VENTURE CAPITALISM FOR LAWSUITS? (PART TWO): Why Champerty Still Matters

In Part I of this two-part series of articles, I reviewed the recent growth in the number of companies that invest in litigation by helping plaintiffs maintain and initiate lawsuits. Despite my focus on the novelty of some recent approaches, the idea of investing in the future outcome of litigation is not new.

In this second article, I want to look at the reasons why there has been so much resistance to allowing the practice of investment in litigation to develop as far as it might-to the point, for example, where there might be companies that fund, buy, litigate, and settle thousands of claims, without the original plaintiff playing much of a role, if any, in the suits. To do this, I will begin with a typical example of the current situation, a Florida case called Kraft v. Mason.

In the mid 1980's, Julian Kraft, Harold Newburg and the companies they owned filed what they considered to be a very strong federal antitrust complaint in federal court in Florida. Their only problem was money: their law firm (a very good firm) told Kraft and Newburg that it would require more money to continue the suit or it would withdraw.

Kraft then approached a man named Gross and offered him the following deal: Gross would obtain a bank loan of $100,000 and lend the proceeds to the plaintiffs. In exchange, if Kraft and Newburg won the lawsuit, they would not only repay the $100,000 loan, but also give Gross 20% of the first $1,000,000 recovered as damages in the suit, 6% of the next $4,000,000 recovered, and 3% of any recovery in excess of $5,000,000. Gross said no.

Zelda then sued Kraft in state court for $355,450, which she believed was her share of the winnings from her brother’s lawsuit. Of that sum, only $15,000 was for the loan she had arranged, and even Julian agreed that he owed her that. The rest was money Zelda claimed she was owed under the 20%/6%/3% deal.

Kraft refused to pay, claiming that the contract between him and Zelda was void. Specifically, Kraft claimed the contract was "champertous" and therefore against public policy. According to Kraft and his partner, the deal that he and Zelda struck was never legally binding in Florida, and his debt to her was moral, and not legal - and therefore not enforceable in court. (Apparently, due to the "unrelated family dispute," Kraft believed Zelda had lost any moral claims on him.)

The legal term "champerty" refers to a form of "maintenance," which, as I described in Part I of this series, has historically been frowned upon in since the early years of English common law. The resolution of the Kraft case will illustrate the legal problems, relating to the prohibition against champerty, that will have to be dealt with before a true market in lawsuits will be possible.

As the court noted in Kraft, maintenance is "officious intermeddling in a suit which in no way belongs to the intermeddler." Champerty is a special form of intermeddling: It occurs when any person (or corporation) contracts to support another’s lawsuit, in exchange for the assignment of the claim or some portion of its proceeds.

Florida, like most states, has a champerty doctrine. In some states (such as New York) the prohibition against champerty is codified in state law. In most states (such as Florida), however, it is part of the common law. Only three states, Massachusetts, South Carolina, and New Jersey, explicitly enforce champertous agreements.

Despite Florida’s prohibition on champerty, the court in Kraft still upheld Zelda’s claim. The contract was not champertous, the court held, for a number of reasons. First, Zelda did not "officiously" intermeddle. In fact, as the court pointed out, she didn’t "intermeddle" at all. The suit was begun without her money, and she did not participate in any part of the suit after she loaned the money. Second, the court found it important that Zelda did not "seek out" her brother, Kraft, to induce him to contract (rather, he sought her out), nor did she bargain over the terms of the contract.

Obviously, Kraft is an unsatisfying decision, which leaves many questions unanswered. What if the lawsuit would not have been filed but for Zelda’s loan? Would the result then have been different? What if Zelda (or Gross) had sought out the deal as an investment opportunity? What if Zelda had bargained for better terms? What if Zelda had asked for more than 50% of the lawsuit’s winnings? What if Zelda had asked to have the lawsuit assigned to her, and had taken control of its course, supplying and controlling the lawyers, experts, and ultimately deciding when and if to settle?

The various companies I described in Part I of this article are betting that the law has already progressed far beyond Kraft, even if the courts have not explicitly admitted it. Answering the questions whether the law has indeed progressed this far - and if so, whether this development is a good one - requires a quick survey of the reasons for and against allowing strangers to invest in lawsuits.

Interestingly, the prohibition against maintenance, including champerty, was a result of Twelfth Century tort reform. Wealthy nobles would command their retainers to bring suits against the noble’s enemies; the noble would control (and fund) those suits. Defendants (often the newly emerging commercial class), inundated with suits, convinced the courts and crown to adopt laws against these "fake" lawsuits. The view that allowing investment in lawsuits "stirs up" litigation is still one of the main reasons for opposing maintenance and champerty.

