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City Bar Center for Continuing Legal EducationTHE NEW YORK CITY BAR

42 West 44th Street, New York, New York 10036

Borrowing from Peter to Sue Paul: Legal & Ethical Issues in Financing a

Commercial Lawsuit

April 15, 2013

6:00 9:00 p.m.

Sponsoring Committees:

Commercial Law & Uniform State Laws Janet M. Nadile, Chair

Professional Ethics Jeremy R. Feinberg, Chair

Borrowing from Peter to Sue Paul: Legal & Ethical Issues in Financing a

Commercial Lawsuit

Program Chair

James M. Haddad Law Office of James M. Haddad

Faculty

Harvey R. Hirschfeld Chairman of the

American Legal Finance Association LawCash

Professor Anthony Sebok Benjamin N. Cardozo School of Law

Selvyn Seidel Chairman & Principal

Fulbrook Capital Management LLC

Sandra Stern Nordquist & Stern PLLC

Aviva O. Will Managing Director

Burford Capital LLC

Borrowing from Peter to sue Paul: Legal & Ethical Issues in Financing a Commercial Lawsuit

April 15, 2013

AGENDA

6:00 6:05 p.m. Introduction & Overview of ProgramJames M. Haddad

6:05 6:45 p.m. Legal Lending, Financing, Funding & Investing Legal & Ethical Issues from the Funders Perspective How it works, whats available, what it looks like, individual plaintiff vs. divorce vs. class vs. commercial, etc., ethical concerns and constraints, regulatory framework, privilege, confidentiality, conflicts, control, involvement, funder liability, duty to know, duty to advise, lawsuits, Spitzer agreement, proposed legislation, social policy, etc.

Harvey R. Hirschfeld, Selvyn Seidel & Aviva O. Will

6:45 6:50 p.m. Break

6:50 7:10 p.m. Funders Perspective (continued) When to use various types of funding, how third party funding impacts tactics and strategy, privilege, confidentiality & the lenders involvement & liability

7:10 7:20 p.m. Panel Q&A

7:20 7:25 p.m. Break

7:25 8:00 p.m. Litigation Funding View from the Counsels TableA view of the practical, tactical, ethical, legal, regulatory, legislative and social issues from the viewpoint of the practitioner/professional/ethicist.

Professor Anthony Sebok

8:00 8:05 p.m. Break

8:05 8:15 p.m. Panel Discussion & Q&A

8:15 8:20 p.m. Break

8:20 8:50 p.m. Securing, Collecting & Alienating the CollateralSandra Stern

8:50 9:00 p.m. Final Q&A Session Panel

Thisprogramwillfulfill3.0CLEcreditstotal:1.0skills&2.0ethicsfortheMCLErequirementforNY,NJ&CA&1.0generalcredits&1.75ethics(pending)forIllinois&

1.0generalcredits&1.5ethicsforPA.

Borrowing from Peter to Sue Paul:Legal & Ethical Issues in Financing a

Commercial Lawsuit

April 15, 2013

Table of Contents

Time to Pass the Baton? .......................................................................................................1 By: Selvyn Seidel

[Law School's] Duty to Know [and to Teach Third Party Funding] ...................................5 By: Selvyn Seidel

The above two articles are reprinted with permission from www.CDR-News.com

The Lawyers Duty-to-Know & Duty-To- Tell in Third PartyParty Funding: A Time to Recognise & Respect these [Legal and Ethical] Obligations ....8

By: Selvyn Seidel

Investigating in Commercial Claims; New York PerspectivesNYSBA, New York Dispute Resolution Lawyer .............................................................11

By: Selvyn Seidel

Reprinted with permission from: New York Dispute Resolution Lawyer, Spring 2011, Vol.4 No. 1, published by the New York State Bar Association,

One Elk Street, Albany, New York 12207

Investment Arbitration Claims Could be Traded like Derivatives .................................16 By: Rebecca Lowe

This article was first published for IBA Global Insight online newsanalysis, 8 February, 2013. [available at www.ibanet.org] and is

reproduced by kind permission of the International Bar Association, London, UK International Bar Association

Third Party Litigation Financing: A New York City Bar Formal Ethics Opinion .......................................................................................................19

American Bar Association Commission on Ethics 20/20: White Paperon Alternative Litigation Finance ......................................................................................20

Copyright 2011 by the American Bar Association. Reprinted with permission.

The New, New Thing: A Study of the Emerging Market in Third-PartyLitigation Funding, November 2010..................................................................................61

Reprinted with permission of Fox Williams LLP.

Professional Responsibility and Third Party Litigation Funding A Brief Tour of the ABA White Paper ..................................................................................84 By: Anthony J. Sebok

This report was prepared by Anthony Sebok. Reprinted with permission.

American Bar Association Commission on Ethics 20/20: InformationalReport to the House of Delegates ......................................................................................90

By: Anthony Sebok & W. Bradley WendelCopyright 2011 by the American Bar Association.

Reprinted with permission.

Litigation Finance: A Market Solution to a Procedural Problem ....................................130 By: Jonathan T. Molot

The above article was reprinted with permission from the author Jonathan T. Molot and from Georgetown University Law Center

Georgetown Law Journal 2010

Stopping the Sale on Lawsuits: A Proposal to Regulate Third-PartyInvestments in Litigation .................................................................................................181

Prepared for the U.S. Chamber Institute for Legal Reform by John H. Beisner & Gary A. Rubin, Skadden, Arps, Slate, Meagher & Flom LLP.

October 2012. All rights reserved.

Litigation Financing .........................................................................................................201 By: Sandra Stern

This section is adapted from Sandra Stern, Structuring and Drafting CommercialLoan Agreements (copyright 2012 Thompson Media Group). Reprinted with

permission of the publisher and sole copyright owner. All rights reserved. Structuring and Drafting Commercial Loan Agreements is available at a 10 percent discount

to program participants through June 30, 2013.

To receive the discount when ordering, please go to http://www.sheshunoff.com/products/Strucutring-and-Drafting-Commerical-Loan-

Agreements.html and enter the code SCLA13. Or you can contact customer service at 800.456.2340

Notes on the Faculty .................................................................................................................. i

Conference preview46 THIRD-PARTY FINANCE: CONTROL

long smouldering issue in the third-party funding industry relates to what might be called the control doctrine. Control in this context has generally been understood to

mean decision making authority, the basic purport being that decision making must remain with the claimant, with advice from their lawyer. The funder can consult and advise, but only within that fenced-in area.

The control doctrine and its current status as an inhibitorFunders have always been challenged on the ground that they, as third parties, should be prohibited from taking over control of anothers claim.1 A key flash point has been the decision regarding whether to settle a case. This decision, which is central to any dispute, can and does generate conflicting interests and positions between the claimant and the funder. The control doctrine says that this decision remains with the claimant (on advice of counsel) at all times.

A

TIME TO PASS THE

1

47Commercial Dispute ResolutionNOVEMBER-DECEMBER 2012

Selvyn Seidel of Fulbrook Capital Management argues that the long held control doctrine in third-party financing is long past its sell-by date, and needs to be replaced by a new set of guiding principles for the industry to reach its full potential

www.cdr-news.com

In some jurisdictions such as the UK, the control doctrine also means that the claim owner might be handicapped or prohibited altogether from selling the claim in its entirety. In the US, sale of the entire claim has been condemned in different circles such as where patent claimants sell their claim to a third party to prosecute it as that partys own. The buyers in such instances are often non-practicing entities (NPEs), more commonly known as patent trolls.

For one who runs afoul of the control doctrine, the penalties can be painful. They range from making the funding agreement unenforceable to imposing sanctions on the funder, exposing the funder to civil and ethical liability or perhaps even to criminal sanctions.

