It’s just money.
“I sort of look at litigation finance like corporate finance for any other type of business whether that’s airplane leasing or franchising a McDonald’s,” said Jay Greenberg, CEO and co-founder of third-party litigation funder LexShares.
It’s not just money.
“It fundamentally distorts our system of justice,” said Michael Resis, founding partner and chairman of SmithAmundsen’s appellate department and president of the Illinois Association of Defense Trial Counsel.
It’s turning justice into a game.
“Third-party investing in litigation [is] as if they were parlaying odds in a horse race or a football game. It would be similar to how consortiums are formed to back racehorses,” said John R. Kouris, executive director of defense bar organization DRI.
It’s turning economics into justice.
“All we are doing is applying market economics to something that has escaped them for a very long time,” said Burford Capital’s Chicago Managing Director Travis Lenkner.
People have different words they apply to third-party litigation funding, basically the practice where investors pay the bills for plaintiffs’ cases in hopes of a return on their investment paid from the eventual settlement or judgment. But there’s one word no one disputes about investor-funded lawsuits — reality.
“There’s just more of this happening in the marketplace,” said John Hughes, a partner at Bartlit Beck who has used third-party funders in multiple cases through his career. “People have different views of the merit of this, but it is a reality of the marketplace.”
Almost unheard of outside Australia a decade ago, the funding pool is now thick with investment firms dipping their toes in the water and startups diving in gleefully.
“I really encourage [law firms] to think about litigation finance the way I was thinking about it initially, and that is ‘How can it help my practice?’” said William P. Farrell, who practiced for 20 years before co-founding Chicago-based Longford Capital in 2012.
Third-party funding is swaddled in, if not secrecy, at least silence. Plaintiffs are under no legal obligation to disclose who’s paying the bills and the nondisclosure agreement funders sign before they review potential fundees mean they can’t tout their wins.
Based on cases where funding has been disclosed, we know these agreements have been used to determine if Eli Lilly violated German researchers’ patents when it started marketing the erection pill Cialis for enlarged prostates (it did) and if comic book legend Stan Lee deserved a bigger cut of Marvel movie profits (he did not), but a defense lawyer can be in the same room with a plaintiff backed by investors’ millions and never know it.
With the legality of third-party funding agreements entrenched in case law, the defense bar’s fight against this new reality has moved to disclosure. They have been joined in their effort by the U.S. Chamber of Commerce, which penned a letter over the summer in support of amending Federal Rules of Civil Procedure Rule 26 to require mandatory disclosure of outside money.
To advocates like Lenkner, third-party funding is using the free market to give valid claims a chance.
“It’s telling when the focus is not on the merit of cases but is on a side issue of the resources that are sometimes used to bring those cases to bear,” he said.
To detractors like Kouris, it’s using Big Business to pay the lawyers who still try to sway juries with talk of “the big, mean corporation against the poor little plaintiff.”
“People don’t know that David has a Goliath too,” Kouris said.
The Diamond Mine
When Greenberg talks about cases his online marketplace LexShares is funding, he slips into finance-ese. It takes a moment to realize the excited Bostonian is talking about the U.S. legal system when he says “the asset class” and about jury verdicts when he refers to “an inevitable monetization event.”
His excitement over finding a space where an investor can make a profit no matter what the economy does dates back to 2012. He was an investment banker at Deutsche Bank with a focus on enterprise software when a friend asked him to invest in, of all things, a lawsuit.
“What attracted me to the space as an investor, sort of from my white-shoe corporate finance background, was really first and foremost the uncorrelated nature of this asset class,” Greenberg said. “I was like, ‘Wow! Here’s something where it doesn’t matter what the stock market does or what commodity prices do or what interest rates do.’ The return associated with my investment in a legal claim is really operating inside of this courtroom vacuum.”
In 2014, he co-founded LexShares, an online marketplace that links lawsuits to high-net-worth individual investors and institutional investors like hedge funds, credit funds and family offices.
“It’s very difficult for individual investors to get their hands on uncorrelated assets,” he said.
Longford, meanwhile, runs a traditional private equity model with investors including state and municipal pension funds, foundations and family offices, Farrell said.
“We think that the private equity model is most attractive because it allows us to be patient. We’re not concerned with quarterly performance metrics as you must be if you’re a public company,” he said.
Longford only funds certain types of commercial disputes with documented damages of $25 million or more. Their average amount in controversy is over $100 million. About two-thirds of their business comes from law firms approaching them with either individual or a portfolio of cases needing funding. The other third comes from general counsels or C-suite executives who approach the funder.
