Under those contracts, in case of an accident that entitles the insured with compensation by the insurer, the insurer pays the insured and is then subrogated into the rights of the insured towards the wrongdoer, so that the insurer can directly sue the wrongdoer on behalf of his client. In these contracts, the potential claimholder "sells" his property rights in litigation in exchange for a premium discount. However, insurers do not acquire complete ownership and control over the prosecution and proceeds of the insured's prospective claims. The subrogation is limited, 29 as the insurer can only recoup from the defendant the amount paid or owed to the insured. 30 In particular, insurance contracts do not include nonpecuniary losses. Thus, insurance companies do not compensate the insured for those losses and subrogation is not allowed in the right to sue the defendant for the losses. Damages for non-pecuniary harm are often substantial in personal injury claims, but - at least in the United States - there is something that courts are not inclined to accept in the idea of selling a claim that is so "personal" as that for non-pecuniary harm in personal injury. 31

5. Assignment of Claims Especially in the common law world, legal and economic scholarship has recently supported liberalization in favor of the formation of "markets in legal claims." 32 The idea of such markets is based on the mechanism known as "assignment." Assignment places the third party acquiring the claim "in the shoes" of the party who originally had the right to bring the lawsuit. [*355] The idea of a market for legal claims, based on the mechanism of assignment, is not new, 33 although

recently it has received increasing attention by legal scholars.

27

Access to Justice with Conditional Fees, supra note 25.

28

Waye, supra note 25, at 87.

34

In such a market, the claim holder would be able

29

For a proposal for deregulating insurance subrogation in order to establish a regime of unlimited subrogation in tort claims, see David Rosenberg, Deregulating Insurance Subrogation: Towards an Ex Ante Market in Tort Claims, Harvard Law School, Public Law Research Paper No. 43 (2002), Harvard Law and Economics Discussion Paper No. 395, available at http://ssrn.com/abstract=350940 or doi:10.2139/ssrn.350940. For a specific focus on medical malpractice liability, see Kenneth S. Reinker & David Rosenberg, Unlimited Subrogation: Improving Medical Malpractice Liability by Allowing Insurers to Take Charge,36 J. Legal Stud. 261 (2007). 30

Rosenberg, supra note 29, at 308.

31

Id. at 309.

32

Traditionally, the common law doctrine of non-assignability of choses-in-action has prevented this type of market to develop. See Sebok, The Inauthentic Claim, supra note 11, at 81. 33

See Marc J. Shukaitis, A Market in Personal Injury Tort Claims, 16 J. Legal Stud. 329 (1987).

Theresa Coetzee

Page 8 of 43 19 Cardozo J. Int'l & Comp. L. 343, *355 to sell his claim to a third party who would then pursue the claim against the defendant. 35 The original claimholder would be paid the expected value of the claim (grossly, the amount likely to be won multiplied by the probability to win). 36 In its most advanced hypothetical version - like in most traditional financial markets - a secondary market would develop, where legal claims would be traded as securities, thereby becoming a negotiable instrument based on a securitization made through normal succession of assignments. 37 In other words, a third party could be assigned a claim and not bring it to court straight away, but rather transfer it again to a new assignee for a higher price. 38 As it has been noted: This speculation can be interesting for investors because the value of the claim can change between the moment it was first transferred and the date of a final ruling on the issue. Not only "natural" causes could modify the value of the claim, but also legal causes, like the modification of a line of case law or a practice of a court in measuring damages, or a lower court decision held in the lawsuit in which rights for action have been assigned. 39 The plausibility, efficiency, and desirability of a so-designed market in legal claims are the objects of fascinating speculations and discussions, but this is not among the objectives of this article, [*356] so I limit myself to reference to the existing literature. 40 However, the question on assignment of legal claims also has a current and much more practical application, concerning TPLF. In principle, the market for TPLF is different from a market for legal claims because in TPLF the control over the lawsuit is not transferred to the third party. This limits its intervention to the passive funding of the litigation expenses. This is different from TPLF - where the original claimholder formally and substantially remains the plaintiff and the third party investor maintains a passive role because, in a market for legal claims, the buyer of the claim would also receive control of the litigation, being placed "in the shoes" of the original claimholder. This metaphor can either indicate a formal substitution of the holder of the claim (from the original plaintiff to the assignee), or indicate a substantial substitution where the original claimholder remains the plaintiff. Indeed, the central issue around which the distinction between the practice of selling claims and TPLF - in its "narrow" sense - is control over the litigation. We can easily imagine two opposite situations: one in which the claimant receives from the funder coverage of all litigation costs, in exchange for a share of the award, but maintains full control over the litigation (choosing counsel, deciding settlement, and so on); and another in which the original plaintiff sells his claim to a professional investor, who acquires complete control over the lawsuit, although the plaintiff formally remains the original claimholder. While the former situation is certainly identifiable as TPLF, and the latter as assignment of claims, many "grey

34

See Waye, supra note 25; Andrea Pinna, Financing Civil Litigation: The Case for the Assignment and Securitization of Liability Claims, in New Trends in Financing Civil Litigation in Europe 109 (Mark Tuil & Louis Visscher eds., 2010); Michael Abramowicz, On The Alienability of Legal Claims, 114 Yale L.J. 697 (2004); Isaac M. Marcushamer, Selling Your Torts: Creating a Market for Tort Claims and Liability, 33 Hofstra L. Rev. 1543 (2005); Molot, supra note 5; Sebok, supra note 11. 35

See Shukaitis, supra note 33, at 329.

36

This is the (simple model) definition of expected gains from trial in the basic economic theory of litigation. See Shavell, supra note 9, at 401-02.

37

Pinna, supra note 34, at 17.

38

As suggested by A. Pinna, two problems would arise immediately under such an outlined system. The first has to do with prescription: indeed, as known, a claim has to be brought to court before it is time barred; however, the legal claim could be traded even once the action is brought. The other problem has to do with the date at which damages would be assessed, i.e., either at the date of the judgment (France) or at the date of the harm (England). Id. at 17-18.

39

Id. at 17.

40

See supra notes 32 and 33.

Theresa Coetzee

Page 9 of 43 19 Cardozo J. Int'l & Comp. L. 343, *356 areas" exist. This is far from a purely hypothetical problem: courts of law have sometimes based the validity or invalidity of litigation funding agreements on the contractual allocation of control over the lawsuit. 41 6. Litigation "Loans" A market that presents very close similarities and connections to TPLF, particularly well-developed in the United States, is one in which private companies provide "litigation loans" to (needy) plaintiffs for covering their expenses (mainly living and medical) 42 [*357] pending the outcome of a lawsuit, on a non-recourse basis, in exchange for a share of the proceeds of any settlement or judgment recovered (only in case a favorable outcome of the pending case results). 43 These cash advances are commonly referred to as "loans," although such a word is misleading because all advances are conditional in nature and repayable only upon receipt of a cash recovery by the plaintiff. 44 The litigation loan industry presents several problems - many of these concerns have been partially addressed by legal scholarship, almost unanimously expressing itself in favor of litigation "loan" agreements, on the grounds of improving access to justice and correcting an imbalance of power between plaintiffs and wealthy defendants. 45 Although no scholar has called for the prohibition of third-party litigation "loans," some scholars have proposed that the industry be properly regulated. 46 Litigation "loans" present several problems, namely the unequal bargaining position of the customer and the financing firm, the financial duress prompting the customer to sign a loan agreement, the usurious profit by the financing firm, and the ethical pressures placed on the attorney-client relationship. 47 In contrast to TPLF, the United States litigation loan market has traditionally been small scale and consumer oriented. 48 It is characterized by a large number of small firms that advance small [*358] amounts of cash (usually a maximum of $ 20,000 49) to individual borrowers who need money to cover living and medical expenses pending the successful outcome of their claim. 50 This market - distinguished from TPLF in the "narrow" sense considered

41

See, e.g., Ahmed v. Powell, [2003] P.N.L.R. 22 (Eng.).

42

The main factor that determined the development of such practices seems to be the prohibition on attorneys, under the ethical and professional responsibility rules, to provide any financial assistance to their clients to meet their day-to-day living expenses. Julia H. McLaughlin, Litigation Funding: Charting a Legal and Ethical Course, 31 Vt. L. Rev. 615, 646-647 (2007).

43

See Susan L. Martin, The Litigation Financing Industry: The Wild West of Finance Should Be Tamed Not Outlawed, 10 Fordham J. Corp. & Fin. L. 55, 55 (2004); Douglas R. Richmond, Other People's Money: The Ethics of Litigation Funding, 56 Mercer L. Rev. 649, 650 (2005). 44

See Echeverria v. Estate of Lindner, No. 018666/2002, 2005 WL 1083704, at 6 (N.Y. Sup. Ct. Mar. 2, 2005), where Judge Warshawsky wrongfully considered a litigation funding agreement a "loan" based on the fact that a positive outcome of the suit was a "sure thing," given that the plaintiff was suing under a statute that imposed strict liability. That judgment has to be considered wrong because it cannot be said that all civil cases based on strict liability can be said to be "sure things." See Anthony J. Sebok, A New York Decision That May Imperil Plaintiffs' Ability to Finance Their Lawsuits: Why It Should Be Repudiated, or Limited to Its Facts, FindLaw, Apr. 18, 2005, http://writ.news.findlaw.com/sebok/20050418.html. 45

For a synthetic survey of the dialogue between proponents and critics of "litigation loans," see Mariel Rodak, It's About Time: A Systems Thinking Analysis of the Litigation Finance Industry and Its Effects on Settlement, 155 U. Pa. L. Rev. 503 (2006). 46

Courtney R. Barksdale, All that Glitters Isn't Gold: Analyzing the Costs and Benefits of Litigation Finance, 26 Rev. Litig. 707, 735 (2007); Martin, supra note 43, at 68; McLaughlin, supra note 42, at 655. 47

McLaughlin, supra note 42, at 627.

48

Waye, supra note 25, at 5.

49

George S. Swan, Economics and the Litigation Funding Industry: How Much Justice Can You Afford?, 35 New Eng. L. Rev. 805, 824 (2001). 50

Waye, supra note 25, at 5.

Theresa Coetzee

Page 10 of 43 19 Cardozo J. Int'l & Comp. L. 343, *358 in this article, according to which funds are advanced to plaintiffs exclusively to cover litigation expenses - is more focused on the advancement of cash "up front" 51 for covering medical and living expenses pending the outcome of a lawsuit, in exchange for a share of any award received. The practice of litigation "loans" has developed in the United States primarily as a response to the broad prohibition against lawyers providing financial assistance to their clients in connection with a pending case, other than court costs and basic litigation expenses. 52 The American Legal Finance Association (ALFA), a trade association made up of twenty-one firms, was created in 2004 in order "to establish industry standards in the Legal Funding industry, especially regarding transparency in transactions and clear disclosure to consumers." 53 Among the firms operating in the litigation "loan" market, 54 some operate in TPLF, broadly [*359] offering a variety of financing services designed to meet plaintiffs', attorneys', and law firms' needs for financial help. Most of these firms have consumer-friendly websites that attract both plaintiffs and potential plaintiffs to turn to litigation finance for covering their litigation and living expenses while waiting for a favorable judgment. There are many similarities between the litigation "loan" market and TPLF, to such an extent that the two markets partially overlap. In fact, from the viewpoint of the funder, its decision to provide cash to a plaintiff for covering his living/medical expenses or financing his litigation costs is equally a bet on the outcome of a case: the funder advances cash and hopes to profit from his better guess; it does not matter what those funds are used for by the plaintiff. He will invest as long as the expected revenue from the investment is higher than the expected cost. 55 From the point of view of the claimholder, selling a portion of the future possible award in exchange for cash up front is a way to maximize the value of the claim bargaining over property rights in litigation. However, the two mechanisms remain conceptually and practically distinct, and they do not present the same problems related to the need to protect the plaintiff, who in the case of TPLF does not ask for cash to satisfy essential needs such as his life or health. Furthermore, for the purposes of this article, the effects of the two systems on the incentives to litigate are different. Cash advances for covering living and medical expenses have a different impact on a plaintiff's incentive to bring suit or to settle. Of course, the influence is indirect (a needy plaintiff will be willing to settle sooner and for lower amounts), but it seems that having or not having external funding available for living and medical expenses does not directly determine the plaintiff's decision to bring or not to bring

51

Terry Carter, Cash Up Front: New Funding Sources Ease Financial Strains on Plaintiffs Lawyers, 90 A.B.A. J. 34, 34 (2004).

52

Model Rules of Professional Conduct, Rule 1.8(e) reads as follows:

A lawyer shall not provide financial assistance to a client in connection with pending or contemplated litigation, except that: (1) a lawyer may advance court costs and expenses of litigation, the repayment of which may be contingent on the outcome of the matter; and (2) a lawyer representing an indigent client may pay court costs and expenses of litigation on behalf of the client. Model Rules of Prof'l Conduct R. 1.8 (2010). See James T. Moliterno, Broad Prohibition, Thin Rationale: The "Acquisition of an Interest and Financial Assistance in Litigation" Rules, 16 Geo. J. Legal Ethics 223 (2003). 53

American Legal Finance Association, http://americanlegalfin.com (last visited Apr. 3, 2011).

54

Among the firms is The Lions Group, which ""lends' money to individuals who would like to maintain their lawsuits but need money immediately. Their typical client would be an auto accident victim who needs cash to pay for medical expenses and cannot wait years to receive a jury verdict or a deferred settlement." Anthony J. Sebok, Venture Capitalism for Lawsuits? Why It Doesn't Exist, and What Alternatives for Financing Exist Instead, FindLaw, Feb. 12, 2001, http://writ.news.findlaw.com/sebok/20010212.html. Others include: Interim Settlement Funding Corporation (Rancman v. Interim Settlement Funding Corp., 99 Ohio St.3d 121 (2003)); Future Settlement Funding Corporation (Rancman v. Interim Settlement Funding Corp., 99 Ohio St.3d 121 (2003)); Lawcash (Echeverria v Estate of Linder, No. 018666/2002, 2005 WL 1083704, at 6 (N.Y. Sup. Ct. Mar. 2, 2005)); Juris Capital; Magnolia Funding; Lawsuit Cash Advance; Plaintiff Support; Preferred Capital Funding; Plaintiff Investment Funding LLC; PS Finance; Golden Pear Funding; Case Funding; Allied Legal Funding; The Law Funder; and Oliver Street Finance. 55

See infra Sections IV.A.1.a and 2.a.

Theresa Coetzee

Page 11 of 43 19 Cardozo J. Int'l & Comp. L. 343, *359 suit. Instead, TPLF has a primary direct effect on the plaintiff's incentives related to the litigation, as its scope is that of eliminating the risk connected to the unfavorable outcome of the case. [*360]

III. The Emergence of TPLF A. Definition The conceptual and practical interconnections between the various markets for property rights in litigation outlined above are extremely interesting and the boundaries that separate them are sometimes highly faded. A few of the authors that have devoted interest to alternative methods for financing civil litigation (including TPLF) have engaged in the discussion concerning conceptual and practical definitions of such boundaries. 56 However, the purpose of this article is not to explore the interconnections and draw lines between TPLF and other similar practices, but rather to conceptually isolate TPLF and analyze it from a comparative legal and economic perspective. For the purpose of this article, therefore, TPLF is to be intended as a specific financial service, which consists of third parties providing funds to plaintiffs to cover their litigation expenses. These funds are provided on a non-recourse basis and are advanced by funders who maintain a passive role, in exchange for the promise by the plaintiff to pay the funder a determined percentage of the award in the case of a favorable settlement or judgment. B. A Factual Survey (Australia, United States, United Kingdom, and Continental Europe) Third-party litigation funding started to develop in Australia at the beginning of the 1990s and soon spread over the rest of the common law world (United States, United Kingdom, New Zealand) and further, developing in some European civil law countries (Germany, Switzerland, Austria). At first, third-party contingency funding emerged in Australia as a statutory exception to the common law prohibition of maintenance and champerty 57 in the specific context of insolvency. 58 Successively, however, third- [*361] party funding extended to other areas, though generally remained largely confined within the boundaries of commercial litigation. 59 Among other factors, the fairly favorable endorsement by Australian courts 60 of non-recourse litigation lending practices allowed the industry to find rapid success and growth in Australia. Since then, several companies, such as IMF (Australia) Ltd., 61 Litigation Lending Services Ltd., 62 and LCM Litigation Fund Pty. Ltd. 63 have engaged in the business of

56

In particular, for a discussion of the boundaries between assignment and TPLF, see Sebok, The Inauthentic Claim, supra note 11. See also Waye, supra note 25.

57

Roughly speaking, "maintenance" indicates the action of one who assists a litigant in prosecuting or defending a claim. "Champerty" is a particular form of maintenance, namely one made for the purpose of gain. The prohibitions of maintenance and champerty are embodied in two ancient common law doctrines, which will be discussed in Section V.A.1.

