Litigation Financing Is Not Champerty: Delaware Confirms That Litigation Financing Is Here To Stay

On March 9, 2016, in Charge Injection Technologies, Inc. v. E.I. Dupont De Nemours & Company, C.A. No. 07C-12-134-JRL, the Superior Court of the State of Delaware issued a decision on a motion to dismiss for violating state champerty and maintenance laws.  In 2008, plaintiff Charge Injection Technologies, Inc. (“CIT”) sued E.I. Dupont De Nemours & Company (“Dupont”) for various patent and trade secrets related infractions.  During the course of the litigation, CIT entered into a litigation financing arrangement with Burford Capital LLC (“Burford”).  Dupont sought to have the case dismissed, arguing in part that CIT was not the true owner of the claims and Burford was wielding de facto control over the lawsuit.  The Court denied Dupont’s motion, finding that CIT had not assigned its claim to Burford, and Burford had no right to maintain, direct, control or settle the litigation.  In denying the motion, the Court affirmed the propriety of litigation financing, and strongly dispelled many of the criticisms raised by those opposed to such arrangements.

Criticism:  Increase of Frivolous Litigation

For example, one of the most commonly expressed criticisms of litigation financing is that it will increase frivolous litigation.  The premise of this criticism is that litigation financing would enable cases to be filed that would otherwise not be brought.  However, if we assume that investors are economically rational actors, driven by return on investment risk and expectation analytics, it is illogical that investors would necessarily fund frivolous cases.  Frivolous cases by definition have very little value or chance of success.  Therefore, economically rational actors would not fund such cases or even so-called “nuisance” cases since they could not support the risk-return requirements of litigation financing.

Indeed, litigation financing may actually have the opposite effect.  Litigation financing would enable parties with strong cases to file suit in order to protect their rights.  Indeed, the Delaware court agreed with this assessment when it found that Burford had not “stirred up” litigation, nor was it controlling or forcing litigation but that CITs “principal asset was and still is its intellectual property rights … which CIT alleges DuPont wrongfully used, disclosed and misappropriated.”  In fact, entities providing litigation financing typically conduct a rigorous evaluation.  They weed out weak cases, helping more cases of merit to reach court or trial, where they otherwise might not.  Consequently, on balance, the net effect may be a relative increase in meritorious cases.  Thus, in this manner, litigation financing plays a beneficial role by acting as an additional gatekeeper to the courthouse.

Criticism:  Ethical Conflicts

Another criticism of litigation financing is that it creates loyalty or ethical conflicts between the attorney and client.  This criticism appears to be based on the conflict that an attorney may face since a third party is paying the legal fees.  However, there is no compelling reason to believe that this should necessarily create a conflict or render an attorney less capable of discharging his or her duties to the client.  As noted in the CIT case, a crucial condition for litigation financing to work is that the client maintain complete control over all aspects of the case.  From the perspective of the attorney’s relationship to the client, the funding aspect is irrelevant.  The attorney still takes instruction from his client; as long as the funding arrangements meets this condition, there is no undue influence that may compromise the attorney.  The Delaware court recognized this separateness of the funder and the litigant when it pointed out components that are typical of any third-party funding arrangement – e.g., the litigant (CIT) “controls the litigation claim”, “is the decision maker with regard to the . . .  litigation,” and that Burford had not reviewed Dupont’s confidential information nor participated in any mediation sessions.

Criticism:  Preventing Cases from Settling

Critics have also questioned whether financing would skew decision making by plaintiffs, particularly as to settlement.  But the economics of funding arrangements are specifically set up to avoid this.  Funding does not mean that plaintiffs now have carte blanche spending – funding is not “free” money that will incentivize plaintiffs to litigate unnecessarily.  Litigation financing arrangements typically replicate the same incentive factors in the client as would exist without the funding because the funded amount is tied to the return structure, in some fashion.  For example, the return may be based on a multiple of the deployed funds or trigger contingency percentages that escalate proportionally to the funds used, all of which reduce the plaintiff’s net return.  Thus, in this sense, every dollar of funding that a plaintiff utilizes, just like every actual dollar of its own, represents a comparative cost.  The plaintiff’s fee expenditure decision-making will involve the same or similar cost-benefit analysis, regardless of whether money comes from its own coffers or from a third party fund.

With specific respect to settlements, the situational factors are comparatively similar.  Outside of the litigation financing context, settlement is a balance of a variety factors including anticipated fees and costs.  Just because a plaintiff is funded does not necessarily mean that the plaintiff is more or less likely to settle early.  Instead, so long as the financing entity exercises no control, the funding arrangement merely adds another layer of economic calculus to the settlement strategy.  In fact, as compared to the pure contingency arrangement, where the settlement pressures may actually be artificially heightened, a funded scenario would actually appear to put the plaintiff in a more “objective” position to evaluate settlement.

This type of criticism also appears to be built on a faulty premise because it compares alleged counter-incentives of a funded plaintiff against a plaintiff who is paying for the litigation out its own pocket and therefore should be motivated to settle early.  But this is the wrong comparison.  In the funding scenarios presented here, the plaintiff would not otherwise be able to pay for the litigation out of its own pocket.  Consequently, to say that such a plaintiff may be “less likely to settle” is comparably nonsensical, since without the funding there would have been no case and no chance for settlement in the first place.  Thus, litigation financing has the benefit of the evening the playing field by removing economic advantage between two parties in litigation from the calculation.

Criticism:  Real Benefits to Plaintiffs

Finally, some critics have questioned the real benefits to plaintiffs and undue burdens leveraged by litigation financing entities.  On the one hand, for any plaintiff faced with foregoing its claims without securing litigation financing, the balance of negotiating power lies with the financier.  But this is a reflection of market forces at play, emphasizing the need for a robust and competitive capital market for litigation financing.  Furthermore, all litigation financing arrangements are non-recourse.  Consequently, plaintiffs will rarely be in a worse financial position, as compared to never having been funded.

Indeed, in one sense, the market forces are already at work.  Since plaintiffs can already turn to the pure contingency firm with no downside for the plaintiff, litigation financing has to offer benefits above and beyond to be competitive.  In effect, litigation financing essentially gives plaintiffs a greater choice of law firms, where they otherwise would only be able to select from the fewer firms willing to take on contingency cases.

In sum, critics may need to take heed – litigation financing appears to be here to stay.

Edited by Mieke Malmberg

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Posted By:
Andrew Choung

Andrew Choung

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