The purpose and policy behind these restrictions and prohibitions are varied and not subject to convenient and comprehensive summary. But they seem traceable to at least several concerns. One is that a claim is personal to the holder, to have and to hold until death do them part. The two simply cannot be delinked through commercial barter or otherwise.

According to some observers, it is also wrong to consider parting the owner from the claim. Comparisons are sometimes

made with elderly peoples interests in life proceeds from insurance policies, on grounds that here too the owner should not be divorced from his or her right. Comparisons are also made to sales of interests in patents.

Basic champerty concerns have underpinned the purpose and policy pronouncements. Champerty has from its birth in the Middle Ages reflected concerns that a claimant is generally in such a helpless position that it is vulnerable to a third party purchaser taking advantage of it in the transfer. The champerty champions also fear that free trade in claims enhances the possibility that litigation will itself be increased intolerably by mercenaries.

The doctrine of control has thus far been respected by the industry. Actually, it might be said that the industry has gone overboard in its deference to and fear of the doctrine. For example, the common position of established members of the funding industry is that once a case is funded, they are hands off. That position reflects champerty-fear at work.

Despite the doctrines long history and serious challenges to the funding industry, the doctrine itself is now not only being challenged, it is in fact being diluted and discarded.

Why the control doctrine is on its way outCritics of the control doctrine have, in strictly limited numbers, just started to step up. Moreover, without fanfare, the doctrine is in reality already gone or rapidly receding

2

Conference preview48 THIRD-PARTY FINANCE: CONTROL

in important areas. For example, the transfer of control has been allowed in part or in its entirety in a number of situations, including when a mortgagee transfers its total interest to a third party (which has already occurred in New York where the mortgagees have on default of mortgagor sold the claims to another);2 in bankruptcy claims; and in certain European and Far Eastern jurisdictions. In June, 2010, the New York City Bar Association issued an ethics opinion on funding, indicating that control was acceptable. Consider this alongside the contingency law relationship of lawyer to claimant and claim, where the law in the US has carved an exception of contingency lawyering from the champerty restrictions.

Further, at the urging of the bench, bar and government in the UK, a group of funders issued a voluntary Code of Conduct in November 2011. Despite the drafters expressed position that restraints on control should in general exist, the Codes language concerning control appears to leave some ambiguities that allow for influence, and more, on the part of the funders.

The Code provides: A Funder will . . . not seek to influence the Litigants solicitor or

barrister to cede control or conduct of the dispute to the Funder. . . (Clause 7 (c))

Within the four corners of this Code, can the funder accept control if it does not seek control but the lawyer or barrister offer it? Beyond this, can the funder sidestep the lawyer altogether and go directly to the claim owner itself and ask it to cede control, rather than going to the lawyers?

The Code might even be construed as creating an accommodation for funders seeking influence. It states that where there is an irreconcilable difference of opinion between the funder and the claimant, the parties can agree in their contract to appoint an independent barrister to resolve the dispute fully and finally, and even though contrary to the wishes of the claim owner (or the funder). Can this provision sustain an attack that it actually crosses the line, giving the funder too much influence? It is not too

far-fetched to raise this question when we see that some arguments have already surfaced claiming that a funder who establishes certain parameters agreed to at the beginning of the contract with the claimant that assist in determining whether the case should be settled, are themselves going too far in controlling a settlement situation.

Furthermore, there is now a serious development in the industry where some recently-established funders (including Fulbrook) are acknowledging they are not hands off, but are hands on. They assert that they are dedicated to supporting the claim after funding, from cradle to grave. They stop short of control, of course, but turn the dial from hands off to hands on. Their premise is that if the claim is meritorious, then they can, by bringing their human and capital resources to bear, enhance the value of the claim more towards its true value.

The doctrine needs a push to finish it exitDo not these developments and the current situation tell us that it is time to revisit the doctrine and explicitly clarify, change, or even discard it? Prior to now, it was probably politically premature to raise this question too loudly (or at all). The industry was too new, struggling with too many issues, and trying to gain some traction and credibility as a new development, to add a question about a doctrine which had become so entrenched.

Now, with the industry gaining credibility and use, champerty concerns fading in the commercial area, the doctrine itself causing conspicuous problems, and with other developments in the industry that cushion the removal of the doctrine, it seems to be a reasonable time to ask this question.

In fact, the time is especially ripe in view of some developments in the UK. For example, in the UK a law will come into effect in April 2013 which in effect allows lawyers to act as contingency lawyers. This practice has been allowed in the US for a long time; it is frequently compared to funding insofar as what third parties might be allowed to do with regard to anothers claim, and it is treated as an exception to the champerty rules. This major development in the UK reflects a mindset that comprehends third-party support of a claim. That should bode well for the funding industry, and the market.

It is also noteworthy that with the recent launch in the UK of the Alternative Business Structures Act, third party business and finance parties can invest in law firms, and also be partners within such firms. Among other things, and although there are restrictions on amounts that can be invested and the degree of involvement of the third party to make decisions in the lawsuit, this arrangement allows third parties to put funds behind a claim, and to be involved in the progress of the dispute. The law firms can in turn commit capital to various business ventures. The Alternative Business Structures Act is affirming, in one fashion or another, the concept of a third party non-lawyers involving itself in a lawsuit, and indeed in a law firm.

Interested parties have been quietly and for some time undermining and abolishing the control rules. A perfect example can be drawn from the corporate world. Here, there is no doubt that a third party can buy control of a company through, say, acquiring 30% with a stockholders agreement bestowing control over the company. That control leaves complete control over any litigation in the company. The control is vested in a party who likely has little idea what the litigation is about, let alone the best way to handle it. If that is acceptable, what justification can there be to barring control in a single case situation, particularly when the control in that case should be far more informed and beneficial to a meritorious claim?

Similar questions can be asked about a private equity party which buys a company, and is free to control it and its litigations. In a forthcoming article, Professor Maya Steinitz, a leading expert on funding, argues that funders are analogous to venture capitalists,

The original purpose of a limitation on a claimants transferring control over the claim protecting the claimant as a self-appointed trustee is no longer alive because that claimant is not

helpless and in need of a guardian, but commercial

3

and that like such investors they should be accorded the right to exercise substantial control over a lawsuit.3

In such a setting, is explicitly acknowledging the right to control such a revolutionary step? Mortgage, bankruptcy, and patent cases already say the claim can be transferred lock, stock and barrel, or that a partial interest can be taken by a third party. Contingency law supports the same conclusion. Some courts both within and outside the UK and US have already indicated that this is possible. The New York City Bar association has indicated support for a funders taking control under circumstances that otherwise comply with a lawyers ethical duties.

In this context it is worth noting that the doctrine of champerty itself has been debunked in the UK with legislation and court decisions. It has, overall, fared somewhat badly in the US as well, with at least half the states abolishing the doctrine altogether, and others restricting severely or prohibiting its application when commercial cases are involved.4

As a result, champerty and maintenance no longer can be used as they were to argue that funding is by nature illegal and unethical. Courts in the UK, the US and Australia leave little doubt here.

Champertys marginalisation in the commercial setting is well justified. The original purpose of a limitation on a claimants transferring control over the claim protecting the claimant as a self-appointed trustee is no longer alive because that claimant is not helpless and in need of a guardian, but commercial.

Indeed, it is the claimant that often wants the option to transfer control, in return for cash or other consideration. The prohibition is in fact a restraint on freedom of contract. Moreover, it turns a deaf ear to the market. If an informed market wants access to funding, and thus to all the potential features of a funding arrangement, who in the government should be authorised to thwart that wish and to deny access as a matter of public policy?