“At Longford, we focus on a pretty tight band of substantive controversy,” Farrell said.
Curious investors who come to the LexShares website scroll through potential investments identified by full plaintiff and defendant names and summaries of facts, plaintiff, defendant, judge and jurisdiction. (The fictional example given on the public area of the site is David Inc. v. Goliath Industries, a riff on the David and Goliath motif Kouris criticized.)
About 20 percent of those cases came from lawyers or plaintiffs who heard about LexShares and reached out. The other 80 percent came from The Diamond Mine, a piece of software LexShares built to scrape data from state and federal court dockets, download complaints and start digitally sussing out the case for investors.
“So the algorithm will look for natural language strings, for instance, of cases which we like to fund. Things like ‘breach of contract,’ ‘breach of fiduciary duty,’ ‘antitrust,’” Greenberg said. “The algorithm will also look for quantitative metrics. We like to invest in cases that have highly quantified damages. Is there a damage amount quantified in the complaint and is that amount in excess of, let’s say $3 million? That will give you a boost in our algorithm score. Who is representing the plaintiff in the matter? Is it a highly reputable law firm? Is it an Am Law 200, Am Law 100 firm? That will give you a different rating in the algorithmic score.”
Cases that pass digital muster get contacted in person to gauge interest. After LexShares signs an nondisclosure agreement, interested firms get turned over the three former litigators on LexShares’ staff, who give the case the same diligence a law firm would give when evaluating whether to take a case on contingency, Greenberg said.
Here’s where Resis starts to have concerns. What information is being given to the firms to help them decide a case is a good investment?
“These are investors with millions of dollars and they choose the lawsuits that they want to invest in based on the information that is often supplied by the lawyers who represent the plaintiffs and who sometimes need to share information that may be privileged to give the investors sufficient information to decide whether to invest,” Resis said.
LexShares does not typically disclose the firms they work with to people other than investors or potential investors, although the company last year issued a news release touting a $28.5 million settlement in a qui tam whistleblower case it funded, U.S. ex rel. Jennifer Perez v. Stericycle Inc, et al. Perez and her lawyers did not respond to e-mailed interview requests for this story. Greenberg said LexShares has funded cases for firms as large as “Am Law 10.”
Kouris shares Resis’ concerns about the entrance of a third party into litigation.
“I have a fundamental concern about the invasion of the attorney-client relationship with certainly the potential for a breach of confidentiality, duty to the client and just [a funder’s reviewing] lawyers making an independent judgment about the prosecution of the claim or the settlement of a claim,” he said.
Longford involves more lawyers in the process, outsourcing some of their diligence to other attorneys to determine if a case is a good investment.
“If we’re handling a patent infringement case in the Central District of California, we’d hire an IP lawyer out in California so that they can give us a full sense not only of the substantive strength of the case but also add color on the local rules, the judge, certain predispositions perhaps and so forth,” Farrell said.
Burford’s Lenkner said that not only would privileged information not be shared with Burford staff or investors, they wouldn’t want it. When deciding what a judge or jury would decide, it would be misleading to look at anything a judge or jury wouldn’t see.
“That privileged e-mail that’s buried in the archives of the company somewhere is nothing we would want to see and it’s not even something we would need to see as part of our diligence process,” Lenkner said. “There are lots of non-lawyers and non-law firms that are part of the constellation of people involved in complex commercial litigation: jury consultants, nontestifying expert witnesses, discovery vendors, on and on. All sorts of people touch litigation, get confidential information related to that litigation and are covered by work product. We look the same as those folks.”
Big Burford
Since third-party funding isn’t disclosed, the U.S. Chamber of Commerce couldn’t look at the number of third-party cases when penning its scathing letter over the summer. Instead, it indicated the industry is growing by citing the financial successes of funders. The first name it listed was Burford Capital.
Founded in 2009, Burford is publicly traded on the London Stock Exchange and claims more than $3 billion committed to the legal market. It is the largest firm dedicated wholly to legal financing. But even its size isn’t an indicator of the third-party funding market — only about a quarter of the investments finance individual lawsuits. The rest of the portfolio is in complex financial transactions in other areas of the legal and regulatory industries.
Unlike Greenberg, Lenkner is an attorney. In 2013, he left Boeing to co-found Chicago-based litigation funder Gerchen Keller, which Burford acquired last year. That combination left the company with two business models potential investors can choose from.
