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July 28th, 2005
Taming the Champerty Beast: A Proposal for Funding Class Action Plaintiffs
Being a plaintiff’s class action lawyer can make you very rich, but no one ever said it was easy. You first have to find willing class representatives with a decent claim. But class representatives generally lack the resources to pay the enormous expenses of moving the case forward, so you have to fund the cases yourself or get other lawyers to help. Meanwhile, deep-pocket defendants often use their superior resources to turn the case into a battle of attrition. Faced with this, you may be forced to settle quickly or to not go forward at all, no matter how strong the class’s claim.
To help eliminate this disparity in resources, “hundreds of litigation funding companies have sprouted nationwide” in recent years. Some of these companies lend money at high interest rates to plaintiffs’ lawyers or their clients. Others are litigation syndication companies that raise money from investors and provide it in exchange for either a portion of the recovery or a flat amount at the end of the case.
In June 2003, however, the Supreme Court of Ohio dealt a severe blow to the litigation funding industry. In Rancman v. Interim Settlement Funding Corp., the Court ruled that a funding company’s advance to a litigant in return for a percentage of the recovery was void under principles of champerty and maintenance.
In this paper, we will show that the Rancman holding is out of step with the times, that court rulings and legislative decisions in other states have severely limited champerty prohibitions in order to permit third-party litigation funding, and that champerty and maintenance rules are no longer needed to protect against the evils which supposedly result from such funding. We will also propose a new funding mechanism for class action plaintiffs that fully answers the concerns raised by champerty adherents while protecting the interests of the parties and the integrity of the courts.
The Definition and Origins of Champerty and Maintenance
Maintenance is “an officious intermeddling in a suit that in no way belongs to one, by maintaining or assisting either party with money or otherwise, to prosecute or defend [the suit].” Thus, any third-party support for a lawsuit theoretically constitutes maintenance. Champerty is a form of maintenance that involves “maintaining a suit in return for a financial interest in the outcome.” “Because money is solicited from disinterested parties to fund litigation,” usually in return for a share of the proceeds, “syndicated lawsuits, by definition, constitute champerty.”
The prohibitions on champerty and maintenance have their roots in medieval England. In the Middle Ages, feudal lords and other wealthy individuals would fund land claims belonging to others – usually the poor and dispossessed – against their political and personal enemies, in return for receiving part ownership of the landed estate. These “champertors” had paid retainers – known as “maintainers” – who would prosecute the suits ruthlessly on their behalf, taking “all necessary steps to win.” Because kings soon found themselves the target of this vexatious litigation, and because of a general distaste for litigation in general, laws against champerty and maintenance were born.
Given its British origins, it is not surprising that state laws or court rules prohibiting champerty have existed since our nation was established. Nevertheless, “the [champerty] doctrine has a . . . checkered history” in the United States. Several states, including South Carolina, Massachusetts, New York and West Virginia, have significantly narrowed the doctrine, while others – Arizona, California, Louisiana, New Jersey and Texas – either never adopted it or have abandoned it.
The Rancman Decision
Nevertheless, champerty survives in the majority of U.S. jurisdictions. The Rancman decision is a prime example. Rancman had been seriously injured in a car crash, and had sued an insurance company for damages. Apparently in need of funds while the case was pending, she contacted Interim Settlement Funding Corporation (“Interim”) to obtain a cash advance secured by her pending claim. Interim agreed to advance her $6,000 in exchange for the first $16,800 she would recover if the case resolved within 12 months, with higher payments due if the case took longer to resolve. If she did not obtain a recovery, she would pay nothing.
Rancman settled the case for $100,000 within 12 months, but refused to pay Interim the amount due under the contract. She eventually sued for rescission, and prevailed in the lower court on the ground that Interim’s advance constituted a usurious loan.
On appeal, Interim argued that the advances were not loans at all, but investments (since there was no absolute obligation to repay). The Supreme Court of Ohio ruled that “[t]he advances here are void as champerty and maintenance regardless of whether they are loans or investments.” The advances constituted champerty because “Interim sought to profit from Rancman’s case,” and constituted maintenance because Interim “purchased a share of a suit to which [it] did not have an independent interest” through an arrangement that “provided Rancman with a disincentive to settle her case.”
