- The Fulbrook Advantage
- Fulbrook Specialties
- Speaking Engagements & Events
- Publications & Presentations
- In The News
Fulbrook Capital Management LLC
by Selvyn Seidel
by Selvyn Seidel
July 29, 2015
By Selvyn Seidel
To many investors in third party finance, if not most, the magnet attracting them to a claim is not any specific aspect of the claim itself. Rather, it is the prosecuting lawyer. The lawyer is the jockey mounted to ride the claim to success. An experienced and skilled rider can make the difference. That is particularly the case when U.S. lawyers are involved, and U.S. lawyers are the focus of this article.
Long before riding the race, and at the investing stage, the lawyer is critical. He or she has done the all-important analysis of the claim’s evaluation and mapped its strategy. The investor must trust that analysis and the lawyer doing it. While the investor will most likely eventually bring in its own lawyers and experts to diligence the case, that expensive and time consuming investigation is only undertaken if the investor believes enough in the claim.
The belief very much turns on the persuasiveness of the prosecuting lawyer’s analysis. All that goes into an investor’s trust and belief in the lawyer’s analysis — such as the lawyer’s reputation, responsiveness, and commitment to the claim; the lawyer’s credibility, conscientiousness, distinction, plus those of the lawyer’s law firm; and the chemistry between the lawyer and investor — come into play here.
Early on especially, the investor places great weight on the time the lawyer and firm have spent reviewing the case. This indicates how reliable the analysis is. Indeed, if for no other reason, this exercise reveals the depth of a lawyer’s commitment to the case, since it is usually done on a contingency or partial contingency basis, reflecting the lawyer’s willingness to put “skin in the game.” Some investors will not even take a peek at a case unless a lawyer has been actively involved.
Shapes and Shades
Jockeys come in many shapes and shades. Each must be evaluated and retained in light of that specific shape and form, and how they fit with: the unique claim and claimant at hand; as well as the unique investor involved and that investor’s preferences or requirements.
Within this context, we also see a quite – limited number of lawyers, and law firms, taking active affirmative steps to become user-friendly to attract financing to their cases, as well as to attract new clients and cases needing funding. They see the benefit to their clients and their business. They are going up the experience and skill curve in their mission to achieve a solid competitive edge in a new world.
That task is a full time job. Law firms are working within a developing and changing context — often dramatically, virtually day by day. It is no small chore for each of the stakeholders to stay abreast. The law service industry’s ability to keep up, let alone excel, is indispensable. That ability will determine whether a law firm and lawyer will make the grade so far as the investor is concerned.
Risk and Cost
The lawyer’s willingness to share the risk though its fee structure is key. A lawyer prepared to discount fees such that a loss in the case means at least a partial loss for the lawyer, is perhaps the most tangible evidence of that lawyer’s faith in the case. Of course the flip side of a discount is a serious premium if the case is successful. The premium is considered by the investor as well as the discount, in measuring the lawyer’s belief in the case. Some investors will not even consider a claim where the lawyer is not prepared to take a risk with the investor.
The lawyer’s fee is usually divided between the investor and the claimant. That division holds its own importance in the investing world. Typical questions and factors resulting in sharing agreements are in summary form illustrated below.
First question: what fee-discount will be accepted by the lawyer and investor? In the past, lawyers typically were asked (usually required by the investor) to work with a discount in the range of 25% of standard rates, and to settle for that fee if the claim were unsuccessful. If the claim were successful, the lawyer would receive the balance of the fee, plus a premium of about 25%.
This structure has the attraction for a lawyer in that even in a loss situation, the lawyers should make a profit from the work, while the lawyers could look forward, based on their analysis and choice of the case, to earning a premium with every win. In the end, this situation, properly managed, should result in higher returns for the lawyer than simply charging the lawyer’s standard rates.
This attractiveness was and is heightened in an environment where law firms have weathered a stormy economy, leaving them on the lookout for work. The storm, while partially abated, is a ways from being over. It is leaving behind changed financial and legal industries.
Earlier on — perhaps five or six years ago — lawyers were by and large wary of litigation funding. That attitude has changed markedly with increased knowledge, understanding, and acceptance, of third party finance, coupled with the ongoing lack of sufficient legal work.
As time has passed, the funding basic fee platform has changed. Investors have sought a deeper discount, often in the 35% to 40% range (if not higher), with a corresponding increase in the premium on success. At the same time, and perhaps in some ways as a result of the deeper discount required, law firms are more frequently now asking for something beyond a premium, but also a percentage of the recovery. That percentage has a wide range — as illustrations: it can easily be between 3% and 10%.
The investor usually does not object to this percentage but can support it. Why? Because the percentage is something the claimant, not the investor, is asked to pay. Receipt by the law firm of this percentage might also, as indicated above, contribute to the law firm’s willingness to take a steeper discount, all to the investor’s benefit.
