Litigation for sale.

• Author: Dobner, Ari
• Position: Litigation investment companies

Introduction

In recent years, several litigation investment companies have appeared.(1) Typically, these companies acquire the rights to patent-infringement suits from private inventors who cannot finance their own lawsuits.(2) These investment companies may then syndicate the lawsuits, that is, sell shares in the lawsuits to raise money to finance the litigation.(3) The potential returns, although highly speculative, are enormous.(4) The syndication market is relatively new, but one company is considering plans to acquire a portfolio of lawsuits and sell shares in the fund to investors.(5)

Buying lawsuits is not a new concept. The ancient common law doctrine of champerty made illegal all agreements to share in the proceeds of another's lawsuit.(6) At common law, speculating in litigation was against public policy.(7) Although much of the common law on champerty has eroded to near obsolescence,(8) the core of the doctrine - the public policy against profiteering and speculating in litigation - still survives in most states.(9)

Despite these laws against investing in litigation, modern lawsuit investors have achieved some success in fending off legal challenges to their syndicated lawsuits. In 1978, in the first modern syndicated lawsuit, Thee v. Parker Bros.,(10) Carl E. Person, the plaintiffs attorney, was able to "cut through the ... maze"(11) of legal technicalities and obtain clearance from the Securities and Exchange Commission, the New York Bureau of Securities, the American Bar Association, and a federal court to offer shares in an antitrust suit against a gamemaker who copied the plaintiff's game.(12) Although the plaintiff ultimately prevailed, the offering of shares in the lawsuit failed due to poor investor interest.(13) More than a decade later, in 1991, two California investors fended off a challenge to the legality of one of the most successful lawsuit syndications ever.(14) One company that invests in disputed intellectual property rights is publicly traded.(15) However, it has encountered judicial hostility to its business.(16)

This Comment discusses the legal impediments to investing in litigation and focuses on reaching concrete and specific conclusions on the viability of and limitations on such investment. To facilitate a more realistic assessment of the practical impact of these legal impediments to litigation investment, the legal analysis is conducted through a hypothetical litigation investment company, "Champerco."

Part I uses a law and economics approach to explore the basic premise underlying this Comment: There is a market for investor-financed litigation. Part I demonstrates some of the benefits of investor-financed lawsuits and, in the process, refutes some popular objections to the practice. Part II sets forth a blueprint for a company designed to meet the market demand for investor-financed litigation envisioned in Part I. Part III discusses the history, policies, and modern status of the law on champerty. Part IV examines the practicability of contracting around champerty laws in light of modern conflicts law and concludes that three steps can be taken to create enforceable champertous agreements.

1. The Market for Litigation Financing

   Litigation is an investment process.(17) Traditionally, plaintiffs pay their litigation expenses as they arise during the progression of their lawsuits. These payments are "investments" by plaintiffs.(18) Often, however, plaintiffs will decide not to invest in their lawsuits. Litigation can drag on for years and the costs can add up tremendously(19) without any guarantee of a recovery. With prospects of any recovery uncertain and, in any event, months or years away, many plaintiffs may find it too risky to "invest." Even a plaintiff willing to make the risky investment in his lawsuit may not have the economic means to do so. These plaintiffs may abandon their claims unless there are alternative, less costly or less risky, methods of financing their lawsuits.

   While borrowing against a claim is theoretically possible, in reality, banks and other lending institutions are unlikely to make such risky loans.(20) A better alternative might be to sell the lawsuit. Rather than abandoning a lawsuit because it is an unaffordable or risky "investment," a plaintiff can sell the lawsuit to an investor who believes that the lawsuit is a good investment. Alternatively, a plaintiff can sell shares in his lawsuit to raise money to finance the suit. This practice is actually widespread.(21) Theoretically, in contingent fee agreements, plaintiffs sell their lawsuits to entrepreneurial lawyers in exchange for a share of the profits. Viewed another way, contingent fee lawyers buy shares in lawsuits and pay with legal services instead of cash.(22)

   Underlying the concept of buying and selling lawsuits is the assumption that a lawsuit might be worth more to one party (that is, the investor) than to another (that is, the plaintiff). Using law and economics analysis, this Part explores the factors that make lawsuits more valuable to one person than another. This analysis will reveal the efficiency and benefits of the free trade of claims.(23)