“There are investors in the private funds that we manage — that’s the old Gerchen Keller business. That looks like a private equity fund or firm basically,” Lenkner said. “And then on the other side of the fork there are investors who buy our stock, because Burford is a publicly traded company.”
Whether investing through the Gerchen Keller or Burford model, the investors are mainly state public pensions, university endowments, large asset managers, nonprofit foundations and large family wealth management offices, Lenkner said. Unlike with LexShares and its website of plaintiff names, Burford investors aren’t given identifying information about the suits they’re funding.
“None of our investors know or have access to specific cases in which we have invested, unless that information is public anyway. In which case, it’s public anyway,” he said. “You could not see any information that would allow you if you knew about the case otherwise to deduce that we had made an investment in Case X.”
Then there’s the question of control. How much of a say in case strategy should the people bankrolling the suit have? LexShares and Longford prefer a hands-off approach.
“We make it perfectly clear in all of our documents — the funding agreement, the nondisclosure agreement and others that we enter into with our client — that Longford has no rights to dictate or influence litigation strategy or settlement decisions. None whatsoever,” Farrell said.
Burford has regular check-ins with the legal teams arguing cases to discuss strategy. In-person meets come about monthly; more frequently right before trial, less frequently in the long lags that can come over a case’s lifespan.
“It’s advice and expertise, but there’s no hands on the wheel. It’s a lot of back-seat driving,” Lenkner said.
Bartlit Beck’s Hughes, who worked with Burford for his $20 million plaintiff verdict this year in the Cialis patent row Erfindergemeinschaft UroPep GbR v. Eli Lilly and Co., et al. and with Gerchen Keller or Burford on a handful of other cases he declined to discuss, confirmed this assessment. Gerchen Keller co-founder Ashley Keller worked with Hughes at Bartlit Beck before leaving to found the funder.
“They are reasonably hands-off in terms of the day to day, week to week activity of a case, but they do have high-level check-ins about how things are going, strategic direction and making sure the budget is adhered to,” Hughes said.
That level of guidance is another question mark for Kouris. Are funding firms stretching out cases in hopes of better returns on their investments? Are people not bound by attorney-client privilege but by economic interest calling the shots?
“No lawyer is going to settle a case of somebody who fronted them money without at least consulting them,” Kouris said. “It’s unusual because these individuals, these entities aren’t parties to the suit, they’re not clients. They’re investors. I don’t think this is what we contemplated when our legal system was invented.”
Hughes said that, if that does exist, it would be a disciplinary issue for an attorney, not a criticism of the funding strategy.
“The client is the client and that’s who the law firm has the attorney-client relationship with. The client needs to make all the calls about settlement and strategy. A concern would be if lines were getting blurred there, but that has not been my experience,” he said. “The funders understand perfectly that that has to be the case. They go into these investments with eyes open to that issue, which is why that has never been an issue that I’ve encountered.”
Lenkner was more dismissive of the charge, which was also echoed in the chamber of commerce letter.
“I think the defense bar is almost obsessed with the view that there must be secret string-pullers running the litigation behind the scenes,” he said.
‘Old-school champerty’
Two charges that have been used to challenge third-party funding agreements in court are maintenance and champerty. Maintenance is “officiously intermeddling” in lawsuits that don’t concern you; champerty is specifically maintenance for profit.
“[Law on champerty and maintenance] has been so pruned away and exceptions so grafted upon it, that there is nothing of substance left of it in this State, and it has been wholly abandoned in others,” an Illinois appellate court justice wrote in Dunne v. Herrick — in 1890.
Although the future Gov. John Peter Altgeld called champerty, maintenance and the related barratry “old law” during the Benjamin Harrison administration, citing British criticism from the late 1700s, the concept guides the business model of LexShares’ online finance marketplace today. It’s part of the reason the company takes a hands-off approach on strategy after funding a case.
“I think this goes back to an attorney-client privilege question,” Greenberg said. “We also sort of start to touch on the old-school champerty and maintenance argument a lot, so we want to ensure we have no control over that litigation.”
Courts have tossed funding agreements for champerty in Pennsylvania in 2016 (WFIC LLC v. Labarre) and New York earlier this year (Justinian Capital SPC v. WestLB AG), but the Northern District of Illinois was clear in 2014 that third-party funding agreements are not inherently champertous.
