It's about time: a systems thinking analysis of the litigation finance industry and its effect on settlement.

• Author: Rodak, Mariel

INTRODUCTION

The developing litigation finance industry is applauded by those who champion its access-granting and bargaining-power-equalizing functions for low-income plaintiffs in civil suits, and derided by those who warn of its unsavory business practices and interference with settlement efforts. With no current body of law adequately addressing the potential problems this burgeoning industry creates, it is vital to develop an approach to litigation finance that protects both the integrity of the settlement process and consumer interests. Such an approach simultaneously must avoid excessive regulation that effectively hinders court access by precluding disadvantaged plaintiffs with viable claims from having their days in court. Applying systems thinking to the field of litigation finance and its effect on settlement reveals a simple objective that would best achieve the necessary balance between this new field's angels and demons: reducing the time delay currently plaguing civil courts.

Part I of this Comment explores the general structure, history, and current status of litigation finance, identifying the circumstances that stimulated its creation and describing its prototypical operation. Part I also briefly reviews existing legal doctrines that have been, or could potentially be, used to regulate litigation finance, including champerty, usury, and contract law. Part II examines the widely diverging viewpoints about the litigation finance industry, focusing in particular on the industry's effect on settlement. Ultimately, Part II concludes that, despite the positive aspects of litigation finance--particularly, increased court access and bargaining power--a modicum of reform is nonetheless necessary to alleviate its negative aspects, which include dubious ethical practices, consumer exploitation, and arguable encouragement of frivolous litigation.

Finally, Part III provides an explanation of the general principles of systems thinking, posits that systems thinking is the best way to approach any attempt to regulate the litigation finance industry, and argues that the best method of regulation is for courts to work to reduce the time between when a claim is brought and when it is terminated by either settlement or trial. A reduction in time delay would curtail the negative effects of litigation finance by limiting the number of plaintiffs who require such financial assistance, the sum required by those plaintiffs who do need assistance, and the accumulation of interest on the principal amount advanced. The industry would nevertheless be able to continue to provide its service to those plaintiffs most in need.

1. THE LITIGATION FINANCE INDUSTRY: AN OVERVIEW

   1. History and Structure

      Litigation financing, the provision of cash advances to plaintiffs prior to the resolution of their claims, (1) has evolved from a virtually unknown and relatively isolated practice to a veritable and thriving industry. (2) The litigation finance industry owes its development to a convergence of factors that left fertile soil for its explosive growth. Astounding technological and informational innovations and their ensuing availability to the masses--particularly the ability to use the Internet to establish a business and the accompanying proliferation of methods allowing for more, faster, and cheaper communication with potential customers--certainly comprise one such factor, as they removed previously existing barriers to entering the marketplace. (3) Skyrocketing litigation costs, (4) combined with both the prohibition on attorneys advancing living expenses to their clients (5) and the refusal of traditional lenders to recognize pending litigation as an asset when determining qualification for borrowing, left an increasing number of plaintiffs financially unable to pursue their claims. (6) Finally, a significant deterioration of laws against champerty--the acquisition of financial interest in a legal claim by a third party--removed any immediate fear of liability that may otherwise have prevented entrepreneurs from embarking upon the business of litigation finance. (7)

      The self-proclaimed father of the modern litigation finance industry is former "rock musician and mobile-home park developer" Perry Walton. (8) Walton was convicted of extortionate collection of debt in 1997 and then turned to litigation finance for his new career, conducting instructional seminars on how to successfully get started in the business as well as managing a firm of his own. (9) Litigation financing is a recent innovation, with its seeds sowed "on a small scale little more than a decade ago with cash advances to individual plaintiffs needing money to keep their lives or their lawsuits going." (10) Since its inception, the field has grown considerably, garnering attention from the bench, the bar, and external analysts alike.

      The litigation finance process typically begins when a plaintiff is referred to a litigation finance company by her attorney; however, such businesses frequently employ advertising techniques that facilitate direct contact from potential clients as well. (11) After a plaintiff seeking funding submits an application to a particular company, an employee (only in some instances an attorney) solicits information about and reviews the applicant's legal claim to determine whether or not the application will be accepted and a financing contract subsequently executed. (12) Described as promoting a "new twist on legalized gambling," (13) litigation financiers offer nonrecourse funding--if the plaintiff ultimately loses her case at trial she has no obligation to repay the amount advanced, and the company thus forfeits its entire investment. (14)

      The procedure following a plaintiff's successful resolution of her claim, be it through settlement or at trial, varies according to the structure of the agreement, which can fluctuate across the industry. Some lenders take a flat fee based on a percentage of the plaintiff's recovery, (15) but most charge interest rates that can be up to 15% monthly and can approach 200% annually when compounded. (16) These extraordinarily high rates are often justified by those in the litigation finance industry as necessary to compensate for the significant risk they assume by advancing money on a nonrecourse basis. (17)

      In order to combat negative attention accorded the litigation finance industry due to such high rates, and spurred by an investigation into the industry by then-New York Attorney General Eliot Spitzer (18)--who later reached an agreement with nine litigation finance organizations to institute certain reforms (19)--the American Litigation Finance Association (ALFA) was formed in March 2005. (20) The first national trade association in the field of litigation finance, ALFA was formed by eleven member companies that agreed upon joining to abide by "best practices." (21) Its creation represented a significant step by the industry--symbolically if not substantively--to self-regulate and improve its public image. (22)

      A young field that, until recently, existed relatively unnoticed, litigation finance has fallen under continuously increasing scrutiny and has incited debate over its virtues and vices and, accordingly, over how (or whether) it should be regulated. (23)

   2. Current Status: In Legal Limbo

      This debate is further complicated by the states' disparate treatment of litigation finance, by an uncertainty concerning which existing legal doctrines are applicable, and by a general lack of modern law directly addressing the industry or analogous enterprises. (24) In Florida, litigation finance cleared its first appellate level hurdle when a court reluctantly upheld the deal being challenged, reasoning that it did not have the authority to void the deal under state law. (25) However, the court, recognizing the potential risks created by financial participation in litigation by parties otherwise extrinsic to the suit, suggested legislative intervention. (26) Similarly, a New York court expressed frustration at being left no choice but to enforce a litigation finance contract due to the fact that "under New York law [litigation finance arrangements] are allowed as long as the primary purpose and intent of the assignment was for some reason other than bringing suit on that assignment." (27) The court thus called for action by the state's Attorney General. (28)

      Courts in other states have approached litigation finance with greater hostility. In North Carolina, a federal court awarded more than $500,000 to a law firm claiming that a litigation finance company interfered with the attorney-client relationship in one of the firm's cases. (29) In that case, two litigation finance companies and five individuals (including the aforementioned Perry Walton) were found liable for "wrongful interference with a contract and for unfair and deceptive trade practices." (30) In Ohio, a surprising and oft-criticized decision declared litigation finance arrangements to be champertous and thus void under Ohio law. (31)

      The ethical ramifications of litigation financing are similarly ambiguous, and vary state by state. Ethics opinions issued in Arizona, Florida, New York, Ohio, South Carolina, Utah, and Virginia reflect the generally uncertain ethical status of litigation finance. (32) These opinions alternately declare that litigation finance contracts violate the prohibition of fee splitting among attorneys and nonattorneys, permit attorneys to provide litigation finance companies with information about a client's case with the client's consent, and enigmatically allow an attorney to offer a client information about litigation financing companies only when doing so is "in the client's interests." (33)

   3. Related Legal Doctrines

      Several areas of the law currently are, or could potentially be, applied to the litigation finance industry--in particular, champerty prohibitions, usury statutes, and certain elements of...