Of conflicts and corporations: analyzing corporate forms for future litigation finance firms.

• Author: Knight, Jared F.

1. INTRODUCTION II. CURRENT PROBLEMS WITH PLAINTIFF LITIGATION AND THE THIRD-PARTY FUNDING SOLUTION A. Champerty, Maintenance, and the Rise of the Contingent Fee Model B. Current Trends in Litigation Finance III. POTENTIAL CORPORATE STRUCTURES FOR LITIGATION FINANCE COMPANIES A. Factors Under Consideration 1. Claimants' Interests 2. Funder's Interests 3. Shareholders' Interests. B. Limited Liability Company 1. Advantages 2. Disadvantages C. Traditional Corporation 1. Advantages 2. Disadvantages 3. Public vs. Private Corporations D. Public Benefit Corporation 1. Advantages 2. Disadvantages IV. CHOOSING THE RIGHT CORPORATE FORM V. CONCLUSION I. INTRODUCTION

   Third-party litigation finance is part of legal scholarship's cutting edge. Proposals for enabling legislation have both ardent supporters and critics, but the idea has already gained traction in Australia and the United Kingdom. (1) It is worth noting that these countries differ from the United States in some respects. (2) However, the push for legalizing this practice appears to be gaining ground rapidly. In fact, several firms are already operating litigation finance operations in the United States. (3)

   Current litigation finance firms operate as limited Guernsey corporations. (4) But these firms operate with the purpose of avoiding conflict with existing U.S. and U.K. law. This operating model may be inefficient. (5) In an ideal world--indeed, the one envisioned by litigation finance proponents--laws would allow plaintiffs to freely contract with these firms to finance their claims. (6) However, scholars have yet to consider what form these now-legal firms might adopt. This Note fills that void.

   Part II analyzes litigation finance's history in the United States. I recount third-party financing' s greatest obstacle--the ancient doctrine of champerty--and the modern workarounds to that rule. I also review the most recent scholarship relating to third-party financing to provide the context for understanding the evolving world in which these firms operate. Part III then analyzes several corporate structures litigation finance companies might choose. While current financing companies operate around existing laws, the options analyzed in this Part assume the underlying laws prohibiting third-party finance are removed. In considering these options, I weigh several sometimes-competing interests, including the ability to raise capital and potential conflicts between capital providers, financiers, and claimants. I conclude that a benefit corporation provides the ideal balance of conflict mitigation and access to capital.

2. CURRENT PROBLEMS WITH PLAINTIFF LITIGATION AND THE THIRD-PARTY FUNDING SOLUTION

   Third-party financing is the latest in a series of developments that could change the landscape of civil litigation. In this Part, I trace litigation finance's development in the United States, including reference to its ancient roots in the English common law. From its early roots in the doctrine of champerty to the rise of the contingent fee model and insurance defense and prosecution, litigation looks very different today than it did at the country's founding. Next, I review modern developments in litigation finance, both in American legal scholarship and in foreign jurisdictions. If, and when, third-party finance takes hold in American litigation, the same forces that reshaped English and Australian laws will likely guide its development.

   1. Champerty, Maintenance, and the Rise of the Contingent Fee Model

      In the United States, plaintiffs and defendants pay their own legal costs in litigation. (7) This "American Rule" developed as a response to complaints of soaring legal costs, which became "altogether disproportionate to the magnitude" of their underlying claims. (8) This contrasts with the "English Rule," in which the losing litigant pays the winner's legal fees. (9) This Section tracks the development and divergence of these two systems and their reticence toward third-party financed litigation.

      While the "English Rule" arose from English statutes (and thus never bound colonial jurisdictions), the doctrine of champerty was a common law rule that made it across the Atlantic. The champerty doctrine was founded on fears that "champertors will encourage frivolous litigation, harass defendants, increase damages, and resist settlement." (10) However, this has rarely been the case, and exceptions to champerty are commonplace. (11) In fact, champertous arrangements tend to increase plaintiffs' access to the courts. (12) Unsurprisingly, one of the biggest opponents to third-party finance is the U.S. Chamber of Commerce, which represents the interests of natural defendants to resource-poor plaintiffs. (13) Furthermore, despite the supposedly grave dangers of incenting frivolous litigation, American courts have largely embraced a different form of litigation finance--the contingency fee. (14)

      Additionally, and importantly, champerty is not even a defense against a lawsuit but merely a doctrine that makes champertous provisions unenforceable in a litigation finance contract. (15) This legal reality led many to question champerty's rationale, as frivolous litigation is not actually prohibited under the doctrine. (16) Those questions have grown into momentum toward courts repealing the doctrine and scholars calling for its abolition nationwide.