Specifically, the Court noted that Rancman, in return for her $6,000 advance, had to pay Interim the first $16,800 she received in settlement and also had to pay her lawyer a 30% contingency payment. Thus, she would pocket nothing for herself unless the settlement exceeded $24,000. According to the Court, this created “an absolute disincentive” to settle for a lower amount, and resulted in prolonging the litigation. Meanwhile, the Court concluded, Interim earned a “handsome profit by speculating in a lawsuit.”
Why the Rancman Court is Wrong
By holding that a financing arrangement that discourages settlement is champertous, Rancman would prohibit any financing arrangement, either by a lawyer or a third party, which allows the financing source to profit at the client’s expense. Among other things, it would prohibit lawyers from borrowing money from third-party lenders and charging the costs of the loan to the client – a practice explicitly permitted in many jurisdictions. Obviously, this reasoning goes too far: even the most innocuous fee arrangement – whether hourly or contingency – potentially imposes costs on the client that make it that much more difficult for her to come out whole in a settlement. A party’s decision to borrow money, even on a contingent basis, does not ipso facto create an improper disincentive to settle any more than that party’s decision to hire a more expensive lawyer.
At any rate, numerous other legal devices exist to protect unsophisticated clients from improprieties by litigation lenders. For example, usury laws prevent unduly high interest rates, sanctions rules guard against frivolous, speculative litigation, and ethical rules protect against excessive fees. Champerty and maintenance merely create blanket prohibitions that make it harder for plaintiffs to bring meritorious claims against wealthy, powerful opponents.
Decisions Limiting Champerty
For this exact reason, the highest courts of several states have explicitly rejected the champerty defense in recent years. Typical is Saladini v. Righellis. There, Righellis obtained a loan from Saladini to help him pursue legal claims arising from his interest in certain real estate. Saladini made the loan in return for a contingent interest in the recovery: This loan principal would be repaid from the first proceeds, plus he would receive 50% of any net recovery after attorneys fees. When Saladini attempted to enforce this agreement, Righellis defended by invoking champerty and maintenance.
The Supreme Judicial Court of Massachusetts rejected this defense, and held that “the common law doctrines of champerty, barratry and maintenance no longer shall be recognized in Massachusetts.” The Court noted that the view of litigation as “social ill” is long outdated. It also recognized that application of the champerty doctrine would provide the litigant with a windfall: Righellis would get to keep the litigation proceeds, while Saladini, whose financial contribution made the recovery possible, would end up with nothing.
According to the Court, fee regulations, sanctions rules, and the doctrines of unconscionability, duress and good faith are more than sufficient to prevent the “evils” that champerty was originally designed to address. Financing arrangements, the Court continued, should be analyzed on a case-by-case basis, with a focus on “whether the fees charged [are] excessive or whether any recovery by a prevailing party is vitiated because of some impermissible overreaching by the financier.”
Massachusetts is not alone in eschewing the doctrines of champerty and maintenance. Two years later, in Osprey v. Cabana Limited Partnership, the Supreme Court of South Carolina whole-heartedly embraced the Saladini analysis and “abolish[ed] champerty as a defense.” That same week, the New York Court of Appeals dramatically limited the scope of the champerty doctrine by holding that claims could be sold freely to third-parties except when “the foundational intent to sue on the claim [was] at least . . . the primary purpose for, if not the sole motivation behind, entering into the transaction. In addition, a Florida appellate court upheld an arrangement in which the litigant had obtained third-party financing in return for giving up set percentages of the ultimate recovery, noting that champerty did not apply because the financier had neither instigated the litigation nor set the loan terms. The Florida holding has special resonance, because those courts that have upheld champerty restrictions in recent years have done so mainly to prevent “officious intermeddlers” – persons who have no personal stake in the claim being pursued – from fomenting litigation.
