by Jeremy Reich
September 25, 2012
Litigation is a relatively recession proof business and is, therefore, an attractive asset class to investors. As a result, third party investment in litigation has become a lucrative business. While third party litigation financing is a recent phenomenon, the emergence of investors who finance commercial claims brought by companies against other companies, is an even newer phenomenon. Third party litigation financing can yield significant rewards for both investors and businesses alike, as long as certain practical and ethical roadblocks are properly navigated.
Third party litigation financing is when litigation is funded by non-traditional sources to civil plaintiffs, defendants, or their lawyers to support litigation-related activities. The financing usually results in a return on the investment from a share of any damage award or settlement. The concept originated in Australia, and then later spread to the United Kingdom before becoming a popular trend in the United States. These arrangements generally take the form of non-recourse loans; the lender only receives a return if the party receives a damage award or settlement. Third party financing is most common in tort litigation, where a majority of the capital is directed at plaintiffs or their attorneys with very little available to defendants. While most third party litigation financing occurs in the realm of personal injury claims, third party litigation financing is gaining popularity among investors who are financing commercial claims.
With banks, hedge funds, and private investors hungry for new and lucrative opportunities, third party financing of commercial litigation can be very appealing. In this context, a legal claim is viewed as an asset class on the balance sheet of a company, where litigation is simply a tool used to monetize that claim. When put in these terms, companies can make money just like any other derivative contract. The basic business model involves pricing the risk in a way that an investor believes will be worth more once monetized.
Not only is third party financing of commercial litigation an opportunity for investors, but it can also be a valuable resource to companies on the receiving end of the financing. For example, companies may want to use less of their own capital to pay their outside counsel. Commercial plaintiffs may also seek this type of financing to obtain assessments of the legal merits and likely economic values of their claims to supplement those provided by outside counsel. Others may use this funding as a signaling tool to opposing counsel with the hopes of strengthening their position during settlement negotiations. Additionally, it can be used by corporate legal departments as off-budget financing; where companies can pursue litigation opportunities that were not identified in their initial budgeting process. Whatever the reason, this type of financing permits corporate plaintiffs to share with their investors the costs of their litigation as well as the risks associated with such litigation, which can provide some relief to the company’s stakeholders.
Of all the potential pitfalls associated with third party litigation financing, the waiver of attorney-client privilege is what, perhaps, strikes the most fear in the hearts of litigators. The attorney-client privilege is an evidentiary doctrine that protects confidential communication from discovery by opposing parties in litigation. Disclosure of privileged communications to anyone other than another privileged person waives the privilege and the communication is subject to discovery. Courts generally take a strict approach to privilege waivers, finding that any voluntary disclosure of private communications will waive the privilege. Therefore, under privilege law in most jurisdictions, sharing of privileged communication with a third party financer is a voluntary disclosure that may amount to a waiver of the attorney-client privilege.
It is possible for a court to rule that such a voluntary disclosure does not amount to a waiver because the third party financer and the client have a common interest in the litigation. The common interest doctrine is an exception to the general rule that the attorney-client privilege is waived following disclosure of privileged materials to a third party. The most important predicate for the application of this doctrine is that the multiple parties have a common interest in the matter and agree to share confidential information concerning the matter. In the case of third party financing, whether courts may protect the attorney-client privilege by holding that the financers and their clients have sufficient interests in common remains an unresolved question.
As time progresses and the industry continues to grow, many of these potential pitfalls and unresolved questions will be answered. Third party financing of commercial litigation will likely forever change the future of commercial litigation.