Litigation Crowdfunding and LexShares: Access to Justice or Ethical Pitfall?

The idea of third parties financing litigation is now catching up to the crowdfunding zeitgeist. CrowdJustice is a UK startup that aims to use crowdfunding to pay legal fees for public interest lawsuits. And recently, LexShares entered the crowdfunding space as an online lawsuit investment vehicle for crowdfunding commercial litigation cases. A search for “legal fees” on GoFundMe yields nearly twenty-thousand active campaigns. Even lawyers have used crowdfunding to get off the ground.

Litigation finance’s entrance into the online crowdfunding space should prompt a discussion about the history of the litigation finance industry, as well as the ethical concerns it raises.

A Las Vegas Loan Shark Hits It Big, and Loses It All

Litigation finance began in the late 1990s with a man named Perry Walton. After he lost his first “fast cash” lending company in 1997 due to criminal charges, Walton hit on the idea of advancing cash to people with pending lawsuits. According to Walton, his cleaning woman needed money to make ends meet. She had no collateral other than a pending auto accident lawsuit. Walton loaned her $1,100 in exchange for a stake in her lawsuit; he ended up nearly tripling his money nineteen months later.

Walton began regularly investing in lawsuits while selling his idea at seminars for thousands of dollars a ticket. But then Walton bet big on a sexual assault lawsuit against the owner of the Charlotte Hornets NBA team, George Shinn, only to see the suit fail at trial. A no-recourse loan meant when the defendant won, Walton lost and had no collateral to collect. Then the woman to whom he loaned money for the case turned around and sued him for wrongful interference in an attorney-client contract. She won a judgment of $1.6 million against him.

Walton is now running a cheesesteak stand in Las Vegas.

The Ethical Concerns of Litigation Financing Companies

Many state bar associations have issued ethics opinions about lawyers using or recommending litigation financing companies. The American Bar Association Commission on Ethics issued a white paper on the issue in 2011 (pdf). The New York Bar also issued an opinion in 2011.

Bottom line: it is not unethical for a lawyer to assist their client in obtaining litigation financing. Bar associations leave the legality of such arrangements up to the courts. But it is a potential ethics pitfall even if it is not necessarily unethical.

The New York Bar ethics opinion raised the issue of client confidentiality and letting a third party exercise control of a case. For instance, LexShares and its ilk want to know details about the litigation to determine if it is worth the risk to invest. This requires knowledge of case details from the lawyer, and the lawyer gets many of those details from the client. From the New York opinion:

Providing financing companies access to client information not only raises concerns regarding a lawyer’s ethical obligation to preserve client confidences, it also may interfere with the unfettered discharge of the duty to avoid third party interference with the exercise of independent professional judgment. While litigation financing companies typically represent that they will not attempt to interfere with a lawyer’s conduct of the litigation, their financial interest in the outcome of the case may, as a practical matter, make it difficult for them to refrain from seeking to influence how the case will be handled by litigation counsel.

In other words, lawyers have to determine how much information they should give the litigation finance company. Give too little information and the case may be rejected for funding. Give too much information and you risk violating client confidence or revealing case strategies best kept under wraps.

Can a Litigation Financing Company Interfere with a Case?

A lawyer also has to make sure the financing company does not start arm-chair quarterbacking the case to strengthen the potential of return.

A litigation finance company can interfere directly by calling up the lawyer and directing them on case strategies. They can also interfere indirectly, such as offering to increase the funding amount if the lawyer adds a party with deep pockets, even if the party’s liability is questionable at best.

Both kinds of conduct veer off into champerty. Champerty is an agreement between a plaintiff in a lawsuit and a non-party to the suit that lets the plaintiff get financing in exchange for letting the non-party interfere in the case. Some states, notably New York, still find some arrangements violate the champerty doctrine.

There are broader policy concerns as well. Business groups, such as the U.S. Chamber of Commerce, are not fans of litigation financing, claiming that it encourages frivolous lawsuits.