The percentage can, in addition, support an investor’s requiring the lawyers to agree to other contributions. In this sense, there are two common potential concerns that investors, and claimants, always face with lawyers’ fees.
First, there is a runaway-fee hazard. Neither the investor nor the claimant wishes to be a victim here. Investors typically ask for and get strict budgets for the work, and the lawyers’ agreement to meet them. If exceeded, that is work the lawyers agree to absorb, without charge to the investor or claimant. Ceilings on fees are, in one form or another, imposed.
Second, we see the “waterfall issue”: On distributions from a success, a waterfall is set governing who gets paid first and as a priority, who gets paid second, and so on. Investors will want that distribution to be first and entirely to them, until at least a certain healthy profit is assured. This is a safety net crucial to investors. It protects them from a disappointing recovery, since they can still do well, while little or nothing is left for the lawyers or the claimant.
This issue is especially acute when the law firm is a “contingency law firm” working on a full-contingency base as to fees (and with some firms, also as to out – of – pocket expenses). That firm is usually committed and used to getting paid first out of any recovery.
The tension can be expected in many if not most cases. It is more severe when the investor is particularly concerned about security in getting the investment back, plus a reasonable profit, rather than an outsized return. The tension naturally becomes less severe as the likelihood increases of a recovery that will be enough to satisfy all the stakeholders.
One important caveat to this should be self-evident, but is worth emphasizing: lawyers need to be able to perform and compete as jockeys, but they should as a rule stay away from also trying to assist in finding and negotiating financing for their client. That is usually outside their competence. Trying to assist on the financing side also draws them into the complicated land of lawyer’s ethics, and duties owed by a lawyer to a client. Potential and actual conflicts alone present a scary land-mine of fault areas.
See e.g.,Selvyn Seidel and Sandra Sherman, Lawyers’ “Competence” in the Funding World, New York Dispute Resolution Lawyer (Fall issue, 2014); See generally, Information Report to the House of Delegate, American Bar Association Commission on Ethics 20/20 (February 2012); For a significant Bar Association opinion on Legal Ethics in Funding, see N.Y.C. Bar Ass’n Comm. on Prof’l and Judicial Ethics, Formal Op. 2011-02 (2011).
The litigating lawyer is of dead-centre importance to the financing industry. In ways, that lawyer is the “straw that stirs the drink”. The more this is understood, and the better the stirring, the better off for all.
Selvyn Seidel is the Founder, and Chairman of Fulbrook Capital Management LLC; and the Co-Founder, and former Chairman of Burford Group Inc. Neil Mitchell, the President of Fulbrook, provided valuable assistance for this article.
New York Dispute Resolution Lawyer – a publication of the Dispute Resolution Section of the New York State Bar Association
by Selvyn Seidel and Sandra Sherman
Corporate LiveWire’s Expert Guide
by Selvyn Seidel and Sandra Sherman
Click here to view article.
Excerpted from ICC publication Dossier X: Third-Party Funding in International Arbitration, Chapter 3
by Selvyn Seidel and Sandra Sherman
Excerpted from ICC publication Dossier X: Third-Party Funding in International Arbitration, Chapter 2
by Selvyn Seidel, Chairman and CEO, Fulbrook Capital Management LLC
Sandra Sherman and Bahar D. Simani, both from Fulbrook Capital Management LLC, made invaluable and much appreciated contributions to this article.
by Selvyn Seidel
Commercial Dispute Resolution Magazine
by Selvyn Seidel
A long smouldering issue in the third-party funding industry relates to what might be called the control doctrine. “Control” in this context has generally been understood to mean “decision making authority,” the basic purport being that decision making must remain with the claimant, with advice from their lawyer. The funder can consult and advise, but only within that fenced-in area.
The control doctrine and its current status as an inhibitor
Funders have always been challenged on the ground that they, as third parties, should be prohibited from taking over control of another’s claim.1 A key flash point has been the decision regarding whether to settle a case. This decision, which is central to any dispute, can and does generate conflicting interests and positions between the claimant and the funder. The control doctrine says that this decision remains with the claimant (on advice of counsel) at all times.
In some jurisdictions such as the UK, the control doctrine also means that the claim owner might be handicapped or prohibited altogether from selling the claim in its entirety. In the US, sale of the entire claim has been condemned in different circles – such as where patent claimants sell their claim to a third party to prosecute it as that party’s own. The buyers in such instances are often non-practicing entities (NPEs), more commonly known as patent trolls.
For one who runs afoul of the control doctrine, the penalties can be painful. They range from making the funding agreement unenforceable to imposing sanctions on the funder, exposing the funder to civil and ethical liability or perhaps even to criminal sanctions.
