Toward Disclosure of Third-Party Litigation Funding in Class Actions

Westlaw Journal Class Action

Authored Article

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In January 2012, a natural gas-drilling rig exploded off the coast of Nigeria and burned for more than 40 days. Two years later, six Nigerians filed suit in the U.S. District Court for the Northern District of California seeking to hold rig owner Chevron Corp. liable for alleged damages from the explosion and fire.

The plaintiffs, represented by two solo practitioners, originally sought damages on behalf of more than 65,000 Nigerians allegedly affected by the rig explosion. After a years-long legal battle, on March 13 the court denied the plaintiffs’ motion to certify the case as a class action in Gbarabe v. Chevron Corp.1

The Gbarabe court’s refusal to certify the class is not extraordinary in itself. What makes this case important is that during the litigation the court allowed a rare look behind the curtain at the nascent business of investing in class action litigation.2

In contrast with the traditional method of funding class actions in the United States, the case against Chevron was not backed by plaintiffs’ lawyers advancingthe costs of the litigation. Instead, it was financed through an investment by Therium, a U.K. company that specializes in investing in lawsuits — the way other investment firms deal in assets like stocks, bonds or real estate.

Third-party litigation funding, the term used to describe this arrangement, is on the rise in the United States for many types of litigation. Class action lawsuits are a vehicle of particular focus for some TPLF firms because of the potential for very large recoveries and the need for significant funding to prosecute the lawsuits.

This analysis will provide a brief explanation and history of TPLF in the United States, with a focus on its use in class action litigation. It will then address the arguments advanced both for and against this industry and examine recent proposed class actions where TPLF issues arose. Finally, it will describe the growing movement toward disclosure of TPLF arrangements, especially in class action litigation.

WHAT IS TPLF?

Third-party litigation funding is the investment in a lawsuit or pool of lawsuits by a stranger to the litigation (i.e., not a party’s counsel, insurer, etc.) in exchange for a contingent share in the proceeds from any judgment or settlement.

These funds are often provided as a non-recourse loan, meaning that the funder is repaid only if there is a recovery. However, due to the lack of disclosure, some known arrangements have involved high-interest recourse loans.

In a real sense, TPLF turns the common contingency fee arrangement into an investment vehicle for nonlawyers.

TPLF rose to prominence over the last 20 years in Australia and the United Kingdom. It has since migrated to the United States, where it is the focus of substantial investment by companies such as Burford Capital (headquartered in the Channel Islands of the U.K. and traded on the London Stock Exchange) and Bentham IMF (headquartered in Australia and publicly traded there).

In 2016, Burford acquired the competing U.S.-based TPLF firm Gerchen Keller for $160 million.

ARGUMENTS SURROUNDING TPLF

Supporters of TPLF argue that it provides necessary funds to prosecute meritorious lawsuits where the plaintiff does not have the capital required to pay out of pocket. “Access to justice!” is the passionate and emotive refrain of those making this argument.

TPLF proponents contend that the practice “levels the playing field” against “deep-pocketed” defendants that may seek to litigate by attrition.

TPLF may also allow parties and their counsel to offload some of the risk of litigation onto the funder in exchange for taking home less of any recovery. Funders argue that encouraging frivolous lawsuits is not a systemic concern due to their involvement, because such litigation would not be a sound investment.

Conversely, opponents of TPLF argue that funders have no particular interest in funding meritorious litigation. They say a funder’s incentive is only to maximize the present value of its investment.

That may mean bombarding a defendant with speculative litigation via an overwhelming number of lawsuits in hopes of pressuring the defendant into a quick settlement — even if the underlying merits are dubious.

The litigation may also cause negative media attention, creating additional incentive to settle.

Further, funders may seek to exercise control over litigation strategy, including whether and for how much to settle a case.

Nonlawyer litigation investors are not subject to the ethical obligations that apply to a party’s counsel, which could result in the use of strategies that benefit the funder but not necessarily the party.

Critics of TPLF are also concerned that using the litigation as an investment vehicle distorts the purpose of the civil justice system — to provide justice by resolving disputes pursuant to the rule of law.