58

Litigation Funding in Australia, Discussion Paper, Standing Committee of Attorneys General (May 2006), http://www.lawlink.nsw.gov.au/lawlink/legislation_policy/ll_lpd.nsf/vwFiles/LitigationFundingDiscussionpaperMay06.pdf/$ file/LitigationFundingDiscussionpaperMay06.pdf. See Waye, supra note 25, at 55. For an example of an insolvency matter for which TPLF was provided, see Anstella Nominees Pty Ltd v. St George Motor Finance Ltd. [2003]FCA 466 (Austl.). 59

See Waye, supra note 25, at 5, 18, 133; Litigation Funding in Australia, supra note 58, at 4-6. For two examples, see QPSX Ltd. v. Ericsson Australia Pty. Ltd. (2005) F.C.A. 933 (Austl.) and Fostif v. Campbell Cash and Carry (2005) N.S.W.C.A. 83 (Austl.). 60

See QPSX Ltd. v. Ericsson Australia Pty. Ltd. (2005) 219 A.L.R. 1 (Austl.); Campbell's Cash & Carry P/L v. Fostif P/L (2006) 299 A.L.R. 200 (Austl.).

61

IMF, which provides funding of legal claims and other related services where the claim size is over $ 2 million, is the largest litigation funder in Australia and the first to be listed on the Australian Stock Exchange. See IMF, http://www.imf.com.au (last visited Mar. 28, 2011).

Theresa Coetzee

Page 12 of 43 19 Cardozo J. Int'l & Comp. L. 343, *361 professional litigation funding. 64 Most funding of litigation is still conducted under the statutory exception for insolvency, 65 involving, for example, the pursuit of voidable transactions and misfeasance by company officers. Outside the insolvency context, litigation funding is usually limited to commercial litigation with large claims (over $ 500,000 or, for some companies, over $ 2 million), although an exception is constituted by class actions, where a large number of [*362] smaller claims can be processed economically. 66 Litigation funding firms in Australia are generally not involved in personal injury-type matters. 67 Some Australian based companies also invest funding claims in foreign jurisdictions. Among them, Litigation Lending Services Ltd., based in Sidney, was involved in the funding agreement analyzed in the first judicial decision that ever dealt with the issue of litigation funding in New Zealand, given by the New Zealand High Court in 2000. 68 In the United States, the industry of third-party investment in litigation started to develop in the mid-1990s. This is different from Australia, where TPLF has developed largely operating in a commercial environment, whereas in the United States, the industry of third-party investments in litigation has traditionally been small scale and more consumer-oriented. 69 In other words, the broad U.S. market for investments in legal claims is the one for litigation "loans" described earlier, 70 which distinguishes itself from TPLF as considered in this article. Notwithstanding, a market also exists that is specifically centered on commercially-focused TPLF. In the United States, this can be considered an "upper" market, where a small number of companies provide large dollar amounts to corporate actors who prefer turning to TPLF rather than risk their own assets to cover litigation costs. The largest company operating in the sector, Juridica Capital Management Ltd., only invests in commercial claims (including IP, antitrust, commercial contracts, bankruptcy and insolvency, securities, and finance). It is the exclusive worldwide manager for Juridica Investments Limited, a UK-based investment company that typically invests amounts between $ 3 million and $ 10 million into claims of the size of at least $ 25-100 million. 71 Another of the largest litigation-finance firms, Burford Capital Limited, also invests in commercial litigation, "providing financing in support of significant corporate litigation, arbitration, and other disputes, working with clients in both the United

62

Litigation Lending Services Ltd., set up in Sydney in 1999, has traditionally focused on the provision of litigation funding for insolvency market actions typically ranging from claims of between $ 200,000 and $ 10 million, though extending their services beyond insolvency to general commercial litigation, class actions and representative proceedings. See Litigation Lending Services, http://www.litigationlending.com.au (last visited Mar. 28, 2011).

63

LCM Litigation Fund Pty Ltd (LCM) has been in business since 1998 and was previously known as Australian Litigation Fund Pty Ltd (until April 2008). "LCM primarily provides litigation funding to insolvency practitioners. However, LCM also provides funding to solvent companies and individuals with worthwhile commercial legal claims… . LCM prefers to undertake projects in which the relevant legal claim is for at least $ 2.5 million." LCM Litigation Fund, http://www.lcmlitigation.com.au (last visited Mar. 28, 2011). 64

As of 2006, five companies operated in the business of commercial litigation funding. Litigation Funding in Australia, supra note 58, at 4. As of May 2010, about six active funders operated in the market. Charlie Gollow, Inv. Manager, IMF (Austl.) Ltd., Trends and Developments in Australian Litigation Funding, Presentation at the RAND ICJ Conference: Alternative Litigation Finance in the U.S.: Where Are We and Where Are We Headed with Practice and Policy?, Washington, D.C. (May 21, 2010). 65

See infra Section V.A.2.

66

Litigation Funding in Australia, supra note 58, at 4.

67

Litigation Funding in Australia, supra note 58, at 4.

68

Re Nautilus Developments Limited (In Liquidation); Montgomerie v Davison (M1285/99; High Court, Auckland; Apr. 14, 2000).

69

Waye, supra note 25, at 5.

70

See supra Section II.B.6.

71

Juridica Capital Management Ltd., http://www.juridicacapital.com/investments.php (last visited Mar. 28, 2011).

Theresa Coetzee

Page 13 of 43 19 Cardozo J. Int'l & Comp. L. 343, *362 States and [*363] internationally." 72 Law Finance Group Inc, created in 1994, advances sums between $ 25,000 and $ 15 million, and up to $ 50 million for appeal cases. Law Funds LLC advances between $ 500 and $ 20 million in exchange for an assignment of the proceeds of a judgment or settlement. 73 These are four examples of companies operating in the TPLF market in the United States, but others include Credit Suisse and more specifically oriented companies like General Patent Corporation. 74 Another important market for litigation funding in the common law world is the United Kingdom. This is different from what the Australian - and to some extent the U.S. - situation might lead one to think; the UK experience demonstrates that there is no reason to believe that litigation funding would be limited to commercial matters. Indeed, litigation funding in the United Kingdom has come to cover such areas as personal injury and family matters (divorces). 75 Private litigation funding in the United Kingdom is mainly the product of a combination of two factors that contributed to its development: (1) a public policy trend during the 1980s and 1990s that focused on the reduction of publicly funded instruments for easing access to justice (legal aid), and (2) a judicial endorsement of private funding practices justified under the rationale of access to justice. 76 Since the 1980s, the English government started reducing legal aid on the grounds that it was too expensive. Meanwhile, [*364] government policy encouraged privately funded access to justice by way of conditional fee agreements and after the event (ATE) insurance agreements, though not mentioning in principle third-party litigation funding. 77 The new policy direction was precisely thought to shift the funding of non-commercial injury claims, i.e., damages claims involving physical or mental injuries, away from the public purse (legal aid) to the private sector. 78 Later on, however, litigation funding expanded to the commercial realm, in particular - as in Australia - in the field of insolvency. 79 Thus the United Kingdom was transformed into an attractive market where companies are willing to

72

The investment advisor of Burford Capital Limited http://www.burfordgroupltd.com/purpose.html (last visited Mar. 28, 2011). 73

Waye, supra note 25, at 45.

74

For example:

is

Burford

Group.

Burford

Group

Ltd.,

General Patent Corporation (GPC) … works on a 100% contingency basis. That means that if GPC accepts you as a client, the company covers ALL [emphasis in the original] fees and costs involved in the litigation. General Patent Corporation is not a law firm, so it will retain a law firm to actually try the case. It will, however, underwrite all legal fees and out-of-pocket expenses related to the lawsuit(s)… . Patent enforcement firms recoup their expenses and earn their fees from the proceeds of the settlements or judgments that result from the lawsuit and share in license fees and royalty payments obtained by them through licensing the patent. General Patent's arrangement is a 50/50 split of all net recoveries. Should the patent enforcement firm fail to secure a settlement for the patent owner, however, they are out the money they invested in the case and the patent owner owes the patent enforcement firm nothing! Financing Patent Infringement Litigation, Generalpatent.com, http://www.generalpatent.com/financing-patent-infringementlitigation-0 (last visited Mar. 28, 2011). 75

Waye, supra note 25, at 81.

76

See infra Section V.A.4.

77

Access to Justice with Conditional Fees, supra note 25, at 3.3. However, third party funding was introduced as a result of an amendment sought in the House of Lords. See infra Section V.A.4. 78

Waye, supra note 25, at 82.

79

Norglen Ltd. (in liq) v. Reeds Rains Prudential Ltd. [1999] 2 A.C. 1 (Eng.); Ramsey v. Hartley [1977] 1 W.L.R. 686 (Eng.); Guy v. Churchill [1888] 40 Ch. 481 (Eng.); In re Park Gate Waggon Works Co. [1881] 17 Ch. 234 (Eng.); Seear v. Lawson [1880] 15 Ch. 729 (Eng.).

Theresa Coetzee

Page 14 of 43 19 Cardozo J. Int'l & Comp. L. 343, *364 invest in a variety of fields that include family matters (divorces), legal system like the UK one. 81

80

favoring access to justice in a highly expensive

Companies operating in the UK litigation funding market include IM Litigation Funding, Harbour Litigation Funding Ltd., 82 and Juridica Investment Limited. 83 While these companies could, until recently, be characterized as "alternative investment firms," 84 in 2007 Allianz Litigation Funding 85 became "the first mainstream [*365] institution to enter the United Kingdom's fledgling market for third-party litigation funding." 86 Furthermore, thirdparty litigation funding is rapidly expanding, and the market certainly benefited from the recent global financial crisis, as the flood of litigation triggered by the credit crunch has prompted the formation of new companies that finance lawsuits. 87 But third-party litigation funding in Europe is not at all limited to the United Kingdom. Claims Funding International, for instance, "is a litigation funding company incorporated in Ireland and managed from its office in Dublin. [Its] mandate is to identify, fund, manage, and resolve multi party (class action) and other significant legal claims in Europe and elsewhere." 88 However, there is even more than that. Third-party litigation funding is also fairly developed in some continental European civil law countries. Apart from (and before) 89 the United Kingdom, Allianz Prozessfinanzierung 90 has funded litigation costs to plaintiffs in Germany, Austria, and Switzerland, holding claims of at least s[euro]s100,000, with a high probability of success and with a potentially divisible award that the company can share, in exchange for 20 to 30% of the proceeds (if any). 91

80

A famous case is that of "Harbour Litigation Funding … financing the legal battle of Michelle Young, wife of the property tycoon Scot Young, [claiming] to have lost most of what was once a £ 400m fortune." Elena Moya, Hedge Funds, Investors and Divorce Lawyers It's a Match Made in Heaven, Guardian.co.uk (Oct. 16, 2009), http://www.guardian.co.uk/business/2009/oct/16/hedge-funds-divorce-litigation-funding. 81

For the most recent and exhaustive report on the costs of the UK civil justice system, see Hon. Lord Justice Jackson, Review of Civil Litigation Costs: Final Report (2010). 82 Harbour

Litigation funds claims with a claim value in excess of £ 3,000,000." Harbour Litigation Funding Ltd., http://www.harbourlitigationfunding.com (last visited Mar. 28, 2011).

83

Juridica predominantly invests in the United States, the United Kingdom, and in international arbitrations cases. Juridica Investments Ltd., http://www.juridicainvestments.com (last visited Apr. 3, 2011). 84

Juridica Investment Limited, for example, with over $ 200 million of assets under management, is listed on the London Stock Exchange's Alternative Investment Market (AIM: JIL). Juridica Investments Ltd., http://www.juridicainvestments.com (last visited Apr. 3, 2011). 85

Allianz Litigation Funding is the UK branch of Munich-based Allianz ProzessFinanz GmbH. Allianz Litigation Funding, http://www.allianz-litigationfunding.co.uk (last visited Apr. 3, 2011). 86

Michael Herman, Allianz to Fund UK Court http://business.timesonline.co.uk/tol/business/law/article2688587.ece.

Cases,

Times

Online,

Oct.

18,

2007,

87

Jane Croft, Litigation Finance Follows Credit Crunch, Financial Times, Jan. 27, 2010, http://www.ft.com/cms/s/0/7c98c38a0ab1-11df-b35f-00144feabdc0.html. 88

Claims Funding International, http://www.claimsfunding.eu (last visited Mar. 28, 2011).

89

Allianz entered the UK market in 2007. Allianz Litigation Funding, http://www.allianz-litigationfunding.co.uk (last visited Apr. 3, 2011). 90

Allianz Prozessfinanzierung, http://www.allianz-profi.com (last visited Mar 28, 2011).

91

Allianz Prozessfinanzierung, http://www.allianz-profi.de (last visited Mar. 28, 2011).

Theresa Coetzee

Page 15 of 43 19 Cardozo J. Int'l & Comp. L. 343, *365 In Germany, apart from subsidiaries of insurance companies like Allianz Prozessfinanzierung or Roland Prozessfinanz, 92 independent companies like FORIS Finanziert Prozesse, 93 the first German company operating in TPLF and recently incorporated, offer to advance court costs and fees necessary to initiate an action, as well as to assume the risk of a cost award if the plaintiff loses. 94 In Germany, there are a number of independent [*366] competing companies that offer similar services, including FORIS, DAS Prozessfinanzierung AG, 95 Juragent 96 and Exactor AG. 97 It is interesting to note that, while FORIS initially demanded 50% of the client's return from settlement or trial, nowadays - with more competition in the market - it only claims 30%. 98 Two common features are that: (1) the asserted claim must be of a certain value (the minimum amounts required vary among the different financing companies ranging between s[euro]s500 and s[euro]s50,000); 99 and (2) the percentage of the claim to be paid to the financer is inversely proportional to the value of the claim. 100 In Austria and Switzerland, as well, independent companies are incorporated and offer litigation funding services to claimants. 101 C. The Scholarly (and Institutional) Debate The TPLF industry has substantially grown over the past fifteen years. Although TPLF has not developed at a pace determined by market forces, it has often encountered the adverse attitude of courts of law, which - in the common law world - have denied enforcement to TPLF agreements based on traditional common law doctrines which prohibit maintenance based on champerty and public policy grounds. 102 Although courts of law have gradually been relaxing said prohibitions, opening the path for TPLF to develop, the legal status of TPLF is still debated. The proliferation and contextual uncertain legal status of TPLF agreements have attracted scholarly interest, and some work has been done in the direction of understanding the validity of the - for many, anachronistic - doctrines of maintenance and champerty in the modern world. Moreover, TPLF has attracted [*367] the attention of the law and economics literature, which has started to study third-party investments on litigation not from a legal perspective, but from the viewpoint of its long-term consequences and social desirability. The ongoing debate that currently faces supporters and critics of TPLF can be summarized as follows.

92

Roland Prozessfinanzierung, http://www.roland-prozessfinanz.de/de/roland_prozessfinanz (last visited Mar. 28, 2011).

93

Foris AG, http://www.foris.de (last visited Mar. 28, 2011).

94

Roland Kirstein & Neil Rickman, FORIS Contracts: Litigation Cost Shifting and Contingent Fees in Germany, CSLE Discussion Paper 2001-04 (2001), available at http://econpapers.repec.org/paper/zbwcsledp/200104.htm; Michael Coester & Dagobert Nitzsche, Alternative Ways to Finance a Lawsuit in Germany, 24 Civ. Just. Q. 83, 84 (2005). 95

D.A.S. Prozessfinanzierung AG, http://www.das-profi.de (last visited Mar. 18, 2011).

96

Juragent Prozessfinanzierung, http://www.juragent.de (last visited Mar. 28, 2011).

97

ExActor, http://www.exactor.de (last visited Mar. 28, 2011).

98

Kirstein & Rickman, supra note 94, at 3-4.

99

See Schuffel, Survey, Prozebetafinanzierung durch Dritte, Berliner Anwaltsblatt, at 82 (2001).

100

Coester & Nitzsche, supra note 94, at 88.

101

For example, in Austria, AdvoFin Prozessfinanzierung AG, or Lexdroit. AdvoFin Prozessfinanzierung AG, http://www.advofin.at (last visited Mar. 28, 2011); Lexdroit, http://www.lexdroit.at. (last visited Mar. 28, 2011). The first Swiss litigation financing company was Prozessfinanz. Prozessfinanz, http://www.prozessfinanz.ch (last visited Mar. 28, 2011). See Christian Toggenburger, Financing Private Litigation - A European Alternative to Contingency Fees, 4 Eur. J. Law Reform 603 (2002). 102

See infra Section V.A.

