Litigations Financing Statutes
State statutes on expense financing:
State of Kentucky
KBA E-420
11/15/02
Subject: Lawyer Borrowing Litigation Costs and Granting Lender a Security Interest in Lawyer’s Contingent Fee
Question 1: May a lawyer who represents a client under a contingent fee contract borrow funds from a lending institution to cover litigation expenses?
Answer: Yes, subject to the cautions set forth below.
Question 2: May the lawyer pass the interest on the loan (along with other related fees) on to the client by deducting them from the proceeds of a judgment or settlement before computing the net sum owed to the client?
Answer: Yes, subject to the cautions set forth below.
Question 3: May the lawyer give a lender a security interest in the contingent fee in a particular case?
Answer: No, for reasons set forth below.
Principal References: Utah State Bar Ethics Advisory Opinion 02-01 (2002); Ohio Board of Commissioners on Grievances and Discipline Opinion 2001-3 (2001); Utah State Bar Ethics Advisory Opinion 97-11 (1997); KBA Ethics Opinions E-216 (1979); Chittenden v. State Farm Mutual Automobile Insurance Co., 788 So.2d 1140 (La. 2001); S.C.R. 3.130 [Kentucky Rules of Professional Conduct], Rules 1.4, 1.5, 1.6, 1.7, 1.8, 5.4.
Opinion:
The inquiry before the Committee raises the question of whether, in a contingent fee case, a lawyer may borrow funds from a lending institution to pay litigation costs. The inquiry raises a further issue as to whether the lawyer may pass the interest and related loan fees on to the client, deducting them from the proceeds of the judgment or settlement in the same manner as other disbursements. The final question raised is whether the lawyer may grant the lender a security interest in the lawyer’s contingent fee as collateral for the loan.
I. Borrowing Litigation Costs from a Lending Institution
We begin with the issues of financial assistance to clients and lawyer borrowing. Rule 1.8 reflects the common law rule against providing financial support to a client “in connection with pending or contemplated litigation.” The concern is that if a lawyer acquires a stake in the outcome, his or her ability to exercise independent judgment on behalf of the client may be impaired. Yet, despite this potential conflict, the prohibition has never been absolute. Rule 1.8(e)(1) embodies a long-standing exception to this general principle by providing that “[a] lawyer may advance court costs and expenses of litigation.” This exception reflects the reality that, without financial assistance to cover litigation costs and expenses, some clients would be unable to pursue their claims.
The inquiry before the Committee adds an additional layer of complexity to the transaction by interjecting a third party — the lending institution — into the relationship. The inquiry contemplates that rather than the lawyer lending his or her own funds to cover litigation costs and expenses, the lawyer will borrow the money from a lending institution. Upon conclusion of the case, the client will be obligated to reimburse the lawyer for the advanced litigation costs, along with interest charges and any related lender fees.
Although nothing in Rule 1.8(e) specifically prohibits a lawyer from borrowing money to cover litigation costs and expenses on behalf of a client, other relevant ethical rules, particularly those relating to personal conflicts of interest, client confidentiality and the lawyer’s independent judgment, must be considered.
By borrowing money from a lending institution to cover advancements for costs and expenses, the lawyer assumes both a financial obligation and a debt management responsibility in the litigation. If these burdens become too great, particularly if a case becomes protracted, the lawyer’s fidelity to the client could be compromised by the lawyer’s perceived need to conclude the representation on a basis that will allow the loan to be paid and the attendant burdens to be lifted. These same observations might be made of any situation in which the lawyer has advanced costs and expenses to a client from personal funds or where a contingent fee is involved. Although we recognize the potential personal conflicts inherent with advancement of litigation costs and contingent fees, we permit these arrangements — subject to Rule 1.7 — because they benefit the client and may provide the only means by which a client can pursue his or her claim.