Second, since the predicate of a funded case is its merit, the doctrine of champerty serves no public policy purpose. True, the courts may be overcrowded, but that is not a reason to bar access by good claimants with good claims. To the extent that there is a fear that bad funders will support bad claims

and increase the frivolous population in the courts, it should be addressed sufficiently by safeguards and rules already in the legal system, and other rules that if needed can be devised.

Third, supporting good claims by supporting good funding adds a financial instrument and service to an economic environment that needs them. These add to both commercial and civil justice, and this virtue is at the heart of the value of funding.

Exit a doctrine, enter some new rulesIt is thus submitted that no genuine question should exist about whether the control doctrine deserves to be buried. The only valid questions here are how related rules and other protections that already exist can be co-ordinated with this development, and what new rules and protections might be put in place. These questions can be illustrated by asking how control enhances the funders exposure to:

tMJBCJMJUZGPSDPTUTBOEGFFTJGUIFDMBJNMPTFTtTBODUJPOTBMPOHXJUIUIFDMBJNBOUGPSBTTFSUJOHBDMBJNUIBUUVSOTPVUUPCFGSJWPMPVTtCFJOHUSFBUFEBTBGVMMFEHFEQBSUZGPSWBSJPVTQVSQPTFTTVDIBTJOEFUFSNJOJOHwhether there is jurisdiction under an ICSID 5SFBUZXIJDISFRVJSFTPSQSPIJCJUTOBUJPOBMTPGDFSUBJODPVOUSJFTPSTPNFPOFTVCKFDUUPEJTDPWFSZPSJOEFUFSNJOJOHUIFBQQMJDBCJMJUZPSOPOBQQMJDBCJMJUZPGUIFBUUPSOFZDMJFOUQSJWJMFHFor work product doctrines tQPTTJCMFEVDJBSZPSPUIFSSFTQPOTJCJMJUJFTTVDIBTGSPNBDPOUSPMMJOHGVOEFSUPBDMBJNBOUXIPJTOPUJOBDPOUSPMQPTJUJPOKVTUBTBNBKPSJUZTIBSFIPMEFSNJHIUIBWFDFSUBJOEVUJFTJNQPTFEPOJUSFMBUJOHUPUIFNJOPSJUZ

With the industry and market active and growing, this project cannot be put on the back burner. All

stakeholders in the market, industry, and among the defendant community, should step up in this effort it affects each and every interest.

Hopefully enough individuals will take an ownership interest in the area and make an effort to study the issues and help to enact good rules that will protect the market, the funders, and the defendants. The time to start this is today, not tomorrow.

www.cdr-news.com

49Commercial Dispute Resolution

NOVEMBER-DECEMBER 2012

About the author

Selvyn Seidel is the founder, chairman and CEO of Fulbrook Capital Management LLC. He was previously a co-founder and chairman of the Burford Group. Sandra Sherman of Fulbrook assisted in the production of this article.

1 See S. Seidel, $POUSPM Commercial Dispute Resolution Magazine, September 2011. 2 S. Seidel, Investing in Commercial Claims: New York Perspective, NYSBA New York Dispute Resolution Lawyer, Spring, 20113 Maya Steinitz, The Litigation Finance $POUSBDU forthcoming, William & Mary L. Rev. __ (2012), http://papers.ssrn.com/sol3/papers.cfm?abstract-id=2049528, comparing Funders to Hedge Funds and Private Equity entities, and indicating that these comparisons support allowing greater influence by Funders coupled with greater responsibilities. 4 See e.g., Anthony Sebok, The *OBVUIFOUJD$MBJN, 64 Vanderbilt Law Review 61, 30 January 2011, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1593329.. http://papers. Ssrn.com/sol3/papers.cfm?abstract-id=1593329##

4

Third-party financexx EDUCATING THE WORLDS FUTURE LAWYERS

or much of its life, third-party funding has been an industry known to only a few, most of whom were the funders themselves. The rest were essentially lawyers scattered here and there. In fact, the industry was so young that it somewhat embarrassingly struggled to invent terminology defining its own activities. This situation made third-party

funders vulnerable to those in more established quarters who wished to challenge the industry, scare the market and inspire regulators to action. Lack of public awareness and understanding were for a long time public enemy number one.

This situation has however changed. Over time and after some heated debates and various studies the industry has caught the eye and pen of the news media. It is also on the agenda of conference planners who are launching ever-more frequent events on the topic. The market is learning, wants to know more, and more parties are turning to funders to access justice. Regulators are starting to sit up and take serious notice.

A growing number of insiders and interested observers alike seem to have concluded that regulators should be involved in some form or another. In the UK, for example, we see an association of funders being formed to impose voluntary rules and regulations. Additionally, in the US, we see Bar organisations (the American Bar Association, the New York City Bar Association, other state Bar associations) writing reports and issuing guidelines, and some state legislators starting to enact some legislation. Similar moves are afoot in Australia, where the modern funding industry started more than a generation ago.

Much however remains to be done. This articles position is that while the overall process and these developments are healthy, laudable and must continue, nobody should be resting on their laurels just yet.

Lawyers duties and positionA critical part of this forward push is the drawing in of other stakeholders. Lawyers have a robust duty here. With some

oor mbbeenof wrrest aandthatto inactiv

fufufundndnderers vulnerable to twho wished to challen

F

Lawyers need to start spreading the message about third-party finance options to the clients, says Selvyn Seidel of Fulbrooke Capital Management. But in order to engender this new awareness, the process has to start in the classroom at law schools

5

xxCommercial Dispute Resolution

SEPTEMBER-OCTOBER 2012

www.cdr-news.com

resistance and some expressed chagrin, this author has written journal articles, supposedly discovering, and then emphasizing this discovery in conferences and other presentations, a duty to know and duty to tell on the part of lawyers a duty to know about funding and to adequately inform their clients so the clients can choose whether to pursue funding. This publication has been among the first to give due attention to and regularly cover this field. Indeed, in a prior articles it has canvassed private practitioners and others for their views, and the results have revealed the truth and benefit of this duty).

But sadly, most clients currently are not adequately informed about funding or are not informed at all. Linked with this is the

fatal fact that most lawyers are not yet able to explain the concepts and pros and cons in sufficient depth or in some cases at all.

The lawyer however cannot decide autonomously whether or not to inform their clients, simply because they have no choice in the matter. They must. They have a legal and ethical duty to be aware of third-party funding and to inform their clients of its existence and purpose.

This is especially pivotal in a world where lawyers potential vulnerability to allegations of negligence is the topic of the day. Continued tough economic times are still affecting the legal market, with firms downsizing, placing extra workloads on those that remain and potentially teeing up an environment for overworked lawyers to get themselves into trouble.

The law schools duties In order to help attack the knowledge vacuum among private practitioners, law schools must start seriously educating their students about funding so that when students qualify the concept will be already familiar. It will have been a learned tool and skill they can, from the start, use to assist their clients to the extent of their abilities. In addition, it will also be knowledge that can protect them as practicing professionals.

Without trying to be overly dramatic, the need in this area is fundamental, particularly given the development of the industry and the markets growing appetite for funding, as well as the responsibilities and vulnerabilities, noted above, faced by lawyers. While no scholarly study has yet

6

Third-party financexx EDUCATING THE WORLDS FUTURE LAWYERS

been done here, it is safe to assume that no leading law school in the world has a course on third-party funding. A brief although not exhaustive survey of course offerings among the leading law schools in the US, UK, Australia and Germany supports this. Nor have we seen (although this is harder to detect) the use of third-party funding taught as a module within a larger and more comprehensive course, such as courses on law and finance, or law and business.