Finally, If the client recovers a settlement or judgment, the amount needed to pay back the litigation financing company can take away most of what the client would have otherwise recovered.

The New Kid on the Block: LexShares

LexShares styles itself as an investment company. Plaintiffs with commercial litigation cases who are in need of funding can turn to LexShares, which then reviews the case for merit and, if it passes muster, puts out an offering for investors to buy. LexShares takes a commission from the funding in exchange for procuring the financing. Assuming the plaintiff’s case is successful, the investors share in the recovery. From the FAQ:

Investment opportunities posted on LexShares are indirect investments in legal claims offered through single purpose pooled investment funds managed by LawShares LLC and sold through WealthForge, LLC, a registered broker dealer and member FINRA / SIPC.

Since LexShares’ site had a chat bubble that popped up, I decided to ask it some questions:

LexShares: Can I answer any questions?

Me: What happens if the plaintiff loses the case?

LexShares: If the plaintiff loses the case, the investor losses their invested capital.

LexShares: Most litigation fundings are structured on a non-recourse basis, ie no win no cost to the plaintiff

LexShares: Are you looking to invest or apply for funding?

Me: Let’s say the jury awards an amount exactly the same as the funding amount. What happens then?

LexShares: We only fund up to 10% of the low bar of our damage analysis of a case, so that situation would be rare

Me: Another scenario: plaintiff loses but has appealable issue and files a notice of appeal. Do investors lose out? Does the financing agreement stay in place?

LexShares: The financing agreement remains in place

Me: So this is essentially a non-recourse litigation loan? What is the interest rate?

LexShares: We structure our deals in 3 ways depending on the type of case, size and risk profile. Terms are bespoke on a case by case basis

It appears LexShares is letting investors buy shares in non-recourse litigation loans. If the plaintiff wins the case, they pay back the loan with interest; but if the plaintiff loses the investors lose out as well because the loan is non-recourse. Of the four cases on LexShares’ site, three have been fully funded. A fourth is on course to be funded as well.

Access to Justice or Ethical Pitfall?

Perhaps there is need and space for innovation in funding litigation, or perhaps giving parties a crowdfunded war chest is the last thing the legal profession needs.

While the “David vs. Goliath” aspirations of lawsuit crowdfunding is a noble aspiration, there is ample room for bad actors to take advantage on both ends of the bargain. Giving investors the opportunity to crowdfund lawsuits online is a new twist in a young industry with a wild history. Companies like LexShares will likely continue to fill the access to justice gap, but only time will tell if they are forces for good or evil.

Featured image: “A lot of hands with important currencies isolated on white ” from Shutterstock.

1 Comment

  1. Avatar Alex says:

    There were a lot of similar concerns around peer to peer lending platforms such as prosper and lending club. Would borrowers screw lenders? Would lenders make any money? Given their track record, it seems like those platforms have mostly been vindicated. People are mostly decent.

    The analogy is imperfect. Here, you have to be an accredited investor, for one (net worth of $1M or $200K annual income.) In P2P lending, anyone can participate and when you loan $5K you generally are making 200 loans of $25 to 200 different people. Here, it appears that Lex Shares wants a minimum of $5K for the loan to fight a lawsuit against a multinational oil company. So you’re much less diversified, much more at risk, and have much more upside. Seems fair–especially, when you consider that it’s only open to accredited investors. It’s less a case of david v goliath, and more a case of finding lots of smaller goliaths to pummel one larger goliath.

    Yes, lawyers’ professional obligations to their clients are unique, and pretty different from a P2P situation. But where lawyers screw up those obligations, we have a generally well functioning disciplinary system to deal with it.

    In my experience, clients are more likely to forgo a meritorious claim for lack of resources than bring a specious claim because they have great resources. My guess is the ACLU, EFF and others would agree. I’d like to see the experiment continue. If it’s a disaster, lawyers should hopefully clamor to shut it down.

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