Third-Party Investors Offer New Funding Source for Major Commercial Lawsuits

Posted on March 10th, 2010

BNA: Daily Report for Executives, Vol. 0, No. 42

March 5, 2010

Ralph Lindeman


With traditional sources of credit in short supply, corporate plaintiffs and law firms are turning to outside investors to help bankroll multimillion dollar commercial lawsuits in a variety of areas, including patent infringement, antitrust, and international arbitration.

Legal experts say the emerging trend has the potential to fortify plaintiffs by providing them with additional funds and spreading litigation risk to outside investors in lawsuits where deep-pocket corporate defendants have traditionally enjoyed an advantage.

While still in its infancy, so-called third-party litigation financing in commercial cases is attracting the attention of large financial services companies, certain hedge funds, and specialized legal claim investment firms which offer funding in return for a sizeable portion of any recovery. As investors, they view the funding concept as a new asset class not tied to the economy or stock market, with the potential for high returns.

At least three large investment firms—Juridica Investments Ltd., Burford Capital Management, and ARCA Capital Partners—have started up recently for the primary purpose of funding large-scale commercial lawsuits.

Other firms engaged in litigation financing to varying degrees include Credit Suisse, Allianz Profess Finanz, IM Litigation Funding, Juris Capital, and Harbour Litigation Funding.

Potential corporate plaintiffs, for their part, are eyeing third-party litigation funding as an attractive source of capital to finance lawsuits—one that enables them to use their own corporate resources for other purposes, while offloading some of the litigation risk to outside investors.

A related business model has been around for years, one in which smaller-scale legal finance firms and contingency-fee lawyers offer funding to—or agree to shoulder litigation costs for—individuals pursuing personal injury or product liability claims for a share in any recovery.

One key distinction in the use of third-party funding for large-scale commercial litigation is the size and sophistication of the parties involved. The parties include some of the nation’s leading corporations and elite law firms, working with outside investors who, in most cases, are not directly involved in the litigation.

Experts See Major Development in Civil Litigation. ‘‘I think this is a really big deal in at least two different ways,’’ Stephen Yeazell, an expert in the history of civil litigation in the United States, told BNA.

First, it demonstrates a strengthening of the corporate plaintiffs’ bar, which for at least the past 75 years has been outgunned by the corporate defense bar, Yeazell said.

Second, driven in part by the economy, several of the nation’s largest law firms—which have traditionally shunned such activity—are entering into outside funding agreements or letting their clients know such arrangements are available, noted Yeazell, who currently serves as interim dean at the UCLA School of Law.

By helping to level the playing field between plaintiffs and defendants, third-party litigation funding ‘‘has the potential to have a major impact on the civil justice system in the United States,’’ according to Steven Garber, who directs a study by the Rand Corporation’s Institute for Civil Justice on the new business concept.

‘‘The confluence of the recent credit shortage, the enormity of the overall market for legal services, and the search for investment opportunities unrelated to general economic risk has created the supreme environment for litigation claim transfer to expand and thrive,’’ Rand’s Civil Justice Institute said in materials prepared for a June 2009 conference it sponsored on the topic.

Proponents of the funding model view it as a way to advance justice by enabling cash-strapped companies to pursue valid claims.

‘‘If a plaintiff fails to pursue a meritorious claim because of cash constraints or risk aversion, our system has failed,’’ wrote John Molot, a law professor at Georgetown University Law Center, in a recent, unpublished paper titled ‘‘A Market in Litigation Claims.’’ Molot was recently appointed chief investment officer of Burford Capital and continues to teach at Georgetown.

Critics Cite Ethics Concerns. But the emerging funding model also has its critics. Some question whether it violates ethics rules going back centuries to English common law that prohibit outside parties from buying legal claims of others, a practice known as champerty.

Many states have relaxed such restrictions in recent years but the rules remain in flux and uncertain in some jurisdictions. To address the ethics concerns, thirdparty financing firms often seek advice from ethics advisers before they fund litigation in a particular jurisdiction.

Other critics, including the U.S. Chamber of Commerce, argue that third-party litigation financing, if successful and more widely used, could attract less reputable financiers interested in targeting corporations with frivolous lawsuits—including class actions—in an attempt to extort huge settlements.

Funders Measure Huge Market. Companies entering the field of litigation financing view it as a huge, untapped market. Juridica and Burford Capital, both publicly traded companies, estimate in their public filings that in 2008 litigation revenues were around $30 billion among the 200 largest U.S. law firms. Moreover, they assess total U.S. litigation-related spending, which includes legal fees and expert witness costs, at about $80 billion.

‘‘That total spending on litigation is theoretically the addressable market for litigation investment in claims and disputes,’’ Burford said in its initial public offering filing. Juridica, citing similar figures in its 2008 annual report, called it ‘‘a very large market indeed.’’

‘Dispute Funding’ More Established in U.K. The use of third-party litigation funding is more prevalent in Europe, particularly in the United Kingdom where it began around 2005. Unlike the legal profession in the United States, lawyers in the United Kingdom are not permitted to take cases on contingency and, as a result, many are looking for outside sources of funding.

Third-party funding in the United Kingdom saw a growth spurt in late 2007 thanks in part to groundbreaking national legislation that explicitly permitted third-party financing of legal claims and eased the way for law firms to be listed on the London stock exchange. The business model is also used in Australia where it has been well-established for about 15 years.

Burford Capital and Juridica are incorporated in the United Kingdom, in the offshore island of Guernsey, doing business both in Europe and the United States.

In October 2009, Burford launched its initial public offering in what turned out to be the London stock market’s second-largest IPO last year, raising some $130 million in capital.

‘‘Dispute funding has been established for a longer period in the U.K. as a dedicated asset class and that fact, coupled with the media attention surrounding it . . . made U.K. investors more familiar with the investment proposition,’’ explained Selvyn Seidel, Burford’s chairman, who retired in 2006 as a senior partner at Latham & Watkins.

‘‘We’ve seen the asset class growing under our noses,’’ added Seidel who chaired Latham & Watkins’s international litigation and arbitration practice. ‘‘It’s evolving and growing, with exceptional demand in the U.S. market.’’

Seidel’s partner at Burford is Christopher Bogart, who serves as the company’s CEO. Bogart is the former executive vice president and general counsel of Time Warner Inc. and, earlier, a partner at Cravath, Swain & Moore. Burford Capital’s board of directors includes several high-powered British luminaries, including Sir Peter Middleton, former U.K. treasurer and chairman of Barclays Bank.

Demand Exceeding Expectations. Echoing Seidel’s enthusiasm for the business model, Richard Fields, chairman and CEO of Juridica, told BNA, ‘‘Frankly, the demand has far exceeded our expectations.’’

Fields’s background includes over 25 years’ experience with several major U.S. law firms where he practiced as a corporate plaintiff’s lawyer, handling complex litigation focused on insurance coverage, contract issues, as well as complex business dispute resolution. Juridica, similar to the other major third-party financing firms, has not spent a lot of time or resources marketing the new business model, said Fields. ‘‘The deals have found us,’’ he said, noting many of the cases Juridica considers for investment are referred from business and legal contacts he made during his years with major law firms.

Juridica predated Burford in the legal claims market, going public in the United Kingdom in December 2007 and quickly raising nearly $200 million in investment capital.

Timothy D. Scrantom, Juridica’s president and founder, also pointed to the U.K.’s familiarity with third-party litigation funding as one of principal reasons for incorporating Juridica there. ‘‘With the passage of legislation there that ‘institutionalized’ litigation financing, the market was sensitized to the phenomenon,’’ Scrantom told BNA.

In addition, many of Juridica’s initial investors were based in the United Kingdom and ‘‘wanted a European investment vehicle so we bowed to their wishes,’’ added Scrantom, who is admitted to practice law in the United States but worked for more than 15 years as an English barrister-at-law, specializing in multinational business litigation.

Juridica’s board of directors is chaired by Lord Daniel Brennan, a member of the House of Lords and former chairman of the bar of England and Wales.

ARCA Capital Based in U.S. Closer to home, ARCA Capital Partners LLC is a third-party litigation investment firm based in the United States, with three offices in California—Los Angeles, San Francisco, and San Jose—and another planned for New York. Launched in June 2009 and privately held, ARCA is not required to disclose its financial information.