This is particularly worrisome and puzzling given the pace at which third-party funding is developing. It is hardly profound to say that the future demands made by the integration of law, finance and business with each other and with the transformations going on inside each of these disciplines, mean that law schools also need to keep up with todays evolutions to provide students with an education that will be relevant to the needs of tomorrow.

It might be noted that this need obviously applies beyond third-party funding. Law schools in general have to become more attuned to the current and future needs of their students. Teaching what was good in the past does not do the trick. Students need to become all-around practitioners, equipped to understand and handle both issues and challenges, present and future. Having a firm grasp of the nexus between law and finance as well as other areas of business and economics is essential.

Law Schools know this. Oxford Laws new joint degree program of law and finance, sponsored and run as a joint venture between Oxford Law and the the Oxford Business School (Said Business School), is perfect evidence of a willingness to move with the times and lead the way into the future.

The stakeholders of the legal education world are not oblivious to the need to improve. In fact, the balance of evidence suggests that they are, such as the recent 18-person study group assembled by the American Bar Association to analyse over the next two

years the needs of the law school community to be more current in its approach.

At the same time, we see reports coming out predicting an increase of claims against lawyers as a result of challenging economic conditions. This trend should be coupled with the fact that law firms themselves are suffering from reduced profits and diminished opportunities, a fact which can encourage lawyers and law firms to travel a bridge too far in terms of their push for greater efficiency in client service and greater profitability, thus enhancing their potential vulnerability to claims of malpractice and other forms of misfeasance.

The takeawayLaw Schools everywhere need to open a new chapter perhaps even write a new book. Just as lawyers have a duty to know and a duty to tell, so do law schools or rather a duty to know and a duty to teach. But semantics aside, the obligations are clear, present and compelling.

Law schools can do a host of things to start this process. They can, as suggested as an example by one of the leading US law professors and experts in third-party funding, professor Maya Steinitz of Iowa Law School, have teachers put together syllabi on this topic to use as a module within another related course. On the other hand, there is definitely scope for full courses on the topic, and lectures by lawyers or funders would be helpful. Online courses might be another path for some. But these are just a sample of what seem like manifold possibilities.

The Bar should also be demanding more from law schools, and the schools in turn should be demanding it from themselves. Students, equipped with sufficient awareness, would be the most vocal and important community of all. Once they start to learn then their collective voice, as with young people in general, should carry the day and point the way to the future.

About the author

Selvyn Seidel is the founder, chairman and CEO of Fulbrook Capital Management LLC. He was previously a co-founder and chairman of Burford Capital. Clementine Travis, Bahar Semani and Inge Mecke of Fulbrook Capital Management all assisted with this article.

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The Lawyers Duty-to-Know & Duty-to-Tell in Third Party Funding: A Time to Recognise & Respect these Obligations Posted: 30th July 2012 08:53 By Selvyn Seidel

Introduction & Overview

A lively focal point in the Third Party Funding industry has been the obligations of the Funders. In the UK that interest and related inquiries and analyses have resulted, after three years of study and debate, in the November 2011 launch of a UK Code of Funding about the Funders obligations. In the US, we have seen similar studies by the American Bar Association and others, with publications of white papers and other reports relating to Funders obligations.

It is now time that the obligations of others in the market and industry receive equal attention and helpful guidelines. In this respect, the spotlight should fall, as a priority, on the legal and ethical obligations of the lawyers for the claimants. In a recent media article, the question of lawyers obligations was raised with various professionals, and those interviewed said that there should be obligations imposed on the lawyers. This article was first published by Commercial Dispute Resolution, a leading journal on litigation, arbitration and funding, on 9th July 2012.

To kick off what hopefully will be a deep research dive into the area, this article contends that lawyers have what should be called a Duty-to-Know, and Duty-to-Tell their clients about Third Party Funding. Only if the lawyer has and fulfills these duties can their clients be given what they need to decide whether or not to seek Funding, and if so, how? what kind? and from whom?

Ethical Duty

The duty seems to be both an ethical duty and a separate legal one. This is the case at least if one focuses on the two most active litigation and funding jurisdictions in the world, the UK and the US. The ethical duty might be found in various explicit and implicit rules in various jurisdictions. For example, in the UK, the newly modified (15 June 2011) Ethical Code of Conduct for Solicitors, the SRA Code of Conduct 2011, lays down this requirement.

Here, in the Code as well as the Indications of Behavior to the Code, there are any number of separate and independent provisions that identify and generate these duties. Collectively, they say the same thing. (The prior Code also contained a provision, RULE 9 that was often read to carry the same obligation).

Indeed the Code emphasises, as does this Article, the overriding importance that the public interest plays in this situation (as in others). It reads:

Where two or more Principles come into conflict the one which takes precedence is the one which best serves the public interest in the particular circumstances, especially the public interest in the proper administration of justice. Compliance with the Principles is also subject to any overriding legal obligations.

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The situation in the U.S. is similar. In general, lawyers of course owe clients a variety of ethical duties with regard to Funding. This was discussed in an important and far reaching ethical opinion issued in June of 2010 by the Ethics Committee of the New York City Bar Association. (For example, the lawyer and the client may face a conflict of interest when the lawyer is negotiating a financing agreement with the Funder.) Among the ethical duties a US lawyer has, it would not be hard to spell out explicitly and/or by inference the Duty to Know about third party funding and when appropriate, the Duty to Tell the client about it.

Legal Duty

Beyond ethics, a legal obligation can be taken from various possible legal sources. In the UK, an illustration of a court decision supporting this position is the Queens Bench decision in 2010,Adris v. Royal Bank[2010] EWHC 941 (QB). There, the Court found that a solicitors failure to obtain costs insurance for his client, protecting against adverse costs that later were incurred, was a gross breach of the Consumer Credit Act of 1974 s. 78. Such a duty here, as in the area of Funding, is one that is rooted in the basic requirement that a lawyer be competent in what the lawyer is doing, and provides his or her client with competent advice. The branches of this fundamental requirement spread far and wide.

Specific Questions & Duties

Within the general duties posited, there is also a need to address concrete specific questions that abound. Can a lawyer avoid culpability for lack of knowledge on the back of an argument that the industry is a young one unknown to many or indeed most lawyers? Is actual knowledge the test, versus should have known? Is there mandated knowledge, and automatic liability?

Does a duty apply in the UK not only to solicitors but also to barristers under the ethical and legal rules that apply to barristers? Can an unknowing barrister maintain that knowledge and guidance here is the responsibility of the solicitors only.

What do the duties entail? How much must be known? Must one know all the basic subtleties that go into Funding? Should, for example, the lawyer be concerned about his or her potential lack of experience or capacity to adequately understand and advise on the topic? What about an actual or potential conflict of interest?Should independent advice be sought by the lawyer on behalf of the client?

What differences exist between common law systems as found in the U.S. and U.K., and civil law systems, as found in Germany and France? What about nuanced differences within different legal systems? How are conflicts resolved or harmonised?

In the study that should go into this area, there should of course be an opportunity for all stakeholders to voice their views. The lawyers are of naturally at the head of the queue among that group. So also is anyone who has challenged the industry on various grounds. The most vocal and well known one is the U.S. Chamber of Commerce. It and any kindred spirit should have the chance to voice their views.

Conclusions & Recommendations

This article is of necessity short and summary, but that should not mask the scope of the need and responsibilities to fill they are broad and deep. The market and industry are young. The guidelines are relatively few, and a work in process. The emphasis to date has been on the requirements imposed on the funders.

