INSIGHT: The Fall of Champerty and the Future of Litigation Funding

June 16, 2020

Reprinted from BloombergLaw. Article by Julia Gewolb and Joshua Libling

Advocates of litigation finance have claimed victory for years. Gone, they assert, are questions about whether funding has a future in the U.S.

Covid-19 is likely to accelerate the industry’s acceptance as funding helps businesses unlock the value of litigation assets to stay afloat, manage litigation risk, or simply reduce uncertainty in litigation outcomes.

Instead, the debate is shifting toward how third-party funding should operate. Is legislation or regulation necessary? Should lawyers’ professional rules of responsibility be interpreted to prohibit standard funding terms? Are special discovery rules necessary?

Advocates, of course, maintain that the answer to all three is “no.” But a recent decision by Minnesota’s Supreme Court abolishing the state’s common law prohibition on champerty sheds some light on how courts should approach these important questions.

Abolishing Antiquated Rules

The ancient doctrine of champerty, as it is typically defined, bars “strangers” to a lawsuit from funding litigation fees and costs in return for a financial interest in the case’s outcome. It is a blunt tool that throws out valuable funding arrangements in pursuit of an antiquated goal.

And it has long been in decline in the U.S.: some states never adopted it, some states did and abandoned it, and some states—notably, New York—continue to have champerty laws on their books but have so limited their scope that they rarely apply. This abandonment of champerty and its close relation, maintenance, has helped fuel the growing demand for litigation funding in the United States in recent decades.

While only a handful of states continue to recognize champerty, until this month Minnesota was one of them. In the case at issue, both the state district court and appeals court refused to enforce a consumer funding agreement. While the equities appeared to weigh in the funder’s favor (the plaintiff sought out the funding and entered into the agreement on the advice of her attorney), the Minnesota Supreme Court seems to have welcomed the opportunity to review whether champerty should ever apply.

Unsurprisingly, it concluded that it should not. For starters, the court acknowledged what industry advocates have long claimed: funding has demonstrated its value and is here to stay. After issuing a reminder that “as society changes, ‘the common law must also evolve’ with it,” the court explained:

Societal attitudes regarding litigation have [] changed significantly. Many now see a claim as a potentially valuable asset, rather than viewing litigation as an evil to be avoided. The size of the market for litigation financing reflects this attitudinal change. Businesses often seek financing to mitigate the risks associated with litigation and maintain cash flow for their operations. It is also possible that litigation financing, like the contingency fee, may increase access to justice for both individuals and organizations.

The court noted that Minnesota had adopted safeguards against abusive practices since champerty was adopted in 1897. For example, its rules of professional responsibility and civil procedure “address the abuses of the legal process that necessitated the common-law prohibition” by regulating attorney solicitations, the filing of frivolous claims, and other issues.

Based on these changes, the court rightly concluded that an outdated common-law rule that bluntly prohibits funding is inappropriate.

How Funding Should Operate

The decision is most obviously notable for what it means to funders and claimants in the immediate term: funding is now possible in Minnesota, where funders are already moving to establish or renew relationships. With an increase in funding will come an increased availability of justice for less well-funded plaintiffs within the state.

But the opinion is also important to the second-order question of how funding should operate. The Minnesota Supreme Court did not set out to decide which safeguards were sufficient to permit third-party funding, or whether further common law rule-making or the “possibility of further regulation by the Legislature” were advisable. But the very same analysis underpinning its decision to abolish champerty contains the seeds of answers to those key questions.

First, as the court’s analysis demonstrates, any attempt at further regulation must account for the myriad relevant safeguards already in place. These include lawyers’ duties of professional responsibility (including the duties to maintain client confidentiality and independent judgment), rules of civil procedure addressing disclosure and discovery, and even common law contract defenses.

As has been written extensively, there is little reason to suppose that those rules—which were designed to apply flexibly to reconcile competing interests—do not already strike an appropriate balance in addressing funding concerns. Indeed, by relying on these rules to cast aside champerty, the court implicitly said they were sufficient.

Second, any proposed regulation has to be grounded in reality. This means both accounting for funders’ natural incentives and ensuring that academic arguments against funding are based in empirical evidence.

As one example, the court noted that funders are naturally incentivized to avoid weak claims because funders lose their entire investment if the suit is unsuccessful. Rulemaking that aims to police funders’ selection of cases thus would be wholly unnecessary and risk limiting the considerable value funding provides to meritorious claimants.

Other proposals for regulation rely on unsubstantiated claims. For example, the court noted that the argument that funding under-incentivizes settlement cited “no empirical evidence” and, indeed, there was “a well-reasoned argument to the contrary.”

In light of the demonstrated value funding provides, courts and legislatures should be reluctant to interfere in the industry absent clear and compelling evidence that such interference is warranted.

Third, broad regulations (and champerty is among the broadest) are inappropriate in circumstances of great variety. The court’s decision hints at finer distinctions that may prove meaningful.

For example, the court distinguished between consumer and commercial funding, the latter of which involves “sophisticated parties” better able to “understand the risks involved with such agreements.” But there are others. And the presence of these key distinctions again means that a narrow and more considered approach to rule-making, whether in the courts or the legislatures, is best.

Fourth, in the midst of all of the debate over whether funding presents any novel risks, it should not be forgotten that it upholds other, competing values. Minnesota’s Supreme Court noted at least one when it declared it “must not lightly disregard” the freedom of tort victims to contract for funding. But funding also allows “plaintiffs who would otherwise be priced out of the justice system to assert their rights.”

To put it slightly differently, the value that third-party litigation funding adds to the legal system is justification for both abolishing outdated rules like champerty and wading carefully into the debate over how funding is best conducted. State courts and legislatures would be wise to bear in mind the positive contributions the funding industry has made to date and the dangers of over-regulating a young industry.

An approach that over-emphasizes issues already addressed by existing rules, or is based on hypothetical concerns not supported by empirical data, would only reintroduce champerty’s blunt and outdated prohibition in a different form. Now that funding is here to stay, we must ensure it continues to provide value to lawyers and claimants.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Julia Gewolb is director of underwriting at Validity Finance.

Joshua Libling is former portfolio counsel at Validity Finance.

Julia Gewolb

Chief Risk Officer
julia@validityfinance.com
646.798.7168