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A recent decision in Delaware court provides guidance on surviving a challenge to claims brought under third-party funding.

Posted on March 22, 2016

Lean margin enterprises are increasingly looking to outside sources for funding of the high costs associated with important, complex business litigation.  As a result, demand for third-party litigation funding has doubled in each of the past few years.  A recent decision by Delaware Superior Court President Judge Jan R. Jurden may eliminate significant obstacles to such funding:  ethical rules against champerty and maintenance. 

Constraints on legal budgets are increasingly a top concern for general counsel.  At the same time, however, traditional methods of externally funding litigation generally have conditions or limits that many enterprises find unacceptable.  Outright assignment of a claim results in the enterprise losing both any potential upside if the claim should prevail and, typically, control over the litigation regarding the claim.  Contingent fee or hybrid fee legal representation agreements with the attorneys handling the matter may involve the attorneys taking a substantial percentage of the proceeds, and may also still require the enterprise to fund “expenses,” which can be substantial when experts and/or voluminous document discovery are involved.  Better terms for third-party funding have been in increasing demand during recent years, and specialty finance companies such as Gerchen Keller Capital, Burford Capital and Lake Whillans have sought to meet that demand.

Two principles of pre-revolutionary English common law constrain third-party litigation funding in many jurisdictions.  “Maintenance” is an agreement by which a disinterested third-party, with no prior interest in a lawsuit, finances the litigation. “Champerty” is a form of maintenance in which the litigation funding is provided in exchange for a share of the proceeds if the suit succeeds.  Prohibitions against champerty and maintenance are both premised on the idea that acts by a “disinterested” third party to encourage or support litigation likely derive from malicious intent regarding a rival and/or foster frivolous claims.  In both champerty and maintenance, such acts are torts giving rise to a separate cause of action by the opposing party in the lawsuit (as well as the possibility of ethical complaints against attorneys involved). 

In the case before Judge Jurden, Charge Injection Technologies Inc. brought state law intellectual property claims against a much larger entity, E.I. duPont de Nemours & Co.  Several years into the litigation, CIT sought and obtained third-party funding for the litigation pursuant to a “Forward Purchase Agreement” of a percentage of any future proceeds, with a security interest.  For over two years, the merits of CIT’s claims languished while E.I. DuPont conducted discovery on and pursued dismissal under its champerty and maintenance contentions. 

Judge Jurden found the finance agreement was not champertous because it did not, as alleged by E.I. DuPont, involve assignment of the claims, establish de facto control by the third-party funding entity, or encourage prosecution of a claim that the owner was disinclined to pursue:

The Court is not persuaded by DuPont's argument that the FPA is champertous because of Burford’s alleged “de facto control." The record before the Court demonstrates that CIT is the bona fide owner of the claims in this litigation, and Burford has no right to maintain this action.  In this case, there was no assignment. Neither the FPA nor the Security Agreement assigns ownership of CIT’s claims against DuPont to Burford.

The doctrine of champerty “is based upon the ground that no encouragement should be given to litigation by the introduction of a party to enforce those rights which the owners are not disposed to prosecute.”  CIT did not bargain with Burford to enforce claims which CIT is not disposed to prosecute.

The judge considered it important that CIT sought out the funding entity, not the other way around, and that the funding occurred several year into the protracted and expensive litigation. 

With legal budgets continuing to face pressure, the marketplace answer to financing litigation may become more viable following this decision.  At a minimum, a template for surviving a challenge to claims brought under third-party funding – without extended, expensive litigation over just the funding, without ever reaching the merits – is provided by the Court’s opinion.