Third-party litigation funding continues to attract investors, as evidenced by relatively new litigation funding firm Gerchen Keller Capital’s recent $260 million capital raise, which brings their total investor commitments to $310 million (as discussed in a January 12, 2013 New York Times article, here). As litigation has become more prevalent, courts have had to grapple with the phenomenon. As highlighted in a recent discovery ruling in a trade secrets lawsuit between Miller U.K. Ltd. and equipment-maker Caterpillar, courts seem to be becoming increasingly comfortable with the involvement third-party litigation financing.
Miller first sued Caterpillar in the Northern District of Illinois in 2010, alleging that Caterpillar had misappropriated trade secrets. According to Magistrate Judge Jeffrey Cole, “the case has been bitterly contested at every turn.” The parties have had extensive discovery disputes, including a dispute about whether or not Caterpillar could discover Miller’s third-party financing arrangements, as well as of the documents and information Miller had supplied prospective funding firms in order to try to obtain financing.
In a January 6, 2014 opinion (here), Magistrate Judge Cole granted in part and denied in part Caterpillar’s motion to compel. The opinion is interesting in a number of respects, particularly with regard to the Magistrate Judge’s consideration of the legality of third-party litigation financing under Illinois law.
Miller had sought to block discovery of its litigation financing agreements, contending that it was not relevant to the parties’ trade secrets dispute. Caterpillar argued that it was entitled to discover the financing transaction documents because, it argued, the financing agreement violated Illinois laws barring “maintenance and champerty” and that discovery of the financing transaction documents would allow Caterpillar to raise the supposed illegality of the funding document as a defense to certain of Miller’s claims. (As discussed here, “maintenance" is the intermeddling of a disinterested party to encourage a lawsuit and “champerty” is the "maintenance" of a person in a lawsuit on condition that the subject matter of the action is to be shared with the maintainer.)
After a detailed review of the relevant legal considerations, as well as the recognition that litigation funding remains controversial, the Magistrate Judge concluded that Caterpillar’s contention that Miller’s financing arrangement violated Illinois law prohibiting champerty and maintenance is “utterly unsupported.” He also rejected Caterpillar’s argument that discovery of the transaction documents would allow Caterpilllar to determine who the “real party in interest” is in the case or that Caterpillar was entitled to discovery of the transaction on that basis.
The Magistrate Judge did conclude that Caterpillar was entitled to discovery of certain of the documents that Miller had provided to prospective financing firms, particularly those where Miller had not take steps (such as entering a written confidentiality agreement) to ensure that the documents provided remained confidential.
As the Wall Street Journal noted in its January 12, 2014 article entitled “Litigation Investors Gain Ground in U.S.” (here), based on the Magistrate Judge’s opinion shows that the litigation funding “climate looks friendlier in Illinois,” and that restrictions on third-party litigation financing also have been “relaxed or abolished” in a number of other states, including Texas, South Carolina, Massachusetts and Florida. The Journal article quotes the counsel for Miller in the Caterpillar case as saying that “the courts are acknowledging that it’s a legitimate method of financing.”
Just the same, as the Magistrate Judge’s opinion expressly acknowledges, litigation funding remains controversial. Its critics contend that the availability of the financing could spur frivolous lawsuits or give the third-party funders undue influence over the case.
Hoping to try to head off these criticisms, some of the financing firm’s have voluntarily adopted their own code of best practices. For example, Bentham IMF, the U.S. affiliated of the Australian-based funding firm, has adopted its own Code, which embodies principles concerning fairness, transparency, responsibility and accountability. However, critics contend that these measures are insufficient. The Journal article quotes a representative of the U.S. Chamber Institute for Legal Reform as saying this type of code falls short because “there is no oversight, no regulation, nothing dealing with conflicts of interest, or disclosure” of funding agreements “either to defendants or to the judge.”
It may be, as the Journal article suggests, that courts are becoming more comfortable with third party litigation financing, but the practice seems likely to remain controversial. Though the debate over the social utility of the practice is likely to continue, the capital raising success of funding firms like Gerchen Keller Capital mentioned above suggests that the prevalence of litigation funding is likely to continue to grow.
As I have previously noted, the requirements of the capital markets do provide a certain kind of discipline, but history has shown that capital does not invariably make the best choices. Moreover, with the kinds of investment returns that the early entrants in the litigation funding arena are producing, new capital will continue to be attracted to the arena. The prospect for rich returns and low barriers to entry increase the likelihood that less meritorious litigation could find funding, or even that funds desperate to produce returns comparable to other funders might finance more speculative suits. Recent history shows what can happen when an asset class gets frothy, and there is nothing about litigation as an asset class that makes it immune from these kinds of risks. My further thoughts about litigation funding can be found here.
Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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