However, Bruce Beron, ARCA’s managing director and chief investment officer, told BNA the company now has about $110 million in investment capital and is working with outside investors, including a few large hedge funds, to increase that amount.

ARCA has not yet invested in any legal claims, but is actively evaluating several opportunities, including multimillion dollar patent infringement claims originating in the Silicon Valley, said Beron, a Stanford-educated physicist, who has spent nearly three decades specializing in litigation risk management.

In 1988, he founded the Litigation Risk Management Institute based in Palo Alto, Calif., which trains and advises corporate counsel on litigation risk management and settlement valuation for complex commercial disputes.

Firms Use Similar Operating Practices. While investing in legal claims is still relatively new in the United States, it appears most third- party litigation investment firms are gravitating toward comparable types of cases for investment, based on publicly available filings and BNA’s interviews with the heads of Juridica, Burford, and ARCA. They also employ similar screening techniques to decide which cases to invest in.

Patent litigation, antitrust claims, and international arbitration—along with a smattering of cases involving shareholder disputes, breach of contract, and defaulted debt—are areas of concentration for the firms.

In a Feb. 1 ‘‘Trading Update,’’ Juridica reported that it currently has $123.3 million invested in 23 cases, which include 12 patent infringement claims, five antitrust claims, two property damage and insurance subrogation claims, two contract claims, one claim involving a shareholder dispute, and another involving a ‘‘statutory claim.’’

Juridica’s average investment in each case is around $5.25 million, it reported, and the average age of the cases is about 2.6 years from the date of filing. The claims Juridica invests in range from $25 million to $100 million.

As of Jan. 21, Burford Capital had about $15 million invested in five pending matters, which include three arbitration claims, and two breach of contract claims, according to an interim management statement released by the company. Three of the pending cases should be resolved in a year or less, as the matters are approaching key hearing dates or trial, said Seidel, Burford’s chairman.

Looking forward, Burford Capital anticipates it generally will be investing from $3 million to $15 million in individual cases, Seidel told BNA, with expectations of a total recovery ‘‘north of $50 million’’ in each case.

Defense Clients Welcome. Although most investments of third-party funders to date have been on the plaintiff’s side, company executives do not rule out targeted investments on the defense side.

‘‘It’s not a matter of favoring plaintiffs over defendants,’’ said Seidel. ‘‘It’s a matter of favoring good claims and good defenses over bad claims and bad defenses.’’ Fields at Juridica agreed, saying, ‘‘Although we haven’t closed a deal on the defense side yet, we are going to be playing in that arena as well.’’

One example of how third-party financing might work on the defense side would be for a defendant corporation to pay a third-party financier to assume several million dollars in asbestos liability claims being litigated and carried on the books of the corporation, according to an attorney familiar with the funding arrangements. The funder would, in essence, be betting that it could defend against or settle the claims for considerably less than it was paid to assume the claims, pocketing the difference as profit.

Case Selection Criteria. In its 2008 annual report, released in April 2009, Juridica revealed some of the thinking behind its choice of cases to invest in. With respect to antitrust cases, Juridica said, ‘‘Price fixing cases are particularly attractive investment opportunities . . . as they are perceived to have a low risk profile and high potential damages. Civil litigation in this arena often, but not always, follows either criminal prosecution by the U.S. Department of Justice or early settlement by a cartel member in exchange for giving evidence against co-conspirators. These events help to establish liability. The multi-defendant nature of these cases increases the likelihood of pretrial settlements.’’

Regarding patent infringement claims, Juridica said it had discovered that ‘‘the cost of patent litigation was often significantly higher than the purchase price of a patent or portfolio of related patents.’’

As a result, Juridica in some cases acquires ‘‘patents outright for litigation’’ and then contracts with ‘‘law firms that are willing to take the best of these cases on pure contingency fee basis and carry the risk of the litigation.’’

As the patent holder, Juridica would reap the rewards of a successful infringement action, while sharing a portion of the recovery with the outside firm. Juridica does not invest in class actions, or cases involving personal injury, product liability, or mass tort. ‘‘Most of our clients are on the receiving end of those cases,’’ explained Fields.

In contrast, Burford Capital—while not yet invested in any such cases—would not automatically exclude investments in class actions or mass tort cases, said Seidel.

‘‘Let’s take a close look and see whether it can serve a useful purpose. If you bring a frivolous class action and get it funded, that’s a bad thing. But if it’s a good claim, why should it be barred from getting financing?’’

Case Screening Is Key Tool. With millions of dollars at stake and given the uncertainties of litigation, the top executives at third-party litigation investment firms uniformly stress the importance of performing extensive ‘‘due diligence’’ in deciding where to invest.

‘‘It’s a very detailed and expensive process, averaging about 60 to 90 days,’’ said Fields, Juridica’s chairman. Juridica spends an average of $75,000-$100,000 for each screening, he said. As an example of the firm’s selectivity, since its startup in December 2007 through June 2009, Juridica considered 340 potential investments and selected just 23 legal matters in which to invest, according to Juridica’s September 2009 interim report.

Juridica and Burford Capital both enlist the aid of outside legal specialists in specific practice areas, as well as consultants on damages and local ethics rules, to evaluate potential case investments.

‘‘We hire one or more lawyer specialists to examine the merits of each case,’’ said Scrantom, Juridica’s president. ‘‘We also often reach out to financial or economic consultants on damages to evaluate the amount that can be recovered, including the amount a defendant can pay.’’

He added: ‘‘The basic guideline is that we would not look at a case unless it was already under engagement with a leading law firm. We would not want to be involved in a case that is not yet filed.’’

Scrantom said Juridica has no preferred stage of litigation at which to become involved in a case, noting the firm has taken cases that were freshly filed, on the eve of trial, as well on appeal.

For its case selection, Burford Capital uses an inhouse screening committee to conduct an initial review, said Seidel. The committee screens using several criteria, including the strength of the claim and its likelihood of success, the claim’s value in both litigation and possible settlement, the enforceability of any award, the defendant’s financial condition, any regulatory or ethical risks in the relevant jurisdiction, and the likely time to reach trial or settlement.

Following the in-house review, the matter is referred to outside legal professionals for a second-level review. Any case recommended for investment is subject to the approval of Burford’s board of directors, Seidel said. ARCA Capital is using similar processes for its due diligence analysis, Beron said, asking the views of ‘‘greybeards that have experience in different case areas.’’

In addition, ARCA will use some proprietary risk management assessment tools developed during his years as a litigation risk expert, Beron said, including ‘‘some game theory tools we plan to use in settlement discussions.’’

Ethics Review Part of Screening Process. Another important part of pre-investment analysis, said Scrantom at Juridica, is an ethics review of the rules in place for the jurisdiction where the case is being brought. Noting the different treatment among the states of ethics rules on champerty—the historical prohibition against purchasing legal claims—Scrantom said Juridica uses a network of about 20 ethics advisers who are asked to deliver written opinions on the applicability of any restrictions on litigation investments. On average, the advisers are paid $10,000-$30,000 for their analyses, he said.

Burford Capital and ARCA also call upon outside ethics advisers. Burford, for example, lists University of Pennsylvania law professor Geoffrey Hazard, author of a leading treatise on legal ethics and former director of the American Law Institute, as its legal ethics counsel.

Successes to Date. Any detailed assessment of thirdparty litigation investment firms’ performance is hard to come by because the business model is new, most cases remain pending, and the firms are reluctant to identify specific cases they have invested in—for fear of creating a distraction in the litigation. Nonetheless, as public companies, Juridica and Burford report case results to their shareholders, though without using specific case identifiers.

While none of Burford’s case investments has yet concluded, Juridica, in its Feb. 1 trading update, reported that it had completed its first patent infringement case. The case settled in December 2009 for $4 million of which $2.4 million was paid to Juridica. The firm had invested $1.4 million in January 2009, earning a 71 percent return on its investment. In its June 30 interim report, Juridica noted it had a gross return of $4.3 million on a case (subject not identified), yielding an annualized internal rate of return of 61 percent on Juridica’s initial investment of $3.1 million.

Stock Prices Show Resiliency. Another measure of success is the stock price of the two publicly traded firms. As world stock markets plunged in 2009 during the financial crisis, an early test came for third-party litigation funding’s claim to be an uncorrelated asset class.

