Pennsylvania appeals court tosses litigation funding deal as champerty

October 5, 2016

(Reuters) – I’m generally a fan of litigation financing, especially when participants in funding deals are sophisticated businesses and law firms hedging their bets on big commercial cases. (As regular readers know, I consider investing in mass tort litigation a different and much more dubious proposition.) Over the past six or eight years, big firm lawyers and general counsel at major corporations have slowly warmed to the idea of offloading litigation risk to investors, who are themselves an increasingly sophisticated bunch.

The ancient laws of champerty and barratry, which, broadly speaking, discourage outsiders from encouraging or meddling with other people’s litigation claims, were once considered a weapon for opponents of litigation funding. They’ve not been. As I reported in a story about billionaire Peter Thiel’s funding of Hulk Hogan’s privacy suit against Gawker, courts in the U.S. tend to prefer to judge suits based on their merit rather than their backers. (There are exceptions, of course, like U.S. District Judge Susan Illston‘s order last summer that Nigerians suing Chevron over alleged damage from a drilling rig explosion disclose their funders.)

A Pennsylvania appeals court, however, has breathed some life into champerty law as it applies to litigation funding deals. In a WFIC LLC v Labarre last month, a three-judge Superior Court panel ruled that a complex funding contract was invalid because it met the definition of champerty.

The case, which I first heard about at the Drug and Device Law blog, is unbelievably complicated, but here are the essential facts. A company called Polymer Dynamics Inc, or PDI, sued Bayer for fraud and theft of trade secrets. PDI believed its case was worth more than $100 million, but a jury awarded it $12.5 million. The company sought investors to fund its appeal and anticipated retrial.

The lawyer who’d been handling the case, Bruce McKissock, had been working on a contingency basis in which he was due to be paid 7.5 percent of PDI’s award. He and PDI restructured the contingency fee agreement so that he would receive a 33 percent fee – but repayment of the litigation funders would come out of the lawyer’s share.

PDI lost the appeal, leaving it with a total judgment of about $14.4 million. When the money was divvied up, McKissock ended up with nothing because the litigation funders were ahead of him in the line for repayment. McKissock, whom PDI blamed for the disappointing outcome of the case, ended up suing the investors to recover the fees he believed he was due. He argued that his fee should have been considered a lien against PDI’s recovery so he should have been paid before investors.

The state appellate panel, in an opinion written by Judge John Bender, agreed with the lower court that McKissock did not have a valid lien under the revised fee agreement, which it deemed invalid. Champerty has three elements, the court said: the outside funder must have no legitimate interest in the underlying suit, must expend its own money on the litigation and must be entitled to share in the proceeds of the suit. PDI’s plan to pay investors out of McKissock’s contingency fee met all of those indicia, the court said.

“The litigation fund investors are completely unrelated parties who had no legitimate interest in the Bayer litigation,” the opinion said. “The litigation fund Investors loaned their own money simply to aid in the cost of the litigation, and in return, were promised to be paid “principal, interest, and incentive” out of the proceeds of the litigation.” Therefore, the court held, the fee agreement is champertous and McKissock is entitled to nothing.

So how worried should litigation financiers doing business in Pennsylvania be about this decision? I asked George Bochetto of Bochetto & Lentz, who represented the big investor in PDI’s case. “It remains to be seen,” he said, noting that there is not much precedent in Pennsylvania on champerty and litigation funding as it’s practiced these days. The arrangement between PDI, McKissock and the investors in this case was much more complicated than ordinary litigation funding agreements, Bochetto said, and the court was concerned about whether the lawyer had a controlling say in the resolution of the litigation.

I left a message for McKissock, who now practices at Marshall Dennehey Warner Coleman & Goggin, but didn’t hear back.

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