NYC Bar Opinion says Law Firm Litigation Finance may be Unethical
The New York City Bar Association’s Professional Ethics Committee (NYCBA) has recently issued an opinion which may affect litigation finance arrangements.
In its Formal Opinion 2018-5, entitled ‘Litigation Funder’s Contingent Interest in Legal Fees’, the NYCBA concluded, “a lawyer may not enter into a financing agreement with a litigation funder, a non-lawyer, under which the lawyer’s future payments to the funder are contingent on the lawyer’s receipt of legal fees or on the amount of legal fees received in one or more specific matters”. This conclusion is based upon interpretation of NY’s Rule 5.4(a) which provides that “a lawyer or law firm shall not share legal fees with a nonlawyer”.
The opinion specifically addresses funding arrangements between law firms and funders, as opposed to funding arrangements between plaintiffs and funders. The latter structure was addressed in a prior NYCBA opinion (Formal Opinion 2011-2) which concluded, “it is not unethical per se for a lawyer to represent a client who enters into a non-recourse litigation financing arrangement with a third party lender”.
The more recent Formal Opinion 2018-5 purports to apply to two alternative structures, both of which the Committee concludes fall foul of Rule 5.4. The first is a structure where the funder’s return is secured only against the lawyer’s fee in one or more cases, in other words ‘non-recourse’ law firm litigation finance where the funder only receives a return if the law firm is successful in collecting contingent fee income. The second is a structure where the amount of the funder’s return is dependent upon the amount of the lawyer’s fee, whether or not the funding is ‘non-recourse’. In many instances, these two “alternative” structures, may in fact be two features of a single arrangement, for example where a funder provides capital to a firm and gets a return which is calculated as a percentage of any contingency fee(s) recovered.
In reaching its conclusion, the NYCBA has to contort its opinion in order to not to catch more traditional bank lending arrangements on which many law firms depend in order to support contingent fee practices. The opinion acknowledges that the Rules do not define what it means to “share” a “legal fee” and that it would not be reasonably possible to prohibit law firms from making payments from ‘income derived from legal fees’.
However, the distinction between “sharing” legal fees and making payments from income derived from legal fees is unclear. A law firm that operates an entirely contingent fee practice and borrows from a lender at a rate of interest would appear not to be caught by Opinion 2018-5, even though in reality the firm’s ability to repay the debt may be dependent upon it receiving contingent fee income in the future. The attempted distinction in the application of Rule 5.4 to different financing arrangements highlights the practical challenges facing any attempt to regulate or restrict litigation finance. Any definition of litigation finance is often either too narrow to catch the myriad ways in which funding deals are structured, or too wide and unintentionally catches other ‘traditional’ banking or insurance arrangements.
Funders are quick to highlight that ethics opinions are advisory and that Formal Opinion 2018-5 is not binding. However, ethics opinions can be cited as persuasive authority before the courts and this opinion could be a potential setback for the continued development of the industry, particularly if followed by other state bar associations. The significance of the opinion for the single case funding market is more limited. Any funding structure sitting behind the law firm for a single matter can usually be structured to face the client (and therefore not violate Rule 5.4) whilst still achieving similar economics for the law firm, plaintiff and funder. However, the significance for the development of portfolio financing for New York law firms may be greater and firms are likely to be more cautious in their approach to such arrangements in future, at least until further guidance is received on this issue.
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