The Pros and Cons of Lawsuit Syndication Arrangements
Nevertheless, while isolated courts have accepted syndication efforts, the issue is anything but settled. Even the Saladini and Osprey courts made clear that their decisions “should not be interpreted to indicate our authorization of the syndication of lawsuits.” While neither court gave any reason for limiting its holding in this way, it appears that even these pro-financing courts view multi-investor arrangements, which may involve huge sums of money and the public solicitation of lay investors, very differently from private, one-on-one arrangements designed to help one impoverished litigant.
According to critics, syndication arrangements:
- encourage meritless litigation;
- encourage speculation in lawsuits;
- allow lay investors to control litigation, in direct contravention of the rules against fee splitting; and
- create a conflict of interest between the investors and clients, who may have differing interests on whether to settle.
But at the same time, syndication arrangements have the enormous potential to do good, particularly in the class action context. Most notably, they would provide another vehicle – aside from standard contingency arrangements funded by lawyers – “to allow those with meritorious claims but insufficient funds access to the courts.” And by eliminating lawyer financing, it would do away with class counsel having a personal stake in obtaining a quick settlement – a situation that often brings the lawyers into conflict with the class as a whole.
Moreover, the concern that syndication arrangements encourage speculation in lawsuits and foment meritless litigation are unfounded. Investors are unlikely to risk substantial sums on worthless claims; indeed, they may be less willing than class representatives, who are often driven by principle, to “throw good money after bad” by pursuing a problematic lawsuit. To the extent courts remain troubled by “officious intermeddlers” fomenting others to start litigation, this can be addressed on a case-by-case basis, as it was in Clark and Accrued Financial Services.
Nevertheless, some of the concerns expressed by champerty’s adherents are real. For example, third parties seeking to invest in litigation for purely financial reasons often take advantage of desperate, impecunious class representatives (and their lawyers) by demanding high interest rates and guaranteed returns. These, in turn, create extraordinary financial pressures that may make it more difficult for the plaintiff class to settle – the type of situation the Rancman court feared.
Similarly, allowing lay people to invest huge sums in a class action makes it almost inevitable that they will try to influence the lawyers’ decision making, if only to protect their financial position. It also raises the danger addressed by Model Rule 5.4(c), which prohibits non-lawyers who “recommend, employ or pay a lawyer” from “direct[ing] or regulat[ing] the lawyer’s professional judgment.”
A New Paradigm For Funding Class Actions
In our view, the legal system should do what it can to ensure that class representatives are able to have third parties finance the prosecution of valid claims. To accomplish this, while at the same time addressing the very real concerns just noted, we suggest the following:
- All third-party investor funds should be placed in a blind trust controlled by class counsel, with the investors having no say as to how the money is spent or whether the case should be settled at any particular time. Class counsel should be prohibited from communicating with the investors – even by providing status reports – absent court approval. This will minimize lay interference with lawyer decision-making.
- To further enforce the separation of class counsel and lay investors, a special master should be appointed with on-going authority to investigate whether investors are participating in decisions on spending trust assets; defense counsel would have no involvement in any such investigation. The special master could provide other assistance to the judge in managing the financing arrangement and evaluating the fairness of any final settlement.
- The court would have to approve the blind trust arrangement from its inception. This would enable the court to protect the class by ensuring the financial terms are fair and inherent conflicts of interest are eliminated.
- Investors may receive only a set percentage of total recovery. They may not receive a guaranteed return with interest (to avoid usury claims and placing class counsel in a conflict of interest) or a percentage of the attorneys’ fees (to avoid fee splitting).
While this proposal is no panacea, it can, if properly implemented and administered, provide a model for allowing third-party investment in class action lawsuits while avoiding the champerty concerns addressed in Rancman – concerns that, for the most part, are hopelessly outdated.
By: Ronald Minkoff and Andrew D. Patrick
This article was originally published in The Professional Lawyer, a quarterly magazine published by the ABA Center for Professional Responsibility and the Standing Committee on Professionalism.
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