Theresa Coetzee

Page 16 of 43 19 Cardozo J. Int'l & Comp. L. 343, *367 On one end of the spectrum, TPLF supporters argue that the industry is beneficial on the grounds of access to justice, playing an equalizing function - "leveling the playing field" 103 - between plaintiffs and defendants, providing the former, who is typically weaker, with the resources necessary to face typically wealthy and powerful defendants. Furthermore, a plaintiff who can rely on solid financial resources is assumed to be more credible in pretrial negotiations than a plaintiff who is experiencing financial pressures and is likely to accept lower settlement offers. Another argument brought by supporters of TPLF is that the industry is beneficial because of the positive deterrent effect it has on potential defendants' behavior, thereby contributing to the social goal of the minimization of the total cost of accidents. 104 Under the law and economics literature, if victims do not have the resources to sue injurers, or if risk-averse victims do not sue injurers, so as to avoid risking their own resources and thus do not bring suit, the resulting scenarios are similar to the reality in which there is no liability for wrongdoers. 105 As the literature points out, if there is no liability, injurers will not exercise any care, for doing so would entail costs but not yield a benefit to them. 106 Potential injurers, who are aware that the victims of their harmful behavior may be able to count on solid financial resources through TPLF, will have an incentive to take more care in order to avoid liability. 107 On the other end of the spectrum, critics have raised objections on a variety of grounds. The first ground is that ethical violations are associated with TPLF: TPLF can create confusion concerning the party who controls the lawsuit and concerning the attorney-client relationship. 108 A second criticism of TPLF is that [*368] it allows the funder to take advantage of claimholders, in particular in light of the fact that the industry does not operate in a competitive environment. 109 A third major ground for criticism has to do with the social costs TPLF produces on society. It is argued that TPLF encourages frivolous and unmeritorious litigation, that it over-deters potential injurers' behavior, 110 and, in general, that it increases the overall (whether frivolous or not) level of civil litigation and its consequent costs for society. 111 The potential consequences of the diffusion of TPLF are enormous. In fact, a widespread use of TPLF in civil litigation would radically change the way in which we conceive the civil justice system. This change would be characterized by an increasing interaction between law, finance, and capital markets (and a variety of professional figures) that challenges the traditional adversarial nature of civil litigation. But the changes posed by TPLF are not merely of theoretical or scholarly interest; they present important political implications. For this reason, the debate on TPLF has gone beyond the scholarly arena and has reached the institutional dimension. In the United States, the U.S. Chamber Institute for Legal Reform recently published the report "Selling Lawsuits, Buying Trouble: Third Party Litigation Funding in the United States," 112 which firmly takes a position against TPLF. In the United

103

Litigation Funding in Australia, supra note 58, at 7.

104

See Shavell, supra note 9, at 178.

105

Id. at 179.

106

Id.

107

For further discussion on the deterrent effect of TPLF, see infra Sections IV.C.2 and C.4.

108

See Fausone v. U.S Claims, Inc., 915 So.2d 626, 630 (Fla. Dist. Ct. App. 2005).

109

See Rodak, supra note 45.

110

Gary Young, Two Setbacks for Lawsuit Financing: But the Practice is Still Alive, N.J. L.J., Aug. 2003, at 21.

111

See Paul H. Rubin, Third Party Financing of Litigation (2009) (presented at the panel on Third Party Financing of Litigation at the Fourth Annual Judicial Symposium on Civil Justice Issues, hosted by the Northwestern Searle Center on Law, Regulation, and Economic Growth, Northwestern University Law School, Judicial Education Program in December 2009); David Abrams & Daniel L. Chen, A Market of Justice: The Effect of Litigation Funding on Legal Outcomes (2009), home.uchicago.edu/dlc/papers/MktJustice.pdf. 112

U.S. Chamber Institute for Legal Reform, Selling Lawsuits, Buying Trouble: Third Party Litigation Funding in the United States (2009).

Theresa Coetzee

Page 17 of 43 19 Cardozo J. Int'l & Comp. L. 343, *368 Kingdom, conversely, a report by the Rt. Honorable Lord Justice Jackson on the costs of civil litigation was recently published that favors TPLF. 113 Especially in the common law world, academic interest in TPLF has, as of late, increased and the debate has expanded beyond national frontiers, reaching a transnational dimension in which scholars from different jurisdictions are confronting [*369] themselves in order to learn from each other's national experience with TPLF. A number of new projects have been launched and conferences organized to study the burgeoning TPLF industry. Among them, the RAND Law, Finance, and Capital Markets Program was recently launched in order to "analyze an emerging development in civil dispute resolution in the United States, namely, providing capital and capital market products for claim holders and those defending against claims, and their respective lawyers." 114 An "International Conference on Litigation Costs and Funding" was held in July of 2009 in Oxford, United Kingdom, which was organized by the Centre for Socio-Legal Studies and the Institute of European and Comparative Law University of Oxford. A conference titled, "Collective Redress and Litigation Funding," was held in Sydney and Canberra in December of 2009, which was organized by the Centre for Law and Economics at The Australian National University, aiming at "coordinating a major research program examining collective redress and litigation funding globally with a focus on the US, Europe, Australia and Asia." 115 The conference "New Trends in Financing Civil Litigation in Europe: A Legal, Empirical and Economic Analysis" was held at the Erasmus University in Rotterdam on April 24, 2009. 116 The conference "Third Party Litigation Funding and Claim Transfer: Trends and Implications for the Civil Justice System," was presented by the RAND Institute for Civil Justice and UCLA School of Law in June of 2009. 117 Lastly, in May of 2010 in Washington, D.C., the Conference "Alternative Litigation Finance in the U.S.: Where Are We and Where Are We Headed with Practice and Policy?," organized by the RAND Institute for Civil Justice, was held, which [*370] brought together litigation finance investors, legal practitioners, policymakers, academics and researchers to discuss and debate issues and trends related to alternative litigation finance in the United States and in other common law jurisdictions. 118 IV. TPLF: An Economic Analysis A. Basic Economic Model In this section I provide a basic economic model of TPLF. I adopt as my starting point Shavell's basic theory of litigation, 119 and I analyze the incentives of the funder and the plaintiff with respect to TPLF, respectively under the "American" rule and the "English" rule for the allocation of legal costs. The economic model is based on the

113

Hon. Lord Justice Jackson, Review of Civil Litigation Costs: Final Report, supra note 81, at 117-24.

114

See Law, Finance, and Capital Markets - A Rand Institute for Civil Justice Program, http://www.rand.org/icj/programs/lawfinance (last visited Mar. 28, 2011). 115

See Conference: Collective Redress & Litigation Funding, Sydney, Dec. 11 2009, Canberra, Dec. 12-13, 2009, law.anu.edu.au/cle/CRLF_Conf09/flyer.pdf.

116

See Conference: New Trends in Financing Civil Litigation in Europe: A Legal, Empirical and Economic Analysis, Erasmus Univ. Rotterdam, Apr. 24, 2009, http://www.frg.eur.nl/home/research/research_programmes/behavioural_approaches_to_contract_and_tort_relevance_for_policy making/financing_civil_litigation (last visited Apr. 8, 2011). 117

Geoffrey McGovern, Neil Rickman, Joseph Doherty, Fred Kipperman, Jamie Morikawa, & Kate Giglio, Trends and Implications for the Civil Justice System, Presentation at Conference: Third-Party Litigation Funding and Claim Transfer, June 2009, http://www.rand.org/content/dam/rand/pubs/conf_proceedings/2010/RAND_CF272.pdf. 118

At the center of the debate was the recent RAND paper. See Steven Garber, Alternative Litigation Financing in the United States: Issues, Knowns and Unknowns (RAND Corp. 2010), http://www.rand.org/pubs/occasional_papers/2010/RAND_OP306.pdf. 119

See Shavell, supra note 9, at 387-443.

Theresa Coetzee

Page 18 of 43 19 Cardozo J. Int'l & Comp. L. 343, *370 following assumptions: (1) all parties are rational and risk neutral; (2) if a plaintiff brings suit, there will definitively be a trial (i.e., I refrain from the possibility of settlement before trial); (3) we are in a simplified world, with only two time dimensions: T1 and T2 (the time of the TPLF agreement and the time of the judgment, respectively); (4) at T2 there are only two possible scenarios: plaintiff wins or plaintiff loses; (5) the lawyer is paid on a hourly basis, and that is included in the costs of litigation; and (6) there are no transaction costs. 1. American Rule

120

a. The Third-party Funder The funder, who is a profit maximizer, will be willing to fund a plaintiff's suit when his expected revenue (E(R)) from his investment is higher than his expected costs (E(C)), i.e., when his expected profit (E( [pi] )) is positive, being E( [pi] ) = E(R) - E(C). The funder will carefully evaluate the merit of the plaintiff's claim and estimate the size of the claim (R), i.e., the dollar amount likely to [*371] be won, and the probability of success of the claim ( [lambda] ). 121 Furthermore, the funder and the plaintiff will contractually determine the share of award that the funder will be entitled to after a judgment is reached ( [sigma] ). The funder's expected revenue is the share of the amount likely to be won multiplied by the probability of winning, such that E(R) = [sigma] ( [lambda] R). The funder's expected costs are the plaintiff's legal expenses associated with the suit, which he is obliging himself to cover by signing the contract. The funder will invest if and only if E(R) > E(C). Suppose the plaintiff holds a claim worth $ 100,000, the funder believes that the plaintiff will win at trial with a probability of 70%, the contractually determined share of the proceeds for the funder is 30%, and the expected litigation costs are $ 20,000. Here, we will have: R = 100,000 [sigma] = 30% [lambda] = 70%E(C) = 20,000 Thus, applying E(R) = [sigma] ( [lambda] R), we will have: E(R) = .3(.7(100,000)) = 21,000 Under the given conditions, because E(R) > E(C), the funder will invest. b. The Plaintiff Assuming that the plaintiff is also a profit maximizer and that he is bringing suit to receive the highest amount of money possible - and not, for example, personal vindication, which he may even be willing to pay for - we know from the basic economics of litigation that, in absence of third-party funding, the plaintiff will bring suit if his expected return from suit is higher than his expected costs. 122 In other words, the plaintiff tries to maximize his E( [pi] ), where E( [pi] ) = E(R) - E(C). In the presence of the availability of TPLF, we have two possible scenarios. In the first scenario, one with no TPLF, plaintiff's E( [pi] ) = E(R) - E(C) = [lambda] R - E(C). In the second scenario, where the plaintiff receives TPLF, we indicate the [*372] respective variables as E( [pi] )' = E(R)' - E(C)'. For the plaintiff, because the funder is entitled to a share of the awards ( [sigma] ), E(R)' = E(R) (1- [sigma] ) = [lambda] R (1 - [sigma] ). By turning to TPLF, the plaintiff does not advance any money and bears no risk, so he eliminates his expected costs and his E(C)' = 0, and therefore E( [pi] )' = [lambda] R (1 - [sigma] ). The plaintiff will be seeking third-party funding if and only if: E( [pi] ) < E( [pi] )' Or [lambda] R - E(C) < [lambda] R (1- [sigma] ) In other words, the plaintiff will be willing to contract with a litigation financing company only if he expects that giving away a share of the proceeds will result in less of a loss than risking his own money to fund the litigation. Before continuing with the explanation, it is necessary to notice that we can distinguish between two types of plaintiffs: (1) the plaintiff under a budget constraint (the "poor" plaintiff), who cannot afford to bring suit without third-

120

Under the American rule, each party pays for its own costs of litigation. See supra note 20.

121

On applying risk analysis to litigation, see R.B. Calihan et al., supra note 18, at 5-33.

122

Shavell, supra note 9, at 390.

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Page 19 of 43 19 Cardozo J. Int'l & Comp. L. 343, *372 party funding; 123 and (2) the plaintiff who does have the resources, but decides to receive external funding because he prefers it as a strategy to manage his risk associated with the litigation. Because he does not want to risk his own money, the latter is willing to pay for protection against risk. The "poor" plaintiff's expected profit under a litigation funding agreement will always be higher than without external funding. The intuition is simple; without any external funding he would not be able to bring suit and his E(R) would be zero. Instead, if he receives third-party funding, his E(C)' will be zero and his E(R)' will always be 0. Thus, the "poor" plaintiff is always better off getting third-party funding. 124 Coming back to the plaintiff who is not under a budget constraint, consider the following numerical example: [*373] R = 100,000 [sigma] = 30% [lambda] = 70%E(C) = 25,000 The plaintiff will be willing to receive external financing when:

E( [pi] ) < E( [pi] )' Thus, [lambda] R - E(C) < [lambda] R (1- [sigma] ) [(.7) 100,000 - (25,000)] < [(.7) (.7) 100,000] 45,000 < 49,000 In this example, we can conclude that the "non-poor" plaintiff would get third-party financing to cover all the costs of his litigation - eliminating any risk - and give up 30% of the award, rather than risk his own money with the hopes of keeping the entire award. After all, the plaintiff's expected profit with TPLF is higher than his expected profit without TPLF. Under all assumptions of the model he will get TPLF. 2. English Rule

125

a. The Third-party Funder Under the English rule, as well as under the American rule, the funder will be willing to invest as long as his E( [pi] ) from the investment is positive, i.e., when his E(R) > E(C). Because all costs are paid by the losing party under the English rule, the expectancies are not as linear as under the American rule. In a case that the plaintiff wins, the funder will have no costs, but if the plaintiff loses his costs will include the defendant's litigation costs (C + C). Thus, for the funder, the E(R) from the investment will be [lambda] ( [sigma] R), and his E(C) will be (1 [lambda] )(C + C). Consequently, the E( [pi] ) for the funder looks as follows: [*374] E( [pi] ) = [lambda] ( [sigma] R) - (1 - [lambda] )(C + C) Consider the following numerical example:

R = 100,000 [lambda] = 60% [sigma] = 30%C = C = 20,000 Applying E( [pi] ) = [lambda] ( [sigma] R) - (1 [sigma] )(C + C), we will have: E( [pi] ) = (.6)(.3)(100,000) - (.4) (40,000) E( [pi] ) = 18,000 - 16,000 E( [pi] ) = 2000 In this numerical example, where there is a positive expected profit of 2000, the funder will decide to fund the lawsuit. b. The Plaintiff From the viewpoint of the plaintiff, the decision to turn to TPLF depends on whether the E( [pi] ) with TPLF is higher than the E( [pi] ) without TPLF. That is to say, recalling that the apostrophe (") is used to make reference to the scenario with TPLF, the plaintiff will turn to TPLF when: E( [pi] ) < E( [pi] )' If the plaintiff sues the defendant with no external funding, then his E( [pi] ) = [lambda] R - (1 [lambda] )(C + C). If the plaintiff decides to turn to TPLF, then his E( [pi] )' = [lambda] R (1 - [sigma] ). 123

In addition to poor people, this category includes creditors in the insolvency context, where it would be impossible to pursue wrongdoers due to lack of funds.

124

Here the comparison is only between the condition of poor people with or without TPLF. I am not discussing other alternatives for financing poor people's litigation.

125

Under the English rule, the losing party pays for all litigation costs. See supra note 21.

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F

Page 20 of 43 19 Cardozo J. Int'l & Comp. L. 343, *374 Consequently, because the plaintiff will turn to TPLF as long as E( [pi] ) < E( [pi] )', he will do so when: [lambda] R - (1 - [lambda] )(C + C) < [lambda] R (1 - [sigma] ) Consider the following numerical example: R = 100,000 [lambda] = 60% [sigma] = 30%C = 20,000C = 30,000 Here, the plaintiff will turn to TPLF if and only if: [*375] (.6) 100,000 - (.4) 50,000 < (.6)(.7) 100,000 40,000 < 42,000 In this numerical example, the plaintiff will be

better off turning to TPLF than by financing the lawsuit with his own resources. A few words are worth mentioning here with respect to what I earlier referred to as the "poor" plaintiff, i.e., the claimholder under a budget constraint that prevents him from the possibility of suing the defendant. The "poor" plaintiff will also be better off turning to TPLF under the English rule, because, without external funding, he will not bring suit and his E( [pi] ) will be zero. Instead, with TPLF, his E( [pi] )' = [lambda] R (1 - [sigma] ) E( [pi] ). Under the English rule, one further possible scenario exists: a claimholder who has the resources to start a lawsuit (i.e., to pay for his own legal expenses), but who would not be able to bear the costs of an "adverse cost order" if he lost. A claimholder in such a situation would find TPLF beneficial because it eliminates the risk of an "adverse cost order" that would oblige him to pay for the winning defendant's litigation costs. B. Lessons from the Economic Model 1. Why Do the Parties Enter into Contract? The economic model has served the function of explaining when the funder and the plaintiff are willing to enter into a contract. As common intuition suggests, they will enter into a contract when the expected utilities of both are increased by the contract; 126 that is why this article represents TPLF as allowing Pareto superior allocations of property rights in litigation. 127 However, in order to see when and why the parties will actually contract, it is worthwhile to consider under what conditions TPLF will increase both parties' expected utilities. If we assume that the two parties in a financing contract have symmetric information, 128 equal predictions about the outcome of [*376] the case, and are equally risk neutral, there is no room for gains from the financing contract there is no possible [sigma] that can be agreed upon to benefit both parties. As is demonstrated in the following subsections, this is true under both the American rule and the English rule for allocation of legal expenses. a. American Rule Assume that both the funder and the plaintiff believe that the outcome of the case will be favorable by a certain percentage [lambda] , the value of the claim is of a certain amount R and that each party's litigation costs are $ 20,000. Under these conditions of perfectly symmetric information, there is no possible [sigma] that the parties will agree upon. Unless their respective expected profit under the financing contract is equal to that without the contract, there will always be a [sigma] by which one party gains and the other loses. In fact, consider the following table, using apostrophe (") to indicate the situation with the funding agreement: Funder E(R) = 0

126

Plaintiff E(C) = 0

E(R) = [lambda] R

E(C) =

See Shavell, supra note 9, at 293.