DISCLOSURE

The shroud of secrecy surrounding TPLF makes it more difficult to understand the practice’s real-world implications. Unlike businesses involved in most other forms of 21st-century commerce, firms specializing in TPLF are open about their desire to remain undisclosed in cases in which they have provided funding.3

Notwithstanding resistance from the TPLF industry, and consistent with ever-growing transparency in our society, the trend appears to favor increased disclosure of third-party funding arrangements, especially in the class-action or collective litigation context.

TPLF IN CLASS ACTION CASES

Much remains unknown about the use and true scope of TPLF in class actions. The limited reported case law on TPLF in class actions concerns challenges to the adequacy of plaintiffs’ counsel under Federal Rule of Civil Procedure 23(g). Rule 23(g)(1)(iv) requires a court to consider “the resources that counsel will commit to representing the class.”

In Kaplan v. S.A.C. Capital Advisors LP, the court refused to allow the defendants in a putative securities fraud class action discovery regarding the plaintiffs’ litigation funder.4

After plaintiffs’ counsel acknowledged the involvement of a third-party funder, the defendants argued that they were entitled to know the terms of the arrangement and the identity of the funder. Otherwise, the defendants said, neither they nor the court could fully analyze whether plaintiffs’ counsel could adequately represent the class.

The court disagreed and found that the defendants’ questioning of the adequacy of counsel was speculative: “The plaintiffs’ admission that they have entered into a litigation funding agreement does not, of itself, constitute a basis for questioning counsel’s ability to fund the litigation adequately.”

The court went on to grant class certification.5

More recently, the Gbarabe case addressed similar issues, but the court ordered disclosure of the funding agreement. There, the defendant also moved to compel disclosure of the plaintiffs’ TPLF arrangement, arguing that it was necessary to evaluate the adequacy of the proposed class counsel.

The plaintiffs conceded the relevance of the funding agreement, and the court agreed that “under the circumstances of this case, the litigation funding agreement is relevant to the adequacy determination and should be produced to defendant.”

Emphasizing the importance of the information, the court declined the plaintiffs’ request for an in camera review of the documents instead of production to the defendant.

The court said failure to disclose them “would deprive Chevron of the ability to make its own assessment and arguments regarding the funding agreement and its impact, if any, on plaintiff’s ability to adequately represent the class.”

Consistent with the industry’s ongoing desire for secrecy, Bentham IMF published an article seeking to minimize the effect of the Gbarabe case.6

NORTHERN DISTRICT OF CALIFORNIA LOCAL RULES

A background consideration in the Gbarabe case was the then-pending proposed revision to the Northern District of California local rules.7 Under the proposed revision, the rule would have specifically required that TPLF arrangements be disclosed.

The proposed revision would have added the bolded text to the existing rule:

The certification must disclose any persons, associations of persons, firms, partnerships, corporations (including parent corporations), or other entities other than the parties themselves (including litigation funders) known by the party to have either: (i) a financial interest (of any kind) in the subject matter in controversy or in a party to the proceeding; or (ii) any other kind of interest that could be substantially affected by the outcome of the proceeding.8

During a comment period (prior to the Gbarabe decision), the Northern District received four comments on the proposed rule change. Of those, one was from Bentham IMF, one was from Burford Capital, and one was from a law professor who has worked for Bentham IMF. These three comments argued that the proposed rule change should not be adopted.

The fourth comment, a brief email from a practitioner, supported the proposed rule change.

Among other things, Burford argued that Rule 3-15 already required disclosure of litigation funders.9

Ultimately, the court did not include the parenthetical regarding third-party funders in the revised rule.10 However, it did update its standing order for all judges to state that “[i]n any proposed class, collective, or representative action, the required disclosure [under Civ. L.R. 3-15] includes any person or entity that is funding the prosecution of any claim or counterclaim.”11

Thus, disclosure of TPLF arrangements is now clearly required in the Northern District of California in, at minimum, all class action, collective or representative action cases.

