Curiouser and Curiouser! A Review of the NYCBA’s Ethics Opinion on Litigation Funding
By: Allison Chock, Chief Investment Officer, Sarah Jacobson, Legal Counsel and Connor Williams, Legal Counsel
Roughly one month ago, the New York City Bar Association Ethics Committee (“NYCBA”) issued Formal Opinion 2018-5 (the “Opinion”), which advised that agreements between litigation funders and lawyers involving future payments contingent on the lawyer’s receipt of future legal fees amount to impermissible fee-splitting between lawyers and non-lawyers in violation of New York’s version of ABA Model Rule 5.4(a). Unsurprisingly, the opinion generated immediate discussion about the proper reading of Rule 5.4(a) and litigation funding in general.
Model Rule 5.4(a) provides simply that a “lawyer or law firm shall not share legal fees with a nonlawyer,” with four explicit exceptions (a deceased lawyer’s firm may make payments to that lawyer’s estate; a lawyer purchasing a deceased lawyer’s practice may pay the estate; a lawyer can include non-lawyer employees in profit-sharing retirement plans; and a lawyer can share court-awarded fees with a non-profit organization that recommended and/or retained the lawyer). As an ABA comment on Rule 5.4 makes clear, the fee-sharing prohibition is to “protect the lawyer’s professional independence of judgment.”
There are two points worth considering in evaluating the NYCBA’s conclusion: First, Rule 5.4(a) predates the arrival of commercial litigation funding in the United States—by decades. The rule was adopted in 1983, and an older iteration (Disciplinary Rule 3-102) appeared in the ABA’s Model Code of Professional Responsibility (the predecessor to the current Model Rules). Second, the plain language of Rule 5.4(a) is incredibly broad. Lawyers earn the bulk of their income through legal fees, and use (or “share”) those fees in any number of ways that could hypothetically impact their judgment. Rule 5.4(a) addresses some of these expenditures in its four exceptions, but the bottom line is that the rule requires a common-sense, rather than a strict and formalistic, reading. If not, the prohibition against fee sharing could be read to prohibit any number of actions that lawyers routinely engage in to maintain and grow their practices. Moreover, context matters: other ABA model rules (see, e.g., Rule 2.1) are also specifically concerned with maintaining the independent judgment of lawyers.[1] So, it isn’t necessary to read Rule 5.4(a) (or any other single rule) broadly in order to ensure ethical conduct, when the underlying ethical principle is clearly set out in its own rule. In fact, as Peter R. Jarvis and Trisha Thompson of Holland & Knight recently noted, the ABA previously interpreted Rule 5.4(a) as rendering two of the current four “black-letter exceptions” unnecessary and extraneous because the behavior at issue was not reasonably likely to affect a lawyer’s exercise of independent judgment.
The Opinion disregards these obvious points and instead opts for a broad reading of an old rule with predictable results. Revisiting it now that the initial round of debate has subsided offers little in the way of additional clarity as to the NYCBA’s thinking. Upon further reflection, here are the most curious aspects of what remains an odd opinion:
The NYCBA effectively ignores legal precedent in New York.
Perhaps counterintuitively, the NYCBA acknowledges the public policy benefit of litigation funding early in the Opinion: “[It] may expand access to the courts to litigants who would otherwise be financially unable to pursue their legitimate claims. Litigation funding may also advance fairness by levelling the dispute-resolution field between parties with deep pockets and those with limited resources.” Nevertheless, the NYCBA ultimately concludes that Rule 5.4(a)’s protection against improper influence over lawyers must override such benefits.
New York courts, however, have reached the opposite conclusion that Rule 5.4(a) does not constitute such a constraint. Buried in footnote 12 of the Opinion, the NYCBA begrudgingly acknowledges three recent cases from the last five years in which courts have enforced litigation funding agreements. See Lawsuit Funding, LLC v. Lessoff, 2013 WL 6409971 (Sup. Ct. N.Y. County Dec. 4, 2013); Heer v. North Moore St. Developers, L.L.C., 140 A.D.3d 675 (1st Dep’t 2016); Hamilton Capital VII, LLC, I v. Khorrami, LLP, 2015 N.Y. Slip. Op. 51199(U) (Sup. Ct. N.Y. County Aug. 17, 2015). The NYCBA’s attempt to wave these away as mere attempts to enforce contractual obligations fails upon even a cursory review of the opinions.