127

A change from one allocation to another is Pareto superior when at least one party is better off and no one else is worse off. See Robert Pindyck & Daniel Rubinfeld, Microeconomics, 590 (7th ed. 2009).

128

For a model of parties' litigation and settlement decisions under imperfect information, see Lucian A. Bebchuk, Litigation and Settlement Under Imperfect Information, 15 Rand Journal of Economics 404 (1984). See also, specifically on the effects of legalexpenses insurance on settlement under asymmetric information (including after-the-event legal-expenses insurance), Yue Qiao, Legal-Expenses Insurance and Settlement, 1 Asian J. L. & Econ. no. 1, art. 4 (2010).

Theresa Coetzee

LF

Page 21 of 43 19 Cardozo J. Int'l & Comp. L. 343, *376 20,000 E(R)' =

E(C)' =

E(R)' = (1 -

E(C)' = 0

[sigma] ( [lambda] R)

20,000

[sigma] ) [lambda] R

Put in terms of E( [pi] ), the following can be stated: Funder

Plaintiff

No TPLF

E( [pi] ) = 0

E( [pi] ) = [lambda] R - 20,000

Yes TPLF

E( [pi] )' = [sigma] ( [lambda] R) 20,000

E( [pi] )' = (1 - [sigma] ) [lambda] R

Because the funder and the plaintiff will only enter into contract if their respective E( [pi] )' > E( [pi] ), the following can be said of the two parties as to whether they will enter into contract: [*377] Funder iff

Plaintiff iff

[sigma] ( [lambda] R) -

(1 - [sigma] ) [lambda] R > [lambda] R

20,000 > 0

- 20,000

Or, [sigma] ( [lambda] R) >

[lambda] R - [sigma] ( [lambda] R) > [lambda] R

20,000

- 20,000

[sigma] ( [lambda] R) >

[sigma] ( [lambda] R) < 20,000

20,000

As a result, under the American rule, if both the funder and the plaintiff have perfectly symmetric information and are risk neutral, they will never enter into a contract. b. English Rule In this subsection I conduct the same test under the English rule and I reach the same conclusion. Assume that both the funder and the plaintiff believe that the claim is of a certain value R, the probability of winning [lambda] is 60%, and the total litigation costs (C = (C + C)) are 40,000. Now consider the following table, which shows the expected payoffs of alternative scenarios (with and without TPLF) for the funder and the plaintiff respectively: No TPLF

Funder

Plaintiff

E( [pi] ) = 0

E( [pi] ) = [lambda] R - (1 - [lambda] ) C

Yes TPLF

E( [pi] )' = [lambda] [sigma] R

E( [pi] )' = [lambda] R (1

- (1 - [lambda] ) C

- [sigma] )

Because both the funder and the plaintiff will only be willing to contract if their respective E( [pi] )' > E( [pi] ), then the following can be said with respect to their willingness to contract: Funder iff

Plaintiff iff

[lambda] [sigma] R - (1

[lambda] R (1 - [sigma] ) > [lambda] R

- [lambda] ) C > 0

- (1 - [lambda] ) C

Or, [*378] [lambda] [sigma] R - C +

[lambda] R - [lambda] R [sigma] > [lambda] R

[lambda] C > 0

- C + [lambda] C

(.6) [sigma] R - 40,000 +

- [lambda] R [sigma] > - C +

24,000 > 0

[lambda] C

(.6) [sigma] R - 16,000

- (.6) R [sigma] > - 16,000

>0 (.6) [sigma] R > 16,000

(.6) R [sigma] < 16,000

Theresa Coetzee

Page 22 of 43 19 Cardozo J. Int'l & Comp. L. 343, *378 As a result, under the described conditions, the funder and the plaintiff will never come into contract. c. Different Perceptions and Attitudes Towards Risk If under symmetric information the parties cannot agree on any [sigma] and thus do not come into contract, what makes them do so? The reasons why the parties come into contract seem to be of two orders. On the one hand, the parties are likely to have different perceptions of R and even more so of [lambda] . 129 On the other hand, they have different attitudes towards risk and different marginal disutility of loss. 130 While for an individual plaintiff a dispute is a single episode, a litigation financing company is a repeat player that can spread the risk across the large pool of cases it decides to finance. Consequently, while the individual claimholder is risk averse, a financing firm is more risk neutral. 2. Efficiency of TPLF It has been demonstrated and explained why, under the right conditions, both parties are made better off by TPLF, which consequently has demonstrated itself to be efficient with respect to the funder and the plaintiff. From the point of view of the funder, a TPLF contract is essentially an investment. Some concerns have been raised with respect to the fact that third parties can profit from other people's litigation in which they have no interest other than financial. However, as it has been shown earlier, investing in litigation is something that already happens - more or less directly - in other [*379] markets that have developed around property rights in litigation. 131 Furthermore, in the business world, virtually any risk other than that of litigation can be spread or eliminated via the market. 132 There is no actual difference between other markets and TPLF that would justify its prohibition on purely ethical grounds. Instead, TPLF is a system that allows claimholders and investors to efficiently manage litigation risk, because it allows the risk to be transferred from the risk-averse individual claimholder to an investor who is able to spread the risk over a large pool of cases. From the point of view of the claimholder, different problems arise. At first glance, it might seem that the funder unduly profits at the expense of the plaintiff, who would be worse off because he has to give up a share of the awards. Instead, both parties are made better off by the contract. In fact, in terms of expectations - at T1 - even the plaintiff is better off. Of course, he eventually will find himself with less money after the judgment, but that is the price he has decided to pay in exchange for the elimination of risk. The plaintiff prefers to eliminate the risk of an unfavorable outcome of the litigation and is willing to pay for it. By bargaining over property rights in litigation, the expected value of his claim increases. TPLF creates gains from trade in property rights in litigation and is thus efficient. Another possible problem might exist, from the perspective of the plaintiff, concerning the issue of whether he comes into contract voluntarily. One example is that of the "poor" plaintiff, who finds it necessary to receive TPLF in order to bring suit. I demonstrated earlier that in these cases, the plaintiff is still better off with TPLF rather than without it. However, the plaintiff might have agreed on contractual conditions that he would not have otherwise agreed on had he not found himself in a state of necessity. Another example is that of a plaintiff holding a claim with a high probability of success, who might be unaware of the high value of his claim, and bargains with a funder for a disproportionately high [sigma] in case of success. In such a case, the funder might be taking advantage of the plaintiff's lack of awareness. This issue becomes problematic especially in the case [*380] of individual plaintiffs

129

Compared to the individual plaintiff, litigation financing firms are likely to have greater expertise and thus a higher ability to evaluate the probability of the success of a claim. 130

In fact, a $ 20,000 loss is likely to negatively affect an individual plaintiff more than a well-financed litigation funding company, for which such a loss might not be as significant. 131

See supra Section II.B.

132

As J. Molot puts it, "companies not only spread business risk through the capital markets, but also dispose of some risk that they simply do not want to bear." Molot, supra note 5, at 367.

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Page 23 of 43 19 Cardozo J. Int'l & Comp. L. 343, *380 outside the commercial context (not corporate actors or professionals), and even more so in the market for litigation "loans." 133 Both situations in the two examples are problematic. However, they are not distinct from other problems that commonly emerge in social and economic life and which are addressed by the legal system in a variety of ways. A number of alternative solutions can be contemplated. In the first place, standard remedies available under contract law can be applied to TPLF contracts: for example, the common law doctrine of unconscionability could apply to vitiate particular instances of unfair TPLF dealings. 134 In the second place, regulatory strategies like mandatory provisions of information, licensing, default rules, codes of conduct 135 and others might be implemented. 136 In the third place, the benefits from a competitive market for litigation financing could be substantial, as competition among litigation financing companies would induce them to offer financing for percentages of awards closer to the real expected costs of financing. Moreover, as far as the benefits from competition are concerned, the availability of TPLF to plaintiffs would force attorneys working under contingency fee agreements to compete with litigation funders, thus disabling the monopoly enjoyed by lawyers on the determination of the percentage of their retainer, which could thus be lowered under the pressure of competition. 137 All this being said, in a competitive market where contract law and regulatory strategies ensure that no party takes advantage of the other, TPLF per se is efficient with respect to the parties involved. C. Externalities We have learnt from the economic model that TPLF is in principle efficient. At this point, the following question comes up: if TPLF is efficient, why has it received judicial and institutional resistance? And why is the question of its desirability receiving [*381] scholarly attention? On the one hand, TPLF has been contested from a rather formalistic and non-consequentialist perspective: third-party support of litigation has traditionally been prohibited by the common law doctrines of maintenance and champerty, and as such it is assumed to deserve prohibition. On the other hand, TPLF has been attacked on the grounds that it creates negative externalities. 138 To be accurate, the scholarly debate has highlighted both positive and negative externalities, which are in fact what the most recent scholarship has pivoted on. The main externalities TPLF is argued to produce are increasing access to justice, the deterrent effect on potential injurers, the increasing amount of frivolous litigation, and the increasing overall volume of litigation. I will address each of these in the next subsections, and try to highlight the most salient arguments contained in the literature. 1. Access to Justice Access to justice is a vague concept. Both terms "access" and "justice" can be interpreted in various ways, which can then combine into a variety of meanings of the concept. 139 In broad terms, access to justice is defined as the set of conditions that allows those who wish to enforce or defend their legal rights the reasonable opportunity to do so. 140 In particular, access to justice has been framed in terms of access to the legal process and access to the

133

See supra Section II.B.6.

134

Waye, supra note 25, at 153.

135

See, e.g., the consultation paper produced by the Civil Justice Council in the United Kigdom: Civil Justice Council, A SelfRegulatory Code for Third Party Funding (2010). All information is available at www.civiljusticecouncil.gov.uk. 136

Waye, supra note 25, at 161-88.

137

Id. at 134-35.

138

See Rubin, supra note 111.

139

See 4 Access to Justice (Mauro Cappelletti ed., 1978-1979); Christine Parker, Just Lawyers and Regulation of Access to Justice (1999); Deborah L. Rhode, Access to Justice (2004); Mattei, Access to Justice, supra note 4. 140

Rhode, supra note 139, at 5.

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Page 24 of 43 19 Cardozo J. Int'l & Comp. L. 343, *381 courts. 141 Furthermore, access to justice has been defined as access to due redress. 142 This article does not address the question of what should be meant by access to justice, and it will limit itself to consider access to justice in the general sense, referring to one's opportunities to defend his legal rights and to obtain due redress for the wrongs received. I mentioned earlier that TPLF increases the chances that a claimholder will act for the protection of his rights. In fact, both the "poor" plaintiff and the "non-poor" plaintiff benefit from TPLF. 143 On the one hand, the claimholder who cannot afford to [*382] bring suit will do so if he has external funding available. On the other hand, the chances that a risk-averse "non-poor" plaintiff brings suit against a wrongdoer will also increase if he does not bear the risk of litigation. This beneficial effect (from the viewpoint of the claimholder) is not to be considered an externality because it is "included" in the Pareto improvement obtained through TPLF in relation to the parties involved. Conversely, it can be inferred that the existence of a system which provides broader access to justice, which as such increases the level of equality within a given society, produces the external effect of increasing all individuals' utilities, because individuals possess, in connection with a notion of morality that includes equality, a set of tastes that affect their utility. 144 Under the classical utilitarian measure of social welfare, the overall level of social welfare rises when any individual's utility increases. Furthermore, under other measures, not just the sum, but also the distribution of utilities generally matters, and more equal distributions of utility may be superior to less equal distributions. 145 In light of these arguments, TPLF produces a positive external effect that increases social welfare. 2. Deterrence The possibility for a claimholder and an investor to bargain over property rights in litigation and to come to a TPLF agreement, apart from making both parties better off, produces an external effect on potential defendants that the law and economics literature refers to as the "deterrence" effect. 146 If potential defendants know in advance or reasonably expect that individuals, who might potentially sue them, will not do so because of lack of funds or risk aversion, then the former will have either no or at least a lesser incentive to avoid the occurrence of those events which would entitle the latter to a legal claim against the former. Optimal deterrence requires potential injurers to be aware of the fact that they will bear full costs of the harm they produce. 147 If potential injurers are aware of that, they will optimally [*383] internalize the costs of their actions so as to engage in their harmful activities to the extent that the private benefits are not outweighed by the costs, which, if the injurers are held fully liable, become private costs. The rationale that applies here is similar to that which explains why strict liability induces injurers to choose socially optimal levels of care in the economic analysis of tort law. 148 If potential injurers expect that potential victims will not sue them because of lack of funds or risk aversion, then they will be led to take a sub-optimal level of care that will result in too many wrongs. TPLF provides funds to claimholders under a budget constraint and increases the expected value of a claim held by risk-averse plaintiffs. Consequently, the availability on the market of TPLF functions as a signal for potential defendants that their counterparts will count on solid financial resources to sue them. Thus, behaviors likely to

141

See Rt. Hon. Lord Woolf, Access to Justice: Final Report (1996).

142

Waye, supra note 25, at 16.

143

See supra Sections IV.A.1.b and 2.b.

144

Shavell, supra note 9, at 601.

145

See id. at 597.

146

See Shavell, supra note 9, at 177; Steven Shavell, Strict Liability Versus Negligence, 9 J. Legal Stud. 1, 1 (1980).

147

Robert Cooter, Commodifying Liability, in The Fall and Rise of Freedom of Contract 139, 141-42 (F.H. Buckley ed., 1999).

148

See Shavell, supra note 9, at 179-80.

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Page 25 of 43 19 Cardozo J. Int'l & Comp. L. 343, *383 create more losses than benefits, which their actors would be held responsible for, are discouraged by the availability of TPLF. 3. Frivolous and Unmeritorious Litigation TPLF has been criticized on the grounds that it encourages frivolous 149 and unmeritorious litigation. 150 It has been argued that, as a matter of simple economics, increasing the amount of money available to plaintiffs makes litigation cheaper and, thus, as it happens when something becomes cheaper, there is more of a demand for it, which results in an increase of the volume of claims litigated. 151 Moreover, "third-party financing particularly increases the volume of questionable claims," 152 because such financing eliminates the incentives not to invest on non-meritorious litigation. 153 TPLF proponents have discredited this argument. 154 The central counterargument underpinning this position is that investors carefully scrutinize the cases brought by their potential [*384] clients. 155 Litigation financing firms "engage in stringent due diligence when evaluating potential investments," 156 and only invest in claims with "good prospect of success." 157 The selection of cases by the financing company works as a "filter" that leaves out frivolous and unmeritorious claims, 158 in the same way attorneys working on a contingency basis do not accept cases that are not likely to be successful. The result of this is that TPLF can be beneficial (both for "society" and for defendants) because it allows "good" claims to be litigated, while it does not support unmeritorious claims. But what is a "good" claim? A counterargument against the claim that litigation-funding firms only invest in "good" claims (identified as claims with high probability of success) is that financiers, who are risk neutral and able to spread the risk on large pools of cases, reason in terms of expected values. For a risk neutral investor, the expected value of a $ 500 million claim with only a 5% chance of success is equal to that of a $ 25 million claim with 100% probability to win. Because investors make their decision to invest based on the comparison between E(R) and E(C), they might be attracted by highly risky (unmeritorious) claims with huge damage awards at stake. 159 4. Increasing Overall Volume of Litigation Closely connected to the issue of frivolous litigation is the concern for the increasing overall (frivolous or not) volume of litigation. This is perhaps the most problematic negative externality discussed by scholarship on TPLF. Roughly speaking, by increasing the funds available to claimholders to pursue litigation, TPLF would cause an

149

On the idea of "frivolous" claims, see Robert G. Bone, Modeling Frivolous Suits, 14 U. Pa. L. Rev. 519, 529-33 (1997).

150

U.S. Chamber Institute for Legal Reform, supra note 112, at 5-7.

151

Id. at 5.

152

Id.

153

Id.

154

See generally Sebok, The Inauthentic Claim, supra note 11.

155

In particular on the pre-check by financing companies in Germany: Coester & Nitzsche. Kirstein & Rickman, supra note 94, at

89. 156

Juridica Capital Management, http://www.juridicacapital.com/how.php (last visited Mar. 28, 2011).

157

Allianz Litigation Funding, www.allianz-litigationfunding.co.uk (last visited Mar. 28, 2011).

158

At the present status of the industry, the selection is often very stringent. For example, IMF (Australia) Ltd, in its 2001-2010 experience, only funded 5% of the matters considered. Similarly, Juridica Capital Management only funded 6% of the cases considered. Data provided at the RAND ICJ Conference in Washington D.C. Conference: Alternative Litigation Finance in the U.S - Where Are We and Where Are We Headed with Practice and Policy?, Washington, D.C., May 20-21, 2010. 159

U.S. Chamber Institute for Legal Reform, supra note 112, at 6.

