Episode 7

Read the transcript below:

The following episode of Beyond Hourly was recorded before the merger of IMF Bentham and Omni Bridgeway.

Sarah Tsou:
Thanks for tuning in to the Beyond Hourly podcast, hosted by Bentham IMF (now known as Omni Bridgeway), one of the world's most experienced commercial litigation and arbitration funders. Our podcast focuses on advancements in legal services that drive economic value for law firms and the clients they serve. Episodes of this podcast can be found on our website, www.benthamimf.com (now at www.omnibridgeway.com), iTunes and other podcast networks. We welcome you to subscribe to the podcast and leave us your reviews.

I'm your host Sarah Tsou. I'm an Investment Manager and Legal Counsel at Bentham's New York office. Prior to joining Bentham, I spent over 12 years as an intellectual property litigator at Kirkland and Ellis LLP. My role at Bentham involves assessing investment opportunities in the IP space and beyond and serving as a strategic resource for the parties we fund throughout the funding relationship.

We have a very exciting guest today, Professor Brian Fitzpatrick of Vanderbilt Law School. Brian and I also recently spoke together at the IPO annual meeting on ethics and litigation funding, and I'm very excited to continue our conversation today. Professor Fitzpatrick's research at Vanderbilt focuses on class action litigation, federal courts, judicial selection, and constitutional law. He has had a distinguished career since graduating first in his class from Harvard Law School, and then going on to clerk for Judge O’Scannlain on the US Court of Appeals for the Ninth Circuit as well as none other than Justice Scalia on the US Supreme Court.

He then practiced commercial and appellate litigation for several years at Sidley Austin in Washington DC, served as special counsel for Supreme Court nominations to US senator John Cornyn and was the John M. Olin fellow at New York University School of Law before joining Vanderbilt's fall faculty in 2007. Professor Fitzpatrick, that's quite a resume, and we're honored to have you here today. Welcome.

Brian Fitzpatrick:
Thank you so much. It's my pleasure.

Sarah Tsou:
You have a new book out, The Conservative Case for Class Actions. What led you to write this book?

Brian Fitzpatrick: 
That's a good question. I'm a Conservative, and I think when I got out of law school and started practicing law, I think I had the same intuitions about class action lawsuits that a lot of Conservatives have. That is, I was against them and thought they were an abuse and dragging down our economy.

As I studied them as an academic for the last 12 years, I've come to a different view. I've come to a view that the bad reputation that class actions and class action lawyers have is largely generated by the United States Chamber of Commerce for very self-interested reasons—big corporations. It doesn't reflect the reality about our class action system, and I think there's actually a lot to like as a Conservative with our class action system.

I wrote the book because I see my friends who are Conservative judges, I see my friends who are Conservative policymakers, I see them reflexively trying to get rid of the class action. I wanted to write this book to say, "Just pause for a second and think about why you think the class action is such a bad thing." From a Conservative perspective, it's private enforcement of the law, and if you don't want private enforcement of the law, then you are going to have to have government enforcement the law. Why do Conservatives want more government instead of a private sector solution to a problem? I just want people to stop and think about that before they put the next nail in the class action coffin.

Sarah Tsou: 
In a nutshell, what is The Conservative Case for Class Actions?

Brian Fitzpatrick: 
Conservatives like private sector solutions to problems, and they like private sector solutions for a host of reasons. They want smaller government, they want better performance. Profit motivated, private sector participants tend to perform better than government bureaucrats. They're profit motivated, they have lots of resources, they're decentralized, they're not captured by industries like a lot of government agencies are. For all these reasons, Conservatives have usually favored private sector solutions to problems, and class action lawsuits are private enforcement of the law, the private attorney general.

I make the case in the book that for all these same reasons that we like other private sector solutions, we should like the private attorney general better than the public attorney general. It's very interesting, because when I go around and talk to audiences about this argument, a lot of Conservatives say, "Well, but if we have private enforcement, the lawyers are profit motivated, and aren't they always going to go too far?"