In Hamilton Capital, for example, the court invokes the same public policy rationale as the NYCBA while reaching the opposite result, noting that “public policy favors this type of financing because it ‘allows lawsuits to be decided on their merits, and not based on which party has deeper pockets’” (citation omitted), and that “other courts have analyzed the legality of similar financing arrangements . . . and held them not to run afoul of the applicable ethical rules.” And, even more problematically for the NYCBA, the court in Lawsuit Funding specifically held that a non-recourse funding agreement—exactly the type the NYCBA advises against—does not run afoul of Rule 5.4(a) because, in part, “The Rules of Professional Conduct ensure that attorneys will zealously represent the interests of their clients, regardless of whether the fees the attorney generates from the contract through representation remain with the firm or must be used to satisfy a security interest.”
A recent review of the Opinion and relevant case law by Anthony E. Davis (partner at Hinshaw & Culbertson) and Anthony E. Sebok (professor at Cardozo School of Law and consultant to Burford Capital) further notes that New York courts’ acceptance of litigation financing arrangements is more widespread than these three cases, and concludes that the Opinion “fails to acknowledge the many cases, in addition to the three it cites, which reflect the degree to which courts accept the very practices that the [NYCBA] deems unethical.” Such clear standing precedents—concerning largely the same public policy grounds cited in the Opinion—make it all the more baffling that the NYCBA couches its conclusion as an inevitable result of Rule 5.4(a). It isn’t.
The NYCBA draws an arbitrary distinction that leads to absurd and damaging results (for law firms and their clients).
The Opinion specifically singles out one type of arrangement as violative of Rule 5.4(a): non-recourse funding arrangements, which allegedly by their very nature deter law firms from exercising independent judgment where the myriad other ways in which lawyers use their fees to support their legal practices do not.
The NYCBA’s efforts to distinguish non-recourse arrangements for this treatment only highlight the arbitrary nature of its ruling. In attempting to explain why recourse loans would not improperly influence a lawyer’s behavior, for example, the NYCBA hypothesizes that, “In the case of a recourse loan, there is no implicit or explicit understanding that the debt will be repaid only if legal fees are obtained in particular matters, and the creditor may seek repayment out of the law firm’s assets.” But imagine a small law firm that secures recourse funding with few hard assets and only a handful of cases on its roster, and the threat of the recourse lender’s collection of law firm assets (or worse, personal assets) used as security for the loan if business or collections slow. It is immediately apparent that this recourse/non-recourse distinction does not necessarily amount to any type of real-world difference. Further, the NYCBA acknowledges, as it must, that Rule 5.4(a) “does not forbid payments from income derived from legal fees… since all or virtually all of lawyers’ income ordinarily derives from legal fees and therefore all payments they make for nonlawyer salaries, services, etc., ordinarily derive from legal fees.” In other words, under the Opinion’s logic, non-recourse litigation funding arrangements present a risk of influencing lawyers’ behavior in a way that non-lawyer law firm staffers who work day-in and day-out with lawyers and are paid bonuses based in part on future fee receipts based on case outcomes do not? This makes no sense; it is at least as plausible (if not more so) that the non-lawyers working with lawyers on a day-to-day basis at a firm would be possibly motivated and able to influence the lawyers’ independent judgment, because their livelihood comes from those same legal fees.