From the date of Juridica’s public offering in December 2007 to April 2009—near market lows—its stock price shot up 20 percent. It has since declined slightly, but currently shows about a 15 percent increase since early 2008.

Burford’s stock price has held relatively steady since the company’s public offering last October, with a five percent increase as of late-February. The new asset class has caught the attention of large institutional investors. Invesco holds 45 percent of Burford’s shares and 30 percent of Juridica’s shares. Fidelity and Baille Gifford Co., a large Scotland-based investment firm, each own another 10 percent of Burford shares, with Baille Gifford also holding 6 percent of Juridica shares.

Perspectives From Outside the Funding Firms. What factors influence companies and law firms to seek out anduse third-party funding in litigation?

As an initial matter, most third-party funders will not disclose the names of companies or law firms they are working with due to confidentiality agreements and to avoid the possibility the outside funding could become an issue in the litigation. ‘‘We just don’t want to invite the distraction,’’ said Fields, Juridica’s CEO.

Those receiving the funds, for their part, see no advantage in letting it be known they have outside resources. Local court rules do not require disclosure of third-party financing and law firms want to minimize the potential for opposing parties to raise the issue as a ‘‘side-show’’ during discovery, said Fields.

At the request of BNA, Juridica contacted a few recipients of its investment funds to inquire whether they would agree to discuss, in general terms and anonymously, their experiences using outside funding. All refused.

Burford provided the name of a leading law firm, Patton Boggs LLP, which has clients who have used thirdparty funding. ‘‘We became involved with this in the last few years,’’ said James E. Tyrrell Jr., the managing partner of Patton Boggs’ law offices in New York and New Jersey. ‘‘At first, I was somewhat dubious, but as we got more involved and began to test the interest of some of our clients, I found they really want to know about this.’’

‘‘General counsels with big companies have cases that they’d like to bring, but they have to take a backseat because of corporate constraints on funding,’’ Tyrrell told BNA in a recent interview. ‘‘We think it is our opportunity to value add by describing these possibilities to our clients.’’

Juridica outlined some of the motivations for both law firms and companies to look for outside funding in its 2008 annual report: ‘‘Traditional sources of hourly billing in the corporate and transactional business have diminished, leading law firms to cut lawyers and staff at a rate never seen in the modern legal market. Furthermore, general counsels of major companies are under pressure to cut legal expenses, particularly where there is discretion to do so—as in cases where the company is bringing a lawsuit as opposed to defending one.’’

In the patent law area, for example, the skyrocketing costs of litigation in infringement cases are forcing many companies to seek outside funding. ‘‘Many small firms simply can’t afford to litigate these claims,’’ noted Beron at ARCA Capital.

Since 2003, the average cost of litigating a high stakes patent infringement case—defined as one seeking at least $25 million in damages—has increased 41 percent since 2003, according to a recent report by the American Intellectual Property Law Association. The costs now average $5.5 million compared with $3.9 million in 2003.

Beron attributes much of the increased cost to expert witness fees. ‘‘In a case involving semiconductor design, for example, it basically requires an expert to reverse-engineer the chip,’’ he said. ‘‘That is very expensive because someone has to examine it and figure out how it works.’’

According to one senior partner specializing in patent law with a major D.C. law firm, ‘‘In the last few years, companies are saying ‘we don’t have the money in our budgets’ or ‘we don’t want to deduct the money from our bottom line,’ ’’ he told BNA. ‘‘We tell them we’ll take the case on partial, not full contingency. We tell the company they need to find additional funding sources to share the risk. Some already know about third-party funders. We let others know about the funders.’’

Customized Agreements. There is no one-size-fits-all funding agreement or contract used by law firms or companies receiving outside funds, said Tyrrell at Patton Boggs. ‘‘One funder tends to invest in cases where the company has already selected its own counsel to handle the case,’’ he explained. ‘‘Another funding firm negotiates with the company to make a joint decision on legal counsel—which is not too different from an insurance company arranging legal counsel for a claimant.’’

One element that Juridica wants to see in any funding arrangement is that ‘‘the lawyer has skin in the game,’’ said Fields, the CEO. ‘‘The law firm has to take on some risk,’’ he said, adding, ‘‘We want to make sure our interests are aligned.’’

Indeed, it is this aspect of third-party funding—spreading the risk—that proponents say provides options to plaintiffs who might otherwise be forced to settle, or be foreclosed from bringing a case in the first place.

‘‘It opens up possibilities for allocating risk that can benefit both attorneys and clients,’’ said Nathan M. Crystal, a professor at Charleston School of Law in South Carolina, who serves as an ethics advisor to Juridica.

Last October, Crystal outlined how various risk allocation strategies can benefit plaintiffs, law firms, and third-party funders at a conference sponsored by the American Bar Association on ethical issues associated with litigation financing.

In a Power Point presentation involving a hypothetical case with a potential $9 million recovery and $700,000 in legal expenses, Crystal showed how the plaintiff, lawyer, and funding firm could all come out ahead.

Opponents Warn of Potential Problems. To the extent there is opposition to third-party litigation financing, it mostly centers on the potential for future abuses, rather than its current use by corporations in major commercial cases.

Critics such as the U.S. Chamber of Commerce point to the extensive use of third-party funding in Australia and argue that it has led to a dramatic increase in litigation there, particularly with respect to class actions, and has handed control of plaintiffs’ cases to outside investors.

The same could happen in the United States, the Chamber has warned.

Moreover, the risk-shifting aspect of third-party funding is viewed by critics as a potential cause for concern. ‘‘By helping would-be plaintiffs shift their costs to others, third-party funding encourages plaintiffs’ attorneys to test claims of questionable merit, knowing that the enormity of the potential risk will often force defendants to settle class and mass actions on suboptimal terms rather than roll the dice at trial,’’ the Chamber argued in a paper issued in October 2009, titled ‘‘Selling Lawsuits, Buying Trouble.’’

John Beisner, a partner with Skadden Arps and a coauthor of the Chamber paper, told BNA the concern of many opponents is more about what third-party funding could lead to, rather than the current practices of the major third-party funders. The Chamber’s paper, he said, ‘‘is more of a warning shot.’’

Walter Olson, a senior policy analyst at the Manhattan Institute, expressed concern about less reputable funding firms entering the market. ‘‘Once you invite in this business model, how do you keep out lower quality operations that will chase more dubious cases?’’ he asked.

‘‘If we open the door for the more conservative players, I predict the door will remain wide open for others who are less conservative and who will go farther in search of a buck,’’ he told BNA.

Paul H. Rubin, a professor of law and economics at Emory University, sees the possibility that third-party funding could, in fact, encourage plaintiffs to file ‘‘large, risky, long-term cases.’’ In a recent paper on third-party funding, Rubin observed: ‘‘If a case turns on a factual matter, then obtaining the facts should not be so expensive and time consuming.

But if a case requires some [major change in the law], then it may well be very risky and time consuming. . . This class of cases may be the most promising for third party financing.’’

Geoffrey L. Lysaught, policy director at Northwestern University’s Searle Center on Law, Regulation, and Economic Growth, warned that if third-party funding becomes more established and attracts more investors, ‘‘It could mean returns on the investments will come down because of supply and demand and lead people to seek out more speculative investments in cases.’’

He also called for more study on the potential impact of third-party litigation. ‘‘We need more rigorous research on this concept before we get too far down the path,’’ he said. ‘‘It has a real potential for unintended consequences.’’

Rand Corp. Initiates Major Study. As it turns out, the Institute for Civil Justice at the Rand Corporation, a leading public policy think tank based in Santa Monica, Calif., has embarked on a major study of third-party litigation financing.

The project began last September following a conference the Institute sponsored on the subject in June, said Steven Garber, director of the project and a senior economist with the Rand Corp.

‘‘We want to take an objective look at what’s going on and hear what people are saying about what is a growing phenomenon,’’ Garber told BNA.

‘‘Third-party financing is getting a lot of attention and there are a lot of calls for public policy responses,’’ Garber noted. ‘‘We’re not sure the knowledge base is there for the right policy choices to be made.’’ To help supplement the knowledge base, Rand’s Civil Justice Institute is preparing a comprehensive report on third-party litigation financing, Garber said. The report is expected to be released at a conference on third-party financing the Institute is sponsoring in Washington, D.C. on May 20-21.