That emphasis on funders is producing results. However, alone, the results are inadequate. The market and industry requirements weave a seamless web. The time has come to expand the emphasis to the other stakeholders. The legal communitys duties are compelling, as ones instincts can confirm. Those duties should be spelled out. The health of the market and industry need this. So does the legal community itself. The project is not a small one. It requires collaboration of the different participants in the industry, clarifying the duties and rights of each segment.

But most of all it takes leadership and time from the legal community. The Law Society in U.K., the bar associations in the U.S. and elsewhere, are logical candidates to take this forward, as they have taken forward so many other projects effecting the law and legal services. The industry should work hand in hand with these groups.

In fact, the duties here go well beyond the practicing lawyers. Law schools and educational programs should be informing their students about the industry and market, and how to act within them. A few are starting to do this. But very few. At one point all the law schools should put this topic on their standard teaching programs.

In the meantime, regardless of the actual state of the ethical and legal responsibilities, it seems sensible to assume there is a duty to adequately know, with a corresponding duty to tell. The assumption in practice will, in

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the end, not only better serve the client, the market, and the industry. It will, in the end, better serve the lawyer. It will also by itself provide impetus to the overall and more formal analysis of and reporting on the situation.

Selvyn Seidel is Founder and Chairman of Fulbrook Management LLC, and Co-Founder and former Chairman of Burford. Clementine Travis, an associate at Fulbrook, contributed valuable assistance.

Selvyn Seidel can be contacted via email at sseidel@fulbrookmanagement.com

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Investment arbitration claims could be traded like derivatives By Rebecca Lowe

Third-party funding of investment arbitration disputes is rapidly growing into a lucrative financial market where cases could ultimately be traded like derivatives, according to insiders. And serious ethical concerns remain over the growing power of an industry lacking both transparency and regulation.

Funding bodies for both litigation and arbitration have multiplied over recent years, but it is investment arbitration funding that has provoked the most controversy. Proponents say the funds improve access to justice and help keep costs down. Opponents argue they encourage frivolous claims, create potential conflicts of interest and give funders unwarranted control over public policy.

Selvyn Seidel, who co-founded Burford Group in 2009 one of the worlds biggest third-party funders and has since founded Fulbrook Capital Management, describes the change in the industry over the past two years as like night and day. I see it in front of me, growing and growing, getting more credibility and spreading, he tells IBA Global Insight. It is no longer an emerging industry, it is maturing, and in my view it will inevitably reach maturity and be a good part of financial day-to-day life.

A commercial claim is no different from any other asset, Seidel explains, and can be compared to a security or share. They can be bought, sold, financed, pledged. I think they will eventually be part and parcel of derivatives. Some people say, isnt that a bad thing? Well, they are good and bad. They can be good just like any other derivatives.

[Third-party funding] is no longer an emerging industry; it is maturing, and in my view it will inevitably reach maturity and be a good part of financial day-to-day life.

Selvyn SeidelCo-founder, Burford Group; founder, Fulbrook Capital Management

Related links

Have your say IBA Dispute

Resolution Section The impact of

third-party fundng - DRI 6:1

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Maya Steinitz, associate professor of law at the University of Iowa and a leading scholar on third-party funding, believes the rise in interest in investment arbitration funding was prompted by the global financial crisis. In forthcoming, unpublished research she draws a parallel between investment arbitration funders and the so-called vulture funds that grew up in the 1990s, which buy the debt of struggling nations at a discounted rate and then claim for a higher rate than the creditor expected to receive.

There are certainly hedge funds and other entities that are paying close attention to see if therell be the kinds of opportunities that the sovereign debt crisis in the 90s presented, she says. The vulture funds that bought the arbitration awards against states [which gave them control over the debt] are in a way what started this. Other investors thought, why wait until there is an award? Why not get involved earlier?

Robert Volterra, co-founding partner of Volterra Fietta law firm and one of the worlds top public international law specialists, is sceptical about the vulture fund argument. In terms of third-party funders, I do not see the overlap with vulture funds, he says. Apart from the fact that some NGOs do not like the fact that they are part of a process that makes governments keep their promises and punishes them for stealing from foreign investors without paying compensation.

Steinitz stresses that her research is in the early stages and she is yet to make a judgement on the full ethical implication of investment arbitration funding. She is however clear that it should be subjected to more rigorous scrutiny than the funding of commercial arbitration due to the public policy issues at stake. Investment arbitration is waged against governments, which means that it is ultimately the public who end up paying when there is a loss. It is a different dynamic. Traditionally we have regarded states as having sovereignty over deciding how to deal with public policy issues such as a financial crisis. Now they have to deal with third-party funders who, unlike the original claimant, never had a direct stake in the country.

The funder will have an influence over the case, but lawyers have to be very, very careful in saying my duty is to the client, not to the funder, There are very serious ethical issues that have to be looked at here.

Andrea DahlbergArbitration practice manager, Allen & Overy

The US Chamber of Commerce has been one of the most vehement critics of third-party litigation funding, arguing that it increases the volume of unmeritorious claims as funders

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are willing to bet money on weak cases that have a chance of a large reward something Seidel and other funders strongly deny. It also compromises the independence of lawyers, the Chamber claims, by making them feel an obligation to funders rather than their clients.

While the UK and US have voluntary regulation in place for third-party funding, international investment arbitration remains unregulated. There are no requirements for disclosure or the amount of control a funder can take over a case, and concerns remain over potential conflicts of interest between arbitrators, counsel and funders.

Even lawyers who support arbitration funding in principle concede that such issues need urgently to be resolved. The funder will have an influence over the case, but lawyers have to be very, very careful in saying my duty is to the client, not to the funder, warns Andrea Dahlberg, arbitration practice manager at Allen & Overy. There are very serious ethical issues that have to be looked at here.

Seidel agrees that third-party funding should be disclosed. This would not only improve transparency, he believes, but potentially speed up settlements and increase their value. If its a respectable funder, it may give the defendant cause to think it is dealing with a meritorious and credible claim, he says. So it may make it more likely to settle.

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Released by the U.S. Chamber Institute for Legal Reform, October 2012

STOPPING THE SALE ON LAWSUITS: A PROPOSAL TO REGULATE THIRD-PARTY INVESTMENTS IN LITIGATION

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Prepared for the U.S. Chamber Institute for Legal Reform by:

John H. Beisner and Gary A. Rubin

Skadden, Arps, Slate, Meagher & Flom LLP

All rights reserved. This publication, or part thereof, may not be reproduced in anyform without the written permission of the U.S. Chamber Institute for Legal Reform. Forward requests for permission to reprint to:

Reprint Permission Office, U.S. Chamber Institute for Legal Reform, 1615 H Street, N.W., Washington, D.C. 20062-2000 (202-463-5724).

U.S. Chamber Institute for Legal Reform, October 2012. All rights reserved.

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Third-party investments in litigation represent a clear and present danger to the impartial and ef cient administration of civil justice in the United States. Such third-party litigation nancing (TPLF) occurs when a specialized investment company provides money to a plaintiff (or counsel) to nance the prosecution of a complex tort or business dispute. In exchange for this nancial assistance, the plaintiff (or counsel) agrees to pay the investor a portion of any proceeds obtained through the litigation.

TPLF investments create the threat of at least four negative public policy consequences for the administration of civil justice:

TPLF investments can be expected to increase the volume of abusive litigation. TPLF companies view disputes as investments and they

I. EXECUTIVE SUMMARYcan hedge any investment against their entire portfolio of cases. This makes them more willing to put money into cases that are weak on the merits but have at least a chance of a large award.