The absurd results of the Opinion are not merely hypothetical. Consider the facts of Hamilton Capital, discussed above. In that case, a law firm received $6 million in funding in 2009 secured by all property and proceeds acquired by the firm (i.e., the type of recourse funding preferred under the Opinion). By 2012, when it defaulted on the loan, it owed more than $600,000 in interest alone. Further failure to repay resulted in the interest ballooning to more than $2 million by 2014. It is difficult to understand how falling behind on a high-interest loan—when the future of the law firm and its partners personal assets are likely at stake—would have less impact on that law firm’s independence on that matter than a non-recourse loan, which limits the lender’s recovery to assets only where the firm is successful. In fact, Bentham IMF’s funding agreements make clear that the client always retains control over the right to direct the legal matter(s) at issue.
The NYCBA appears to tacitly acknowledge the untenable nature of distinguishing recourse and non-recourse funding, noting in footnote 11 that “One might […] argue that any creditor has an incentive to encroach on lawyer independence and that there is no reason to single out those particular creditors who have a stake in lawyers’ fees in particular matters.” In response, the NYCBA blithely points to “90 years of ethics rules and opinions” have “at least implicitly assumed” a difference (emphasis added). This response cannot withstand even the barest amount of scrutiny. First, the NYCBA provides no analysis of any such ethics rules and opinions.[2] Second, the reference to “90 years” is baffling, as large commercial litigation funders have only been operating in the United States for just over ten years. Third, even if New York rules and ethics opinions have assumed a difference, New York courts have not, as shown in their upholding of the arrangements in both Hamilton Capital (recourse) and Lawsuit Funding (non-recourse). Finally—and perhaps most importantly—modern litigation finance contracts explicitly disclaim any control over the litigation by the funder. It is inconceivable that in the context of such contractual language, any reasonable lawyer would allow him or herself to be bullied by a funder into violating his or her professional independence.
The Opinion is unnecessary and runs contrary to the very public policy it acknowledges is important.
The NYCBA concludes the Opinion by essentially saying its hands are tied by the language of Rule 5.4(a), suggesting that perhaps a change to the rule should be proposed to the state judiciary or legislature. This peculiarly suggests that the NYCBA was little more than an unwilling participant without any choice but to issue the Opinion despite the public policy benefits of litigation funding, acknowledged at the beginning of the Opinion itself.
If the NYCBA’s goal is to trigger a change to Rule 5.4(a), issuing an ethics opinion is an inefficient and ineffective method of doing so. Had the NYCBA simply not opined on this matter at all, practitioners in New York could still comfortably follow the legal precedents discussed above and the NYCBA could have quietly worked toward a rule change, explicitly or by the exceptions being created in the case law. Instead, the NYCBA opted to inject itself into this discussion in the form of an advisory opinion contrary to New York court opinions, adding unnecessary confusion to the issue.
Contrast, for example, the more measured approach to considering rules changes in support of improving public policy that has recently occurred in California. Earlier this year, the Board of Trustees for the State Bar of California commissioned an analysis of the legal services market. The resulting report voiced concerns like those raised in the Opinion: both individual and corporate clients are facing rising costs and increased difficulties with gaining meaningful access to the justice system. The proposed solution? Relaxing ethics rules (including specifically Rule 5.4) to allow for greater collaboration between lawyers and non-lawyers, including restrictions on non-lawyer ownership of law firms. By going out of its way to issue an arbitrarily restrictive interpretation of Rule 5.4(a), the NYCBA has pushed New York in the opposite direction and made access to justice more difficult.
Given that the NYCBA’s ethics opinions are advisory—that is, they have no regulatory authority over attorneys or the courts—it is tempting to simply write off concerns over their merits or public policy implications as merely theoretical. But that approach shortchanges the important role that the NYCBA can and should have in leading efforts to ensure that legal ethics rules best meet the needs of lawyers and clients alike. The Opinion falls short of this mark, instead introducing unjustified and unnecessary confusion into the field of litigation finance.
[1] Rule 2.1 expressly states: “Rule 2.1 Advisor. In representing a client, a lawyer shall exercise independent professional judgment and render candid advice.”
[2] One can only assume that the Opinion is referring to the ethics opinions previously cited in footnote 8 of the Opinion. Notably, those ethics opinions date from 1997-2007, prior to the advent of modern litigation finance in the United States, and none of them deal with any sort of modern commercial litigation finance contract with the express “no control” provisions that are typically included in such contracts.