Ethics Rules Post Challenge. Any third-party litigation firm planning to invest in a lawsuit faces a broad array of ethics rules across the 50 states that govern how lawyers conduct their practice.

Enacted by state legislatures, adopted by bar associations, or contained in court rulings, the rules may or may not condone the use of outside funding in a lawsuit.

It is for that reason that litigation financing firms engage teams of pre-investment ethics advisers to look into any potential ethical restrictions in a particular jurisdiction.

‘‘The ethical doctrines governing this type of activity are not yet refined,’’ noted Stephen Gillers, a nationally-known expert in legal ethics at New York University School of Law. ‘‘There are all kinds of potholes along the way that people have to anticipate.’’

He added: ‘‘The way established doctrines apply is quite uncertain. It is likely that judges will be quite suspicious of anything like this that is still in its infancy.’’

A principal concern is champerty, the restriction against selling or assigning a claim to another party.

‘‘Champerty is the elephant in the room,’’ Gillers told BNA, adding, ‘‘While some states have rejected it, most states still recognize it, although its contours are quite ill-formed and its scope varies from state to state. It is a big issue the funders have to worry about.’’

Other issues facing third-party litigation financiers, Gillers said, include ethical restrictions against fee-splitting between lawyers and non-lawyers, rules against interfering with the independent judgment of a lawyer, as well as the risk of waiving the confidential privilege between lawyer and client by disclosing certain information to an outside party.

‘‘Many states are now accepting or at least tolerating legal financing,’’ he noted. ‘‘It is very difficult to stop when there is a market between buyers and sellers. You don’t have a prominent high state court coming down with a condemnation of the practice. Something like that could stop it.’’

Gillers noted the Ohio Supreme Court, in a 2003 decision in Rancman v. Interim Settlement Funding Corp., 99 Ohio 3d 121 (2003), barred third-party funding.

However, in 2008 the Ohio state legislature negated the decision, passing one of the first statutes that explicitly permitted litigation financing in the consumer financing context. At the same time, the statute required disclosure of the annualized rate of interest to be paid and allowed the recipient to cancel the contract within five days.

The Rancman case and the following legislation, however, addressed third-party funding on a very limited scale. The case involved a $7,000 non-recourse advance of funds to the plaintiff in a personal injury suit by Interim Settlement Funding Corp., a small company providing modest amounts of cash with interest to individuals wanting to pursue a claim. The firm is typical of a subcategory of lawsuit financing companies, which have been around for years, that do not fund large-scale commercial litigation.

State Rules on Champerty Vary. Anthony Sebok, a law professor at Yeshiva University’s Cardozo School of Law, has examined state restrictions on champerty.

‘‘Most states care about champerty,’’ he told BNA. About 30 states have laws that prohibit champerty or have some form of restriction on investments in litigation for profit, he said.

However, ‘‘The trend is mostly toward liberalization,’’ Sebok added, focusing primarily on eliminating restrictions that would bar lending companies from providing funds to claimants in the consumer finance context.

‘‘The common law in most states is so old and antiquated,’’ Sebok said, it is difficult to tell exactly what modern practices the early court decisions could apply to. ‘‘The precedents certainly could not encompass modern-day consumer-oriented loans,’’ he said. For that reason, state courts in South Carolina and Maine recently reversed earlier, champerty-based court decisions that had been interpreted to bar third-party funding in personal injury cases, Sebok noted.

While few cases to date have addressed the use of third-party funding in large commercial cases, the liberalization trend likely would encompass them as well, Sebok said, adding, ‘‘The cases allowing it in the consumer context are not implying that nothing else will be permitted.’’

Georgia is considered the most restrictive jurisdiction with respect to champerty, said Sebok, who is an advisor to the Rand Institute for Civil Justice’s study on third-party financing. Texas is the most liberal state.

Other permissive states include California, Hawaii, Louisiana, Massachusetts, New Jersey, and Tennessee.

Privilege Waiver Another Concern. In addition to champerty, another major problem area in third-party investment transactions is the possibility of causing a waiver of the confidentiality privilege between lawyer and client, Gillers said. This potential pitfall arises when a third-party financing firm undertakes its due diligence examination of the lawsuit, he explained.

Under long-standing privilege doctrine, if a party to a lawsuit discloses information to an outside party, the privilege is waived and the information may no longer be kept confidential. As a result, if the opponent in the lawsuit learns that an outside party has had access to the information, the opponent can demand that it be turned over in discovery.

As a way around that risk, Scrantom, Juridica’s president, told BNA that Juridica employs the use of the ‘‘common interest exception’’ to privilege waiver. This doctrine provides that when two parties have a common interest in the litigation, information can be shared and the privilege remains preserved.

‘‘I think that’s risky,’’ said Gillers, referring to the use of the exception by third-party financiers. ‘‘The common interest rule is narrow and is usually intended to benefit only co-litigants in pending litigation,’’ he continued. ‘‘A funding company is not a litigant, it’s in a business relationship.’’

Another way to minimize the risk of privilege waiver, Scrantom said, is by using another law firm to act as an intermediary between the claimant and the investment firm. ‘‘We often engage another law firm to look at the merits of a case,’’ he said. ‘‘If the law firm has communications with the claimant, they are protected from disclosure.’’ He added, ‘‘We often find that claimants and lawyers welcome a second look at a case.’’

Systemic Impacts on Litigation Eyed. Given the limited amount of time third-party financing in commercial cases has been in use, its future as a business model is unclear.

‘‘Like all new business models, it will be interesting to see what level of demand there is for it and how successful it will be,’’ said Yeazell, the interim dean at UCLA law school. ‘‘These are really expensive and uncertain investments. I think there will be a shakeout— there’s not necessarily a bottomless well of profits out there.’’

Carl T. Bogus, a law professor who has focused on tort reform and civil justice issues at Roger Williams University School of Law in Rhode Island, said, ‘‘You have to wonder, as this practice grows and gains more attention, whether it will create some political blowback.’’ He sees the possibility that tort reform advocates, among others, could seek curbs on the activity. ‘‘There is a feeling that lawsuits shouldn’t be made too easy to bring—that it should be difficult, it’s part of the culture.’’

Fields, the Juridica CEO, expressed optimism that over time the appearance in a case of a well-established third-party financing firm could operate ‘‘as an added value.’’

He explained: ‘‘If you have the right funder in a case, one that has funded 100 cases and won 98, it would represent a third-party’s endorsement of a case, almost like a bond rating. It will be interesting to see if we can get to that point in the legal market.’’

One long-time hedge fund manager expressed some skepticism that mainstream funds would view thirdparty litigation financing as a hot new investment opportunity.

‘‘Legal cases are not linked to any particular security or corporate debt-related instrument,’’ said Ezra Zask, who spent nearly three decades as a hedge fund manager and now heads Ezra Zask Advisors in Connecticut.

With respect to litigation funding, Zask said a hedge fund could have some concern about issues related to liquidity, valuation, time frame, and the expertise needed to evaluate a case’s prospects. He added, ‘‘This kind of investment is definitely outside the normal range of hedge fund activities.’’

Regulation Suggested. Law professors Gillers and Sebok, while both supportive of third-party litigation funding, saw a role for some type of regulation of the activity.

‘‘The way to do this is to allow it, but regulate it,’’ said Gillers. ‘‘You want make sure a funding company is not in a position to exploit a needy plaintiff,’’ he said. ‘‘Legislators that permit litigation funding should also write into the statute some consumer protection rules, similar to how some states now cap contingency fees in personal injury cases.’’

According to Sebok, ‘‘It should be regulated or monitored like any other complex legal relationship and run by the norms of consumer protection, so people signing a contract know what they are doing.’’

To date, there have been only limited efforts to regulate third-party funding. Along with Ohio, Maine also has enacted legislation that permits third-party litigation financing, but also imposes disclosure requirements, similar to the Ohio law.

The rules in both states, however, are aimed principally at the smaller firms offering funding for personal injury actions and the like.

Supporters of the use of third-party funding in large commercial cases argue no regulation is needed, citing the experience and sophistication of the parties involved.

‘‘The cases and investments we are talking about here involve hundreds of millions of dollars and very sophisticated parties,’’ noted Crystal, the Juridica ethics adviser teaching at Charleston School of Law. ‘‘They are certainly capable of evaluating risk.’’

