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Schaeffer on litigation financing



Evan Schaeffer links to an American Lawyer piece on litigation financing by Alison Frankel—the practice of contingent loans that, though charging a high interest rate, are not recoverable if the attorney loses the litigation. (Ohio has outlawed the practice from the bench, though one-sidedly and retroactively. OL, Aug. 4, 2003; Oct. 25, 2003.) The paper quotes Professor Anthony Sebok giving the mysterious quote that such financing is a "safety valve for tort reform." While Sebok is correct that it is ironic that capitalists will effectively find it profitable to sell plaintiffs' attorneys the rope with which to hang themselves (a problem we've seen elsewhere with Wal-Mart, some IP litigation, and the AMA's support for questionable class action schemes against HMOs, among other places), it's hard to see any relationship between tort reform and litigation financing (other than that some of the authors of the site oppose it).

Evan's complaint that "It's a case of putting makeup on a pig" to use "anti-tort-reform sentiment to sell expensive loans to plaintiffs' lawyers" seems unfair on two levels. First, it doesn't appear that Professor Sebok is trying to sell the loans, rather than simply making a sloppy sound-bite. Second, a contingent nonrecourse loan with a three-year interest rate of 37% and an after-three-year interest rate of 0% (the one deal described at length in the article) is hardly "expensive." It's a plaintiffs' attorney hedging her risky portfolio of litigation by selling some of that risk to group with a larger portfolio, which is no different than plaintiffs' law firms trading pieces of cases to one another or what large plaintiffs' law firms do internally. But if Evan thinks such loans are expensive, there's clearly a profit opportunity for the plaintiffs' bar to provide the same financing for cheaper through conventional means that do not have the smack of champerty.

The existence of such economically equivalent arrangements are why I disagree with Walter on this issue. If anything, litigation financiers suffer from moral hazard, since they're only taking the cases that couldn't be offered to larger plaintiffs' firms for less money, and there's a severe issue of asymmetric information. That said, plaintiffs' work in the lottery-litigation age may be sufficiently profitable that even a low-performing portfolio of litigation may outperform other hedge-fund opportunities.

One problem with a loan like this is that it could change the attorneys' incentives. Settlements that may be beneficial to the client may lose the attorney money depending on the structure of the loan. The fiduciary duty of an attorney to a client does require disclosure and a full explanation of the effects of the loan on the client's case.

(Disclosures: As of the date of this post, I own Wal-Mart stock worth between $50,001 to $100,000. As an attorney, I worked on behalf of an HMO sued by doctors. In the late 1990s, I was asked to consult on a couple of cases that a litigation financing company was considering financing. I thought both cases involved ludicrous judgments that would likely be reversed on appeal. The partner overruled me and recommended investments that were made. Both cases lost on appeal, and the litigation finance company lost its investment.)

 

 


Rafael Mangual
Project Manager,
Legal Policy
rmangual@manhattan-institute.org

Katherine Lazarski
Manhattan Institute
klazarski@manhattan-institute.org

 

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.