Roughly one month ago, the New York City Bar Association Ethics Committee (“NYCBA”) issued Formal Opinion 2018-5 (the “Opinion”), which advised that agreements between litigation funders and lawyers involving future payments contingent on the lawyer’s receipt of future legal fees amount to impermissible fee-splitting between lawyers and non-lawyers in violation of New York’s version of ABA Model Rule 5.4(a). Unsurprisingly, the opinion generated immediate discussion about the proper reading of Rule 5.4(a) and litigation funding in general.
Model Rule 5.4(a) provides simply that a “lawyer or law firm shall not share legal fees with a nonlawyer,” with four explicit exceptions (a deceased lawyer’s firm may make payments to that lawyer’s estate; a lawyer purchasing a deceased lawyer’s practice may pay the estate; a lawyer can include non-lawyer employees in profit-sharing retirement plans; and a lawyer can share court-awarded fees with a non-profit organization that recommended and/or retained the lawyer). As an ABA comment on Rule 5.4 makes clear, the fee-sharing prohibition is to “protect the lawyer’s professional independence of judgment.”
There are two points worth considering in evaluating the NYCBA’s conclusion: First, Rule 5.4(a) predates the arrival of commercial litigation funding in the United States—by decades. The rule was adopted in 1983, and an older iteration (Disciplinary Rule 3-102) appeared in the ABA’s Model Code of Professional Responsibility (the predecessor to the current Model Rules). Second, the plain language of Rule 5.4(a) is incredibly broad. Lawyers earn the bulk of their income through legal fees, and use (or “share”) those fees in any number of ways that could hypothetically impact their judgment. Rule 5.4(a) addresses some of these expenditures in its four exceptions, but the bottom line is that the rule requires a common-sense, rather than a strict and formalistic, reading. If not, the prohibition against fee sharing could be read to prohibit any number of actions that lawyers routinely engage in to maintain and grow their practices. Moreover, context matters: other ABA model rules (see, e.g., Rule 2.1) are also specifically concerned with maintaining the independent judgment of lawyers.[1] So, it isn’t necessary to read Rule 5.4(a) (or any other single rule) broadly in order to ensure ethical conduct, when the underlying ethical principle is clearly set out in its own rule. In fact, as Peter R. Jarvis and Trisha Thompson of Holland & Knight recently noted, the ABA previously interpreted Rule 5.4(a) as rendering two of the current four “black-letter exceptions” unnecessary and extraneous because the behavior at issue was not reasonably likely to affect a lawyer’s exercise of independent judgment.
The Opinion disregards these obvious points and instead opts for a broad reading of an old rule with predictable results. Revisiting it now that the initial round of debate has subsided offers little in the way of additional clarity as to the NYCBA’s thinking. Upon further reflection, here are the most curious aspects of what remains an odd opinion:
The NYCBA effectively ignores legal precedent in New York.
Perhaps counterintuitively, the NYCBA acknowledges the public policy benefit of litigation funding early in the Opinion: “[It] may expand access to the courts to litigants who would otherwise be financially unable to pursue their legitimate claims. Litigation funding may also advance fairness by levelling the dispute-resolution field between parties with deep pockets and those with limited resources.” Nevertheless, the NYCBA ultimately concludes that Rule 5.4(a)’s protection against improper influence over lawyers must override such benefits.
New York courts, however, have reached the opposite conclusion that Rule 5.4(a) does not constitute such a constraint. Buried in footnote 12 of the Opinion, the NYCBA begrudgingly acknowledges three recent cases from the last five years in which courts have enforced litigation funding agreements. See Lawsuit Funding, LLC v. Lessoff, 2013 WL 6409971 (Sup. Ct. N.Y. County Dec. 4, 2013); Heer v. North Moore St. Developers, L.L.C., 140 A.D.3d 675 (1st Dep’t 2016); Hamilton Capital VII, LLC, I v. Khorrami, LLP, 2015 N.Y. Slip. Op. 51199(U) (Sup. Ct. N.Y. County Aug. 17, 2015). The NYCBA’s attempt to wave these away as mere attempts to enforce contractual obligations fails upon even a cursory review of the opinions.