Lindeman, Ralph, Third-Party Investors Offer New Funding Source for Major Commercial Lawsuits, BNA: Daily Report for Executives, Vol. 0, No. 42, March 5, 2010.

With traditional sources of credit in short supply, corporate plaintiffs and law firms are turning to outside investors to help bankroll multimillion dollar commercial lawsuits in a variety of areas, including patent infringement, antitrust, and international arbitration.

Legal experts say the emerging trend has the potential to fortify plaintiffs by providing them with additional funds and spreading litigation risk to outside investors in lawsuits where deep-pocket corporate defendants have traditionally enjoyed an advantage.

While still in its infancy, so-called third-party litigation financing in commercial cases is attracting the attention of large financial services companies, certain hedge funds, and specialized legal claim investment firms which offer funding in return for a sizeable portion of any recovery. As investors, they view the funding concept as a new asset class not tied to the economy or stock market, with the potential for high returns.

At least three large investment firms—Juridica Investments Ltd., Burford Capital Management, and ARCA Capital Partners—have started up recently for the primary purpose of funding large-scale commercial lawsuits.

Other firms engaged in litigation financing to varying degrees include Credit Suisse, Allianz Profess Finanz, IM Litigation Funding, Juris Capital, and Harbour Litigation Funding.

Potential corporate plaintiffs, for their part, are eyeing third-party litigation funding as an attractive source of capital to finance lawsuits—one that enables them to use their own corporate resources for other purposes, while offloading some of the litigation risk to outside investors.

A related business model has been around for years, one in which smaller-scale legal finance firms and contingency-fee lawyers offer funding to—or agree to shoulder litigation costs for—individuals pursuing personal injury or product liability claims for a share in any recovery.

One key distinction in the use of third-party funding for large-scale commercial litigation is the size and sophistication of the parties involved. The parties include some of the nation’s leading corporations and elite law firms, working with outside investors who, in most cases, are not directly involved in the litigation.

Experts See Major Development in Civil Litigation. ‘‘I think this is a really big deal in at least two different ways,’’ Stephen Yeazell, an expert in the history of civil litigation in the United States, told BNA.

First, it demonstrates a strengthening of the corporate plaintiffs’ bar, which for at least the past 75 years has been outgunned by the corporate defense bar, Yeazell said.

Second, driven in part by the economy, several of the nation’s largest law firms—which have traditionally shunned such activity—are entering into outside funding agreements or letting their clients know such arrangements are available, noted Yeazell, who currently serves as interim dean at the UCLA School of Law.

By helping to level the playing field between plaintiffs and defendants, third-party litigation funding ‘‘has the potential to have a major impact on the civil justice system in the United States,’’ according to Steven Garber, who directs a study by the Rand Corporation’s Institute for Civil Justice on the new business concept.

‘‘The confluence of the recent credit shortage, the enormity of the overall market for legal services, and the search for investment opportunities unrelated to general economic risk has created the supreme environment for litigation claim transfer to expand and thrive,’’ Rand’s Civil Justice Institute said in materials prepared for a June 2009 conference it sponsored on the topic.

Proponents of the funding model view it as a way to advance justice by enabling cash-strapped companies to pursue valid claims.

‘‘If a plaintiff fails to pursue a meritorious claim because of cash constraints or risk aversion, our system has failed,’’ wrote John Molot, a law professor at Georgetown University Law Center, in a recent, unpublished paper titled ‘‘A Market in Litigation Claims.’’ Molot was recently appointed chief investment officer of Burford Capital and continues to teach at Georgetown.

Critics Cite Ethics Concerns. But the emerging funding model also has its critics. Some question whether it violates ethics rules going back centuries to English common law that prohibit outside parties from buying legal claims of others, a practice known as champerty.

Many states have relaxed such restrictions in recent years but the rules remain in flux and uncertain in some jurisdictions. To address the ethics concerns, thirdparty financing firms often seek advice from ethics advisers before they fund litigation in a particular jurisdiction.

Other critics, including the U.S. Chamber of Commerce, argue that third-party litigation financing, if successful and more widely used, could attract less reputable financiers interested in targeting corporations with frivolous lawsuits—including class actions—in an attempt to extort huge settlements.

Funders Measure Huge Market. Companies entering the field of litigation financing view it as a huge, untapped market. Juridica and Burford Capital, both publicly traded companies, estimate in their public filings that in 2008 litigation revenues were around $30 billion among the 200 largest U.S. law firms. Moreover, they assess total U.S. litigation-related spending, which includes legal fees and expert witness costs, at about $80 billion.

‘‘That total spending on litigation is theoretically the addressable market for litigation investment in claims and disputes,’’ Burford said in its initial public offering filing. Juridica, citing similar figures in its 2008 annual report, called it ‘‘a very large market indeed.’’

‘Dispute Funding’ More Established in U.K. The use of third-party litigation funding is more prevalent in Europe, particularly in the United Kingdom where it began around 2005. Unlike the legal profession in the United States, lawyers in the United Kingdom are not permitted to take cases on contingency and, as a result, many are looking for outside sources of funding.

Third-party funding in the United Kingdom saw a growth spurt in late 2007 thanks in part to groundbreaking national legislation that explicitly permitted third-party financing of legal claims and eased the way for law firms to be listed on the London stock exchange. The business model is also used in Australia where it has been well-established for about 15 years.

Burford Capital and Juridica are incorporated in the United Kingdom, in the offshore island of Guernsey, doing business both in Europe and the United States.

In October 2009, Burford launched its initial public offering in what turned out to be the London stock market’s second-largest IPO last year, raising some $130 million in capital.

‘‘Dispute funding has been established for a longer period in the U.K. as a dedicated asset class and that fact, coupled with the media attention surrounding it . . . made U.K. investors more familiar with the investment proposition,’’ explained Selvyn Seidel, Burford’s chairman, who retired in 2006 as a senior partner at Latham & Watkins.

‘‘We’ve seen the asset class growing under our noses,’’ added Seidel who chaired Latham & Watkins’s international litigation and arbitration practice. ‘‘It’s evolving and growing, with exceptional demand in the U.S. market.’’

Seidel’s partner at Burford is Christopher Bogart, who serves as the company’s CEO. Bogart is the former executive vice president and general counsel of Time Warner Inc. and, earlier, a partner at Cravath, Swain & Moore. Burford Capital’s board of directors includes several high-powered British luminaries, including Sir Peter Middleton, former U.K. treasurer and chairman of Barclays Bank.

Demand Exceeding Expectations. Echoing Seidel’s enthusiasm for the business model, Richard Fields, chairman and CEO of Juridica, told BNA, ‘‘Frankly, the demand has far exceeded our expectations.’’

Fields’s background includes over 25 years’ experience with several major U.S. law firms where he practiced as a corporate plaintiff’s lawyer, handling complex litigation focused on insurance coverage, contract issues, as well as complex business dispute resolution. Juridica, similar to the other major third-party financing firms, has not spent a lot of time or resources marketing the new business model, said Fields. ‘‘The deals have found us,’’ he said, noting many of the cases Juridica considers for investment are referred from business and legal contacts he made during his years with major law firms.

Juridica predated Burford in the legal claims market, going public in the United Kingdom in December 2007 and quickly raising nearly $200 million in investment capital.

Timothy D. Scrantom, Juridica’s president and founder, also pointed to the U.K.’s familiarity with third-party litigation funding as one of principal reasons for incorporating Juridica there. ‘‘With the passage of legislation there that ‘institutionalized’ litigation financing, the market was sensitized to the phenomenon,’’ Scrantom told BNA.

In addition, many of Juridica’s initial investors were based in the United Kingdom and ‘‘wanted a European investment vehicle so we bowed to their wishes,’’ added Scrantom, who is admitted to practice law in the United States but worked for more than 15 years as an English barrister-at-law, specializing in multinational business litigation.

Juridica’s board of directors is chaired by Lord Daniel Brennan, a member of the House of Lords and former chairman of the bar of England and Wales.

ARCA Capital Based in U.S. Closer to home, ARCA Capital Partners LLC is a third-party litigation investment firm based in the United States, with three offices in California—Los Angeles, San Francisco, and San Jose—and another planned for New York. Launched in June 2009 and privately held, ARCA is not required to disclose its financial information.