But borrowing money from a lending institution to finance litigation expenses raises additional risks not present when the lawyer merely advances personal funds or takes a case on a contingent fee. Where a lending institution is involved, it might attempt to influence the lawyer’s handling of a case in order to ensure timely repayment of the loan. Similarly, it might seek information about a case or its status and the client’s right to confidentiality under Rule 1.6 might be jeopardized. These risks are substantially reduced if the loan is not tied to a particular case, but rather is a line of credit upon which the lawyer may draw upon for any case. In any event, the Committee recognizes that there are some risks, but also recognizes the client’s interest in having adequate funds available to cover litigation costs and expenses. As a recent Ohio opinion observed:
Since clients are not always financially able to obtain a loan to finance the expenses of litigation, the clients look to lawyers to advance the expenses of litigation. Depending upon the lawyer’s financial position, a lawyer may need to obtain a loan in order to advance the litigation expenses. As a fiduciary for the client, the lawyer must negotiate appropriate and reasonable loan terms. Ohio Board of Commissioners on Grievances and Discipline Opinion 2001-3 (2001)
A number of other jurisdictions have addressed litigation-financing arrangements similar to those described above. Although many have acknowledged the potential problems discussed here, the overwhelming majority has concluded that such arrangements are permissible. See, e.g.,Chittenden v. State Farm Mutual Automobile Insurance Co., 788 So.2d 1140 (La. 2001); Utah State Bar Ethics Advisory Opinion 02-01 (2002); Ohio Board of Commissioners on Grievances and Discipline Opinion 2001-3 (2001); Association of the Bar of the City of New York Committee on Professional and Judicial Ethics Opinion 1997-1 (1997); Georgia Advisory Opinion 92-1 (1992). State Bar of Texas Opinion 465 (1990); New Jersey Supreme Court Advisory Committee on Professional Ethics Opinion 603 (1987).
The committee is in agreement with those jurisdictions that have authorized the lawyer to borrow funds to finance litigation costs and expenses. In our view, the rules do not prohibit such a loan transaction, as long as the lawyer guards against improper influences and improper disclosure of client confidences.
II. Charging the Client Interest on the Loan and Deducting It from Proceeds
The next question is whether a lawyer who borrows money from a lending institution can pass the interest charges and other related expenses on to the client. In KBA E-216, this Committee decided that with “full consent and disclosure” the lawyer could charge interest on advancements made from the lawyer’s own funds. In the Committee’s view, “an interest charge on advancements would seem to be only a further expense of the litigation and as such could be charged against the client.” From the client’s financial perspective, there is no difference between charging the client interest on the lawyer’s money and charging the client interest on the financial institution’s money — both are expenses occasioned by the litigation. See also, Ohio Board of Commissioners on Grievances and Discipline Opinion 2001-3 (2001).
But the inquiry does not end here. Recent decisions from other jurisdictions, as well as the current Rules of Professional Conduct, suggest that much more is required that mere consent and disclosure. Of particular importance are the rules dealing with client communications, business transactions and fees.
We begin with Rule 1.4, which addresses the importance of keeping the client informed and of explaining matters to the extent reasonably necessary to permit a client to make informed decisions. Thus, in the context of this inquiry, it would appear that the loan and other fees, along with the interest rate and its method of calculation, must be explained fully to the client and the client must consent. See, e.g., New Jersey Supreme Court Advisory Committee on Professional Ethics Opinion 603 (1987).
Moreover, once the advancement authorized by 1.8(e) take the form of a loan with interest, it takes on the characteristics of a business transaction and is subject to the mandates of Rule 1.8(a). See, American Law Institute, Restatement (Third) of the Law Governing Lawyers § 36, comment c (lawyer may advance costs and expenses of litigation, with client to repay the advance from proceeds of case, but any greater obligation on the part of the client, such as payment of interest, subjects the arrangement to rules governing business transactions between a lawyer and client).