TPLF undercuts plaintiff and lawyer control over litigation because the TPLF company, as an investor in the plaintiffs lawsuit, presumably will seek to protect its investment, and can therefore be expected to try to exert control over the plaintiffs and counsels strategic decisions.

TPLF investments prolong litigation by deterring plaintiffs from settling. The TPLF investor is a third party that, like the plaintiff and the plaintiffs lawyer, demands a share of any litigation proceeds. The plaintiffs obligation to satisfy this extra demand

STOPPING THE SALE ON LAWSUITS:

A PROPOSAL TO REGULATE THIRD-PARTY INVESTMENTS

IN LITIGATION

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2makes reasonable settlement offers less attractive.

TPLF investments compromise the attorney-client relationship and diminish the professional independence of attorneys by injecting a third party into disputes. Lawyers will inevitably feel at least some obligation to the TPLF investors, who are paying their bills and who might be a source of future business. As a result, counsel may give less attention to the clients interests, which should be counsels sole concern.

Given the risks inherent in third-party investments in litigation, the U.S. Chamber Institute for Legal Reform (ILR) supports establishing a robust oversight regime to govern this type of TPLF at the federal level. The risks of TPLF are simply too acute to be left to industry self-regulation. And since TPLF substantially affects interstate commerce and the federal courts, the federal government has jurisdiction to oversee TPLF on a uniform, nationwide basis.

The focus of a federal oversight regime should be on TPLF investors. The lawyers

involved in TPLF-funded cases should continue to be governed by state bar associations and courts, and the states respective rules of professional conduct. ILR has engaged vigorously in recent and ongoing debates about the impact of TPLF investments on professional conduct issues and will continue to do so. But at this point, the most pressing need is for investor oversight.

ILR favors legislation that appoints a federal agency to regulate third-party investments in litigation an agency empowered to make rules and regulations in pursuit of its mandate and to enforce any laws, rules, or regulations governing TPLF. Substantively, the federal oversight regime should include legislative and rule-based safeguards against the risks inherent in TPLF, including statutes and court rules requiring the disclosure of TPLF investments and requiring TPLF investors to pay costs associated with the litigation they generate (particularly defendants discovery costs).

TPLF investments compromise the attorney-client relationship and diminish the professional

independence of attorneys by injecting a third party into disputes.

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3has no other connection. In exchange, the investor is promised a portion of any recovery from the dispute. The nominal borrower in these cases may be a company involved in commercial litigation or an individual or group of individuals. In cases involving individuals or groups, the plaintiffs law rm typically is heavily involved in nding and securing the third-party nancing and, in some instances, is the real party in the TPLF relationship that receives the funds.

In TPLF investment nancing, the investors return is usually a portion of any recovery that the plaintiff receives from the resolution of the dispute, whether through litigation or settlement. The amount of recovery the TPLF provider will receive usually turns on several factors, including the amount of money advanced, the length of time until recovery, the potential value of the case and whether the case is resolved by trial or settlement. In this type of TPLF, the nancing entity essentially invests money in the outcome of the plaintiffs case, betting that it will be successful. TPLF nancing arrangements generally are nonrecourse (in whole or in part); the recipient of the funds obtains money to pursue a proceeding and is required to provide a return to the TPLF company only if the recipient is awarded damages at trial or settles on favorable terms.1

Third-party litigation nancing (TPLF) describes the practice of a stranger to a lawsuit providing money to a party in connection with the lawsuit for pro t. TPLF generally falls into two broad categories:

Consumer Lawsuit Lending, which typically involves individual personal-injury cases, and

Investment Financing, which includes investments in large-scale tort and commercial cases and alternative dispute-resolution proceedings.

In consumer lawsuit lending, a lawsuit lending company advances money to an individual plaintiff to cover living or medical expenses essentially giving him or her upfront cash while his or her lawsuit is still pending. The plaintiff agrees to repay the lender, with interest, out of any proceeds from the lawsuit. Interest rates on these loans are commonly in the range of 3-5% per month (which, even without compounding, can mean 60% annually). These loans are generally nonrecourse, which means the plaintiff need not repay the loan if the lawsuit is not successful.

In the investment nancing variant of TPLF, which is the subject of this paper, a specialized investment rm provides nancing to plaintiffs or their attorneys for litigation costs (including attorneys fees, court costs, and expert-witness fees) regarding litigation to which the investor

II. INTRODUCTION: WHAT IS TPLF?

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4As noted in the executive summary, TPLF investments have at least four negative consequences for the sound administration of civil justice. Several ILR publications, as well as commentary by other authors, have explained these consequences in more detail. Brie y, however, they are as follows:

First, TPLF can be expected to prompt an increase in the ling of questionable claims. TPLF companies are mere investors and they base their funding decisions on the present value of their expected return, of which the likelihood of success at trial is only one component. In addition, TPLF providers can mitigate their downside risk by spreading the risk of any particular case over their entire portfolio of cases and by spreading the risk among their investors. For these reasons, TPLF providers can be expected to have higher risk appetites than most contingency-fee attorneys and to be more willing to back claims of questionable merit.2

The most notorious example of this problem was the investment by a fund associated with Burford Capital Limited in a lawsuit against Chevron led in an Ecuadorian court alleging environmental contamination in Lago Agrio, Ecuador. Burford made a $4 million investment with the plaintiffs lawyers in the Lago Agrio suit in October/November 2010 in exchange for a percentage of any award to the plaintiffs. In February 2011, the Ecuadorian trial court awarded the plaintiffs an $18

III. PROBLEMS POSED BY TPLF INVESTMENT FINANCING

billion judgment against Chevron, which is on appeal.3 In March 2011, Judge Lewis Kaplan of the Southern District of New York issued an injunction against the plaintiffs trying to collect on their judgment because of what he called ample evidence of fraud on the part of the plaintiffs lawyers.4 Indeed, long before Burford had made its investment in the case, Chevron had conducted discovery into the conduct of the plaintiffs lawyers under a federal statute that authorizes district courts to compel U.S.-based discovery in connection with foreign proceedings, and at least four U.S. courts throughout the country had found that the Ecuadorian proceedings were tainted by fraud.5

According to a December 2011 press release, as a result of [f]urther developments, Burford conclude[d] that no further nancing w[ould] be provided in the Lago Agrio case.6 Nevertheless, its year-long involvement and its initial decision to invest $4 million with the plaintiffs lawyers despite allegations of fraud in the proceedings powerfully demonstrate that TPLF investors have high risk appetites and are willing to back claims of questionable merit.

Second, TPLF changes the traditional way litigation-related decisions are made. When no TPLF investment has been made, the plaintiff, advised by counsel, decides the legal strategy for pursuing the claims asserted. TPLF can be expected to change that dynamic. As an investor in the plaintiffs

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5lawsuit, the TPLF company presumably will seek to protect its investment, and can be expected to try to exert control over the plaintiffs strategic decisions. The plaintiffs lawyer, as the person being paid by and possibly even retained by the investor, may accede to those efforts. Even when the TPLF providers efforts to control a plaintiffs case are not overt, the existence of TPLF funding naturally subordinates the plaintiffs own interests in the resolution of the litigation to the interests of the TPLF investor.