My response is, "Well, businesses are profit motivated, but do we think that they're always going to go too far? Do we want to have the government take over all of the industries in this country?" No. The profit motive inspires people, and it can inspire people for good or for bad, and all we need to do is put rules in place to harness the profit motive for good and not for bad. We've done it for businesses, and as I say in the book, we can do it for class action lawyers too.

Sarah Tsou: 
Do you think there's a Conservative case for third-party litigation funding?

Brian Fitzpatrick:
I do. I find that many of the same people that are against third-party financing are the ones who are against class actions. It's big businesses. It's not small businesses, it's not medium sized businesses. It's big businesses, and there are similar reasons that the big business community is against third-party financing.

One reason is, right now, big businesses have an advantage in litigation. They have the resources to litigate for as long as they need to and they have liability insurance if they're defendants, if they're plaintiffs. They're so big that they can act in a very risk neutral way. They don't have to settle early because they're afraid of trial outcomes, but other litigants do not have those same advantages.

Third-party financing is a market solution to a procedural problem. The procedural problem is some litigants do not have access to resources and they do not have access to risk financing, and because of those two things, they're either not going to sue when they've been harmed or they're going to sue and not do a very good job or settle too quickly because they can't take risks. That means we get results in litigation that are out of whack with the merits of the lawsuit.

That's fine if you're the big business that can take advantage of that situation, but it's not fine if we want our laws to be enforced correctly. We don't want our laws to be systematically under-enforced because one side doesn't have access to a product that the market is trying to deliver.

Sarah Tsou: 
It seems like this is a very important topic, and in fact, you teach litigation funding in your law school classes.

Brian Fitzpatrick: 
Yes, I do. I started teaching a seminar on litigation finance about 10 years ago now and just when the field was getting off the ground. It's only grown in importance since then. Now, I try to incorporate litigation finance really into all my classes. In civil procedure we talk about it and in complex litigation we talk about it because it's part of what every law student needs to know.

It's not only a big deal now, but it's going to be a huge deal in the future. The more new people understand what it is, what it can do, what it can't do, I think the better equipped they're going to be to serve their clients, and frankly, the better equipped they're going to be as policymakers, because we're training law students, not just to be lawyers, but we're training them to be judges and policymakers. I hope that when my students encounter a litigation finance problem, they're not going to be hearing about it for the first time and have a fear of the unknown. I hope that they'll be prepared to assess it with a thoughtful and rational approach.

Sarah Tsou: 
In addition to leveling the playing field for these smaller claimants and aligning litigation results with the actual merits of the case, are there other benefits that you teach your students that litigation funding can provide?

Brian Fitzpatrick: 
Yes. There's one benefit that I'm especially excited about, and that is, a lot of my work as a scholar has been on attorney's fees. There's always been a question of how best to pay lawyers, because if you pay them by the hour, then the lawyer has the incentive to drag cases out longer than the client might want. If you pay lawyers on the contingency fee, then the contingency fee lawyer wants to settle early, quickly, because the you can maximize your hourly rate that way. If the client is not knowledgeable enough to know when the lawyer is dragging things out or settling too early, the client can really be taken advantage of by the lawyers. 

There's a wonderful article by a professor at Cornell, brilliant professor named Kevin Claremore and he gets his pencils out and his graphs out and does the all the hard law and economics work, and he shows that the ideal arrangement, which you should pay a lawyer, is a percentage of the recovery plus an hourly rate, because there you have the lawyers' incentives working against each other and the conflict actually produces the best result for the client. 

One of the things that excites me about litigation finance is, intentionally or not, that is a world that litigation finance makes a reality, because the way a lot of these financing arrangements work is the financier is getting a percentage of the recovery and the funding goes a lot of times to pay the lawyer by the hour. You have one actor making money by the hour and one actor getting a percentage, and my hope and belief is that by having two different parties incentivized in two different directions, that together they get a better result for the client. I think it's a very exciting innovation that litigation finance is bringing to litigation.

Sarah Tsou: 
One thing we talked about at our recent panel at IPO is just how widely adopted litigation funding has become over the past several years. Despite that sort of widespread adoption and further education of people in the community, including thanks to people like you, it seems like there are still some misconceptions out there. I'm curious to know what you think are the biggest misconceptions that are out there.