The purpose and policy behind these restrictions and prohibitions are varied and not subject to convenient and comprehensive summary. But they seem traceable to at least several concerns. One is that a claim is personal to the holder, to have and to hold until death do them part. The two simply cannot be delinked through commercial barter or otherwise.
According to some observers, it is also wrong to consider parting the owner from the claim. Comparisons are sometimes made with elderly people’s interests in life proceeds from insurance policies, on grounds that here too the owner should not be divorced from his or her right. Comparisons are also made to sales of interests in patents.
Basic champerty concerns have underpinned the purpose and policy pronouncements. Champerty has from its birth in the Middle Ages reflected concerns that a claimant is generally in such a helpless position that it is vulnerable to a third party purchaser taking advantage of it in the transfer. The champerty champions also fear that free trade in claims enhances the possibility that litigation will itself be increased intolerably by mercenaries.
The doctrine of control has thus far been respected by the industry. Actually, it might be said that the industry has gone overboard in its deference to and fear of the doctrine. For example, the common position of established members of the funding industry is that once a case is funded, they are “hands off.” That position reflects champerty-fear at work.
Despite the doctrine’s long history and serious challenges to the funding industry, the doctrine itself is now not only being challenged, it is in fact being diluted and discarded.
Why the control doctrine is on its way out
Critics of the control doctrine have, in strictly limited numbers, just started to step up. Moreover, without fanfare, the doctrine is in reality already gone or rapidly receding
in important areas. For example, the transfer of control has been allowed in part or in its entirety in a number of situations, including when a mortgagee transfers its total interest to a third party (which has already occurred in New York where the mortgagees have on default of mortgagor sold the claims to another);2 in bankruptcy claims; and in certain European and Far Eastern jurisdictions. In June, 2010, the New York City Bar Association issued an ethics opinion on funding, indicating that control was acceptable. Consider this alongside the contingency law relationship of lawyer to claimant and claim, where the law in the US has carved an “exception” of contingency lawyering from the champerty restrictions.
Further, at the urging of the bench, bar and government in the UK, a group of funders issued a voluntary Code of Conduct in November 2011. Despite the drafters’ expressed position that restraints on control should in general exist, the Code’s language concerning “control” appears to leave some ambiguities that allow for influence, and more, on the part of the funders.
The Code provides:
“A Funder will . . . not seek to influence the Litigant’s solicitor or barrister to cede control or conduct of the dispute to the Funder. . . ” (Clause 7 (c))
Within the four corners of this Code, can the funder accept control if it does not seek control but the lawyer or barrister offer it? Beyond this, can the funder sidestep the lawyer altogether and go directly to the claim owner itself and ask it to cede control, rather than going to the lawyers?
The Code might even be construed as creating an “accommodation” for funders seeking influence. It states that where there is an irreconcilable difference of opinion between the funder and the claimant, the parties can agree in their contract to appoint an independent barrister to resolve the dispute fully and finally, and even though contrary to the wishes of the claim owner (or the funder). Can this provision sustain an attack that it actually crosses the line, giving the funder too much influence? It is not too far-fetched to raise this question when we see that some arguments have already surfaced claiming that a funder who establishes certain parameters – agreed to at the beginning of the contract with the claimant – that assist in determining whether the case should be settled, are themselves going too far in “controlling” a settlement situation.
Furthermore, there is now a serious development in the industry where some recently-established funders (including Fulbrook) are acknowledging they are not “hands off,” but are “hands on.” They assert that they are dedicated to supporting the claim after funding, from cradle to grave. They stop short of control, of course, but turn the dial from “hands off” to “hands on.” Their premise is that if the claim is meritorious, then they can, by bringing their human and capital resources to bear, enhance the value of the claim more towards its true value.
The doctrine needs a push to finish it exit
Do not these developments and the current situation tell us that it is time to revisit the doctrine and explicitly clarify, change, or even discard it? Prior to now, it was probably politically premature to raise this question too loudly (or at all). The industry was too new, struggling with too many issues, and trying to gain some traction and credibility as a new development, to add a question about a doctrine which had become so entrenched.
Now, with the industry gaining credibility and use, champerty concerns fading in the commercial area, the doctrine itself causing conspicuous problems, and with other developments in the industry that cushion the removal of the doctrine, it seems to be a reasonable time to ask this question.
In fact, the time is especially ripe in view of some developments in the UK. For example, in the UK a law will come into effect in April 2013 which in effect allows lawyers to act as contingency lawyers. This practice has been allowed in the US for a long time; it is frequently compared to funding insofar as what third parties might be allowed to do with regard to another’s claim, and it is treated as an exception to the champerty rules. This major development in the UK reflects a mindset that comprehends third-party support of a claim. That should bode well for the funding industry, and the market.
