Can a North Carolina lawyer invest in a litigation-finance fund that advances money to plaintiffs and law firms for a share of recoveries?

Plain-English summary

The opinion addresses an associate who wants to invest, through a "feeder fund," in a litigation-finance Fund that advances money to plaintiffs or law firms in commercial litigation in exchange for a share of any recovery, with the advances used to pay litigation expenses and attorney fees. The associate would not refer clients to the Fund or control its decisions, and the Fund does not disclose its clients to investors. The Fund might advance money to the associate's firm, to a plaintiff the firm represents, or to a party opposing the firm. The committee concludes the lawyer may not invest.

The opinion first recognizes that alternative litigation-financing arrangements can be permissible (2000 FEO 4, 2005 FEO 12, 2018 FEO 4), but a lawyer may never let a financing arrangement interfere with the duty to act in the client's best interest (Rule 1.7, cmt. [10]), as in 2006 FEO 2. Applying Rule 1.7(a)(2), the committee finds that the Fund's profit goal may not align with a recipient's best interests, and that if the lawyer learns during a representation that a client or opposing party received money from the Fund, the lawyer would have a conflict requiring disclosure and consent under Rule 1.7(b). Because that latent conflict exists before any representation and the lawyer cannot obtain informed consent to it in advance (Rule 1.7, cmt. [3]), the investment is prohibited.

The opinion adds two independent Rule 1.8 grounds. Rule 1.8(e) bars financial assistance to a client in connection with pending or contemplated litigation beyond court costs and expenses, and the Fund's advances pay litigation expenses and attorney fees (relying on N.Y. State Bar Op. 1145 (2018)); through the lawyer's investment, this would be assisting a violation under Rule 8.4(a). Rule 1.8(i) bars a lawyer from acquiring a proprietary interest in the cause of action or subject matter of litigation the lawyer is conducting, except a lien or a reasonable contingent fee; the Fund acquires a prohibited proprietary interest in clients' claims, and as an investor the lawyer would too. Neither Rule 1.8(e) nor Rule 1.8(i) has an informed-consent exception, and the conflicts are imputed to all lawyers in the firm under Rule 1.8(j). The lawyer therefore may not invest so long as there is a possibility the Fund will advance money to the firm, a plaintiff the firm represents, or an opposing party.

In practice

Under the North Carolina rules as they stood at the time of the opinion, a lawyer may not invest in a litigation-finance fund where the fund might advance money to the lawyer's firm, a firm client, or an opposing party. The opinion treats the arrangement as creating a latent Rule 1.7(a)(2) conflict that arises if the lawyer learns a client or opposing party took fund money; because that conflict precedes representation and cannot be cured by advance informed consent, the investment is barred.

The opinion holds that the investment also violates Rule 1.8(e) (the fund's advances cover litigation expenses and attorney fees, which a lawyer may not provide, with Rule 8.4(a) reaching acts through another) and Rule 1.8(i) (the fund, and the investing lawyer, would acquire a prohibited proprietary interest in clients' claims). Neither rule has a consent exception, and both prohibitions are imputed to the whole firm under Rule 1.8(j). The opinion distinguishes permissible financing arrangements approved in 2000 FEO 4, 2005 FEO 12, and 2018 FEO 4.

Common questions

Q: Can a North Carolina lawyer invest in a litigation-finance fund?

A: No, where the fund might advance money to the lawyer's firm, a firm client, or an opposing party. The opinion concludes such an investment is prohibited by Rule 1.7 and by Rule 1.8(e) and 1.8(i).

Q: Why can't the conflict just be waived?

A: The opinion concludes the conflict is latent and exists before any representation, so the lawyer cannot obtain informed consent to it in advance (Rule 1.7, cmt. [3]); and the Rule 1.8(e) and 1.8(i) prohibitions have no informed-consent exception at all.

Q: How do Rule 1.8(e) and 1.8(i) apply?

A: The opinion concludes the fund's advances pay litigation expenses and attorney fees, which a lawyer may not provide (Rule 1.8(e); Rule 8.4(a) for acting through another), and the fund acquires a prohibited proprietary interest in clients' claims, which the investing lawyer would share (Rule 1.8(i)).

Q: Does this affect the lawyer's whole firm?

A: Yes. The opinion notes that the Rule 1.8 prohibitions are imputed to all lawyers associated in the firm under Rule 1.8(j).

Q: Are litigation-financing arrangements ever allowed?