Business transactions covered by Rule 1.8(a) must be “fair and reasonable.” This assumes, among other things, that the charges to the client are reasonable in amount, that they do not exceed those paid by the lawyer, and that the lawyer does not have an interest in the financial institution that would violate Rule 1.7(b). See, e.g., Association of the Bar of the City of New York Op. 1997-1 (1997). Moreover, Rule 1.8(a) requires that the arrangement be “fully disclosed and transmitted in writing to the client in a manner which can be reasonably understood by the client.” In addition, the client must have a “reasonable opportunity to seek the advice of independent counsel” and must “consent in writing.” See, e.g. Ohio Board of Commissioners on Grievances and Discipline Opinion 2001-3 (2001).
This particular inquiry relates to a contingent fee case. Consequently, Rule 1.5(c) must be considered, because it sets out certain requirements about both the agreement’s form and its content. Specifically, it provides as follows: A contingent fee agreement shall be in writing and should state the method by which the fee is to be determined, including the percentage or percentages that shall accrue to the lawyer in the event of settlement, trial or appeal, litigation and other expenses to be deducted from the recovery, and whether such expenses are to be deducted before or after the contingent fee is calculated.
Thus, in the context of this inquiry, the contingent fee agreement must be in writing and must explain how the interest will be calculated, and that the interest and other loan related expenses will be deducted from the settlement or judgment as an expense of litigation. The contingent fee agreement also must clearly state whether contingent fee percentages are computed before or after the deduction of these expenses. Finally, the agreement must advise the client of whether the duty to repay litigation expenses (including interest) is contingent upon the outcome of the case. See, e.g., Ohio Board of Commissioners on Grievances and Discipline Opinion 2001-3 (2001); Chittenden v. State Farm Mutual Automobile Insurance Company, 788 So.2d 1140 (La. 2001); Association of the Bar of the City of New York Formal Opinion 1997-1 (1997).
The duty to inform the client about fees and other charges extends beyond the initial agreement. Once there has been a recovery, Rule 1.5 obligates the lawyer to provide the client with a written statement “showing remittance to the client and the method of determination,” which would include deductions for the advances, interest and other reimbursable charges. This written statement should be sufficiently detailed so that the client can understand what costs, including loan-related expenses, the client has been charged. See, ABA Formal Opinion 93-379 (1993).
Therefore, upon review of the applicable rules and the opinions from other jurisdictions, the Committee finds no specific prohibition against a lawyer obtaining a third-party loan to cover litigation expenses and later deducting expenses — including interest and lender fees — from the proceeds recovered on behalf of the client. However, the lawyer is cautioned that several Rules of Professional Conduct are implicated in such a transaction, and the lawyer must consider each one of them carefully before entering into a loan transaction to finance the litigation expenses of a client.
Granting the Lender a Security Interest in the Lawyer’s Contingent Fee
The final question — whether the lawyer may grant a security interest in his or her contingent fee as collateral for the loan — is more problematic. One of the primary purposes of the conflict of interest rules (Rule 1.7 — 1.12) is to protect the lawyer’s independent judgment. Under these rules, the lawyer must avoid representations where the lawyer’s own interest or those of another person may impair the lawyer’s judgment on behalf of a client. If a loan is tied, either formally or informally, to a specific case the lender may try to protect its investment by attempting to influence the lawyer’s management of the case. This is always a risk, but it becomes even more so when the lawyer’s prospective fee in a specific case serves as collateral for the loan. The fact that the agreement with the lender might recite a disavowal that the lender would interfere with the lawyer’s independent judgment, or that the client has consented to the loan arrangement, does not alter the economic reality that the lawyer could feel pressured to bring the case to conclusion — thereby turning the unearned fee expectancy into an earned fee — in order to satisfy the claim of a creditor with a security interest in that specific fee. In addition, a secured creditor might deem itself insecure if the lawyer missed one or more monthly interest payments, and might seek to accelerate the loan, bringing even greater pressure on the lawyer to conclude the matter quickly or, perhaps, to relinquish control to another lawyer.
The Committee recognizes that lawyers and law firms borrow money from lending institutions every day and, in some cases, they secure those loans with various firm assets. But this is far different than the arrangement under consideration here. The circumstances in which a lawyer would borrow money and grant a security interest in the fee are those in which neither the lawyer nor the client has other access to funds (or other security) — thus setting the stage for the economic pressure that may compromise the lawyer’s judgment.