FAIRNESS IN CLASS ACTION LITIGATION ACT OF 2017

The Northern District of California’s approach may soon go nationwide. On March 9, the U.S. House of Representatives passed the Fairness in Class Action Litigation Act of 2017, and the bill is now in the Senate’s hands.12

The full extent of civil justice reforms proposed in the bill is beyond the scope of this analysis, but one provision is of particular importance to third-party funders and class action litigators. That proposed provision would require disclosure in class action cases:

§1722. Third-party litigation funding disclosure

In any class action, class counsel shall promptly disclose in writing to the court and all other parties the identity of any person or entity, other than a class member or class counsel of record, who has a contingent right to receive compensation from any settlement, judgment, or other relief obtained in the action.

Notably, prominent TPLF firms like Burford Capital and Bentham IMF apparently have not lobbied against this bill.13

Burfordsays funding class action litigation is not “a core part of our business,” and Bentham IMF has stated that it refrains from funding class actions in the United States because of concerns over ethical rules.

The bill’s prospects in the Senate are not yet clear, so TPLF firms may be holding their fire until the bill’s future is more certain. Regardless, the issue of disclosure of TPLF, especially in class actions, has moved to the fore.

CONCLUSION

Although the changes have been incremental, a clear trend toward greater disclosure of third-party funding arrangements is afoot, particularly in class action and collective litigation. That trend is certain to continue given the transparency that pervades all other aspects of the U.S. civil justice system.

1 Gbarabev. Chevron Corp., No. 14-cv-173, 2017 WL 956628, at *1-2 (N.D. Cal. Mar. 13, 2017).

2 Gbarabev. Chevron Corp., No. 14-cv-173, 2016 WL 4154849, at *2 (N.D. Cal. Aug. 5, 2016).

3 See, e.g., Matthew D. Harrison & Priya D. Pai, Calif. Court Gets Automatic Funding Disclosure Right, LAW360 (Feb. 22, 2017) (Bentham IMF authors arguing that disclosure of TPLF arrangements is typically unnecessary).

4 Kaplan v. S.A.C. Capital Advisors LP, No. 12-cv-9350, 2015 WL 5730101, at *5 (S.D.N.Y. Sept. 10, 2015).

5 Kaplan v. S.A.C. Capital Advisors LP, 311 F.R.D. 373, 380 (S.D.N.Y. 2015).

6 See Ralph Sutton & Julia Gewolb, OPINION: Overreaction Over 3rd-Party Class Action Funding, LAW360 (Aug. 25, 2016) (arguing that the reaction to decision was overblown because the plaintiffs conceded their strongest arguments against disclosing the details of their TPLF arrangement).

7 See Gbarabe, 2016 WL 4154849, at *2 n.3 (“The court notes that third party litigation funding is a relatively recent practice in this district. The court is informed that the Northern District is currently considering a proposed revision to Rule 3-15 that would require disclosure of litigation funders.”).

8 See Draft Revision to N.D. Cal. Civ. L.R. 3-15, available at http://bit.ly/2ogY9bF.

9 See Letter from Christopher P. Bogart, CEO, Burford Capital, to Susan Y. Soong, Clerk of Court, U.S. District Court, Northern District of California (July 22, 2016), available at http://bit.ly/2oaLEBn  (“The existing rule already requires disclosure of litigation funders (e.g., as entities that have an interest that could be substantially affected by the outcome of the proceeding).”).

10 See N.D. Cal. Civ. L.R. 3-15 (effective Jan. 17, 2017).

11 See N.D. Cal. Standing Order for All Judges (effective Jan. 17, 2017), available at http://bit.ly/2oy04HO.

12 See Fairness in Class Action Litigation and Furthering Asbestos Claim Transparency Act of 2017, H.R. 985, 115th Cong. (2017), http://bit.ly/2mPLcbI.

13 Ben Hancock, Why Lit Funders Didn’t Lobby to Stop Class Action Bill, NAT’L L.J. (Mar. 10, 2017).

Republished with permission. This article, "Toward Disclosure of Third-Party Litigation Funding in Class Actions," first appeared in the April 2017 issue of Westlaw Journal Class Action.

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