Brian Fitzpatrick: 
One misconception that is out there is that this is new. It is new in the sense that we have different people getting a percentage of lawsuits in exchange for some upfront financing, but that practice of someone getting a percentage in exchange for an upfront financing has been around since contingency fees for lawyers. 

Contingency fees for lawyers used to be banned. There were these two old torts in common law England, one called maintenance and one called champerty, and they prohibited anyone from profiting from someone else's litigation. We can talk about why those torts were adopted if you want to, but the upshot was not even lawyers could earn contingency fees, and of course we had to change that in America to allow our lawyers to earn contingency fees. Other countries in the world, they still don't let lawyers earn contingency fees. 

We have been letting someone invest in a lawsuit and take a share of the recovery for 200 years. It's really not much different than the contingency fee. The third-party financing is a very similar structure, and some people do worry, "Well, the third-party financer, they're not bound by the ethical rules that lawyers are bound by." That might be a concern in a world where the third-party financers were trying to exercise control over the litigation, but in my experience, the funders are mostly sitting back and they're not trying to drive the litigation. I just don't think there's much of a concern with third-party funders not being bound by the same ethical rules as the lawyers. I think that there's nothing really that new about this practice. 

In addition, there's all kinds of other financing arrangements that are not that much different from third-party financing as we're discussing it. Banks and others have been offering non-recourse loans to lawyers for their cases. Non-recourse loans can very easily blend into third-party funding arrangements where you've got a percentage of the lawsuit being pledged to the third party. You can arrange a non-recourse loan to have graduated rates. If the litigation lasts longer, you get a higher rate of return. If the litigation recovers X amount, you can get a higher rate of return. These things are all pretty much the same, so I don't think people should be so concerned when they see a slightly different manifestation of the same old thing.

Sarah Tsou: 
I wanted to pick up on one of the points you mentioned about control, and we certainly take the view, as many funders do, that we should not exert control over litigation. In fact, we specify in our contracts that the clients shall have the sole and exclusive right to settle claims. Of course, that doesn't stop people from asking us for advice, given we employ investment managers all with at least 10 years of litigation experience. I'm curious to hear what your view is from where you sit on how much control you think funders should be able to exert.

Brian Fitzpatrick: 
On this question, I'm a little bit of an outlier I would say. I appreciate that you and all of your competitors in the industry do not want to exercise control. I think that's probably very wise. I'll tell you, I don't see why it would be a problem if you did want to exercise control. 

There are two markets of third-party financing that we need to keep in mind. There's a consumer market and there's a commercial market, and when we're dealing with the commercial market, which is the market you're in, we are dealing with businesses. The businesses are the ones that are asking for funding. The businesses are sophisticated, they have legal advice, they have general counsels, they have others advising them, they know what they're doing. If a sophisticated party wants an arrangement where a non-lawyer is going to be exercising some control, I think that is their business and up to them.

Let's imagine two different products on the market. Let's imagine a product where you can get funding at 20% of whatever is eventually recovered on your claim where the funder says, "We will not exert any control.” Then, let's say there's another product where the funder will take only 15% but says, "We want a veto over settlement." If a sophisticated business is willing to give away 5% in order to allow the funder to have a veto, they want to collect another 5% of their proceeds in exchange for giving a funder veto, I think that is their business. They know how best to arrange their affairs, and if they're willing to sell a veto over settlement for five extra percent that they can keep, I don't know why the government should step in and say, "No, we know better than you do about how you should litigate your claim.

I think sophisticated parties should arrange their affairs the way they want to. A lot of these ethical rules and these other rules are really designed for unsophisticated consumer markets. That's one thing. Here, we're talking about sophisticated parties, and we make exceptions all the time to rules like this for sophisticated parties. If you're a high end investor, a lot of the securities rules are a wage for you, because you're not trying to protect you from yourself anymore. I think the same thing should be said in this market. If you're a high-end commercial lender, then you ought to be able to arrange your affairs as you want to.

Sarah Tsou: 
Well, that's certainly a very rational perspective, and I appreciate hearing it, and maybe you've given us a little bit of a glimpse into the future. Another hot topic is the question of whether certain funding arrangements would run afoul of ethical rules prohibiting lawyers from splitting fees with non-lawyers. To start, let's talk about the rule against fee splitting. What is its origin and what purpose is it intended to serve?