   1. Risk-Bearing and the Willingness to Litigate Claims

      The most significant factor that makes a claim more valuable to one party than another is the difference in the parties' relative risk-bearing abilities. There are several factors that affect a party's risk-bearing ability. One factor is a party's wealth. To illustrate the effect of a party's wealth on its risk-bearing ability and, thus, on the value it places on a claim, consider the following two hypothetical scenarios.(24)

      First, suppose someone holds the winning ticket to a $150,000 lottery, but the lottery company refuses to honor the ticket because it claims that the ticket is a forgery. The ticket holder consults with a lawyer, who informs her that it will cost $25,000 to sue the lottery company and that she will have a 50% chance of recovering the $150,000 jackpot. The ticket holder, hereinafter the "blue collar plaintiff," has savings totalling only $25,000. After weighing the 50% chance of recovering $125,000 (after costs) against the 50% chance of losing $25,000, her entire life savings, she decides that a $25,000 loss would be too devastating to her financial position, and she simply "cannot afford" to take that risk. She feels that she has worked too hard to save the $25,000 to just "gamble" it away on a lawsuit. She, therefore, abandons her claim.

      Second, suppose the same facts as the first scenario, except that the ticket holder, hereinafter the "white collar plaintiff," is a wealthy investor. To the white collar plaintiff, the lawsuit is an excellent investment opportunity. With an average recovery of $75,000 and a cost of only $25,000, he can earn a hefty 200% return by "investing" in the lawsuit. He can afford the risk of a $25,000 loss, as it would only marginally affect his total wealth. He, therefore, hires a lawyer and sues the lottery company.

      As these two scenarios illustrate, the same claim that one party abandons without any recovery is pursued by another party for an average recovery of $50,000 (after litigation costs). The difference between the two plaintiffs is their risk-bearing abilities. The white collar plaintiff is a better risk bearer simply because the claim constitutes a much smaller percentage of his wealth.(25) The risk is diversified with the rest of his wealth. This difference in risk-bearing abilities creates a difference in valuation between the blue collar plaintiff, for whom the claim is worth nothing, and the white collar plaintiff, for whom the claim is worth close to $50,000.(26)

      The different values the two plaintiffs place upon the claim creates an opportunity for a mutually beneficial trade. Rather than abandoning her claim, the blue collar plaintiff can sell her claim to the white collar plaintiff. Suppose, for example, the blue collar plaintiff sells the lottery ticket for $10,000 to the white collar plaintiff. To the white collar plaintiff, a $40,000 average return on a $35,000 investment far exceeds the market, rate of return.(27) To the blue collar plaintiff, a guaranteed $10,000 gain is preferable to abandoning her lawsuit and recovering nothing. The sale of the lottery ticket will, therefore, benefit both parties. The only loser in this sale is the lottery company, which might now be forced to honor the lottery ticket.(28) These two hypotheticals illustrate the potential gains from the free trade of claims from poor risk-bearing parties to better risk-bearing parties. These potential gains from trade create a market for litigation.(29) As with the free trade of other property, the gains are efficient and beneficial.(30)

      Another factor that affects a party's risk-bearing ability is the party's risk diversification. A party owning many risky claims is better able to bear the risk of any particular claim and will, therefore, value the claim higher than another nondiversified party.(31) Returning again to the lottery ticket scenario, suppose that several other lottery companies, on rumors of rampant lottery ticket counterfeiting, have all refused to honor winning lottery tickets. The white collar plaintiff, pleased with his 114% expected return on the disputed winning lottery ticket he purchased, seeks out more blue collar plaintiffs who "cannot afford" to litigate their claims and purchases fifty more disputed winning lottery tickets for $10,000 each. Assuming that the outcome of each lottery ticket lawsuit is independent of the others, the more claims the white collar plaintiff purchases, the more he will be willing to pay for them. The reason is that, by owning many claims, the white collar plaintiff diversifies out much of the riskiness of the claims so that the risk-discounted value of the claims to him is close to the full $50,000 average expected recovery. Put another way, by eliminating the riskiness of...