In Miller UK Ltd., et al., v. Caterpillar Inc., the Peoria-based machinery company sought discovery of the third-party funder the smaller British company was using in its ultimately successful trade secrets case by, in the words of the Miller court, “invoking the hoary doctrines of maintenance and champerty.”
In Illinois, a state Supreme Court case did away with the common-law offense of maintenance in 1907. The modern state statute covering maintenance includes the line “officiously intermeddles.” Agreements between cash-strapped litigants and funders don’t meet the unrequested kibitzing those words imply, the Miller court found.
Lenkner wasn’t surprised the court found for Miller UK and its still-anonymous funder.
“In several of our investments we have been involved in situations where a defendant has gone down the path of trying to discover whether there is funding and if so in what amount and from whom,” he said. “No defendant has succeeded in an investment in which we’ve been involved. Every judge in every court has said this does not bear on whether the patents are valid and were infringed, this does not bear on whether the contract was breached. It’s a sideshow.”
To Resis, the questions of who funds a lawsuit can affect the nature of justice. The cases where agreements have been tossed — WFIC, where a lawyer split his fee with a funder after a verdict came in lower than expected and Justinian Capital, where a German bank handed a funder allegedly fraudulent notes so it could sue the original provider — show the potential for abuse.
“The concern is that whenever you have a pot of money out there that is being used to fund litigation that’s going to ultimately exercise control,” Resis said. “It can be at the expense of independent professional judgment and the obligations that lawyers have to their clients and under the rules of professional responsibility.”
Disclosing argument
“We would like to see third-party litigation funding go away,” Kouris said. “It’s probably not going to happen, but we think fairness demands a disclosure that this suit is being funded by a third-party investor.”
Some members of the defense bar want to amend Federal Rules of Civil Procedure Rule 26 and, locally, Illinois Supreme Court Rule 213 to require automatic disclosure of any agreements where investors foot the legal bills. The U.S. District Court for the Northern District of California this year added disclosure requirements to its standing orders for judges. Trade industry articles from Texas indicate the U.S. District Court for the Eastern District of Texas is mulling a similar move.
One entry to this debate is the U.S. Chamber of Commerce, which advocates a Rule 26 change to mandate disclosure.
“Absent a robust disclosure requirement, plaintiffs will continue to utilize [third-party litigation funding] — in some situations, illegally — undetected and unchecked,” U.S. Chamber Institute for Legal Reform President Lisa A. Rickard wrote in a June 1 letter on behalf of state and local chambers and defense bar groups, including Kouris’ DRI, from across the nation.
Lenkner joked the pro-business chamber would be on the funders’ side “if you replace ‘litigation’ with any other word.”
One criticism the letter lodged, and one that Resis and Kouris echoed, was that the new funding stream would lead to a glut of filings.
Hughes agrees. But where the chamber sees a flood of frivolous suits, he sees a hike in valid cases that previously would not have had the funding to proceed.
“The availability of money in the system certainly leads to more cases being filed. That’s as true as night follows day,” Hughes said. “For me, I think it’s just a question of whether you’re taking a case you think is meritorious and you think the plaintiff is deserving of being able to vindicate their rights in courts.”
Greenberg and Lenkner laughed off criticism third-party funding will lead to frivolous suits. Investors wouldn’t be penalized for backing frivolous suits the way lawyers get disciplined for filing them, but frivolous suits can get tossed. Investors don’t like when a judge can make their entire portfolio vanish with the bang of a gavel.
“LexShares doesn’t make money investing in frivolous lawsuits. LexShares makes money by investing in highly meritorious cases we believe will have a strong outcome,” Greenberg said. “[The allegation is] an interesting reaction and I think it makes sense for those folks that want to maintain the status quo — large corporations out there that want to be able to fight their war of attrition and that’s sort of their litigation strategy.”
Lenkner agreed.
“We’re not in the business of taking flyers. That is not why we exist and that is not what our investors expect us to do. If that is what we are doing, watch this conference room,” Lenkner said, gesturing out a dizzying 27th-floor panoramic view of River North. “Because you’ll be able to sublease it in six months.”
Outside money in litigation is nothing new, Greenberg said. The change is which side it’s falling on.
“This has been happening on the defense side forever,” Greenberg said. “Insurance companies and insurance policies exist. I’m not sure why this would be large news on the plaintiff’s side.”
Resis separately made the connection between insurance and third-party funding, but pointed out one area where he wants to see them even more in line.
“If there’s insurance coverage, the defendant is required to disclose the insurance coverage,” he said.