In Hamilton Capital, for example, the court invokes the same public policy rationale as the NYCBA while reaching the opposite result, noting that “public policy favors this type of financing because it ‘allows lawsuits to be decided on their merits, and not based on which party has deeper pockets’” (citation omitted), and that “other courts have analyzed the legality of similar financing arrangements . . . and held them not to run afoul of the applicable ethical rules.” And, even more problematically for the NYCBA, the court in Lawsuit Funding specifically held that a non-recourse funding agreement—exactly the type the NYCBA advises against—does not run afoul of Rule 5.4(a) because, in part, “The Rules of Professional Conduct ensure that attorneys will zealously represent the interests of their clients, regardless of whether the fees the attorney generates from the contract through representation remain with the firm or must be used to satisfy a security interest.”
A recent review of the Opinion and relevant case law by Anthony E. Davis (partner at Hinshaw & Culbertson) and Anthony E. Sebok (professor at Cardozo School of Law and consultant to Burford Capital) further notes that New York courts’ acceptance of litigation financing arrangements is more widespread than these three cases, and concludes that the Opinion “fails to acknowledge the many cases, in addition to the three it cites, which reflect the degree to which courts accept the very practices that the [NYCBA] deems unethical.” Such clear standing precedents—concerning largely the same public policy grounds cited in the Opinion—make it all the more baffling that the NYCBA couches its conclusion as an inevitable result of Rule 5.4(a). It isn’t.
The NYCBA draws an arbitrary distinction that leads to absurd and damaging results (for law firms and their clients).
The Opinion specifically singles out one type of arrangement as violative of Rule 5.4(a): non-recourse funding arrangements, which allegedly by their very nature deter law firms from exercising independent judgment where the myriad other ways in which lawyers use their fees to support their legal practices do not.
The NYCBA’s efforts to distinguish non-recourse arrangements for this treatment only highlight the arbitrary nature of its ruling. In attempting to explain why recourse loans would not improperly influence a lawyer’s behavior, for example, the NYCBA hypothesizes that, “In the case of a recourse loan, there is no implicit or explicit understanding that the debt will be repaid only if legal fees are obtained in particular matters, and the creditor may seek repayment out of the law firm’s assets.” But imagine a small law firm that secures recourse funding with few hard assets and only a handful of cases on its roster, and the threat of the recourse lender’s collection of law firm assets (or worse, personal assets) used as security for the loan if business or collections slow. It is immediately apparent that this recourse/non-recourse distinction does not necessarily amount to any type of real-world difference. Further, the NYCBA acknowledges, as it must, that Rule 5.4(a) “does not forbid payments from income derived from legal fees… since all or virtually all of lawyers’ income ordinarily derives from legal fees and therefore all payments they make for nonlawyer salaries, services, etc., ordinarily derive from legal fees.” In other words, under the Opinion’s logic, non-recourse litigation funding arrangements present a risk of influencing lawyers’ behavior in a way that non-lawyer law firm staffers who work day-in and day-out with lawyers and are paid bonuses based in part on future fee receipts based on case outcomes do not? This makes no sense; it is at least as plausible (if not more so) that the non-lawyers working with lawyers on a day-to-day basis at a firm would be possibly motivated and able to influence the lawyers’ independent judgment, because their livelihood comes from those same legal fees.
The absurd results of the Opinion are not merely hypothetical. Consider the facts of Hamilton Capital, discussed above. In that case, a law firm received $6 million in funding in 2009 secured by all property and proceeds acquired by the firm (i.e., the type of recourse funding preferred under the Opinion). By 2012, when it defaulted on the loan, it owed more than $600,000 in interest alone. Further failure to repay resulted in the interest ballooning to more than $2 million by 2014. It is difficult to understand how falling behind on a high-interest loan—when the future of the law firm and its partners personal assets are likely at stake—would have less impact on that law firm’s independence on that matter than a non-recourse loan, which limits the lender’s recovery to assets only where the firm is successful. In fact, Bentham IMF’s funding agreements make clear that the client always retains control over the right to direct the legal matter(s) at issue.