   2. Current Trends in Litigation Finance

      Recent scholarship has called on governments to enable third-party litigation finance. These calls have taken several forms. For example, some scholars have called for simply eliminating the doctrine of champerty and allowing third-party finance with little to no restriction; (17) some call for allowing plaintiffs to incorporate their claim as an SPV and distribute shares; (18) still others call for allowing secondary markets to buy and sell litigation risk. (19) This Section focuses primarily on arguments for and against enabling litigation finance, as this Note considers what form a firm financing litigation may take. (20)

      Arguments against the doctrine of champerty are nothing new, and some states have embraced those arguments. The doctrine was abrogated in Massachusetts, where the state's Supreme Judicial Court held "the common law doctrines of champerty ... and maintenance no longer shall be recognized." (21) Curiously, and in a footnote, the Massachusetts high court noted in dicta that its ruling "should not be interpreted to indicate our authorization of the syndication of lawsuits." (22) It is unclear what that means, though it is fair to say it at least illustrates a judicial mood more concerned about the efficient administration of the courts. Similarly, New York courts have opened the door to third-party finance. The New York Court of Appeals recently held "the champerty statute is violated by an attorney 'only if the primary purpose of the purchase or taking by assignment of the thing in action is to enable the attorney to commence a suit thereon.'" (23)

      While these state courts and others hedge on the champerty question, some foreign jurisdictions have tackled the issue head-on. The English Legal Services Act of 2007 deregulated that country's legal sector, resulting in the common law world's first publicly traded law firms. (24) Similarly, the High Court of Australia held in Campbells Cash & Carry Pty Limited v. Fostif that third-party finance was legal in that country. (25) In reaching this conclusion, the Australian court asked "what exactly is the corruption of the processes of the [Australian courts] that is feared?" (26) The Fostif court held any such concerns are "sufficiently addressed by existing doctrines of abuse of process and other procedural and substantive elements," and further that "there is no reason proffered for concluding that present rules regulating lawyers' duties to the court and to clients are insufficient." (27)

      Scholars criticize American resistance to European and Australian progress as inefficient and unnecessary. On the inefficiency argument, scholars note that third-party funding can "enhance[] social welfare to the extent it can resolve the incentive divergence problem in the presence of high transaction costs between potential injurers and potential victims." (28) Scholars also note third-party funding's ability to "play for rules" to the same extent as repeat-players. (29)

      As to champerty's unnecessity, scholars note that existing causes of action--such as malicious prosecution and abuse of process--make a ban on champerty unnecessary. (30) Similarly, scholars note that other areas of law respond to incentive problems by ameliorating the concerns rather than banning a practice entirely. (31) Finally, scholars argue attorneys' existing rules of professional conduct already prohibit frivolous litigation and actions conflicting with the client's best interest. (32)

      Third-party finance is certainly not without its criticisms. (33) However, this phenomenon looks poised to take root in the United States. The remainder of this Note considers the best corporate form for a new litigation finance firm.

3. POTENTIAL CORPORATE STRUCTURES FOR LITIGATION FINANCE COMPANIES

   Once states adapt to this new litigation framework, firms will have to confront a new question: what is the optimal corporate form to operate a litigation finance firm? The ideal corporate choice balances factors such as access to capital; duties and obligations to capital contributors; conflicts of interest between capital sources, the firm, and claimants; information costs; and the firm's own liability. (34) Of course, states crafting finance- enabling legislation may answer that question for these firms, but this analysis assumes states simply negate laws prohibiting third-party litigation finance and allow new firms to organize and operate like any other business. (35) This Note further assumes that the hypothetical firm requires capital from multiple sources, and also that...