New York City Bar Opinion on Commercial Litigation Funding Raises Concerns
But It Also Suggests a Way Forward
- The New York City Bar Association's Professional Ethics Committee recently issued advisory (i.e., not legally binding) Opinion 2018-5 (Opinion), which concludes that nonrecourse commercial litigation funding agreements between a lawyer or law firm and a litigation funder violate the prohibition on sharing fees with nonlawyers in Rule of Professional Conduct (RPC) 5.4(a).
- Although the authors of the Opinion concluded that they had no flexibility under RPC 5.4(a) to reach a different conclusion, that conclusion is highly debatable. The purpose of the rule, its history and New York case law do not compel this conclusion.
- The Opinion concludes by recognizing that the rule can be said to be overbroad and to go beyond what is necessary to protect lawyer independence. The Opinion therefore notes that one way out of this situation would be consideration of an additional black letter exception to RPC 5.4(a).
The New York City Bar Association's Professional Ethics Committee (Committee) on July 30, 2018, issued advisory Opinion 2018-5 (Opinion), which concludes that nonrecourse commercial litigation funding agreements between a lawyer or law firm and a litigation funder violate the prohibition on sharing fees with nonlawyers in Rule of Professional Conduct (RPC) 5.4(a).1 Many professional responsibility lawyers submit that the Opinion inadequately considers the purpose of the rule, the history of the rule and New York case law.
Understanding Litigation Funding
Litigation can be extremely expensive, and capital is no more free to lawyers than to others. Commercial litigation funding provides lawyers with an alternative to traditional borrowing or self-financing. Instead of lending funds on a recourse basis (that is, with an obligation to repay the funds plus interest), a commercial litigation funder advances funds to cover some or all of third-party costs and legal fees but is only to be repaid if, and when, funds are received either in settlement or in collection of a judgment. In other words, the litigation funder receives neither a return of capital nor any profit if there is no recovery.
The Opinion notes that when a client arranges for litigation funding, there is no problem regarding the sharing of fees with nonlawyers because it is the client, and not the lawyer, who is sharing. Unfortunately, there are many instances in which client-directed litigation funding will not work. For example, client-directed litigation funding generally cannot be used successfully in plaintiffs' class action litigation or in most mass tort litigation. Alternatively, some individual cases may have an insufficient amount in controversy to qualify for client-directed funding but may benefit from lawyer-directed funding on a portfolio basis. The Opinion advises against most, if not all, lawyer-directed litigation funding for the sole reason that it ostensibly violates New York RPC 5.4(a) which, like parallel rules elsewhere, provides that "A lawyer or law firm shall not share legal fees with a nonlawyer ... ."
A Disservice to Independent Professional Judgment?
The Opinion notes that RPC 5.4 is entitled "Professional Independence of a Lawyer" and that Comment  to RPC 5.4 makes clear that "These limitations are to protect the lawyer's professional independence of judgment." Nonetheless, the Opinion does not explain how or why its prohibition on lawyer-directed litigation funding serves these purposes. Consider, for example, Lawyer A and Lawyer B, each of whom represents one or more plaintiffs in a potentially very large case. Lawyer A finances Case A with a traditional bank loan for which Lawyer A (or at least Lawyer A's firm) is on the hook for principal and interest. Lawyer B, by contrast, uses nonrecourse commercial litigation funding. If one asks, for example, which lawyer is less likely to feel the pressure to settle for less than what otherwise might be in their clients' interest in order to minimize or avoid self-interested financial risk, the answer is Lawyer B, the lawyer with nonrecourse litigation funding. This is because if Case B is unsuccessful, Lawyer B has no obligation to repay the litigation funder while Lawyer A would.
The only contrary argument would appear to be that the litigation funder working with Lawyer B could seek to apply pressure on Lawyer B to settle for less than the amount on which Lawyer B might insist if capital were free. The problem with this argument is that it presupposes either that there is an alternative of free capital or that lawyers who obtain traditional recourse loans or who self-finance their cases are not at least equally pressured, whether internally or externally.2 In addition, and in class action situations, there will necessarily be judicial involvement which will allow a full airing of any claims that lawyers settled for too little or were otherwise adversely influenced by litigation funders (or others) in any respect.
Ignoring the History of the Rule?
The Opinion asserts that the Committee had no choice in its interpretation of RPC 5.4(a) because none of the black letter exceptions to that rule cover commercial litigation funding. While it is true that none of the present black letter exceptions to the rule address lawyer-directed commercial litigation funding, this statement ignores critical aspects of the rule's history.