However, Bruce Beron, ARCA’s managing director and chief investment officer, told BNA the company now has about $110 million in investment capital and is working with outside investors, including a few large hedge funds, to increase that amount.

ARCA has not yet invested in any legal claims, but is actively evaluating several opportunities, including multimillion dollar patent infringement claims originating in the Silicon Valley, said Beron, a Stanford-educated physicist, who has spent nearly three decades specializing in litigation risk management.

In 1988, he founded the Litigation Risk Management Institute based in Palo Alto, Calif., which trains and advises corporate counsel on litigation risk management and settlement valuation for complex commercial disputes.

Firms Use Similar Operating Practices. While investing in legal claims is still relatively new in the United States, it appears most third- party litigation investment firms are gravitating toward comparable types of cases for investment, based on publicly available filings and BNA’s interviews with the heads of Juridica, Burford, and ARCA. They also employ similar screening techniques to decide which cases to invest in.

Patent litigation, antitrust claims, and international arbitration—along with a smattering of cases involving shareholder disputes, breach of contract, and defaulted debt—are areas of concentration for the firms.

In a Feb. 1 ‘‘Trading Update,’’ Juridica reported that it currently has $123.3 million invested in 23 cases, which include 12 patent infringement claims, five antitrust claims, two property damage and insurance subrogation claims, two contract claims, one claim involving a shareholder dispute, and another involving a ‘‘statutory claim.’’

Juridica’s average investment in each case is around $5.25 million, it reported, and the average age of the cases is about 2.6 years from the date of filing. The claims Juridica invests in range from $25 million to $100 million.

As of Jan. 21, Burford Capital had about $15 million invested in five pending matters, which include three arbitration claims, and two breach of contract claims, according to an interim management statement released by the company. Three of the pending cases should be resolved in a year or less, as the matters are approaching key hearing dates or trial, said Seidel, Burford’s chairman.

Looking forward, Burford Capital anticipates it generally will be investing from $3 million to $15 million in individual cases, Seidel told BNA, with expectations of a total recovery ‘‘north of $50 million’’ in each case.

Defense Clients Welcome. Although most investments of third-party funders to date have been on the plaintiff’s side, company executives do not rule out targeted investments on the defense side.

‘‘It’s not a matter of favoring plaintiffs over defendants,’’ said Seidel. ‘‘It’s a matter of favoring good claims and good defenses over bad claims and bad defenses.’’ Fields at Juridica agreed, saying, ‘‘Although we haven’t closed a deal on the defense side yet, we are going to be playing in that arena as well.’’

One example of how third-party financing might work on the defense side would be for a defendant corporation to pay a third-party financier to assume several million dollars in asbestos liability claims being litigated and carried on the books of the corporation, according to an attorney familiar with the funding arrangements. The funder would, in essence, be betting that it could defend against or settle the claims for considerably less than it was paid to assume the claims, pocketing the difference as profit.

Case Selection Criteria. In its 2008 annual report, released in April 2009, Juridica revealed some of the thinking behind its choice of cases to invest in. With respect to antitrust cases, Juridica said, ‘‘Price fixing cases are particularly attractive investment opportunities . . . as they are perceived to have a low risk profile and high potential damages. Civil litigation in this arena often, but not always, follows either criminal prosecution by the U.S. Department of Justice or early settlement by a cartel member in exchange for giving evidence against co-conspirators. These events help to establish liability. The multi-defendant nature of these cases increases the likelihood of pretrial settlements.’’

Regarding patent infringement claims, Juridica said it had discovered that ‘‘the cost of patent litigation was often significantly higher than the purchase price of a patent or portfolio of related patents.’’

As a result, Juridica in some cases acquires ‘‘patents outright for litigation’’ and then contracts with ‘‘law firms that are willing to take the best of these cases on pure contingency fee basis and carry the risk of the litigation.’’

As the patent holder, Juridica would reap the rewards of a successful infringement action, while sharing a portion of the recovery with the outside firm. Juridica does not invest in class actions, or cases involving personal injury, product liability, or mass tort. ‘‘Most of our clients are on the receiving end of those cases,’’ explained Fields.

In contrast, Burford Capital—while not yet invested in any such cases—would not automatically exclude investments in class actions or mass tort cases, said Seidel.

‘‘Let’s take a close look and see whether it can serve a useful purpose. If you bring a frivolous class action and get it funded, that’s a bad thing. But if it’s a good claim, why should it be barred from getting financing?’’

Case Screening Is Key Tool. With millions of dollars at stake and given the uncertainties of litigation, the top executives at third-party litigation investment firms uniformly stress the importance of performing extensive ‘‘due diligence’’ in deciding where to invest.

‘‘It’s a very detailed and expensive process, averaging about 60 to 90 days,’’ said Fields, Juridica’s chairman. Juridica spends an average of $75,000-$100,000 for each screening, he said. As an example of the firm’s selectivity, since its startup in December 2007 through June 2009, Juridica considered 340 potential investments and selected just 23 legal matters in which to invest, according to Juridica’s September 2009 interim report.

Juridica and Burford Capital both enlist the aid of outside legal specialists in specific practice areas, as well as consultants on damages and local ethics rules, to evaluate potential case investments.

‘‘We hire one or more lawyer specialists to examine the merits of each case,’’ said Scrantom, Juridica’s president. ‘‘We also often reach out to financial or economic consultants on damages to evaluate the amount that can be recovered, including the amount a defendant can pay.’’

He added: ‘‘The basic guideline is that we would not look at a case unless it was already under engagement with a leading law firm. We would not want to be involved in a case that is not yet filed.’’

Scrantom said Juridica has no preferred stage of litigation at which to become involved in a case, noting the firm has taken cases that were freshly filed, on the eve of trial, as well on appeal.

For its case selection, Burford Capital uses an inhouse screening committee to conduct an initial review, said Seidel. The committee screens using several criteria, including the strength of the claim and its likelihood of success, the claim’s value in both litigation and possible settlement, the enforceability of any award, the defendant’s financial condition, any regulatory or ethical risks in the relevant jurisdiction, and the likely time to reach trial or settlement.

Following the in-house review, the matter is referred to outside legal professionals for a second-level review. Any case recommended for investment is subject to the approval of Burford’s board of directors, Seidel said. ARCA Capital is using similar processes for its due diligence analysis, Beron said, asking the views of ‘‘greybeards that have experience in different case areas.’’

In addition, ARCA will use some proprietary risk management assessment tools developed during his years as a litigation risk expert, Beron said, including ‘‘some game theory tools we plan to use in settlement discussions.’’

Ethics Review Part of Screening Process. Another important part of pre-investment analysis, said Scrantom at Juridica, is an ethics review of the rules in place for the jurisdiction where the case is being brought. Noting the different treatment among the states of ethics rules on champerty—the historical prohibition against purchasing legal claims—Scrantom said Juridica uses a network of about 20 ethics advisers who are asked to deliver written opinions on the applicability of any restrictions on litigation investments. On average, the advisers are paid $10,000-$30,000 for their analyses, he said.

Burford Capital and ARCA also call upon outside ethics advisers. Burford, for example, lists University of Pennsylvania law professor Geoffrey Hazard, author of a leading treatise on legal ethics and former director of the American Law Institute, as its legal ethics counsel.

Successes to Date. Any detailed assessment of thirdparty litigation investment firms’ performance is hard to come by because the business model is new, most cases remain pending, and the firms are reluctant to identify specific cases they have invested in—for fear of creating a distraction in the litigation. Nonetheless, as public companies, Juridica and Burford report case results to their shareholders, though without using specific case identifiers.

While none of Burford’s case investments has yet concluded, Juridica, in its Feb. 1 trading update, reported that it had completed its first patent infringement case. The case settled in December 2009 for $4 million of which $2.4 million was paid to Juridica. The firm had invested $1.4 million in January 2009, earning a 71 percent return on its investment. In its June 30 interim report, Juridica noted it had a gross return of $4.3 million on a case (subject not identified), yielding an annualized internal rate of return of 61 percent on Juridica’s initial investment of $3.1 million.

Stock Prices Show Resiliency. Another measure of success is the stock price of the two publicly traded firms. As world stock markets plunged in 2009 during the financial crisis, an early test came for third-party litigation funding’s claim to be an uncorrelated asset class.