Theresa Coetzee

Page 26 of 43 19 Cardozo J. Int'l & Comp. L. 343, *384 increase in the overall number of [*385] claims, resulting in a more costly civil justice system. 160 It has been asserted that "even if this were true, why would this be a bad thing?" 161 If the funded claims are not fraudulent and are based on valid law, then it would not be a bad thing for these cases to increase in number, because it would mean that more legal wrongs are repaired and more wrongdoers are held accountable. 162 Perhaps society should devote more resources to the civil justice system. The question regarding the volume of litigation can also be addressed from a different perspective, namely, the social versus the private incentive to bring suit in a costly legal system. 163 This perspective does not focus on the costs of the court system that are borne by taxpayers. Instead, it focuses on the relationships between, on the one hand, the private and social costs of litigation, respectively (C) and (C + C), and, on the other, the private and social benefits of litigation, respectively [lambda] R, and the external effect on the behavior of potential defendants generally. 164 Assuming that the overall level of litigation increases due to TPLF, the question to address is whether the absolute value of the increasing social costs (C + C) - determined by the amount of litigation that depends on the private incentive to litigate under TPLF (which in turn depends on the private costs and benefits) - outweighs the absolute value of the social benefits of litigation, which can be defined as the decrease of social costs due to the precautionary activities of defendants which decreases the probability of loss to victims from p to q, where p > q. If the absolute value of litigation costs outweighs the absolute value of the deterrence benefits, then TPLF is socially undesirable; in the opposite case, TPLF is desirable. This is true under a perspective where the criterion for desirability is assumed to be the minimization of total social costs, which equals the sum of expected losses, prevention costs and expected legal expenses. 165 The following model depicts the social desirability of TPLF [*386] from the perspective of the social versus private incentive to bring suit, adopting as the starting point Shavell's model 166 and assuming the American rule for allocations of legal costs applies. Define l = loss suffered by plaintiff, where l > 0; p = probability of loss if defendants do not engage in preventive activity, p > 0; q = probability of loss if defendants do engage in preventive activity, p > q > 0; x = cost to a defendant of preventive activity; a = plaintiff's legal expenses, a > 0; b = defendant's legal expenses, where b > 0. Under Shavell's model, legal expenses apart, a social interest in affecting defendants' behavior exists when: x + ql < pl Now two scenarios will be modeled. The first is one in which plaintiffs are expected to bring suit (because of their private incentives), and thus defendants will engage in preventive activities. The social costs are: x + q(l + a + b) In the second scenario plaintiffs are not expected to bring suit; thus, defendants will not engage in precautionary activities. The social costs are: pl Consequently, when considering legal expenses, a social interest (plaintiffs bringing suit) exists when:

160

For the first attempt of empirical investigation in this direction, considering the experience of Australia, see Abrams & Chen, supra note 111.

161

Sebok, The Inauthentic Claim, supra note 11, at 68.

162

Id. See New Hampshire Ins. Co. v. McCann, 707 N.E.2d 332, 337 (Mass. 1999); Kevin Pennell, On the Assignment of Legal Malpractice Claims: A Contractual Solution to a Contractual Problem, 82 Tex. L. Rev. 481, 494-96 (2003). 163

See Steven Shavell, The Social Versus the Private Incentive to Bring Suit in a Costly Legal System, 11 J. Legal Stud. 333, 333-339 (1982).

164

Id. at 334.

165

Id. at 335.

166

Id. at 334-36.

Theresa Coetzee

Page 27 of 43 19 Cardozo J. Int'l & Comp. L. 343, *386 x + q(l + a + b) < pl TPLF is capable of affecting plaintiffs' private incentives to bring suit. I have shown in the basic model of TPLF 167 that, with no TPLF available, the plaintiff will bring suit when [lambda] R - C > 0 and, if TPLF is available, the plaintiff will turn to TPLF when [lambda] R (1 - [sigma] ) > [lambda] R - C. Consequentially, TPLF might become problematic when it creates higher incentives for the plaintiff to bring suit. When [lambda] R (1 - [sigma] ) > [lambda] R - C, the plaintiff will have a higher incentive to bring suit if TPLF is available than if it is not [*387] available. This point is crucial when it comes to questioning the social desirability of TPLF. Allowing a claimholder to bargain over his property rights in litigation with a third party increases his incentives to bring suit when there are gains from trade. Thus, allowing TPLF permits the possibility of higher incentives to bring suit; prohibiting TPLF does not. In light of the theory surrounding the social versus private incentive to bring suit, the question of the social desirability of TPLF looks as follow: does TPLF increase plaintiffs' incentives to bring suit to such an extent that the total increase in social costs - the amount which depends on the "new" incentive - outweigh the social benefits, which derive from the deterrence effect determined by the existence of TPLF on the behavior of potential defendants? If the answer is no, then TPLF is to be considered desirable. If the answer is yes, then TPLF is socially undesirable under this theory. The question, however, cannot be answered unequivocally in general terms. Instead, the social desirability of TPLF depends on many factors to be taken into consideration on a case-by-case basis. The answer will depend, apart from the costs of litigation, on the nature of defendants' activities, which could be activities for which harmfulness may or may not be substantially reduced with little marginal effort. V. TPLF: A Comparative Legal Analysis A. Common Law World 1. Traditional Prohibitions TPLF has been growing throughout the common law world during the past fifteen years. 168 However, the pace of its development has not yet been determined by free market forces as the industry has encountered resistance from courts of law which have long been debating the legal status of TPLF. On the one hand, in general terms - the range of which is broader than TPLF as "narrowly" considered in this article 169 - third-party financing of litigation has encountered its biggest obstacles in the common law [*388] prohibitions of assignment and maintenance. 170 On the other hand, in particular, the main challenge to the validity of TPLF "narrowly" considered is embodied in the common law doctrine of champerty. 171 This single doctrine will be the focus of our discussion. Although there is a disagreement about what precisely constitutes "champerty," it has been defined as "an agreement between an officious intermeddler in a lawsuit and a litigant by which the intermeddler helps pursue the litigant's claim as consideration for receiving part of any judgment proceeds." 172 Although many common law jurisdictions have abolished champerty as a tort and criminal offence, 173 the doctrine of champerty continues to

167

I consider the model under the American rule. See supra Section IV.A.1.

168

See supra Section III.B.

169

See supra Section III.A.

170

Sebok, The Inauthentic Claim, supra note 11.

171

See Paul Bond, Making Champerty Work: An Invitation to State Action, 150 U. Pa. L. Rev. 1297 (2002); Barksdale, supra note 46; Martin, supra note 43; McLaughlin, supra note 42; Richmond, supra note 43; Rodak, supra note 45; Sebok, The Inauthentic Claim, supra note 11. 172

Black's Law Dictionary 262 (9th ed. 2009).

173

Criminal Law Act, 1967, c. 13 (U.K.). Identical provision was made for Northern Ireland by Section 16 of the Criminal Justice Act, 1968, c. 28 (N.Ir.). Australian states: Maintenance, Champerty and Barratry Abolition Act 1993 (N.S.W); Civil Law (Wrongs)

Theresa Coetzee

Page 28 of 43 19 Cardozo J. Int'l & Comp. L. 343, *388 survive as a rule of public policy that can been raised to render TPLF agreements void and unenforceable. result, the legal status of TPLF is disputed.

174

As a

In general terms, what characterizes the experience of TPLF in the common law world is a tendency that traces back from an original broad prohibition of champertous agreements, towards a gradually increasing relaxation of that doctrine and contextual liberalization of the practice of third-party financial support of litigation. Before beginning the exploration of how such relaxations have taken place in the three main common law jurisdictions where TPLF has developed (Australia, the United States and the United Kingdom), it is useful to briefly explain what champerty is, its rationale, and its historical origins. 175 Champerty is considered a species within the wider category [*389] of maintenance, where to "maintain" indicates the action of one who "assists a litigant in prosecuting or defending a claim." 176 In particular, champerty is considered to be an illegal form of maintenance. 177 In the words of Justice Benjamin Cardozo, "maintenance inspired by charity or benevolence has been sharply set apart from maintenance for spite or envy or the promise or hope of gain." 178 Charitable maintenance is considered legal, while spiteful or envious maintenance, and maintenance for gain - actions encompassed by the terms champerty - are illegal. 179 An agreement in which a third party supports another's litigation in exchange for a share of the proceeds if successful but nothing in the case of loss, and where the funder's interest is solely financial, is understood to fall under the category of champertous agreements and is thus, at least in principle, considered void. The doctrine of champerty is an ancient one. It developed in medieval England as the merchant class was growing in importance and the economic power of the feudal nobles was beginning to decline. 180 In particular, the doctrine developed as a judicial and statutory 181 reaction to a practice that was taking place among feudal lords, whereby they would underwrite the costs of suits carried out by others for the recovery of land in exchange for a share of the result. Through this means, the lords could become joint owners of estates at investment prices well below the market value of the land, increasing the size of their retinues and thus aggrandizing their political power. 182 In light of this background, the doctrine of champerty seems to owe much of its rationale to a particular historical, economic, and social context that no longer subsists in the modern world. Legal rules are not unresponsive to social and economic changes; alternatively, they follow them, and adapt throughout time depending on new social contexts. 183 Due to the changes that differentiate current times from the Middle Ages, the doctrine of [*390] champerty seems to have lost its importance, which justifies loosening its severity and allowing TPLF to develop. Act 2002 (A.C.T.); Criminal Law Consolidation Act 1935 (S.A.). In the United States, only a few cases seem to have applied champerty as a tort in the last hundred years. See Waye, supra note 25, at 14. 174

Wallersteiner v. Moir, [1975] Q.B. 373 (Eng.); Trendtex Trading Corp v. Credit Suisse, [1982] A.C.Q.B. 629, 702 (Eng.); Roux v. Australian Broadcasting Comm'n [1992] 2 V.R. 577, 605 (Austl.); Quach v. Huntof Pty. Ltd. [2000] 32 M.V.R. 263 (Austl.); Smits v. Roach [2002] 42 A.C.S.R. 148. (Austl.). 175

I make reference to the existing literature for more in-depth discussions of what I summarize in this section.

176

Black's Law Dictionary 1039 (9th ed. 2009).

177

Sebok, The Inauthentic Claim, supra note 11, at 72-74.

178

In the Matter of the Estate of Gilman, 251 N.Y. 265, 271 (1929).

179

Sebok, The Inauthentic Claim, supra note 11, at 72-74.

180

Max Radin, Maintenance by Champerty, 24 Cal. L. Rev. 48, 51-52 (1935).

181

The English legislature passed a series of statutory instruments prohibiting champerty between 1275 and 1541, which are well described in Percy H. Winfield, History of Conspiracy and Abuse of Legal Process 151 (1921), and in 3 W. Holdsworth, A History of English Law 395-400 (5th ed. 1942). 182

Waye, supra note 25, at 12-13.

183

See Oliver W. Holmes, The Path of the Law, 10 Harv. L. Rev. 457, 469 (1897).

Theresa Coetzee

Page 29 of 43 19 Cardozo J. Int'l & Comp. L. 343, *390 However, according to a different view, valid reasons for prohibiting champerty still subsist. They include a desire to discourage frivolous litigation, quarrels, resistance to settlement, and interference with the attorney-client relationship, 184 which explains why courts from time to time continue to apply the prohibition of champerty to void TPLF agreements. Apart from champerty, some argue that the other chief potential legal impediment to TPLF is usury statutes. 185 Usury, the act of lending money at an unlawfully high rate of interest, is another ancient legal doctrine. 186 In its common conception, a fundamental element of usury that distinguishes it from TPLF is the borrower's absolute obligation to repay with repayment not contingent on any other event or circumstance: in TPLF, the repayment is contingent upon the plaintiff's recovery of any proceeds. In other words, usury laws apply to loans but not to TPLF agreements, which cannot be qualified as loans. 187 In the following sections, I will briefly survey how and to what extent the law in Australia, the United States, and the United Kingdom, respectively, has been moving away from a strict application of the prohibition on champerty, thus embracing an increasing liberalization of the practice of TPLF. 2. Australia Maintenance and champerty were once torts and crimes in all Australian jurisdictions. 188 However, courts allowed TPLF [*391] pursuant to settled common law exceptions: if there was a bona fide community of interest between the plaintiff and the funder, or if the plaintiff was impecunious and the funder was not acting with any collateral motive. 189 Today, legislation in the Australian Capital Territory, New South Wales, South Australia and Victoria has expressly abolished maintenance and champerty both as a crime and as a tort. 190 In these jurisdictions, however, courts may set aside a TPLF agreement if it is found to be inconsistent with public policy considerations upon which the prohibition was based at common law. 191

184

A.L.G., The Effect of Champerty in Contractual Liability, 79 L. Q. Rev. 493, 494 (1963).

185

See Susan L. Martin, Financing Litigation On-Line: Usury and Other Obstacles, 1 DePaul Bus. & Com. L.J. 85, 89-94 (2002). Other opinions that consider the relevance of usury for TPLF include: McLaughlin, supra note 42; Rodak, supra note 45; Barksdale, supra note 46; Richmond, supra note 43; Martin, supra note 43; Waye, supra note 25. 186

The world's first recorded usury law was part of the Babylonian Code of Hammurabi, circa 1700 B.C.

187

In Echeverria v. Estate of Lindner, No. 018666/2002, 2005 WL 1083704, at 6 (N.Y. Sup. Ct. Mar. 2, 2005), Judge Warshawsky wrongfully considered a litigation funding agreement a "loan" based on the fact that a positive outcome of the suit was a "sure thing," because the plaintiff was suing under a statute that imposed strict liability. That judgment has to be considered wrong because recovery in civil cases is not a "sure thing" just for the fact of being based on strict liability. See supra note 44. 188

In Australia, the common law prohibition of litigation funding was justified in part by the concern that the judicial system should not be the site of speculative business ventures. However, the primary aim was to prevent abuses of court process (vexatious or oppressive litigation, elevated damages, suppressed evidence, suborned witnesses) for personal gain. Litigation Funding in Australia, supra note 58, at 4. 189

Id. at 4.

190

Civil Law (Wrongs) Act 2002 (A.C.T.) s. 221 (Austl.); Maintenance, Champerty and Barratry Abolition Act 1993 (N.S.W.) ss. 3, 4, 6 (Austl.); Criminal Law Consolidation Act 1935 (S.A.) sch. 11, ss. 1(3), 3 (Austl.); Wrongs Act 1958 (Vic) s. 32 (Austl.); Crimes Act 1958 (Vic) s. 322A (Austl.). 191

See, e.g., Maintenance, Champerty and Barratry Abolition Act 1993 (N.S.W.) s. 6 (Austl.); Wrongs Act 1958 (Vic) s. 32(2) (Austl.).

Theresa Coetzee

Page 30 of 43 19 Cardozo J. Int'l & Comp. L. 343, *391 Since 1995, a new statutory exception to the rule against champerty has developed. Under their statutory powers of sale, 192 insolvency practitioners may now contract for the funding of lawsuits if these are characterized as company property. Many such actions are for voidable transactions or misfeasance by company officers. 193 Litigation funding companies emerged to serve this market, 194 and most litigation funding continues to be under the statutory exception for insolvencies. However, a number of companies have begun to fund non-insolvency plaintiff lawsuits. 195 The legitimacy of TPLF agreements outside insolvency was challenged by courts of law, producing a series of conflicting judicial decisions. 196 Central to the question on the legitimacy of TPLF is a series of conflicting public policy arguments. On the one hand, access to justice has become a powerful consideration [*392] for courts in approving these new funding arrangements. On the other hand, defendants challenge courts arguing the traditional prohibitions of maintenance and champerty. Access to justice has played a fundamental role in leading courts in Australia (as well as in the United Kingdom) to approve funded proceedings 197 to such an extent that, despite numerous challenges in the last decade, no funding agreements have been stricken down in Australian courts. Until recently, however, TPLF in cases other than insolvency cases was still uncertain. In 2006, the Australian High Court in Campbells Cash & Carry Pty Ltd v. Fostif Pty Ltd 198 resolved the conflict and gave its imprimatur to litigation funding. 199 Since then, TPLF has been growing and other judges have endorsed commercial litigation funding for its potential to "inject a welcome element of commercial objectivity into the way in which [litigation] budgets are framed and the efficiency with which litigation is conducted," 200 as well as to foster the aims of Australian class action legislation. 201 Support for commercial litigation funding has also come from outside the courts, namely from the Law Council of Australia, 202 the NSW Young Lawyers Civil Litigation Committee & Pro Bono TaskForce, 203 and the Law Institute

192

For example, the powers of disposal given to a receiver to dispose of a company's property under the Corporations Act 2001 (Cth) s. 420(2)(b) and (g) (Austl.). See also the powers of disposal accorded to a liquidator by Corporations Act 2001 (Cth) s. 477(2)(c) (Austl.). Statutory powers of sale also arise from provisions of the Bankruptcy Act 1966 (Cth) (Austl.), and for trustees in all jurisdictions.

193

Litigation Funding in Australia, supra note 58, at 5.

194

See supra Section III.B.