Recent commercial arbitration between a company called S&T Oil Equipment & Machinery Ltd. and the Romanian government provides an example. S&T had sought nancing for its case from Juridica Investments Limited, and, under their agreement, Juridica paid some legal fees for S&T in exchange for a percentage of arbitration proceeds. After Juridica withdrew funding, causing S&Ts case to collapse, a sealed complaint led by S&T against Juridica in Texas federal court alleged that S&Ts own lawyers had begun seeking legal advice from Juridica after Juridica began paying their fees, and that Juridica required the lawyers to share with Juridica their legal strategy for the arbitration and any factual or legal developments in the case.7

The lawsuit-investment industry makes no secret of its interest in protecting litigation investments by in uencing cases. A principal of investor BlackRobe Capital Partners, LLC, was quoted as saying his rm would take a pro-active role in lawsuits.8 A former Burford chairman said that his new investment company would

not control litigation, but would do[] more than was done before.9

Third, TPLF prolongs litigation by deterring settlement. A plaintiff who must pay a TPLF investor out of the proceeds of any recovery can be expected to reject what may otherwise be a fair settlement offer, hoping for a larger sum of money.10 This problem is illustrated by litigation between a network-security company called Deep Nines and a TPLF provider that had invested in Deep Niness prior commercial litigation against a software company. Deep Nines had entered into an agreement with the TPLF company to nance patent litigation with an $8 million investment. Deep Nines had a strong case, and eventually, the case settled for $25 million. After paying off the investor, as well as paying its attorneys and court costs, how much did Deep Nines actually keep? $800,000 about three percent of the total recovery. The TPLF investor took $10.1 million (the return of its $8 million investment, plus 10% annual interest, plus a $700,000 fee). Remarkably, though, the investor wasnt satis ed and sued Deep Nines in New York state court for even more money.11 More than four years after the TPLF company rst invested in Deep Niness suit, the parties nally settled in May 2011. No settlement terms were disclosed.12

The Chevron/Lago Agrio case also powerfully demonstrates this problem. The investment agreement in that case included a waterfall repayment provision, which provided for a heightened percentage recovery on the rst dollars of any award. Under the agreement, Burford would receive

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6approximately 5.5% of any award, or about $55 million, on any amount starting at $1 billion.13 But, if the plaintiffs settled for less than $1 billion, the investors percentage would go up in fact, all the way down to a mathematical oor of about $70 million, the investor would get the same $55 million. The effect of a waterfall is to maximize the investors recovery early on, but it incentivizes plaintiffs to continue litigating in hopes of a higher settlement.

Fourth, TPLF investments compromise the attorney-client relationship and diminish the professional independence of attorneys by inserting a new party into the litigation equation whose sole interest is making a pro t on its investment. In recent litigation

regarding injuries to 9/11 Ground Zero workers, for example, one of the plaintiffs rms representing the workers was nanced by a TPLF investment that provided for passing the interest on the investment on to the plaintiffs, to be paid out of any recovery by them. After settling with the defendants, the rm sought to pass along $6.1 million in interest payments to the plaintiffs. The plaintiffs lawyers argued strenuously in support of their position. The judge overseeing the settlement acknowledged that passing on the interest to the plaintiffs may be permissible, but disapproved doing so in this case because it wasnt clear that the plaintiffs had understood or approved the charges.14

Investor5.5% of

any award

Plaintiffs[I]f the plaintiffs

settled for less than $1 billion, the investor's

percentage would go up...

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7for attorneys are not compromised, and to continue to build awareness of the dangers of TPLF and the need for reform. While ILR addresses the ethical dangers of TPLF with the ABA, it is simultaneously addressing TPLFs other policy dangers through public advocacy, including the proposals contained in this paper.

B. Government Oversight Is NecessaryILR proposes to implement safeguards against the dangers inherent in TPLF through a regime of government oversight and regulation. ILR believes that the risks posed by TPLF investments are so serious, and the incentives for misconduct by TPLF investment companies so great, that industry self-regulation is not a viable option to protect the administration of civil justice. Government oversight and regulation is particularly appropriate because TPLF investors use litigated proceedings and compulsory court process as their investment vehicles. In other words, TPLF investors make money by co-opting the coercive power of government to command defendants to appear in court or before arbitrators, turn over documents, and defend themselves. In these circumstances, regulating TPLF investors actions is an entirely proper function of government.

A. TPLF Investors Should Be RegulatedGiven the serious risks to the sound administration of civil justice posed by TPLF investments, an oversight regime that implements safeguards against these risks is necessary. This raises the threshold question, however, whether such a regime should be targeted to TPLF investors, to attorneys who represent clients receiving TPLF investments, or to both.

ILR believes that the focus for safeguards should be on the TPLF investors, whose activities are presently not subject to regulation. To be sure, attorneys involved in funded cases need oversight as well. But merely regulating such attorneys will not address most risks posed by TPLF. That can only be achieved by direct regulation of the investors, the parties who provide the nancing and therefore yield the clout. In any event, attorneys are already governed by existing state bar requirements and rules of professional conduct at the state level.15 The American Bar Association (the ABA) currently is analyzing how the Model Rules of Professional Conduct apply to TPLF, including by soliciting the views of stakeholders. ILR has engaged in this important discussion and has highlighted for the ABA the inherent dangers of TPLF to the administration of civil justice and to the legal profession. ILR will continue to be engaged in that debate to ensure that existing rules

IV. THE NEED FOR FEDERAL OVERSIGHT OF TPLF INVESTORS

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8C. Government Oversight Should Be FederalHaving concluded that government oversight of TPLF investments is necessary and proper, the next question is whether federal or state regulation is most appropriate. ILR supports a robust federal regulatory regime for at least four reasons:16

First, TPLF investors operate nationally (and internationally), and use the means and instrumentalities of interstate commerce (e.g., the mails, telecommunications, and money transfers) to carry out their business. Congress accordingly has the power to regulate TPLF investors because they are engaged in interstate commerce, or, at least, are engaged in economic activity that substantially affects interstate commerce.17 Under the effects test for federal jurisdiction enunciated in United States v. Lopez, Congress may regulate economic activity that substantially affects interstate commerce,18 as TPLF does. Moreover, Congress could even enact legislation governing a TPLF investor that operates only in a single state and does not provide nancing or engage in any economic activities beyond its borders as a necessary and proper component of an effective national effort to regulate interstate TPLF.19 After all, if domestic providers could escape uniform federal regulation by forming entities that only operate intrastate, they could thwart efforts to create a uni ed national regulatory regime.20

Second, in addition to interstate commerce, TPLF also implicates commerce with foreign entities. Many of the largest TPLF

investors are organized under foreign laws. For example, Burford and Juridica are both registered in Guernsey; Calunius Capital LLP is organized under the laws of England & Wales; and IMF (Australia) Ltd., which operates a subsidiary in the United States called Bentham Capital LLC, is organized under the laws of Australia. Congress may regulate foreign TPLF investors based on the portion of the Commerce Clause that empowers Congress to regulate commerce with foreign Nations, provided that a nexus exists between the foreign providers nancing activities and the United States.21 Such a nexus exists when foreign TPLF providers engage in TPLF in connection with matters pending in the United States.

Third, as discussed below, one of the prongs of ILRs proposed safeguards regime involves amending court rules to address cases in which TPLF is involved. Since TPLF naturally ows into large, complex cases, we believe most TPLF investment activity will occur in the federal court system, and focusing on amending federal court rules is therefore logical. In addition, many states have modeled their rules of civil procedure on the federal rules and periodically adopt changes in the federal rules for use in their own courts. Thus, amending the federal rules would in uence state court rules as well.

Finally, from a practical standpoint, we believe that attempting to implement a federal regulatory regime to govern TPLF will be more effective than attempting to achieve harmonized state regimes. Adopting federal TPLF rules, laws, and regulations

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9would ensure that one oversight regime is in place that covers all 50 states. Such an approach would avoid a checkerboard of disparate state laws, rules, and regulations that apply only within any given state, and which, owing to the differences among the state oversight regimes, likely would funnel TPLF- nanced cases to the state courts in the jurisdictions with the weakest oversight regimes. In this respect, ILR believes that seeking adoption of uniform state-level oversight regimes in all jurisdictions would be far more dif cult than simply adopting a single federal standard. Moreover, implementing uniform state-level regulations might not be possible, because some states might not possess a regulatory apparatus with the maturity and expertise to regulate TPLF adequately.