Brian Fitzpatrick: 
Well, the rules against fee splitting have been around for a very long time, and I think that one of the original purposes of the rule was to prevent the lawyer from being influenced by the non-lawyer in a way that would make the lawyer charge more fees than the lawyer otherwise would. I think there is a notion that if you have a non-lawyer involved, a non-lawyer only wants money and they will encourage the lawyer to bill to maximize fees. We don't want the non-lawyer to collect any fees, because they're going to be a bad influence on the lawyer. 

I think that is a very naive view of how lawyers operate. I am a realist. I think people are self-interested. I think lawyers already have plenty of incentive to want to maximize their own fees. I don't think they need a non-lawyer to help them. 

I think the case for maintaining these rules against fee splitting is fairly weak, and I think that eventually, states are going to rescind those rules in the same way that states are in process of rescinding the rules against champerty and maintenance. They don't make sense from an economic perspective. They may have been based on some romantic notions 200 years ago, but they do not make sense from an economic perspective today. 

Why should one product, legal services, cut itself off from all the same financing opportunities that every other product in our economy has access to? All it does is keep prices high and retard the extension of legal services to more people. As you break down barriers to financing, the predictable effects are going to be, prices will go down and access will be extended. Right now, we have a very expensive profession because we have very limited opportunities to finance our product, and as those opportunities grow, as I think they will, we should see prices for clients go down and greater volume of access offered.

Sarah Tsou: 
Yes, of course. There are some who believe that the rule against fee splitting should be interpreted to prohibit direct funding to law firms. It occurs to me that if you apply the rule that way, it would also prohibit many other types of traditional arrangements, like a firm taking a loan from a bank and making repayments that necessarily come from fees.

Brian Fitzpatrick: 
All of these financing practices are so functionally equivalent. You end up splitting these formalist hairs to try to make distinctions between direct investments and loans, "What can you pledge as collateral on the loan? Can you pledge the outcome in one case? Can you pledge the outcome in two cases, three cases? When does it become okay?" Again, from an economic perspective, these things are all the same. When we have sophisticated parties involved, they should be free to arrange their affairs the way that they want to without the government telling them what is best for them.

Sarah Tsou: 
Currently in the industry, funders, including Bentham, are funding law firms directly in a portfolio context, when there's at least three cases for example. If we moved into the direction of abolishing that type of direct firm funding in light of these rules against fee splitting, what do you think the impact of that would be?

Brian Fitzpatrick: 
Well, I think the impact would be much like the impact would be if we were to get rid of all the forms of third-party finance, and that is some cases that are being brought now would not be able to be brought because people would not have access to the money that they need to bring their lawsuit. Even if cases could be brought, people would not be able to litigate to the extent they can litigate them now because they wouldn't have access to funding. They'd have to settle cases earlier than they do now and they'd have to accept less money for their settlement than they do now. 

All of the problems that we talked about at the outset, how litigation that could be very meritorious would not be able to be brought, how litigation that is brought would end up being resolved at a price that is very different from what the merits of the lawsuit would have suggested, and we have under-enforcement of the law. People are always afraid of too many lawsuits, but we also have a problem if there are too few lawsuits. 

I remember reading for my book a quotation from a very famous Conservative economist, Nobel Prize winning economist, Gary Becker, the University of Chicago, Chicago School of Economics. He says in one of his papers, "The view of litigation as a bad thing is mistaken. Litigation enforces the law, and enforcement of the law is just as important as the law that you put on the books to enforce." 

This notion that more lawsuits necessarily is bad is just wrong. If lawsuits are enforcing laws that we care about, then the lawsuits are a good thing, because the laws that we care about are a good thing. To the extent we get rid of direct investment in law firms, we're going to end up with less enforcement the law, and if the law is good, less enforcement of it is bad.

Sarah Tsou: 
Well luckily, if anything, it appears we're moving in the opposite direction and many states are considering changes to attorney regulations or have already made changes that would open up the legal sector to more participation from non-lawyers. In fact, Bentham recently submitted written comments to the California bar in support of the measures under consideration that would loosen these sharing restrictions and permit non-attorneys to own or have financial interests in legal entities. What's your view on this movement?

