by Paul A. Stewart
A relatively recent phenomenon in the law is the rise of litigation funding entities. These are companies that fund all or part of the expenses of a lawsuit in exchange for a share of the plaintiff’s proceeds if the litigation is successful. Very often, the funder pays not only the attorneys’ fees but also the representing attorneys’ out-of-pocket expenses, such as expert witness fees and court reporter fees. Typically, the funder pays the attorney directly, although sometimes the funder will pay the client, who then pays the attorney.
In some states, litigation funding agreements are unenforceable as a form of champerty or maintenance. See, e.g., Maslowski v. Prospect Funding Partners LLC, 890 N.W.2d 756 (Minn. App. 2017). California, however, has no prohibition against champerty or maintenance, see Mathewson v. Fitch, 22 Cal. 86 (1863), and thus there would appear to be no basis for a sweeping challenge to the enforceability of litigation funding agreements in this state. Nevertheless, litigation funding agreements raise a variety of ethical issues that attorneys should consider before undertaking representation of a client funded in litigation by a third party.
The first and most obvious ethical concern arises if the attorney is accepting payment directly from the funder. Rule 1.8.6 of the California Rules of Professional Conduct prohibits attorneys from accepting payment from a third party unless the client gives informed written consent. This Rule reflects a concern that an attorney may improperly place the interests of the funder on par with or ahead of the interests of the client. Thus, a first step in undertaking any third-party-funded representation is to explain to the client the risk of misplaced loyalty inherent in any third-party funding arrangement, and to obtain the client’s written consent to proceed with the arrangement. Of course, even after obtaining consent, the attorney must be mindful always to place the client’s interests above those of the funder.
Next, before agreeing to fund a lawsuit, the third-party funder will almost certainly want to obtain information and analysis from the attorney about the merits of the case. It may seem expedient and tempting to simply include the funder in client meetings or client calls, or to share with the funder correspondence with the client about the merits of the case. This, however, poses a risk that a court will find a waiver of the attorney-client privilege. For example, in Miller UK Ltd. v. Caterpillar, Inc., 17 F. Supp. 3d 711, 734 (N.D. Ill. 2014), the court held that a waiver of the attorney-client privilege had occurred when attorney-client communications were disclosed to a third-party funder. Some other courts have disagreed, finding that the “common interest” exception to waiver of the attorney-client privilege applies. See In re Int’l Oil Trading Co., 548 B.R. 825 (Bnkr. S.D. Fl. 2016). Nevertheless, the more prudent course is to avoid disclosure of attorney-client communications to the funder if at all possible.
Rather than sharing attorney-client communications with the funder, it is generally preferable for the attorney to have separate communications with the funder. These communications may provide the funder with essentially the same information and analysis that the attorney has provided to the client, but the attorney is not providing a copy of an actual attorney-client communication to the funder.
Many courts, including those that find the attorney-client privilege to be waived, have found that communications with the third-party funder are protected by the work product doctrine. See Miller, 17 F. Supp. 3d at 738. These courts reason that work-product protection is waived only if the disclosure of the work product is made under circumstances likely to lead to disclosure to the litigation adversary. Id. Disclosure to a funder typically is not likely to lead to disclosure to the opposing party in litigation. This is especially so if the funder has executed a written non-disclosure agreement prohibiting all disclosure of communications with the attorney or the client—a step that is definitely recommended in these circumstances.
Nevertheless, caution is still the watchword. At least one court has held that work-product protection is waived by disclosure of work product to a funding entity. See Leader Technologies v. Facebook, 719 F. Supp. 2d 373, 376-77 (D. Del. 2010). Because of this risk in this new and developing area of the law, the attorney should advise the client of the risks inherent in sharing confidential information with a funder before entering into the funding arrangement. In addition, Rule 1.6 requires the attorney to obtain client consent before sharing confidential information with anyone. Accordingly, the attorney must obtain the client’s consent, preferably in writing, before sharing confidential information with the funder.