For these reasons, ILR proposes creation of a uniform federal system as the most sensible way to regulate a cross-border industry like TPLF.

D. Regulating TPLF: Policy or Ethics?Before discussing the substance of ILRs proposed regulatory regime, we note that we are proposing laws, regulations, and rules to address TPLF as a policy (rather than an ethical) matter. As noted above, the ABA recently considered TPLF from the point of view of lawyer ethics, and ILR contributed to that discussion.22 The ABA concluded that, while attorneys are not per se prohibited from representing clients who have received TPLF, TPLF does implicate a number of professional responsibility rules, and attorneys should

therefore exercise extreme caution in such cases. In our submissions to the ABA in connection with its TPLF consultation, we noted that TPLF could result in violations of a number of ethical standards, and the ABA commission studying TPLF adopted that position in the Informational Report to the House of Delegates on Alternative Litigation Finance that the commission submitted after concluding its analysis.

As noted above, ILR will continue to remain engaged in the ABA debate about TPLF, to raise awareness about its dangers, and to build support for ethics reforms. In this paper, however, we address a more fundamental question whether TPLF has serious adverse effects on the administration of civil justice beyond those concerned with existing ethical rules. Thus, this paper is part of ILRs continuing effort to address TPLF broadly as a policy matter.

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ILR proposes a three-pronged approach to federal TPLF oversight: (a) designation of a federal agency to oversee TPLF investors and make regulations concerning TPLF investments, (b) a regime of statutory safeguards to be enforced by the federal agency; and (c) court rules requiring disclosures when TPLF is being used. We address below what would be involved in each of these efforts.

A. Appointment Of A Federal Agency To Oversee TPLF InvestmentsThe rst step in our proposed oversight regime is to appoint a federal agency to regulate TPLF. ILR believes that Congress should empower the Federal Trade Commission to regulate the TPLF investment industry. The FTC was created in 1914 to prevent unfair methods of competition in commerce. This agency has a long, successful record of bringing enforcement actions against entities that engage in unfair or deceptive acts or practices. In the past year, for example, the agency has obtained over $9 million in civil penalties from companies that engaged in unfair or deceptive practices.23 During this same period, the FTC has obtained numerous cease-and-desist, disgorgement, and civil-contempt orders against companies that have violated the Federal Trade Commission Act.24

V. THE SUBSTANCE OF THE PROPOSED OVERSIGHT REGIME

If it is designated as the federal agency to oversee TPLF investments, the FTC should be given three speci c grants of authority: (1) to license TPLF investors, (2)to make rules and regulations governing TPLF investments, and (3) to enforce any laws, rules, and regulations governing TPLF investments.

1. Licensing

ILR proposes that the FTC should be empowered to create and oversee a licensing regime for TPLF investments. Licensing will permit effective oversight of TPLF investors and guard against potential abuses by them. ILR proposes that any applicant for a license to invest in lawsuits be required to pay a $1 million fee. This money would remain in an account administered by the FTC, with any interest or dividends going to fund enforcement and oversight activities by the agency.

2. Rules And Regulations

As the TPLF regulator, the FTC must be authorized to promulgate such rules and regulations as are necessary to carry out its mandate. We would anticipate that the FTC would, over time, create a comprehensive regulatory regime appropriate to carry out the intent of Congress in enacting our proposed legislative safeguards, much as the Securities and Exchange Commission has done with respect to the various statutes, like the Securities Act and the Securities Exchange Act, that are within its purview.

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3. Enforcement

Finally, the FTC should have meaningful authority to enforce all laws, rules, and regulations governing TPLF investments. As part of this authority, the FTC should be empowered to bring lawsuits in federal court and obtain civil penalties for violations. Again, Congresss grant of authority to the SEC to bring civil actions to enforce the securities laws and its rules and regulations is instructive. The FTC should (like the SEC) have the power to seek scaled monetary penalties against violators, based upon the seriousness of the offense and to seek enhanced penalties for repeat violations.

B. Statutory Safeguards Against Abuses In TPLF InvestmentsIn addition to legislation designating the FTC to oversee TPLF investments, ILR also believes that Congress should, by legislation, implement speci c safeguards that the FTC may enforce. These safeguards would be of two types: statutory provisions that would govern TPLF investors generally, and statutory provisions governing TPLF investors conduct in particular disputes.

1. Provisions Governing TPLF Investors Generally

a) Prohibition On Ownership By Law Firms Or Investors With Interests In Law Firms

TPLF companies should not be owned by law rms or have membership interests in

law rms; nor should persons who engage in TPLF be permitted to hold themselves out to the public as attorneys for hire. Permitting TPLF investors to become part of a law rm or to offer legal advice to others would diminish the quality of legal advice available to clients. There is a substantial risk that non-lawyer owners of rms will focus only on their own pro t and not on client interests or the advancement of the legal profession (of which they are not a part). For similar reasons, non-lawyer involvement in law rm management would threaten to further dilute the already-diminishing role of the client in the U.S. legal system because lawyers may feel pulled by the interests of in uential investors more so than the interests of their clients.

b) Prohibition On Contracts Between TPLF Investors And Lawyers

A robust safeguards regime would prohibit any direct funding contracts between a TPLF investor and a lawyer that does not also include the client as a party because such contracts would cut out the very person the lawyer is supposed to represent. Above, we discussed the attempt by the attorneys for the 9/11 Ground Zero workers to pass on to the workers $6.1 million in interest payments on nancing obtained by the rm without the workers approval. Legislation should speci cally provide that any person responsible for repaying a TPLF investment, or whose recovery may be diminished by any payment to the investor, must be a party to the investment agreement and must explicitly consent to all of its terms.

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c) Case Control

Legislation should prohibit any attempt by TPLF investors to control the litigation they are nancing. All litigation decisions must be made independently by the plaintiff, with the advice of his or her attorney, consistent with governing ethics rules. The interests of TPLF investors are not necessarily aligned with those of the plaintiffs. TPLF investors incentives are to maximize the amount of their recovery, even at the expense of the plaintiffs wishes. This safeguard will help assure that the plaintiff remains in control of the prosecution of the lawsuit.

2. Provisions Governing TPLF Investors Conduct In Particular Cases

a) Requirement Of Bond

Each TPLF investor should be required to post a bond with respect to each lawsuit it funds. This bond would be posted with the clerk of the court in which the funded action is pending and would be in the face amount of 25% of the damages claimed by the TPLF investors borrower. The bond would be for the bene t of the party not receiving TPLF and would help ensure that the TPLF investor has suf cient money to satisfy any adverse cost awards. The bond may be released at the conclusion of the case, and after the TPLF investor satis es any order for costs issued by the court.

b) TPLF Provider Jointly And Severally Liable For Costs Awarded Against The Plaintiff

In the event that a plaintiff whose case is funded by a TPLF investor has an order

to pay costs entered against it, the TPLF investor should be jointly and severally liable with the plaintiff for satisfying the cost award. TPLF investors make litigation possible when they invest in claims and provide the funding for the conduct of litigation. They should also be responsible for paying all costs that the court awards to the opposing party.

c) Limited Fee Shifting

When the party that receives funding does not prevail in a civil action, the party and the TPLF investor that invested in the case should be jointly and severally liable for paying the attorneys fees and costs of the prevailing p