From the date of Juridica’s public offering in December 2007 to April 2009—near market lows—its stock price shot up 20 percent. It has since declined slightly, but currently shows about a 15 percent increase since early 2008.

Burford’s stock price has held relatively steady since the company’s public offering last October, with a five percent increase as of late-February. The new asset class has caught the attention of large institutional investors. Invesco holds 45 percent of Burford’s shares and 30 percent of Juridica’s shares. Fidelity and Baille Gifford Co., a large Scotland-based investment firm, each own another 10 percent of Burford shares, with Baille Gifford also holding 6 percent of Juridica shares.

Perspectives From Outside the Funding Firms. What factors influence companies and law firms to seek out anduse third-party funding in litigation?

As an initial matter, most third-party funders will not disclose the names of companies or law firms they are working with due to confidentiality agreements and to avoid the possibility the outside funding could become an issue in the litigation. ‘‘We just don’t want to invite the distraction,’’ said Fields, Juridica’s CEO.

Those receiving the funds, for their part, see no advantage in letting it be known they have outside resources. Local court rules do not require disclosure of third-party financing and law firms want to minimize the potential for opposing parties to raise the issue as a ‘‘side-show’’ during discovery, said Fields.

At the request of BNA, Juridica contacted a few recipients of its investment funds to inquire whether they would agree to discuss, in general terms and anonymously, their experiences using outside funding. All refused.

Burford provided the name of a leading law firm, Patton Boggs LLP, which has clients who have used thirdparty funding. ‘‘We became involved with this in the last few years,’’ said James E. Tyrrell Jr., the managing partner of Patton Boggs’ law offices in New York and New Jersey. ‘‘At first, I was somewhat dubious, but as we got more involved and began to test the interest of some of our clients, I found they really want to know about this.’’

‘‘General counsels with big companies have cases that they’d like to bring, but they have to take a backseat because of corporate constraints on funding,’’ Tyrrell told BNA in a recent interview. ‘‘We think it is our opportunity to value add by describing these possibilities to our clients.’’

Juridica outlined some of the motivations for both law firms and companies to look for outside funding in its 2008 annual report: ‘‘Traditional sources of hourly billing in the corporate and transactional business have diminished, leading law firms to cut lawyers and staff at a rate never seen in the modern legal market. Furthermore, general counsels of major companies are under pressure to cut legal expenses, particularly where there is discretion to do so—as in cases where the company is bringing a lawsuit as opposed to defending one.’’

In the patent law area, for example, the skyrocketing costs of litigation in infringement cases are forcing many companies to seek outside funding. ‘‘Many small firms simply can’t afford to litigate these claims,’’ noted Beron at ARCA Capital.

Since 2003, the average cost of litigating a high stakes patent infringement case—defined as one seeking at least $25 million in damages—has increased 41 percent since 2003, according to a recent report by the American Intellectual Property Law Association. The costs now average $5.5 million compared with $3.9 million in 2003.

Beron attributes much of the increased cost to expert witness fees. ‘‘In a case involving semiconductor design, for example, it basically requires an expert to reverse-engineer the chip,’’ he said. ‘‘That is very expensive because someone has to examine it and figure out how it works.’’

According to one senior partner specializing in patent law with a major D.C. law firm, ‘‘In the last few years, companies are saying ‘we don’t have the money in our budgets’ or ‘we don’t want to deduct the money from our bottom line,’ ’’ he told BNA. ‘‘We tell them we’ll take the case on partial, not full contingency. We tell the company they need to find additional funding sources to share the risk. Some already know about third-party funders. We let others know about the funders.’’

Customized Agreements. There is no one-size-fits-all funding agreement or contract used by law firms or companies receiving outside funds, said Tyrrell at Patton Boggs. ‘‘One funder tends to invest in cases where the company has already selected its own counsel to handle the case,’’ he explained. ‘‘Another funding firm negotiates with the company to make a joint decision on legal counsel—which is not too different from an insurance company arranging legal counsel for a claimant.’’

One element that Juridica wants to see in any funding arrangement is that ‘‘the lawyer has skin in the game,’’ said Fields, the CEO. ‘‘The law firm has to take on some risk,’’ he said, adding, ‘‘We want to make sure our interests are aligned.’’

Indeed, it is this aspect of third-party funding—spreading the risk—that proponents say provides options to plaintiffs who might otherwise be forced to settle, or be foreclosed from bringing a case in the first place.

‘‘It opens up possibilities for allocating risk that can benefit both attorneys and clients,’’ said Nathan M. Crystal, a professor at Charleston School of Law in South Carolina, who serves as an ethics advisor to Juridica.

Last October, Crystal outlined how various risk allocation strategies can benefit plaintiffs, law firms, and third-party funders at a conference sponsored by the American Bar Association on ethical issues associated with litigation financing.

In a Power Point presentation involving a hypothetical case with a potential $9 million recovery and $700,000 in legal expenses, Crystal showed how the plaintiff, lawyer, and funding firm could all come out ahead.

Opponents Warn of Potential Problems. To the extent there is opposition to third-party litigation financing, it mostly centers on the potential for future abuses, rather than its current use by corporations in major commercial cases.

Critics such as the U.S. Chamber of Commerce point to the extensive use of third-party funding in Australia and argue that it has led to a dramatic increase in litigation there, particularly with respect to class actions, and has handed control of plaintiffs’ cases to outside investors.

The same could happen in the United States, the Chamber has warned.

Moreover, the risk-shifting aspect of third-party funding is viewed by critics as a potential cause for concern. ‘‘By helping would-be plaintiffs shift their costs to others, third-party funding encourages plaintiffs’ attorneys to test claims of questionable merit, knowing that the enormity of the potential risk will often force defendants to settle class and mass actions on suboptimal terms rather than roll the dice at trial,’’ the Chamber argued in a paper issued in October 2009, titled ‘‘Selling Lawsuits, Buying Trouble.’’

John Beisner, a partner with Skadden Arps and a coauthor of the Chamber paper, told BNA the concern of many opponents is more about what third-party funding could lead to, rather than the current practices of the major third-party funders. The Chamber’s paper, he said, ‘‘is more of a warning shot.’’

Walter Olson, a senior policy analyst at the Manhattan Institute, expressed concern about less reputable funding firms entering the market. ‘‘Once you invite in this business model, how do you keep out lower quality operations that will chase more dubious cases?’’ he asked.

‘‘If we open the door for the more conservative players, I predict the door will remain wide open for others who are less conservative and who will go farther in search of a buck,’’ he told BNA.

Paul H. Rubin, a professor of law and economics at Emory University, sees the possibility that third-party funding could, in fact, encourage plaintiffs to file ‘‘large, risky, long-term cases.’’ In a recent paper on third-party funding, Rubin observed: ‘‘If a case turns on a factual matter, then obtaining the facts should not be so expensive and time consuming.

But if a case requires some [major change in the law], then it may well be very risky and time consuming. . . This class of cases may be the most promising for third party financing.’’

Geoffrey L. Lysaught, policy director at Northwestern University’s Searle Center on Law, Regulation, and Economic Growth, warned that if third-party funding becomes more established and attracts more investors, ‘‘It could mean returns on the investments will come down because of supply and demand and lead people to seek out more speculative investments in cases.’’

He also called for more study on the potential impact of third-party litigation. ‘‘We need more rigorous research on this concept before we get too far down the path,’’ he said. ‘‘It has a real potential for unintended consequences.’’

Rand Corp. Initiates Major Study. As it turns out, the Institute for Civil Justice at the Rand Corporation, a leading public policy think tank based in Santa Monica, Calif., has embarked on a major study of third-party litigation financing.

The project began last September following a conference the Institute sponsored on the subject in June, said Steven Garber, director of the project and a senior economist with the Rand Corp.

‘‘We want to take an objective look at what’s going on and hear what people are saying about what is a growing phenomenon,’’ Garber told BNA.

‘‘Third-party financing is getting a lot of attention and there are a lot of calls for public policy responses,’’ Garber noted. ‘‘We’re not sure the knowledge base is there for the right policy choices to be made.’’ To help supplement the knowledge base, Rand’s Civil Justice Institute is preparing a comprehensive report on third-party litigation financing, Garber said. The report is expected to be released at a conference on third-party financing the Institute is sponsoring in Washington, D.C. on May 20-21.