195

For two examples, see QPSX Ltd v. Ericsson Australia Pty. Ltd. (2005) F.C.A. 933 (Austl.) and Fostif v. Campbell Cash & Carry (2005) N.S.W.C.A. 83 (Austl.).

196

The key cases are discussed in Fostif v. Campbells Cash & Carry Pty. Ltd. (2005) N.S.W.C.A. 83 (Austl.).

197

See also Waye, supra note 25, at 63-67.

198

Campbells Cash & Carry Pty. Ltd. V. Fostif Pty. Ltd. (2006) 229 A.L.R. 58 (Austl.).

199

Waye, supra note 25, at 55.

200

QPSX Limited v. Ericsson Australia Pty. Ltd. (2005) F.C.A. 933, at 54 (Austl.).

201

Kirby v. Centro Prop. Ltd. (2008) F.C.A. 1505 (Austl.).

202

See Law Council of Austl., Standing Committee of Attorneys-General (Sept. 14, 2006), http://www.lawcouncil.asn.au/shadomx/apps/fms/fmsdownload.cfm?file_uuid=8C744AB2-1C23-CACD-22975D181CEBB545&siteName=lca. 203

available

at

NSW Young Lawyers Civil Litig. Comm. & NSW Young Lawyers Pro Bono TaskForce, Joint Submission to the Standing Committee of Attorney Generals' Review into Litigation Funding in Australia (2006), http://www.lawsociety.com.au/idc/groups/public/documents/internetyounglawyers/025814.pdf.

Theresa Coetzee

Page 31 of 43 19 Cardozo J. Int'l & Comp. L. 343, *392 of Victoria. 204 Furthermore, the Federal Financial Services Minister recently commenced an inquiry as to how litigation funders might be regulated by the Australian Securities and Investment Commission (ASIC), which is the Australian equivalent of the U.S. Securities and Exchange Commission, and stated that it is possible that some form of [*393] regulation will be introduced during 2010. 205 3. United States The doctrines of maintenance and champerty traditionally are also found in U.S. state common law, where they typically relate back to the English common law doctrines which were previously received and maintained following the American Revolution. 206 The two doctrines are very much interrelated or, more precisely, champerty is a form of maintenance - namely an illegal form of maintenance. 207 Restrictions to maintenance exist in varying degrees across U.S. states. All states now permit at least one form of maintenance - lawyer's contingency fees 208 - while, conversely, all states prohibit at least what is referred to as "malice maintenance," i.e., when a third party supports a stranger litigant for pure spite of malevolence toward the target of the person aided by the maintainer. 209 As it appears from these two examples, many conceptions of maintenance exist that are prohibited in varying degrees across U.S. states. 210 What is of interest here is what is referred to as "profit maintenance," or champerty. The legal status of champerty in the United States is not uniform and its picture is quite complex. 211 For the purpose of this section of the article - that of providing an overview of the status of TPLF in the common law world I will use the following paragraphs to summarize the evolution of the legal status of TPLF in the United States, referring to the existing literature for more detailed observations. 212 As in Australia, champerty is neither a tort nor a crime in [*394] most U.S. states, but its most visible impact is as a contract defense. 213 Until the emergence of TPLF, 214 however, U.S. courts rarely enforced the doctrine of champerty. When TPLF first emerged, American courts rarely enforced the doctrine of champerty to void TPLF agreements. Some courts expressly took the position in favor of the abolition of maintenance and champerty on the grounds that those doctrines no longer responded to the need of protecting against speculations in lawsuits, the

204

See Bernard Murphy & Camille Cameron, Access to Justice and the Evolution of Class Action Litigation in Australia, 30 Melb. U. L. Rev. 399, 438 (2006); John North, Litigation Funding: Much to be Achieved with the Right Approach, 43 L. Soc'y J. 66, 69 (2005). 205

Charlie Gollow, Inv. Manager, IMF (Austl.) Ltd., Trends and Developments in Australian Litigation Funding, Presentation at the RAND ICJ Conference: Alternative Litigation Finance in the U.S.: Where Are We and Where Are We Headed with Practice and Policy?, Washington, D.C. (May 21, 2010). 206

Sebok, The Inauthentic Claim, supra note 11, at 98.

207

See supra Section V.A.1.

208

Lawyers' contingency fees have also been defined as an exception to the prohibition of champerty. See Martin, supra note 43, at 57; Sebok, The Inauthentic Claim, supra note 11, at 100.

209

Sebok, The Inauthentic Claim, supra note 11, at 102.

210

For a detailed discussion, see id. at 94.

211

For an in-depth analysis, see id. at 107. According to Sebok, restriction on champerty can be classified under three categories: (1) restrictions on what lawsuits may be maintained for profit; (2) restrictions on how lawsuits may be maintained for profit; and (3) restrictions on the cause of the maintenance for profit. See id. at 108. 212

See id. at 74; Bond, supra note 171, at 1333-41 (who offers an overview of champerty law in all fifty-two states).

213

As such, its visibility in case law is somehow proportional to the amount of champertous agreements. Id. at 1304.

214

See supra Section III.B.

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Page 32 of 43 19 Cardozo J. Int'l & Comp. L. 343, *394 bringing of frivolous claims, and other public policy concerns that could be addressed more efficiently by other means. 215 At the turn of the new millennium, there has been a judicial backlash against commercial investment in litigation in the United States. 216 A number of U.S. courts have taken a negative view and have used champerty 217 and other doctrines - in particular usury 218 - as significant obstructions to commercial investments in litigation. The recent situation in the United States is not uniform and can be organized into four categories: (1) states where champerty is subject to statutory prohibition; 219 (2) states where its prohibition is embodied in the common law; 220 (3) states where it remains relevant only as a principle of public policy; and (4) states where it is permitted, 221 sometimes explicitly. 222

215

Hardick v. Homol, 795 So. 2d 1107 (Fla. 5th Dist. Ct. App. 2001); Osprey, Inc. v. Cabana Ltd. P'ship, 532 S.E.2d 269 (S.C. 2000); Saladini v. Righellis, 687 N.E.2d 1224 (Mass. 1997). 216

217

Waye, supra note 25, at 111. Rancman v. Interim Settlement Funding Corp., 99 Ohio St.3d 121 (Ohio 2003).

218

See, e.g., the position of the lower courts then reversed by the Ohio Supreme Court in Rancman, 99 Ohio St.3d 121 (Ohio 2003). 219

See, e.g., Ga. Code Ann. § 13-8-2 (West 2009); Ky. Rev. Stat. Ann. § 372.060 (West 1942); La. Civ. Code Ann. art. 2447 (1995) (but only applies to purchases by attorneys and officers of the court); Miss. Code Ann. § 97-9-11 (West 1976); N.Y. Judiciary Law § 489 (McKinney 2004). 220

See, e.g., Midtown Chiropractic v. Illinois Farmers Ins. Co., 812 N.E. 2d 851 (Ind. Ct. App. 2004); Johnson v. Wright, 682 N.W.2d 671 (Minn. Ct. App. 2004); Fleetwood Area School Dist. v. Berks Cnty Bd. of Assessment Appeals, 821 A.2d 1268 (Pa. Commw. Ct. 2003); Toste Farm Corp. v. Hadbury, Inc., 798 A.2d 901 (R.I. 2002). The examples are among those reported by Waye, supra note 25, at 112. 221

Based upon the survey offered by Bond, supra note 171 (Appendix), reported and updated by Sebok, The Inauthentic Claim, supra note 11, twenty-eight U.S. states permitted champerty as of 2002: Me. Rev. Stat. tit. 9A, § 12-101 (2007) (partially amending Me. Rev. Stat. tit. 17A, § 516(1) (1975)); Ohio Rev. Code Ann. § 1349.55 (West 2008) (reversing Rancman v. Interim Settlement Funding Corp., 99 Ohio St.3d 121 (Ohio 2003)); Landi v. Arkules, 835 P.2d 458 (Ariz. Ct. App. 1992); Abbott Ford, Inc. v. Superior Court, 741 P.2d 124 (Cal. 1987); Fastenau v. Engel, 240 P.2d 1173 (Colo. 1952); Robertson v. Town of Stonington, 750 A.2d 460 (Conn. 2000); Kraft v. Mason, 668 So.2d 679 (Fla. Dist. Ct. App. 1996); TMJ Hawaii, Inc. v. Nippon Trust Bank, 153 P.3d 444 (Haw. 2007); Wright v. Meek, 3 Greene 472 (Iowa 1852); Boettcher v. Criscione, 299 P.2d 806 (Kan. 1956); Martin v. Morgan Drive Away, Inc., 665 F.2d 598 (5th Cir. 1982); Son v. Margolius, Mallios, Davis, Rider & Tomar, 709 A.2d 112 (Md. 1998); Saladini v. Righellis, 687 N.E.2d 1224 (M.A. 1997); Smith v. Childs, 497 N.W.2d 538 (Mich. Ct. App. 1993); Schnabel v. Taft Broad Inc., 525 S.W.2d 819 (Mo. Ct. App. 1975); Green v. Gremaux, 945 P.2d 903 (Mont. 1997); Adkin Plumbing & Heating Supply Co. v. Harwell, 606 A.2d 802 (N.H. 1992); Polo v. Gotchel, 542 A.2d 947 (N.J. Super. Ct. Law Div. 1987); Leon v. Martinez, 638 N.E.2d 511 (N.Y. 1994); Odell v. Legal Bucks, LLC, 665 S.E.2d 767 (N.C. Ct. App. 2008); Interstate Collection Agency, Inc. v. Kuntz, 181 N.W.2d 234 (N.D. 1970); Mitchell v. Amerada Hess Corp., 638 P.2d 441 (Okla. 1981); Brown v. Bigne, 28 P. 11 (Or. 1891); Osprey v. Cabana Ltd. P'ship, Inc., 532 S.E.2d 269 (S.C. 2000); Record v. Ins. Co. of N. Am., 438 S.W.2d 743 (Tenn. 1969); Anglo-Dutch Petroleum Int'l, Inc. v. Haskell, 193 S.W.3d 87 (Tex. App. 2006); Giambattista v. Nat'l Bank of Commerce of Seattle, 586 P.2d 1180 (Wash. Ct. App. 1978); and Currence v. Ralphsnyder, 151 S.E. 700 (W. Va. 1929). 222

As reported by A. Sebok, sixteen U.S. states now explicitly permit champerty as a form of maintenance for profit: CO: Fastenau v. Engel, 240 P.2d 1173 (Colo. 1952); CT: Robertson v. Town of Stonington, 750 A.2d 460 (Conn. 2000); FL: Kraft v. Mason, 668 So. 2d 679 (Fla. 1996); IA: Wright v. Meek, 3 Greene 472 (Iowa 1852); KS: Boettcher v. Criscione, 299 P.2d 806 (Kan. 1956); ME: Me. Rev. Stat. tit. 9A § 12-101 (2009) (partially amending Me. Rev. Stat. 17A § 516(1) (2009)); MD: Son v. Margolius, Mallios, Davis, Rider & Tomar, 709 A.2d 112 (Md. 1998); MA: Saladini v. Righellis, 687 N.E.2d 1224 (M.A, 1997); MO: Schnabel v. Taft Broad. Co., 525 S.W.2d 819 (Mo. App. 1975); NH: Adkin Plumbing & Heating Supply Co. v. Harwell, 606 A.2d 802 (N.H. 1992); NC: Odell v. Legal Bucks, LLC, 665 S.E.2d 767 (N.C. App. 2008); OH: Orc Ann. 1349.55 (2009)

Theresa Coetzee

Page 33 of 43 19 Cardozo J. Int'l & Comp. L. 343, *394 [*395] Even in states that have retained champerty, it has been argued that the doctrine is on the wane, in light of developments that have considerably broadened the exceptions to the champerty prohibition. 223 First, champerty only applies to TPLF where the party sharing in the proceeds has no legitimate interest in the outcome of the action. 224 Second, champerty (and maintenance) cannot be established unless there is officious intermeddling. Thus, the doctrines may not apply where the maintained party has initiated suit prior to entering a TPLF agreement, where the funder plays no role in the conduct of the litigation and where the terms of the financing agreements are fair. 225

From these exceptions, one can conclude that the doctrine of [*396] champerty covers a much broader set of situations than TPLF (as "narrowly" considered in this article), namely a funding agreement where the funder acquires no control of the litigation. 226 As briefly mentioned earlier, 227 the issue of who retains control of the litigation is of fundamental relevance for the law. Assume to represent with a line a series of situations. On one end is TPLF narrowly considered where no control is transferred from the claimholder to the funder. On the opposite end is a funding agreement in which the claimholder transfers to the funder complete control over the lawsuit: this extreme situation coincides with what is referred to as "assignment" of claims. The assignment of a claim falls under a different doctrine, the common law rule of non-assignability. 228 Between these two extreme solutions is an indefinite quantity of intermediate situations that can fall under the realm of either common law doctrine. The distinction between maintenance, champerty, and assignment is extremely faded. As far as TPLF in its "narrow" definition is concerned, as of late courts have broadened the exceptions to the prohibition of champerty, thus paving the way for further development of the TPLF industry. 229 Conversely, outside the courts, TPLF has been strongly attacked: the U.S. Chamber Institute for Legal Reform published in October of 2009 a report that takes a firm position against TPLF and advocates for its prohibition. 230 4. United Kingdom The experience of the United Kingdom is similar to the Australian one to the extent that TPLF first developed in the context of insolvency before expanding to the whole realm of commercial litigation. Furthermore, unlike Australia (and the United States), the UK experience has demonstrated that TPLF need not to be so confined, but it can expand outside the commercial context into what is commonly referred to as the personal injury sphere. 231 Apart from the development of case law on litigation funding, [*397] the English government's substantial shift in public policy from public mechanisms of financing poor people's litigation (legal aid) towards market-based alternatives during the 1990s, was an important factor that contributed to the expansion of TPLF in the United Kingdom, especially for non-commercial matters. The reforms that were enacted at the end of the 1990s were stimulated by the increases in legal aid expenditure and were specifically adopted in order to shift the funding of non-commercial litigation away from the public purse. The Access to Justice Act of 1999 removed legal aid for all civil cases involving monetary claims and introduced conditional fees and after-the-event insurance as new, private (reversing Rancman, 99 Ohio St.3d 121(2003)); OK: Mitchell v. Amerada Hess Corp., 638 P.2d 441 (Okla. 1981); OR: Brown v. Bigne, 28 P. 11 (Or. 1891); WA: Giambattista v. Nat'l Bank of Commerce of Seattle, 586 P.2d 1180 (Wash. App. 1978); and WV: Currence v. Ralphsnyder, 151 S.E. 700 (W. Va. 1929). Sebok, The Inauthentic Claim, supra note 11, at 99. 223

Waye, supra note 25, at 113.

224

For examples and cases, see id. at 113.

225

Id. at 114.

226

See supra Section III.A.

227

See supra Section II.B.5.

228

Sebok, The Inauthentic Claim, supra note 11, at 74.

229

Waye, supra note 25, at 113.

230

U.S. Chamber Institute for Legal Reform, supra note 112. For comment, see supra Section IV.C.3.

231

Waye, supra note 25, at 105.

Theresa Coetzee

Page 34 of 43 19 Cardozo J. Int'l & Comp. L. 343, *397 and market-based alternatives to finance litigation. 232 The Act in principle did not mention litigation funding, which was introduced as a result of an amendment sought in the House of Lords, 233 which, however, has never been brought into effect. 234 The Access to Justice Act of 1999 can be considered the outcome of a general shift in public policy that matured during the 1990s concerning access to justice, which has been of important background relevance for the development of TPLF. Until the beginning of the 1990s, the law on champerty and maintenance in the United Kingdom looked as follows: the common law principle was that contracts involving maintenance or champerty were void for public policy unless they fell within recognized exceptions, such as the common interest exception 235 or the statutory insolvency exceptions. 236 However, in 1994, Giles v. Thompson 237 represented a fundamental change in British judicial [*398] thinking with respect to maintenance and champerty. Following Giles, English courts tended to consider that there are no longer public policy reasons supporting the general prohibition of third-party funding agreements limited by some exceptions. Conversely, the new position of United Kingdom courts is that no prohibition on maintenance and champerty applies, with the exception of the case of wanton and officious intermeddling 238 and the case of trafficking in legal claims, 239 which are often intertwined. 240 Once again, central to the evaluation of the validity of a litigation funding agreement is the issue of who controls the litigation. English courts maintain strong resistance against the cession of control from the claimholder to the funder. A TPLF agreement that contemplates full transfer of control to the funder is void for champerty. 241 However, absent the cession of control, agreements providing assistance to claimholders in exchange for a portion of the proceeds of the litigation (i.e., TPLF as considered in this article) are valid under current UK law, 242 provided that they do not involve litigators subject to the conditional fee regime. 243

232

See Access to Justice with Conditional Fees, supra note 25.

233

See Access to Justice Bill, 1998-9, H.L. Bill [58B] cl. http://www.publications.parliament.uk/pa/cm199899/cmstand/e/st990513/am/90513s01.htm. 234

38

(Eng.),

available

at

Waye, supra note 25, at 87.