Brian Fitzpatrick: 
I think it is progress. I think it's the future, that a lot of these arbitrary or protectionist measures that have been around for quirky historical reasons are being toppled and we're letting economic freedom flow to whichever places there are needs. I think that this is going to be the future. I do think we will end up with a lot more investment by non-lawyers in law firms, in legal matters, and I think it will be a good thing. It'll be a good thing for the people that need to sue because something bad has happened to them, and they don't have the resources on their own. They're going to be able to turn to more people to help them than they can now. That should lower prices and expand access, and I think that'll be a good thing for everyone except the big companies who don't need access to these products.

Sarah Tsou: 
To close out our discussion, what's your prediction for how the law and regulation of litigation finance will evolve in the next 5 to 10 years?

Brian Fitzpatrick:
What I see is a bifurcated future. This consumer market that we spoke briefly about, these are regular plaintiffs with personal injury cases. Largely, they get small non-recourse loans from lenders. That's not your piece of the industry. I suspect we're going to see more and more regulation of this industry, because the consumers are not very sophisticated and people are worried that they need to be protected from their own lack of sophistication. Like we see with payday lending and all kinds of other consumer driven industries, there's going to be more regulation. 

On the commercial side, which is your side of the industry, I think it's very hard to justify very much regulation. I think that we have sophisticated parties. They know how to arrange their affairs that's best for them. It doesn't make sense for the government to come in and tell a small or medium sized business, "We know better than you do about how to litigate a case." I think we're probably going to let the sophisticated parties do what they want to do, and I don't see much regulation. 

I see only one piece of regulation that could affect the commercial market, and that is disclosure of financing agreements. I do see some appetite for forcing some level of disclosure of a financing agreement either to the judge in a case or maybe even to the other side in a case when there is a litigation. I know the federal rule makers and people who write the rules of civil procedure are looking at this issue. They've been studying it for a couple of years now, and I could see something happen there. Besides disclosure though, I don't see much appetite for telling sophisticated parties how they should arrange their affairs.

Sarah Tsou:
This is certainly something we've been keeping a watchful eye on, and I would say as far as we're concerned, some sensible regulation could be palatable, especially that prevents opponents from going down the rabbit hole of discovery, which by the way, we've seen more and more courts blocking. We've actually authored a number of articles and blog posts on this, and I would invite our listeners to check them out on our website. Finally, is there anyone you'd like to give a shout out to who has influenced your career or who you think is another significant thought leader in this area?

Brian Fitzpatrick: 
I'd like to give two shout-outs if I could. One in terms of influence was my mentor at Vanderbilt, Richard Nagareda. He passed away a few years ago, but he was just a terrific inspiration to me. He also studied complex litigation like I do, and he was really the reason why I got into academia. I miss him every day, but I'm very grateful to him every day for the start that he gave me. 

I'd also like to mention another mentor, who thankfully is still with us, who also has done some study of the third-party finance industry, and that is Professor Sam Issacharoff at NYU. He is one of the most brilliant people I've ever met in my life, and whenever I need to start thinking about a new problem, I always start with him because he usually has already thought about it and already has the right answer. He's also someone that I would look to for guidance in this area.

Sarah Tsou: 
That's great. Professor Fitzpatrick, I want to thank you again for appearing on our Beyond Hourly podcast and sharing your wonderful insights with us today.

Brian Fitzpatrick: 
Thank you so much. It was my pleasure to be here.

Sarah Tsou: 
As I mentioned at the outset, episodes of the Beyond Hourly podcasts can be found on our website, www.benthamimf.com (now at www.omnibridgeway.com), iTunes and other podcast networks. We'll be back soon with another episode focused on advancements in legal services that drive economic value for law firms and the clients they serve.

Until then, I'd like to thank our audience for listening in and invite you to subscribe to the podcast and leave reviews. Please feel free to follow up with me at [email protected] (now at [email protected]) for any feedback, ideas, or insights you have on topics we should cover on the podcast. Thank you and be well.