At the American Bar Association (ABA) level, two of the black letter exceptions to the rule – RPC 5.4(a)(3) authorizing nonlawyer employee participation in profit-sharing plans and RPC 5.4(a)(4) regarding sharing court-awarded legal fees with nonprofits – were expressly recognized by the ABA as straightforward readings of the purpose of the rule without any need for black letter exceptions. In both instances, the ABA Committee on Ethics and Professional Responsibility noted that the purpose of the prohibition on sharing fees with nonlawyers is to protect independent legal judgment. And in both instances, the ABA Committee went on to hold well before the existence of these black letter exceptions that because these kinds of activities did not reasonably appear likely to affect a lawyer's exercise of independent professional judgment, they were not prohibited by the rule. See ABA Formal Op. 93-374 (1993); ABA Informal Op. 1440 (1979). While the subsequent creation of the black letter exceptions was no doubt helpful to remove any lingering questions, they were not required to limit the rule according to its stated purpose. As noted in Comment  to the ABA Model Rules, the RPCs are "rules of reason" which "should be interpreted with reference to the purposes of legal representation and of the law itself." The same logic and the same result can be applied to lawyer-directed commercial litigation funding.
Finally, commercial litigation funding in the United States postdates publication of the RPCs, including RPC 5.4(a). Consequently, the lack of an express exception is not an indication that the drafters of the RPCs intended to prohibit commercial litigation funding.
New York Case Law Misstated?
As a key component of its conclusion, the Opinion limits its discussion of three significant judicial decisions in New York to a footnote in which the Opinion attempts to distinguish them. According to the Opinion, Hamilton Capital VII, LLC v. Khorrami, LLP,3 Lawsuit Funding, LLC v. Lessoff,4 and Heer v. North Moore Street Developers, LLC.5 stand solely for the proposition that a lawyer who obtains commercial litigation funding cannot use the violation of RPC 5.4(a) as a justification for refusing to pay the funder. However, that is not what these cases say.
In Lessoff, for example, the court expressly adopted the language of a prior Delaware case noting, inter alia, that "The Rules of Professional Conduct ensure that attorneys will zealously represent the interests of their clients, regardless of whether the fees the attorney generates from the contract through representation remain with the firm or must be used to satisfy a security interest" and "there is no real 'ethical' difference whether the security interest is in contract rights (fees not yet earned) or accounts receivable (fees earned) in so far as Rule of Professional Conduct 5.4, the rule prohibiting the sharing of legal fees with a nonlawyer, is concerned." And in Hamilton Capital, the court stated that "While it is well settled that actual fee-sharing agreements are illegal and unenforceable ... the case law cited by defendants does not support the proposition that a credit facility secured by a law firm's accounts receivable constitutes impermissible fee sharing with a non-lawyer. To the contrary ... courts have expressly permitted law firms to fund themselves in this manner." 6 Moreover, "Providing law firms access to investment capital where the investors are effectively betting on the success of the firm promotes the sound public policy of making justice accessible to all, regardless of wealth." 7
The advisory Opinion concludes by recognizing that the rule can be said to be overbroad and to go beyond what is necessary to protect lawyer independence. The Opinion therefore notes that one way out of this situation would be consideration of an additional black letter exception to RPC 5.4(a). In light of the purpose of the rule, the history of the rule and pertinent case law, an amendment should not be necessary. Nonetheless, an amendment to remove any remaining doubt would appear to be desirable. Unfortunately, such an amendment will likely take some time to bring to fruition. Until then, there are very sound reasons not to take the Opinion as the last, or ultimately correct, word on this subject.
2 Contemporary litigation funding agreements also make clear that the funder may not interfere in any way with lawyer decision-making and is not entitled to access to confidential client information.
3 No. 650791/2015, 48 Misc.3d 1223(A), 2015 WL 4920281 (N.Y. Sup. Ct. Aug. 17, 2015).
4 No. 650757/2012, 2013 WL 6409971 (N.Y. Sup. Ct. Dec. 4, 2013).
5 140 A.D.3d 675, 36 N.Y.S.3d 93 (N.Y. Sup. Ct. 2016).
6 2015 WL 4920281 at *5.
7 Id. See also Roy D. Simon, Simon's New York Rules of Professional Conduct Annotated (2017 ed.) at 1420 ("New York courts have created what I call a 'litigation funding exception' to Rule 5.4(a).").
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