235

Traditionally the common interest had to derive from the subject matter of the claim, rather than being a commercial interest coincidental to the claim (Alabaster v. Harness, [1895] 1 Q.B. 339 (Eng.)). However, in the 1990s, that requirement was relaxed allowing for any genuine commercial interest to be the basis for an exception to the common law position (see comments in Giles v. Thompson, [1993] 3 All E.R. 321, 333 (Eng.)).

236

As noted by Waye, supra note 25, at 106-07, in England, the general position in relation to insolvency office holders such as liquidators or trustees in bankruptcy is that those office holders are exempt from prohibitions arising in champerty and maintenance preventing the assignment of legal claims. Norglen Ltd. (in liq) v. Reeds Rains Prudential Ltd., [1999] 2 A.C. 1 (Eng.); Ramsey v. Hartley, [1977] 1 W.L.R. 686 (Eng.); Guy v. Churchill, [1888] 40 Ch. D. 481 (Eng.); In re Park Gate Waggon Works Co., [1881] 17 Ch. D. 234 (Eng.); Seear v. Lawson, [1880] 15 Ch. D. 729 (Eng.). 237

Giles v. Thompson, [1994] 1 A.C. 142 (Eng.).

238

Ahmed v. Powell, [2003] P.N.L.R. 22 (Eng.); Factortame & Ors v. Sec'y of State for Transport, Local Government and the Regions (No. 8) [2003] Q.B. 381 (Eng.). 239

Trendtex Trading Corp. v. Credit Suisse, [1982] A.C. 679, 683 (Eng.).

240

Waye, supra note 25, at 104.

241

Ahmed v. Powell, [2003] P.N.L.R. 22 (Eng.).

242

This approach is confirmed by the recently proposed Code of Conduct for the Funding by Third Parties of Litigation in England and Wales, proposed for consultation by the Civil Justice Council to civil justice stakeholders in the summer of 2010. See Civil Justice Council, supra note 135.

243

If a conditional fee regime applies, funding agreements must conform to its requirements. See Factortame & Ors v. Sec'y of State for Transport, Local Government and the Regions (No. 8) [2003] Q.B. 381 (Eng.); Awwad v. Geraghty & Co., [2001] Q.B. 570 (Eng.).

Theresa Coetzee

Page 35 of 43 19 Cardozo J. Int'l & Comp. L. 343, *398 The TPLF industry is rapidly growing in the United Kingdom 244 in a climate that is moving towards increasing liberalization. This trend is supported both by the government through public policy and by courts through case law. Six years ago, Arkin v. Borchard Lines Ltd. 245 was the first case where the courts indicated that third-party funding should not only be tolerated but also encouraged as a useful tool for facilitating access to justice. 246 Furthermore, the climate of support that reigns in the United Kingdom has found recent expression in the report by the [*399] Rt. Honorable Lord Justice Jackson on the costs of civil litigation that was published in January of 2010. Justice Jackson stated that "in some areas of civil litigation costs are disproportionate and impede access to justice." 247 With the scope in mind of "proposing a coherent package of interlocking reforms, designed to control costs and promote access to justice," 248 Justice Jackson stated that third-party funding is beneficial and should be supported in that it promotes access to justice. 249 B. Civil Law World 1. Traditional Prohibitions? In the civil law world no specific legislative or judicial prohibitions seem to apply to TPLF. However, the industry is not developed. According to a recent report in the civil law world: 250 in Argentina "there is no regulation on this issue;" in Brazil "third party funding is not prohibited;" in Bulgaria "neither special regulation nor restrictions on third party funding are provided;" in Estonia "third party funding of claims is permitted based on the general rules governing the performance of obligation by third party;" in Finland "generally speaking, third party funding of claims is not restricted but not very common;" in France "third-party funding is not forbidden per se. As French lawyers can only be paid by their clients or the clients' agent (article 11.3 of the National Bar Association Rules), third-party funding appears possible under French law provided that the private party concludes a contract with the plaintiff governing the funding and apportioning of the damages obtained, and does not directly pay the lawyers' fees." In Italy, "third party funding is possible but not frequent;" in Latvia "there are no restrictions on third party funding of claims; however, it is not common practice in Latvia;" in Mexico "there is no express prohibition about third party funding neither on the Federal Bill nor in the Mexico City Bill;" in [*400] Slovakia "although third party funding is not prohibited (however not regulated) under Slovak law, if at all, it is rarely used;" in Spain "although nothing under Spanish law prohibits it, there is no experience of third party funding in the Spanish day-to-day practice." 251 In all these countries, despite the absence of formal prohibitions, third-party funding of litigation is virtually nonexistent. Furthermore, in most Asian countries TPLF is not officially available, although some countries belonging to the civil law tradition, such as China and Japan, 252 are considering introducing it. 253 The only

244 245

See supra Section III.B. Arkin v. Borchard Lines Ltd., [2005] 2 Lloyd's Rep. 187 (Eng.).

246

Waye, supra note 25, at 105.

247

Hon. Lord Justice Jackson, supra note 81, at i.

248

Id.

249

Id. at 117. The Civil Justice Council (CJC) has expressed a similar view. See Civil Justice Council, Report, Improved Access to Justice -Funding Options and Proportionate Costs, Chapter C and Recommendation 3, 53 (June 2007). 250

Here I am following the classification of legal systems offered by the research group JuriGlobe at the University of Ottawa. Univ. of Ottawa, World Legal Systems Research Group, http://www.juriglobe.ca/eng/index.php (last visited Mar. 28, 2011). 251

Global Research Group., International Comparative Legal Guide to: Class & http://www.iclg.co.uk/khadmin/Publications/pdf/3167.pdf [hereinafter Class & Group Actions 2010].

252

Group

Actions

(2010),

China and Japan are seen as belonging to the civil law world, though as "mixed systems of civil law and customary law," see the classification made available by JuriGlobe, supra note 250.

253

Y. Qiao, supra note 128.

Theresa Coetzee

Page 36 of 43 19 Cardozo J. Int'l & Comp. L. 343, *400 exceptions to the absence of TPLF in the civil law world - at least in the everyday practice - seem to be Germany, Austria and Switzerland. 254 Because no prohibitions seem to apply, the reasons why TPLF has not developed in the civil law world are not clear. This article argues that possible explanations should be looked for in some general structural and cultural characteristics of civil law jurisdictions, rather than in any positive rule. A number of factors are worth underlying that might have significance in the explanation of why TPLF has not developed in the civil law world. Before entering that inquiry, however, it is worth briefly analyzing the German experience with TPLF from a legal point of view. 2. Germany TPLF in Germany operates in the framework of the following context: as a rule, legal costs are borne by the losing party (or apportioned between the parties); 255 costs are often high, are fixed by law 256 and include court fees 257 and attorney fees; 258 additional [*401] costs particular to a case, including witnesses and expert reports, may arise for the means of proof. 259 In light of this context, high litigation costs determine a financial risk that can be prohibitive for the plaintiff. Contingency fees, which might be a solution for the elimination of the plaintiff's risk, are prohibited. This background scenario seems to have favored the emergence of TPLF, which relieves plaintiffs of the costs connected with initiating a lawsuit. TPLF was introduced in Germany by FORIS in 1998 and is now offered by a number of companies. 260 TPLF contractual agreements, previously unknown in Germany, seem now to have taken a quite harmonious default structure within the industry. 261 Of interest here, however, are not the contractual rules that govern the relationship between the parties, but rather how TPLF contracts are considered from the perspective of their legal character and validity. As far as the legal character of TPLF contracts is concerned, the prevailing opinion in German literature 262 is that TPLF contracts create silent partnerships under the German Civil Code (Stille Gesellschaft burgerlichen Rechts) between the funder and the plaintiff. 263 This partnership is not registered in the commercial register, and the

254 In

Switzerland, a third party can agree to cover the costs of litigation. In return, the third party may agree to accept a share of the outcome of the litigation." Class & Group Actions 2010, supra note 251, at 150.

255

Zivilprozessordnung [Civ. Pro. Code] § 91 (F.R.G.). For an economic model, see supra Section IV.A.2.

256

Gerichtskostengesetz [Court Fees Act] (F.R.G.) and Rechtsanwaltsvergutungsgesetz [Attorney Remuneration Act] (F.R.G.).

257

Court fees are directly proportional to the value of the claim, increasing at a diminishing marginal rate. See Coester & Nitzsche, supra note 94, at 84.

258

Introduction to German Law 377 (Mathias Reimann & Joachim Zekoll eds., 2d ed. 2005).

259

Coester & Nitzsche, supra note 94, at 84.

260

See supra Section III.B.

261

For an in-depth analysis of the contractual agreement regulating the relationship between a plaintiff and a funder, see Coester & Nitzsche, supra note 94, at 87-94.

262

See id. at 95; N. Dethloff, Vertrage zur Prozessfinanzierung gegen Erfolgsbeteiligung, Neue Juristische Wochenschrift 2225, 2227 (2000) (F.R.G.). See also Dirk Bottger, Gewerbliche Prozessfinanzierung und Staatliche Prozesskostenhilfe: Am Beispiel der Prozessfuhrung durch Insolvenzverwalter (2008) (F.R.G.). 263

It is interesting to notice here the typical civil lawyer's attitude toward trying to bring back innovative contractual agreements within the pre-determined contractual "types" designed in the civil code. See Mauro Bussani, Liberta Contrattuale e Diritto Europeo 28-35 (2005) (Italy).

Theresa Coetzee

Page 37 of 43 19 Cardozo J. Int'l & Comp. L. 343, *401 personal liability of the parties is unlimited. insurance contract. 266

264

The financing contract is not considered a loan agreement

265

or an

[*402] It is argued that a silent partnership under the German Civil Code arises in TPLF because the funder and the claimholder are pursuing a joint aim; the common goal of both parties is to assert the plaintiff's claim before a court and to achieve the highest possible award. 267 A comment deserves attention here. The existing literature on TPLF, both in the common law and civil law world, has highlighted the existence of possible conflicts of interest between the funder and the plaintiff. Consequently, if on the one hand, it is true that the funder and the plaintiff are moved by a common scope, then on the other hand, at some point, their interests and goals can diversify. 268

The possible solution to this apparent contradiction concerns, once again, the issue of control. In my opinion, it moves from a descriptive toward a normative dimension. It has been argued that the partnership created by a TPLF contract is an undisclosed partnership, i.e., one in which only one partner - the plaintiff - is entitled to represent the partnership vis-a-vis third parties. 269 Furthermore, the plaintiff asserts the claim in his own name and decides on all steps to be taken independently. 270 This might certainly be a descriptive assertion (in that it describes what in fact happens), but in my view, it is relevant in a normative dimension - that is to say that a TPLF agreement should be considered a silent partnership, and, thus, valid, as long as the funder does not acquire any control over the lawsuit. Once again - as in the common law world - central to the validity of TPLF is the issue of control: if no control is transferred to the funder, TPLF does not seem to present any particular problem. Another reason to interpret TPLF contracts as creating silent partnerships - as opposed to ordinary partnerships - is that no partnership asset exists. Notwithstanding the existence of a TPLF contract, the plaintiff's and the funder's assets remain strictly [*403] separated. 271 The financing company, which is the silent partner, contributes to the partnership through the assumption of financial risk (through the advancement of payments) relating to the claimholder's lawsuit. 272 After the final court decision, the partnership is liquidated according to the rules established in the contract. 273 As far as the validity of TPLF is concerned, the prevailing opinion is that TPLF is permissible. The main problem 274 it encounters lies in its relationship with the prohibition of lawyers' contingency fees. Contingency fees, according to which a lawyer advances all litigation costs of his client in exchange for a share of the proceeds in

264

Coester & Nitzsche, supra note 94, at 94.

265

A loan exists only where the borrower is obliged to pay back the received amounts under no contingency. In TPLF contracts, the plaintiff is only obliged to repay if he is successful and receives from the defendant the amount advanced by the funder. The same argument has been made in the context of U.S. law. Echeverria v. Estate of Lindner, 2005 WL 1083704, at 6. See supra note 44 and comments therein. 266

An insurance contract requires that the insurance coverage be provided in return for a premium. See M. Henssler, Risiko als Vertragsgegenstand 373 (1994) (F.R.G.); Coester & Nitzsche, supra note 94, at 95. 267

Coester & Nitzsche, supra note 94, at 95.

268

Vicki Waye, Conflicts of Interests Between Claimholders, Lawyers and Litigation Entrepreneurs, 19 Bond L. Rev. 225, 249 (2007) (discussing the existence of possible conflicts of interest between the funder and the plaintiff in common law); Toggenburger, supra note 101, at 627 (discussing the existence of possible conflicts of interest between the funder and the plaintiff in civil law). 269

Coester & Nitzsche, supra note 94, at 95.

270

Id.

271

Id.

272

Id.

273

Id. at 95.

274

For a description of other minor problems, see Coester & Nitzsche, supra note 94, at 98-101.

Theresa Coetzee

Page 38 of 43 19 Cardozo J. Int'l & Comp. L. 343, *403 case of success and nothing in case of loss, are prohibited in Germany. 275 Critics of TPLF have argued that TPLF essentially serves the same function as contingency fees. 276 In fact, from the perspective of the plaintiff, having the lawsuit financed by the lawyer or by a third party funder is essentially the same, the result being the elimination of his risk in litigation costs. The first issue is whether the prohibition of contingency fees should apply to TPLF. The answer is no, because the Bundesrechtsanwaltsordnung 277 contains ethical regulations for the Bar, and thus only applies to contractual relationships between lawyers and clients. 278 The financing contract is between the plaintiff and the funder only, the lawyer is neither part of the contract nor does he have any obligation under this contract. 279 The second issue is whether TPLF contracts should be considered void because they circumvent the prohibition against contingency fees. In fact, under German law, legal acts that circumvent a prohibition are null and void if the regulation is designed to avoid the result reached by the circumventing legal act. 280 This argument is based on the assumption that the prohibition against contingency fees is designed to prevent the [*404] plaintiff from eliminating his litigation costs risk through recourse to external capital. This assumption is wrong. The sole aim of the prohibition of contingency fees is to preserve the independence of the lawyer from his client, i.e., no acts taken by the lawyer when representing his client should relate to his own profit and economic interest. It is not the interest of the client that is protected by the prohibition of contingency fees, but rather the independence of lawyers. 281 Under German law, legal acts circumventing a prohibition are null and void only if the act reaches the aim that the regulation is designed to avoid. 282 Thus, TPLF shall not be considered void, because TPLF does not interfere with the independence of the legal profession. 283 The problem with independence of lawyers, from a broader perspective than that considered with regard to contingency fees, is the third major validity issue faced by TPLF. Apart from the specific prohibition of contingency fees, judicial decisions mandate that each lawyer must be personally and professionally independent from any third parties. 284 Accordingly, the validity of TPLF is challenged by the possibility that TPLF creates conflicts of interest between lawyers and clients. 285 A client's financing contract, however, does not create a conflict of interest. The lawyer is not bound in any respect to instructions from the financing firm and may completely disregard them. 286 From the observation of the three main issues that jeopardize the validity of TPLF contracts, a common leitmotif exists: TPLF is deemed valid because of the fact that the lawyer's incentives in carrying out his work are not altered by the existence of the TPLF contract. Apparently, this is only a descriptive argument. However, in my view, it is a normative argument that is essentially based on the problematic issue of the control of the litigation. Let us

275

Bundesrechtsanwaltsordnung [BRAO] [Federal Lawyer's Act ], Aug. 1, 1959, § 49(b) no. 2 (F.R.G.).

276

As reported by Coester & Nitzsche, supra note 94, at 95-98.

277

Toggenburger, supra note 101.

278

See Dethloff, supra note 262, at 2228; Coester & Nitzsche, supra note 94, at 96.

279

Coester & Nitzsche, supra note 94, at 96.

280

See id. at 96-97.

281

Deutscher Bundestag [BT]12/4993, § 31 (F.R.G.).

282

See Coester & Nitzsche, supra note 94, at 97.

283

Id. at 97.

284

See Federal Constitutional Court, BVerfGE 76, 184; see also Busse, Freie Advokatur, AnwBl. 2001, 135, Federal Court of Justice, BGH, BGHSt 22, 157.

285

See supra note 255.

286

Coester & Nitzsche, supra note 94, at 100.

