“Republished with permission from Legal Funding Central“
Victoria Shannon is an Assistant Professor at Washington & Lee School of Law and the co-author of the 2012 book “Third Party Funding in International Arbitration.” Her research for the book included a 51-jurisdiction survey of legal funding laws in the United States, meaning she probably knows more about America’s byzantine web of legal funding regulations (or lack thereof) than anyone else around. Before the joining the faculty of Washington & Lee, Shannon worked at the International Court of Arbitration at the International Chamber of Commerce, which was where she was first introduced to legal funding. We recently interviewed Shannon on the state of legal funding in the United States and abroad.
What is legal funding like here in the United States?
The Federal Government is refraining from regulating the industry. Right now, we have a state-by-state regulatory system similar to what we have in other industries, like insurance. However, in those other industries, there is some consensus regarding a framework for regulation, so each state’s regulatory scheme is roughly similar to the other states, with some customization. For example, there is a general sense of how to regulate the insurance industry, so states don’t differ that much in their insurance regulations. We don’t have that kind of consensus for third-party funding. We have states in which the practice is completely unregulated, as well as states where legal funding is explicitly prohibited and many states that are somewhere in between.
There are four states with statutes right now: Maine, Ohio, Nebraska, and Oklahoma. Oklahoma is the most recent. [Since we talked to Shannon, Tennessee has also passed what are the nation’s most restrictive regulations on legal funding.]
In most other states, there are no statutes, but there might be a smattering of case law. Whether a state has case law on the issue depends on whether a dispute about a litigation funding agreement has been brought to the state courts. In most situations, the funding arrangement runs smoothly, so there is no dispute, and, therefore, no case.
When there have been disputes about funding arrangements, the court decisions in the various states have been all over the place. Some courts have said that legal funding is a loan subject to usury caps, while others have said it’s not a loan. Some courts have applied those ancient doctrines of champerty and maintenance to prohibit legal funding; others have said that champerty and maintenance do not prohibit legal funding (that’s the view in Florida); and still others have abolished the champerty and maintenance doctrines altogether. As you can see, the state courts have wide ranging and often conflicting views.
The problem I see with these differing state laws is that legal funding transactions are not always wholly within the same state. Often the client and the funder are from different states, and the pending funded case might be in court in a different state as well. For example, if the court hearing the client’s case is in state X and is funded by a funder from state Y, the court will apply state X’s law on legal funding. But the funding contract itself might state that its governing law is the law of state Y or even a third state, Z. What if states Y and Z allow legal funding, but state X doesn’t? Is the legal funding contract unenforceable? The answer is unclear.
This is why we need some harmonization of general principles among the state laws to avoid confusion as the industry grows, just as the insurance industry has some general principles in common among all state laws. We don’t necessarily need federal regulation, though.
Will this happen? Will there be a harmonization soon?
I don’t think harmonization will happen soon. Litigation funding is a growing industry, but not widespread enough to spark a joint effort among state legislatures. For example, look at the development of the laws on same-sex marriages. When there were only a few court cases, it wasn’t as big of a national issue. Now, with more courts weighing in on the issue, you see state after state legislating in this area to legalize same-sex marriage. The number of cases has grown so much that at least a minority of states are trying to harmonize their laws.
Right now, in legal funding, I don’t think enough people see that there’s an issue. There haven’t been enough cases yet, because most legal funding arrangements go smoothly. For now, we’ll have some states in which cases will go all the way to the state supreme courts, where judges will have to make fundamental decisions about the limits on funding and the categorization of funding. Down the line, more states may see this as a widespread problem. But, until it is seen as widespread, not much will happen in terms of harmonization.
If there was a high profile funded case involving a public figure or some famous entity, and if that case became national news, then perhaps people might talk about litigation funding in the broader national conversation. But that’s not likely at this stage.
The closest example in recent times is the Chevron case involving environmental pollution in Ecuador. Burford was the funder involved in the case funding the side of the Ecuadorean plaintiffs. The underlying substantive litigation was like a movie: bribery, corruption, fraud, etc., but there wasn’t a dispute about the litigation funding agreement itself, and Burford end up pulling out of the case. That kind of case could bring legal funding to the national conversation, if there were a disagreement about the funding arrangement itself.
How does legal funding work international arbitration?
We can’t really have a worldwide set of regulations in international arbitration. Arbitration somewhat exists outside of any particular international court or national legislature, so guidelines and treaties form one of the major sources of international arbitration rules. I’m a member of the Task Force on Third Party Funding in International Arbitration. It is jointly organized by the International Council for Commercial Arbitration (ICCA) and Queen Mary University of London (School of Law). They put together this task force to look at third-party funding and determine whether there should be any guidelines for international arbitration.
Arbitration institutions that issue arbitration rules are another major source of rules. When parties agree to arbitration under the rules of a particular institution, they are binding themselves to those arbitration rules. Arbitration institutions could change their arbitration rules to address third-party funding. But the international arbitration institutions probably won’t do this, because it would be too difficult to come to a consensus about what the new rule should be.
International arbitration is supposed to transcend national laws, but also be compatible with national laws. This means that you can chose arbitration and whatever substantive national laws you want to use, too. The law of the place of arbitration is significant, too. For example, Singapore currently prohibits third-party funding in all litigation and arbitration there, while Australia allows third-party funding in litigation and arbitration. The arbitration institutions cannot write arbitration rules that conflict with either of those positions. Therefore, the arbitration institutions will likely remain neutral and not address third-party funding in their arbitration rules.
