ISO's 'Litigation Funding Mutual Disclosure' Is Unenforceable

The Condition

For at least the last decade, insurers and the U.S. Chamber of Commerce have unsuccessfully sought to enlarge the scope of Federal Rule of Civil Procedure 26(f) to require the blanket disclosure of litigation finance in every civil case.  Only a handful of federal courts have adopted a varying degree of disclosure requirements over the past ten years.¹  Faced with the lack of progress in the courts, the insurance industry has recently introduced a new insurance form condition entitled “Litigation Funding Mutual Disclosure” (the “Condition”) (ISO Form CG 99 11 01 26), which may be included in liability policies such as commercial general liability and electronic data liability policies, among others, starting this month.

In a nutshell, the Condition states that to the extent an insurer and policyholder “do not agree whether or to what extent a claim or ‘suit’ is covered by this Policy, either party may make a written demand for mutual disclosure of any ‘third-party litigation funding agreement(s)’ regarding that claim or ‘suit.’”  The Condition is not limited to funding for the policyholder but includes funding for law firms relating to the claim or suit at issue.  Moreover, the Condition requires that the policyholder furnish a copy of the funding agreement as well as a description of all material terms.  Finally, the Condition is evergreen such that if a policyholder or its law firm obtains funding after the disclosure request is made, the funding must be disclosed within 30 days. 

However, this Condition is unenforceable because (i) when it actually might apply, the insurer likely has waived compliance with conditions; (ii) it interferes with contractual relations; and (iii) it lacks mutuality.

The “Need” for the Condition is Baseless

Insurance Services Office, Inc., a unit of Verisk Analytics, Inc. that issues standard insurance forms, provides the following explanation for it:

Third-party litigation funding (TPLF or third-party funding) is on the rise and may be a contributing factor to social inflation.  This growing multi-billion-dollar industry, which remains largely unregulated, is changing the claims and litigation landscape.  There have been efforts at both the federal and state levels to establish TPLF disclosures rules as part of litigation discovery practices.  Some states have enacted laws addressing the discoverability of TPLF, which may include a requirement to disclosure the existence or contents of the TPLF agreement.

The rationale echoes the refrain that litigation funding is a contributing factor to the narrative umbrella of “social inflation,” “nuclear verdicts,” and that it impacts premiums and insurer loss ratios.  There simply is no actual authority for any of these positions. ²  To the contrary, commercial litigation companies that provide non-recourse capital to claimants or law firms rigorously underwrite their investments to ensure that only the strongest claims are funded and, on average, reject more than 95% of the opportunities presented to them.³  Just as the rationale for the condition is unsupported, the Condition also makes little sense and lacks enforceability for many reasons. 

The Condition Will Not Apply In Third-Party Liability Cases

First, general liability policies provide for defense and indemnity of third-party claims.  After a policyholder provides notice of a claim or suit to its insurer, the insurer can deny coverage, agree to defend under a reservation of rights, or defend without a reservation of rights.  Whatever the case, litigation funders generally do not invest in defense-side claims, making the insurer’s side of the supposedly “mutual” disclosure a fiction.  Its true purpose, of course, is to allow discovery of funding arrangements by the insurer in coverage litigation and ensure that it retains a litigation advantage against less-resourced policyholders.  More on “mutuality” later, but of critical importance is the questionable “need” for the Condition itself in a liability policy.

The Condition Is Not Enforceable in Coverage Litigation

Assume an insurer has denied coverage and the policyholder has commenced coverage litigation to enforce its rights.  Under the Condition, the insurer makes a demand for mutual disclosure of litigation funding.  Regardless of whether the policyholder has litigation funding for its coverage case, the Condition likely would not be enforceable since the denial of coverage has relieved the policyholder of the policy’s conditions.  In a similar vein, if the insurer denies coverage and the policyholder then defends and settles the case on its own, the policyholder is not required to obtain the insurer’s consent to the settlement under the policy’s consent clause.⁴ 

Many courts also have held that unless the insurer can establish that it has been actually and substantially prejudiced by a policyholder’s failure to perform a condition, coverage is not barred.⁵  Here, when the insurer has denied coverage, it is hard to imagine how an insurer could prove actual (or any) prejudice by a lack of information relating to the policyholder’s litigation funding arrangements.  The insurer could not demand to see the policyholder’s engagement letter with its lawyers (i.e., whether on an hourly or contingency or hybrid fee basis) so it follows logically that it should not be permitted access to the private financial information associated with how the policyholder is paying for its lawsuit.  This is especially true given the overwhelming majority of US commercial cases in which courts have held that litigation finance is rarely relevant to the claims and defenses of the parties. 

The Condition Intentionally Interferes With Contractual Relations

The Condition ostensibly would require the policyholder to breach its NDA and confidentiality provision of the litigation funding agreement by complying.  Although most funders leave the decision of whether to disclose funding up to its counterparty or carve out exceptions to NDAs for court orders or applicable laws, these provisions are not universal.  Whatever the case, the Condition is tantamount to intentional interference with contractual relations.⁶ 

Moreover, the Condition is extremely broad and defines “third party litigation funding agreement” as “any agreement for funding provided to a party or their attorney(s) for a specified legal matter, or portfolio of specified legal matters, in exchange for an agreement by the party or their attorney(s) to repay the funding or pay any applicable consideration, contingent upon the outcome of the specified matters.”  If the funding agreement is between the policyholder’s attorneys and a litigation funder, the insurer has no privity with either party to require disclosure.  The best practice is for attorneys to advise their clients of the existence of litigation funding that collateralizes the firm’s contingency fee interest in the claim.  But in the event a policyholder was not informed of funding, it is hard to imagine a court enforcing the Condition against the policyholder itself, assuming it somehow had not been already voided by the insurer’s denial of coverage.   

There is Nothing “Mutual” About the Disclosure Obligation

Another issue with the Condition is that it requires “mutual disclosure.”  As noted, insurers who use litigation funding typically only do so for subrogation claims and would have nothing to disclose under the Condition.  Calling it “mutual” does not make it so.  But because words in an insurance policy must have meaning, it strongly suggests that insurers should also be forced to disclose their reinsurance.⁷  Insurers routinely fight against disclosure of their reserves and reinsurance so what’s good for the goose is apparently not good for the gander.  If so, this appears more and more like a unilateral disclosure that teeters on bad faith. 

Conclusion

The ISO explanation of the Condition states that it is optional.  Although the Condition has little chance of being enforced, policyholders should be on the lookout for these provisions in their policy renewals and reject the inclusion whenever possible.  Similarly, law firms seeking litigation finance should review their clients’ policies to confirm whether the Condition has been included.