It is also noteworthy that with the recent launch in the UK of the Alternative Business Structures Act, third party business and finance parties can invest in law firms, and also be partners within such firms. Among other things, and although there are restrictions on amounts that can be invested and the degree of involvement of the third party to make decisions in the lawsuit, this arrangement allows third parties to put funds behind a claim, and to be involved in the progress of the dispute. The law firms can in turn commit capital to various business ventures. The Alternative Business Structures Act is affirming, in one fashion or another, the concept of a third party non-lawyer’s involving itself in a lawsuit, and indeed in a law firm.
Interested parties have been quietly and for some time undermining and abolishing the control rules. A perfect example can be drawn from the corporate world. Here, there is no doubt that a third party can buy control of a company through, say, acquiring 30% with a stockholders agreement bestowing control over the company. That control leaves complete control over any litigation in the company. The control is vested in a party who likely has little idea what the litigation is about, let alone the best way to handle it. If that is acceptable, what justification can there be to barring control in a single case situation, particularly when the control in that case should be far more informed and beneficial to a meritorious claim?
Similar questions can be asked about a private equity party which buys a company, and is free to control it and its litigations. In a forthcoming article, Professor Maya Steinitz, a leading expert on funding, argues that funders are analogous to venture capitalists, and that like such investors they should be accorded the right to exercise substantial control over a lawsuit.3
In such a setting, is explicitly acknowledging the right to control such a revolutionary step? Mortgage, bankruptcy, and patent cases already say the claim can be transferred lock, stock and barrel, or that a partial interest can be taken by a third party. Contingency law supports the same conclusion. Some courts both within and outside the UK and US have already indicated that this is possible. The New York City Bar association has indicated support for a funder’s taking control under circumstances that otherwise comply with a lawyer’s ethical duties.
In this context it is worth noting that the doctrine of champerty itself has been debunked in the UK with legislation and court decisions. It has, overall, fared somewhat badly in the US as well, with at least half the states abolishing the doctrine altogether, and others restricting severely or prohibiting its application when commercial cases are involved.4
As a result, champerty and maintenance no longer can be used as they were to argue that funding is by nature illegal and unethical. Courts in the UK, the US and Australia leave little doubt here.
Champerty’s marginalisation in the commercial setting is well justified. The original purpose of a limitation on a claimant’s transferring control over the claim – protecting the claimant as a self-appointed trustee – is no longer alive because that claimant is not helpless and in need of a guardian, but commercial.
Indeed, it is the claimant that often wants the option to transfer control, in return for cash or other consideration. The prohibition is in fact a restraint on freedom of contract. Moreover, it turns a deaf ear to the market. If an informed market wants access to funding, and thus to all the potential features of a funding arrangement, who in the government should be authorised to thwart that wish and to deny access as a matter of public policy?
Second, since the predicate of a funded case is its merit, the doctrine of champerty serves no public policy purpose. True, the courts may be overcrowded, but that is not a reason to bar access by good claimants with good claims. To the extent that there is a fear that bad funders will support bad claims and increase the frivolous population in the courts, it should be addressed sufficiently by safeguards and rules already in the legal system, and other rules that if needed can be devised.
Third, supporting good claims by supporting good funding adds a financial instrument and service to an economic environment that needs them. These add to both commercial and civil justice, and this virtue is at the heart of the value of funding.
Exit a doctrine, enter some new rules
It is thus submitted that no genuine question should exist about whether the control doctrine deserves to be buried. The only valid questions here are how related rules and other protections that already exist can be co-ordinated with this development, and what new rules and protections might be put in place. These questions can be illustrated by asking how control enhances the funders’ exposure to:
With the industry and market active and growing, this project cannot be put on the back burner. All stakeholders in the market, industry, and among the defendant community, should step up in this effort – it affects each and every interest.
Hopefully enough individuals will take an ownership interest in the area and make an effort to study the issues and help to enact good rules that will protect the market, the funders, and the defendants. The time to start this is today, not tomorrow.
1 See S. Seidel, Control, Commercial Dispute Resolution Magazine, September 2011.
2 S. Seidel, “Investing in Commercial Claims: New York Perspective,” NYSBA New York Dispute Resolution Lawyer, Spring, 2011
3 Maya Steinitz, The Litigation Finance Contract, forthcoming, William & Mary L. Rev. __ (2012), http://papers. ssrn.com/sol3/papers.cfm?abstract-id=2049528, comparing Funders to Hedge Funds and Private Equity entities, and indicating that these comparisons support allowing greater influence by Funders coupled with greater responsibilities.
4 See e.g., Anthony Sebok, The Inauthentic Claim, 64 Vanderbilt Law Review 61, 30 January 2011, http://papers.ssrn.com/sol3/papers. cfm?abstract_id=1593329.. http:// papers. Ssrn.com/sol3/papers. cfm?abstract-id=1593329##