For the above reasons, the Committee is of the view that it would be unethical for a lawyer to borrow funds to pay litigation expenses in a particular case and grant a security interest in the lawyer’s contingent fee as collateral for the loan.
11/15/2002
KBA E-420
State of Tennessee
Advisory Ethics Opinion 98-A-659
Board of Professional Responsibility of the Supreme Court of Tennessee (July 9, 1989), draws a similar conclusion from similar facts described in the Utah inquiry. The Board concludes “a lawyer may advance or guarantee certain expenses” by means of “a lending company or recommending such services to clients.”
State of South Carolina
Ethics Advisory Opinion 94-04
Upon the request of a member of the South Carolina Bar, the Ethics Advisory Committee has rendered this opinion on the ethical propriety of the inquirer’s contemplated conduct. This Committee has no disciplinary authority. Lawyer discipline is administered solely by the South Carolina Supreme Court through its Commission on Lawyer Conduct.
A number of attorneys in South Carolina have received communications from a company that is engaged in the business of financing litigation by purchasing or taking assignments of personal injury causes of action. The communications include a “green card” that provides the name, address, and telephone number of the financing entity. The card states: “We will purchase a percentage of the expected personal injury action (prior to the resolution of the case).” The card also states: “When Clients Ask You For A Cash Advance Give Them This Card.” The Committee has also received copies of two form documents that the financing entity plans to use to carry out the proposed transaction. One document is entitled “Assignment and Sale.” Under this document in exchange for an agreed-upon payment, the client transfers to the financing entity a specified percentage of the gross settlement amount of the client’s personal injury action. The document provides that the assignment and sale may not be canceled without the express written consent of the financing entity. The second document is a letter from the client to the attorney informing the attorney of the sale/assignment and directing the attorney to pay a designated percentage of the gross settlement amount to the financing entity within 10 days after the attorney receives settlement funds.
The Committee has been asked whether an attorney may ethically participate in such a financing transaction.
Summary:The Committee does not express opinions on questions of law. An attorney considering participating in such a financing transaction, however, should review applicable statutory provisions and common law principles to determine whether such financing transactions are illegal under South Carolina law. In particular, the Committee notes the possible applicability of S.C. Code Ann. 16-17-10, prohibiting various practices that amount to barratry. If the transaction is illegal under South Carolina law, an attorney may not ethically participate. S.C. Rule of Prof. Cond. 1.2(d), 8.4(b).
Assuming that the transaction is not illegal under South Carolina law, an attorney may ethically counsel a client of the availability of opportunities to finance litigation when the client asks for such information or when the attorney in his professional judgment concludes that a client’s legal and economic position warrants advice about such an opportunity. An attorney should render candid advice to the client about the advantages and disadvantages of the proposed transaction. S.C. Rule of Prof. Conduct 2.1.
If a client decides to proceed with a financing transaction, the attorney should inform both the client and the financing entity in writing that the client retains the right to control all aspects of the litigation and that the attorney will maintain confidentiality of client communications. Cf. S.C. Rule of Prof. Cond. 1.8(f), 5.4(c).
Opinion: The Committee does not issue opinions on questions of law. An attorney who is considering participating in such a transaction, however, should review applicable statutory and common law to determine whether the proposed transaction is illegal under South Carolina. If the transaction is illegal, an attorney may not ethically participate in the transaction. S.C. Rule of Prof. Cond. 1.2(d), 8.4(b). In particular, the Committee notes the possible applicability of the South Carolina barratry statute, S.C. Code Ann. 16-17-10, which provides as follows:
Any person who shall: (1) Willfully solicit or incite another to bring, prosecute or maintain an action, at law or in equity, in any court having jurisdiction within this State and (a) thereby seeks to obtain employment for himself or for another to prosecute or defend such action, (b) has no direct and substantial interest in the relief thereby sought, (c) does so with intent to distress or harass any party to such action, (d) directly or indirectly pays or promises to pay any money or other thing of value to, or the obligations of, any party to such an action or (e) directly or indirectly pays or promises to pay any money or other thing of value to any other person to bring about the prosecution or maintenance of such an action; or (2) Willfully bring, prosecute or maintain an action, at law or in equity, in any court having jurisdiction within this State and (a) has no direct or substantial interest in the relief thereby sought, (b) thereby seeks to defraud or mislead the court, (c) brings such action with intent to distress or harass any party thereto or (d) directly or indirectly receives any money or other thing of value to induce the bringing of such action; shall be guilty of the crime of barratry. The crime of barratry shall be punishable by a fine of not more than five thousand dollars or by imprisonment of not more than two years, or both.