A: Yes, in other contexts. The opinion notes prior opinions approving certain financing arrangements (2000 FEO 4, 2005 FEO 12, 2018 FEO 4), but a lawyer may never let the arrangement interfere with the duty to act in the client's best interest.

Background and rules framework

The opinion interprets the conflict and financial-assistance rules. Rule 1.7 (Model Rule 1.7) bars a representation materially limited by the lawyer's personal interest (Rule 1.7(a)(2)) and requires informed consent where a conflict can be waived (Rule 1.7(b)); comments [3] and [10] address pre-representation conflicts and financing arrangements that could interfere with the client's interest. Rule 1.8(e) (Model Rule 1.8) bars financial assistance to a client in connection with litigation beyond court costs and expenses; Rule 1.8(i) bars acquiring a proprietary interest in the cause of action, except a lien or reasonable contingent fee; and Rule 1.8(j) imputes the paragraph (a)-(i) prohibitions to all lawyers in a firm. Rule 8.4(a) (Model Rule 8.4) bars violating the Rules through the acts of another.

The opinion draws on prior North Carolina opinions approving certain financing arrangements (2000 FEO 4, 2005 FEO 12, 2018 FEO 4) and limiting them (2006 FEO 2), and on N.Y. State Bar Op. 1145 (2018) for the point that a lawyer may not advance non-contingent attorney fees.

Citations and references

Rules of Professional Conduct:

• Model Rule 1.7 / NC Rule 1.7(a)(2), 1.7(b) and cmts. [3], [10] (material-limitation conflict; financing must not interfere with the client's interest)
• Model Rule 1.8 / NC Rule 1.8(e) (no financial assistance beyond litigation costs and expenses)
• Model Rule 1.8 / NC Rule 1.8(i) (no proprietary interest in the cause of action)
• Model Rule 1.8 / NC Rule 1.8(j) (imputation of paragraph (a)-(i) prohibitions to the firm)
• Model Rule 8.4 / NC Rule 8.4(a) (violating the Rules through the acts of another)

Other opinions cited:

• 2000 FEO 4; 2005 FEO 12; 2018 FEO 4: permissible litigation-financing arrangements.
• 2006 FEO 2: a finder's fee or referral merely to get paid is impermissible.
• N.Y. State Bar Op. 1145 (2018): a lawyer may not advance attorney fees billed on a non-contingency basis.

See also

• Illinois Bar Op. 19-02: Helping a Client Obtain Third-Party Litigation Financing
• Nevada Bar Op. 36: Borrowing Funds to Finance Litigation Costs
• NC State Bar Op. 2018 FEO 4: On-Site Access to a Legal Fee Financing Broker

Source

• Landing page: https://www.ncbar.gov/for-lawyers/ethics-and-governing-rules/ethics-opinions/opinions/2020-formal-ethics-opinion-4/

Original opinion text

Reproduced from the official source for research purposes. The linked source is authoritative.

Facts:

Lawyer is an associate at Law Firm. Lawyer has no control over Law Firm’s selection of clients or matters. Fund is an investment vehicle that provides litigation financing. Fund advances money to plaintiffs or law firms in commercial litigation in exchange for a share of any recovery. The money advanced by Fund is used to pay litigation expenses and attorney fees. Fund makes numerous investments on behalf of its partners, with the goal of turning a profit. Fund’s profits are passed through to investors pro rata.

Lawyer would like to invest in a “feeder fund” that aggregates smaller investments and invests the larger total in Fund in order to meet Fund’s investment minimums. Lawyer will not refer clients to Fund and will have no control over Fund’s investment decisions. Fund does not disclose the identity of their clients to their investors (if at all) until the litigation matter is concluded.

It is possible that Fund would advance money to Law Firm to support litigation that Firm is handling on behalf of a plaintiff or directly to a plaintiff that is represented by Law firm. It is also possible that Fund would advance money to support a plaintiff or law firm in litigation where Firm is representing the defendant. If Law Firm represents a plaintiff that has obtained money from Fund, Law Firm’s litigation team for the case will likely be aware of the client’s transaction with Fund. If a client’s opponent obtains money from Fund, it is unlikely that Lawyer or Law Firm would learn about the transaction. However, if a court ordered disclosure in discovery of litigation finance agreements, Firm’s litigation team on the particular matter would learn of the transaction with Fund.

Inquiry:

May Lawyer invest in Fund?

Opinion:

No.