Theresa Coetzee

Page 39 of 43 19 Cardozo J. Int'l & Comp. L. 343, *404 reconsider the conditions under which TPLF is deemed valid under the perspective of the three issues raised above: (1) the financing contract is between the plaintiff and the funder only and the lawyer is neither part of the contract nor does he have any [*405] obligation under this contract; (2) TPLF does not interfere with the independence of the legal profession, the safeguard of which is the aim of prohibition against contingency fees; and (3) a client's financing contract does not create a conflict of interest between the lawyer and the client. The three conditions above clearly do not matter in their descriptive dimension, but rather in their normative dimension. In other words, the point is not that TPLF is permissible because that is what happens in fact, but rather that TPLF contracts, in order to be valid, must respect the above conditions. Once again, the transfer of control of the litigation is what creates problems for the validity of TPLF. If control is transferred from the claimholder to the funder, then it is not true that the financing contract does not have an impact on the lawyer. The lawyer will follow instructions from the funder, will further the funder's interest and not the plaintiff's interest (when they diverge); he will have obligations to the funder (e.g., duties to inform and provide documents), and conflicts of interest will exist when the plaintiff and the funder have different interests. 287 Once again, transfer of control in third-party litigation financing contracts is a very delicate aspect. For our purposes, however, which are limited to "narrowly" considering the TPLF, TPLF contracts are to be considered valid under German law. 3. Absence of TPLF and Perspectives of Development in the Civil Law World I mentioned earlier that TPLF is virtually nonexistent in the civil law world with the exceptions of Germany, Austria and Switzerland. Because no specific prohibition seems to apply, 288 it is unclear why TPLF has not developed. I argue that a number of structural and cultural factors, characteristic of the civil law tradition, should be taken into consideration to explain the fact [*406] that TPLF has not yet developed in the civil law world. On the one hand, structural differences include the costs of the legal system and the civil justice system, alternative methods of compensation of attorneys and procedural rules. 289 That is to say that not just positive rules, but rather all formants of legal system should be considered in analyzing TPLF. 290 On the other hand, cultural differences include deep cultural models that are rooted in a legal system, sometimes even in a way that is "unconscious" - not realized by the people within that legal system - , but play a significant role in the evolution of the law and legal culture. 291 First, litigation in common law jurisdictions is much more expensive than in civil law countries. The very structure of the American judicial process decentralizes power and activity: a large variety of activities within litigation which are

287

It is true - in principle - that both the plaintiff's and the funder's interest is to achieve the maximum possible award. However, their interests may diverge with respect to timing and - eventually - also to the amount of the award. While a plaintiff is usually a one-shot player, who will then try to maximize the awards, a financing company is a repeated player. The amount of awards it is interested in is a function of the investment, not at all related to the merit of the claim. Possibly, if things get "complicated" during the course of the litigation, the funder will be willing to accept any amount that is superior to the costs he incurred, and will prefer to bring that case to conclusion soon instead of investing further resources. 288

See supra note 242.

289

Some skepticism has been expressed with respect to the economical viability of the TPLF industry in Europe. Toggenburger, supra note 101, at 621-627.

290

Sacco, after dwelling on the different formative elements of a system - namely the legal formants - challenges the traditional standpoint adopted by domestic jurists in analysing their systems. In particular, he rejects the traditional static approach whereby the legal rule is considered uniform and all the legal formants of one legal system are regarded as being coherent with each other (thus giving the same answer to a question of law). To the contrary, he argues that only through a dynamic and antiformalistic approach, whereby legal formants are in a competitive relation with each other, is it possible to unveil the analogies and differences between different legal systems and to fill the hiatus between operative rules and declamations. See Rodolfo Sacco, Legal Formants: A Dynamic Approach to Comparative Law, Inst. 1 & 2, 39 Am. J. Comp. L. 1, 343 (1991); P.G. Monateri & Rodolfo Sacco, Legal Formants, in 1 The New Palgrave Dictionary of Economics and the Law 531 (P. Newman ed., 1998).

291

In the comparative law literature, these are known as crittotipi. See Rofolfo Sacco, Introduzione al Diritto Comparato, in Trattato di Diritto Comparato 125 (5th ed. 2005).

Theresa Coetzee

Page 40 of 43 19 Cardozo J. Int'l & Comp. L. 343, *406 labeled "official" in European legal systems, such as service of process, discovery, 292 and questioning of witnesses, are private matters in American law and are therefore paid for by the parties. 293 Furthermore, punitive damages are not contemplated in civil law countries thus reducing the margin of profit from funding litigation. 294 Second, from a broader viewpoint, within the civil law-common law divide, the civil law culture is considered to be less "litigious" compared to its common law counterpart. 295 Third, [*407] from an even broader perspective, common law legal systems - especially the United States and the United Kingdom - are the ones that have reached the highest level of "commodification" of justice and legal services among the world's legal traditions - a trend where legal services are treated as "commodities," and which has found further epiphanies, e.g., in contingency fee schemes, advertisement of legal services, aggregate litigation, and generally a more entrepreneurial-oriented class of legal professionals. 296 The increasing commodification of civil justice in the common law probably creates a cultural environment that is fertile ground for the development of markets based on the transferability of property rights in litigation like those for TPLF and other similar practices. In the civil law world, the use of the legal system is traditionally seen more as a way for the victim of a wrong to have his day in court and receive compensation, rather than a system through which private incentives and commodified legal services combine within a market-inspired framework for the pursuit of social welfare and efficiency. 297 A hypothetical explanation of the prevalence of the latter conception of the legal system in the United States may be found in the success of the law and economics movement in American contemporary legal thought. The discipline of law and economics has not reached an equal [*408] degree of prevalence in the civil law world. 298

292

Fed. R. Civ. P. 26.

293

See Rudolf B. Schlesinger et al., Comparative Law: Cases, Texts, Materials 428, 448 (6th ed. 1998); Ugo Mattei, A Theory of Imperial Law: A Study on U.S. Hegemony and the Latin Resistance, 3 Global Jurist Frontiers, Art. 1, 9, 36 (2003), available at http://www.bepress.com/cgi/viewcontent.cgi?article=1088&context=gj. 294

Toggenburger, supra note 101, at 620.

295

According to the data offered by Marc Galanter in 1983, the only countries, out of a group of fifteen, that presented more than 40 yearly civil cases per 1000 people were Australia, Canada (Ontario only), Denmark, England/Wales, New Zealand and the United States. Among them, Denmark was the only civil law country (according to the classification of legal systems provided by the University of Ottawa, supra note 250). Among the others, Belgium, France, Japan, Norway, Sweden and West Germany were between 20 and 31 per 1000 people; while Italy, The Netherlands, and Spain were below 10. See Marc Galanter, Reading the Landscape of Disputes: What we Know and Don't' Know (and Think we Know) about our Allegedly Contentious and Litigious Society, 31 UCLA L. Rev. 4, 54 tbl. 3 (1983). On the litigiousness of the United States, see Walter K. Olson, The Litigation Explosion: What Happened When America Unleashed the Lawsuit (1991); Macklin Fleming, Court Survival in the Litigation Explosion, 54 Judicature 109 (1970); B. Manning, Hyperlexis: Our National Disease, 71 Nw. U. L. Rev. 767 (1977). See also Thomas F. Burke, Lawyers, Lawsuits and Legal Rights: The Battle over Litigation in American Society (2002). For a more recent view on the level of litigation in a comparative perspective, see Stephen C. Yeazell, Contemporary Civil Litigation 39-64 (2009). 296

See Richard Susskind, The End of Lawyers? Rethinking the Nature of Legal Services 27 (2008).

297

This approach is also visible in other fields of the law and perhaps it mirrors a general attitude. Consider, for example, breach of contract: while in the United States the primary remedy for breach of contract is compensatory monetary damages and specific performance being the "exception;" in the civil law world, it is the other way around.

298

For an early, comprehensive work discussing the success of the economic analysis of law in civil law countries, see 11 Int'l Rev. L. & Econ. (1991), containing: R. Cooter & J.R. Gordley, Economic Analysis in Civil Law Countries: Past, Present, Future, 261; U. Mattei & R. Pardolesi, Law and Economics in Civil Law Countries: A Comparative Approach, 265; C. Kirchner, The Difficult Reception of Law and Economics in Germany, 277; G. Hertig, Switzerland, 293; S. Ota, Law and Economics in Japan: Hatching Stage, 301; S. Pastor, Law and Economics in Spain, 309; G. Skogh, Law and Economics in Sweden, 319; W. Weigel, Prospects for Law and Economics in Civil Law Countries: Austria, 325; and G. Hertig, The European Community, 331. For later works, see Mattei, Comparative Law, supra note 8; Law and Economics in Civil Law Countries (Bruno Deffains & Thierry Kirat eds., 2001); Edgardo Buscaglia & William Ratliff, Law and Economics in Developing Countries (2000); Richard A. Posner, Law and Economics in Common-Law, Civil-Law, and Developing Nations, 17 Ratio Juris 66 (2004); Aristides N. Hatzis, Civil Contract

Theresa Coetzee

Page 41 of 43 19 Cardozo J. Int'l & Comp. L. 343, *408 Traditionally, in civil law legal systems, the claim is considered something very "personal," which cannot be sold or assigned an interest on - as in TPLF - in exchange for money. The origin of that notion can be traced back to ancient Roman and Greek jurisprudence, which was dominated by the view that only the litigants and judges should participate in the judicial process. 299 Under that jurisprudence, if an action was pursued on behalf of someone other than the party affected, the maintained action was unworthy and seen as a vehicle of oppression. 300 The factors and broad trends discussed above might be among a few of the reasons why TPLF is not developing in civil law countries as it is in the common law world. However, it does not seem unlikely that TPLF will soon develop in continental Europe and other parts of the world, 301 especially in countries that are devoting efforts to strengthening access to justice but are simultaneously experiencing difficulties in the publicly-funded systems for financing civil litigation for the poor - e.g., legal aid. 302 These prospects of growth are suggested by the observation that TPLF is economically viable in the context of the civil law world, as demonstrated both by the economic model studied earlier 303 [*409] and by the experience of Germany. 304 Moreover, the recognition of the fact that "litigation funding by private third parties (e.g. companies specializing in financing litigation) is practiced successfully in some Member States" has also come from the European Commission. 305 TPLF seems to have development potentials in the civil law world. Apart from the likelihood that favorable economic conditions exist for the development of the industry, which deserves to be carefully studied, what appears to be true is that claimholders would largely benefit from TPLF in many civil law countries, which could create a high demand for TPLF. Take the example of Italy, and consider the following quotation: The Italian John Doe who needs the support of a court in order to obtain the fulfillment of a right or of a legally protected interest is in a very unfortunate situation… . In Italy, contingent fees are forbidden by the law and lawyers will not bear the costs of a case by themselves without being paid for their work throughout the entire proceedings. Therefore, our John Doe will be required to pay in advance, and in the course of the process, all the money necessary to cover the costs of the case and at least a part of the attorney's fees, until the moment when the judgment allocates all these costs according to the "loser pays all" rule. This would not be a great problem if the time required to achieve the judgment were short. On the contrary, however, the length of civil proceedings in Italy is, in most cases, excessive. An average case may require three or four years to proceed through the court of first instance… . This means that our John Doe must be able to bear all the costs for several years, until the case comes to a conclusion in the court of first instance. 306

Law and Economic Reasoning: An Unlikely Pair?, The Architecture of European Codes and Contract Law 159 (Stefan Grundmann & Martin Schauer eds., 2006). 299

Radin, supra note 180, at 48.

300

Waye, supra note 25, at 12.

301

As mentioned earlier, in Asia, China and Japan are considering introducing legal-expenses insurance. See Qiao, supra note 128, at 1. 302

Russia, for example, is showing interest in learning about best practices in (and alternatives to) legal aid. See, e.g., Inst. of L. and Pub. Pol'y, Project, Strengthening Access to Justice for the Poor in the Russian Federation 2008-2012, http://ilpp.ru/page_pid_578_lang_2.aspx (last visited Mar. 28, 2011). 303

See supra Section IV.A.2.

304

See supra Section V.B.2.

305

Comm'n Green Paper on Consumer Collective Redress, COM (2008) 794 final (Nov. 27, 2008) § 51.

306

M. Taruffo, Civil Procedure and the Path of a Civil Case, in Introduction to Italian Law 159-160 (Jeffrey S. Lena & Ugo Mattei eds., 2002).

Theresa Coetzee

Page 42 of 43 19 Cardozo J. Int'l & Comp. L. 343, *409 The length of Italian civil proceedings generates high costs for plaintiffs, which are often prohibitive. 307 Although its effect on the length of civil proceedings is not easily predictable, TPLF might represent a solution to the problems faced by claimholders who cannot afford to bring a lawsuit or who, considering its outcome uncertain and indeterminable in time, choose not to bring suit because the expected value of the claim does not outweigh its [*410] expected costs. The possibility for claimholders to bargain over property rights in litigation with third parties in a way that allows them to promise a share of the awards in exchange for having all litigation costs covered, would allow them to eliminate the risks connected with bringing suit, thus increasing the expected value of the claim and making them better off. If TPLF were to develop in the civil law world, who should be investing in litigation? It has been argued that TPLF is a tough business: 308 it is a risky business that can lead to large losses very quickly. 309 The risk of litigation has to be evaluated very carefully. 310 On the one hand, a recent trend has been the establishment of financing companies by large insurance companies. 311 This development is not surprising, given that the business model of TPLF is similar to that of legal expenses insurance policies, and, therefore, fit into the product lines of many insurance companies. On the other hand, a recent trend has been the creation of litigation financing companies by large well-capitalized financial companies that raise capital on stock markets. 312 VI. Conclusion The ability of claimholders and third parties to bargain over property rights in litigation enables interactions between the civil justice system and the world of finance, which break with the traditional conception of the litigation process. This approach addresses a major problem traditionally considered inevitable: the costs and risks of litigation. Thirdparty litigation funding - one of the most innovative trends in civil litigation financing today - is based on the existence of gains from trade in property rights in litigation, and permits claimholders to eliminate the risk connected to litigation. In exchange for the elimination of risk, the claimholder pays a price, which is represented by the share of awards that he promises to give to the funder in case of a favorable outcome of the litigation. The legal status of TPLF is currently at the center of a heated [*411] debate among courts, institutions, professionals, and academics on both sides of the Ocean. This article proposes a comparative legal and economic approach to the study of TPLF. The economic and the legal issues created by this innovative practice - both in the "is" and in the "ought to be" dimensions - should be looked at from a transnational and interdisciplinary perspective. Among the main results of this article, is the acknowledgment of the importance of control over litigation. That courts are highly concerned about control and have considered this analysis as one criterion for determining the validity of TPLF agreements, both in the common law and in the civil law world, emerges from this comparative legal analysis. Moreover, it has been determined that when no transfer of control is contemplated under the funding agreement, TPLF is permitted in all the jurisdictions considered. This jurisprudential orientation has proved to deserve approval and encouragement in light of the economic analysis, which has shown that TPLF - under the model - leads to efficient allocations of property rights in litigation, despite some remaining externality problems. TPLF requires further study, which should not prescind from a comparative approach. One observation should be kept in mind: as TPLF allows claimholders to eliminate the risk connected to litigation, the objective should be that such elimination of risk happens at the lowest possible price for claimholders, in order for the TPLF market to operate efficiently.

307

Id.

308

Toggenburger, supra note 101, at 627.

309

Coester & Nitzsche, supra note 94, at 101.

310

On the role of risk analysis in claim evaluation and litigation management, see Calihan, Dent & Victor, supra note 18.

311

See, e.g., Allianz Prozessfinanzierung, supra note 90.

312

See, e.g., Juridica Capital Management, supra note 156.

Theresa Coetzee

Page 43 of 43 19 Cardozo J. Int'l & Comp. L. 343, *411 The following considerations are thus worth mentioning to conclude. First, TPLF should continue to be permitted, as a further development of the industry would allow a higher degree of competition among litigation financing companies. This would lower the price of TPLF to a level closer to the marginal costs. Second, the issue of the control over the litigation should be studied more in depth. Currently, in all jurisdictions, the contractual transfer of control over the litigation from the claimholder to the funder is looked at with suspicion. Certainly, the funder benefits from acquiring control. However, that does not necessarily mean that the transfer of control harms the claimholder; the more control the funder acquires over the litigation, the lower will be the price (i.e., the share of awards) that he will require from the claimholder in exchange. This is not to say that the conflict of interest problems that can derive from the transfer of control are of minor importance, but I suggest that the control over the litigation has an economic value that should be given a price. If the parties of a TPLF contract were allowed to [*412] bargain over the transfer of control, this might lead to Pareto superior allocations of resources. In fact, the claimholder would be required to pay a lower price for TPLF if he transfers some portion of control power. Third, further interactions between litigation and finance should be explored that might be beneficial in order to reduce the price that the claimholders pay for the elimination of risk in TPLF. Financial instruments that permit litigation funders to reduce the riskiness of their investments might be used, so that they could reduce the price they charge claimholders. For example, if the funder were able to use a credit-default-swap-like contract with a third party - making periodical payments in exchange for receiving a payoff (equal to the amount invested) in the case his client loses at trial - he would reduce the risk of loss linked to the plaintiff's loss at trial and thus could charge him a lower share of awards in case of success. This is just one example that demonstrates the further potential that the interrelationships between litigation and finance can offer in the service of the civil justice system, thus countering the problem of the costs and risk of civil litigation. A greater liberalization of the ability of claimholders and investors to bargain over property rights in litigation, and the consequent increasing interrelationships between civil justice and finance, would produce efficient and socially desirable markets in litigation risk that could develop both in the common law and in the civil law world. Cardozo Journal of International and Comparative Law Copyright (c) 2011 Yeshiva University Cardozo Journal of International and Comparative Law

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Theresa Coetzee