The Committee is also not passing on whether the financing transaction involves a “security” under either federal or state securities laws. Assuming that the transaction is not illegal under South Carolina law, may a lawyer ethically participate in such a transaction? The Committee assumes that the attorney representing the client does not also have a financial interest in the financing entity. If so, the attorney could not ethically participate in the transaction because the attorney would be violating Rule 1.8(e) (providing financial assistance to a client other than litigation costs) and Rule 1.8(j) (acquiring a proprietary interest in the client’s cause of action). See S. C. Bar Advisory Opinions 92-06 (lawyer may have financial interest in business organized to make consumer loans so long as business does not make loans to lawyer’s clients) and 91-15 (lawyer may participate in organization of loan business to which they referred their clients when lawyers did not have financial interest in business).
The Committee also assumes that the attorney is not receiving a fee from the financing entity. If so, the attorney could not participate in the transaction without complying with the requirements of Rules 1.8(a) and 1.7(b). Cf. S.C. Bar Advisory Opinion 92-03 (permissible for lawyer to act as agent for title insurance company and receive commission provided lawyer complies with Rules 1.8(a) and 1.7(b)).
Rule 2.1, dealing with the lawyer’s role as advisor, provides as follows: In representing a client, a lawyer shall exercise independent professional judgment and render candid advice. In rendering advice, a lawyer may refer not only to law but to other considerations such as moral, economic, social and political factors, that may be relevant to the clients situation.
The Committee concludes that under this rule a lawyer may appropriately advise a client of the opportunity to finance the client’s personal injury cause of action when the client asks about such a possibility, or when the attorney in his professional judgment concludes that the client’s situation warrants such advice. See also Rules 1.2(a) (lawyer shall consult with client regarding means used in handling case); Rule 1.4(b) (lawyer shall explain matter to client so that client can make informed decisions). As Rule 2.1 requires, in advising a client about financing options, the attorney should fully advise the client about the advantages and disadvantages of the transaction that the client is considering. It appears to the Committee that the principal advantage of the transaction is that the client obtains immediate cash rather than having to wait until the conclusion of the personal injury action to receive funds.
Some clients may want or even have a desperate need for immediate funds. The transaction, however, may have a number of disadvantages that the attorney should bring to the client’s attention. These include the following: The amount that the financing entity is offering to the client may be too low based on the attorney’s evaluation of the case. If the client assigns a percentage of the gross settlement proceeds to the financing entity, the client may regret the transaction if the ultimate settlement or judgment turns out to be more favorable than client anticipates. Further, if the settlement or judgment of the client’s case is insufficient to repay the financing entity, the client may have an obligation to repay the entity the difference, depending on the terms of the assignment. If the client has a specific, immediate financial need, the client may be better off considering other possible sources of funds, such as a credit union, an insurance policy, family or friends. Any communications between the attorney and the financing entity may not be subject to the attorney-client privilege. The terms of the financing arrangement may be discoverable and could adversely affect settlement negotiations.
If a client decides to proceed with the transaction after being fully advised by the attorney, the attorney may ethically participate in the financing transaction by recognizing the financing entity’s interest and by paying any settlement proceeds to the financing entity in accordance with the terms of the assignment. Before accepting any assignment the attorney should clarify in writing to both the client and the financing entity that the attorney will still look to the client for all decisions regarding the litigation, and will maintain confidentiality of client communications. Cf. Rule 1.8(f) and 5.4(c) (prohibiting third party interference with lawyer’s professional judgment).