Several prior ethics opinions have approved alternative litigation financing arrangements. In 2000 FEO 4, the Ethics Committee concluded that a lawyer may refer a personal injury client to a finance company that would advance funds to the client in exchange for an interest in any recovery the client might obtain. In 2005 FEO 12, the Ethics Committee concluded that a lawyer may obtain litigation funding from a financing company. In 2018 FEO 4, the Ethics Committee concluded that a lawyer may offer clients on-site access to a financial brokerage company as a payment option for legal fees.

Although an alternative litigation financing arrangement may be permissible, a lawyer may never allow the financing arrangement to interfere with his duty to act in the best interests of his client. See Rule 1.7, cmt. [10]. In that regard, the Ethics Committee concluded in 2006 FEO 2 that a lawyer may not refer a client to a company that pays a lump sum to a client in exchange for the client’s interest in a structured settlement if the lawyer receives a “finder’s fee” from the company in exchange for the referral. Furthermore, the opinion rules that the lawyer may not refer a client to the company merely as a means of paying the lawyer for his legal services. The lawyer’s interest in obtaining a finder’s fee or in getting paid from the lump sum could interfere with the lawyer’s duty to act in the client’s best interest.

So too, Lawyer may not invest in Fund if the investment will compromise his professional responsibilities to Lawyer’s current or future clients. Rule 1.7(a)(2). Fund advances money to plaintiffs or law firms in commercial litigation in exchange for a share of any recovery. Fund’s goal of turning a profit may not align with the best interests of a particular recipient of money from Fund. If a firm client, or an opposing party to a firm client, independently contracts with Fund to obtain litigation financing, and Lawyer has no knowledge of the arrangement, it is unlikely that Lawyer’s independent professional judgment will be affected by the financial arrangement. However, if Lawyer learns during the representation that a client or opposing party has received money from Fund, Lawyer would then have a duty to disclose the conflict to Firm’s client and seek consent. Rule 1.7(b). The possibility of a conflict arising in the midst of litigation based on Lawyer’s investment in Fund necessarily means that Lawyer is putting his own interest in receiving a return from Fund over a potential client’s interest to be represented by a lawyer without conflict. Comment [3] to Rule 1.7 states that when a conflict of interest exists before representation is undertaken, the representation much be declined, unless the lawyer obtains the informed consent of the client. The potential latent conflict that exists, to which Lawyer is unable to obtain informed consent, prohibits Lawyer from investing in Fund.

In addition to the prohibitions set out in Rule 1.7, Lawyer is also prohibited from investing in Fund due to prohibitions set out in Rule 1.8. Rule 1.8(e) prohibits lawyers from providing clients with financial assistance in connection with pending or contemplated litigation with limited exceptions. A violation of Rule 1.8(e) arises because the payments from Fund would constitute financial assistance to Lawyer’s client. While Lawyers may advance court costs and expenses of litigation, money advanced by Fund is used to pay litigation expenses and attorney fees. Lawyers are not permitted to advance financial assistance that includes lawyer’s fees billed on a non-contingency basis. N.Y. State Bar Ass’n Comm. on Prof’l Ethics, Op. 1145 (2018); see also Rule 8.4(a) (lawyer may not violate Rules of Professional Conduct through the acts of another.)

Lawyer is also prohibited from investing in Fund by Rule 1.8(i), which provides that a lawyer may not acquire a proprietary interest in the cause of action or subject matter of litigation the lawyer is conducting for a client, except for a lien authorized by law or a reasonable contingent fee in a civil case. Rule 1.8(i) is designed to avoid giving a lawyer too great an interest in the representation. By providing money to Lawyer’s client in exchange for a share of any recovery, Fund would acquire a prohibited proprietary interest in the client’s claim. As an investor in Fund, Lawyer would also acquire a prohibited proprietary interest.

While there is only the possibility that the conflicts addressed in Rule 1.8(e) or Rule 1.8(i) may arise if Lawyer invests in Fund, there are no informed consent exceptions to either Rule. Furthermore, the conflict issues raised by Rule 1.8 in relation to Lawyer’s investment in Fund would be imputed to all lawyers associated with Law Firm. See Rule 1.8(j) (while lawyers are associated in a firm, a prohibition in paragraphs (a) through (i), that applies to any one of them applies to all of them). Therefore, Lawyer may not invest in Fund so long as there is a possibility that Fund will advance money to either Lawyer’s firm, to a plaintiff represented by Lawyer’s firm, or to a plaintiff or law firm that is on the opposite side of litigation with Lawyer’s firm.