So, we’re left with guidelines, which are a lot like best practices. Sometimes parties will adopt them in their arbitration clauses, but that’s rare. The institutions that promulgate international arbitration rules may issue guidelines for their arbitrators about things like disclosing conflicts of interests, and that is where third-party funding will be addressed, if it’s addressed at all.
International arbitration is unique; often the same people acting as arbitrators are also acting as counsel in other cases. It’s a relatively small group of practitioners. For example, let’s say there is an international arbitration case, and there is a third-party funder backing one of the parties in the case. A problem arises if the arbitrator from that case also serves as legal counsel in other cases, and if the third-party funder is also funding one of that arbitrator’s clients in a different matter. This creates a conflict of interest – can the arbitrator truly be unbiased in that situation?
International arbitration practitioners are a smaller group across the globe. People know each other, and people are constantly representing different clients and serving as arbitrator in other cases at the same time. At most, less than two dozen funders worldwide have the capacity to fund international arbitration. So, there is a huge potential for conflicts of interest, because of repeat player funders, attorneys and arbitrators.
In most cases, it’s okay in international arbitration to have a conflict of interest, as long as the conflicts are disclosed and then waived by the parties. The client can say, “We know this arbitrator is an arbitration insider with connections to both parties, and we waive this conflict of interest.”
But it can only be waived if the parties know about the conflict, and they only know if the arbitrator discloses and says, “Yes, I have a connection to the funder in this case.” But how does the arbitrator know the funder is participating? Usually the funding agreements are secret. The funder keeps its clients secret. The funder might not tell the arbitrator, “I’m funding these other cases, too, including this one that you’re representing the other side on.” The funder often has a confidentiality agreement with the client, so the funder actually can’ttell the arbitrator. So, the only way the arbitrator knows is if the funded party tells the arbitrator.
We can’t tell the funders what to do, but we can tell the parties what to do. Should we? That’s the debate going on in the Task Force and at the International Bar Association right now. We can put the duty on the arbitrator to disclose any potential conflicts of interest, but there is a knowledge gap, because the arbitrators don’t know about the funders’ connections to parties.
The other big issue is how to define third-party funding if we want to write guidelines? This is also a problem for U.S. domestic regulations. There are so many different possibilities for the structure of the arrangement and the calculation of the funder’s share. The definition could refer to an entity having a financial interest in the outcome, but that would be overly inclusive. For example, that definition would include traditional insurance companies or traditional banks that issue regular loans. So right now we use a “we know it when we see it” standard in international arbitration regarding legal funding.
So, in both international arbitration and domestic litigation, there are disclosure issues and definition issues.
In addition, there’s a problem with evidence in the case. Most jurisdictions in the world have an attorney-client privilege, which means that statements a client makes to his or her attorney are protected from disclosure to the opposing party. However, the privilege is waived if you disclose the information to a third-party freely. Therefore, the information is discoverable by the opposing party.
The funder will ask the client for confidential information about the case in order to decide whether to fund the case. Client has to consider its options. Do I risk waiving the privilege by divulging information to funder? Or do I not obtain third-party funding? There is a question regarding whether we should extend the attorney-client privilege to include the funder. In the United States, we also have an additional privilege called the attorney work product doctrine that protects the documents the attorney creates to prepare for the client’s litigation. It’s unclear whether the work product doctrine would apply to the funder as well.
A case in Illinois – Miller v. Caterpillar – addressed both of the privileges. The key fact in that case was that there was a confidentiality agreement between the client and the funder. With the confidentiality agreement in place, there was an expectation, or an indication, that party was trying to preserve the privilege. The court also made a distinction between the attorney-client privilege and the attorney work product doctrine, and said that only the work product doctrine applied to funders. That ruling is Illinois-specific though, and isn’t the rule in the entire United States. For international arbitration, most countries only have the attorney-client privilege and it is unclear whether that privilege applies to funders.
So, has this come up as a big problem? Not so much. I think we should change the rules of privilege to protect disclosures to the funder, but it’s not a big enough problem yet to expect legislatures to act.
Anything else that you really want to say?
After talking to attorneys, funders, clients, and other academics, I have noticed that the perception and reality of litigation funding are very different. The perception about third-party funding by people who have never experienced it is very different from people who have been part of a funding arrangement.
Often when people tell horror stories about funding, they are talking about certain cases in the news involving funders who may not have been very reputable or trustworthy. There are certain funders – particularly the large ones, worldwide – that are already regulated by a government regulatory body and are very trustworthy. The Securities and Exchange Commission (SEC) in the United States, and similar government bodies around the world, regulate commercial funders that have shareholders and issue securities. So the big players, especially those in international arbitration, are already regulated to some extent. Many of those big players are welcoming regulations for the legal funding industry. There are other funders who are usually smaller and may not have internal best practices that are the ones causing problems. They are the ones who end up in court, and then people say, “All litigation funding is bad!” The funders that are already complying with laws and best practices are frustrated, because all it takes is one bad case for public opinion to turn against them.
Even with regulations, we can’t say, “these funders are good, and those funders are bad.” But we can say, “funders who are complying with the regulations are more likely to give you a fair deal, and funder who are not complying are less likely to give you a fair deal.” Right now, all funders are being lumped together, and that’s not accurate.