Third Party Litigation Financing: A New York City Bar Formal Ethics Opinion

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, states a formal opinion from the New York City Bar Association’s Committee on Professional Ethics (Formal Opinion 2011-2). Nevertheless, when clients contemplate or enter into such arrangements, lawyers must be mindful of the various ethical issues that may arise and should advise clients accordingly. The issues may include the compromise of confidentiality and waiver of attorney-client privilege, and the potential impact on a lawyer’s exercise of independent judgment.

Non-recourse litigation financing is repaid to third party lenders by a litigant only in the event he or she settles the case or is awarded a judgment upon its completion. The reimbursement is drawn from the proceeds of the lawsuit. As the Opinion notes, “from the legal ethics perspective, perhaps the greatest concern stems from a financing company’s involvement in the details of a claimant’s case.”

Because a third party lender’s decision to provide funding largely relies on its analysis of the merits of the lawsuit, the lender necessarily requires access to information relevant to its assessment of risks of its investment, both before and after a decision to fund has been made. As part of this process, a financing company may contact the claimant’s lawyer to obtain confidential and privileged information regarding the case before making a loan commitment, in addition to requiring updates from counsel regarding developments in the case and/or direct access to the claimant’s file.

“Providing financing companies access to client information not only raises concerns regarding a lawyer’s ethical obligation to preserve client confidences, it also may interfere with the unfettered discharge of the duty to avoid third party interference with the exercise of independent professional judgment,” states the Opinion. And while third party lenders typically represent that they will not attempt to interfere with a lawyer’s conduct of the litigation, “their financial interest in the outcome of the case may, as a practical matter, make it difficult for them to refrain from seeking to influence how the case will be handled by litigation counsel.”

The Committee addresses the issue that non-recourse financing arrangements could result in waiver of the attorney-client privilege or other protection from disclosure, stating that “a lawyer may not disclose privileged information to a financing company unless the lawyer first obtains the client’s informed consent, including by explaining to the client the potential for waiver of privilege and the consequences that could have in discovery or other aspects of the case.”

On the issue of keeping the client’s financing company apprised of any developments in the case or of seeking its consent when taking steps to pursue or resolve the lawsuit, the opinion states, “While a client may agree to permit a financing company to direct the strategy or other aspects of a lawsuit, absent client consent, a lawyer may not permit the company to influence his or her professional judgment in determining the course or strategy of the litigation, including the decisions of whether to settle or the amount to accept in any settlement.”

A lawyer may also be asked by a client to recommend a source of third party funding or to review or negotiate a non-recourse financing agreement for a client. If this occurs, Rule 2.1 of the New York Rules of Professional Conduct requires the lawyer to provide candid advice regarding whether the arrangement is in the client’s best interest. As the report points out, lawyers should advise their clients to consider the costs and the benefits of non-recourse financing, which can involve large fees, as well as possible alternatives such as bank loans. The Opinion notes, “Before recommending financing companies, a lawyer should conduct a reasonable investigation to determine whether particular providers are able and willing to offer financing on reasonable terms. In addition, if a lawyer assists a client with non-recourse financing, the lawyer may wish to make clear that such assistance itself is not an endorsement of the financing company.”

Non-recourse litigation financing is on the rise, and, as the Opinion states, “provides to some claimants a valuable means for paying the costs of pursuing a legal claim, or even sustaining basic living expenses until a settlement or judgment is obtained. It is not unethical per se for a lawyer to advise on or be involved with such arrangements.” However, the Committee concludes, “a lawyer representing a client who is party, or considering becoming party, to a non-recourse funding arrangement should be aware of the potential ethical issues and should be prepared to address them as they arise.”

The opinion also addresses conflict of interest, usury and champerty issues relating to non-recourse litigation financing. The full opinion can be read here.