Ethics Rules Post Challenge. Any third-party litigation firm planning to invest in a lawsuit faces a broad array of ethics rules across the 50 states that govern how lawyers conduct their practice.

Enacted by state legislatures, adopted by bar associations, or contained in court rulings, the rules may or may not condone the use of outside funding in a lawsuit.

It is for that reason that litigation financing firms engage teams of pre-investment ethics advisers to look into any potential ethical restrictions in a particular jurisdiction.

‘‘The ethical doctrines governing this type of activity are not yet refined,’’ noted Stephen Gillers, a nationally-known expert in legal ethics at New York University School of Law. ‘‘There are all kinds of potholes along the way that people have to anticipate.’’

He added: ‘‘The way established doctrines apply is quite uncertain. It is likely that judges will be quite suspicious of anything like this that is still in its infancy.’’

A principal concern is champerty, the restriction against selling or assigning a claim to another party.

‘‘Champerty is the elephant in the room,’’ Gillers told BNA, adding, ‘‘While some states have rejected it, most states still recognize it, although its contours are quite ill-formed and its scope varies from state to state. It is a big issue the funders have to worry about.’’

Other issues facing third-party litigation financiers, Gillers said, include ethical restrictions against fee-splitting between lawyers and non-lawyers, rules against interfering with the independent judgment of a lawyer, as well as the risk of waiving the confidential privilege between lawyer and client by disclosing certain information to an outside party.

‘‘Many states are now accepting or at least tolerating legal financing,’’ he noted. ‘‘It is very difficult to stop when there is a market between buyers and sellers. You don’t have a prominent high state court coming down with a condemnation of the practice. Something like that could stop it.’’

Gillers noted the Ohio Supreme Court, in a 2003 decision in Rancman v. Interim Settlement Funding Corp., 99 Ohio 3d 121 (2003), barred third-party funding.

However, in 2008 the Ohio state legislature negated the decision, passing one of the first statutes that explicitly permitted litigation financing in the consumer financing context. At the same time, the statute required disclosure of the annualized rate of interest to be paid and allowed the recipient to cancel the contract within five days.

The Rancman case and the following legislation, however, addressed third-party funding on a very limited scale. The case involved a $7,000 non-recourse advance of funds to the plaintiff in a personal injury suit by Interim Settlement Funding Corp., a small company providing modest amounts of cash with interest to individuals wanting to pursue a claim. The firm is typical of a subcategory of lawsuit financing companies, which have been around for years, that do not fund large-scale commercial litigation.

State Rules on Champerty Vary. Anthony Sebok, a law professor at Yeshiva University’s Cardozo School of Law, has examined state restrictions on champerty.

‘‘Most states care about champerty,’’ he told BNA. About 30 states have laws that prohibit champerty or have some form of restriction on investments in litigation for profit, he said.

However, ‘‘The trend is mostly toward liberalization,’’ Sebok added, focusing primarily on eliminating restrictions that would bar lending companies from providing funds to claimants in the consumer finance context.

‘‘The common law in most states is so old and antiquated,’’ Sebok said, it is difficult to tell exactly what modern practices the early court decisions could apply to. ‘‘The precedents certainly could not encompass modern-day consumer-oriented loans,’’ he said. For that reason, state courts in South Carolina and Maine recently reversed earlier, champerty-based court decisions that had been interpreted to bar third-party funding in personal injury cases, Sebok noted.

While few cases to date have addressed the use of third-party funding in large commercial cases, the liberalization trend likely would encompass them as well, Sebok said, adding, ‘‘The cases allowing it in the consumer context are not implying that nothing else will be permitted.’’

Georgia is considered the most restrictive jurisdiction with respect to champerty, said Sebok, who is an advisor to the Rand Institute for Civil Justice’s study on third-party financing. Texas is the most liberal state.

Other permissive states include California, Hawaii, Louisiana, Massachusetts, New Jersey, and Tennessee.

Privilege Waiver Another Concern. In addition to champerty, another major problem area in third-party investment transactions is the possibility of causing a waiver of the confidentiality privilege between lawyer and client, Gillers said. This potential pitfall arises when a third-party financing firm undertakes its due diligence examination of the lawsuit, he explained.

Under long-standing privilege doctrine, if a party to a lawsuit discloses information to an outside party, the privilege is waived and the information may no longer be kept confidential. As a result, if the opponent in the lawsuit learns that an outside party has had access to the information, the opponent can demand that it be turned over in discovery.

As a way around that risk, Scrantom, Juridica’s president, told BNA that Juridica employs the use of the ‘‘common interest exception’’ to privilege waiver. This doctrine provides that when two parties have a common interest in the litigation, information can be shared and the privilege remains preserved.

‘‘I think that’s risky,’’ said Gillers, referring to the use of the exception by third-party financiers. ‘‘The common interest rule is narrow and is usually intended to benefit only co-litigants in pending litigation,’’ he continued. ‘‘A funding company is not a litigant, it’s in a business relationship.’’

Another way to minimize the risk of privilege waiver, Scrantom said, is by using another law firm to act as an intermediary between the claimant and the investment firm. ‘‘We often engage another law firm to look at the merits of a case,’’ he said. ‘‘If the law firm has communications with the claimant, they are protected from disclosure.’’ He added, ‘‘We often find that claimants and lawyers welcome a second look at a case.’’

Systemic Impacts on Litigation Eyed. Given the limited amount of time third-party financing in commercial cases has been in use, its future as a business model is unclear.

‘‘Like all new business models, it will be interesting to see what level of demand there is for it and how successful it will be,’’ said Yeazell, the interim dean at UCLA law school. ‘‘These are really expensive and uncertain investments. I think there will be a shakeout— there’s not necessarily a bottomless well of profits out there.’’

Carl T. Bogus, a law professor who has focused on tort reform and civil justice issues at Roger Williams University School of Law in Rhode Island, said, ‘‘You have to wonder, as this practice grows and gains more attention, whether it will create some political blowback.’’ He sees the possibility that tort reform advocates, among others, could seek curbs on the activity. ‘‘There is a feeling that lawsuits shouldn’t be made too easy to bring—that it should be difficult, it’s part of the culture.’’

Fields, the Juridica CEO, expressed optimism that over time the appearance in a case of a well-established third-party financing firm could operate ‘‘as an added value.’’

He explained: ‘‘If you have the right funder in a case, one that has funded 100 cases and won 98, it would represent a third-party’s endorsement of a case, almost like a bond rating. It will be interesting to see if we can get to that point in the legal market.’’

One long-time hedge fund manager expressed some skepticism that mainstream funds would view thirdparty litigation financing as a hot new investment opportunity.

‘‘Legal cases are not linked to any particular security or corporate debt-related instrument,’’ said Ezra Zask, who spent nearly three decades as a hedge fund manager and now heads Ezra Zask Advisors in Connecticut.

With respect to litigation funding, Zask said a hedge fund could have some concern about issues related to liquidity, valuation, time frame, and the expertise needed to evaluate a case’s prospects. He added, ‘‘This kind of investment is definitely outside the normal range of hedge fund activities.’’

Regulation Suggested. Law professors Gillers and Sebok, while both supportive of third-party litigation funding, saw a role for some type of regulation of the activity.

‘‘The way to do this is to allow it, but regulate it,’’ said Gillers. ‘‘You want make sure a funding company is not in a position to exploit a needy plaintiff,’’ he said. ‘‘Legislators that permit litigation funding should also write into the statute some consumer protection rules, similar to how some states now cap contingency fees in personal injury cases.’’

According to Sebok, ‘‘It should be regulated or monitored like any other complex legal relationship and run by the norms of consumer protection, so people signing a contract know what they are doing.’’

To date, there have been only limited efforts to regulate third-party funding. Along with Ohio, Maine also has enacted legislation that permits third-party litigation financing, but also imposes disclosure requirements, similar to the Ohio law.

The rules in both states, however, are aimed principally at the smaller firms offering funding for personal injury actions and the like.

Supporters of the use of third-party funding in large commercial cases argue no regulation is needed, citing the experience and sophistication of the parties involved.

‘‘The cases and investments we are talking about here involve hundreds of millions of dollars and very sophisticated parties,’’ noted Crystal, the Juridica ethics adviser teaching at Charleston School of Law. ‘‘They are certainly capable of evaluating risk.’’