The manner in which the funder will be billed for the attorneys’ fees and out-of-pocket expenses also raises potential issues. The funder necessarily will demand to see the attorneys’ invoices before paying them. Accordingly, to preserve the attorney-client privilege, it is important not to disclose any privileged information in the time entry descriptions in the invoices. This ordinarily means that time entries should be written at a relatively high level of generality to avoid disclosing attorney-client communications or legal advice. For example, an appropriate entry might read: “Conference with client regarding case status.” Far more problematic would be an entry reading: “Respond to client request for advice regarding the weakness of potential summary judgment motion.” Such a time entry reveals a specific client communication, and disclosure of this communication to the funder could give rise to a waiver argument.
It is also important at the outset of the relationship to clarify in writing that the funder is not a client of the attorney in the funded litigation. The funder may believe, based upon its close relationship with the attorney, including its payment of invoices and its reliance upon the attorney for information about the case status, that the attorney represents the funder. A misunderstanding of this type could lead to many pitfalls down the road. For example, the client and the funder may get into a dispute that the client asks the attorney to resolve. If the attorney represents both the client and the funder in the litigation, the attorney cannot represent the client in this dispute without the informed written consent of both parties.
Still another concern arises if the funder demands full or partial control over litigation strategy or settlement as part of the funding agreement. Rule 1.7 requires an attorney to obtain informed written consent before representing a client where there is a significant risk that the representation will be materially limited by the attorney’s relationship with a third party. An argument plainly can be made that an attorney’s ability to represent the client will be materially limited if the attorney must accept the funder’s directions in litigating or settling the case. Thus, at a minimum, client consent is required for such an arrangement.
But is client consent enough, or is outsourcing control of litigation unethical under all or some circumstances? There is currently no California authority directly on point on this issue, and it is an issue that has divided the other jurisdictions. For example, in perhaps the earliest opinion on the subject, the South Carolina Bar instructed its members not only to avoid third-party funder control of litigation, but to inform both the client and the funder in writing that control over the litigation remains with the client. S.C. Bar Ethics Advisory Comm., Advisory Op. 94-04. Similarly, an Ohio ethics opinion instructs attorneys not to permit funders to dictate the attorney’s representation of the client, though that opinion was influenced in part by an Ohio statute specifically governing litigation funding. See Ohio Supreme Court Ethics Op. No. 2012-3. In contrast, the New York City bar has issued an ethics opinion concluding that funders may control litigation strategy and settlement with the client’s informed written consent. Assn. of the Bar of the City of N.Y. Com. On Prof. and Jud. Ethics, Formal Op. 2011-02.
The State Bar of California has recently circulated for public comment a draft ethics opinion regarding litigation funding that touches on this issue. See State Bar of Cal. Formal Opinion Interim No. 14-0002. There, the California State Bar “does not reach a general conclusion that any particular degree of control is per se unethical.” Id. at 6. At the same time, the Bar cautions that “[a] lawyer’s duties are not dictated by the funding contract but by the lawyer’s ethical duties.” Id. Thus, the California Bar appears to be suggesting a case-by-case approach to determining whether the amount and kind of control exercised by a funder creates an ethical concern, even with client consent. It remains to be seen how this issue will play out in California.
The California State Bar’s tentative decision to provide little guidance on this issue illustrates that the ethical issues surrounding litigation funding agreements are still very much a developing area of the law. Any attorney considering a relationship with a litigation funding entity must proceed with caution, particularly if the funder seeks any control of settlement or litigation strategy. In all cases, the attorney must remember that the interests of the client come before the interests of the funder, and the attorney must work vigilantly to protect the attorney-client privilege and work-product protection when communicating with the funder.
Paul A. Stewart is a partner in the law firm of Knobbe, Martens, Olson & Bear, LLP, based in Irvine, California. Mr. Stewart’s practice focuses on intellectual property litigation. In addition, he serves as Chairman of the firm’s Ethics Committee, and is a member of the Orange County Bar Association Professionalism and Ethics Committee. He can be reached at paul.stewart@knobbe.com.