State of Ohio
ETHICS OPINION 2001-3
1. A lawyer may obtain a loan from a third party lending company provided that the loan is not secured by the client´s interest in any settlement or judgment. This provision does not prohibit the lending company from securing the loan through the borrowing attorney´s fee on the case. The client should also be informed of the loan and his or her consent should be obtained by the borrowing attorney/firm.
2. It is proper for the borrowing attorney to deduct the costs of the loan and interest or fees thereon from a client´s settlement or judgment, since these costs are appropriately considered “costs of doing business” or “litigation expenses”.
The cited Ohio Ethics Opinion may be found on the web at: http://www.sconet.state.oh.us/
Please reference your local state ethics rules.
State of Illinois
Illinois State Bar Association
CHARGING INTEREST ON ADVANCED EXPENSES TO CLIENT
ISBA Advisory Opinion on Professional Conduct
Opinion No. 94-06
July, 1994
ISBA Advisory Opinions on Professional Conduct are prepared as an educational service to members of the ISBA. While the Opinions express the ISBA interpretation of the Illinois Rules of Professional Conduct and other relevant materials in response to a specific hypothesized fact situation, they do not have the weight of law and should not be relied upon as a substitute for individual legal advice.
Digest: It is professionally proper for a lawyer to charge a client interest on advanced expenses.
Ref.: Illinois Rules of Professional Conduct, Rules 1.5(a) and 1.8(d)
ISBA Opinion Nos. 87-10, 632, 490 (overruled) and 380 (overruled).
A law firm handles personal injury and worker’s compensation cases for claimants. The law firm is considering borrowing money on a line of credit to pay for advanced costs of litigation and passing along the pro-rata share of interest charged to each client, subject to disclosure of that interest expense in each retainer agreement.
May a lawyer charge a client interest on expenses advanced on the client’s behalf?
ISBA Opinion No. 87-10, affirmed by the Board of Governors in January, 1991, is dispositive. The digest of that opinion stated, “It is professionally proper for a lawyer to charge a client interest on either overdue bills or advanced expenses.” ISBA Opinion No. 632, the principal foundation for the above opinion, had expressly overruled and rejected two earlier opinions, ISBA Opinion Nos. 380 and 490, which had held it unethical to charge interest on either expenses advanced to the client or past due fees. The Illinois Rules of Professional Conduct, Rule 1.8(d) provides:
While representing a client in connection with contemplated or pending litigation, a lawyer shall not advance or guarantee financial assistance to the client, except that a lawyer may advance or guarantee expenses of litigation, including but not limited to, court costs, expenses of investigation, expenses of medical examination, and costs of obtaining and presenting evidence if:
(1) the client remains ultimately liable for such expenses; or
(2) the repayment is contingent on the outcome of the matter; or
(3) the client is indigent.
There is no prohibition in this or any other Rule preventing a lawyer from charging a client interest upon advanced expenses. Although the Rules now allow a lawyer to guarantee costs and expenses with repayment contingent on the outcome of the matter, the lawyer may also elect to advance expenses and charge interest where the client remains ultimately liable regardless of the outcome of the case.
In ISBA Opinion No. 87-10, the Committee stressed that any agreement providing for the charging of interest on expenses should be placed in writing prior to the accrual of any such interest and at the earliest opportunity, usually being the execution of a written fee agreement/contract. The Committee now, as then, offers no opinion whether any agreement incorporating an interest provision might trigger statutory reporting and disclosure requirements, including issuance of periodic statements to the client. Lastly, Rule 1.5(a) requires that a lawyer’s fee shall be reasonable. The Committee believes that the rate or amount of interest charged upon advanced expenses should likewise be reasonable, as should the costs and expenses upon which the interest is charged. IL Adv. Op. 94-06, 1994 WL 904189 (Ill.St.Bar.Assn.)