During the Nineteenth and early Twentieth Centuries, other, more moralistic reasons for opposing the purchase of all or any part of a lawsuit developed. As an Arizona court, in the case of Karp v. Speizer, recently expressed it, the state should not encourage people to "traffic in lawsuits for pain and suffering."

The general prohibitions described above have softened in the face of the modern realities of litigation. Even the common practice of charging contingency fees is a form of champerty. Yet every state allows such fees - and few, if any, have a good explanation for why the investment of legal resources is different from Zelda’s loan. (The same point can be made about subrogation, in which insurance companies purchase, in advance, a lawsuit.)

Moreover, the opposition to maintenance and champerty seems to end, as I pointed out in Part I, after a judgment has been rendered by a trial court. Thus, there is an extremely well developed market in appellate financial support.

It is possible to suggest that prohibiting investment in lawsuits until after there is a verdict does not "stir up" litigation, but any economist will tell you that is silly - for people will act differently if they know in advance that appellate financial support is available. And besides, isn’t investing in an appeal over a products liability case still investing in "pain and suffering"?

Finally, if the law has softened, it has done so in an interesting yet unspoken way: American courts do not want to encourage the wholesale transfer of a legal claim, especially when the claim is based on a personal injury. Thus, it is simply impossible to assign a claim for personal injury in almost every state. (In some states, it is possible to assign the proceeds from a lawsuit for personal injuries, but the law is murky in that regard.)

The reason for these legal rules is another rule: Actions in tort for injuries to the body do not survive if the victim does not sue for them. Thus, the question of maintenance or champerty does not arise in tort suits, for the defendant in a car accident case can have it dismissed if the victim assigns his suit to a stranger and only participates (if at all) as a third party, such as a witness. Nevertheless, the modern trend is to allow people to lend money to the victims of car accidents (through, for example, attorneys’ contingency fees) and to enforce those loan contracts, as long as they are not against public policy.

It is no accident that so many of the cases which have tested the various states’ common law rules and statutes against champerty have been either contract claims or business torts - not personal injury claims. Clearly, the courts feel less anxious about allowing individuals to "traffic" in lawsuits when all they are trafficking in are balance sheets, lost sales, and patent claims, rather than "pain and suffering."

Is there an emerging norm in all of this? Is there room for some principled distinctions, and have the courts been trying to find them? It seems to me that the route Florida has taken (which is not too different from New York’s) is not going to work. There are three questions that must be asked if we are to develop a coherent legal structure that allows a market in lawsuits.

First, do we want to allow strangers to invest in lawsuits at all? The distinction drawn between our current system of contingency fee arrangements and Zelda is fetishistic - it’s a distinction without a difference. So, too, is the supposed distinction between supporting an appeal and supporting a lawsuit from its moment of conception. If we think that it is good that plaintiffs have access to cash-and we should, given the realities of the modern legal world-then our rules should not discriminate when it comes to who can accept money, and when it can be accepted.

Second, do we want to allow lawsuits to be assigned? I think the courts that permit "soft," limited forms of champerty have to ask themselves why they won’t go hardcore. Why not allow Zelda not only to fund the lawsuit, but also to own all its proceeds and to control its lawyers and whether it settles? If Julian and Harold would rather be passive observers to the suit (retaining, perhaps, a stake large enough to insure that they will bother to show up in court and testify even if they live beyond the court’s subpoena power), then why not allow Zelda to pay them for transferring their control to her? In the case of many smaller suits, it is possible that the lawyering and settling might be much better after such a transfer, than it would be if the original plaintiffs remained in control.

Third, if we do want to allow lawsuits to be assigned in toto, do we want to forbid the assignment of suits for personal injury (and wrongful death)? This question is very difficult. I believe that we cannot ignore the fact that tort law is a practice of corrective justice, not just a system designed to compensate victims and (perhaps) price risk. The structure of tort law-that it requires the victim to bring and prove a claim against a wrongdoer-suggests that the suit (if not the damages) must retain some personal connection between the victim and the wrongdoer.

If nothing else, I think that it should be the victim of a horrific injury caused by, say, a defective car should have the final say over whether to settle with the manufacturer or go to trial - thereby making the claim more public, and perhaps leading to an embarrassing award of punitive damages. For an investor who bought the suit years earlier to make this important decision seems wrong, and possibly hurtful to society, which benefits, to some extent, from a public trial in cases of serious wrongdoing.

I think it is not an accident that despite the softening of the rules against the buying and selling of lawsuits, the assignment of personal injury claims has hardly budged. (Though contingency fee arrangements are still common, plaintiffs do retain control, rather than transferring it for money). There are some things that money can’t buy, and I don’t think that tort law should try to sell them.