The NYCBA appears to tacitly acknowledge the untenable nature of distinguishing recourse and non-recourse funding, noting in footnote 11 that “One might […] argue that any creditor has an incentive to encroach on lawyer independence and that there is no reason to single out those particular creditors who have a stake in lawyers’ fees in particular matters.” In response, the NYCBA blithely points to “90 years of ethics rules and opinions” have “at least implicitly assumed” a difference (emphasis added). This response cannot withstand even the barest amount of scrutiny. First, the NYCBA provides no analysis of any such ethics rules and opinions.[2] Second, the reference to “90 years” is baffling, as large commercial litigation funders have only been operating in the United States for just over ten years. Third, even if New York rules and ethics opinions have assumed a difference, New York courts have not, as shown in their upholding of the arrangements in both Hamilton Capital (recourse) and Lawsuit Funding (non-recourse). Finally—and perhaps most importantly—modern litigation finance contracts explicitly disclaim any control over the litigation by the funder. It is inconceivable that in the context of such contractual language, any reasonable lawyer would allow him or herself to be bullied by a funder into violating his or her professional independence.
The Opinion is unnecessary and runs contrary to the very public policy it acknowledges is important.
The NYCBA concludes the Opinion by essentially saying its hands are tied by the language of Rule 5.4(a), suggesting that perhaps a change to the rule should be proposed to the state judiciary or legislature. This peculiarly suggests that the NYCBA was little more than an unwilling participant without any choice but to issue the Opinion despite the public policy benefits of litigation funding, acknowledged at the beginning of the Opinion itself.
If the NYCBA’s goal is to trigger a change to Rule 5.4(a), issuing an ethics opinion is an inefficient and ineffective method of doing so. Had the NYCBA simply not opined on this matter at all, practitioners in New York could still comfortably follow the legal precedents discussed above and the NYCBA could have quietly worked toward a rule change, explicitly or by the exceptions being created in the case law. Instead, the NYCBA opted to inject itself into this discussion in the form of an advisory opinion contrary to New York court opinions, adding unnecessary confusion to the issue.
Contrast, for example, the more measured approach to considering rules changes in support of improving public policy that has recently occurred in California. Earlier this year, the Board of Trustees for the State Bar of California commissioned an analysis of the legal services market. The resulting report voiced concerns like those raised in the Opinion: both individual and corporate clients are facing rising costs and increased difficulties with gaining meaningful access to the justice system. The proposed solution? Relaxing ethics rules (including specifically Rule 5.4) to allow for greater collaboration between lawyers and non-lawyers, including restrictions on non-lawyer ownership of law firms. By going out of its way to issue an arbitrarily restrictive interpretation of Rule 5.4(a), the NYCBA has pushed New York in the opposite direction and made access to justice more difficult.
Given that the NYCBA’s ethics opinions are advisory—that is, they have no regulatory authority over attorneys or the courts—it is tempting to simply write off concerns over their merits or public policy implications as merely theoretical. But that approach shortchanges the important role that the NYCBA can and should have in leading efforts to ensure that legal ethics rules best meet the needs of lawyers and clients alike. The Opinion falls short of this mark, instead introducing unjustified and unnecessary confusion into the field of litigation finance.
[1] Rule 2.1 expressly states: “Rule 2.1 Advisor. In representing a client, a lawyer shall exercise independent professional judgment and render candid advice.”
[2] One can only assume that the Opinion is referring to the ethics opinions previously cited in footnote 8 of the Opinion. Notably, those ethics opinions date from 1997-2007, prior to the advent of modern litigation finance in the United States, and none of them deal with any sort of modern commercial litigation finance contract with the express “no control” provisions that are typically included in such contracts.